Procter & Gamble: Cost of Capital

To assess whether a company should enter the household-products market, Procter and Gamble's weighted-average cost of capital is computed. Clorox's cost of capital is also computed as a check on the P&G estimate. The case emphasizes the conceptual as well as mechanical aspects of computing cost of capital for a company with homogeneous business risk and stable capital structure. Excerpt UVA-F-0931 PROCTER AND GAMBLE: COST OF CAPITAL Since February 19, 1990, three days previously, Mary Shiller had been looking forward to receiving a reaction from her boss regarding her estimate of Procter and Gamble's (P&G) cost of capital. Ms. Shiller reported directly to Ron Emory, the president of CORPSTRAT, a consulting firm located in Washington, D.C. CORPSTRAT had been successful since its founding in 1980 by providing high-quality analysis for a few large corporate clients. Recently one of its largest clients had revealed that it was considering entering the household-products market and competing directly with P&G, the detergent and soap giant. The client's chief financial officer had stated that his company had become “a highly diversified conglomerate with subsidiaries spanning a host of unrelated businesses” and that “our company's overall cost of capital is neither useful as a benchmark for any of the existing subsidiaries, nor as a hurdle rate for entering new markets like consumer products.” Although the CFO's staff had computed its own estimate of the household-products industry's cost of capital, the CFO wanted an independent estimate before taking the plan to the board of directors in March. If the estimated cost of capital was “significantly lower than the expected return” of entering the new market, he fully expected the company to introduce its own brand of detergents, soaps, cleansers, and personal-care products by the end of 1990. CORPSTRAT had never before been asked to compute a client's cost of capital. The company's real expertise was defining and evaluating the strategic goals of a corporation. Therefore, upon receiving the client's request, Ron Emory quickly assigned the task to Ms. Shiller in order to take advantage of her recent exposure to financial theory in her MBA curriculum. Ms. Shiller decided that she would compute P&G's cost of capital, because P&G was the dominant player in the household-products and consumer-goods markets. Since this was her first project after joining CORPSTRAT, she had spent many hours preparing the first draft of her analysis as a memo to Mr. Emory (Exhibit 1). Unfortunately, Emory's memo in response to her work (Exhibit 2) indicated that much remained to be done. Exhibit 1 . . .