Calculation of cost of equity using capm approach

Reference no: EM1315060

Calculation of cost of equity using CAPM approach

All questions relate to the Kimberly-Clark Corp. Annual Report (Form 10-K) for the year ending December 31, 2007. Kimberly-Clark (the "Company") "is a global health and hygiene company with manufacturing facilities in 36 countries and its products are sold in more than 150 countries." The Company's "products are sold under such well-known brands as Kleenex, Scott, Huggies, Pull-Ups, Kotex and Depend."

The Company operates in the Paper Mills industry. Median data relating to the Paper Mills industry are:

ROE	10.35%
Beta	0.97
Market-to-book	1.97
Net profit margin (Return on sales)	5.86%
Total asset turnover	1.12
Financial leverage	1.56
Gross profit margin	22.93%
Receivable days (Average collection period/Days to collect)	48.06
Inventory days (Days inventory held)	62.42
Payable days (Days to pay)	32.29
Current ratio	1.59
Interest coverage (Times interest earned)	1.81

Note: Although an individual company's ROE is the product of net profit margin, total asset turnover, and financial leverage, this relationship will not hold when using the three median variables as shown above because medians distort the relationships among individual company ratios.

Please read the instructions and each question carefully.

Some aspects of Kimberly-Clark's (hereafter, the "Company") 2007 financial statements are noteworthy.

1. Two "above-the-line" special, non-recurring items were reported. The first item was a $107.2 million net charge ($61.4 million after tax (given in annual report)) for a strategic cost reduction plan allocated as follows on a pre-tax basis: $89.4 million charge included in Cost of products sold; $31.8 million charge included in Marketing, research and general expenses; and $14 million gain on dispositions of facilities included in Other (income) and expense, net (See MD&A, pp. 24-25, Note 2, pp. 49-52). The second item was an $16.4 million gain for a settlement of litigation that was included in Other (income) and expense, net (See MD&A, p.25). The after-tax amount for the first item is given; however, consider the second item a taxable gain.

2. Treat Redeemable preferred securities of subsidiary, included in the balance sheet, as interest bearing debt in problem 8(d). Do not treat this item the same way as the preferred stock adjustment that was discussed in Module 5, p.23. Assume that the preferred dividends are already included in the interest expense reported in the 2007 income statement.

Show the adjustments for each problem individually and not a cumulative adjustment unless the question directs you to do so.

(a) Compare the Company's computed ROE (a)+ with its cost of equity capital, where the risk free rate is 5%, the market risk premium is 4%, and the Company's beta is .61. What does this comparison tell an analyst?

2007 Cost of equity capital ____________________
Discussion:

(b) The Company's year-end market price per share was $69.34. Compute the market-to-book ratio as of the end of 2007. What does this ratio reveal? How does it compare to the industry? Include all the appropriate adjustments addressed earlier in the exam as they apply to book value.

2007 Market-to-book ratio ____________________

Reference no: EM1315060

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