Accounting and Finance Square
Henkel AG is a multinational company focusing its brand and technologies in three business areas that include Beauty Care, Laundry & Home Care and Adhesive Technologies. Established in 1976, the company holds its global market positions in both the consumer and industrial products with well-known brands that include Lactate, Persil, and Schwarzkopf. Henkel's headquarter is in Dusseldorf in German and the company has over 47,000 employees globally. Typically, the company is considered among the most "internationally aligned German-based companies in the global marketplace." (Henkel 2012).
Objective of this paper is to use various financial models to carry out financial analysis and valuation of financial Henkel AG.
One of the methods to carry out the valuation of a company is to use enterprises discounted cash flow (DCF). The DCF could be carried out using WACC (weighted average cost of capital) that represents the opportunity costs that investors will face when they decides to invest their funds in the capital market. To determine WACC, the three components are used which include after-tax cost of debt, the company target capital structure and the cost of equity. However, none of the variables is observable, various models, approximations and assumptions are used to estimate each of the components.
To carry out the valuation of Henkel AG, the report uses the market data of the company and examines the most appropriate method to carry out the valuation of the company.
Answer to Question 1
a. Generally, the cost of equity is built on three factors, which include the market risk premium, a company specific risk adjustment and the risk. Typically, a commonly used model to estimate the cost of equity is CAPM (capital asset pricing model. To determine the CAPM it is critical to estimate the following:
A Risk-free rate
Market risk premium and,
This report determines the risk free rate by using the U.S. Treasury rates.
Determination of a Risk Free Rate using U.S. Treasury Rates
Theoretically, risk free rate is the rate of returns of an investment that carries no risk of financial loss. The interpretation is that the risk free rate represents the total interests that investors would expect from their investments over a given period. (Damodaran, 2008).
In other word, a risk free rate is an investment where limited rate of return could be obtained with limited credit risks. The U.S. government treasury bill of short-term investment and back by the U.S. government is considered an investment that involves the risk free rates. U.S. Treasury securities are generally considered risk free and considered safest of all investments because the federal government full backs them. (Fleming, 2000). Due to the degree of safety of the treasury bills, the interest's rates are generally low compared to other securities in the capital market.
Thus, this paper uses the three-month U.S. Treasury bill of which maturity is three months to carry out the valuation of Henkel Company. Theoretically, a risk free rate of U.S. Treasury bill is considered short-term investment of approximately three-month U.S. Treasury bill. This paper collects three-month data of the U.S. Treasury bill to determine the risk free rate. This paper chooses the three-month U.S. Treasury bill to value the company because the three-month Treasury bill is carrying the least risks since it is less affected by the fluctuation of the interest rates and the state of the economy such as inflation. However, when the investment on U.S. treasury bills is more than three months, the risks will become high because Treasury bill may be affected by interest rates risks and inflation. Three-month Treasury rate is 0.07% as of April 05, 2013. The three-month Treasury data that determine the risk-free rate of Treasury rate is revealed in Table 1. The company cost of debt is 4.1% and is calculated using the 3-month risk free rate of 8%, where the company beta is 0.7.
Table 1: Three-Month Treasury Risk Free Rate.
U.S. Treasury (2013).
b). The paper performs regression analysis of 10-year monthly returns of Henkel AG personal product against MSCI World Index. The result of regression analysis is presented in Table 2.
Table 2: SUMMARY OUTPUT of Regression Analysis
X Variable 1
Results of regression analysis of Henkel since 2003 against MCI World Index reveal that the company beta is estimated to be 0.70. The cost equity is 8.5%, while the cost of equity is 8.5%, and the company WACC is 8.0%.
The paper also determines the Henkel's corporate beta, the paper re-lever the industry average industry beta using Henkel's year debt-to-equity ratio. Debt-equity ratio measures the financial leverage ratio of a company. Typically, financial leverage ratio measures company's ability to settle its short-term and long-term obligations. The formula to calculate debt-to-equity ratio is as follows:
Debt-to-equity-ratio= Total Liabilities/Shareholder Equities
Debt-to-equity-ratio is particularly important is calculating levered beta. For example, with increase in a company debt, there is an increase in the company debt-to-equity-ratio leading to the increase company beta. Typically, a high debt/equity means that a company is aggressively financing its growth with debt, which consequently leads to high beta.
Financial Health / Liquidity
Since 2003, the company debt/equity declines considerably. In 2003, the debt/equity was 0.56 and in 2012/2013, the debt-to-equity-ratio declined to 0.26, which is 115% decrease between 2003 and 2013. Henkel risk indicator is presented in the Table below.
Table: Henkel AG Current Risk Indicators
Risk Adjusted Performance
Market Risk Adjusted Performance
Coefficient Of Variation
Analysis of Henkel portfolio reveals that the company stock has 1.12 volatility and is 1.35 times volatile than DAX. Moreover, 16% of all portfolio and equities are less risky than Henkel. Comparative analysis of Henkel equities with global equities reveals that volatility of Henkel's historical daily returns is 16% lower than of all global equities. The Beta of Henkel AG is 0.70, and beta refers to the volatility of the stock of Henkel compared to the entire stock market. As being revealed in Fig 1, Henkel perform better than the S & P. 500 since 2003.
"Henkel shares showed a very positive performance overall in 2012. Over the course of the year, the DAX rose by 29.1% to 7,612.39. The index for consumer goods stocks -- the Dow Jones Euro Stoxx Consumer Goods -- increased 26.0%, closing at 423.06. Against this market backdrop, the price of Henkel preferred shares increased to 62.20 Euros, closing the year 39.5% higher on a year-on-year basis. Our ordinary share price likewise posted strong gains, ending the year 38.9% higher at 51.93 Euros. As such, our shares performed clearly better than both the DAX and other shares representing the consumer goods sector." (Henkel, 2012 P. 1).
Fig 1: Henkel Performances Compared to S & P. 500.
Answer to Question 2
A).The most appropriate Treasury rate in valuing the cost of debt of the Henkel AG is ten-year Treasury note. The 10-year Treasury note is a loan that organizations and individuals loans to the U.S. government. The 10-year Treasury note is the rate of return that organization gets from investing in government bond. Typically, the rate is the benchmark of the interest rates. Since, the Henkel debt is driven by risk factors, it would not be appropriate to use Treasury risk free rates to value the cost of debt of the Henkel AG. Analysis of Henkel financial instruments reveals that the company engages in series of long-term debt making the company to enter into series of hedging and derivatives to guide against interest rates risks. As of December 2012, the total amount of company debt was 3.4 Billion Euro. Within the company liabilities, Henkel borrowings with hedging relationship valued 3.5 Billion Euro while the company borrowing with no hedging relationships valued 241 Million Euro. To guide against the interest rates fluctuation associated with long-term debt, the company also enters into the following financial instruments:
Forward exchange contracts, which involves hedging the loans entered by the company,
Interest rate swaps designated for fair value hedge and cash flow hedge,
Other type of interest rate hedging associated designated for hedge accounting,
Commodity futures associated with hedging accounting.
In 2012, the interest rate swap was appropriately 4.7 Billion Euro.…
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