Kohler Case

Kohler Co.

Lead Case

BUSFIN 4213 T/TH 8AM Group H:

Aubrey Gartlan, Austin Garcia, Caitlyn Crawley,

Carter Brown, Faith Constance, Junhan Ge,

Max Kadish, Michael Rhoa, Sebastian Dangond

In order to determine if Kohler is better off taking their dispute to court or settling with dissenting shareholders, we must first evaluate the firm to determine the “fair” share price.  Our team has decided to analyze the firm through multiple different approaches, including diversified and consolidated discounted cash flow models as well as a multiples approach, in an attempt to give as accurate a valuation as possible.

Before calculating the weighted average cost of capital (WACC), we must come up with discount rates to represent multiple views of investors. We looked at the well-diversified investor that is not exposed to idiosyncratic risk, and we also looked from the perspective of an investor who has a high concentration of their portfolio with Kohler. In order to find the WACCs, we must calculate the betas. We came up with both a diversified beta and a concentrated beta to represent the different risks of the investors. Finding the diversified beta is very similar to finding the beta of a common public company. We used Kohler’s competitors’ numbers to unlever their respective betas. After unlevering the betas, we combined them using a weighted average to create a combined unlevered beta to represent Kohler. We used a 73.33% weight for the kitchen and bath companies, while using a 26.67% for the power systems companies.  After finding a weighted average debt to equity ratio, we relevered the beta to ultimately end up with a diversified beta of 1.26. This beta is lower than the beta from the perspective of the concentrated investor. This lower WACC makes sense since it is less risky than the concentrated WACC. (Exhibit 1a)

As mentioned before, there can be many perspectives on the Kohler share price. If an investor has many of their assets in Kohler shares, they are much more exposed to risks of the company not performing well. This higher risk requires a higher WACC due to the higher expected returns from investors. We found this higher beta by dividing the standard deviation of the stock with an 80/20 split of kitchen and bath and power systems (5.8%) by standard deviation of the market (3.3%). We chose this standard deviation because we found the weight of Kohler to be 73.33% for kitchen and bath, and 26.67% for power systems, which is very similar to the 80%/20%. This resulting in a higher concentrated beta of 1.76.

With the betas, we then solved for Cost of Equity using the CAPM formula. We got a risk free rate of 6.07% from using the 20 year T-bills from the case and the return on market of 10.62% was found using the geometric mean from historical data since 1928. Using CAPM, we got a return on equity of 14.07% for the concentrated perspective, and an 11.8% for the diversified perspective. To find the cost of debt we simply looked at the interest payments and book value of long-term debt each year from 1993-97 and divided them to get an average ratio of 7.37%.