Coca Cola Harvard Case Study
Michael Barrett Michael Abaci Michael Bloch argali Biennially FIN 6416 Case 1: Valuing Coca Cola stock Executive Summary The case that has been presented is a valuation of Coca Cola, its current stock price, and whether Coca Cola has the potential to be a good recommendation for clients to add to their portfolios. The analysis herein takes into account historical Coca Cola financial information, and uses the information to ascertain whether or not Coca Cola, at its current stock price of $58. 0 a share, is a viable security for investors o add to their portfolios.
Methodologies The completed analysis of Coca Cola’s investment potential required the use of a few calculations to gather enough information regarding the selling price of its stock. Rhea first of these calculations used is the Capital Asset Pricing Model (Exhibit 1). This model was used to calculate the required rate of return for an investor in Coca Cola. In this calculation, Beta was set at 1. 24, and the risk free rate was set at the 30-year government bond rate of 6.
The market risk premium was set at the stated 5. 00% rate, resulting in a required rate of return of 13. 66%. Once this required rate of return was calculated, the Dividend Discount Model Exhibit 2) was used to calculate a forecasted 1997 stock price for Coca Cola.
Using the required rate of return of 13. 66%, a forecasted dividend of $0. 62, and the expected constant dividend growth rate of 12% for this calculation, the model has forecasted a 1997 stock price of $37. 35. For this analysis, a PIE ratio calculation (Exhibit 3) was used to estimate the Coca Cola stock price.
To calculate this, it was stated that Coca Cola was currently traded at PIE ratio of 35, forecasted earnings per share for 1997 was stated at $1. 0 per share, and the model calculated a stock price of $59. 50. Sensitivity analysis has also been completed for these calculations to consider any changes in the numbers used in our methodologies above. Sensitivity Analysis The analysis has taken into account the possible fluctuations of several variables in the market and performance of competitors.
The variables in the first calculation are Beta, dividends per share, and the expected dividend growth rate (Exhibit 2).
Regarding Beta, the values range from a level of volatility that is less than that of the market to almost twice that of the market. Given the historical information, the real ‘alee has a 99. 7% chance to fall within the calculated range (Exhibit AAA). A potential limitation to the usefulness of the sensitivity analysis can be found in the dividend gar n model to stock valuation.
The dividend payout ratio used is a five year average of Coca Cola’s payout ratio (Exhibit B).
This does not take into account the consistent pattern of decreasing dividend payouts. Conversely, the decreased payout ratio leads to higher amount of retained earnings. The analysis has also used a five year average for the blowback ratio, and the calculated number s lower than the recent actual retained earnings. These assumptions, particularly in the areas of growth rate, show that more information is needed in these areas.
Exhibit 3, AAA, and B showcase the PIE Multiple valuation model. The variables on Coca Cola’s data show that unless Coca Cola maintains its price to earnings ratio that is 15.
8% above the industry average, another significant drop is projected. Using the average and below average numbers of the industry and Pepsi shows an expected and pessimistic stock valuation scenario, respectively. The overall conclusion of the sensitivity analysis is supportive of the original ululations that Coca Cola is currently overvalued.
The majority of possible scenarios resulting from variations of the inputs project a future stock price with ‘raying directional strengths, but a consistent downward movement in price. Recommendation The results of the analysis speak clearly. The recommended action is to sell Coca Cola.
At the time of this analysis, Coca Cola is currently selling for $58. 00 per share. Calculated prices in this analysis have shown this price to be inflated as of 1997. Holders of this security should either liquidate the security or hedge their long positions.