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Table of Contents
1.0 The Coca-Cola Company..................................................................................................... 1 1.1 Global Beverages Industry ........................................................................................... 1 1.2 Competitors .................................................................................................................. 1 2.0 SWOT Analysis ................................................................................................................... 2 2.1 Strengths ....................................................................................................................... 3 2.2 Weaknesses ................................................................................................................... 4 2.3 Opportunities ................................................................................................................ 4 2.4 Threats .......................................................................................................................... 6 3.0 Porters Five Forces ............................................................................................................. 7 3.1 Threats of New Entrants ............................................................................................... 7 3.2 Threats of Substitute Products ...................................................................................... 8 3.3 Bargaining Power of Buyers......................................................................................... 8 3.4 Bargaining Power of Suppliers ..................................................................................... 9 3.5 Competitor Rivalry ....................................................................................................... 9 4.0 Ratio Analysis .................................................................................................................... 10 4.1 DuPont Analysis: ROE ............................................................................................... 10 4.2 Net Profit Margin........................................................................................................ 12 4.3 Total Asset Turnover .................................................................................................. 13 4.4 Equity Multiplier ........................................................................................................ 14 4.5 Additional Ratios ........................................................................................................ 16 4.5.1 Total Debt Ratio ...................................................................................................... 16 4.5.2 Debt-to-Equity Ratio ............................................................................................... 17 4.5.3 Net Working Capital Ratio ..................................................................................... 18 4.5.4 Current Ratio ........................................................................................................... 19 5.0 Analysis of Firm Risk ........................................................................................................ 21 5.1 Altman Z-Score .......................................................................................................... 21 5.2 Calculation of Beta ..................................................................................................... 22 6.0 Firm Valuation ................................................................................................................... 23 6.1 WACC: Weighted Average Cost of Capital ............................................................... 23 6.2 Dividend Growth Model ............................................................................................. 23 6.3 Recommendations: Buy Coca-Cola Stock ................................................................ 24 Appendix A: Rates of Return S&P500 and Coca-Cola ...............................................................
1.2 Competitors
The non-alcoholic beverages segment of the commercial beverages industry is highly competitive. Commercial beverages companies compete with each other in multiple geographic
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Mission Statement & Vision: The Coca-Cola Company. Coca-Cola: The Coca-Cola Company. Retrieved Oct. 26, 2011, from <http://www.thecoca-colacompany.com/ourcompany/mission_vision_values.html/> The Coca-Cola Company. (2010). 10-K Annual Report 2010. Retrieved Oct. 26, 2011, from SEC EDGAR. Datamonitor. (2011, June). Global Beverages Industry Profile. Retrieved Oct. 26, 2011, from Datamonitor Business Information Center.
areas. Competitive products include numerous non-alcoholic sparkling beverages, various water products, juices and nectars, fruit drinks, coffees and teas, energy and performanceenhancing drinks, dairy-based drinks, functional beverages and other ready-to-drink form. PepsiCo, Inc. is the primary competitors of The Coca-Cola Company in many countries, including the United States. Other significant competitors include Nestle, Dr. Pepper Snapple Group, Inc., Group Danone, Kraft Foods Inc. and Unilever.2
Internal
Opportunities External Increasing bottled water consumption globally Acquisition of CCE New product penetration Potential growth outside U.S. NARTD market growth
Threats Biggest competitor: PepsiCo Increasing cost of raw material Reduced demand worldwide due to health concerns & purchasing power Changes in consumer preferences
2.1 Strengths
Coca-Cola has been accepted as a part of American culture for over a century. One of the biggest strengths of Coca-Cola is the companys brand recognition. The Coca-Cola brand image is displayed on items ranging from clothing to souvenirs, and this recognizable branding helps distinguish Coca-Cola from competitors. Their brand is a symbol of enjoyment and quality, and it has allowed Coca-Cola to retain current customers and penetrate new markets.2 Coca-Cola owns four of the top five non-alcoholic beverage brands: Coca-Cola, Diet Coke, Sprite, and Fanta.4 The wide variety in their product line and product popularity gives the Coca-Cola a competitive advantage because of their huge market presence. The company has 500 brands and 3,500 beverages that are sold to consumers in over 200 countries around the world. Coca-Cola is considered one of the largest beverage manufacturers in the world, and of the 55 billion beverage servings consumed worldwide each day, 1.7 billion of those servings are trademarks owned or licensed by Coca-Cola. The companys global presence not only diversifies Coca-Colas revenue streams, but it makes the company less reliant on a single economy and reduces business risk.4 Datamonitor reports that Coca-Cola has the worlds largest beverage distribution system, and these distribution capabilities have allowed them to produce beverages on a global level. Their distribution network is difficult to copy and has acted as a sturdy barrier to entry in the industry. 4 The company has the highest market share in the global beverage market (and carbonated soft drinks market) and differentiates itself and through heavy advertising and promotion activities. According to a recent report published in Beverage-Digest, Coca-Colas market share for 2010 U.S. carbonated soft drinks (CSD) was 42.0% compared to PepsiCos CSD market share of 29.3%. 5 In the global beverages industry, which includes both alcoholic and non-alcoholic beverages worldwide, Coca-Cola holds a market share of 16.3%, which is almost double PepsiCos market share of 9.2%.4
Datamonitor. (2011, June). The Coca-Cola Company SWOT Analysis. Retrieved Oct. 26, 2011, from Datamonitor Business Information Center. Sicher, John (2011, May 17). Top-10 CSD Results for 2010. Beverage Digest. Retrieved Oct. 26, 2011, from <http://www.beverage-digest.com/pdf/top-10_2011.pdf/>
2.2 Weaknesses
Coca-Cola South Pacifics marketing director Lucie Austin says launching new flavors will always be a gamble for Coca-Cola. Never mind the extent of research that goes in to the planning phase, if the product doesnt connect with consumers, the whole brand is in trouble. Although Coca-Cola has been successful with new product launches, like Coke Zero, launches of products like New Coke have been disasters. The fact that some CocaCola products die off rapidly and disappear as if they never existed can be considered a weakness of Coca-Cola because the company does not always consider the impact of these new products entering the market.6 Product recalls have negatively impacted Coca-Colas brand image, which have decreased some consumers confidence in Coca-Cola products. In 2010, SmartWater PET Bottles were recalled in North America because the beverages did not meet the FDAs quality standards for bottled water. In 2009 at Coca-Cola Israel, traces of benzene and sulfur were found in 1.5 liter bottles of Coke and Diet Coke, which also resulted in a product recall.4 As a result of product recalls and consumer perception, destocking of Coca-Cola products is another weakness for the company. During product recalls, stores are forced to destock contaminated products. Businesses may choose to destock these products in response to actions the company may take, such as closing local bottling plants. In either case, destocking hurts the image of Coca-Cola, and consumers who wish to purchase Coca-Cola products cannot from these particular stores.
2.3 Opportunities
Bottled water consumption has been increasing rapidly around the globe, and this consumption increase is promising for Coca-Cola products like Dasani and SmartWater. According to recent bottled water statistics provided by the International Bottled Water Association, the overall consumption of bottled water in the U.S. has increased by 3.5% in 2010. The entire U.S. refreshment beverage category also grew by 1.2%, and bottled waters market share grew to 15% as consumer interest in healthy, calorie-free beverages increased.7
Marketing Mag. (2011, Oct. 7). Black Gold. Marketing Mag. Retrieved Oct. 26, 2011, from <http://www.marketingmag.com.au/features/black-gold-6884/> U.S. Bottled Water Volume Grew 3.5% in 2010 as Economic Conditions Begin to Improve. International Bottled Water Association. Retrieved Oct. 26, 2011, from <http://www.bottledwater.org/news/us-bottled-watervolume-grew-35-2010-economic-conditions-begin-improve/>
Coca-Colas acquisition of its major bottler in North America, Coca-Cola Enterprises (CCE), is an opportunity for Coca-Cola to take control of more company business functions and to become more flexible by integrating 90% of its regional volume. 4 Acquisitions, like CCE, extend Coca-Colas control over manufacturing and distribution all over the world and give the company opportunity for growth through new product launch or greater penetration of existing markets. According to Datamonitor, emerging countries in Asia and Africa account for 76% of the worlds population. The soft-drink market in Asia-Pacific has increased by 4.1% in 2010, and that percentage is expected to increase to 29.3% in 2015. Growth in these markets gives Coca-Cola an opportunity to establish new market bases and strengthen current ones to increase revenue and volume growth.4 Complementary food products will increase the drink consumption. When two complementary products used together, the value of each product increases; therefore people will more likely to buy Coca-Cola products with complementary food products that the company owns. The company will be able to enhance its brand awareness through complementary food products because the channels that beverage distributed will increase.8 Coca-Cola has had great success in the past with innovative products like Coke Zero, and if the company can continue developing new, popular beverages, there is an opportunity for company growth and increased profits. The nonalcoholic ready-to-drink (NARTD) beverage market is expected to grow at 6% per year over the next 12 years, which will increase retail sales in this industry to more than $1 trillion by 2020. This expansion is fueled by increase in middle-class consumers and indicates that there will be more people with more disposable income who potentially will tap into refreshment and convenience. 4 If Coca-Cola can take advantage of this growth through innovative, new products, the company can increase profits and market presence.
Harvard Business Review. (2008). The Five Competitive Forces that Shape Strategy by Porter, E. Michael. Retrieved Oct. 26, 2011, from AscendCFO website.
2.4 Threats
The increasing competition and ability to expand in emerging markets are two factors that might hurt the company. The major competitors are PepsiCo, Nestle, Dr. Pepper, Group Danone, Kraft Foods, and Unilever. Coca-Colas primary competitor, PepsiCo Inc., has been increasing advertising and promotion costs. In 2010, PepsiCo reported $824 million for marketing commitments for the next five year period. 9 However, as of the 2011 3rd quarter, the marketing commitments for the same time period increased to $2,501 million.10 The expected cost of marketing activities for the next five year period is $4,557 million for Coca-Cola. 2 Evolving customer preferences are a threat for most businesses, and public health concerns are a challenge to Coca-Cola and the beverage industry. Health advocates are also advising people to decrease their intakes of high fructose corn syrup (HFCS), a form of sugar which many Coca-Cola products contain. The United States government has increased the number of regulations associated with carbonated drinks, and some state public school systems have even banned soft drink sales on school campuses. Because consumer preference may be shifting to healthier drinks, growth rates for carbonated drink sales will likely decline, creating a threat for the company because carbonated drinks constitute 77% of Coca-Colas sales. Even though Coca-Cola offers healthy alternatives, these changing consumer preferences will decrease the sales of Coca-Cola carbonated drinks, which will decrease the companys overall profitability.4 Reduced consumer purchasing power has shifted customer preference to value products. In 2009, Coca-Cola refused to cut prices at Costco, which resulted in Costco destocking Coca-Cola products. As a result, Coca-Cola lost market share to PepsiCo. If Coca-Cola gives in to stores like Costco and Wal-Mart by lowering their prices, the pricing power of Coca-Cola and other beverage manufacturers also would decline.4 Water scarcity and poor water quality impact Coca-Cola production costs, because water is the main ingredient for most Coca-Cola products. Datamonitor predicts that by 2025, the demand for freshwater will rise by 56% of what people are currently demanding, which will result in increased production costs for Coca-Cola and possibly capacity constraints in production.4
9
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Pepsi-Co Inc. (2011, Sept. 3). Quarterly Report 2011. Retrieved Oct. 26, 2011, from Morningstar website. Pepsi-Co Inc. (2010, June). 10-K Annual Report 2010. Retrieved Oct. 26, 2011, from SEC EDGAR website.
The increasing price of raw materials, such as sugar and metals used in manufacturing, might have negative impacts on the companys operations. Especially, the fluctuations in the prices of those ingredients and packaging materials might cause harm for Coca-Cola. These factors will increase the operating costs which will increase the prices of final products. Consequently, high prices will result in a decrease in sales, and therefore in profitability.2 Coca-Colas worldwide operations are impacted by foreign exchange fluctuation, which means that increases or decreases in the value of the U.S. dollar against other currencies will impact financial statements denominated in foreign currencies. Devaluation of currencies can also negatively impact company earnings and assets in those markets.4
Customer and brand loyalty make it very problematic for new competitors to enter into the beverage industry. Coca-Cola is the most known beverage brand throughout the world, which has been made possible through advertising and marketing.2 Advertising and marketing are a key component for a new company to gain recognition from consumers. However, both these components require large amounts of funding to produce broad scale marketing campaigns that will gain the recognition needed to compete with industry leaders, such as Coca-Cola.8 Access to distributing channels is an important factor when entering into a new market. It can be tiresome for new entrants to find retailers that will carry their product before they are established. Shelf space will rarely be made for products that cannot prove they have consumers to regularly buy their product.2
Coca-Cola and other industry leaders have strict bottling contracts in all of their sales areas. These contracts block the bottling company from doing business with companies producing a similar product. One of the only alternatives for the new company is to do the bottling themselves, which requires high amounts of capital.8
Marketing and advertising, again, have a major impact on the substitute products. If the consumers do not know about a particular product, then retailers do not want to stock that product.8 The switching cost for retailers is fairly low, so retailers can easily switch to more popular products. This can create an advantage for the retailer from a cost standpoint and for the producers of the substitute product.2 Throughout the beverage industry, product lines are very similar in price between competing companies. Differentiation techniques are taken so consumers will choose their product. This can give substitute products the opportunity to use promotional influences to gain consumers favor.8
Fast food chains have the highest bargaining power out of the other buyers, simply because they buy in bulk. This method of purchasing provides the least profit for CocaCola due to small margins. It is more for the customer to sample the product and grow a loyalty toward the brand name.8 Vending machines provide a straight line approach from getting the product directly into the hands of the consumer. There is literally no bargaining power for the buyer.8 Convenience stores, like vending machines, have no bargaining power. The reason for this low bargaining power is because convenience stores pay inflated prices for the products since they are buying smaller quantities.8
Super markets have low bargaining power. The power they possess is best shelf space, but consumers usually make the final decision of the most popular products.8
The basic materials used to make Coca-Cola products are easily found with many suppliers. This ease of access gives a huge advantage to Coca-Cola because the company can set their own prices with the suppliers.8 Switching costs are also very low, so the ability for manufacturers to change suppliers is easily done.8 There is great emphasis put on the buyer industry to suppliers. The industry utilizes large quantities of raw materials the suppliers must remain in good standing with the buyers.8
Brand loyalty is a determinant of the rivalry between competitors. In the end the consumers chooses the product, so the rivalry comes in the form of advertising and marketing strategies to gain market value.2 Products in the industry are easily differentiated. This differentiation lowers the level of rivalry because each company is trying to create the next product that will have high consumer reviews.2 The ability for consumers to control the market greatly boosts competitor rivalry. Because stores stock their shelves with the most popular products, competitors are always fighting for their product to be the most popular and easiest to recognize.2
Expansion opportunities are one of the major factors affecting rivalry. The best way to gain market share is to enter into a market that is not already occupied by strong competitors.2
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Table 4.1: Return on Equity Year ROE 2006 2007 2008 2009 2010 0.30 0.28 0.28 0.28 0.38 Coca-Cola (NPM x AT x EM) (0.21 x 0.80 x 1.77) (0.21 x 0.67 x 1.99) (0.18 x 0.79 x 1.98) (0.22 x 0.64 x 1.96) (0.34 x 0.48 x 2.35) ROE 0.37 0.33 0.42 0.35 0.30 PepsiCo (NPM x AT x EM) (0.16 x 1.17 x 1.95 ) (0.14 x 1.14 x 2.01) (0.12 x 1.20 x 2.97) (0.14 x 1.08 x 2.37) (0.11 x 0.85 x 3.22)
The financial strength of a company can be determined by using DuPont analysis which breaks ROE into three parts: net profit margin, total asset turnover, and equity multiplier. Net profit margin (NPM) is used to measure operating efficiency. Asset turnover (AT) is a measure of asset use efficiency, and the equity multiplier (EM) is a measure of financial leverage. Each of these ratios is described in more detail below.
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Table 4.2: Net Profit Margin Year NPM 2006 2007 2008 2009 2010 0.21 0.21 0.18 0.22 0.34 Coca-Cola (Net Income Sales) (5,080,000 24,088,000) (5,981,000 28,857,000) (5,807,000 31,944,000) (6,824,000 30,990,000) (11,809,000 35,119,000) NPM 0.16 0.14 0.12 0.14 0.11 PepsiCo (Net Income Sales) (5,642,000 35,137,000) (5,658,000 39,474,000) (5,142,000 43,251,000) (5,946,000 43,232,000) (6,320,000 57,838,000)
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In the analysis of Net Profit Margin (NPM) the data shows that between the years of 2006 and 2010, Coca-Cola has had a larger Net Profit Margin than PepsiCo. This shows that PepsiCo is taking on a higher risk than Coca-Cola, and is susceptible to a net loss if there is a reduction in sales. Therefore, Coca-Cola is performing more efficiently, based on profit, than PepsiCo.
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Table 4.3: Total Asset Turnover Year AT 2006 2007 2008 2009 2010 0.80 0.67 0.79 0.64 0.48 Coca-Cola (Sales Total Assets) (24,088,000 29,963,000) (28,857,000 43,269,000) (31,944,000 40,519,000) (30,990,000 48,671,000) (35,119,000 72,921,000) AT 1.17 1.14 1.20 1.08 0.85 PepsiCo (Sales Total Assets) (35,137,000 29,930,000) (39,474,000 34,628,000) (43,251,000 35,994,000) (43,232,000 39,848,000) (57,838,000 68,153,000)
For every year between 2006 and 2010, PepsiCo has higher AT ratios than Coca-Cola. This indicates that, relative to the beverage industry, Coca-Cola is not efficiently using its assets to generate sales. However, as discussed above, due to the inverse relationship with NPM, CocaCola has a smaller AT than PepsiCo which means that Coca-Colas NPM is higher.
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Table 4.4: Equity Multiplier Year EM 2006 2007 2008 2009 2010 1.77 1.99 1.98 1.96 2.35 Coca-Cola (Total Assets Total Equity) (29,963,000 16,920,000) (48,671,000 21,744,000) (40,519,000 20,472,000) (48,671,000 24,799,000) (72,921,00 31,003,000) EM 1.95 2.01 2.97 2.37 3.22 PepsiCo (Total Assets Total Equity) (29,930,000 15,368,000) (34,628,000 17,234,000) (35,994,000 12,106,000) (39,848,000 16,804,000) (68,513,000 21,164,000)
Coca-Cola has smaller EM ratios than PepsiCo for every year between 2006 and 2010. Because this ratio shows a companys total assets per dollar of stockholders equity, CocaColas lower EM ratios indicate that they have lower financial leverage than PepsiCo. This relationship means that Coca-Cola relies less on debt to finance its assets than the industry.
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The Total Debt Ratio was calculated as (Total Assets - Total Equity) Total Assets for each year between 2006 and 2010 for both Coca-Cola and PepsiCo, and is shown for each year in Figure 4.5 and Table 4.5.2, 10 A TD ratio greater than 0.5 indicates that the company has more debt than assets, and both of these companies are below that number every year. However, Coca-Colas TD ratios were lower than PepsiCo every year. This finding means that PepsiCo has more debt relative to assets than Coca-Cola, and is therefore, more leveraged.
Figure 4.5: Total Debt
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Table 4.5: Total Debt Year TD Coca-Cola (Total Assets - Total Equity) Total Assets 2006 0.44 (29,963,000-16,920,000) 29,963,000 2007 0.50 (43,269,000-21,744,000) 43,269,000 2008 0.49 (40,519,000-20,472,000) 40,519,000) 2009 0.49 (48,671,000-24,799,000) 48,671,000 2010 0.57 (72,921,000-31,003,000) 72,921,000 0.69 0.58 0.66 0.50 0.49 TD PepsiCo (Total Assets - Total Equity) Total Assets (29,930,000-15,368,000) 29,930,000 (34,628,000-17,234,000) 34,628,000 (35,994,000-12,106,000) 35,994,000 (39,848,000-16,804,000) 39,848,000 (68,153,000-21,164,000) 68,153,000
4.5.2
Debt-to-Equity Ratio
The Debt/Equity Ratio was calculated as Total Debt Total Equity for each year between 2006 and 2010 for both Coca-Cola and PepsiCo, and is shown for each of these years in Figure 4.6 and Table 4.6.2, 10 Coca-Cola has a smaller D/E ratio for each year compared to PepsiCo, which means that PepsiCo has relied more on financing its growth with debt than Coca-Cola. Again, because these ratios are smaller for Coca-Cola, Coca-Cola is less leveraged than PepsiCo.
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Table 4.6: Debt To Equity Year D/E 2006 2007 2008 2009 2010 0.77 0.99 0.98 0.96 1.35 Coca-Cola Total Debt Total Equity 13,043,000 16,920,000 21,525,000 21,744,000 20,047,000 20,472,000 23,872,000 24,799,000 41,918,000 31,003,000 D/E 0.95 1.01 1.97 1.37 2.22 PepsiCo Total Debt Total Equity 14,562,000 15,368,000 17,394,000 17,234,000 23,888,000 12,106,000 23,044,000 16,804,000 46,989,000 21,164,000
4.5.3
The Net Working Capital Ratio was calculated as Current Assets Current Liabilities for each year between 2006 and 2010 for both Coca-Cola and PepsiCo, and is shown for each of these years in Figure 4.7 and Table 4.7. 2, 10 NWC essentially measures a companys operating liquidity. In reviewing the data PepsiCo is operating with a positive Net Working Capital, while Coca-Cola is operating at a working capital deficit for three of the five years shown. A number of scenarios could be the cause for Coca-Colas deficit, including: a small amount of
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assets readily convertible to cash, short-term loans from the bank, or lines of credit with suppliers.
Figure 4.7: Net Working Capital
Table 4.7: Net Working Capital Year NWC Coca-Cola Current Assets Current Liabilities 2006 2007 2008 2009 2010 -449,000 -1,120,000 -812,000 3,830,000 3,071,000 8,441,000 8,890,000 12,105,000 - 13,225,000 12,176,000 - 12,988,000 17,551,000 - 13,721,000 21,579,000 - 18,508,000 2,270,000 2,398,000 2,019,000 3,815,000 1,677,000 NWC PepsiCo Current Assets Current Liabilities 9,130,000 - 6,860,000 10,151,000 - 7,753,000 10,806,000 - 8,787,000 12,571,000 - 8,756,000 17,569,000 - 15,892,000
4.5.4
Current Ratio
The Current Ratio was calculated as Current Assets Current Liabilities for each year between 2006 and 2010 for both Coca-Cola and PepsiCo, and is shown for each of these years in Figure 4.8 and Table 4.8. 2,10 Current Ratio measures and companies market liquidity and
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whether or not the company has enough resources to pay its debts within the current accounting period. This means that for every dollar of short-term debt that is owed by the companies the current ratio of each year is the dollar amount of assets the firm has that can be converted to cash quickly. The data shows that PepsiCo has a larger value of resources to pay creditors than that of Coca-Cola.
Figure 4.8: Current Ratio
Table 4.8: Current Ratio Year CR Coca-Cola Current Assets Current Liabilities 2006 2007 2008 2009 2010 0.95 0.92 0.94 1.28 1.17 8,441,000 8,890,000 12,105,000 13,225,000 12,176,000 12,988,000 17,551,000 13,721,000 21,579,000 18,508,000 1.33 1.31 1.23 1.44 1.11 CR PepsiCo Current Assets Current Liabilities 9,130,000 6,860,000 10,151,000 7,753,000 10,806,000 8,787,000 12,571,000 8,756,000 17,569,000 15,892,000
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4.07
This beta was calculated using the returns from Coca-Cola and the S&P 500 from this year, 2011, and is shown in Appendix A. Using a Linear Regression Analysis (calculated in SPSS) with returns for the S&P 500 as the independent variable and returns for Coca-Cola as the dependent variable from Jan. 2006 Nov. 2011, is estimated at 0.517. 11 So, as you can see in the calculation of beta, The Coca-Cola Corporation is 51.7% as volatile or as risky as the market. The numbers generated through this calculation are shown in Table 5.2.
Table 5.2: Linear Regression Analysis Regression Statistics R2 Adjusted R2 Standard Error Observations ANOVA Coefficient R Coca-Cola
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T Stat 5.016
0.517
S&P 500 (2011, Nov). S&P Monthly Returns. Retrieved Dec. 4, 2011, from S&P website.
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From our previous calculation, in 2010 is 43.0%, is 57.0%. Beta equals 0.517, as calculated previously. Other variables included an Rf of 2.0%, which is the current 4 week Tbill rate. The risk premium was calculated as 12.3% - 2.0% = 10.3%. The effective tax rate for 2010 was 16.7% according to Coca-Colas 10k.2 historical market premium equals 12.3% and is based on market return from average return for large cap stocks as discussed in our Ch. 10 slides.
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We will use WACC for the required rate of return, because we want that to cover our cost of capital. Therefore, r = 0.0899. With a current dividend of $0.47, this gives us a $1.88 current year dividend (calculated as $0.47 4). From these estimates, we can calculate the following stock prices for next year, keeping the required rate of return constant and keeping the growth rate constant at our predicted 6.4%, as shown in Table 5.3.
Table 5.3: Stock Price Calculations Stock Price (Constant required rate of return)
Lower than expected growth (5.4%) Lower than expected growth (6.0%) Expected growth (6.4%) Higher than expected growth (7.4%)
As indicated in the calculations above, a change in the growth rate will change the intrinsic value at close to the same amount as a change in the rate of return using the Gordon Dividend Model. Also, we can see from the sensitivity analysis that a rise in the growth rate will increase the intrinsic value of the stock as well as a decrease in the growth rate will decrease the intrinsic value of the stock. Conversely, a rise in the cost of capital or required rate of return will decrease the intrinsic value of the stock and a decrease in the cost of capital will increase the intrinsic value of the stock.
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because the company has little power over the market threats. The second types of risks are related to companys financial results. Although market risks exist for Coca-Cola, we recommend buying Coca-Cola stock because the stocks intrinsic value is greater than the stock market price (currently $66.31), based on our expected growth rate and cost of capital.12 Therefore, we can conclude that Coca-Cola is undervalued in the market with the respect to its intrinsic value. However, if we have an expected growth rate lower than 6.0% or an expected cost of capital above than 9.45%, we recommend holding the stock, because in both cases, the company is overvalued with the respect to its intrinsic value. Because these numbers vary only fractions of a percentage from our expected growth and cost of capital, there is a chance that we would change our recommendations from a buy to a hold. Even though there are risks associated with these recommendations, Coca-Cola is a fairly stable company based on our Z-Score and Beta calculations, as discussed in Section 5.0, and we would recommend purchasing Coca-Cola stock for a long-term investment.
12
Google Finance: KO (2011, Dec. 5). The Coca-Cola Company (KO). Retrieved Dec. 5, 2011, from Google finance.
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Jun-08 May-08 Apr-08 Mar-08 Feb-08 Jan-08 Dec-07 Nov-07 Oct-07 Sep-07 Aug-07 Jul-07 Jun-07 May-07 Apr-07 Mar-07 Feb-07 Jan-07 Dec-06 Nov-06 Oct-06 Sep-06 Aug-06 Jul-06 Jun-06 May-06 Apr-06 Mar-06 Feb-06 Jan-06
-0.0843 0.013 0.0487 -0.0043 -0.0325 -0.06 -0.0069 -0.0418 0.0159 0.0374 0.015 -0.031 -0.0166 0.0349 0.0443 0.0112 -0.0196 0.0151 0.014 0.019 0.0326 0.0258 0.0238 0.0062 0.0014 -0.0288 0.0134 0.0124 0.0027 0.0265
-0.1232 0.1922 -0.0845 0.0902 0.1333 -0.0503 0.0748 0.0089 0.143 -0.0318 -0.0634 -0.021 0.121 0.034 0.0576 -0.0659 -0.0318 0.0511 0.0106 0.1677 0.0297 0.0571 -0.0455 0.0498 -0.0545 -0.0711 0.0123 0.1012 0.008 0.1074
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