978-1285190907 Chapter 13 Part 2

Chapter 13

Valuation: Earnings-Based Approach

13-11

in whole or in part.

Exhibit 13.A

Residual Income Valuation of the Coca-Cola Company

(Problem 13.19)

Continuing

1 2 3 4 5 Value

Residual Income Valuation Year +1 Year +2 Year +3 Year +4 Year +5 Year +6

Comprehensive Income Available for Common Shareholders 8,648.5 9,094.5 9,542.9 10,014.4 10,510.1 10,825.4

Lagged Book Value of Common Shareholders’ Equity (at t – 1) 32,790.0 34,367.0 35,693.3 36,998.9 38,276.6 39,525.4

Required Earnings 2,459.3 2,577.5 2,677.0 2,774.9 2,870.7 2,964.4

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in whole or in part.

b. Based on the 7.50% required rate of return on equity capital computed in Solu-

tion a, the projected residual income amounts in Years +1 to +6 are as follows:

Year +1 Year +2 Year +3 Year +4 Year +5 Year +6

Lagged Book Value of Common

Shareholders’ Equity (at t – 1) $32,790.0 $34,367.0 $35,693.3 $36,998.9 $38,276.6 $39,525.4

Comprehensive Income Available

for Common Shareholders 8,648.5 9,094.5 9,542.9 10,014.4 10,510.1 10,825.4

name and intangible asset value of Coca-Cola has never been capitalized,

leading to a large off-balance-sheet asset and equity amount. These residual

income amounts reflect that Coca-Cola is realizing shareholder value each

year through the use of its brand name. Put differently, because Coca-Cola’s

13.11.

c. The data in Exhibit 13.A show that the sum of the present value of residual

income for Coca-Cola for Years +1 through +5, discounted at 7.50%, is

$27,665.9 million.

d. The data in Exhibit 13.A show that the present value at the start of Year +1 of

e. The data in Exhibit 13.A show the following computations:

(1) The sum of the present value of residual income is $149,347.6 million

($27,665.9 million + $121,681.7 million).

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Valuation: Earnings-Based Approach

13-13

in whole or in part.

(2) Adding beginning book value of common shareholders’ equity indicates

that the total value of equity is $182,137.6 ($149,347.6 million +

$32,790.0 million).

common equity is $188,967.8 million.

(4) The per share value estimate for Coca-Cola, after dividing the total

Part II—Sensitivity Analysis and Recommendation

Scenario 1: If we 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 8.50%,

the resulting share value estimate falls to roughly $31 per share. That amount

is 26% lower than our base case estimate of $42.28 and 12% lower than cur-

rent market price of $35.48.

double the current market price.

g. At the start of Year +1, Coca-Cola’s share price was $35.48. Our baseline

share value estimate is $42.28, implying that Coca-Cola shares are under-

priced by roughly 19%. Sensitivity analysis reveals that slight variations in the

fore would have recommended a buy.

h. In Problem 12.16, we used the free cash flows to common equity shareholders

approach and determined that Coca-Cola’s share value estimate is $42.28,

identical to the value we determined here.

Chapter 13

Valuation: Earnings-Based Approach

13-14

in whole or in part.

Exhibit 13.B

Residual Income Valuation Sensitivity Analysis for the Coca-Cola Company

(Problem 13.19)

Residual Income Valuation Sensitivity Analysis:

Long-Run Growth Assumptions

42.28 0% 2% 3% 4% 5% 6% 8% 10%

Discount 5% 45.88 67.59 94.72 176.12

Rates: 6% 38.08 50.67 63.26 88.43 163.94

6.5% 35.09 45.03 54.27 70.89 109.67 303.57

7.5% 30.30 36.84 42.28 50.84 66.24 102.18

8.5% 26.65 31.17 34.66 39.70 47.63 61.89 261.55

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in whole or in part.

13.20 Residual Income Valuation.

This is an extensive integrated problem that connects the topics of Chapter 13 to

those of Chapters 10–12 using Walmart Stores, Inc. This problem also demon-

strates the valuation approaches in Chapters 14. Note that these analyses have

the end of 2012 was 1.00. Assume that the risk-free interest rate was 3.0% and the

Part I—Computing Walmart’s Share Value Using the Residual Income Valua-

tion Approach.

a. Following the CAPM, Walmart faces a required rate of return on equity capi-

tal of 9.0% at the end of 2012. This rate is computed as follows:

E[RWMT] = E[RF] +

β

b., c., d., e., and f.

income for Years +1 through +5 to present value, computing continuing value,

and computing share value. The share value estimate is $86.88, which is iden-

tical to the estimate using the dividends model in Chapter 11 and the free cash

flows to common equity shareholders model in Chapter 12.

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Valuation: Earnings-Based Approach

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in whole or in part.

Exhibit 13.C

Residual Income Valuation of Walmart Stores

(Problem 13.20)

Continuing

1 2 3 4 5 Value

Comprehensive Income Available for Common Shareholders 17,666.5 18,415.7 19,195.4 20,006.7 20,851.0 21,476.5

Lagged Book Value of Common Shareholders’ Equity (at t – 1) 76,343.0 79,201.1 80,718.6 81,738.5 82,116.8 81,853.5

Required Earnings 6,870.9 7,128.1 7,264.7 7,356.5 7,390.5 7,366.8

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in whole or in part.

b. and c. Projected residual income amounts in Years +1 to +6 are as follows:

Residual Income Valuation Year +1 Year +2 Year +3 Year +4 Year +5 Year +6

Lagged Book Value of Common

Shareholders’ Equity (at t – 1) $76,343.0 $79,201.1 $80,718.6 $81,738.5 $82,116.8 $81,853.5

Comprehensive Income Available for

shareholders.

d. The data in Exhibit 13.C show that the sum of the present value of residual in-

come for Walmart for Years +1 through +5, discounted at 9.0%, is $46,327.6

million.

$152,838.9 million.

f. The data in Exhibit 13.C show the following computations:

(1) The sum of the present value of residual income is $199,166.5 million

lion + $76,343.0 million).

(3) After adjusting the sum of the present value using the midyear discount-

ing adjustment factor of 1.045 (1 + 0.090/2), the total present value of

common shareholders’ equity is $287,907.4 million.