CASE HINDUSTAN UNILEVER LIMITED

Hindustan Unilever Limited (HUL) was known as paying dividends regularly. HUL’s shares have enjoyed
Hindustan Lever Limited (HLL) until 18 May 2007. The high price in the stock market. The company’s sales and
company was set up in 1933. It completed 75 years of assets have shown significant growth, and company’s
operations in India on 17 October 2007. It is an important profitability has also increased over years (Table 9.1.2).
subsidiary of Unilever. Unilever has a large number The company is conservatively financed (Table 9.1.2).
of subsidiary and associate companies in more than
100 countries. HUL’s business areas include home and Table HUL’s Financial Performance
personal care, foods and beverages, industrial, agricultural
and other products. It is one of the largest producers of (` million)
soaps and detergents in India. The company has grown 2011 2012 2013
organically as well as through acquisitions.
Gross sales 202,854.40 228,003.20 266,797.60
HUL places equal focus on serving both the employees
and the shareholders, and it is committed to add value PBIT 27,304.40 33,502.84 43,744.95
to both. Over years, the company has built diversified Interest 2.40 1.24 250.15
portfolio of powerful brands, a number of them being PAT 21,532.50 25,992.00 3,314.35
household names.
Share capital 2,181.70 2,159.50 2,162.50
The company requires the cost of capital estimates
for evaluating its acquisitions, investment decisions and Reserve & Surplus 23,653.50 24,435.70 24,577.70
the performance of its businesses and for determining Loan Funds 17043.1 14711.1 560.94
the value added to shareholders. It needs to develop a
Capital employed 40,696.60 39,146.80 25,138.64
methodology of calculating costs of equity and debt and
determine the weighted average cost of capital.
Cost of Capital Assumptions at HUL
HUL’s Performance The company considers cost of its debt as the effective
rate of interest applicable to an ‘AAA’ rated company. It
Table 9.1.1 contains a summary of HUL’s EPS, DPS, share thinks that considering the trends over years, this rate is
price and market capitalization. The company has been

Table HUL: EPS, DPS, Share Price and MCAP

Year 2003 2004 2005 2006 2007 2008-09 2010 2011 2012 2013
EPS 8.05 5.44 6.40 8.41 8.73 11.46 10.10 10.58 12.46 17.56
DPS 5.50 5.00 5.00 6.00 9.00 7.50 6.50 6.50 7.50 18.50
MV 204.7 143.5 197.3 216.6 213.9 237.5 238.7 284.6 409.9 466.1
MCAP (` million) 4505.9 3158.7 4341.9 4778.8 4657.5 5177.0 5207.7 6145.9 8860.0 10079.3
Note: Data adjusted for bonus shares (stock dividend).

9.5 per cent in 2013. The risk-free rate is assumed as the
yield on long-tern government bonds, which the company
regards as about 8 per cent. HUL regards the market-risk
premium to be equal to about 3 per cent. The company
uses CAPM to calculate its cost of equity. The alternative
method is the constant growth model. HUL’s beta is 0.708.
Discussion Questions
1. Calculate HUL’s cost of equity by using the
dividend-growth model.
The Cost of Capital 215
2. Calculate HUL’s cost of equity by using the
capital asset pricing model. Do you agree with the
company’s assumptions regarding the estimates
of the risk-free rate and the market premium?
3. Between the dividend-growth model and CAPM,
which method do you recommend to HUL and
why?
4. Calculate HUL’s cost of assets reflecting only the
business risk?
5. What is HUL’s before tax and after-tax weighted
average cost of capital (WACC)?
 CASE SOLIDAIRE INFRASTRUCTURE COMPANY

Solidaire Infrastructure Company has three businesses The power division has strongly opposed the use of
organized under three separate divisions. The cement the firm’s WACC as cut-off rate for allocating funds and
division has its manufacturing plant in Gujarat. It sells evaluating its investment projects. The divisional head
about two-thirds of its cement in Gujarat and the remaining of power argues that his division is not exposed to the
quantity in Rajasthan and Madhya Pradesh. The fertilizers demand uncertainty, and it has steady flow of earnings.
division manufactures and markets urea in Gujarat, Hence, its operating risk is much less than the risks of
Maharashtra and Madhya Pradesh. The power generation other divisions. He also thinks that the power division
division, under a long-term agreement, supplies three- has a higher debt capacity; as an independent company,
fourths of power generated to the government of Gujarat it could easily borrow four times of equity. He wondered
at an agreed price, which is periodically revised with that because of the low operating risk and high debt
mutual consent of the two parties. All three divisions are capacity, the cut-off rate for his division should be lower.
profitable and they have plans to expand their activities The CEO and some divisional heads thought that the
in the future. Table 9.2.1 gives some financial data for corporate-wide, single cut-off would ensure that only the
the divisions. highly profitable projects will be accepted, and thus, the
Table 9.2.1: Financial Data for company will be able to maximize the shareholders wealth.
Solidaire Infrastructure Company They also thought the average borrowing capacity of the
(` million) company defines the total amount that it can borrow, and
therefore, the debt capacity of a division is not relevant.
Cement Fertilizer Power The target debt-equity ratios for the fertilizer and cement
Division Division Division Solidaire divisions, respectively, are 2:1 and 2.5:1.
Sales 700 450 350 1,500 The CFO didn’t subscribe to this reasoning. According
PAT 29 17 24 70 to him, the cut-off rates of the divisions should reflect
Assets 550 230 420 1,200 their unique risk-return characteristics and debt-bearing
Current assets 210 100 20 330 capacities. Each division has its own economic sector
Equity in which it competes with other firms. According to
(Market value) 1,000 him, the company’s beta is the average of the betas for
Debt 1,800 divisions, and it reflects average risk. He argued that
if there are synergy benefits, than there is a possibility
Solidaire has so far used the corporate-wide weighted that the average beta of divisions will be less than the
average cost of capital (WACC) as a cut-off rate for allocating company’s beta.
funds to the divisions. The company uses CAPM to
The CFO suggested that the cut off rates of the
determine the cost of equity. Its equity beta, as observed
divisions should be calculated as if they were stand
in the market, is 1.5. Investments of the company have
alone companies. Their risks and debt capacities should
long gestation period and lives. Therefore, it uses yield
be considered in the calculations of cut-off-rates by using
on 30-year government bonds as the risk-free rate, which
data of the comparable firms in the market. He asked
currently is 5.6 per cent. The company’s estimates show
his assistant to collect relevant information about the
that the 30-year simple average of the Sensex stock returns
comparable firms so that he could estimate the cut-off
is 17.6 per cent, and 30-year government bonds’ yield is
rates for divisions. The assistant was unable to identify
7.8 per cent. The current debt-equity ratio of Solidaire is
a comparable power generation firm as most firms were
1.8:1. Being a highly capital intensive company, it has a
under the government control and they did not have
target debt-equity ratio of 2.5:1. The company after-tax
market data. The information about two comparable
average borrowing rate is 8 per cent.
cement and fertilizer firms is given in Table 9.2.2.