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Sheet1
Tool Kit for Capital Structure Decisions
Optimum Capital Structure Problem (Millions of Dollars Except Per Share Data)
NUMBERS IN RED MUST BE INPUTTED, NUMBERS IN BLUE ARE CALCULATED
Input Data (Millions Except Per Share Data) Data From:
Tax rate 39%
Debt (D) $2,119,560,000.00
Number of shares (n) 728,100,000
Stock price per share (P) $12.81
Capital Structure (Millions Except Per Share Data)
Market value of equity (S = P n) $9,326,961,000.00
Total value (V = D + S) $11,446,521,000.00
Percent financed with debt (wd = D/V) 18.5%
Percent financed with stock (ws = S/V) 81.5%
Cost of Capital Data From
Cost of debt (rd) 3.26%
Beta (b) 1.14
Risk-free rate (rRF) 2.87%
Market risk premium (RPM) 6.54%
Cost of equity (rs = rRF + b RPM ) 10.31%
Cost of Equity from Dividend Growth Model
Future Dividend Growth Rate 10.60%
Last Dividend $ 0.0345
Share Price $ (4/5/13) $ 12.81
Cost of Equity from Dividend Growth Model 10.90%
Cost of Equity from Bond Plus Markup
Cost of debt 3.26%
Risk Markup 7.20%
Cost of Equity from Bond Plus Markup 10.46%
Average rs 10.6%
WACC 8.97%
ESTIMATING THE OPTIMAL CAPITAL STRUCTURE
The optimal capital structure is the one that maximizes the value of the company. Also, that same capital structure minimizes the WACC. We begin by estimating how capital structure affects the costs of debt and equity. The effects on debt are usually estimated by talking with bankers and investment bankers. Discussions with its bankers indicate that Strasburg can borrow different amounts, but the more it borrows, the higher the cost of its debt. Note: the percentages are based on market values.
Estimating Optimal Capital Structure (Millions of Dollars)
Percent of Firm Financed with Debt (wd)
10% 15% 20% 25% 30% 35% 40%
1. ws 90.00% 85.00% 80.00% 75.00% 70.00% 65.00% 60.00%
2. rd 2.80% 3.00% 3.26% 3.50% 4.00% 5.00% 5.75%
3. b 1.07 1.11 1.15 1.20 1.26 1.33 1.41
4. rs 9.85% 10.11% 10.41% 10.74% 11.12% 11.56% 12.07%
5. rd (1T) 1.71% 1.83% 1.99% 2.14% 2.44% 3.05% 3.51%
6. WACC 9.04% 8.87% 8.72% 8.59% 8.51% 8.58% 8.64%
Notes: 1. The percent financed with equity is: ws = 1 wd
2. The interest rate on debt, rd, is obtained from investment bankers.
3. The levered beta is estimated using Hamada’s formula, and unlevered beta of bU = x
and a tax rate of 39%: b = bU [1 + (1-T) (wd/ws)].
4. The cost of equity is estimated using the CAPM formula with a risk-free
rate of 2.87% and a market risk premium of 6.54%: rs = rRF + (RPM)b.
5. The after-tax cost of debt is rd (1T), where T = 39%.
6. The weighted average cost of capital is calculated as:
WACC = ws rs + wd rd (1-T).
THE HAMADA EQUATION
Hamada developed his equation by merging the CAPM with the Modigliani-Miller model. We use the model to determine beta at different amount of financial leverage, and then use the betas associated with different debt ratios to find the cost of equity associated with those debt ratios. Here is the Hamada equation:
b = bU x [1 + (1-T) x (D/S)]
b = bU x [1 + (1-T) x (wd/ws)]
bU = b / [1 + (1-T) x (wd/ws)]
Here b is the leveraged beta, bU is the beta that the firm would have if it used no debt, T is the marginal tax rate, D is the market value of the debt, and S is the market value of the equity.
Levered beta, b 1.14
Current wd 19%
Current ws 81%
Tax rate 39%
bU 1.0012
As shown above, beta rises with financial leverage. With beta specified, we can determine the effects of leverage on the cost of equity.
Sheet1
0 0
Plan U
Break-even Q
Cross Over at 80 Million Units
Plan A
Plan B
Units Sold
(Millions)
NOPAT
(Millions)
Panel a: Operating Leverage
0
0
Sheet2
0 0
Cross Over at
ROIC = (1T) rd = 4.8%
Unlevered
Levered
Return on
Invested Capital
Return
on Equity
Panel b: Financial Leverage
0
0
Sheet3
Plan A
Break-even Q
Sheet4
Sheet5
Sheet6
Sheet7
Sheet8
Sheet9
Sheet10
Sheet11
Sheet12 1
RUNNING HEAD: COCA-COLA REPORT
COCA-COLA REPORT
Coca-cola company
Cherod Jones
9 September 20
Table of contents
1.0
Introduction
3
2.0 Background Information
3
3.0
Financial Analysis
4
3.1 Cost of Equity
4
3.1.2
Discounted
cashflow
4
3.1.3
CAPM
4
3..2 Own yield Plus Market Premium
5
3.3Cost of Preferred shares
5
3.4 Cost of Debt
6
3.5 Market values
6
3.6 Weighted values
8
3.7 Weighted Average Cost of Capital
8
4.0 Assumptions
9
5.0
Conclusion
10
6.0
Recommendations
11
1.0 INTRODUCTION
The Coca Cola Company is headquartered in Atlanta, Georgia, and it has been a franchise since 1889. The company majorly sells syrup concentrate, which is sold to various bottlers. The company shares are listed on the New York Security Exchange (Brondoni, 2020). Coca Cola Company acquired some companies such as the minute maid in 1960, the Indian Brand. The share price of Coca-Cola Company in 1919 costed $40. The dividends were re-invested and accumulated a net worth of $9.8 million. Sun trust underwritten for the Coca-Cola company which grew their worth by 42 billion in the year 2012. Coca-Cola generated dividends since 1920, which has gradually increased from the years (Foster, 2014). The essence of the report is to clearly illustrate the cost of the capital of the firm using equity, preferred stock.
2.0 BACKGROUND
The Coca-cola company is one of the largest producers of the world plastic waste, which is over 3 million tons of plastics and 110 billion plastic bottles. The company was started in 1889 as a franchised distribution system(Irefin, 2014). Coca-cola owns the Coca Cola refreshments in Northern America. Coca Cola initially started as a syrup selling company. Later, it developed the Coca-cola drink, which is a beverage that claimed to reduce headaches, which was invented by Pemberton from Columbus. The Pemberton’s bookkeeper was the one who invented the name and the logo for the Coca-cola company. Candler was the first businessman to use the Coca-Cola brand to promote his sales. In 1948, CocaCola had a market share of about 60%, while in the year 1984, its market share decreased to about 21.8% due to extreme competition from Pepsi(Brandoni, 2020). Coca-cola bought out many companies from 1960 until recently in 2019. As in 2005 financial reports, it indicated that the Coca Cola company beverage products were sold to over 200 countries, which accounted for the sales volume of around 78%.
3.0FINANCIAL ANALYSIS
3.1 COST OF EQUITY.
Beta from regression
Beta= Covariance/ Variance
Covariance(V1V2)=1/ (T-1)
3.1 .1CAPM
CAPM= Rf+Bi /(E(R)m- Rf)
R(f)- Risk free rate
B1-Beta
E(R)M- expected rate of return
Risk free rate= 1+ Nominal Risk Free Rate/(1+ Inflation rate)
Risk free rate= 1+0.019/(1+0.023)= 1, The beta is 1 since the nominal risk free rate is 1 ,and the inflation rate is equal to 2.3%.
Beta (5) years = 0.54
Expected rate of return = 0.05
Cost of equity= 1+0.54/(1+0.023)= 1.5053
3.1.2 Dividend Yield
Cost of equity =Risk free rate of return + Beta( market rate of return-risk free rate of return)
Es= Rf +B(Rm-Rf)
Cost of equity= 1+0.54(1-0.025)= 1.5265
3.13 Own bond yield judgmental risk premium.
Coupon Rate= Annual Coupon payment/ Bond Face Value
104.67/0.25=418.68.
3.2 Cost of preferred stock
Cost of preferred stock= Dividend rate x par value/ (Share price at issue x (1-Isssue%)
3.43% x 25/5 x(5 x( 1-0.7))=0.5717
3.3 Cost of debt
Interest expense x 1- tax rate/ outstanding debt
849M( 1-21%)/64.329 billion=0.012
3.4 Market value of preferred stock
V= D/(1+ r)1+ D/( 1+r)2
V= 0.025/(1+0.019)^1 +0.025/(1+0.019)^2 +0.025/(1+0.019)^3=0.0722
3.4 Market value of equity
outstanding common stock x market value of stock
4280million x 57=243,960 million
Market value of debt= Bonds issued x current price
$1000million x $50= $50 billion
3.5 Value of the firm
outstanding common stock x market value of stock
4280million x 57=243,960 million
3.5 Firms tax rate.
Company earnings / Amount paid in taxes.
$37.27 billion/ $1801 million= 20.69%
3.6 Weight of equity
Total market value of equity and debt=Market value of equity + Market value of debt
$243.960 billion +$50 billion =$293.960billion
Market value of equity/ Total market value of equity and debt x 100
243.960billion/ 293.960 x 100=83%
3.6 Weight of debt
100%- weight of the equity
100%-83%=17%
3.6 Weight of preferred stock
cost of debt(1-tax rate)
0.012(1-21%)=0.01.
3.7 Weighted Average cost of capital
WACC= E/(D+E)(re)+ D/(D+E)(rd)(1-t)
Where:
E-market value of equity
D- Market value of debt
Re-cost of equity
Rd- cost of debt corporate tax rate
WACC=243960billion/(50billion+ 243960billion)+ 50 billion/(50 billion+ 243960bilion)(1-21%)=
WACC= 0.83 x 0.17(1-0.21)=0.111( market premium rate x beta + risk free rate)
0.111(0.59 x0.54+0.025) x 100= 3.8%
The coca-cola company must pay 3.8% on an average of $0.038 in return for every $1 in extra funding.
4.0 ASSUMPTIONS.
There is no change in capital. Any change of capital, which may increase the capital basis, will be treated like the existing capital of the equity to debt ratio, 83%: 17%, which sums up to 100%.
The quantification of the cost of the capital provides the quantification of the risk since it is straight forward as it is derived from the current interest rates.
The firm does not consider the firm’s tax benefit with the presence of a high lower debt as compared to the tax rate, which yields benefits that benefit the firm as it borrows.
The risk associated with a new project will be like the existing one. The risk for any of the businesses is the same. The risk will not change irrespective of the business.
The cashflow on purchases on any date is summed up together. This is because the recording of the purchases helps in the ability of the business to calculate the total sales revenue.
The risk-free rate represents the investors investment, which does not have any risk associated with it. There is the assumption that there is no risk involved when investing in irrespective of the market.
The CAPM does not pay attention to the other risks which might affect the business.
The risk-free rate shows the return on the free government bonds with equal maturity as the duration in which each of the cash flows is discounted.
5.0 CONCLUSION.
The Coca-cola company is a crucial company to invest in as there is no overreliance on external debts; it mainly uses internal funding to run its operations, which is significant. The high equity development indicates the management’s efficiency to manage available resources to ensure they sustain the business’s goals. The higher debt security will act as security in any form of financial organization, which will enhance the financial credibility of Coca-cola. The high equity will be a form of an attraction to the investors who will increase the base of the finances available for the organization. The reliance on equity funding will enhance the stakeholder’s trust in the organization’s sustainability to their dividends, which will help them retain their stakeholders’ trust.
The WACC indicates the company is not at high risk due to the low percentage. This is an indicator of the company’s ability to settle the dues to its legal debt obligation. The payment of the debts it will help in the ability of the business to expand its operations.
6.0 RECOMMENDATIONS
The Coca-cola company should result in cheaper means of funding, which will help reduce the WACC. This might be through issuing bonds, which might be more attractive than issuing the stock in a scenario that the interest rates are lower than the demanded rate of return on the stock.
Coca-cola should consider using a more sophisticated capital structure, which might lead to an increase in the firm’s profitability.
.
APPENDIX
Price:47.80 | Annualized Dividend:$1.64 | Dividend Yield:3.4%
Ex-Div. Date
Amount
Type
Yield
Change
Decl. Date
Rec. Date
Pay. Date
Details
9/14/2020
$0.41
Quarter
3.4%
N/A
7/16/2020
9/15/2020
10/1/2020
Details
6/12/2020
$0.41
Quarter
3.6%
N/A
4/22/2020
6/15/2020
7/1/2020
Details
3/13/2020
$0.41
Quarter
3.4%
+2.5%
2/21/2020
3/16/2020
4/1/2020
Details
9/13/2019
$0.40
Quarter
2.9%
N/A
7/18/2019
9/16/2019
10/1/2019
Details
6/13/2019
$0.40
Quarter
3.1%
N/A
4/25/2019
6/14/2019
7/1/2019
Details
3/14/2019
$0.40
Quarter
3.5%
+2.6%
2/21/2019
3/15/2019
4/1/2019
Details
11/29/2018
$0.39
Quarter
3.2%
N/A
10/18/2018
11/30/2018
12/14/2018
Details
9/13/2018
$0.39
Quarter
3.4%
N/A
7/19/2018
9/14/2018
10/1/2018
Details
6/14/2018
$0.39
Quarter
3.6%
N/A
4/26/2018
6/15/2018
7/2/2018
Details
3/14/2018
$0.39
Quarter
0.9%
+5.4%
2/15/2018
3/15/2018
4/2/2018
Details
11/30/2017
$0.37
Quarter
3.2%
N/A
10/19/2017
12/1/2017
12/15/2017
Details
9/14/2017
$0.37
Quarter
3.2%
N/A
7/20/2017
9/15/2017
10/2/2017
Details
6/13/2017
$0.37
Quarter
3.3%
N/A
4/27/2017
6/15/2017
7/3/2017
Details
3/13/2017
$0.37
Quarter
3.5%
+5.7%
2/16/2017
3/15/2017
4/3/2017
Details
11/29/2016
$0.35
Quarter
3.4%
N/A
10/20/2016
12/1/2016
12/15/2016
Details
9/13/2016
$0.35
Quarter
3.3%
N/A
7/21/2016
9/15/2016
10/3/2016
Details
6/13/2016
$0.35
Quarter
3.1%
N/A
4/28/2016
6/15/2016
7/1/2016
Details
3/11/2016
$0.35
Quarter
3.1%
+6.1%
2/18/2016
3/15/2016
4/1/2016
Details
11/27/2015
$0.33
Quarter
3.1%
N/A
10/15/2015
12/1/2015
12/15/2015
Details
9/11/2015
$0.33
Quarter
3.5%
N/A
7/16/2015
9/15/2015
10/1/2015
Details
6/11/2015
$0.33
Quarter
3.3%
N/A
4/30/2015
6/15/2015
7/1/2015
Details
3/12/2015
$0.33
Quarter
3.3%
+8.2%
2/19/2015
3/16/2015
4/1/2015
Details
11/26/2014
$0.305
Quarter
2.8%
N/A
10/16/2014
12/1/2014
12/15/2014
Details
9/11/2014
$0.305
Quarter
2.9%
N/A
7/15/2014
9/15/2014
10/1/2014
Details
3/12/2014
$0.305
Quarter
3.2%
+8.9%
2/20/2014
3/14/2014
4/1/2014
Details
11/27/2013
$0.28
Quarter
2.8%
N/A
10/17/2013
12/2/2013
12/16/2013
Details
3/13/2013
$0.28
Quarter
2.9%
+9.8%
2/21/2013
3/15/2013
4/1/2013
Details
11/28/2012
$0.255
Quarter
2.1%
N/A
10/18/2012
11/30/2012
12/17/2012
9/12/2012
$0.255
Quarter
2.7%
N/A
7/30/2012
9/14/2012
10/1/2012
Details
3/13/2012
$0.51
Quarter
2.9%
+8.5%
2/16/2012
3/15/2012
4/1/2012
Details
11/29/2011
$0.47
Quarter
3.9%
N/A
10/20/2011
12/1/2011
12/15/2011
Details
9/13/2011
$0.47
Quarter
3.9%
N/A
7/21/2011
9/15/2011
10/1/2011
Details
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See More
Coca-Cola annual/quarterly income tax history and growth rate from 2006 to 2020. Income taxes can be defined as the total amount of income tax expense for the given period.
Coca-Cola income taxes for the quarter ending June 30, 2020, were $0.438B, a4.04% increaseyear-over-year.
Coca-Cola income taxes for the twelve months ending June 30, 2020, were $1.511B, a4.06% declineyear-over-year.
Coca-Cola’s annual income taxes for 2019 were $1.801B, a2.97% increasefrom 2018.
Coca-Cola’s annual income taxes for 2018 were $1.749B, a68.81% declinefrom 2017.
Coca-Cola’s annual income taxes for 2017 were $5.607B, a253.53% increasefrom 2016.
Based on its current market price and future growth prospects,Coca-Cola(NYSE: KO)looks undervalued at present. Trefis has a price estimate of $57 per share for Coca-Colas stock, higher than its current market price of $53 (as on November 19, 2019), which reflects an upside of 7.5%.
References
Foster, R. J. (2014). Corporations as Partners: “Connected Capitalism” and The CocaCola Company. PoLAR: Political and Legal Anthropology Review,37(2), 246-258.
Brondoni, S. M. (2020). Shareowners, Stakeholders & the Global Oversize Economy. The Coca-Cola Company Case.Symphonya. Emerging Issues in Management, (1), 16-27.
Irefin, P., & Mechanic, M. A. (2014). Effect of employee commitment on organizational performance in Coca Cola Nigeria Limited Maiduguri, Borno state.Journal of Humanities and Social Science,19(3), 33-41. OCS Assignment
This assignment follows from your previous WACC project. Here, you must determine what the optimum capital structure is for your firm. A sample spreadsheet is provided where you may input the data that you have already found for the WACC. The spreadsheet will use Hamadas Equation to recalculate the levered betas based on the weights that you choose.
NOTE: You cannot just assume that your weights and your bond values are the same as the sample. You must choose the appropriate weights first based on the market value weights your firm currently has. Then, you must choose appropriate bond rates as you increase or decrease the weight for debt.
You must explain and reference how you chose your numbers and attach a copy of the spreadsheet.
Note that the spreadsheet has all the calculations for the WACC on the top portion, but Hamadas Equation only uses the CAPM to refigure the levered beta and the new WACC for that beta.
