PAPER : COST OF CAPITAL

PT INDOFOOD SUKSES MAKMUR Tbk

Syndicate 3 :
Christian Hamonangan 29113025
Irsyad Ahamadi 29113072
Kuspratama 29113021
Lea Shaula Salim 29113126
Mattheus Biondi 29113056
Aditya Ismoyo 29113065




Master of Business Adminstration
School of Business and Management ITB
2014
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I. Introduction
Many companies use a combination of debt and equity to finance their businesses, and for
such companies, their overall cost of capital is derived from a weighted average of all capital
sources, widely known as the weighted average cost of capital (WACC). Since the cost of
capital represents a hurdle rate that a company must overcome before it can generate value,
it is extensively used in the capital budgeting process to determine whether the company
should proceed with a project.

II. Company Profile

PT Indofood Sukses Makmur Tbk manufactures noodles and flour milling. Divisions The
company operates in four business groups: Consumer Branded Products, Bogasari,
Agribusiness, and Distribution. Consumer Branded Products (CBP) Group produces a range of
packaged foods, including noodles, food seasonings, snack foods, and nutrition and special
foods. CBP Group is supported by the Food Ingredients, Packaging, and International divisions.
Bogasari Group primarily produces flour, as well as pasta and supported by shipping unit.
Agribusiness Group engages in the research and development, oil palm seed breeding, and
cultivation, as well as refining, branding, and marketing of cooking oils. Its operation also
includes rubber, tea, and cocoa plantations. Distribution Group operates a distribution
network in Indonesia. It distributes the majority of the companys consumer products, as well
as third party products. Strategic Alliances The company has technical services agreements
with Pinehill Arabia Food Limited, Saudi Arabia (Pinehill) De United Food Industries Limited,
Nigeria (DUFIL), and Salim Wazaran Brinjikji Company, Syria (SAWAB). The company grants
Pinehill, DUFIL, and SAWAB nonexclusive licenses to use the Indomie brand in their
respective territories. In connection with the joint venture agreement between the company
and Nestle S.A., it licensed PT Nestle Indofood Citarasa Indonesia for the use of its Indofood
and Piring Lombok. History PT Indofood Sukses Makmur Tbk was founded in 1990. On
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September 4, 2013, the Company announced that it has raised its stake in China Minzhong
Food Corporation Limited from 29.59% to 51.62%

2012


III. Literature Review

The cost of debt is merely the interest rate paid by the company on such debt. However,
since interest expense is tax-deductible, the after-tax cost of debt is calculated as: Yield to
maturity of debt x (1 - T) where T is the companys marginal tax rate.

The cost of equity is more complicated, since the rate of return demanded by equity
investors is not as clearly defined as it is by lenders. Theoretically, the cost of equity is
approximated by :

The Capital Asset Pricing Model (CAPM) = Risk-free rate + (Companys Beta x Risk Premium).

A calculation of a firm's cost of capital in which each category of capital is proportionately
weighted. All capital sources - common stock, preferred stock, bonds and any other long-
term debt - are included in a WACC calculation. All else equal, the WACC of a firm increases
as the beta and rate of return on equity increases, as an increase in WACC notes a decrease
in valuation and a higher risk. The WACC equation is the cost of each capital component
multiplied by its proportional weight and then summing:
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Weighted Average Cost Of Capital (WACC)


Where:
Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V = E + D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate
Businesses often discount cash flows at WACC to determine the Net Present Value (NPV) of a
project, using the formula:
NPV = Present Value (PV) of the Cash Flows discounted at WACC.


IV. Analysis

While the Cost of Equity is a major expense for the company to maintain share price
could theoretically meet the expectations of investors . Calculation of Cost of Equity is
considered quite complicated because the new shares would be worth if the stock is
bought and sold . It is not like the Cost of Debt which the company has to pay a sum of
money in the form of a clear nominal interest .

Cost of Equity equation is as follows :

where :




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Rf : Risk Free Rate
This figure represents the value of % interest can be obtained in the absence of such risk
government bonds of emerging countries . Examples of U.S. Treasury Bills .

( Rm - Rf ) : Equity Market Risk Premium ( EMRP )
This figure represents additional compensation to the investor of the investment risk to
the company concerned .

: Beta Coeffecient
This figure illustrates how the company's stock price reaction to the stock market as a
whole . Beta value of 1 means the movement of stock prices in line with the movement
of the stock market . If the value of beta less than 1 means the company's stock price
folatilitas no effect on the stock market or in other words more stable .

The result of the calculation Cost of Equity in PT Indofood in 2012 with the CAPM
method is 7,70%. (The detail of the calculation can be seen in the excel files which
placed it in the same folder of this file).

Cost of debt (cost of debt) demonstrated how much it costs to be borne by the
company, if the company uses the funds derived from loans. We can calculate the cost
of debt of Nike using the yield to maturity (YTM) approach. In this paper we use the tax
rate of Indonesia in 2012 is 25%.

Calculation of Cost of Debt can use the following equation:

where:



Wd: Interest rate corporate debt
Q: Corporate Tax

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The result of the calculation Cost of Debt in PT Indofood in 2012 with the Yield to
Maturity approach is 2,23%

WACC (company - wide WACC ) should not be used if the investment project in question
does not have the same risk to the company's overall risk . However, in practice , the
company WACC can be the beginning of the project WACC determination that will be
used to download the discounted net cash flow ( net cash flow ) or free cash flow ( free
cash flow ) of investment projects .

when calculating the WACC using the formula above, note that the cost of equity capital
(rE) and loans (rD), the leverage ratio will be changed for this to different companies
mean, if the loan and total debt + equity (Debt + Equity) changing all the time, then
technically, the new WACC needs to be recalculated every time the component is
changed. The implication, WACC easiest to use when the ratio of loans to total loans +
equity is constant over the life of the project. However, in practice, small fluctuations in
the equity or loan will not result in re-calculation of WACC.

In calculating WACC details can follow the following equation where:



D: Total Debt
E: Total Equity
To: Cost of Equity
Kd: Cost of Debt

The result of the calculation WACC in PT Indofood in 2012 with the following
approach is 6,00%

Technically, the WACC will be said to be true, if the total amoun of loan is fixed /
constant. It is derived from the decrease in the WACC formula in the original writings. If
the amount of a fixed loan amount, the interest tax shield will remain throughout the
life of the investment project and logically, the tax savings from the use of the loan will
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have the same risk with the loan itself. Please note, the amount of the loan amount may
be fixed, but if the amount of the total amount of loans and equity changed, then the
WACC still need to be recalculated every time the total loans and equity changed.

V. Conclusion
So at the conclusion of this discussion is that if PT Indofood willing to make an investment in
the form of project funding should be the magnitude of the internal rate of return (IRR) on
offer is greater than 6%. In calculating the Profitability Index and Net Present Value
calculation results should be used as the basis of the WACC Cost of Capital in decision
making.
The basis of the calculation of the WACC can be so used if the assumption - assuming the
cost of capital is not a significant change . The assumptions in the model capital costs include
:
1 . Business risk is constant .
Business risk is the potential change in the level of return on an investment . The level of
business risk in a company is determined by the investment management policy . The cost of
capital is an investment that is only appropriate criterion for an investment that has the
same level of business risk with the assets that already exist .
2 . Financial risk is constant .
Financial risk is defined as the increase in variation of return on common stock due to
increased resource utilization pemiayaan debt and preferred stock . The capital cost of the
individual sources is a function of the current financial structure .
3 . Dividend policy is constant .
This assumption is necessary in estimating capital costs related to the company 's dividend
policy . This assumption states that the dividend payout ratio ( dividends / net income ) is
also constant .



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In addition , the result come from in the calculation of WACC are considered to be updated and
calculated again if there is a change in these factors that can affect the capital cost component is
controlled by a company which is as follows :

1 . Capital Structure Policy
WACC calculation is based on the interest rate of each capital components of the composition of its
capital structure . So if the capital structure changes, the cost of capital will change .

2 . Dividend Policy
As a result of the investment policy will take effect be risky . The size of this risk that will affect the
cost of capital .

3 . Interest Rate .
If interest rates rise in the interconnected economy , the cost of debt will also increase because the
company must pay the bondholders a higher interest rate to obtain debt capital .

4 . Tax Rates .
Tax rate used in calculating the cost of debt used in the WACC , and there are other ways that are
less obvious in which tax policy affects the cost of capital .






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Detail of the calculation