# The Coca-Cola Company is a global soft-drink beverage company that is a primary and direct competitor with

## Question:

The market equity beta for Coca-Cola at the end of 2012 is 0.75. Assume that the risk-free interest rate is 3.0% and the market risk premium is 6.0%. Coca-Cola has 4,469 million shares outstanding at the end of 2012, when Coca-Cola's share price was $35.48.

REQUIRED

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 Exhibits 12.14-12.16, derive the projected residual ROCE (return on common shareholders' equity) for Coca-Cola for Years +1 through +5.

c. The projected income statements and balance sheets for Year +6 assume Coca-Cola will grow at a steady state growth rate of 3.0%. Derive the projected residual ROCE for Year +6 for Coca-Cola.

d. Using the required rate of return on common equity from Requirement 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 Requirement a as a discount rate and the long-run growth rate from Requirement 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 2012 with the following three steps:

(1) Compute the total sum of the present value of all future residual ROCE (from Requirements d and e).

(2) To the total from Requirement f (1), add 1 (representing the book value of equity as of the beginning of the valuation as of the end of 2012).

(3) Adjust the total sum from Requirement f (2) using the midyear discounting adjustment factor.

g. Compute Coca-Cola's market-to-book ratio as of the end of 2012. 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?

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.

j. Use the forecast data for Year þ1 to project Year þ1 earnings per share. To do so, divide the projection of Coca-Cola's comprehensive income available for common shareholders in Year þ1 by the number of common shares outstanding at the end of 2012. Using this Year þ1 earnings-per-share forecast and the share value computed in Requirement h, compute Coca-Cola's value-earnings ratio.

k. Using the Year þ1 earnings-per-share forecast from Requirement j and using the share price at the end of 2012, 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 Requirement g?

l. Note: For this part only, assume Coca-Cola's long-run growth beginning in Year þ6 will be 1% rather than 3%. With a 1% growth rate, Year þ6 comprehensive income will be $10,615 million. Compute Coca-Cola's price differential at the end of 2012. 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 2012 to solve for the implied expected rate of return. First, assume that value equals price and that the earnings and 3% long-run growth forecasts through Year þ6 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. (Hint: 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 2012 market price of $35.48 per share.)

n. Reverse engineer Coca-Cola's share price at the end of 2012 to solve for the implied expected long-run growth. First, assume that value equals price and that the earnings forecasts through Year þ5 are reliable proxies for the market's expectations for Coca-Cola.

Also assume that the discount rate implied by the CAPM (computed in Requirement 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.

Financial Statements

Financial statements are the standardized formats to present the financial information related to a business or an organization for its users. Financial statements contain the historical information as well as current period’s financial... Discount Rate

Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal...

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**Related Book For**

## Financial Reporting Financial Statement Analysis and Valuation a strategic perspective

**ISBN:** 978-1285190907

8th edition

**Authors:** James M. Wahlen, Stephen P. Baginski, Mark Bradshaw