1 Coca-Cola Financial Review and Weighted Average Cost of Capital Study Jose Sola Florida Institute of Technology Spring 216 Financial Management Florida Institute of Technology
2 Index Introduction..3 Cost of Equity..5 Beta.5 Capital Assets Pricing Model...5 Discounted Cash Flow Approach 6 Own-Bond-Plus-Judgement-Risk Premium.6 Cost of Debt.6 Market Value of Debt..6 Market Value of Equity...7 Value of Firm...7 Tax Rate...7 Weighted Average Cost of Capital..7 Assumptions.8 Appendix..8 References..18
3 Introduction The Coca-Cola Company is the world s largest beverage manufacturer and distributor, producing several ready-to-drink beverages in over 2 countries. Incorporated in 1919, Coca- Cola owns and licenses a portfolio of more than 5 beverage brands comprised of carbonated drinks, still beverages, energy drinks, teas and juices among others. The company s shares are traded in the New York Stock Exchange (NYSE). In addition to the beverage operation, the company also produces and sells syrups and concentrates, including fountain drink concentrate. The company provides its beverages through a network of company-owned or controlled bottling and distribution operators, as well as independent bottling partners, distributors, wholesalers, and retailers. The company owns and markets four of the world s top five non-alcoholic sparkling beverage brands which include Coca-Cola, Diet Coke, Sprite and Fanta. With a global distribution system, Coca-Cola structures its operations into segments consisting of Eurasia and Africa, Europe, Latin America, North America, Asia Pacific, Bottling Investments, and Corporate. As part of its finished product operations, Coca-Cola generates net operating revenue by selling its ready-to-drink beverages to retailers, distributors, wholesalers or bottling partners who then distribute them to retailers. As part of this operation, the company also produces fountain syrups sold to restaurants, convenience stores or other authorized retailers. While its finished products operations generate higher net operating revenues, its concentrate operations generate higher gross profit margins. From its concentrate operations, the company generates operating revenue by selling concentrates and syrups to authorized bottlers, subsequently referred to as bottling partners. Bottling partners combine the concentrates with sweeteners and still or sparkling waters to create a finished product. It is then packaged in authorized containers such as cans or plastic bottles bearing the company s trademark and sold to
4 retailers or wholesalers. Outside the United States, concentrates are also sold to bottling partners to produce fountain syrups. In addition to its finished products and concentrate operations, the company generates revenues through distribution partnerships with Monster Energy Drinks, Dr. Pepper Snapple Group, and Nestle, through ownership of Aujan Industries which is one of the largest beverage companies in the Middle East. The company measures its sales volume based in two ways; units of cases of finished products which consist of 24, 8 ounce servings and concentrate sales which consist of equivalent unit cases that form the finished products. With over 1.9 billion of its beverages consumed daily in 215, the company had sales of 29.2 billion unit cases in the same year of which 19 percent were consumed by the United States. With 81 percent of its sales being worldwide, its largest consumers were Mexico, China, Brazil, and Japan accounting for 31 percent of worldwide cases sold. The main raw materials purchased for its products are nutritive and non-nutritive sweeteners, including sucralose and aspartame, juices and juice concentrates, and water. Headquartered in Atlanta, Georgia, the company owns and operates 63 production facilities and 1 concentrate manufacturing plants in North America. Outside North America, the company owns 18 production facilities and has a majority interest in 76 other facilities. In addition to its owned facilities, the company leases additional real estate for manufacturing, packaging and storing, and distribution of its products. As of 216, the company employed between 123,2 and 129,2 employees, of which 6,9 to 65,3 where based in the United States. The company controls 42 percent of the market share of the carbonated soft drinks market. Its main competitors include PepsiCo, which 3 percent market share, in addition to Nestle, Kraft Foods, and Suntory Beverage Company, among others. Other risk factors include;
5 raising trends in concerns of obesity which may lower future product demand, water scarcity or poor water quality, and global political unrest or conflict. Cost of Equity Beta Coca-Cola s beta was.58. The market has a beta of 1. and stocks with beta s higher than 1. represent stocks that a risk higher than the market with higher returns, while stocks with beta s less than 1. represent stocks with less risk in relation to the market. Coca-Cola s beta means that purchasing its stock can be considered safer investment. The company s beta was determined by performing a regression analysis of the company s closing stock price and the NYSE s closing price for the previous 5 years with an outcome of.43. Additionally, a beta of.8 was obtained from Google Finance and.52 from Yahoo Finance. In order to obtain a more comprehensive picture and to avoid placing emphasis on information that might skew one of the beta s, the three beta s were averaged resulting in a beta of.58 (.43+.8+.52/3). Capital Assets Pricing Model The model measures the required return of investors and the cost of equity from a firm s perspective. After previously determining Coca-Cola s beta, the company s required return using the CAPM was 4.94, meaning the company has a relatively low cost of equity and similar to its assumption from the beta coefficient, it signifies a relative lower risk investment. The risk free rate was determined using 1 year U.S. treasury yield. As there are several approaches to determining the market risk premium, a market risk premium of 5.5 was used for calculations as opposed to historical or forward-looking models with the assumption that the survey of experts provides a closer estimate of the market risk premium since data is obtained from experts which
6 might use historical or forward-looking components, in addition to being able to capture investor confidence and market trends. Discounted Cash Flow Approach In addition to the CAPM, cost of equity was calculated using the DCF approach. For the calculation, a historical growth rate of 8.7 was used. A growth rate based on historical data was used because the company has had decades of stability and has steadily paid dividends which have grown steadily. Additionally, dividends for 216 are expected to be $1.4 per share and the current price per stock was $46.2. Coca-Cola s cost of equity using the DCF approach was 11.7%. This yield s a number considerably higher than the CAPM and suggests that DCF approach might not be the most accurate in determining Coca-Cola s cost of equity because of the inexact nature of growth rates. Own-Bond-Yield-Plus-Judgment Risk-Premium (BPM) Cost of long-term debt was obtained by using the weighted yield to maturity on its bonds. Brigham and Ehrhardt (25) recommend a judgmental risk premium between 3 and 5 percent and as a result a midpoint of 4 was used for the judgment risk premium with a result of 5.1%. While not an exact calculation, the approach serves as a good ballpark estimate and would seem to support the results obtained with CAPM. Cost of Debt Coca-Cola s debt represents 14 percent of its capital structure and its cost of debt is 1.12 %. This suggests that the company generates most of its capital through equity as opposed to debt. This was calculated by obtaining the weighted yield to maturity of each of the company s bonds and adding the values. Market Value of Debt
7 Coca-Cola s market value of debt is $32.6 billion. That market value of debt was derived by obtaining the total market value of bonds, 31.9 billion and adding lease obligations of $716 million. Market Value of Equity Coca-Cola s market value of equity is just above $1 trillion. The value was calculated by multiplying the price per share of $46.2 by the number of shares outstanding of 4.3 billion. Value of the company Coca-Cola s market value is $232.6 billion. The firm s value was calculated by adding the previously discussed market value of debt and market value of equity. Tax Rate Coca-Cola s tax rate is 35% and was obtained from the company s 215 Annual Report to Shareholders From 1-K. Weighted Average Cost of Capital Coca-Cola s WACC calculation consisted of its weighted average cost of debt and its weighted average cost of equity, as the company does not have preferred stocks. As previously described, its weighted average of equity was 86% of its capital structure while weighted average of equity represented 14% of its capital structure. The company s WACC is 6.35%. This suggests that the company represents a lesser risk to investors. Additionally, it also represents the required return for the company on its investments and how much it pays for every dollar it finances. An excel spreadsheet was used to complete the calculation and reflects the results below. To start, the three results of cost of equity that were obtained using CAPM, DGM, and BPM were averaged, resulting in an average cost of equity of 7.3% (4.94 + 11.73 + 5.12 / 3). Weight of debt which represented 14% was then multiplied by after tax cost of debt (1-.35 tax
8 rate) and again multiplied by the cost of debt (1.12). These results were then added to the results of the weighted equity (86%) multiplied by the average cost of equity (7.3%). Assumptions The data used above assumes a risk free rate of 1.7483% and represents the current yield to maturity on 1 year U.S. Treasury note. Additionally, a market risk premium of 5.5% was used in calculating the data. The market risk premium was obtained from a survey of experts conducted by Fernandez, Pizarro, and Acin (215) comprised of 1,983 responses from financial experts, company managers, and financial and economic professors in the United States. The data above also assumes a growth rate of 8.7% composed of historical dividend data. Historical data was used as the company produces a stable dividend growth. This data was obtained from gurufocus, a financial website, which comprises and analyses financial data. Appendix Data for Beta Calculation and Regression Analysis Dividend data was obtained from Yahoo Finance and placed in a spreadsheet to perform regression analysis. The data bellow shows dividend data obtained for the company and the NYSE. NYSE Adj Market KO Adj KO's Date Close Return Close Return 4/1/216 1219.96.12 46.87.13 3/1/216 127.3799.678 46.39.84 2/1/216 9559.5327 -.76 42.79625.49 1/4/216 9632.7996 -.53 42.58787 -.9 12/1/215 1143.4199 -.256 42.62756.8 11/2/215 149.5898 -.49 42.292.141
9 1/1/215 146.96.675 41.7247.556 9/1/215 9799.6943 -.37 39.5657.292 8/3/215 1176.5 -.649 38.38623 -.428 7/1/215 1882.283.71 4.1444.472 6/1/215 185.22 -.227 38.29837 -.343 5/1/215 1156.2998.6 39.669.99 4/1/215 1149.742.138 39.27279.2 3/2/215 1899.194 -.148 39.2631 -.557 2/2/215 1162.79.499 41.588.517 1/2/215 1537.2197 -.279 39.53537 -.249 12/1/214 1839.242 -.16 4.54368 -.582 11/3/214 1955.412.12 43.55.778 1/1/214 1845.133 39.9411 -.183 9/2/214 172.9297 -.311 4.68499.3 8/1/214 1146.29.298 39.573.618 7/1/214 1726.4297 -.23 37.2 -.725 6/2/214 1979.4199.27 4.1669.432 5/1/214 1756.396.122 38.44469.29 4/1/214 1627.1699.94 38.33192.551 3/3/214 1527.7695.98 36.3328.21 2/3/214 1425.864.46 35.61581.1 1/2/214 9967.6539 -.416 35.26152 -.845 12/2/213 14.323.213 38.51542.279 11/1/213 1183.235.173 37.47119.228 1/1/213 19.6396.44 36.63649.446 9/3/213 9621.2423.378 35.7177 -.6 8/1/213 927.6616 -.31 35.943 -.474 7/1/213 9558.838.49 36.8474 -.7
1 6/3/213 9112.6943 -.24 36.86832.99 5/1/213 932.26953.27 36.557 -.553 4/1/213 9276.87988.186 38.64181.467 3/1/213 917.44.269 36.91648.52 2/1/213 8868.71973 -.29 35.9232.397 1/2/213 8894.7996.534 33.7598.273 12/3/212 8443.5977.222 32.85373 -.44 11/1/212 826.42969.47 34.36727.269 1/1/212 8221.439 -.36 33.46698 -.198 9/4/212 8251.295 34.1428.211 8/1/212 814.9318.192 33.43772 -.743 7/2/212 7863.9318.8 36.11989.334 6/1/212 781.83984.453 34.95314.534 5/1/212 7463.95996 -.87 33.17987 -.28 4/2/212 8119.66 -.17 33.88582.312 3/1/212 826.92969.115 32.8619.672 2/1/212 8113.2423.351 3.7921.345 1/3/212 7838.47998.483 29.76511 -.349 12/1/211 7477.2979 -.1 3.8459.48 11/1/211 7484.5 -.14 29.63288 -.88 1/3/211 7563.37988.1136 29.89614.112 9/1/211 6791.6499 -.979 29.56357 -.345 8/1/211 7528.3914 -.682 3.61937.359 7/1/211 879.43994 -.288 29.55889.17 6/1/211 8319.9961 -.187 29.24596.145 5/2/211 8477.2827 -.224 28.82862 -.96 SUMMARY OUTPUT
11 Regression Statistics Multiple R.459441 R Square.164796 Adjusted R Square.15395 Standard Error.365586 Observations 6 ANOVA Significance df SS MS F F Regression 1.152948.152948 11.443664.1296 Residual 58.775188.13365 Total 59.928137 Coefficient s Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.% Upper 95.% Intercept.72757.47397 1.535584.13269 -.22118.167633 -.2211825.16763266 X Variable 1.4279392.126526 3.3828486.1296.1747167.6811617.174716694.681161691 Capital Assets Pricing Model Capital Asset Pricing Model Where R rf = 1.7483 B i =.58 R p = 5.5 R i = R rf +B i (R P ) R i = 1.7483 +.58 x 5.5 R i = 2.3283 x 5.5 R i = 4.9383 Discounted Cash Flow Approach Discounted Cash Flow Approach R s = D 1 /P + g
12 Where: G= 8.7 D 1 = 1.4 P = 46.2 R s = 1.4/46.2 + 8.7 R s = 3.% + 8.7 % R s = 11.7 Own-Bond-Plus-Judgement Risk Premium R s = R d + Judgment risk premium Where: R d = 1.116 Judgement risk premium = 4% R s = 1.116 + 4. R s = 5.116 Cost of Debt A list of bonds issued by Coca-Cola was obtained from Morningstar. The bonds were placed in a spreadsheet where their market values and weights were calculated. The data is shown below. Name Maturity Date Amoun t $(Mil) Par Value Number Bonds Price YT M YTM as a decimal Market Value $(Mil) Weigh t Weighte d YTM Coca Cola 1.8% 9/1/216 1646. 1 1646 14..83.8 1652.58.5.4 Coca Cola 144A 1.8% 9/1/216 8.92 1 8923 1. 1.8.18 8.92.. Coca Cola.28275% 9/1/216 8.92 1 8923 996. 2.97.3 8.89.. Coca Cola.75% 11/1/216 5. 1 5 11..61.6 5.5.2.1 Coca Cola 11/1/216 5. 1 5 1..38.4 5..2.1 Coca Cola 3/9/217 2229.3 1 22293 1... 2229.3.7.
13 Coca-Cola 1/2/217 22.5 1 225 12... 22.91.1. Coca Cola.875% 1/27/217 75. 1 75 11..84.8 75.75.2.2 Coca Cola 5.35% 11/15/217 1159.8 1 11598 1192..9.9 1382.48.4.4 Coca Cola 1.65% 3/14/218 75. 1 75 114..89.9 76.5.2.2 Coca Cola 1.15% 4/1/218 125. 1 125 15..9.9 1256.25.4.4 Coca Cola 1.65% 11/1/218 125. 1 125 118..93.9 1272.5.4.4 Coca Cola 4.875% 3/15/219 89.7 1 897 1184..23.2 154.59.3.1 Coca Cola 9/9/219 2229.3 1 22293 1..27.3 2229.3.7.2 Coca Cola 1.875% 1/27/22 15. 1 15 117. 1.48.15 1525.5.5.7 Coca Cola 2.45% 11/1/22 125. 1 125 144. 1.45.15 135..4.6 Coca Cola 3.15% 11/15/22 1. 1 1 172. 1.53.15 172..3.5 Coca Cola 3.3% 9/1/221 1324.1 1 13241 18. 1.73.17 143.3.4.8 Coca Cola.28275% 9/1/221.35 1 35 179. 1.75.18.38.. Coca Cola 144A 3.3% 9/1/221.35 1 35 1. 3.3.33.35.. Coca Cola 1.125% 9/22/222 888.6 1 8886 1. 1.13.11 888.6.3.3 Coca Cola.25% 12/22/222 558. 1 558 124..13.1 571.39.2. Coca Cola.75% 3/9/223 1666.1 1 16661 1..75.8 1666.1.5.4 Coca Cola 2.5% 4/1/223 75. 1 75 126. 2.9.21 769.5.2.5 Coca Cola 3.2% 11/1/223 15. 1 15 172. 2.16.22 168..5.11 Coca Cola 2.875% 1/27/225 175. 1 175 137. 2.44.24 1814.75.6.14 Coca Cola 1.875% 9/22/226 1332.8 1 13328 1. 1.88.19 1332.8.4.8
14 Coca Cola 1.125% 3/9/227 1666.1 1 16661 1. 1.12.11 1666.1.5.6 Coca Cola 1% 1/2/228 583.3 1 5833 198..2.2 64.46.2. Coca Cola 1.625% 3/9/1935 1666.1 1 16661 1. 1.62.16 1666.1.5.8 Coca Cola 7.375% 7/29/1993 95.8 1 958 1379. 5.32.53 132.11..2 Mv Bonds 31898.64 Mv Leases 716. MV d 32614.64 1. 1.116% 433 Common shares MV e 246. preferred shares MV PF. Common Price 4/15/16 46.2 MV f 23266.64 preferred price W s.86 W d.14 w pf Market Value of Debt Mv Bonds 31898.64 Mv Leases 716. MV d 32614.64 Market Value of Equity Common shares 433 Common Price 4/15/16 from Yahoo Finance 46.2 MV e 246. Firm s Value
15 MV d 32614.64 MV e 246. MV f 23266.64 Weighted Average Cost of Capital Input Data (Millions Except Per Share Data) Source 215 Annual Tax rate 35% Report Form 1k Morningstar Bonds and 215 Annual Debt (D) $32,614,64,. Report Form 1k Number of common shares (n) Stock price per share (P) 4,33,, Yahoo Finance $46.2 Yahoo Finance Capital Structure (Millions Except Per Share Data) Market value of equity (S = P n) $2,46,,. Total value (V = D + S) $232,66,64,. Percent financed with debt (w d = D/V) 14.% Percent financed with stock (w s = S/V) 86.% Cost of Capital Morningstar Bonds Weighted cost of Cost of debt (r d ) 1.12% debt
16 Beta from 5 years Beta (b).58 data 3 Year Treasury Yield, Yahoo Risk-free rate (r RF ) 1.75% Finance 4/15/16 Market risk premium (RP M ) 5.5% Cost of equity from CAPM (r s = r RF + b RP M ) 4.94% Cost of Equity from Dividend Growth Model Future Dividend Growth Rate 8.7% 216 Dividend $ 1.4 $ Share Price $ (4/15/16) 46.2 Cost of Equity from Dividend Growth Model 11.73% Cost of Equity from Bond Plus Markup Cost of debt 1.12% Risk Markup 4.% Cost of Equity from Bond Plus Markup 5.12% Average rs 7.3% WACC 6.35%
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18 References 215 Annual Report on Form 1-K. (216, February 22). Retrieved April 15, 216, from http://www.coca-colacompany.com/investors/annual-other-reports/ Brigham, E. F., & Ehrhardt, M. C. (25). Financial management: Theory and practice. Mason, OH: Thomson/South-Western. Coca-Cola Co (KO) Dividend Data. (n.d.). Retrieved April 15, 216, from http://www.gurufocus.com/dividend/ko Coke Vs. Pepsi: By The Numbers. (214, March 24). Retrieved April 15, 216, from http://www.nasdaq.com/article/coke-vs-pepsi-by-the-numbers-cm33799 KO Coca-Cola Co XNYS:KO Stock Quote Price News. (n.d.). Retrieved April 15, 216, from http://www.morningstar.com/stocks/xnys/ko/quote.html Fernandez, P., Ortiz Pizarro, A., & Fernandez Acin, I. (215, April 23). Market Risk Premium & Risk-Free Rate Used For 41 Countries In 215. Retrieved April 14, 216, from http://www.valuewalk.com/215/5/market-risk-premium-risk-free-rate-used-for-41- countries-in-215/ The Coca-Cola Company. (n.d.). Retrieved April 15, 216, from http://finance.yahoo.com/q?s=ko