Compute the coca-colas value-to-book ratio

Reference no: EM13902030

VALUATION OF COCA-COLA USING MARKET MULTIPLES. The 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 invest- ment 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?

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 com- puted 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 mar- ket'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 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 earn- ings 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. (Hint: 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.)

Text Book: Financial Reporting, Financial Statement Analysis and Valuation: A Strategic Perspective By James Wahlen, Stephen Baginski, Mark Bradshaw.

Reference no: EM13902030

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