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3 WACC Project: Coca Cola Company

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6.3 WACC Project: Coca Cola Company

Marietta Veluz

Florida Tech University

BUS 5440: Financial Management

Dr. Mitchell Miller

February 18, 2024

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Table of Contents

Introduction 3

Financial Data 3

Cost of Equity 5

Beta Assumption 6

Capital Assets Pricing Model 6

Discounter Cash Flow 7

Own-Bond-Yield-Judgmental-Risk- Premium 7

Cost of Debt 7

Market Value of Debt 8

Weighted Values 9

Market Value of Equity 9

Value of Firm

Firm’s Tax Rate 10

Weighted Average Cost of Capital 10

Assumption 11

Conclusion 11

Appendix A: Beta Regression Report 13

Appendix B: Bond Detail Report 14

Appendix C: Market Values and Weighted Assumptions 15

Appendix D: WACC Summary 16

References
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Introduction

Born in 1892, the Coca-Cola Company has morphed from a single fizzy drink into a global

beverage behemoth. More than just the iconic Coca-Cola, its portfolio boasts over 500 brands,

reaching thirsty consumers in over 200 countries. This American corporation, headquartered in

Atlanta, even ranks as the world's largest beverage manufacturer (The Coca-Cola Company,

2024).

Holding the title of one of the most successful brands ever marketed, Coca-Cola leverages a

well-oiled top-down structure and a vast network of local bottlers to ensure global reach and

consistent growth. Its remarkable track record even earned it the coveted status of a "dividend

king" for maintaining dividend increases for over 60 years (Britannica, 2024).

This WACC project delves into the financial makeup of Coca-Cola to determine its weighted

average cost of capital. Understanding WACC is crucial for evaluating investment decisions and

ensuring the company utilizes capital efficiently. Coca-Cola operates within a dynamic and

competitive beverage industry. The company faces constant pressure to innovate, expand into

new markets, and adapt to changing consumer preferences (Euromonitor International, 2023). To

maintain its leading position, Coca-Cola relies on a robust financial strategy that includes

efficient capital allocation.

Financial Data

Investing in any company, including Coca-Cola (KO), requires careful analysis to ensure it will

generate a desirable return. This analysis considers various indicators, and one crucial metric for

investors is the Weighted Average Cost of Capital (WACC).

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Simply put, WACC represents the minimum rate of return a company must achieve on its

invested capital (debt, equity, and preferred stock) to satisfy its investors. Calculating WACC

involves:

1. Identifying the cost of each capital component:

 Cost of Equity (Re): This reflects the expected return investors demand for common

shares, often determined through models like CAPM or DCF.

 Cost of Preferred Stock (Rpf): This reflects the required return for preferred

stockholders, typically based on market yields or comparable companies.

 Cost of Debt (Rd): This represents the interest rate the company pays on borrowed

funds, usually calculated as the weighted average cost of its outstanding debt.

2. Weighting each cost based on its proportion in the company's capital structure:

 Weight of Equity (We): The percentage of capital represented by common shares.

 Weight of Preferred Stock (Wpf): The percentage of capital represented by preferred

shares.

 Weight of Debt (Wd): The percentage of capital represented by debt.

3. Adjusting for corporate taxes: Since interest expense on debt is tax-deductible, we

consider the effective tax rate (1-Tc) when calculating the cost of debt's impact on

WACC.

Ultimately, the WACC formula combines these elements:

WACC = [We x Re] + [Wpf x Rpf] + [Wd x Rd x (1-Tc)]

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By analyzing Coca-Cola's capital structure and calculating its WACC, investors can assess

whether the expected return on their investment justifies the associated risk. This analysis

ultimately helps in determining whether Coca-Cola presents a sound investment opportunity.

Cost of Equity

Determining the cost of equity for Coca-Cola (KO) involves several approaches, each with its

own strengths and limitations. This analysis explores three key methods: Capital Asset Pricing

Model (CAPM), Dividend Growth (DCF), and Judgmental Risk Premium (Brigham et.al, 2017):

The Dividend Growth Model (DCF) is utilized when dividends are involved, while the

Judgmental Risk Premium calculation provides an approximate estimate if the dividend growth

and the Capital Asset Pricing Model (CAPM) differ significantly. This can assist investors in

determining which valuation is more precise.

Capital Asset Pricing Model (CAPM)

 Re= Rrf + (Rm –Rf)b or Rrf + (RPm)b

Dividend Growth Model (DCF)

 DCF: Re= (D1/P0) + g

Judgmental Risk Premium

 Judgmental Risk Prem.: Rs = Rd + Bond RP Note: Bond RP Doesn’t = RPm

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To assess the firm's equity risk, I conducted market research to determine Beta, a measure of risk

from general market exposure. A Beta below one indicates lower volatility. I used Beta data

from two analysts and performed a regression analysis using five years of market and industry

returns from Coca-Cola and the S&P 500 (Appendix A). The regression report concluded a slope

of 0.78 with a significance level of 7.6538E-06, which is acceptable when the significance level

is below 0.10. The regression report also supported slight variance but remained consistent with

the data from the analysts. To ensure a reliable assumption, I averaged the three Beta values to

support an assumption of 0.69 for Coca-Cola's Beta.

To continue estimating the cost of equity, I must make assumptions for the risk-free rate (Rrf)

and the market risk premium (RPm) within the CAPM framework. The risk-free rate can be

associated with long-term government bonds (10 to 20 years) and is considered an acceptable

assumption due to the long-term stability of the rate without volatility. During the valuation of

Coca-Cola's (KO) debt, the bond detail report for 10 to 20-year bonds yielded a rate around 3%,

which I used to support a risk-free rate of 3%.

Furthermore, the market risk premium typically falls within a range of 3.5% to 6%. I have opted

to establish an assumption for a market risk premium formula, as the market return is usually

based on past returns for the entire stock market, and I believe this assumption is somewhat

inflated. The market risk premium can be computed by subtracting the risk-free rate previously

calculated from the anticipated equity market return. With a previously calculated Beta of 0.69,

we can infer an expected return of 6.9%, and subsequently subtract the 3% risk-free rate to

derive an acceptable market risk premium of 3.9%.

 CAPM: Re= Rrf (0.03) + [RPm(0.039)b(0.69)]= 0.0569

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The DCF method is required for consideration due to KO's dividend payouts, as it is only

unnecessary when dividends have been constant for a while and expected to remain the same.

The DCF model requires us to use the dividend in the next period (D1) divided by the price

today (P0) plus the growth rate (g). The dividend payout of 0.37 (Coca Cola: 10-K Form, 2023)

and the current price from yahoo finance information previously recorded from Appendix C,

Common Stock current price of 44.68. Since I am not sure if the future and the past will be

similar, I used the earnings retention model of the retention rate (1- payout rate) multiplied by

the return on equity to assume a growth rate of -14% (1- 3.66(557.15)). For the payout rate, I

used the company's dividends of 4,324,000,000 divided by the net income of $1,182,000,000

(3.66) and the return on equity of was found by dividing the same net income by the average

shareholder's equity of $2,121,500 (Coca Cola: 10-K Form, 2023) .

 DCF: Re= D1(0.37 )/P0( 44.68) + g( -.14)= -0.13

The DCF calculation indicates a required return on equity of -0.13, whereas the CAPM model

suggests a Re of 0.06. As the variance between the two is insignificant, I have chosen to

disregard the Own-Bond-Yield-Plus-Judgmental-Risk-Premium and instead take an average of

the two, resulting in a final assumption of -0.035 for our Re.

Cost of Debt

To determine the precise cost of debt for Coca-Cola (KO), I conducted a comprehensive analysis

leveraging two key sources:

1. Morningstar Bond Analysis (Bond,n.d):

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I obtained detailed information on each of KO's outstanding bonds from Morningstar. This data

included current market values, yields to maturity, and spreads. By analyzing this data, I was

able to:

 Calculate the actual cost of debt for each bond.

 Assess the variation in market values across different bonds.

 Determine the appropriate weight for each bond based on its market value in the overall

debt structure.

2. Coca-Cola 10-K Form (Coca Cola Annual Filings, n.d) :

This financial report revealed the presence of long-term leases, which are considered equivalent

to debt when calculating the cost of capital. I incorporated the estimated cost spread associated

with these leases into the analysis. By combining these insights from both sources, I performed a

market-weighted analysis of KO's debt structure. This means: Each bond's weight was directly

proportional to its market value within the total debt amount. I multiplied each weight by the

respective bond's yield to maturity. Summing these product terms for all bonds resulted in a

weighted average cost of debt (WACD) of 3.05%. You can find a detailed breakdown of this

analysis, including individual bond data and calculations, in Appendix B.

Market Value of Debt

To ensure accurate weighted averages, it is necessary to calculate the market values of debt,

preferred shares, common stock, and firm value. The detailed bond report in Appendix B

provides information on the debt. There were no values for preferred shares for KO, and the

shares of common stock are divided by the price, as shown in Appendix C.

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Weighted Values

The weight for equity and debt is allocated based on the division of market value and the

predetermined weighted cost of debt, which is 3.05%. This is determined using the same method

as shown in Appendix C.

Market Value of Equity

The Market Value of Equity for Coca-Cola (KO) as of the latest available data is $25.826 billion

(macrotrends, n.d). This figure represents the total market value of the company's outstanding

shares.

Value of Firm

The firm value of Coca-Cola (KO) is estimated using a 2-stage Free Cash Flow to Equity (FCFE)

model. This valuation method is based on the company's future cash flows, discounted at an

appropriate rate to account for the time value of money. The FCFE model is a widely used

method to estimate the intrinsic value of a company.

The 2-stage FCFE model is used to estimate the firm value of Coca-Cola (KO) because it

considers the company's growth rate in the near term and the stable growth rate in the long term.

The model is divided into two stages:

1. The first stage (years 1 to n) considers the company's high growth rate, which is expected

to slow down in the long term.

2. The second stage (years n+1 to infinity) considers the company's stable growth rate.
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The estimated firm value of $329 billion suggests that Coca-Cola is currently undervalued by

approximately 23% (Yahoo Finance, 2023). This means that the company's current market price

does not reflect its true intrinsic value, and investors may benefit from purchasing the stock at its

current price.

Firm’s Tax Rate

Tax Rate % is the ratio of tax expense divided by pretax income, usually presented in
percent (Businesswire, n.d).

According to the notes in the Consolidated Financial Statement of Coca-Cola's annual 10-K

report, the company adheres to a 35% corporate tax rate, as mandated by the Tax Cuts and Jobs

Act of December 22, 2017. This tax rate is then incorporated into the Weighted Average Cost of

Capital (WACC) formula

Weighted Average Cost of Capital

 WACC = ([We x Re] + [Wpf x Rpf] + [Wd x Rd x (1-Tc)])

= ([.03 x -0.035] + [0] + [0.95 x 0.031 x (1-.35)]) = -0.005 + 0 + 0.191425

= 0.0141425 = 1.41%

Based on my manual calculations, the difference between a WACC of 1.41% and an automatic

calculation of 2.77% from the summary spreadsheet may stem from initial assumptions,

rounding, and averaging, leading to such a variance (see Appendix D). It was intriguing to

observe how specific elements of the formula align with historical data.

Assumption
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Estimating Coca-Cola's cost of equity (Re) involved several key assumptions. For Beta, we

averaged analyst estimates and a regression analysis (0.69), indicating moderate market risk. The

risk-free rate (3%) came from KO's recent debt valuation, representing a stable long-term return.

The market risk premium (3.9%) factored in expected market returns. Current dividend and stock

price were sourced from official reports. However, the growth rate (-14%) predicted by the

earnings retention model suggests a potential decline in dividends, requiring further

investigation. Due to available methods and missing information, the "Own-Bond-Yield-Plus-

Judgmental-Risk-Premium" approach wasn't used. Finally, Re was estimated by averaging

CAPM and DCF results (-0.035%), but the negative DCF output and their significant

discrepancy highlight limitations and the need for further analysis and potential adjustments to

assumptions. Remember, these are estimations based on historical data and may not always

reflect future performance.

Conclusion

The calculated Weighted Average Cost of Capital (WACC) for Coca-Cola is 1.41%. This low

WACC suggests that Coca-Cola may have a relatively favorable cost of capital, which can have

significant implications for investment decisions. With a WACC of 1.41%, the company may

find it easier to pursue new projects or investments, as the expected return on these endeavors

would need to exceed this rate to create value for investors.

Investors may perceive Coca-Cola as having a lower cost of capital, indicating potential stability

and confidence in the company's ability to generate returns. This may enhance Coca-Cola's

attractiveness as an investment opportunity. However, it's crucial to consider other factors, such
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as market conditions, industry trends, and specific risks associated with Coca-Cola, to make a

comprehensive assessment of the investment landscape.

Appendix A: Beta Regression Report

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Source: Yahoo Finance. (2024, February 18). The Coca-Cola Company (KO) balance sheet.
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Appendix B: Bond Detail Report

Source: Morningstar (2023). Coca Cola Company (KO) Bonds

Appendix C: Market Values and Weighted Assumptions

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Source: Morningstar (2023). Coca Cola Company (KO) Bonds

Source: Annual filings (10-K). The Coca-Cola Company. (2023).

Appendix D: WACC Summary

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References:

Coca Cola (n.d).Our company. About Us. https://www.coca-colacompany.com/about-us

The Coca-Cola Company. (n.d.) Investors. https://investors.coca-colacompany.com/about

Encyclopædia Britannica, inc. (2024, February 13). The Coca-Cola Company. Encyclopædia

Britannica. https://www.britannica.com/topic/The-Coca-Cola-Company

Euromonitor. (2023) Soft drinks: Half-year update H1 2023. https://www.euromonitor.com/soft-

drinks-half-year-update-h1-2023/report#:~:text=Consistent%20outlook%20for%20the

%20first,with%20the%20November%20publication%20baseline.

Annual filings (10-K). The Coca-Cola Company. (2023a). https://investors.coca-

colacompany.com/filings-reports/annual-filings-10-k

Botosan, C. A., Plumlee, M. A., & Yuan Xie. (2004). The Role of Information Precision in

Determining the Cost of Equity Capital. Review of Accounting Studies, 9(2/3), 233–259.

https://doi-org.portal.lib.fit.edu/10.1023/B:RAST.0000028188.71604.0a

Regassa, H., & Corradino, L. (2011). Determining the value of the Coca Cola Company--a case

analysis. Journal of the International Academy for Case Studies, 8, 79

Bonds. (n.d.). Retrieved October 07, 2023, from

http://finra-markets.morningstar.com/BondCenter/Results.js

KO Balance Sheet | Coca-Cola Company (The) Stock. (2023). Retrieved from

https://finance.yahoo.com/quote/KO/balance-sheet?p=KO
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KO: Summary for Coca-Cola Company (The). (2023). Retrieved from:

https://finance.yahoo.com/quote/KO?p=KO&.tsrc=fin-srch

Zacks Investment Research. (2018). KO is up 0.09% today, but where's it headed in 2019?

Retrieved from: https://www.zacks.com/stock/quote/KO