To evaluate a company using enterprise discounted cash flow (DCF), we discount free cash flow by the weighted average cost of capital (WACC). The weighted average cost of capital represents the opportunity cost that investors face for investing their funds in one particular business instead of others with similar risk.
To determine the weighted average cost of capital, calculate its three components:
- The cost of equity
- The after-tax cost of debt and
- The company's target capital structure
Since none of the variables is directly observable, we employ various models, assumptions, and approximations to estimate each component.
In this assignment you will be using financial information from Henkel AG and selected market data (in Excel) to assist in answering the questions given below.
Question
The cost of equity is built on the three factors:
- The risk-free rate
- The market risk premium and
- A company-specific risk adjustment
a. The most commonly used model for this estimate is the capital asset pricing model (CAPM). To determine the CAPM, we need to estimate a risk-free rate, the market risk premium and the market beta.
To determine the risk-free rate, please use Treasury data from the "select Market Data" spreadsheet. On the "Yields" tab, you will find yields to maturities for U.S. and German Treasury rates. For Henkel AG, which Treasury rate at which maturity is most appropriate to use in valuing the company?