The problem set forth in the Coca-Cola case was aimed at making an investment decision regarding the company’s stock. By utilizing the Capital Asset Pricing Model, (CAPM), we were able to establish an appropriate rate. The Constant Growth Dividend Model and the P/E Multiple Model allowed us to determine a fair price and compare it to the stock’s current price.
According to the case study Coca Cola international groups (Latin America, Middle East, Far East, Africa and Greater European Groups) are expected to continue a steady rate of growth in the year 1998. Therefore, the investment in this group will still be a positive of around 15% in the next three to five years, due to the rapid increase in new markets such as China India and the Middle East. Domestically Coca Cola is projected to stay at a high level of sales. A slight increase can be expected in the upcoming business periods due to Coke’s new Barq’s and PowerAde line.
Methodology/ Sensitivity Analysis
When using the CAPM model we chose to implement the adjusted beta. We felt the adjusted beta would be the appropriate choice. This is due to the fact that we want to know the future financial status of Coke. The raw beta is derived from the history of the stock, not the future cash flows. The Raw beta is based on the last 24 months.
A stock’s price history is typically of little concern when investing in a company. Prices are based on expected cash flows, which adjusted beta is also based on. To further my point, Coca Cola has been around for many decades. The last 24 months is no true indication of what the future value of Coca Cola will be. We chose a 10 year bond as the risk free rate.
The purpose of this rate is because; we wanted a model with a higher required return (compared to a 5 year bond). With a higher required return we can make sure this is a good investment. The case study stated Coke was trading at 58 dollars per share. The purpose of the Dividend Discount Model (DDM) and the Price to Earnings (P/E) Ratio is to determine if this is the appropriate selling price for a share of Coke.
According to the DDM model Coca Cola share price should be $45. 3. This would mean Coke is selling at a premium and it would not be a good buy. We then plugged in the numbers for the P/E Ratio model. This model came to a very different conclusion. The P/E Ratio suggested a retail value at $68. 25. This would mean the stock was selling at a discount.
After taking the two models in consideration we came to the conclusion that markets are efficient and Coca Cola is a good buy. 58 dollars a share is almost exactly the mean of the two models. With that being said it appears Coke is selling at its true value. Coke is a financially strong company that has gradually grown bigger throughout the years. In our opinion adding Coke to a well diversified portfolio will bring great benefits for an investor. Exhibit 6 shows how high the price to earnings ratio is for Coke. Coke’s price to earnings ratio has increased every year since 1981. With comparison to competitors and other companies Coke is currently doing quite well for themselves.