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4 Questions are attached

Topics come from: Target, Heinz, WACC, IRR, NPV, PV

Please type out calculation work, in which you must show the methods/steps.

Example:
Ã¢â€“Âª Showing formula + entry data + result
Ã¢â€“Âª Problem solving IRR:

IRR = 8.14%

IRR(-100000;15000;15000;15000;15000;15000;15000;15000;15000;15000;15000)
Ã¢â€“Âª Problem Solving PV:

Formula: PV / ((1-(1/(1+I)^n))/I)

125,000 / ((1-(1/(1+0.92%)^120))/0.92%)

For the exclusive use of Y. Fang, 2021.
UV1057
Rev. Jan. 19, 2021
Target Corporation
On November 14, 2006, Doug Scovanner, CFO of Target Corporation, was preparing for the November
meeting of the Capital Expenditure Committee (CEC). Scovanner was one of five executive officers who
were members of the CEC (Exhibit 1). On tap for the 8:00 a.m. meeting the next morning were 10 projects
representing nearly \$300 million in capital-expenditure requests. With the fiscal yearÃ¢â‚¬â„¢s end approaching in
January, there was a need to determine which projects best fit TargetÃ¢â‚¬â„¢s future store growth and capitalexpenditure plans, with the knowledge that those plans would be shared early in 2007, with both the board
and investment community. In reviewing the 10 projects coming before the committee, it was clear to
Scovanner that five of the projects, representing about \$200 million in requested capital, would demand the
greater part of the committeeÃ¢â‚¬â„¢s attention and discussion time during the meeting.
The CEC was keenly aware that Target had been a strong performing company in part because of its
successful investment decisions and continued growth. Moreover, Target management was committed to
continuing the companyÃ¢â‚¬â„¢s growth strategy of opening approximately 100 new stores a year. Each investment
decision would have long-term implications for Target: an underperforming store would be a drag on
earnings and difficult to turn around without significant investments of time and money, whereas a topperforming store would add value both financially and strategically for years to come.
Retail Industry
The retail industry included a myriad of different companies offering similar product lines (Exhibit 2).
For example, Sears and JCPenney had extensive networks of stores that offered a broad line of products,
many of which were similar to TargetÃ¢â‚¬â„¢s product lines. Because each retailer had a different strategy and a
different customer base, truly comparable stores were difficult to identify. Many investment analysts,
however, focused on Wal-Mart and Costco as important competitors for Target, although for different
reasons. Wal-Mart operated store formats similar to Target, and most Target stores operated in trade areas
where one or more Wal-Mart stores were located. Wal-Mart and Target also carried merchandising
assortments, which overlapped on many of the same items in such areas as food, commodities, electronics,
toys, and sporting goods.
Costco, on the other hand, attracted a customer base that overlapped closely with TargetÃ¢â‚¬â„¢s core
customers, but there was less often overlap between Costco and Target with respect to trade area and
merchandising assortment. Costco also differed from Target in that it used a membership-fee format.1 Most
of the sales of these companies were in the broad categories of general merchandise and food. General
1
SamÃ¢â‚¬â„¢s Club, which was owned by Wal-Mart, also employed a membership-fee format and represented 13% of Wal-Mart revenues.
This case was prepared by David Ding (MBA Ã¢â‚¬â„¢08) and Saul Yeaton (MBA Ã¢â‚¬â„¢08) under the supervision of Kenneth Eades, Professor of Business
Administration. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation.
sales@dardenbusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by
any meansÃ¢â‚¬â€electronic, mechanical, photocopying, recording, or otherwiseÃ¢â‚¬â€without the permission of the Darden School Foundation. Our goal is to publish materials of
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merchandise included electronics, entertainment, sporting goods, toys, apparel, accessories, home furnishing,
and dÃƒÂ©cor, and food items included consumables ranging from apples to zucchini.
Wal-Mart had become the dominant player in the industry with operations located in the United States,
Argentina, Brazil, Canada, Puerto Rico, the United Kingdom, Central America, Japan, and Mexico. Much of
Wal-MartÃ¢â‚¬â„¢s success was attributed to its Ã¢â‚¬Å“everyday low priceÃ¢â‚¬Â pricing strategy that was greeted with delight by
consumers but created severe challenges for local independent retailers who needed to remain competitive.
Wal-Mart sales had reached \$309 billion for 2005 for 6,141 stores and a market capitalization of \$200 billion,
compared with sales of \$178 billion and 4,189 stores in 2000. In addition to growing its top line, Wal-Mart
had been successful in creating efficiency within the company and branching into product lines that offered
higher margins than many of its commodity type of products.
Costco provided discount pricing for its members in exchange for membership fees. For fiscal 2005,
these fees comprised 2.0% of total revenue and 72.8% of operating income. Membership fees were such an
important factor to Costco that an equity analyst had coined a new price-to-membership-fee-income ratio
metric for valuing the company.2 By 2005, CostcoÃ¢â‚¬â„¢s sales had grown to \$52.9 billion across its 433
warehouses, and its market capitalization had reached \$21.8 billion. Over the previous five years, sales
excluding membership fees had experienced compound growth of 10.4%, while membership fees had grown
14.6%, making the fees a significant growth source and highly significant to operating income in a low-profitmargin business.
In order to attract shoppers, retailers tailored their product offerings, pricing, and branding to specific
customer segments. Segmentation of the customer population had led to a variety of different strategies,
ranging from price competition in Wal-Mart stores to TargetÃ¢â‚¬â„¢s strategy of appealing to style-conscious
consumers by offering unique assortments of home and apparel items, while also pricing competitively with
Wal-Mart on items common to both stores. The intensity of competition among retailers had resulted in
razor-thin margins making every line item on the income statement an important consideration for all
retailers.
The effects of tight margins were felt throughout the supply chain as retailers constantly pressured their
suppliers to accept lower prices. In addition, retailers used off-shore sources as low-cost substitutes for their
products and implemented methods such as just-in-time inventory management, low-cost distribution
networks, and high sales per square foot to achieve operational efficiency. Retailers had found that profit
margins could also be enhanced by selling their own brands, or products with exclusive labels that could be
marketed to attract the more affluent customers in search of a unique shopping experience.
Sales growth for retail companies stemmed from two main sources: creation of new stores and organic
growth through existing stores. New stores were expensive to build, but were needed to access new markets
and tap into a new pool of consumers that could potentially represent high profit potential depending upon
the competitive landscape. Increasing the sales of existing stores was also an important source of growth and
value. If an existing store was operating profitably, it could be considered for renovation or upgrading in
order to increase sales volume. Or, if a store was not profitable, management would consider it a candidate
for closure.
Target Corporation
The Dayton Company opened the doors of the first Target store in 1962, in Roseville, Minnesota. The
Target name had intentionally been chosen to differentiate the new discount retailer from the Dayton
2
Ã¢â‚¬Å“Costco Wholesale Corp. Initiation Report,Ã¢â‚¬Â Wachovia Capital Markets, September 18, 2006.
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CompanyÃ¢â‚¬â„¢s more upscale stores. The Target concept flourished. In 1995, the first SuperTarget store opened
in Omaha, Nebraska, and in 1999, the Target.com website was launched. By 2000, the parent company,
Dayton Hudson, officially changed its name to Target Corporation.3
By 2005, Target had become a major retailing powerhouse with \$52.6 billion in revenues from 1,397
stores in 47 states (Exhibits 3 and 4). With sales of \$30 billion in 2000, the company had realized a 12.1%
sales growth over the past five years and had announced plans to continue its growth by opening
approximately 100 stores per year in the United States in the foreseeable future. While Target Corporation
had never committed to expanding internationally, analysts had been speculating that domestic growth alone
would not be enough to sustain its historic success. If Target continued its domestic growth strategy, most
analysts expected capital expenditures would continue at a level of 6% to 7% of revenues, which equated to
about \$3.5 billion for fiscal year 2006.
In contrast with Wal-MartÃ¢â‚¬â„¢s focus on low prices, TargetÃ¢â‚¬â„¢s strategy was to consider the customerÃ¢â‚¬â„¢s
shopping experience as a whole. Target referred to its customers as guests and consistently strived to support
the slogan, Ã¢â‚¬Å“Expect more. Pay less.Ã¢â‚¬Â Target focused on creating a shopping experience that appealed to the
profile of its Ã¢â‚¬Å“core guestÃ¢â‚¬Â: a college-educated woman with children at home who was more affluent than the
typical Wal-Mart customer. This shopping experience was created by emphasizing a store dÃƒÂ©cor that gave just
the right shopping ambience. The company had been highly successful at promoting its brand awareness with
large advertising campaigns; its advertising expenses for fiscal 2005 were \$1.0 billion or about 2.0% of sales
and 26.6% of operating profit. In comparison, Wal-MartÃ¢â‚¬â„¢s advertising dollars amounted to 0.5% of sales and
9.2% of operating income. Consistent advertising spending resulted in the Target bullÃ¢â‚¬â„¢s-eye logoÃ¢â‚¬â„¢s (Exhibit 5)
being ranked among the most recognized corporate logos in the United States, ahead of the Nike Ã¢â‚¬Å“swoosh.Ã¢â‚¬Â
As an additional enhancement to the customer shopping experience, Target offered credit to qualified
customers through its REDcards: Target Visa Credit Card and Target Credit Card. The credit-card business
accounted for 14.9% of TargetÃ¢â‚¬â„¢s operating earnings and was designed to be integrated with the companyÃ¢â‚¬â„¢s
overall strategy by focusing only on customers who visited Target stores.
Capital-Expenditure Approval Process
The Capital Expenditure Committee was composed of a team of top executives that met monthly to
review all capital project requests (CPRs) in excess of \$100,000. CPRs were either approved by the CEC, or in
the case of projects larger than \$50 million, required approval from the board of directors. Project proposals
varied widely and included remodeling, relocating, rebuilding, closing an existing store, and building a new
store.4 A typical CEC meeting involved the review of 10 to 15 CPRs. All of the proposals were considered
economically attractive, as any CPRs with questionable economics were normally rejected at the lower levels
of review. In the rare instance when a project with a negative net present value (NPV) reached the CEC, the
committee was asked to consider the project in light of its strategic importance to the company.
CEC meetings lasted several hours as each of the projects received careful scrutiny by the committee
members. The process purposefully was designed to be rigorous because the CEC recognized that capital
investment could have significant impact on the short-term and long-term profitability of the company. In
addition to the large amount of capital at stake, approvals and denials also had the potential to set precedents
that would affect future decisions. For example, the committee might choose to reject a remodeling proposal
3 The Dayton Company merged with J. L. Hudson Company in 1969. After changing its name to Target, the company renamed the DaytonHudson stores as Marshall FieldÃ¢â‚¬â„¢s. In 2004, Marshall FieldÃ¢â‚¬â„¢s was sold to May Department Stores, which was acquired by Federated Department Stores
in 2006; all May stores were given the MacyÃ¢â‚¬â„¢s name that same year.
4 Target expected to allocate 65% of capital expenditures to new stores, 12% to remodels and expansions, and 23% to information technology,
distribution, and so on.
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for a store with a positive NPV, if the investment amount requested was much higher than normal and
therefore might create a troublesome precedent for all subsequent remodel requests for similar stores.
Despite how much the projects differed, the committee was normally able to reach a consensus decision for
the vast majority of them. Occasionally however, a project led to such a high degree of disagreement within
the committee that the CEO made the final call.
Projects typically required 12 to 24 months of development prior to being forwarded to the CEC for
consideration. In the case of new store proposals, which represented the majority of the CPRs, a real-estate
manager assigned to that geographic region was responsible for the proposal from inception to completion
and also for reviewing and presenting the proposal details. The pre-CPR work required a certain amount of
expenditures that were not recoverable if the project were ultimately rejected by CEC. More important than
these expenditures, however, were the Ã¢â‚¬Å“emotional sunk costsÃ¢â‚¬Â for the real-estate managers who believed
strongly in the merits of their proposals and felt significant disappointment if any project was not approved.
The committee considered several factors in determining whether to accept or reject a project. An
overarching objective was to meet the corporate goal of adding about 100 stores a year while maintaining a
positive brand image. Projects also needed to meet a variety of financial objectives, starting with providing a
suitable financial return as measured by discounted cash-flow metrics: NPV and IRR (internal rate of return).
Other financial considerations included projected profit and earnings per share impacts, total investment size,
impact on sales of other nearby Target stores, and sensitivity of NPV and IRR to sales variations. Projected
sales were determined based on economic trends and demographic shifts but also considered the risks
involved with the entrance of new competitors and competition from online retailers. And lastly, the
committee attempted to keep the project approvals within the capital budget for the year. If projects were
approved in excess of the budgeted amount, Target would likely need to borrow money to fund the shortfall.
Adding debt unexpectedly to the balance sheet could raise questions from equity analysts as to the increased
risk to the shareholders as well as to the ability of management to accurately project the companyÃ¢â‚¬â„¢s funding
needs.
Other considerations included tax and real-estate incentives provided by local communities as well as area
demographics. Target typically purchased the properties where it built stores, although leasing was considered
on occasion. Population growth and affluent communities were attractive to Target, but these factors also
invited competition from other retailers. In some cases, new Target stores were strategically located to block
other retailers despite marginal short-term returns.
When deciding whether to open a new store, the CEC was often asked to consider alternative store
formats. For example, the most widely used format was the 2004 version of a Target store prototype called
P04, which occupied 125,000 square feet, whereas a SuperTarget format occupied an additional 50,000 square
feet to accommodate a full grocery assortment. The desirability of one format over another often centered on
whether a store was expected to eventually be upgraded. Smaller stores often offered a higher NPV; but the
NPV estimate did not consider the effect of future upgrades or expansions that would be required if the
surrounding communities grew, nor the advantage of opening a larger store in an area where it could serve
the purpose of blocking competitors from opening stores nearby.
The committee members were provided with a capital-project request Ã¢â‚¬Å“dashboardÃ¢â‚¬Â for each project that
summarized the critical inputs and assumptions used for the NPV and IRR calculations. The template
represented the summary sheet for an elaborate discounted cash flow model. For example, the analysis of a
new store included incremental cash flow projections for 60 years, over which time the model included a
remodeling of the store every 10 years. Exhibit 6 provides an example of a dashboard with a detailed
explanation of the Ã¢â‚¬Å“Store SensitivitiesÃ¢â‚¬Â section. The example dashboard shows that incremental sales
estimates, which were computed as the total sales expected for the new store less the sales cannibalized from
Target stores already located in the general vicinity. Sales estimates were made by the Research and Planning
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group. The R&P group used demographic and other data to make site-specific forecasts. Incremental sales
were computed as total sales less those cannibalized from other Target stores. The resulting NPV and IRR
metrics were divided between value created by store sales and credit-card activity. NPV calculations used a
9.0% discount rate for cash flows related to the store cash flows and a 4.0% discount rate for credit-card cash
flows. The different discount rates were chosen to represent the different costs of capital for funding store
operations versus funding credit-card receivables.
The dashboards also presented a variety of demographic information, investment-cost details and
sensitivity analyses. An important sensitivity feature was the comparison of the projectÃ¢â‚¬â„¢s NPV and IRR to the
prototype. For example, the P04 store had an NPV of about \$10 million and an IRR of 13%.5 The sensitivity
calculations answered the question of how much a certain cost or revenue item needed to change in order for
the project to achieve the same NPV or IRR that would be experienced for the typical P04 or SuperTarget
store.
The November Meeting
Of the 10 projects under consideration for the November CEC meeting, Doug Scovanner recognized
that five would be easily accepted, but that the remaining five CPRs were likely to be difficult choices for the
committee. These projects included four new store openings (Gopher Place, Whalen Court, The Barn, and
GoldieÃ¢â‚¬â„¢s Square) and one remodeling of an existing store into a SuperTarget format (Stadium Remodel).
Exhibit 7 contains a summary of the five projects, and Exhibit 8 contains the CPR dashboards for the
individual projects.
As was normally the case, all five of the CPRs had positive NPVs, but Scovanner wondered if the
projected NPVs were high enough to justify the required investment. Further, with stiff competition from
other large retailers looking to get footholds in major growth areas, how much consideration should be given
to short-term versus long-term sales opportunities? For example, Whalen Court represented a massive
investment with relatively uncertain sales returns. Should Scovanner take the stance that the CEC should
worry less about Whalen CourtÃ¢â‚¬â„¢s uncertain sales and focus more on the project as a means to increase
TargetÃ¢â‚¬â„¢s brand awareness in an area with dense foot traffic and high-fashion appeal? GoldieÃ¢â‚¬â„¢s Square
represented a more typical investment level of \$24 million for a SuperTarget. The NPV, however, was small
at \$317,000, well below the expected NPV of a SuperTarget prototype, and would be negative without the
value contribution of credit-card sales.
As CFO, Scovanner was also aware that Target shareholders had experienced a lackluster year in 2006,
given that TargetÃ¢â‚¬â„¢s stock price had remained essentially flat (Exhibit 9). Stock analysts were generally pleased
with TargetÃ¢â‚¬â„¢s stated growth policy and were looking for decisions from management regarding investments
that were consistent with the company maintaining its growth trajectory. In that regard, Scovanner recognized
that each of the projects represented a growth opportunity for Target. The question, however, was whether
capital was better spent on one project or another to create the most value and the most growth for Target
shareholders. Thus Scovanner believed that he needed to rank the five projects in order to be able to
recommend which ones to keep and which ones to reject during the CEC meeting the next day.
5
These NPV and IRR figures exclude the impact of the credit card.
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Exhibit 1
Target Corporation
Executive Officers and Capital Expenditure Committee Members
Timothy R. Baer
Executive Vice President, General Counsel, and Corporate Secretary
Michael R. Francis
Executive Vice President, Marketing
John D. Griffith
Executive Vice President, Property Development
Jodeen A. Kozlak
Executive Vice President, Human Resources
Troy H. Risch
Executive Vice President, Stores
Janet M. Schalk
Executive Vice President, Technology Services and Chief Information Officer
Douglas A. Scovanner
Executive Vice President and Chief Financial Officer
Terrence J. Scully
President, Target Financial Services
Gregg W. Steinhafel
President
CEC
Robert J. Ulrich
Chairman and Chief Executive Officer
CEC
CEC
CEC
CEC
Chairman and CEO Bob Ulrich, 62. Ulrich began his career at Dayton-Hudson as a merchandising
trainee in 1967. He advanced to the position of CEO of Target Stores in 1987 and to the position of
Dayton-HudsonÃ¢â‚¬â„¢s CEO in 1994.
EVP and CFO Doug Scovanner, 49. Scovanner was named Target CFO in February 2000 after
previously serving as CFO of Dayton-Hudson.
President of Target Stores Gregg Steinhafel, 50. Steinhafel began his career at Target as a merchandising
trainee in 1979. He was named president in 1999.
EVP of Stores Troy Risch, 37. Risch was promoted to EVP in September 2006.
EVP of Property Development John Griffith, 44. Griffith was promoted to EVP in February 2005 from
the position of senior vice president of Property Development he had held since February 2000.
Source: Target Corporation, used with permission.
This document is authorized for use only by Yongjia Fang in FINC 614 Spring 2021 Readings taught by Heather Boren, Pepperdine University from Dec 2020 to May 2021.
Target Corporation
Bed Bath & Beyond Inc.
Costco Wholesale Corp.
DickÃ¢â‚¬â„¢s Sporting Goods, Inc.
JCPenney Company, Inc.
KohlÃ¢â‚¬â„¢s Corporation
Sears Holdings Corporation
Wal-Mart Stores, Inc.
\$315.7
\$52.6
\$2.6
\$18.8
\$13.4
\$49.1
\$5.8
\$30.8
\$52.9
Revenue
(billions)
Data source: Yahoo! Finance and Value Line Investment Survey.
Page 7
\$2.73
\$1.95
\$2.33
\$2.24
\$1.47
\$4.30
\$2.45
\$5.63
\$2.68
Basic
EPS
\$38.8
\$9.9
\$0.0
\$0.6
\$0.8
\$0.2
\$3.5
\$1.2
\$4.0
Debt
(billions)
A+
BBB
BBB
A
Not Rated
BB+
BBB
BB+
AA
Debt
Rating
(S&P)
Retail Company Financial Information
Target Corporation
Exhibit 2
1.05
1.05
1.25
0.85
1.15
1.05
0.90
NMF
0.80
Beta
Jan-06
Feb-06
Feb-06
Aug-05
Jan-06
Jan-06
Jan-06
Jan-06
Jan-06
Fiscal Year
Ended
\$50.1
\$11.4
\$26.2
\$24.1
\$1.3
\$16.6
\$23.1
\$26.9
\$199.9
Market Capitalization
as of Oct. 31, 2006
(billions)
UV1057
For the exclusive use of Y. Fang, 2021.
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Exhibit 3
Target Corporation
Target Income Statements (in millions of US dollars)
Fiscal Year Ending
Net revenues
Cost of goods sold
Depreciation, depletion, and amortization
Gross income
Earnings before interest and taxes (EBIT)
Net interest expense
Pretax income
Income taxes
Net income before extra items
Gain (loss) sale of assets
Net income after extra items
Capital expenditures (net of disposals)
Capital expenditures/sales
28 Jan 2006
52,620
34,927
1,409
16,284
11,961
4,323
463
3,860
1,452
2,408
29 Jan 2005
2,408
46,839
31,445
1,259
14,135
10,534
3,601
570
3,031
1,146
1,885
1,313
3,198
3,330
6.3%
3,012
6.4%
Data source: Target Corporation annual reports.
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Exhibit 4
Target Corporation
Balance Sheet Statements (in millions of US dollars)
Fiscal Year Ending
Assets
Cash and cash equivalents
Accounts receivable (net)
Inventory
Other current assets
Total current assets
Property, plant, and equipment, net
Other assets
Total assets
28 Jan 2006
29 Jan 2005
31 Jan 2004
1,648
5,666
5,838
1,253
14,405
19,038
1,552
34,995
2,245
5,069
5,384
1,224
13,922
16,860
1,511
32,293
708
4,621
4,531
3,092
12,952
15,153
3,311
31,416
Liabilities
Accounts payable
Current portion of LT debt and notes payable
Income taxes payable
Other current liabilities
Total current liabilities
Long-term debt
Other liabilities
Total liabilities
6,268
753
374
2,193
9,588
9,119
2,083
20,790
5,779
504
304
1,633
8,220
9,034
2,010
19,264
4,956
863
382
2,113
8,314
10,155
1,815
20,284
ShareholdersÃ¢â‚¬â„¢ equity
Common equity
Retained earnings
Total liabilities and shareholdersÃ¢â‚¬â„¢ equity
2,192
12,013
34,995
1,881
11,148
32,293
1,609
9,523
31,416
Data source: Target Corporation annual reports.
Exhibit 5
Target Corporation
Target Logo
Source: Target Corporation, used with permission.
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Example of a Capital Project Request Dashboard
Target Corporation
Page 10
Exhibit 6
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Exhibit 6 (continued)
Dashboard Sensitivities Key (use with “Sensitivities Key – Dashboard Example”)
Dashboard Example: P04; Store NPV: \$12,860; Store IRR: 12.8%
Sales
NPV
(3.0%) Sales could decrease (3.0%) and still achieve Prototype Store NPV
IRR
1.0% Sales would have to increase 1.0% to achieve Prototype Store IRR
Gross Margin the amounts listed are the amounts
NPV
(0.55) Gross Margin could decrease (0.55) pp and still achieve Prototype Store NPV
IRR
0.19 Gross Margin would have to increase 0.19 pp to achieve Prototype Store IRR
Construction (Building & Sitework) For this Dashboard Example:
NPV
\$2,398 Construction costs could increase \$2,398 and still achieve Prototype Store NPV
IRR
Full Transfer Impact
(\$498) Construction costs would have to decrease (\$498) to achieve Prototype Store IRR
Prototype Assumption: A nearby store transferring sales to a new store, fully recovers these sales by the 5th yr.
Sensitivity Assumption: If transfer sales are NOT fully recovered by the transferring store in year 5:
NPV
4.0% Sales would have to increase 4.0% to achieve Prototype Store NPV
IRR
7.5% Sales would have to increase 7.5% to achieve Prototype Store IRR
RISK/OPPORTUNITY
10% Sales Decline
NPV
IRR
(\$6,259) If sales decline by 10%, Store NPV would decline by (\$6,259).
(1.8) If sales decline by 10%, Store IRR would decline by (1.8) pp.
Approx \$ IMPACT ON STORE NPV
1 pp GM Decline Cost NPV %
NPV
IRR
(\$3,388) If margin decreased by 1 pp, Store NPV would decline by (\$3,388).
(1.0) If margin decreased by 1 pp, Store IRR would decline by (1.0) pp.
10% Construction Cost Increase
NPV
IRR
(\$1,287) If construction costs increased by 10%, Store NPV would decline by (\$1,287).
(0.6) If construction costs increased by 10%, Store IRR would decline by (0.6) pp.
Market Margin, Wage Rate, etc.
NPV
IRR
Cost
NPV
%
Land:
\$100K
\$100K
Sitework:
\$100K
\$100K
110%
70%
Building:
\$100K
\$100K
85%
Ongoing Exp:
\$100K
\$100K
x10
Ongoing Expense: eg. Real Estate Taxes, Operating Expense
Assumes Store Opening occurs 1 year after closing.
(\$603) If we applied market specific assumptions, Store NPV would decrease by (\$603).
(0.2) If we applied market specific assumptions, Store IRR would decrease by (0.2) pp.
10% Sales Increase
NPV
IRR
\$6,269 If sales increased by 10%, Store NPV would increase by \$6,269.
1.8 If sales increased by 10%, Store IRR would increase by 1.8 pp.
VARIANCE TO PROTOTYPE
The example dashboard with a Store NPV of \$12,860 is \$1,860K above Prototypical Store NPV. The following items contributed to the variance:
Land
NPV
IRR
(\$219) Land cost contributed a negative (\$219) to the variance from Prototype.
(0.1) Land cost contributed a negative (0.1) pp to the variance from Prototype.
Non-Land Investment
NPV
IRR
(\$2,660) Building/Sitework costs contributed a negative (\$2,660) to the variance from Prototype.
(1.5) Building/Sitework costs contributed a negative (1.5) pp to the variance from Prototype.
Sales
NPV
IRR
\$4,818 Sales contributed a positive \$4,818 to the variance from Prototype.
1.4 Sales contributed a positive 1.4 pp to the variance from Prototype.
Real Estate Taxes
NPV
IRR
(\$79) Real Estate Taxes contributed a negative (\$79) to the variance from Prototype.
0.0 Real Estate Taxes contributed a negative (0.0) pp to the variance from Prototype.
Source: Target Corporation, used with permission.
This document is authorized for use only by Yongjia Fang in FINC 614 Spring 2021 Readings taught by Heather Boren, Pepperdine University from Dec 2020 to May 2021.
\$16,800
\$25,900
\$20,500
\$300
\$15,700
(\$4,722)
(\$16,611)
(\$4,066)
(\$4,073)
(\$7,854)
12.3%
9.8%
16.4%
8.1%
10.8%
IRR
NPV is computed using 9.0% as discount rate for store cash flows and 4.0% for credit-card cash flows.
Trade area is the geographical area from which 70% of store sales will be realized.
\$23,000
\$119,300
\$13,000
\$23,900
\$17,000
Investment
(\$000)
Net Present Value*
10% Sales
Decline
Base Case
Impact on
NPV (\$000) NPV (\$000)
70,000
632,000
151,000
222,000
N/A
Population
Economic Analysis Summary of Project Proposals
Target Corporation
Exhibit 7
27%
3%
3%
16%
N/A
Population
Increase
2000-2005
\$56,400
\$48,500
\$38,200
\$56,000
\$65,931
Median
Income
12%
45%
17%
24%
42%
yrs. college
UV1057
Whalen Court was a request for \$119.3 million to build a unique single-level store scheduled to open in October 2008. The prototype NPV could be
achieved with sales of 1.9% above the R&P forecast level. Although Target currently operated 45 stores in this market, the Whalen Court market
represented a rare opportunity for Target to enter the urban center of a major metropolitan area. Unlike other areas, this opportunity provided Target
with major brand visibility and essentially free advertising for all passersby. Considering TargetÃ¢â‚¬â„¢s larger advertising budget, the request for more than
\$100 million of capital investment could be balanced against the brand awareness benefits it would bring. Further, this opportunity was only available
for a limited time. Unlike the majority of Target stores, this store would have to be leased. Thus if it was not approved at the November meeting, the
property would surely be leased by another retailer.
Gopher Place was a request for \$23.0 million to build a P04 store scheduled to open in October 2007. The prototype NPV would be achieved with
sales of 5.3% below the R&P forecast level. This market was considered an important one, with five existing stores already in the area. Wal-Mart was
expected to add two new supercenters in response to favorable population growth in the trade area, which was considered to have a very favorable
median household income and growth rate. Because of the high density of Target stores, nearly 19% of sales included in the forecasts were expected to
come from existing Target stores.
**
*
Gopher Place
Whalen Court
The Barn
GoldieÃ¢â‚¬â„¢s Square
Page 12
For the exclusive use of Y. Fang, 2021.
This document is authorized for use only by Yongjia Fang in FINC 614 Spring 2021 Readings taught by Heather Boren, Pepperdine University from Dec 2020 to May 2021.
Exhibit 7 (continued)
UV1057
Source: Target Corporation, used with permission.
Stadium Remodel was a request for \$17.0 million to remodel a SuperTarget store opening March 2007. As a remodel, there was no prototype NPV
for comparison. The recent sales decline and deteriorating facilities at this location could lead to tarnishing the brand image. This trade area had
supported Target stores since 1972 and had already been remodeled twice previously. The \$17 million investment would certainly give a lift to the
lagging sales.
GoldieÃ¢â‚¬â„¢s Square was a request for \$23.9 million to build a SuperTarget store scheduled to open in October 2007. The prototype NPV required sales
45.1% above the R&P forecast level. This area was considered a key strategic anchor for many retailers. The GoldieÃ¢â‚¬â„¢s Square center included Bed Bath
& Beyond, JCPenney, Circuit City, and Borders. Target currently operated 12 stores in the area and was expected to have 24 eventually. Despite the
relatively weak NPV figures, this was a hotly contested area with an affluent and fast-growing population, which could afford good brand awareness
should the growth materialize.
The Barn was a request for \$13.0 million to build a P04 store scheduled to open in March 2007. The prototype NPV was achievable with sales of
18.1% below the R&P forecast level. This project was being resubmitted after initial development efforts failed because of a disagreement with the
developer. This small rural area was an extreme contrast to Whalen Court. The small initial investment allowed for a large return on investment even if
sales growth turned out to be less than expected. This investment represented a new market for Target as the two nearest Target stores were 80 and 90
miles away.
Page 13
For the exclusive use of Y. Fang, 2021.
This document is authorized for use only by Yongjia Fang in FINC 614 Spring 2021 Readings taught by Heather Boren, Pepperdine University from Dec 2020 to May 2021.
Individual Capital Project Request Ã¢â‚¬Å“DashboardsÃ¢â‚¬Â
Target Corporation
Page 14
Exhibit 8
UV1057
For the exclusive use of Y. Fang, 2021.
This document is authorized for use only by Yongjia Fang in FINC 614 Spring 2021 Readings taught by Heather Boren, Pepperdine University from Dec 2020 to May 2021.
Page 15
Exhibit 8 (continued)
UV1057
For the exclusive use of Y. Fang, 2021.
This document is authorized for use only by Yongjia Fang in FINC 614 Spring 2021 Readings taught by Heather Boren, Pepperdine University from Dec 2020 to May 2021.
Page 16
Exhibit 8 (continued)
UV1057
For the exclusive use of Y. Fang, 2021.
This document is authorized for use only by Yongjia Fang in FINC 614 Spring 2021 Readings taught by Heather Boren, Pepperdine University from Dec 2020 to May 2021.
Page 17
Exhibit 8 (continued)
UV1057
For the exclusive use of Y. Fang, 2021.
This document is authorized for use only by Yongjia Fang in FINC 614 Spring 2021 Readings taught by Heather Boren, Pepperdine University from Dec 2020 to May 2021.
Page 18
Source: Target Corporation, used with permission.
Exhibit 8 (continued)
UV1057
For the exclusive use of Y. Fang, 2021.
This document is authorized for use only by Yongjia Fang in FINC 614 Spring 2021 Readings taught by Heather Boren, Pepperdine University from Dec 2020 to May 2021.
For the exclusive use of Y. Fang, 2021.
Page 19
UV1057
Exhibit 9
Target Corporation
Stock Price Performance 2002Ã¢â‚¬â€œ06
Data source: Yahoo! Finance.
This document is authorized for use only by Yongjia Fang in FINC 614 Spring 2021 Readings taught by Heather Boren, Pepperdine University from Dec 2020 to May 2021.
UV5147
Rev. Jan. 6, 2016
H. J. Heinz: Estimating the Cost of Capital in Uncertain Times
To do a common thing uncommonly well brings success.
Ã¢â‚¬â€H. J. Heinz Founder Henry John Heinz
As a financial analyst at the H. J. Heinz Company (Heinz) in its North American Consumer Products
division, Solomon Sheppard, together with his co-workers, reviewed investment proposals involving a wide
range of food products. Most discussions in his office focused on the potential performance of new products
and reasonableness of cash flow projections. But as the company finished its 2010 fiscal year at the end of
AprilÃ¢â‚¬â€with financial markets still in turmoil from the onset of the recession that started at the end of 2007Ã¢â‚¬â€
the central topic of discussion was the companyÃ¢â‚¬â„¢s weighted average cost of capital (WACC).
At the time, there were three reasons the cost of capital was a subject of controversy. First, HeinzÃ¢â‚¬â„¢s stock
price had just finished a two-year roller coaster ride: Its fiscal year-end stock price dropped from \$47 in 2008
to \$34 in 2009, then rose back to \$47 in 2010, and a vigorous debate ensued as to whether the weights in a cost
of capital calculation should be updated to reflect these changes as they occurred. Second, interest rates
remained quite lowÃ¢â‚¬â€unusually so for longer-term bond rates; there was concern that updating the cost of
capital to reflect these new rates would lower the cost of capital and therefore bias in favor of accepting
projects. Third, there was a strong sense that, as a result of the recent financial meltdown, the appetite for risk
in the market had changed, but there was no consensus as to whether this should affect the cost of capital of
the company and, if so, how.
When Sheppard arrived at work on the first of May, he found himself at the very center of that debate.
Moments after his arrival, SheppardÃ¢â‚¬â„¢s immediate supervisor asked him to provide a recommendation for a
WACC to be used by the North American Consumer Products division. Recognizing its importance to capital
budgeting decisions in the firm, he vowed to do an Ã¢â‚¬Å“uncommonly goodÃ¢â‚¬Â job with this analysis, gathered the
most recent data readily available, and began to grind the numbers.
Heinz and the Food Industry
In 1869, Henry John Heinz launched a food company by making horseradish from his motherÃ¢â‚¬â„¢s recipe. As
the story goes, Heinz was traveling on a train when he saw a sign advertising 21 styles of shoes, which he
thought was clever. Since 57 was his lucky number, the entrepreneur began using the slogan Ã¢â‚¬Å“57 VarietiesÃ¢â‚¬Â in
his advertising. By 2010, the company he eventually founded had become a food giant, with \$10 billion in
revenues and 29,600 employees around the globe.
This case was prepared by Associate Professor Marc L. Lipson. It was written as a basis for class discussion rather than to illustrate effective or
ineffective handling of an administrative situation. Copyright Ã‚Â© 2010 by the University of Virginia Darden School Foundation, Charlottesville, VA. All
rights reserved. To order copies, send an e-mail to sales@dardenbusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used
in a spreadsheet, or transmitted in any form or by any meansÃ¢â‚¬â€electronic, mechanical, photocopying, recording, or otherwiseÃ¢â‚¬â€without the permission of the Darden School
Foundation.
Page 2 UV5147
Heinz manufactured products in three categories: Ketchup and Sauces, Meals and Snacks, and Infant
Nutrition. HeinzÃ¢â‚¬â„¢s strategy was to be a leader in each product segment and develop a portfolio of iconic
brands. The firm estimated that 150 of the companyÃ¢â‚¬â„¢s brands held either the number one or number two
position in their respective target markets.1 The famous Heinz Ketchup, with sales of \$1.5 billion a year or 650
million bottles sold, was still the undisputed world leader. Other well-known brands included Weight Watchers
(a leader in dietary products), Heinz Beans (in 2010, the brand sold over 1.5 million cans a day in Britain, the
Ã¢â‚¬Å“biggest bean-eating nation in the worldÃ¢â‚¬Â), and Plasmon (the gold standard of infant food in the Italian
market).2 Well
known brands remained the core of the business with the top 15 brands accounting for about 70% of
revenues, and each generating over \$100 million in sales.
Heinz was a global powerhouse. It operated in more than 200 countries. The company was organized into
business segments based primarily on region: North American Consumer Products, U.S. Foodservice, Europe,
Asia Pacific, and Rest of World. About 60% of revenues were from outside the United States and the North
American Consumer Products and Europe segments were of comparable size. Increasingly, the company was
focusing on emerging markets, which had generated 30% of recent growth and comprised 15% of total sales.
The most prominent global food companies based in the United States included Kraft Foods, the largest
U.S.-based food and beverage company; Campbell Soup Company, the iconic canned food maker; and Del
Monte Foods, one of largest producers and distributers of premium-quality branded food and pet products
focused on the U.S. market (and a former Heinz subsidiary). Heinz also competed with a number of other
global players such as NestlÃƒÂ©, the world leader in sales, and Unilever, the British-Dutch consumer goods
conglomerate.
Recent Performance
With the continued uncertainty regarding any economic recovery and deep concerns about job growth
over the previous two years, consumers had begun to focus on value in their purchases and to eat more
frequently at home. This proved a benefit for those companies providing food products and motivated many
top food producers and distributors to focus on core brands. As a result, Heinz had done well in both 2009
and 2010, with positive sales growth and profits above the 2008 level both years, although 2010 profits were
lower than those in 2009. These results were particularly striking since a surge in the price of corn syrup and
an increase in the cost of packaging had necessitated price increases for most of its products. Overseas sales
growth, particularly in Asia, had also positively affected the companyÃ¢â‚¬â„¢s operations. Exhibit 1 and Exhibit 2
present financial results for the years 2008, 2009, and 2010.
The relation between food company stock prices and the economy was complicated. In general, the
performance of a food products company was not extremely sensitive to market conditions and might even
benefit from market uncertainty. This was clear to Heinz CFO Art Winkelblack, who in early 2009 had
remarked, Ã¢â‚¬Å“IÃ¢â‚¬â„¢m sure glad weÃ¢â‚¬â„¢re selling food and not washing machines or cars. People are coming home to
Heinz.Ã¢â‚¬Â3 Still an exceptionally prolonged struggle or another extreme market decline could drive more
consumers to the private-label brands that represented a step down from the Heinz brands. While a double
dip recession seemed less likely in mid-2010, it was clear the economy continued to struggle, and this put
pressure on margins.
While the stock price for Heinz had been initially unaffected by adverse changes in the economy and did
not decline with the market, starting in the third quarter of 2008, HeinzÃ¢â‚¬â„¢s stock price began tracking the
marketÃ¢â‚¬â„¢s
1
Ã¢â‚¬Å“H. J. Heinz Corporate Profile,Ã¢â‚¬Â http://www.heinz.com/our-company/press-room.aspx (accessed Sep. 27, 2010).
2
3
http://www.heinz.com/our-company/press-room.aspx.
Andrew Bary, Ã¢â‚¬Å“The Return of the Ketchup Kid,Ã¢â‚¬Â BarronÃ¢â‚¬â„¢s, January 26, 2009.
Page 3 UV5147
movement quite closely. Figure 1 plots the Heinz stock price against the S&P Index (normalized to match
HeinzÃ¢â‚¬â„¢s stock price at the start of the 2005 fiscal year). The low stock price at the start of 2009 had been
characterized by some as an over-reaction and, even with the subsequent recovery, it was considered
undervalued by some.4
Figure 1. Heinz stock price and normalized S&P 500 Index.
Price Normalized Index
60
50
40
30
20
10
0
5/2/2005 5/2/2006 5/2/2007 5/2/2008 5/2/2009
Data sources: S&P 500 and Yahoo! Finance.
Cost of Capital Considerations
Recessions certainly could wreak havoc on financial markets. Given that the recent downturn had been
largely precipitated by turmoil in the capital markets, it was not surprising that the interest rate picture at the
time was unusual. Exhibit 3 presents information on interest rate yields. As of April 2010, short-term
government rates and even commercial paper for those companies that could issue it were at strikingly low
levels. Even long-term rates, which were typically less volatile, were low by historic standards. Credit spreads,
which had drifted upwards during 2008 and jumped upwards during 2009, had settled down but were still
somewhat high by historic standards. Interestingly, the low level of long-term rates had more than offset the
Sheppard gathered some market data related to Heinz (also shown in Exhibit 3). He easily obtained
historic stock price data. Most sources he accessed estimated the companyÃ¢â‚¬â„¢s beta using the previous five years
of data at about 0.65.5 Sheppard obtained prices for two bonds he considered representative of the companyÃ¢â‚¬â„¢s
outstanding borrowings: a note due in 2032 and a note due in 2012. Heinz had regularly accessed the
commercial paper market in the past, but that market had recently dried up. Fortunately, the company had
other sources for short-term borrowing and Sheppard estimated these funds cost about 1.20%.
4
Bary; the same article noted that Heinz had Ã¢â‚¬Å“an above-average portfolio of brands, led by its commanding global ketchup franchiseÃ¢â‚¬Â and, even at
January 2009 prices, could be a takeover target.
5
Sheppard was sufficiently curious as to whether this number was still relevant that he calculated his own estimated of beta from the last year of daily
returns. His estimate was 0.54, close to the five-year estimate from Value Line, but still notably lower.
Page 4 UV5147
What most surprised Sheppard was the diversity of opinions he obtained regarding the market risk
premium. Integral to calculating the required return on a companyÃ¢â‚¬â„¢s equity using the capital asset pricing
model, this rate reflected the incremental return an investor required for investing in a broad market index of
stocks rather than a riskless bond. When measured over long periods of time, the average premium had been
had been closer to 6.0% and by some measures even lower. Most striking were the results of a survey of CFOs
indicating that expectations were for an even lower premium in the near futureÃ¢â‚¬â€close to 5.0%. On the other
hand, some asserted that market conditions in 2010 only made sense if a much higher premiumÃ¢â‚¬â€something
close to 8%Ã¢â‚¬â€were assumed.
As Sheppard prepared for his cost of capital analysis and recommendation, he obtained recent
representative data for HeinzÃ¢â‚¬â„¢s three major U.S. competitors (Exhibit 4). This information would allow
Sheppard to generate cost-of-capital estimates for these competitors as well as for Heinz. Arguably, if market
conditions for Heinz were unusual at the time, the results for competitors could be more representative for
other companies in the industry. At the very least, Sheppard knew he would be more comfortable with his
recommendation if it were aligned with what he believed was appropriate for the companyÃ¢â‚¬â„¢s major
competitors.
6
After some research, Sheppard was confident that the appropriate rate was the arithmetic mean (simple average) of past annual returns rather than
the geometric mean in this context. The reason was that the arithmetic mean appropriately calculates the present value of a distribution of future cash
flows.
Page 5 UV5147
Exhibit 1
H. J. Heinz: Estimating the Cost of Capital in Uncertain Times
Income Statement
(numbers in thousands except per-share amounts; fiscal year ends in April)
2008 2009 2010
Revenue 9,885,556 10,011,331 10,494,983
Costs of goods sold 6,233,420 6,442,075 6,700,677
Gross profit 3,652,136 3,569,256 3,794,306
SG&A expense 2,081,801 2,066,810 2,235,078
Operating income 1,570,335 1,502,446 1,559,228
Interest expense 323,289 275,485 250,574
Other income (expense) (16,283) 92,922 (18,200)
Income before taxes 1,230,763 1,319,883 1,290,454
Income taxes 372,587 375,483 358,514
Net income after taxes 858,176 944,400 931,940
Adjustments to net income (13,251) (21,328) (67,048)
Net income 844,925 923,072 864,892
Diluted EPS 2.61 2.89 2.71
Dividends per share 1.52 1.66 1.68
Data source: H. J. Heinz SEC filings, 2008Ã¢â‚¬â€œ10.
Page 6 UV5147
Exhibit 2
H. J. Heinz: Estimating the Cost of Capital in Uncertain Times
Balance Sheet
(numbers in thousands except per-share amounts; fiscal year ends in April)
2008 2009 2010
Cash 617,687 373,145 483,253 Net receivables 1,161,481 1,171,797 1,045,338 Inventories
1,378,216 1,237,613 1,249,127 Other current assets 168,182 162,466 273,407 Total current
assets 3,325,566 2,945,021 3,051,125
Net fixed assets 2,104,713 1,978,302 2,091,796 Other noncurrent assets 5,134,764
4,740,861 4,932,790 Total assets 10,565,043 9,664,184 10,075,711
Accounts payable 1,247,479 1,113,307 1,129,514 Short-term debt 124,290 61,297 43,853
Current portion of long-term debt 328,418 4,341 15,167 Other current liabilities 969,873
883,901 986,825 Total current liabilities 2,670,060 2,062,846 2,175,359
Long-term debt 4,730,946 5,076,186 4,559,152 Other noncurrent liabilities 1,276,217
1,246,047 1,392,704 6,007,163 6,322,233 5,951,856
Equity 1,887,820 1,279,105 1,948,496 Total liabilities and equity 10,565,043 9,664,184
10,075,711
Shares outstanding (in millions of dollars) 311.45 314.86 317.69 Data source: H. J. Heinz SEC filings,
2008Ã¢â‚¬â€œ10.
Page 7 UV5147
Exhibit 3
H. J. Heinz: Estimating the Cost of Capital in Uncertain Times
Capital Market Data
(yields and prices as of the last trading day in April of the year indicated)
Average Historic Yields
2003 2004 2005 2006 2007 2008 2009 2010 1-year 1.22% 1.55% 3.33% 4.98% 4.89% 1.85% 0.49% 0.41%
5-year 2.85% 3.63% 3.90% 4.92% 4.51% 3.03% 2.02% 2.43% 10-year 3.89% 4.53% 4.21% 5.07% 4.63%
3.77% 3.16% 3.69%
30-year1 4.79% 5.31% 4.61% 5.17% 4.89% 4.49% 4.05% 4.53% MoodyÃ¢â‚¬â„¢s Aaa 5.53% 5.87% 5.21% 5.95%
5.40% 5.51% 5.45% 5.13% MoodyÃ¢â‚¬â„¢s Baa 6.65% 6.58% 5.97% 6.74% 6.31% 6.87% 8.24% 6.07% 3-month
commercial
paper 1.21% 1.08% 2.97% 4.90% 5.22% 1.91% 0.22% 0.24%
Heinz Capital Market Prices of Typical Issues
2009 2010 Heinz stock price \$34.42 \$46.87 Bond price: 6.750% coupon, semiannual bond due 3/15/32 (Baa
rated) 91.4 116.9 Bond price: 6.625% coupon, semiannual bond due 10/15/12 (Baa rated) 116.5 113.7
Note that bond data were slightly modified for teaching purposes.
Data sources: Federal Reserve, Value Line, Morningstar, and case writer estimates.
1
The 20-year yield is used for 2003Ã¢â‚¬â€œ05, when the 30-year was not issued.
Page 8 UVA-F-1634
Exhibit 4
H. J. Heinz: Estimating the Cost of Capital in Uncertain Times
Comparable Firm Data
Campbell Del Kraft Soup Monte Financial Summary
Revenues (in millions of dollars) 40,386 7,589 3,739 Book value of equity (in millions of dollars) 25,972
728 1,827 Book value of debt (in millions of dollars)18,990 2,624 1,290
Market Data
Beta 0.65 0.55 0.70 Shares outstanding (in millions of dollars) 1,735 363 182 Share price (dollars as of
close April 30, 2010) 29.90 35.64 15.11 Typical Standard & PoorÃ¢â‚¬â„¢s bond rating BBBÃ Âµâ€  A BB
Representative yield on long-term debt 5.12% 4.36% 6.19%
Data sources: Value Line; H. J. Heinz SEC filings, 2008Ã¢â‚¬â€œ10; case writer estimates; Morningstar.
You are looking to evaluate Coca Cola (KO) in terms of their capital structure based on the
following information:
Risk Free Rate: 3%
Beta: 0.43
Cost of Debt: 2.00%
% of Debt: 30%
% of Equity: 70%
Tax Rate: 29%
Part A: If their ROIC is 16.8%, are they destroying or creating value for their shareholders? Be sure
to show your work and explain
Part B: What is the unlevered beta?
Using the Target Corporation Harvard Business course pack case and discussions from lecture,
pack to aid in your analysis; however, the case analysis requires very little data manipulation.
Assuming you are in the role of Target Corporation’s CFO, Doug Scovanner, which of the five
capital-project requests (CPRs) would you accept and why? What were the project attributes that
you considered as part of your decision?
Using the Heinz Case from your Harvard Business course pack case and discussions from lecture,
course pack to aid in your analysis.
Part A: What were the WACC estimates for Kraft Foods, Campbell Soup Company, and Del Monte?
Be sure to show your calculation steps.
Part B: After evaluating all 3 comparable companies, how would you evaluate Heinz’s optimal
capital structure? How does this compare to their WACC in 2009 and 2010?
The Pepperdine Real Estate Fund is looking at purchasing a real estate asset valued currently at
\$5,520,000. You have been asked to analyze the cash flow provided below based on a period of 7
years.
Purchase Price: \$5,520,000
Sale Price: \$6,100,000
Year Cash Flow
1 \$250,000
2 \$264,000
3 \$363,681
4 \$509,000
5 \$532,000
6 \$587,000
7 \$613,700
PART A: If you require an 8.00% IRR and are using a discount rate of 10%, solve for the (i) IRR; (ii)
Present Value; and (iii) Net Present Value.
PART B: Based on your calculations, would you recommend purchasing the property? Why or why
not?
Figure 1. Heinz stock price and normalized S&P 500 Index.
Price
Normalized Index
60
50
40
30
20
10
0
5/2/2005
5/2/2006
5/2/2007
5/2/2008
5/2/2009
Data sources: S&P 500 and Yahoo! Finance.
Exhibit 1
H. J. Heinz: Estimating the Cost of Capital in Uncertain Times
Income Statement
(numbers in thousands except per-share amounts, fiscal year ends in April)
Revenue
Costs of goods sold
Gross profit
2008
9,885,556
6,233,420
3,652,136
2009
10,011,331
6,442,075
3,569,256
2010
10,494,983
6,700,677
3,794,306
SG&A expense
Operating income
2,081,801
1,570,335
2,066,810
1,502,446
2,235,078
1,559,228
Interest expense
Other income (expense)
Income before taxes
323,289
(16,283)
1,230,763
275,485
92,922
1,319,883
250,574
(18,200)
1,290,454
Income taxes
Net income after taxes
372,587
858,176
375,483
944,400
358,514
931,940
Net income
(13,251)
844,925
(21,328)
923,072
(67,048)
864,892
Diluted EPS
Dividends per share
Data source: H. J. Heinz SEC filings, 2008-10.
2.61
1.52
2.89
1.66
2.71
1.68
Exhibit 2
H. J. Heinz: Estimating the Cost of Capital in Uncertain Times
Balance Sheet
(numbers in thousands except per-share amounts; fiscal year ends in April)
Cash
Net receivables
Inventories
Other current assets
Total current assets
2008
617,687
1,161,481
1,378,216
168,182
3,325,566
2009
373,145
1,171,797
1,237,613
162,466
2,945,021
2010
483,253
1,045,338
1,249,127
273,407
3,051,125
Net fixed assets
Other noncurrent assets
Total assets
2,104,713
5,134,764
10,565,043
1,978,302
4,740,861
9,664,184
2,091,796
4,932,790
10,075,711
Accounts payable
Short-term debt
Current portion of long-term debt
Other current liabilities
Total current liabilities
1,247,479
124,290
328,418
969,873
2,670,060
1,113,307
61,297
4,341
883,901
2,062,846
1,129,514
43,853
15,167
986,825
2,175,359
Long-term debt
Other noncurrent liabilities
4,730,946
1,276,217
6,007,163
5,076,186
1,246,047
6,322,233
4,559,152
1,392,704
5,951,856
Equity
Total liabilities and equity
1,887,820
10,565,043
1,279,105
9,664,184
1,948,496
10,075,711
Shares outstanding (in millions of dollars)
311.45
314.86
317.69
Data source: H. J. Heinz SEC filings, 2008-10.
Exhibit 3
H. J. Heinz: Estimating the Cost of Capital in Uncertain Times
Capital Market Data
(yields and prices as of the last trading day in April of the year indicated)
Average Historic Yields
1-year
5-year
10-year
2003
1.22%
2.85%
3.89%
2004
1.55%
3.63%
4.53%
2005
3.33%
3.90%
4.21%
2006
4.98%
4.92%
5.07%
2007
4.89%
4.51%
4.63%
2008
1.85%
3.03%
3.77%
2009
0.49%
2.02%
3.16%
2010
0.41%
2.43%
3.69%
30-year!
Moody’s Aaa
Moody’s Baa
3-month commercial
paper
4.79%
5.53%
6.65%
5.31%
5.87%
6.58%
4.61%
5.21%
5.97%
5.17%
5.95%
6.74%
4.89%
5.40%
6.31%
4.49%
5.51%
6.87%
4.05%
5.45%
8.24%
4.53%
5.13%
6.07%
1.21%
1.08%
2.97%
4.90%
5.22%
1.91%
0.22%
0.24%
Heinz Capital Market Prices of Typical Issues
Heinz stock price
Bond price: 6.750% coupon, semiannual bond due 3/15/32 (Baa rated)
Bond price: 6.625% coupon, semiannual bond due 10/15/12 (Baa rated)
2009 2010
\$34.42 \$46.87
91.4 116.9
116.5 113.7
Note that bond data were slightly modified for teaching purposes.
Data sources: Federal Reserve, Value Line, Momingstar, and case writer estimates.
Exhibit 4
H. J. Heinz: Estimating the Cost of Capital in Uncertain Times
Comparable Firm Data
Kraft
Campbell
Soup
Del
Monte
40,386
25,972
18,990
7,589
728
2,624
3,739
1,827
1,290
Financial Summary
Revenues (in millions of dollars)
Book value of equity (in millions of dollars)
Book value of debt (in millions of dollars)
Market Data
Beta
Shares outstanding in millions of dollars)
Share price (dollars as of close April 30, 2010)
Typical Standard & Poor’s bond rating
Representative yield on long-term debt
0.65
1,735
29.90
BBB-
5.12%
0.55
363
35.64
ÃÂ
4.36%
0.70
182
15.11
BB
6.19%
Data sources: Value Line; H. J. Heinz SEC filings, 2008-10; case writer estimates, Momingstar.