Corporate Finance Project

on
Estimation of Beta and Weighted Average Cost of
Capital (WACC) of selected stock (HUL)

Under the Guidance of

Dr. Barnali Chaklader

GROUP 5

Siddhartha Mazumdar (190103143)

Harshita Jain (190103060)

Kartik Laad (190103067)

Kabir Kumar (190101053)

Sumedh Harsh Bhagwat (190103151)

Srujan Mukkavili Sarma (190103081)

OBJECTIVE OF THE WORK

1. To select a company of our choice and calculate the Beta of that company to measure
the volatility.
2. To calculate the Cost of Capital of the same company.

INTRODUCTION

The Beta coefficient is used for measuring the systematic risk or the volatility of an
individual stock when compared to the unsystematic risk of the market. Statistically, it is a
representation of the slope of the regression of data points from a stock's returns against those
of the market.

The beta coefficient is used in CAPM, which is used to calculate the expected return of an
asset and uses beta and expected market returns. Beta describes a security's returns activity
responding to swings in the market. It is calculated by dividing the product of the covariance
of the gains by the variance of the market's returns over a period.

Beta coefficient helps investors understand how risky it is compared to the market. A stock
that deviates very little from the market doesn't add much risk to a portfolio, but it also
doesn't increase the theoretical potential for higher returns.

The cost of capital is the minimum return that a business must earn before generating value.
A company must make a sufficient income to cover the cost of the money it uses to fund its
operations.

The cost of capital consists of both the cost of debt and the cost of equity used for financing a
business. A company's cost of capital depends to no small extent on the type of financing,
i.e., equity or debt, or use a combination of the two.

The choice of financing is crucial for any company as it will determine the company's capital
structure. So they look for the optimal mix of funding that provides adequate funding and
minimizes the cost of capital.

Investors use the cost of capital as one of the financial metrics they consider in evaluating
companies as potential investments.

The conventional approach is to use the Weighted Average Cost of Capital (WACC). All
sources are included in the calculation, and each source is given a weight relative to its
proportion in the company's capital structure.

The cost of debt in WACC is the interest rate that a company pays on its existing debt. The
cost of equity is the expected rate of return for the company's shareholders.
ABOUT THE COMPANY

HUL works every day to create a better future and helps people look and feel good and, get
more out of life with products that are good for them and others.

They have over 35 brands spread across 20 distinct categories such as packaged foods, soaps,
detergents, shampoos, skincare, kinds of toothpaste, deodorants, cosmetics, tea, coffee, ice
cream, and water purifiers, HUL is a part of the everyday life of more than millions of
consumers across India. Its portfolio includes top household brands such as Lux, Lifebuoy,
Surf Excel, Wheel, Fair & Lovely, Pond’s, Vaseline, Lakmé, Dove, Clinic Plus, Rin, Sunsilk,
Pepsodent, Closeup, Axe, Brooke Bond, Bru, Knorr, Kissan, Kwality Wall’s and Pureit.

Hindustan Unilever has around 18,000 employees and has sales of INR 37660 crores (the
financial year 2018-19). It is a subsidiary of Unilever, which is one of the world’s leading
suppliers of Food, Home Care, Personal Care, and Refreshment products. It has sales in more
than 190 countries and an annual turnover of €51 billion in 2018. Unilever has over 67%
shareholding in HUL.

Hindustan Unilever Ltd was incorporated in 1933 as Lever Brothers India Ltd. United
Traders Ltd and Hindustan Vanaspati Mfg. Co. Ltd. merged with the company in 1956 and
the name was changed to Hindustan Lever Ltd. Lipton was acquired in 1972, and Lipton Tea
(India) Ltd was incorporated. Brooke Bond joined in 1984 through an international
acquisition. Pond's Ltd joined in 1986 through an acquisition of Chesebrough Pond's USA.

The liberalization of the Indian economy which started in 1991, clearly marked an inflexion
in the company's growth curve. The removal of regulatory framework allowed the company
to explore every single product and opportunity segment, without any constraints on
production capacity. Simultaneously, deregulation permitted alliances, acquisitions and
mergers.
 Methodology

 Beta Estimation
For Beta Estimation, the weekly adjusted close price of the stock (Hindustan Unilever
Limited ) and benchmark index (NIFTY50) for a period of 5 years from FY14-FY19 was
selected. NIFTY 50 was chosen as stock HUL is constituent of NIFTY 50 Index. Percentage
change in adjusted close price of HUL and Nifty50 was calculated. Beta was estimated using
three methods

o Covariance Method

1. Find the Variance of the stock using =VAR.S(all the percent changes of the asset).
2. Find the Covariance of stock to the benchmark index using =COVARIANCE.S(all
the percent changes of the asset, all the percent changes of the benchmark).

o Slope Method

Use the slope function of Excel.

SLOPE(known_y's, known_x's)
Where
known_y's is an array of %change in HUL stock
known_x’s is an array of %change in benchmark index NIFTY50.
Slope is Beta of stock

o Regression Method

Run regression through an array of datasets.

The slope of X-Intercept in regression analysis is Beta.
 X Variable 1 Line Fit Plot
0.2

0.1 Y
Y Predicted Y
0
8 6 4 2 0 02 0 4 0 6 08
.0 .0 .0 .0 0. 0 . 0 . 0.
-0 -0 -0 -0 -0.1
X Variable 1

Beta found by all three methods is 0.6464

Unelevred Beta was not found as HUL has 0.00 Debt to equity ratio (D/E) hence
levered and un-levered Beta is the same .

 WACC Estimation
The WACC( Weighted Average Cost of Capital) is based on a company's capital
structure (how it is financed) and consists of both debt financing and equity financing. The
cost of capital is how much firm pays to finance its operations (either debt or equity). As per
HUL’s Annual Report it doesn’t have any debt or preference share liability hence Cost of
Debt and Cost of Preference Share wasn’t computed.

o Cost of Equity (Ke)

Dividend Growth Model was used to estimate Cost of Equity (Ke). As HUL is one of the few
firms which pays out dividend regularly Dividend Growth Model was chosen over Capital
Asset Pricing Model (CAPM) to estimate Cost of Capital. Company Database and Yahoo
Finance were sources for historical dividend payout data and ex-dividend market price.
Formula for Cost of Capital (Ke) is
Ke = (D1 / P0) + g
Where
Where:

P0 = ex-dividend equity value today.

D1 = expected future dividend at Time 1 period later.
Ke = cost of equity per period.
g = constant periodic rate of growth in dividend from Time 1 to infinity.

Cost of Equity (Ke) found by Dividend Discount method is 0.11485 or 11.485%

CAPM (Capital Asset Pricing Model ) model takes into account the asset's responsiveness to
systematic risk, often denoted by the beta (β) in the financial sector , as well as the expected
return of the market and the expected return of a risk-free theoretical asset. CAPM assumes
alternatively asset returns whose probability distributions are completely defined by the first
two moments and zero transaction costs.

CAPM = Rf + β (Rm-Rf)
Where
Rf is Risk-Free Return
Rm is Market Return
Β is Beta of equity or stock

Cost of equity measured using (Ke) CAPM method is 11.46%

 Analysis and Interpretation

Hindustan Unilever Limited has a Beta of 0.64, which means the stock is less volatile than
the underlying market index (NIFTY50). For a risk-averse investor, HUL stock can be a
better choice as it is less volatile than the market index. A risk-averse investor can mitigate
systematic risk by choosing low beta stocks like HUL.

Determinants of HUL’s Beta

 Cyclicity of Revenues
Companies behave differently with business cycles. The earnings of some firms fluctuate
more with the business cycles. Their profits grow during the growth phase of the business
cycle and decline during the contraction phase. FMCG Companies like HUL have a steady
revenue stream which don’t vary with the business cycle. As most of there are essentials or
staples, they aren’t affected much by a slowdown. A stock's profits may be highly variable,
but it may not have high beta. The profitability variability is an example of a specific risk that
can be diversified. Cyclically of a company’s earnings, on the other hand, is the variability of
its earnings vies-à-vis the aggregate earnings of the economy.

 Operating Leverage
The operating leverage measures how sensitive a firm (or project) is to its fixed costs.
Operating leverage rises as fixed costs rise and variable costs fall.HUL has an operating
leverage of 1.80. Operating leverage magnifies the effect of cyclicity on beta. HUL has
operating leverage less than that of the index (NIFTY50) it’s constituent of which has
operating leverage of around 2.2

 Financial Leverage
Financial leverage is the sensitivity of a company’s fixed costs of financing. Financial
leverage always increases the equity beta relative to the asset beta. According to its annual
report, HUL has no long term debts; hence, its financial leverage is zero. A firm with lower
financial leverage has a lower beta.
 Weighted Average Cost of Capital (WACC)

As the capital structure of HUL is pure equity (100% equity ). The cost of equity is the cost
of capital. HUL undertakes any new project or launches a new product it’s internal rate of
rate return (IRR) should at least be more than 11.48% for it to be successful. According to
RBSA Report WACC of FMCG Companies is at 14.8% while that of HUL is just 11.48 %.
HUL is performing better than it’s peers by having a cheaper source of funding. If any
projects offer returns below the cost of capital it’s destroying shareholder wealth.WACC is
also used to find the Net Present Value of the company as WACC is taken as discount rate for
NPV estimation. A lower WACC entails superior valuation for firm.
 Limitations and Conclusions

Beta will be reliable only if the script trades frequently. The conclusions might be biased if
beta of an illiquid stock.
Beta just indicates the volatility of a security in viz a cis to the market and not in general.
Security or asset might be risky in nature but not correlated with market returns (β=0). So, it
should be used cautiously.
Beta does not provide the complete picture of the stock’s risk profile. It is suitable for
measuring short-term volatility but in long-term investors will find it less utility . Long-term
investors will have to include multiple underlying factors along with market risk to get a full
picture.

The CAPM has serious pitfalls in the real world, as most of the assumptions, are impractical .
Many investors do not diversify in a systematic manner. Besides, Beta coefficient is
inconsistent, varying from period to period depending upon the method of computation. They
may not be representative of the true risk involved. Due to the unstable nature of Beta it may
not reflect the future volatility of yield , although it is based on the Past history. Empirical
evidence of the tests of Betas showed that they are unstable and that they are not useful
estimates of future risk. But the Betas of a portfolio may be stable.

For companies like HUL with negligible debt WACC is fully dependent of Cost of Equity
which in turn is dependent on Dividend payout. Companies can easily manipulate or keep the
dividend payout ratio very low to reflect lower WACC. Hence WACC not useful for
companies having 100% Equity capital structure .
References

1. https://www.investopedia.com/ask/answers/063014/what-formula-calculating-weighted-
average-cost-capital-wacc.asp
2. https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-wacc-
formula/
3. http://people.stern.nyu.edu/adamodar/podcasts/valspr15/valsession6.pdf
4. http://www.hec.unil.ch/ejondeau/lecturenotes/EMBA/Print_EJ_Lecture1.pdf