Coca-Cola Case

Coca-Cola Case 2008

Summary

Recommending any securities in an attempt to improve a client’s portfolio requires estimating a fair value of the security in question. Currently, the security in question is Coca-Cola at a stock price of $58.19. Estimating the fair value can be assessed in various ways using security pricing models. After conducting an analysis of the security’s fair market price, it is possible to compare the actual price with the estimate determining whether the security is overpriced or underpriced. If neither, the security is decided to be a fair price. Assuming the stock is underpriced or fair, it would be a considered investment recommended to clients. However, if the price is determined to be overpriced, it would be an ill-advised asset at this time. The analysis will determine whether to propose the security to the client.

After much consideration of the Coca-Cola stock, it can be concluded that the current price of the stock is overpriced using two different models; the dividend growth model and the price-earnings ratio. It has come to attention that the estimated dividend growth model valued the stock at $50.99 per share, overpricing the model approximately $7.00. The price-earnings ratio analysis has appraised the current stock price to be $53.25 per share which gives an overpricing of approximately $5.00. Both models have assessed the Coca-Cola stock to be overpriced given its current state. Therefore, it is not recommended to purchase the Coca-Cola stock presently.

Analysis

In finding the stock price using the dividend growth model, it was necessary to first use the capital asset pricing model (CAPM). The CAPM is a model that describes the relationship between risk and expected return, a model regularly used in the pricing of risky securities. Finding the CAPM gives the required return needed in using the dividend growth model. The formula for the CAPM is:

R= Rf + ОІ(Rm-Rf)

That is, the Expected Security Return = Riskless Return + Beta x (Expected Market Risk Premium). The given risk free rate was taken from the U.S. 5-year treasury bond (frequently considered risk free as being offered by the government) because the valuation was projected for 3-5 years. Any outlook past 5 years generally gives a potential inaccurate statement meaning there is additional risk involved. The treasury bond risk free rate is 5.79%. The adjusted beta was used because it is the estimated future outlook beta which is 1.24. The market risk premium is historically 6%. Given these numbers, the CAPM is 13.35% (appendix 2).

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