Solved: Coca Cola Company is a global soft drink beverage

company ticke

Coca-Cola Company is a global soft-drink beverage company (ticker symbol + KO) that is a
primary and direct competitor with PepsiCo. The data in Chapter 12’s Exhibits 12.13–12.15
include the actual amounts for 2008 and projected amounts for Year +1 to Year +6 for the
income statements, balance sheets, and statements of cash flows for Coca-Cola (in millions).
The market equity beta for Coca-Cola at the end of 2008 is 0.61. Assume that the risk-free
interest rate is 4.0 percent and the market risk premium is 6.0 percent. Coca-Cola has 2,312
million shares outstanding at the end of 2008, when Coca-Cola’s share price was $44.42.
In this problem, we use these actual and projected financial statement data to apply the
techniques in Chapter 14 to compute Coca-Cola’s required rate of return on equity and share
value based on the value-to-book valuation model. We also compare our value-to-book ratio
estimate to Coca-Cola’s market-to-book ratio at the end of 2008 to determine an investment
recommendation. In addition, we compute the value-earnings and price-earnings ratios and the
price differential and we reverse-engineer Coca-Cola’s share price as of the end of 2008.

Required
Part I—Computing Coca-Cola’s Value-to-Book Ratio Using the Value-to-Book Valuation
Approach.
a. Use the CAPM to compute the required rate of return on common equity capital for Coca-
Cola.
b. Using the projected financial statements in Chapter 12’s Exhibits 12.13–12.15, derive the
projected residual ROCE (return on common shareholders’ equity) for Coca-Cola for Years +1
through +5.
c. Assume that the steady-state long-run growth rate will be 3 percent in Year +6 and beyond.
Project that the Year +5 income statement and balance sheet amounts will grow by 3 percent in
Year +6; then derive the projected residual ROCE for Year +6 for Coca-Cola.
d. Using the required rate of return on common equity from Part a as a discount rate, compute
the sum of the present value of residual ROCE for Coca-Cola for Years +1 through +5.
e. Using the required rate of return on common equity from Part a as a discount rate and the
long-run growth rate from Part c, compute the continuing value of Coca-Cola as of the start of
Year +6 based on Coca-Cola’s continuing residual ROCE in Year +6 and beyond. After
computing continuing value as of the start of Year +6, discount it to present value at the start of
Year +1.
f. Compute Coca-Cola’s value-to-book ratio as of the end of 2008 with the following three
steps: (1) Compute the total sum of the present value of all future residual ROCE (from Parts d
and e). (2) To the total from (1), add 1 (representing the book value of equity as of the beginning
of the valuation as of the end of 2008).
(3) Adjust the total sum from (2) using the midyear discounting adjustment factor.
g. Compute Coca-Cola’s market-to-book ratio as of the end of 2008. Compare the value-to-
book ratio to the market-to-book ratio. What investment decision does the comparison suggest?
What does the comparison suggest regarding the pricing of Coca-Cola shares in the market:
underpriced, overpriced, or fairly priced?

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h. Use the value-to-book ratio to project the value of a share of common equity in Coca-Cola.
i. If you computed Coca-Cola’s common equity share value using the free cash flows to
common equity valuation approach in Problem 12.16 in Chapter 12 and/or the residual income
valuation approach in Problem 13.19 in Chapter 13, compare the value estimate you obtained in
those problems with the estimate you obtained in this case. You should obtain the same value
estimates under all three approaches. If you have not yet worked those problems, you would
benefit from doing so now.

Part II—Analyzing Coca-Cola’s Share Price Using the Value-Earnings Ratio, the Price- Earnings
Ratio, Price Differentials, and Reverse Engineering
j. Use the forecast data for Year +1 to project Year +1 earnings per share. To do so, divide the
projection of Coca-Cola’s comprehensive income available for common shareholders in Year
+1 by the number of common shares outstanding at the end of 2008. Using this Year +1
earnings-per-share forecast and using the share value computed in Part h, compute Coca-
Cola’s value-earnings ratio.
k. Using the Year +1 earnings-per-share forecast from Part j and using the share price at the
end of 2008, compute Coca-Cola’s price-earnings ratio. Compare Coca-Cola’s value-earnings
ratio with its price-earnings ratio. What investment decision does the comparison suggest?
What does the comparison suggest regarding the pricing of Coca-Cola shares in the market:
underpriced, overpriced, or fairly priced? Does this comparison lead to the same conclusions
you reached when comparing value-to-book ratios with market-to-book ratios in Part g?
l. Compute Coca-Cola’s price differential at the end of 2008. Compute Coca-Cola’s price
differential as a percentage of Coca-Cola’s risk-neutral value. What dollar amount and what
percentage amount has the market discounted Coca-Cola shares for risk?
m. Reverse-engineer Coca-Cola’s share price at the end of 2008 to solve for the implied
expected rate of return. First, assume that value equals price and that the earnings and growth
forecasts through Year +6 and beyond are reliable proxies for the market’s expectations for
Coca-Cola. Then solve for the implied expected rate of return (the discount rate) the market has
impounded in Coca-Cola’s share price. (Begin with the forecast and valuation spreadsheet you
developed to value Coca-Cola shares. Vary the discount rate until you solve for the discount
rate that makes your value estimate exactly equal the end of 2008 market price of $44.42 per
share.)
n. Reverse-engineer Coca-Cola’s share price at the end of 2008 to solve for the implied
expected long-run growth. First, assume that value equals price and that the earnings forecasts
through Year +5 are reliable proxies for the market’s expectations for Coca-Cola. Also assume
that the discount rate implied by the CAPM (computed in Part a) is a reliable proxy for the
market’s expected rate of return. Then solve for the implied expected long-run growth rate the
market has impounded in Coca-Cola’s share price. (Begin with the forecast and valuation
spreadsheet you developed to value Coca-Cola shares and use the CAPM discount rate. Set
the long-run growth parameter initially to zero. Increase the long-run growth rate until you solve
for the growth rate that makes your value estimate exactly equal the end of 2008 market price of
$44.42 per share.)

Coca Cola Company is a global soft drink beverage company ticke

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