Calculate the Cost of Equity (Ka) for both Coke and Pepsi as of the end of 2000
ID: 2671861 • Letter: C
Question
Calculate the Cost of Equity (Ka) for both Coke and Pepsi as of the end of 2000 using each of the following 3 methods: Calculate Ka using the capital asset pricing model (CAPM) Calculate K, using the dividend discount model (DDM) Calculate K. using the earnings capitalization model (ECM) Of the3 methods above, which do you feel n most appropriate? Calculate the Weighted Average Cost of Capital (WACC) for both Coke and Pepsi as of the end of 2000 using book values of debt and equity Calculate the Weighted Average Cost of Capital (WACC) for both Coke and Pepsi as of the end of 2000 using market values of debt and equity Of the two calculations above in (C) and (0), which do you feel is most appropriate? interpret the results of your WACC calculation. What observations can you make, if any? Do a logic check; do the numbers make sense? Why or why not?Explanation / Answer
I don't have the numbers in 2000, so I used current values instead. If u have those numbers just plug them in here..
(A)
Coke (KO) : Current price $68.09
CAPM: Ke= Rf+ MRP(Beta) = 2+7(0.49) = 5.43%
DDM: Ke = Dividend / Price + Dividend growth rate = $1.88/$68.09 + 6.5%= 9.26%
ECM: Ke = Projected EPS upcoming year/ Price = 1/(forward P/E) = 1/16.61 = 6.02%
Pepsi (PEP) : Current price $66.28
CAPM: Ke= Rf+ MRP(Beta) = 2+7(0.42) = 4.94%
DDM: Ke = Dividend / Price + Dividend growth rate = $2.06/$66.28 +6.8%= 9.91%
ECM: Ke = Projected EPS upcoming year/ Price = 1/(forward P/E) = 1/14.54 = 6.88%
(B) DDM should be the most appropiate to use in this case since both companies are paying dividends and their dividends have been growth CAPM can be used for non-dividend paying companies and ECM is suitable for no-growth company
(C) Rf = 2% Book value of equity = Book value per share * total share outstanding
Bond rating CDS Cost of debt Debt Book value of Equity D+E
KO AA- 2% 4% 29.19B 33.19B 62.38B
PEP AA- 2% 4% 26.85B 23.57B 50.42B
KO: WACC = (29.19/62.38)*4%+(33.19/62.38)*9.26% = 6.80%
PEP: WACC = (26.85/50.42)*4%+(23.57/50.42)*9.91% = 6.76%
(D)
Rf = 2% Book value of equity = Book value per share * total share outstanding
Bond rating CDS Cost of debt Debt Market value of Equity D+E
KO AA- 2% 4% 29.19B 154.65B 183.84B
PEP AA- 2% 4% 26.85B 103.62B 50.42B
KO: WACC = (29.19/183.84)*4%+(154.65/183.84)*9.26% = 8.42%
PEP: WACC = (26.85/130.47)*4%+(103.62/130.47)*9.91% = 8.69%
(E) answers in part (D) are more appropiate to use since we always use the market value of equity to calculate CAPM (not the book value)
(F) I think you might be able to answer this by yourself, just anything you observed
e.g. using book value of debt and equity yields lower of WACC for both PEP and KO
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