Through the use of historical sales, growth rate, and capital structure data for Kraft Foods, Inc. we were able to estimate a current valuation of the company. Furthermore, by projecting historical data out to predict future cash flows, we were able to fairly value Kraft Foods.
1. Estimate the WACC for Kraft
2. Calculate historic growth rate
3. Calculate the average income tax rate and determine the relationship between sales and cost of sales, capital expenditures, depreciation, and net working capital 4. Determine the sales growth rate required to meet Kraft’s 2016 sales projections 5. Project 5-year cash flows starting in 2012 and ending in 2016 6. Discount cash flow projections beyond 2016 at the WACC rate to estimate the projected firm value in 2016 7. Discount cash flow projections from 2012 to 2016 at the WACC rate to estimate the fair firm value today, and add the present value of the cash flows beyond 2016, to estimate the value of the firm 8. Calculate Kraft’s capital structure to better understand this valuation 9. Determine the current fair share price
Estimating the WACC
In order to calculate the WACC, we used the following figures: Cost of equity: 5.5155%
Cost of debt: 4.31%
Percentage of equity financing: 0.667
Percentage of debt financing: 0.333
Corporate tax rate: 28%
Plugging these figures into the WACC formula, we were able to determine a weighted average cost of capital of 4.711%.
Calculating the Historic Growth Rate
To calculate the historic growth rate, we averaged the growth rate from the past 10 years. This yielded us an average historic growth rate of 7.212%.
Average Income Tax Rate
The average income tax rate for the past 10 years was determined to be 30.64%.
Next, the the relationship between sales and cost of sales, capital expenditures, depreciation, and net working capital are presented in the following table:
Projecting Sales Growth Rate
In order to determine the necessary annual growth rate to meet the 2016 sales projections, we had to make sure to adjust for inflation, these projections are presented in the following table:
Projecting 5-year Cash-Flows
Next, we attempted to project cash for the next five year to better understand the company’s current value. For this calculation, we used current cash flows of $8,323.50 and the growth rate of 5.44%. This yielded a projected cash flow of $8,776.30 million.
Estimating Projected Firm Value in 2016
Using a WACC of 4.71% and an inflation rate of 2%, we then calculated a perpetuity of future cash flows starting in 2016. This perpetuity came out to $96,990.12 million.
Estimating Total Firm Value
In order to determine the total firm value, we must take the present value of the cash flows in the next five years in addition to discounting the perpetuity beyond 2016. Combining these two calculations, yielded a total present value of $88,206.91 million.
Considering that Kraft’s E/V is 2/3 and D/V is 1/3, we can determine their
value in both equity and debt by multiplying the present value by those fractions, respectively. This yields a present equity value of $58,804.60 million and a present debt value of $29,402.30 million.
Fair Share Price
Considering that there are many current outstanding shares, the fair share price is likely higher than the current price. This makes Kraft a potentially attractive investment.
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