FINANCIAL ANALYSIS

Financial Analysis



Financial Analysis

Introduction

There is a requirement in the topic to assess the financial data of the company known as Henkel AG. There are several calculations that would be carried out in the topic. There are two questions that have different parts which needs separate calculation based on the given data. It is necessary to value a company by using the enterprise discounted cash flows (DCF), which is discounted by the technique known as Weighted Average Cost of Capital. The weighted average cost of capital represents an opportunity cost of capital that investors must evaluate before making any investment in one particular business. The risk assessment in this regard also carries immense importance. There are three components which must be calculated for the WACC that includes the cost of equity, the after-tax cost of debt and the company's target capital structure. The information would be taken from the company known as Henkel AG and the selected market data will be used as a guide to calculate the entire questions. Therefore, this is the overview of the task.

Background of the Financial Concepts

The detailed answer will be provided to this question in the following paragraphs. It is important to understand the concept of CAPM and WACC before approaching towards the calculation part. The theoretical part of both these concepts is important and a comprehensive understanding is necessary in this regard. The cost of the equity is a major instrument in calculating the WACC. The three main factors that are needed for the calculation of WACC is risk free rate, the market risk premium and a company specific risk adjustment. The main model that is used in this data is Capital Asset Pricing model. The CAPM usually requires a risk free rate, the market risk premium and the beta. The traditional mean-variance Capital Asset Pricing Model (CAPM) developed by the researchers known as Sharpe in 1964 and Lintner in 1965 has long served as the backbone of academic finance, and it has been used in numerous important applications (Agrawal & Mandelker, 1987, 837).

However, several studies indicate that the cross-section of stock returns cannot be explained by market beta alone as predicted by the CAPM. In particular, the mean-variance CAPM fares poorly in explaining the high risk premiums of portfolios formed by small cap, high book-to-market securities and momentum winners. For example, the researchers known as Harvey and Siddique in 2000 and Dittmar in 2002 studied the three-moment CAPM, which takes into account skewness in addition to mean and variance. The literature on downside risk, in contrast, considers semi variance, rather than variance, as the primary source of risk. These alternative asset pricing models fit stock return data better than the standard mean-variance CAPM, but size, value, and momentum effects remain. The three main characteristics of the model allow the A-CAPM to rationalize size, value, and momentum effects. In fact, small cap, high book-to-market securities, and momentum winners deliver higher loadings on the three factors that are priced by the A-CAPM (the ...