procter and gamble - cost of capital - pgp 2012

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Procter and Gamble: Cost ofCapital



Details

Dated: 19 Feb, 1990 People

Mary Shiller Ron Emory, President, Corpstrat

Boss reaction on cost o capital Corpstrat

Cons!ltin" irm #ocated in $ashin"ton D%C% S!ccess!l since 19&0 Pro'ided hi"h()!ality analysis or a e* lar"e corporate clients



Issues

#ar"e client *anted to enter ho!sehold prod!cts andcompete *ith P+ - deter"ents, soaps, cleansers, and

personal care Cost o capital o the client not easible d!e to%%,

.i"hly di'ersiied con"lomerate - !nrelated b!siness /'erall $CC not !se!l or eistin" s!bsidiaries /'erall $CC not !se!l or ne* b!siness - cons!mer prod!cts

CF/ had estimated his o*n $CC CF/ *anted to 'eriy his $CC estimate Corpostrat has been ne'er as2ed to comp!te $CC o

clients



P&G

Deter"ent and Soap "iant

Dominant player in ho!sehold prod!cts andcons!mer "oods mar2ets



Corpostrat

Epertise: deinin" and e'al!atin" "oals o a

corporation



Analysis of P&G Cost of Capital

ss!mptions$CC is a mar2et 'al!e concept - mar2et 'al!e *ei"hts, c!rrent

mar2et rate o ret!rn Mana"ement ma2es in'estment decision *ith the "oal o

maimi3in" *ealth o in'estors

$CC is minim!m rate o ret!rn that ade)!ately compensatesthe company4s in'estors or the ris2 o in'estin" in company

Pro5ect4s 6RR sho!ld be more than $CC Bond and stoc2 mar2et are reasonably eicient

ES/P and capital str!ct!re chan"es are not rele'ant to thecalc!lation o company4s $CC



P&G’s Business Risk

Epected ann!al re'en!es 719908: ;<%= bn Pop!lar brands: >ide, Cheer, Bold, 6'ory, ?est, and Coast

/ther prod!cts%%, .ead and Sho!lder Shampoo Scope mo!th*ash Bo!nty paper to*els #!'s disposable diapers Crisco Shortenin"

Prin"les potato chips Fol"er4s coee Dramamine or motion sic2ness @ic2s co!"h drops $ood p!lp and animal(eed in"redients




Corporate sales distrib!tion%%, #a!ndry and cleanin" prod!cts: <;%=A

Personal(care prod!cts: =%A Food and be'era"es: 1<%&A P!lp and chemicals: &%1A

Personal care and ood + be'era"es se"ments ha'e ris2s that aresimilar to those o the la!ndry(and(cleanin" prod!cts se"ments

Distrib!tes all its prod!cts thro!"h%%,

rocery stores Retail o!tlets - ro"ers, (Mart, $al Mart

Soaps, deter"ents, toothpaste, pean!ts, b!tter, etc%, ( small tic2etitems on a'era"e homema2er4s shoppin" list

Relati'ely insensiti'e to s*in"s in the economy




P!lp and Chemicals%%, Sold directly or thro!"h 5obbers

.ad proit mar"ins abo!t do!ble that o personal(care andla!ndry(and(cleanin" prod!cts "ro!ps

Made !p o &%1A o 19&9 sales

6nd!strial prod!ct se"ments seems to be the only b!sinessse"ment that is o s!iciently dierent ris2 to merit ha'in" a

dierent cost o capital Small inl!ence o this se"ment can saely be i"nored in the

calc!lations

F+B se"ment bro2en e'en o'er past three years



Cost of Debt

Cost o re!ndin" the debt on the company4s boo2s Rele'ant debt: interest(bearin" debt on the boo2s as o

the end o F19&9: <,<<1 million Pri'ately placed debt, no p!blic price inormation

a'ailable >raded co!pon iss!e: &%;=A at a mar2et price o 9;%=0

>M: 9%1&A 'ery close to aa bonds o 9%;;A 9%1&A is 'ery close to a'era"e co!pon rate o the dollar

denominated debt on P+4s boo2s



Cost of Euity and CAP!

Recent beta estimate: 0%9=

R rate

Ris2 premi!m

E)!ity ris2 premi!m 719;G(19&&8 Common stoc2s - Bonds

M: =%A

M: %GA

Common stoc2s - Bills M: G%;A

M: &%A



"ACC

e H 0%0& I 0%9= J 0%0= H 1<%GA

Corporate ta rate: <A >ar"et DK@ ratio: <=A

$CC H 0%<=J9%;AJ71(0%<8 I 0%G=J1<%GA H11A



Response to P&G "ACC

P+ has a dominant mar2et share - client is a ne* entrants Competitors that can be incl!ded in analysis - Cloro, Col"ate(

Palmoli'e, and Ch!rch + D*i"ht Compare Cloro4s $CC to P+ $CC Cloro is small in si3e to match the ne* entrants Epected ret!rn on bond is%%,

'era"e yield H Co!pon K 'era"e price H &%;=A K 779;%= I 1008K;8 H &%=A

'era"e "ain H 7Par - Price8 K ears to mat!rity H 7100 - 9;%=8 K 1= H 0%=0 'era"e percenta"e "ain H 'era"e "ain K 'era"e price H 0%=0 K 779;%=I1008K;8 H 0%=;A

>otal ret!rn H ield I "ain H &%=A I 0%=;A H 9%09A



Response to P&G "ACC

e H sho!ld !se DDM "ro*th and earnin" capitali3ation models

Cost o debt inanced epansion is 9%;A b!t cost o e)!ity is

1<%GA F!nds are already a'ailable

F!nd H RE and S> ban2 loans L prime rate

Cost o RE

se 6RR Coro has hi"her proportion o e)!ity than P+

Coro has no p!blicly traded bonds - can !se P+ bond



Discussion #uestion

$CC comparable



Cloro$’s Business Risk

Speciali3es in deter"ents and cleansers Cloro bleach

#i)!id(Pl!mer Sot Scr!b Form!la 09

Prod!ces other prod!cts lines as *ell in"sord

Match li"ht Charcoal .idden @alley Ranch Salad dressin"s Fresh step cat litter Small A o Cloro4s sales some rom /lympic and #!citic paint brands



Cloro$’s Business Risk

Mar2ets are mat!re

Most o the "ro*th is thro!"h ac)!isition 19&G entered *ater mar2et ac)!irin" spen

$ater, Deep Roc2 $ater, and c)!a P!re$ater



Discussion #uestion

Does loo2in" at companies other than P+ ma2esense $hy



Discussion #uestion

6s Mr% Emory4s method or comp!tin" >Mcorrect



Discussion #uestion

re the other cost o e)!ity methods as "ood asCPM



Discussion #uestion

Sho!ld the company comp!te the cost o RE aspart o cost o capital



Discussion #uestion

6s anythin" lost i Ms% Shiller4s recommendation is*ritten in terms o 6RR rather than NP@



Discussion #uestion

Since Cloro is more conser'ati'ely inancedthan P+, do yo! epect its $CC to be

"reater or less than P+4s $hy



Discussion #uestion

Based on yo!r assessment o Mr% Emory4s S!""estions,*hat is yo!r estimate o P+4s $CC Care!lly state

all the ass!mptions !sed in yo!r analysis



Discussion #uestion

$hat is Cloro4s cost o capital



Discussion #uestion

$hat is C/RPS>R>4s ob5ecti'e in thissit!ation



%eed for P&G’s "ACC

Cloro is a hi"hly di'ersiied company

Dierent b!siness ris2 H dierent re)!ired rateo ret!rn



Discussion #uestion

$hat do yo! li2e and disli2e abo!t Mr% Emory4ss!""estions or Ms% Shiller



Emory’s !emo

Firm si3e and mar2et share inl!ences

b!siness ris2S!itability o Cloro

Simple capital str!ct!re

Reasonably "ood b!siness ris2 match

Col"ate H has preerred stoc2Dependin" on more than one company4s

$CC ma2es sense



Emory’s !emo

Emory4s methods o estimatin" >M is close b!t noteact

>M H a'era"e yield I a'era"e capital "ain 6"nores time 'al!e o money E)!als >M *hen c!rrent mar2et price e)!als par 'al!e

>M is an !p*ardly biased estimate o cost o debt

Bias res!lts beca!se the cash lo*s disco!nted are thecontracted cash lo*s rather than epected cash lo*s O!n2 bond yield H represents maim!m possible ret!rn

or the in'estor rather than the epected ret!rn



Emory’s !emo

6mportant to chec2 rob!stness o CPM RE can be matched *ith cost o e)!ity .i"her P+ inancial ris2 *ill ma2es its cost o e)!ity

hi"her than Cloro Mar2et 'al!e o debt K total capital H <,<<1 K 7<,<<1 I

1;G%;= 1G98 H 1=%GA

$CC H 0%1=G 79%;A871(0%<8 I 0%& J 1<%GA H 1;%GA 1%GA more than Mary Shillor4s boo2('al!e based $CC



Emory’s !emo

M may be !sed beca!se%%,CPM is a sin"le period model H M and >Bill

Can incorporate mar2et4s #> epectations o inlation H MI >reas!ry Bond

M may be !sed beca!se%%,$CC is compared to 6RR *hich is compo!nd or

"eometric ret!rn>M is a "eometric ret!rn



Discussion #uestion

$hat is P+4s cost o Debt Cost o E)!ity$CC



Discussion #uestion

$hat is Cloro4s $CC $hy does it dier romP+4s



Discussion #uestion

$hy is cost o capital important to corporations



Alternatie to Cost of Euity 'DD!(

Di'idend ro*th Model 19&9 di'idend yield H <%00 K 1;G%;= H ;%<&A

#> "ro*th rate estimate%%, .istorical DPS 719&0(19&98: G%=A

.istorical EPS 719&0(19&98: %0A

@al!e line pro5ections o Di'idend "ro*th: 11A

@al!e line pro5ections o earnin" "ro*th: 1=%=A

sin" "ro*th in EPS o 1=%=A I ;%<&A yield implies a cost oe)!ity o 1&A

$ith a'era"e EPS and "ro*th in DPS, cost o e)!ity *ill be1=%G=A



Alternatie to Cost of Euity 'Earnin)s

Capitali*ation !odel(

Cost o e)!ity H in'erse o PKE ratio

$ill be reasonable estimate only !nder!n!s!al circ!mstances

19&9 EPS H %1;

Share price as on ;<rd Feb 1990: 1;G%;=

EKP H %1; K 1;G%;= H =%GA

6ts less than cost o debt



Cloro$’s "ACC

>otal interest bearin" debt H commercial paper I c!rrentmat!rities o #> debt I #> debt and other obli"ations

H 9,=&0 I 1,G=& I ,0=1 H 101,;&9 i'en the predominance o S> obli"ations, boo2 'al!e is a

close approimation to mar2et 'al!e o debt Mar2et 'al!e o e)!ity H price per share no% o o!tstandin"

shares

H <&%;= == million shares H ;,10 million Debt H %=A E)!ity H 9=%A @al!e line beta: 0%90



Cloro$’s "ACC

CPM e H 0%0& I 0%90J0%0= H 1<%<A

DDM 2e%%,Di'idend yield H 1%09 K <&%;= H ;%&=A

#> "ro*th estimate .istorical DPS 719&0(19&98: 1;%1A .istorical EPS 719&0(19&98: 1<%A

@al!e line pro5ections o Di'idend "ro*th: 1<%=A @al!e line pro5ections o earnin" "ro*th: 1=%=A

DDM e H ran"e rom 1A to 1G%=A



Cloro$’s "ACC

Earnin"s Capitali3ation Model19&9 EPS: ;%;

;<rd Feb 1990 share price: <&%=0

e H ;%;K<&%;= H =%9A

e is less than cost o debt



Cloro$’s "ACC

'era"e e o CPM and DDM H 1%9A

P+ cost o debt H 9%;A$CC H 0%0=79%;A871(0%<8 I 0%9==J1%9A H

1%=A



Cloro$’s "ACC s+ P&G’s "ACC

P+ cost o !nds co!ld be lo*er beca!se opr!dent !se o ta(ad'anta"ed debt

Cloro4s conser'ati'e !se o debt increased$CC



Discussion #uestion

$hat is best debt str!ct!re or the ne* client

Cloro4s %=A

P+4s 1=%GA



Discussion #uestion

.o* C/RP/S>R> sho!ld present its res!lts tothe client

Sho!ld it try to reconcile the dierence or sho!ldit 5!st report the indin"s and let the client

interpret the res!lt on its o*n



,ero Coupon Bond -.!

Par 'al!e H 100 ears to mat!rity H 10

Mar2et 'al!e H =0 ct!al >M H %0=A 'era"e yield H co!pon K a'era"e price H 0A 'era"e "ain H 7Par - price8Kyear to mat!rity H 7100(=08K10

H = 'era"e percenta"e "ain H a'era"e "ain K a'era"e price H

= K 7=0 I 1008K; H G%GA >otal ret!rn H yield I "ain H 0A I G%GA H G%GA

procter and gamble - cost of capital - pgp 2012

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