Question

Estimating the Weighted Average Cost of Capital

Kellogg Company manufactures cereal and other convenience food under its many well-known brands such as Kellogg’s®, Keebler®, and Cheez-It®. The company, with over $13.5 billion in annual sales worldwide, partially finances its operation through the issuance of debt. At the beginning of its 2015 fiscal year, it had $6.5 billion in total debt. At the end of fiscal year 2015, its total debt had increased to $6.6 billion. Its fiscal 2015 interest expense was $227 million, and its assumed statutory tax rate was 37%. Kellogg has an estimated market beta of 0.60. Assume that the expected risk-free rate is 2.5% and the expected market premium is 5%.

Kellogg’s stock closed at $76.38 on December 31, 2015. On that same date, the company had 420,315,589 shares issued, of which 70,291,514 shares were in treasury.

a. What is Kellogg’s total market capitalization as of December 31, 2015?

Enter answer in billions, rounding to one decimal place.

$Answer billion

b. Compute Kellogg’s WACC.

Use your rounded answer above for computation.

Round answer to one decimal place (ex: 0.0245 = 2.5%).

Answer%

Answer 1

A: Market capitalization = (number of shares issued – shares in treasury)*market price per share

= (420,315,589-70,291,514)*$76.38

= $26,734,838,848.50

Or $26.7 billion

B:

WACC = Re x (E/E+D) + Rd (D/E+D)

= 5.5 x (26.73/33.28)

+ 3.47 x (6.55/33.28)

=4.42 + 0.68 = 5.10 %

Working:

re= rf + ? (rm - rf)
Where rf = risk free rate
rm - rf = market premum
Re = 2.5 +0.6 x 5= 2.5+3
re= 5.5%
Beginning Debt		6.5
Ending debt		6.6
Average debt   (6.5+6.6)/2    (D)		6.55
Market cap of equity (E)		26.73
Total Capital (E+D)		33.28
Interest expense for the year		0.227
Rate of interest (0.227/6.55) Rd		3.47%