Valuation Approaches Problems and Cases The purpose of this assignment is to apply principles and skills associated with valuation approaches

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Valuation Approaches Problems and Cases

The purpose of this assignment is to apply principles and skills associated with valuation approaches.

Using what you have learned from the topic materials, complete the following problems and cases from the textbook.

1. Problems and Cases 13.19
2. Problems and Cases 14.18
3. Problems and Cases 14.20

Prepare the assignment in Excel with each problem or case as a separate tab. All narrative questions should be fully addressed within the Excel document on the tab associated with the problem or case.

APA style is not required, but solid academic writing is expected.

This assignment uses a rubric. Please review the rubric prior to beginning the assignment to become familiar with the expectations for successful completion.

You are not required to submit this assignment to LopesWrite.

13.19 Residual Income Valuation. The Coca-Cola Company is a global soft drink beverage company (ticker: KO) that is a primary and direct competitor with Starbucks. The data in Chapter 12's Exhibits 12.14, 12.15, and 12.16 (pages 806-809) include the actual amounts for 2013, 2014, and 2015 and projected amounts for Year +1 to Year +6 for the income statements, balance sheets, and statements of cash flows, respectively, for Coca-Cola. The market equity beta for Coca-Cola at the end of 2015 is 0.75. Assume that the risk-free inter-est rate is 3.0% and the market risk premium is 6.0%. Coca-Cola had 4,324 million shares out-standing at the end of 2015, when Coca-Cola's share price was $42.96. 
REQUIRED Part I—Computing Coca-Cola's Share Value Using the Residual Income Valuation Approach a. Use the CAPM to compute the required rate of return on common equity capital for Coca-Cola. b. Derive the projected residual income for Coca-Cola for Years } 1 through 16 based on the projected financial statements. The financial statement forecasts for Year 6 assume that Coca-Cola will experience a steady-state, long-run growth rate of 3% in Year 1 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 residual income for Coca-Cola for Years 1 1 through 15. 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 16 based on Coca-Cola's continuing residual income in Year I 6 and beyond. After computing continuing value as of the start of Year 6, dis-count it to present value at the start of Year 11. e. Compute the value of a share of Coca-Cola common stock. (1) Compute the total sum of the present value of all residual income (from Requirements c and d). (2) Add the book value of equity as of the beginning of the valuation (that is, as of the end of 2015, or the start of Year t 1). (3) Adjust the total sum of the present value of residual income plus book value of com-mon equity using the midyear discounting adjustment factor. (4) Compute the per-share value estimate. 
Part II—Sensitivity Analysis and Recommendation f. Using the residual income valuation approach, compute 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 above, and that Coca-Cola's required rate of return on equity is 1% higher than that calcu-lated in Requirement a. Scenario 2: Assume that Coca-Cola's long-run growth will be 4%, not 3% as above, and that Coca-Cola's required rate of return on equity is 1% lower than that calculated 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. g. 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 would you have recommended? h. If you completed Problem 12.16 in Chapter 12, compare the value estimate you obtained in Requirement e of that problem (using the free cash flows to common equity share-holders valuation approach) with the value estimate you obtained here using the resid-ual income valuation approach. The value estimates should be the same. If you have not completed Problem 12.16, you would benefit from doing so now. 
14.18 Interpreting Market-to-Book Ratios. Exhibit 14.10 presents data on market-to-book (MB) ratios, ROCE, the cost of equity capital, and price-earnings (PE) ratios for seven pharmaceutical companies. (Note that PE ratios for these firms typically fall in the 30-35 range.) Exhibit 14.10 also provides historical data on the five-year average rate of growth in earnings and dividend payout ratios for each firm. The data on excess earnings years represent the number of years that each firm would need to earn a rate of return on common sharehold-ers' equity (ROCE) equal to that in Exhibit 14.10 in order to produce value-to-book ratios that equal the market-to-book ratios shown. For example, Bristol-Myers Squibb would need to earn an ROCE of 48.9% for 58.3 years in order for the present value of the excess earnings over the cost of equity capital to produce a value-to-book ratio that matches the market-to-book ratio of 13.9. 
REQUIRED Assume that market share prices for each firm are reasonably efficient. That is, do not simply assume that the market has over- or undervalued these firms. Considering the theoretical deter-minants of the market-to-book ratio, discuss the likely reasons for the relative ordering of these seven companies on their market-to-book ratios. 
14.20 Market Multiples and Reverse Engineering Share Prices. In 2000, Enron enjoyed remarkable success in the capital markets. During that year, Enron's shares increased in value by 89%, while the S&P 500 index fell by 9%. At the end of 2000, Enron's shares were trading at roughly $83 per share, and all of the sell-side analysts following Enron recommended the shares as a "buy" or a "strong buy." With 7522 million shares out-standing, Enron had a market capitalization of $62,530 million and was one of the largest firms (in terms of market capital) in the United States. At year-end 2000, Enron's book value of com-mon shareholders' equity was $11,470 million. At year-end 2000, Enron posted earnings per share of $1.19. Among sell-side analysts following Enron, the consensus forecast for earnings per share was $1.31 per share for 2001 and $1.44 per share for 2002, with 10% earnings growth expected from 2003 to 2005. At the time, Enron was paying dividends equivalent to roughly 40% of earnings and was expected to maintain that payout policy. At year-end 2000, Enron had a market beta of 1.7. The risk-free rate of return was 4.3%, and the market risk premium was 5.0%. (Note: The data provided in this problem, and the inferences you draw from them, do not depend on foresight of Enron's declaring bankruptcy by the end of 2001.) 
REQUIRED a. Use the CAPM to compute the required rate of return on common equity capital for Enron. b. Use year-end 2000 data to compute the following ratios for Enron: (1) Market-to-book (2) Price-earnings (using 2000 earnings per share) (3) Forward price-earnings (using consensus forecast earnings per share for 2001) c. Reverse engineer Enron's $83 share price to solve for the implied expected return on Enron shares at year-end 2000. Do the reverse engineering under the following assumptions: (1) Enron's market price equals value. (2) The consensus analysts' earnings-per-share forecasts through 2005 are reliable prox-ies for market expectations. (3) Enron will maintain a 40% dividend payout rate. (4) Beyond 2005, Enron's long-run earnings growth rate will be 3.0%. d. What do these analyses suggest about investing in Enron's shares at a price of $83?