The Coca-Cola Company is a global soft drink beverage company (ticker symbol = KO) that is a primary and direct competitor with Starbucks. The data in Exhibits 12.14 to 12.16 (pages 806-809) include the actual amounts for fiscal 2015 and projected amounts for Year +1 to Year +6 for the income statements, balance sheets, and statements of cash flows for Coca-Cola (in millions). The market equity beta for Coca-Cola at the end of 2015 is 0.75.

Assume that the risk-free interest rate is 3.0% and the market risk premium is 6.0%. Coca-Cola has 4,324 million shares outstanding at the end of 2015, when the share price was $42.96.

REQUIRED

Part I

Computing Coca-Cola's Share Value Using Free Cash Flows to Common Equity Shareholders
a. Use the CAPM to compute the required rate of return on common equity capital for Coca-Cola.
b. Derive the projected free cash flows for common equity shareholders for Coca-Cola for Years +1 through +6 based on the projected financial statements. Assume that Coca-Cola's changes in cash each year are necessary for operating liquidity purposes. The financial statement forecasts for Year +6 assume that Coca-Cola will experience a steady-state long-run growth rate of 3% in Year +6 and beyond.
c. Using the required rate of return on common equity from Requirement a as a discount rate, compute the sum of the present value of free cash flows for common equity shareholders for Coca-Cola for Years +1 through +5.
d. Using the required rate of return on common equity from Requirement a as a discount rate and the long-run growth rate from Requirement b, compute the continuing value of Coca-Cola as of the start of Year +6 based on Coca-Cola's continuing free cash flows for common equity shareholders in Year +6 and beyond. After computing continuing value as of the start of Year +6, discount it to present value at the start of Year +1.
e. Compute the value of a share of Coca-Cola common stock.
(1) Compute the total sum of the present value of all future free cash flows for equity shareholders (from Requirements c and d).
(2) Adjust the total sum of the present value using the midyear discounting adjustment factor.
(3) Compute the per-share value estimate.
Part II

Computing Coca-Cola's Share Value Using Free Cash Flows to All Debt and Equity Stakeholders
f. Compute the weighted-average cost of capital for Coca-Cola as of the start of Year +1. At the end of fiscal 2015, Coca-Cola had $44,213 million in outstanding interest bearing debt on the balance sheet and no preferred stock. Assume that the balance sheet value of Coca-Cola's debt is approximately equal to the market value of the debt. The forecasts assume that Coca-Cola will face an interest rate of 2.0% on debt capital and that Coca-Cola's average tax rate will be 24% (based on the past five-year average effective tax rate). Coca-Cola also had non controlling interests of $210 million at that time. The forecasts assume a 15.0% cost of capital for non controlling interests. (For our forecasts, we assume non controlling interests receive dividends equal to the required rate of return each year.)
g. Beginning with projected net cash flows from operations, derive the projected free cash flows for all debt and equity Stakeholders for Coca-Cola for Years +1 through +6 based on the projected financial statements. Assume that the change in cash each year is related to operating liquidity needs.
h. Using the weighted-average cost of capital from Requirement f as a discount rate, compute the sum of the present value of free cash flows for all debt and equity Stakeholders for Coca-Cola for Years +1 through +5.
i. Using the weighted-average cost of capital from Requirement f as a discount rate and the long-run growth rate from Requirement b, compute the continuing value of Coca Cola as of the start of Year +6 based on Coca-Cola's continuing free cash flows for all debt and equity Stakeholders in Year +6 and beyond. After computing continuing value as of the start of Year +6, discount it to present value as of the start of Year +1.
j. Compute the value of a share of Coca-Cola common stock.
(1) Compute the total value of Coca-Cola's net operating assets using the total sum of the present value of free cash flows for all debt and equity Stakeholders (from Requirements h and i).
(2) Subtract the value of outstanding debt to obtain the value of equity.
(3) Adjust the present value of equity using the midyear discounting adjustment factor.
(4) Compute the per-share value estimate of Coca-Cola's common equity shares.
Do not be alarmed if your share value estimate from Requirement e is slightly different from your share value estimate from Requirement j. The weighted-average cost of capital computation in Requirement f used the weight of equity based on the market price of Coca-Cola's stock at the end of fiscal 2015. The share value estimates from Requirements e and j likely differ from the market price, so the weights used to compute the weighted-average cost of capital are not internally consistent with the estimated share values.
Part III

Sensitivity Analysis and Recommendation
k. Using the free cash flows to common equity shareholders, recompute the value of Coca-Cola shares under two alternative scenarios.
Scenario 1: Assume that Coca-Cola's long-run growth will be 2%, not 3% as before, and assume that Coca-Cola's required rate of return on equity is 1% higher than the rate you computed for Requirement a.
Scenario 2:?Assume that Coca-Cola's long-run growth will be 4%, not 3% as before, and assume that Coca-Cola's required rate of return on equity is 1% lower than the rate you computed in Requirement a. To quantify the sensitivity of your share value estimate for Coca-Cola to these variations in growth and discount rates, compare (in percentage terms) your value estimates under these two scenarios with your value estimate from Requirement e.
l. Using these data at the end of 2015, what reasonable range of share values would you have expected for Coca-Cola common stock? At that time, what was the market price for Coca-Cola shares relative to this range? What investment strategy (buy, hold, or sell) would you have recommended?

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Exhibit 12.14 The Coca-Cola Company Income Statements for 2015 (Actual) and Year +1 through Year +6 (Projected) (amounts in millions; allow for rounding) (Problem 12.16) Actual Forecasts 2015 Year +1 Year +2 Year +3 Year +4 Year +5 Year +6 INCOME STATEMENT Revenues $ 44,294 $ 45,623 $ 46,992 $ 48 401 $ 49,853 $51,349 $ 52,889 (18,562) $ 28 430 (17,387) (1,410) $ 9,633 Cost of goods sold (17,482) $ 26,812 (16,427) (18,021) (19,118) (19,692) (20,283) (20,891) Gross Profit $ 27,602 $ 29,283 $ 30,161 $ 31,066 $ 31,998 Selling, general, and administrative expenses Other operating expenses Operating Profit (1,657) $ 8,728 (16,880) (1,369) $ 9,353 (17,908) (1,452) $ 9,922 (18,446) (1,496) $ 10,220 (18,999) (1,540) $ 10,527 (19,569) (1,587) $ 10,842 Interest income 613 606 623 642 661 681 701 (951) 696 (1,034) (1,065) Interest expense Income from equity affiliates Other gains (losses) (856) (887) (910) (993) 489 631 663 731 767 790 631 $ 9,605 $ 9,702 $ 10,009 $ 10,309 (2,474) $ 7,835 Income before Tax $ 10,619 $ 10,940 $ 11,269 (2,704) $ 8,564 Income tax expense (2,239) (2,329) (2,402) (2,549) (2,626) Net Income $ 7,366 $ 7,374 $ 7,607 $ 8,071 $ 8,315 Net income attributable to noncontrolling interests (15) (32) (32) (32) (32) (32) (32) Net Income attributable to common $ 7,342 $ 7,575 $ 7,803 $ 8,039 $ 8,283 $ 8,532 $ 7,351 (4,412) $ 2,954 shareholders Other comprehensive income items Comprehensive Income $ 7,342 $ 7,575 $ 7,803 $ 8,039 $ 8,283 $ 8,532