Value of the Shares of Coca Cola Company - Case Study Example

THE COCA-COLA CORPORATION. FURTHER ANALYSIS STUDENT:XXXXXX Table of Contents 1 Introduction……………………………………………………………………………...3 2. Thesis statement ………………………………………………………………………..4 3. Valuation of share………………………………………………………………………5 4. Determination of the value of shares…………………………………………………...5 5 .Determination of shares by use of divided yield……………………………………….6 6. Values compared for 2009……………………………………………………………...7 7. Values compared for 2008……………………………………………………………..8 8. Values compared for 2007…………………………………………………………….8 9. Present values of the expected cash flows……………………………………………..9 10. Working assumptions………………………………………………………………..10 11. Sensitivity analysis-for projects …………………………………………………….11 12. WACC……………………………………………………………………………….12 13. WACC……………………………………………………………………………….13 14. Conclusion……………………………………………………………………… …14 References……………………………………………………………………………….15 INTRODUCTION Coca-cola was started in 1886 and fully incorporated in 1972 by candler. It is one of the leading manufacture and distributor of a soft drink coke. Currently coca-cola has grown spreandly and has improved its products with time, with most current, the direct coke popular known for its vitamin content Coca-cola has variety of brands currently in the market like fresco,fanta ,diet coke,dasani water and many more. Indeed coca cola is known for its big market share in over 200 countries in the world. Investors may admire the performance of the coca-cola company and its advanced marketing network. They may be interested to own shares and also shareholders would want to how much divide they expect at the end of an accounting period. This may necessitate the valuation of the company’s shares to know its worth. It is therefore the responsibility of the management to give correction information when it comes to published accounts as this becomes the source of information to base when an investor is interested with a company. Other parties interested include the suppliers, the lenders and many others. THESIS STATEMENT The research paper deals with determination of the value of the shares of Coca Cola Company. The research has been built on the plat form of the previous assignment of the coca-cola corporation and will wholly rely on the figures given in the first assignment report. The objective is to determine the value of the share using reports given by the first assignment which was based on deponent model of analysis. The report discusses the present value of the future cash flows of the company to determine its worth by using divided yield model. The report will discuss sensitivity analysis and WACC, and how they affect the performance of the company. The report will discuss how coca-cola can use WACC to measure its credit worthy and how the management can use sensitivity analysis to measure investment risks and uncertainties as a tool. The report shall conclude by citing WACC and its implication to the business and importance of valuing the company’s performance. DETERMINATION OF THE SHARES Valuation is one of the tool investor uses in order to determine whether the value of the share is worth the buy and gives them the plat form on which to make a decision for investment. Basically there are many ways of valuing shares; one of it is the divided yield method, which an investor may use to know how much the share is worth. Divided is the percentage of profit of the company that is paid to its share holders according to the number of shares each member holds, which is a must for public limited company. VALUATION OF THE SHARES OF COCA-COLA COMPANY The value of a financial asset is its worth .valuation of financial assets is based on determining the present value of the future cash flows. Common stock represents an ownership interest in a company entities its owner to divided payments and capital gains. The valuation of share of stock is determined as the present value of the expected future divided stream. An investor may invest in bonds, preference shares or ordinary share. Ordinary share are not redeemable securities .R turns from ordinary shares takes two form ordinary share divided and capital gains. Ordinary share divided is expected to grow, hence the relatively simple annuity and per perpetuity formulae are used in valuation of bonds and preference shares cannot therefore be applied in valuation of ordinary share. Cash inflows expected from ordinary shares are there more difficult to measure and ascertain. Since ordinary shares are not redeemable securities, they are held by the investors infinitely .Cash inflows expected from ordinary shares consists of an infinite stream of divided payment. The present value of ordinary shares to the investors in general is therefore the present value of the infinite stream of divided payment .The divided payment is expected to grow at a constant rate denoted a letter(g). The value of shares to the investors in general is therefore determined by capitalizing the infinite stream of divided payment at the firm equity capital cost minus the growth rate. To get this there is a formula applied thus Po = Do (1+q) . Ke-g This is the basic share valuation model known as divided valuation model ,perpetual growth model or Gordon’s share valuation model ( Scott, jr,martin , petty, ke own 8 ed) Po: is the present value of the ordinary shares Ke; is the cost of equity capital (the minimum rate of return required by the investor in common equity capital) g: the growth rate in divide Do: is the current divided (most recent divided or divided for the year first ended D; is the expected divided, divided payable at end of year 1. The above model is based on the following assumption-; 1. Growth rate in divided (g) is assumed to be constant throughout. 2. The cost of equity (ke) is assumed to greater thin the growth rate in divided (g) otherwise absurd results would be attained example if Ke, were equal to (g) the value of the shares would be infinity. 3. Expected divided (1) is assumed to be greater than zero. However it should be noted that the perpetual growth model is only applicable in normal growth firm where growth rate is divided is constant throughout and divided may not always grow at constant rate. In a super normal growth firm divided would grow at very high rate during the years when the demand for the firm’s product is very high. As the demand for the products falls growth rate in divided would also fall. Eventually the divided may grow at a normal constant rate. The value of the shares in a super normal growth firm is determined by adding the total sum of the present value of the divided expected during the super normal growth period to the total sum of the present value of the divided expected during the super normal growth period. The formula is as under; Po= total sum of the divided expected in the super normal period. =total sum n /t =1Do (1+q) t+ qn Din ((1+g) t-n (1+Ke) (1+Ke) t Where: Do=present value of ordinary-shares N=super normal growth period. (Eugene F. Brigham, Philiph R. 8TH edition) Based on the above notes and the figure of the assignment we can get the value of shares of coca-cola for the years as follows. 2009 Valuation of common stock for year 2009. Vs=D/K D= divided payment K=required rate of valuation. Working assumptions 1. From the retained earnings for the year 2009, 37.911 meaning therefore a decrease of 602 (closing balance of 37.911 less opening balance of 38.513) 2. The net profit 1059 was paid as dividends Dividends per share =amount paid / number of shares = 1059/20712 =0.05 Required rate of return seen as 7% Therefore vs. = 0.05/0.07 =0.71 2008 VS=D/K D=divided per share K=required rate of return D=amount paid/ number of shares D=1511/20472 D=0.07 K= 5 %( =995/20472) VS=0.07/0.05 VS=1.5 2007 VS=DX/K D=1511/20223=0.075 K=5% =1.49 PRESENT VALUE FUTURE EXPECTED CASH FLOWS YEAR 1 2 3 2007 2008 2009 Cash flows 1511 1511 1059 Discounts 5% 5% 7% 1511 1511 1059 1+0.05 (1.05) ^2 91.07)3 NPV= 1,439 1,360 864 Q2. Compare your value of the shares with market values. Value of shares market value 2007 0.71 0.05 2008 1.5 0.07 2007 1.49 0.075 WORKING ASSUMPTIONS Market value is same as earning per share worked as amount of divided pay out / number of shares The final value of the share is higher than the market value as per the above computations. Valuation of final coca- cola V=debt +equity WACC =D/V I (I-T) + E/V Ke 2009 DEPT=3139 QUALITY=43,103 VALUE OF=46,242 FINAL 1. WACC= 3,139/46242+43,103/46,242*7% =0.0679+0.652==13.35 WORKING ASSUMPTIONS 1. a. ke =required value of return b. d=dept capital c. e=equity capital d. vr=value of firm e. l= rate of dept f. t=tax Sensitivity Analysis Investors are normally faced with many challenges when it comes to evaluating the risks involved in making investment decisions. There are many risks as well as uncertainties involved in various projects in business world. Risks refers to the possibility of a loss where as uncertainty refers to unavailable of information regarding a project or something. These two terms used interchangeably may mean that there is a possibility of the actual outcome of a project deviating from the expected. Risks may refer to several variables including the initial outlay of the project’s cash flows, government policies among others. The longer into the distance in future the more uncertain a variable is. (Myers B., principles of corporate finance). Sensitivity analysis is a tool used to evaluate risks and uncertainties. It is a behavioral approach that uses a number of possible values or decision to assess the risk inherent in an investment. The analysis indicates how sensitive the optimal solution (decision criteria ) is to changes in individual variables .it can be used to determine the critical variables for which additional information is required ,further it can be used to establish the maximum advance allowable changes in each critical variable.( Lucey T.,2002) Sensitivity may be of importance in various fields, like aids in data collection, identify good criteria to be used and also can be used in resource allocation. The management of coca-cola company may use such tools for evaluation purposes when taking any investment decision. Though according to the financial report of 2007-2009 the leverage decreased meaning the company should adjust its capital structure by reducing the debt portion. This becomes a signal in making future investment decisions. Weighted Average Cost of Capital. The weighted average cost of capital (WACC), refers to the average cost of raising funds from the available sources of funds. It is found by multiplying the specific costs of each source and sum up the results of the weighted costs and the results will indicate whether it is worthy for the company to take the debt. Mostly companies consider only the long term debts when calculating the WACC which is considered unwise. There are three schemes used in the computation of the WACC. The historical, Target and the market value weights. 1: Historical. This refers to the book value weights as depicted in the financial statement. The weights are easily obtainable from the published sources but are influenced by accounting policies used in the determination of net incomes and asset values. 2. Target. These are the weights of optimal capital structure as perceived by the management. This refers to the mix of debt and equity that management intends to maintain in the long run given the firms operating conditions and the attitudes of the management towards the risks. These weights are subjectively determined. 3. Market value weights. These are weights which are determined competitively in the markets through the forces of demand and supply. They reflect the relative market values or capitalization of various sources of finance. WACC is normally used to value proposed capital investment, though to some extent is used as a discount rate to value the whole company. According to Myers, valuing companies has no problems as long as the company is treated as one big project and forecast the company’s cash flow and discount back to the present value. Ideally WACC becomes the right discount rate if the company’s debt ratio is expected to remain to a constant. Further more if that is the way to go by, cash flows must be projected like capital investment project without interest and cash flows may not be forecasted to infinity. (Myers B., principles of corporate finance). The management of coca-cola can best make use of WACC to do evaluation on the best financing option best suits them by applying the WACC rate. The management should also consider by increasing the debt ratio to the company increase financial risks to shareholders and thereby reducing the rate of return. However there many theories which attempts to explain the relationship between the capital structures, firm’s value and cost of capital. By extension whether there is an optimal capital structure that simultaneously maximizes firm’s value and minimizes the over all cost of capital. Generally the use of leverage magnifies earnings (EPS) and the effects of leverage on cost of capital however is not clear hence capital structure theories. One of the notable is the Modigliani-miller theorem, 1958 -without taxes. He argued in the absence of taxes the firm’s market value and cost of capital remain a variance to independent capital structure changes and capital structure is irrelevant. They argued that if two firms are similar in all respects except for their capital structure and market values then this represents a disequilibrium that cannot persist or continue for long. Investor will soon realize that one firm is over valued and the other is under valued ,they will sell the shares of over valued firm, buy shares of the under valued firm and continue this arbitrage process until the two firms command the same market value. CONCLUSION The management of the coca-cola company must ensure that the capital structure of the company is optimal. They must apply all the available managerial tool in ensuring balance is attained in the capital structure of the company. They are supposed to publish their management account on quarterly basis to asses how the company is performing. The management should not only rely on the internal operation but should take care of the external competition in order to maintain the high trend in business growth. References Dirk J, 2003, Lecture Notes, Finance Theory II Gordon, Myron J. (1989). "Corporate Finance under the MM Theorems". Financial Management   Pannell, D.J. (1997). Sensitivity analysis of normative economic models: Sobol’, I. (1990). Sensitivity estimates for nonlinear mathematical models. Anderson, K.; Brooks, C. (2006). The Long-Term Price-Earnings Ratio Lucey T.(2002), Qualitative Techniques ,6th edition Myers B.,principles of corporate finance 8th edition. Lucey T.2003,management Accounting 5th edition Read More