DOW 30 FINAL PAPER

(KO)

Bobby RichardsDow 30 Company Project

FINC 365/Dr. Balyeat4/13/16

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Table of Contents

Company Description…………………………………………………………………………….3

Phase 1: Top-down Economic Analysis………………………………………………….………4

Part 1: Economic Outlook for the United States Economy………………………………4

Part 2: Economic Outlook for Coca-Cola’s Industry……………………………………..7

Part 3: Economic Outlook for Coca-Cola………………………..………………………10

Phase 2: Variance Decomposition……………………………………………………………….12

Phase 3: Weighted Average Cost of Capital…………………………………………..…………14

Works Cited…………………………………………………………...…………………………18

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Company Description

The Coca-Cola Company was founded in 1886 and is headquartered in Atlanta, Georgia. The company is most famous for its staple product Coca-Cola, and provides a wide variety of beverages and soft drinks to markets all over the world, in more than 200 countries (Coca-Colacompany.com). The Coca-Cola Company falls into the Consumer Staples segment of the market and owns a number of products and other well-known brands, including Sprite, Fanta, PowerAde, and Dasani. Unlike some of its competitors, The Coca-Cola Company’s only market is the beverage and soft drink industry. Not only is this company well known and marketed prevalently through the United States, it is a leader in its industry and an intriguing firm for many investors.

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Phase 1: Top-Down Economic Analysis

Part 1: Economic outlook for the US economy

Question 1.1

(a) What does the Conference Board Leading Economic Index (LEI) for the U.S. measure? How many components are there in the Conference Board Leading Economic Index (LEI)? What are the components of the Conference Board Leading Economic Index (LEI) for the U.S. (please note that the Conference Board LEI is different from the OECD U.S. Composite of Leading Indicators)?

The Conference Board Leading Economic Index (LEI) for the U.S measures the highs and lows of the business cycle. The Conference Board Leading Economic Index uses variables that forecast future activity happening in the market. The indicator has ten key components that have proven to be effective in predicting recessions and other trends in the economy. The ten components include:

1. Average weekly hours, manufacturing2. Average weekly initial claims for unemployment insurance3. Manufacturers’ new orders, consumer goods, and materials4. ISM Index of New Orders5. Manufacturers’ new orders, non-defense capital goods excluding aircraft orders6. Building permits, new private housing units7. Stock prices, 500 common stocks8. Leading Credit Index9. Interest rate spread, 10-year Treasuring bonds minus federal funds10. Average consumer expectations for business conditions

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(b) What has been the trend in the Conference Board Leading Economic Index (LEI) for the U.S. over the last few years and what does this imply about the U.S. economy?

The LEI has steadily increased since March of 2009 to the present and has returned to where it was in 2006, seeing a slight decrease in September 2011. Prior to 2009, the LEI decreased drastically. The trend of consistent increase in LEI suggests the economy is continually improving since the trough of the recession.

(c) What does the current level of the index predict for the near-term outlook of the U.S. as a whole?

The current level of the index predicts that the near-term outlook for the U.S as a whole is continually increasing from year to year since 2006. Although the growth is consistent, it appears to be slowing and wavering with slight decreases in August 2015 and February 2016. The rate of the economy has been slowing down and in certain instances plateauing.

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Fed Forecast:

Country United StatesContributor Contributor CompositePeriod YearlyIndicator 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018Economic ActivityReal GDP (YoY%) -2.8 2.5 1.6 2.2 1.5 2.4 2.4 2.0 2.3 2.2Industrial Production -11.4 5.5 2.9 2.8 1.9 2.9 0.3 0.3 2.2 2.3Price IndicesCPI (YoY%) -0.3 1.6 3.2 2.1 1.5 1.6 0.1 1.3 2.2 2.3Core PCE (yoy%) 1.2 1.3 1.5 1.9 1.5 1.5 1.3 1.6 1.8 1.9Labor MarketUnemployment (%) 9.3 9.6 8.9 8.1 7.4 6.2 5.3 4.8 4.6 4.7

Question 1.2

(a) What US data series does the Fed forecast?  The US data series that the Fed forecasts are a year-over-year percent of Real Gross Domestic Product, a year-over-year percent of Consumer Price Index, a year-over-year percent of the Core Personal Consumption Expenditures and the rate of unemployment.

(b) Why are these series important?These series are important because they give insight into the growth and status of the economy, and series such as GDP and Core PCE help when making important business decisions.

(c) What do these forecasts indicate about the near-term prospects for the US economy?The forecasts indicate that the unemployment rate will plateau and hover between 4.8% -4.6% moving forward. Based on the projections we can see the economy will continue to grow at a steady rate

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Part 2: Economic outlook for Coca-Cola’s Industry

Question 2.1

(a) Who are some of your major competitors?

Coca-Cola competitors include the following:

-Monster Beverage Corporation-Dr. Pepper Snapple Group Inc.-Cott Corporation-Organizacion Cultiba-Lassonde Inds Inc.-National Beverage Corp-Fomento Economico Mexica-Pepsico Inc.-Constellation Brands Inc.-Molson Coors Brewing Co.-Brown-Forman Corp.-Boston Beer Company Inc.

(b) What is the name and description of your firm’s industry benchmark?

The industry benchmark is the S&P 500 Consumer Staples Sector Index (S5CONS Index). “The index was developed with a base level of 10 for the 1941-43 base period. The Parent index is SPXL1” (Bloomberg). As of April 7th, the benchmark level index was at 544.75. The members of Coca-Cola’s industry benchmark are a part of the GICS Level 1 sector group.

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(c) Which firms are in your firm’s industry benchmark, are these reasonable firms for your firm’s industry benchmark?

According to Bloomberg, the members in the S&P 500 Consumer Staples Sector Index are companies such as Kroger Co., Mead Johnson Nutrition Co., McCormick & Co. Inc., and Kellogg Co. After looking at the firms within the industries benchmark, some of Coca-Cola’s competitors have slight advantages because they are in the market for more than just soft drinks and beverages, Coca-Cola’s only product.

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Question 2.2

(a) How has your industry compared to the broader-based market index?Compared to the Wilshire 5000, my industry has consistently had a higher percentage return over the last ten years. Following the recession, the S5CONS Index has grown at a higher rate and has a total return of 193.67% compared to the Wilshire 5000’s 59.27%.

(b) How did the industry do when the general market was increasing?The industry followed the market, so when the market was increasing, the industry was as well. In fact, the industry has increased above market returns. When the market rebounded and improved, the industry followed and took off, and in recent years has been doing significantly better than the market.

(c) How did the industry do when the general market was falling?

The industry followed the market when the economy took a hit and fell into a recession. However, the industry was not as drastically affected as the general market during this period. The industry fell into the negatives for about the time of a quarter, from January 2009 to April 2009, but has been increasing, and increasing at a faster rate than the market since.

(d) Given your forecast concerning the near-term prospects for the US economy, what is your forecast for the near-term prospects of your firm’s industry?

Based on the data, particularly from the last 5 years, the industry is continuing to grow at a significantly higher rate than the general market. The industry index seems to have a similar movement as the Wilshire economy index. When the Wilshire index rises, the industry index will also rise with it, and if the market were to fall, the industry index would follow, but the past suggests that the industry index would not take as hard of a hit.

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Part 3: Economic Outlook for Coca-Cola

Question 3.1

(a) How has your firm compared to its industry?

Compared to the industry index, Coca-Cola has shown a flux from consistently maintaining a higher percentage return from early 2007 to December 2014 before falling below the industry index since then. In the last quarter Coca-Cola has made a jump and for the first time since December 2014 has slightly risen above the industry index. From these returns, Coca-Cola has consistently hovered right around the industry index.

(b) How did your firm do when the industry was increasing?

When the industry was increasing, Coca-Cola was increasing at a higher rate than the industry average until December 2014 when it fell below. For the past few years Coca-Cola has continued to increase while being outperformed by the industry index, however has just recently passed the industry and now has an increased growth rate of 1.74%.

(c) How did your firm do when the industry was falling?

When the industry was falling, Coca-Cola fell but not as drastically. Although Coca-Cola saw their percentage return fall to a greater degree from where it had been, it continued to outperform the industry average and avoided falling into the negatives when the industry did in February 2009. Coca-Cola took a hit during the recession but not as significant of a hit as the industry did.

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(d) Given your forecast concerning the near-term prospects for the US economy and your firm’s industry, what is your forecast for the near-term prospects of your firm?

Overall, I believe that as long as the industry index continues to consistently increase, so will Coca-Cola. Since the recession, the firm has steadily improved and although it has been outperformed by the industry index for the past few years, it has continued to grow and just recently increased enough to surpass the industry.

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PHASE 2: Variance DecompositionSUMMARY OUTPUT

Regression StatisticsMultiple R 0.561194703R Square 0.314939495Adjusted R Square 0.312294474Standard Error 0.017403481Observations 261

ANOVAdf SS MS F Significance F

Regression 1 0.036063694 0.036063694 119.0687955 4.66774E-23Residual 259 0.078446219 0.000302881Total 260 0.114509913

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.00062454 0.001082657 0.576858571 0.564536029 -0.001507391 0.002756471 -0.001507391 0.002756471RAY Total Ret 0.581086718 0.053252741 10.9118649 4.66774E-23 0.476223254 0.685950182 0.476223254 0.685950182

Question 4

(a) What is the beta of your firm?

The beta for Coca-Cola is 0.5811

(b) Is this what you expected? Why or why not?

This value for Coca-Cola’s beta slightly surprised me because a beta value under 1, particularly one of 0.5811 suggests it is considerably less volatile than the market. As seen in the graphs in question two of phase one, although Coca-Cola has consistently outperformed the market, its rises and falls appear to be much steeper. Also, the fact that it fell below the consumer staples index for more than a year and then jumped back above recently made me guess that the beta would be closer to one. This beta makes sense due to Coca-Cola’s performance relative to the market as a whole; however by just analyzing the graph, I would have anticipated it being at least a little bit closer to 1.

(c) What is the variance of the returns for your firm (use the VARP function over cells E4:E264)? This is a weekly variance since your data interval was weekly.

The variance of returns for Coca-Cola is 0.0004.

(d) What is the annual variance of your firm?

The annual variance of returns for Coca-Cola is 0.0228.

(e) What is the annual variance for the RAY index?

The annual variance for Russell 3000 index is 0.0213.

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(f) How does the annual variance for your firm compare to the annual variance for the Russell 3000 index (RAY)? In other words, how risky is your firm?

The annual variance for the Russell 3000 index (0.0213) is smaller than the annual variance for Coca-Cola (0.0228). Because Coca-Cola has a higher variance, it implies that Coca-Cola has a higher risk than the Russell 3000 index.

(g) What is the annual variance for the residuals? What type of risk does the variance of these residuals measure (i.e. What type of risk)?

The annual variance for the residuals is 0.0156. The variance of the residuals measures the amount of idiosyncratic risk.

(h) What proportion of the total variance for your firm is systematic?

Total Variance = Systematic Risk + Idiosyncratic Risk

0.0228 = Systematic Risk + 0.0156Systematic Risk = 0.0072Proportion of total variance that is systematic = 0.0072/0.0228 = 0.3158 = 31.58%

(i) What proportion of the total variance for your firm is idiosyncratic?

Total Risk = Systematic Risk + Idiosyncratic Risk

1 = .3158 + Idiosyncratic RiskIdiosyncratic Risk = 0. 6842= 68.42%

(j) What does this mean when you add your firm to a well-diversified portfolio?

A stock’s idiosyncratic risk is eliminated when you add it to a well-diversified portfolio so the only risk left is the systematic risk. If one were to add Coca-Cola to a well-diversified portfolio there is a small amount of risk that cannot be diversified away, the systematic risk of 31.58%.

(k) Does your result in part j change your perspective on your result in part f?

Although Coca-Cola has a higher variance than the Russell 3000, this is due to the fact that the Russell 3000 index is already diversified as opposed to a single stock of Coca-Cola. If Coca-Cola were placed into a well-diversified portfolio, the systematic risk would be eliminated leaving 31.58% of systematic risk to be factored in. So, because Coca-Cola has a significantly larger amount of risk that is diversified away, I would change my perspective on my result in part f.

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PHASE 3: Weighted Average Cost of Capital

Question 5

(a) What is the WACC for your firm?

According to Bloomberg, Coca-Cola’s WACC is 6.4125%

(b) What has been the trend in the WACC over the last few years? What do you think has been driving this trend?

Over the last few years, Coca-Cola’s WACC has been volatile while continually trending down. In the last three years, Coca-Cola’s WACC has fluctuated from 6.2483% -7.7438%. The weighted cost of capital has been driven down, especially since 2009, because the Fed has set very low interest rates many companies are finding it inexpensive to issue new debt.

(c) What is the capital structure for your firm? (i.e. what percentage of the firm’s assets is funded by equity debt, and preferred stock?)

Coca-Cola is structured with 80.8% in equity, 19.2% in debt, and 0% in preferred stock.

(d) Comment on the capital structure of the firm. Is the firm primarily funded with debt or equity? Please comment on why your firm might have this particular capital structure.

Coca-Cola has a capital structure that has most of its weight in equity. Financing primarily through means of equity allows Coca-Cola to focus their attention on producing profit and keeping their shareholders happy instead of using debt and having to pay interest on loans. Coca-Cola is marketed very heavily in the United States and through this is able to attract people to buy securities in them who recognize the brand from so many different places.

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(e) What beta did Bloomberg use to calculate the cost of equity? Does this beta equal the beta that you calculated in question 4 part a? If not, why might this be the case?

Bloomberg used a beta of 0.075 to calculate the cost of equity. The beta Bloomberg uses is higher than the beta calculated in question 4 of 0.5811. These values could be different for a number of reasons. The most prevalent reason is that the beta that we calculated incorporated the Russell 3000 index, Bloomberg calculates beta using the S&P Index.

(f) What we called in class the market risk-premium or the excess return of the market, Bloomberg calls the Country Premium. What is the Country Premium for your firm?

According to Bloomberg, the Country Premium is 7.93%

(g) Where did Bloomberg get the risk-free rate that it used to calculate the cost of equity? What was the risk-free rate? Is this a reasonable proxy for the risk-free rate?

Bloomberg calculates the risk-free rate from the U.S. Generic Government 10-year yield index or USGG10YR. Bloomberg calculates the risk free rate to be 1.71%. Because Bloomberg goes back and uses 10 years of data to calculate the risk free rate, I would say this is a reasonable proxy for the risk free rate.

(h) What is the cost of equity for your firm? Please include a screen capture for where you got this information.

The cost of equity for Coca-Cola is 7.64%

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(i) What tax rate did Bloomberg use in the cost of debt calculation? Exactly how was this rate calculated?

Bloomberg used the tax rate of 23.31% to calculate the cost of debt. Bloomberg calculated this rate by dividing the income tax expense from the previous twelve months by the pre-tax income from the same previous twelve months and multiplied this value by 100.

(j) Bloomberg uses a debt adjustment factor. What is Bloomberg’s debt adjustment factor for your firm? What does this debt adjustment factor measure? What is the debt rating for your firm? Please include the screen capture for where you got this information and any necessary calculations. If your firm were to be downgraded, how would this affect your firm’s debt adjustment factor?

Bloomberg’s debt adjustment factor for Coca-Cola is 1.19. The debt adjustment factor measures how much riskier a firm is when compared to U.S government securities. Because Coca-Cola’s debt adjustment factor is 1.19, the firm is calculated to be 19% riskier than government securities. The debt rating for Coca-Cola is AA-. If Coca-Cola’s debt rating were to be downgraded the debt adjustment factor would increase. The lower the credit rating of a firm, the higher the debt adjustment factor.

(k) What was the note rate used in the calculation of your firm’s cost of debt? What was the bond rate used in the calculation of your firm’s debt adjustment factor?

The note rate used to calculate Coca-Cola’s short-term debt is 0.70%. The bond rate used to calculate Coca-Cola’s long-term debt is 1.71%.

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(l) What was the cost of debt for the short-term debt of the firm? Exactly how did you calculate this? What is the cost of debt for the long-term debt of the firm? Exactly how did you calculate this? What is the overall cost of debt for the firm? Please replicate the calculation for the cost of debt. Does Bloomberg display a pre-tax or after-tax cost of debt?

Cost of Debt for Short Term Debt = Note Rate x Debt Adjustment Factor

= 0.0070 x 1.19 = 0.0083 = 0.083%

Cost of Debt for Long Term Debt = Bond Rate x Debt Adjustment Factor

= 0.00171 x 1.19 = 0.0203 = 2.03%

Overall Cost of Debt = [(Note Rate x Debt Adjustment Factor x Weight of ST Debt) +

(Bond Rate x Debt Adjustment Factor x Weight of LT Debt)] x (1-Tax Rate)

= [(0.0070 x 1.19 x 0.357497) + (0.0171 x 1.19 x 0.642503)] x (1-0.2331) = 0.0123 = 1.23%

(m)What proportion of the debt is short term? What proportion of the debt is long-term? What implications does this have for the firm in the short and long-term?

Short-Term Debt = 15806/44213 = 0.3575 = 35.75%

Long-Term Debt = 28407/44213 = 0.6425 = 64.25%

The majority of Coca-Cola’s debt is long term. Based on these calculations, Coca-Cola will have more obligations to pay off in the long run than short-term. Meaning, the majority of the firm’s debt is to be paid off in more than one year or one operating cycle, whichever is longer.

(n) Even if the firm does not have any preferred stock, how does Bloomberg calculate the cost of preferred stock? Does this methodology make sense? Please explain why or why not.

Although Coca-Cola does not have any preferred stock, Bloomberg calculates the preferred stock by dividing the preferred dividends by the market capitalization of preferred equity. This makes sense because it gives investors up to date cost of preferred, using market prices and weights, the best way to measure the cost of current preferred outstanding.

Works Cited

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“Bloomberg.” Bloomberg.com. Bloomberg. n.d. Web. 28 March. 2016

O'Reilly, Lara. "15 Mind-blowing Facts about Coca-Cola." Business Insider. Business Insider, Inc, 25 Sept. 2015. Web. 9 Apr. 2016.

The Coca-Cola Company. "Brands: The Coca-Cola Company." The Coca-Cola Company. The Coca-Cola Company, n.d. Web. 10 Apr. 2016.

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