978-1337614689 Chapter 14 Part 2

Chapter 14

Valuation: Market-Based Approaches

14-12

d. Under these assumptions, Enron’s shares appear to be priced by the market to

yield a 4.413% rate of return, as shown above, which is only marginally

greater than the prevailing risk-free rate of return. Enron’s shares appear to be

14.21 Valuation of Coca-Cola Using Market Multiples. This is an extensive integrat-

ed problem that connects the topics of Chapter 14 to those of Chapters 10–13 us-

Chapter 14

Valuation: Market-Based Approaches

14-13

Part I—Computing Coca-Cola’s Value-to-Book Ratio Using the Value-to-Book

Valuation Approach

b.–i.

Exhibit 14.A presents the excerpts from FSAP for the valuation of Coca-Cola

based on projected residual ROCE and the value-to-book approach. The first

Chapter 14

Valuation: Market-Based Approaches

Exhibit 14.A

Value-to-Book Model Valuation for Coca-Cola

(Problem 14.21)

Continuing

RESIDUAL INCOME VALUATION 1 2 3 4 5 Value

Market-to-Book Approach Year +1 Year +2 Year +3 Year +4 Year +5 Year +6

Residual ROCE 21.2% 21.1% 21.4% 21.7% 22.0% 22.5%

Cumulative growth factor in common equity as of t–1 100.0% 103.5% 105.8% 107.9% 109.7% 111.3%

Residual ROCE times cumulative growth 21.2% 21.9% 22.6% 23.4% 24.2% 25.0%

Chapter 14

Valuation: Market-Based Approaches

14-15

b. and c.

Projected residual ROCE amounts for Coca-Cola in Years +1 to +6 are

shown in Exhibit 14A.

d. The data in the exhibit indicate that the sum of the present value of residual

ROCE for Coca-Cola for Years +1 through +5 amounts to 1.91. This indicates

that over Years +1 through +5, Coca-Cola will earn positive residual ROCE

that, in present value, is equivalent to 0.91 times beginning book value of

equity.

e. The data in the exhibit indicate that projected residual ROCE in Year +6 will be

22.5%. Using the 7.50% required rate of return on common equity from Solu-

tion a as a discount rate and the 3.0% long-run growth rate from Solution c,

we compute the continuing value of Coca-Cola as of the start of Year +6 and

discount it to present value at the start of Year +1. The present value of con-

tinuing value is 3.88 [0.225/(0.0750 – 0.030) × 0.697].

Chapter 14

Valuation: Market-Based Approaches

14-16

Part II—Analyzing Coca-Cola’s Share Price Using the Value-Earnings Ratio,

Price-Earnings Ratio, and Reverse Engineering

j. Our Year +1 earnings per share based on projected comprehensive income

available for common shareholders in Year +1 of $7,342.3 million divided by

7.50% expected return implied by the CAPM. We determine this by assuming

that value equals price and that our earnings and 3% long-run growth forecasts

through Year +6 and beyond are reliable proxies for the market’s expectations

for Coca-Cola. We then solve for the implied expected rate of return (the dis-

count rate) the market has impounded in Coca-Cola’s share price by varying

14-17

14.22 Analysis of Comparable Companies Using Market Multiples.

a. The following table uses data and analyses for Starbucks from this chapter and

the data and analyses for Coca-Cola from the previous problem to compare

these two competitors on the following dimensions:

dollar amounts in millions Starbucks Coca-Cola

(1) Both Starbucks and Coca-Cola have similar costs of equity capital and both

are expected to generate very high ROCE next year (and beyond). Forecasts

(2) Reverse engineering suggests that the market has priced Starbucks’ shares to

14-18

(3) Reverse engineering suggests that the market prices for Starbucks’ shares

reflect less value for long-run growth than Coca-Cola shares (2.157% versus

4.030%, respectively).

Integrative Case 14.1

Valuation of Walmart Using Market Multiples. This is an extensive integrated

was $67.50.

Part I—Computing Walmart’s Value-to-Book Ratio Using the Value-to-Book Valua-

tion Approach

Exhibit 14.B

Value-to-Book Model Valuation for Walmart Stores

(Integrative Case 14.1)

Continuing

RESIDUAL INCOME VALUATION 1 2 3 4 5 Value

Market-to-Book Approach Year +1 Year +2 Year +3 Year +4 Year +5 Year +6

Cumulative growth factor in common equity as of t–1 100.0% 99.5% 97.4% 94.5% 91.0% 86.8%

Residual ROCE times cumulative growth 9.2% 9.6% 10.2% 10.8% 11.5% 12.5%

Implied Market-to-Book Ratio 2.870

Times Beginning Book Value of Equity $ 80,546.0

Total Present Value of Equity $231,184.5

Chapter 14

Valuation: Market-Based Approaches

14-20

b. and c.

0.030) × 0.650].

f. We compute Walmart’s value-to-book ratio as of the end of 2015 with the following

Chapter 14

Valuation: Market-Based Approaches

14-21

k. Using the Year +1 EPS forecast of $4.65 from Solution j and the $67.50 share price at

the end of 2015, Walmart’s price-earnings ratio is 14.5. Thus, Walmart’s value-

Chapter 14

Valuation: Market-Based Approaches

14-22

This page is intentionally left blank