Consistency in Chocolate. A Fresh Look at Copeland's Hershey Foods & Co Case

11 Pages Posted: 19 Feb 2004

See all articles by Ignacio Velez-Pareja

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Joseph Tham

Duke University - Duke Center for International Development in the Sanford School of Public Policy; Academy of Public Administration under the President of the Republic of Kazakhstan

Date Written: January 18, 2004

Abstract

In cash flow valuation, on grounds of simplicity, it is common to assume that the leverage is constant over time. With constant leverage, the return to levered equity is constant and consequently, the Weighted Average Cost of Capital (WACC) applied to the Free Cash Flow is constant. However, typically the constant leverage is not reflected in the financial statements. Specifically, the values of the annual debt (as listed in the balance sheet) as percentages of the annual levered values are not constant. The Hershey case study in the popular book on valuation by Copeland et al. (2nd edition, 1995) is a good illustration of this common and widespread inconsistency. Distressingly, readers may not realize or recognize the inconsistency between the cost of capital and the financial statements and authors of textbooks make no attempt to mention it. The consistency between the leverage assumption in the WACC applied to the FCF and the values for the debt in the balance sheet can be resolved if the debt is rebalanced each year to maintain the constant leverage. In this paper, we demonstrate the inconsistency. First, we calculate the annual leverage and show that it is not constant. Second, we calculate the annual equity by subtracting the annual debt values from the annual levered values and demonstrate the discrepancies with the present value of the CFE. This paper is aimed to those who have learnt valuation with that edition (1995).

Keywords: Cash flows, Copeland, Hershey, free cash flow, cash flow to equity, valuation, levered value, levered equity value, terminal value, cost of levered equity, cost of unlevered equity, tax savings

JEL Classification: M21, M41, M46, G12, G31, J33

Suggested Citation

Velez-Pareja, Ignacio and Tham, Joseph, Consistency in Chocolate. A Fresh Look at Copeland's Hershey Foods & Co Case (January 18, 2004). Available at SSRN: https://ssrn.com/abstract=490153 or http://dx.doi.org/10.2139/ssrn.490153

Ignacio Velez-Pareja (Contact Author)

Grupo Consultor CAV Capital Advisory & Valuation ( email )

Ave Miramar # 18-93 Apt 6A
Cartagena
Colombia
+573112333074 (Phone)

HOME PAGE: http://cashflow88.com/decisiones/decisiones.html

Joseph Tham

Duke University - Duke Center for International Development in the Sanford School of Public Policy ( email )

Box 90312
302, Towerview Dr, Rubenstein Hall, Room 272
Durham, NC 27708
United States
919-613-9234 (Phone)
919-681-0831 (Fax)

HOME PAGE: http://fds.duke.edu/db/Sanford/faculty/thamjx

Academy of Public Administration under the President of the Republic of Kazakhstan ( email )

Abay Street, 33a
Astana
Kazakhstan
+7 8 7172753422 (Phone)

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