1. Integrative Case: Henkel AGCost of Cost Capital Valuation The Cost of Capital at Henkel AG Professor David Wessels ©2010 The Wharton School of the University of Pennsylvania 3620 Locust Walk, Philadelphia PA 19104

2. Integrative Case: Henkel AGCost of Cost Capital The Cost of Capital at Henkel To value Henkel using DCF and to evaluate Henkel’s ability to create value, we need a robust estimate of the company’s cost of capital. Based on today’s low interest rates (the 10-year German Treasury trades at just 3.4%), we estimate Henkel’s after-tax cost of capital at 6.6%. This estimate is based on a cost of debt of 3.2% (using a default rating of A-), a cost of equity of 7.5% (using a relevered industry beta of 0.82), and a debt- to-value ratio of 22.0%. In this presentation, we step through the calculation of each component. We start with the cost of debt, followed by the cost of equity, and conclude with a short discussion on the company’s capital structure. Valuation, Measuring and Managing the Value of Companies 2

3. Integrative Case: Henkel AGCost of Cost Capital The Cost of Capital Valuation, Measuring and Managing the Value of Companies 3 Yield to maturity of 10- year German Treasuries German statutory tax rate reported by the company Yield to maturity of 10- year German Treasuries Estimated using betas from industry comparables We assume Henkel will maintain its current 22.0% debt-to-value ratio. We estimate the after-tax cost of capital for Henkel at 6.6%. The cost of capital is historically low, driven primarily by low interest rates (only 3.4% for 10-year German Treasuries) and a low beta for Henkel (estimate at 0.82). Cost of capital: 6.6% After-tax cost of debt: 3.2% Cost of debt: 4.6% Marginal tax rate: 31.0% Cost of equity: 7.5% Risk-free rate: 3.4% Industry beta: 0.82

4. Integrative Case: Henkel AGCost of Cost Capital Credit Ratings Since Henkel does not carry long-term debt, use the company’s credit rating to determine the cost of debt. As of its last rating, the company was rated A-, which translates to a yield-to-maturity of 4.63%. Valuation, Measuring and Managing the Value of Companies 4

5. Integrative Case: Henkel AGCost of Cost Capital After-Tax Cost of Debt Since interest is tax deductible, and this deduction is not included in free cash flow or ROIC, it must be incorporated into the cost of debt. In 2009, Henkel paid a marginal tax rate of 31%. Therefore, we reduce the cost of debt from 4.6% to 3.2 percent. Valuation, Measuring and Managing the Value of Companies 5 After-tax cost of debt = (1-31%) (4.63%)

6. Integrative Case: Henkel AGCost of Cost Capital The Risk Free Rate To calculate the cost of equity for Henkel AG, we start with a euro- denominated 10-year German Treasury rate. Use a risk-free rate from the same currency as the company’s cash flows to properly account for imbedded inflation (in both the cash flows and the cost of capital). In 2010, the 10-year Germany Treasury rate was 3.38%. Valuation, Measuring and Managing the Value of Companies 6

7. Integrative Case: Henkel AGCost of Cost Capital Cost of Equity: Unlevered Beta To compute the cost of equity, we rely on the CAPM, which in turn requires beta. To calculate beta, we first unlevered each company in the European HPC industry (as defined by JP Morgan). Henkel’s unlevered beta of 0.59 is at the upper range of its competitors. The relatively high unlevered beta is a factor of a high levered beta and a low level of debt. Valuation, Measuring and Managing the Value of Companies 7

8. Integrative Case: Henkel AGCost of Cost Capital Beta Calculations by Segment To calculate a cost of capital by segment, we look to industry competitors on a broader scale. Although no true “pure play” competitors exist, there is consistency within each segment. The unlevered beta is lowest for “Laundry & Home Care” (0.44) and highest for “Adhesives” (0.71). This is consistent with the stability of consumer staples and the cyclical nature of adhesives. Valuation, Measuring and Managing the Value of Companies 8

9. Integrative Case: Henkel AGCost of Cost Capital Valuation, Measuring and Managing the Value of Companies 9 To determine the cost of equity, we relever industry betas to Henkel’s debt- to-equity ratio. We then apply the capital assets pricing model: Cost of Equity by Segment using a risk free rate of 3.38% and a market risk premium of 5%. Based on a levered beta of 0.64, we estimate the cost of equity for Henkel AG at 6.6%.

10. Integrative Case: Henkel AGCost of Cost Capital Capital Structure To create the weighted average cost of capital, we weight the cost of debt and cost of equity by the market values of debt in equity. For Henkel, debt comprises 22.0% of the total enterprise value. Valuation, Measuring and Managing the Value of Companies 10