Question

PLEASE ANSWER 5-8

The​ Coca-Cola Company​ (ticker: KO), along with its North American anchor bottler​ Coca-Cola Refreshments, is considering launching a new product. This new​ product, Coca-Cola​ YOU!, will allow customers to customize the flavor of their soda at the point of sale. This project requires an initial investment at​ t=0 of​$350 million. KO expects that cash flows in the first year of the project will be​ $20 million, growing to​ $30 million in year​ 2, and growing by​ 3% per year from year 3 onward. KO pays a corporate tax rate of​ 35%.Assume that the market risk of this project is the same as that for​ Coca-Cola’s overall business. You have been asked by your manager to determine the NPV of this project. ​Unfortunately, before your manager left for ​ lunch, you forgot to ask what the appropriate weighted average cost of capital is to use in your analysis. Your manager wants this analysis completed ASAP and you decide you cannot wait. Over the next few​ questions, you will determine the information necessary to complete your analysis.

1) Coca-Cola has debt due in 2028 with a coupon rate of​ 6.75%, priced at​ $1,248.26 per​ $1,000 face value. The YTM on this debt is​ 3.75%. What is​ KO's effective cost of debt​ capital? 2.44%

2) Coca-Cola has class A preferred stock priced at​ $29.45 that pays an annual dividend of​ $1.25. What is​ KO's cost of preferred​equity? 4.24%

3) KO’s equity Beta is 0.59. The current yield on​ 10-year Treasury notes is​ 2.92%. You estimate the market risk premium to be​ 5.5%. Estimate​ KO's cost of common equity capital using the capital asset pricing model​ (CAPM). 6.17%

4) KO stock is currently priced at​ $49.58, you anticipate next​year’s dividend to be​ $1.56, and​ long-run earnings are expected to grow at​ 4%. You expect​ KO's dividend payout rate to be constant. Estimate​ KO's cost of common equity capital using the constant dividend growth model​ (CDGM). 7.15%

5) The market values of​ KO’s common​ stock, preferred​ stock, and debt are​ $211,296 million,​ $101 million, and​ $44,910 million respectively. Determine the appropriate weights to use for each source of capital in your WACC calculation. Express your calculated weights in​ %.

6) Calculate​ Coca-Cola's weighted average cost of capital​(WACC) using the information you have collected in the previous questions.  Use the cost of equity capital determined using the constant dividend growth model​ (CDGM) approach in your calculation of WACC.

7) Now that you have determined the appropriate WACC to use in your capital budgeting​ analysis, you can proceed. Calculate the net present value​ (NPV) of the​ Coca-Cola YOU! investment opportunity described above.

The NPV of the project​ is:__million​ (round to two decimal​places)

Based on your​ analysis, should​ Coca-Cola pursue this investment​ opportunity?

8) Coca-Cola plans on financing the entire investment via the issuance of new equity and debt. These new issues will be structured so as not to alter the current capital structure of the firm​ (the relative weightings of common​ equity, preferred​equity, and debt will remain​ unchanged).

​Coca-Cola will need to have​ $350 million left over after paying the underwriting fees related to the issuance of these new securities. Underwriting fees are determined based upon the size of the issuance. If​ Coca-Cola will have to pay a fee of​ 4% of the total amount of financing raised to the investment bank handling the​ issuance, what is the updated NPV of the​ project?

The NPV of the​ project, updated to reflect the underwriting​fees, is:__million​ (round to two decimal​ places)

Answer 1

Q5) Total value of debt + equity = 211296 + 101 + 44910 = 256307

Weight of common stock=211296/256307 = 0.82

Weight of preferref stock=101/256307 = 0.0004

Weight of debt= 44910/256307 = 0.175

Q6) Cost of debt (Kd) = 2.44%

Cost of preferred equity (Kp)= 4.24%

Cost of common equity (Kc)= 7.15%

WACC=0.82*Kc + 0.0004*Kp + 0.175*Kd

=0.82*0.0715 + 0.0004*0.0424 + 0.175*0.0244 = 0.0629

Q7) Initial investment = 350 million

PV of cash flow = Cash flow/(1+WACC)ⁿ

PV of year 1 cash flow= 20/(1+0.0629) = 18.816

PV of year 2 cash flow= 30/(1+0.0629)² = 26.554

Terminal value (TV) of cash flow at year 3 = year 2 cash flow * (1+g)/(WACC-g) , where g is the growth rate

TV = 30*(1+0.03)/(0.0629-0.03) = 939.21

PV of TV = 939.21/(1+0.0629)³ = 782.142

NPV = -350 + 18.816 + 26.554 + 782.142 = $477.51 million

Q8) flotation costs like underwriting fees are one time costs, therefore it has to be adjusted in the cash flow

Underwriting fee in year 0 = 0.04 * 350 million = 14 million

Therefore new NPV = 518.45-14 = $504.45 million