Clorox’s financial information


Clorox’s financial information

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Problem

  1. Determine the cost of capital for CORPSTRAT’s client to enter the household products market to decide if entry would be worthwhile.
  2. Previous analysis of Proctor and Gamble was not an accurate representation of a new entry due to its market share in the industry as well as the financing strategy.  Clorox was used as a proxy, reflecting a company with smaller market capitalization.

 

Recommended Course of Action

  • Use Clorox’s financial information to determine client’s WACC.  Proctor & Gamble was not a suitable comparison because its larger market capitalization, $21.4 billion vs Clorox’s $2.2 billion.

 

  • Based upon CAPM model, derived return on equity of 13.87% using the following calculations:
    • Risk free rate – 8.47%, return of 10 year bond because project is long term.
    • Beta of equity – .9998, regression of  five years of Clorox returns.
    • Risk free premium – 5.4%, geometric mean of the premium derived from Common Stocks – Bonds from 1926-1988.

 

  • After achieving the return on equity, used the following calculations for the adjusted WACC of 12.91%:
    • Cost of debt – 8.22%, 3 month commercial paper, since firm was looking at short term bank loans to finance project.
    • Leverage ratio – .114, based upon total debt (from commercial paper and long term debt)/sum of total debt and stockholder’s equity.
    • Corporate tax rate – 34%

 

  • Return on equity using the accounting method, of net income/shareholder’s equity yielded 15.79%.

 

  • Opted not to use the dividend growth model because of Clorox’s small market capitalization of $2.2 billion.  The model would require a constant growth rate and the average growth rate from the previous eight years of 28.42% would not be sustainable and continued growth would be inconsistent until Clorox attained larger market capitalization .  Using dividend growth model, assuming 2% constant growth, return on equity was 14.4%.

 

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