Shippensburg University
John L. Grove College of Business
FIN 311 Financial Management
Spring 2011
Class at [5:00 pm]
Group [4] Term Project
[Coca-Cola Company]
[KO]
Name
Kaitlyn Higley
Shannon Vevante
Chuck Sabol
Tyler Musselman
Duty
Ratio analysis (Part I)
Tables 1-2
Data construction
Abstract
Tables 3-4
Stand-alone analysis (Part II)
Market risk (Part II)
Systematic & unsystematic risk (Part II)
Required rate of return (Part II)
Table 5
April 19, 2011
1
Summary
The company we chose for our project is Coca-Cola. This company is part of the soft-drink
industry. It is one of the leading companies with its main competitor being Pepsi-Co. We followed the
stock prices over a 10-week period from January 28th to April 1st.
Our findings from part 1 show that with respect to liquidity, debt, and profitability, Coke is
outperforming its competitors. However, in liquidity and activity it is underperforming in the industry.
Since the debt ratio is better all around, the company is less risky and has more potential for growth.
Based on our findings in part 2, and the fact that our company’s Beta is very close to 1, it shows
that our company’s performance will very closely match that of the S&P500. Overall, Coke’s stock
returns were slightly higher than the market returns. Also, our company faces more risk compared to the
market overall.
Overall, we feel that based on our evaluation that Coke would be a good company to invest in.
This is due to the fact that over the sample period there was an overall gain on the stock. The fact that
there is large growth potential also makes it appealing.
Part I: Ratio Analysis
Liquidity ratios
Liquidity - A firm’s ability to satisfy its short-term obligations as they come due. Liquidity refers to the
solvency of the firm’s overall financial position, the ease with which it can pay its bills. The higher the
ratio, the more liquid it is.
Current Ratio - A measure of liquidity calculated by dividing the firm’s current assets by its current
liabilities. Generally, the higher the current ratio, the more liquid the firm is considered to be.
Quick Ratio - A measure of the liquidity calculated by dividing the firm’s current assets minus inventory
by its current liabilities. A quick ratio of 1.0 or greater is occasionally recommended, but what value is
acceptable depends largely on the industry.
2
For the current ratio Coca-Cola has a 1.17 ratio compared to the industry average at 1.3. It has a
higher ratio than its competitor Pepsi. Typically the larger the corporation the smaller the current ratio,
this figure shows that Coke is underperforming compared to the industry, but outperforming its rival
Pepsi. The Quick ratio follows the same trend. With a comparison of previous years there is an upward
trend in liquidity peaking in 2009 while somewhat decreasing in 2010.
Activity ratios
Activity - Measures the speed with which various accounts are converted into sales or cash, inflows or
outflows. The higher the ratio, the more efficient the company is with a specific amount of capital.
Inventory Turnover - Measures the activity, or liquidity, of a firm’s inventory. The higher the inventory
turnover the more efficient it is.
Total asset turnover - Indicates the efficiency with which the firm uses its assets to generate sales.
Generally, the higher a firm’s total asset turnover, the more efficiently its assets have been used.
With respect to the activity ratios, inventory and total asset turnover, Coca-Cola is
underperforming compared to both the industry and its biggest rival, Pepsi. This shows that Coke is less
efficient at using its assets to generate sales compared to other companies in the industry.
For the activity ratios there is no definite trend of an increase or decrease across the 5 years, but
overall there is a small net decrease in the firm’s efficiency.
Debt ratios
Debt - The higher the debt ratio, the company is subject to higher risk of bankruptcy.
Debt Ratio - Measures the proportion of the total assets financed by the firm’s creditors. The higher the
ratio, the greater the amount of other people’s money being used to generate profits.
Debt/Equity - Measures the long-term debt divided by equity.
Financial Leverage - The potential use of fixed financial costs to magnify the effects of changes in
earnings before interest and taxes on the firm’s earnings per share.
3
Coca-Cola has a lower debt ratio than both the industry and its rival, Pepsi. For the Debt equity
ratio, both Coke and Pepsi have almost identical ratios, both being lower and less risky than the industry
average. When looking at financial leverage, Coca-Cola is lower than both the industry and Pepsi. Overall
Coke is assuming less risk than the industry average, while its rival Pepsi is assuming much more risk
than the industry. Throughout all debt ratios for Coca-Cola over the five years, Coke has become
increasingly more indebted.
Profitability ratios
Profitability - The relationship between revenues and costs generated by using a firms assets, both current
and fixed, in productive activities. The higher the ratio, the company is more profitable.
Gross Profit Margin - Measures the percentage of each sales dollar remaining after the firm has paid for
its goods.
Operating Profit Margin - Measures the percentage of all sales dollars remaining after all costs and
expenses other than interest, taxes and preferred stock dividends are deducted; this is the “pure profits”
earned from each sales dollar.
Net Profit Margin - Measures the percentage of each sales dollar remaining after all costs and expenses,
including interest, taxes, and preferred stock dividends, have been deducted.
Earnings per Share - the amount earned during the period on behalf of each outstanding share of common
stock, calculated by dividing the period’s total earnings available for the firm’s common stockholders by
the number of shares of common stock outstanding.
Return on Assets - Measures the overall effectiveness of management in generating profits with its
available assets. Also called return on investment.
Return on Equity - Measures the return earned on common stockholders’ investment in the firm
For profitability, throughout all measures Coca-Cola has larger returns than both the industry
average and Pepsi. From 2006 to 2009, there has been little to no change in Cokes profitability. However,
2010 proved to show much growth in the profitability of all ratios.
4
Market ratios
Market ratios - Relate a firm’s market value, as measured by its current share price, to certain accounting
values. The higher these ratios are the higher the investors’ confidence.
Price/Earnings Ratio - Measures the amount that investors are willing to pay for each dollar of a firms
earnings; the higher the P/E Ratio, the greater the investor’s confidence.
Market/Book Ratio - provides an assessment of how investors view the firm’s performance. Firms
expected to earn high returns relative to their risk typically sell at higher M/B multiples.
For Coca-Cola the Price to Earnings ratio is lower than both the industry and its rival. When
looking at the Market to Book Coca-Cola has a higher ratio than the industry but slightly lower than
Pepsi. These ratios indicate the level of shareholders’ confidence in the firm’s performance.
With regards to the Market ratios price to earnings displays a general downward trend throughout
the years. This is also apparent in reference to the Market/Book ratio. Overall Coca-Cola has seen a
decrease in consumer confidence for their products.
DuPont System of Analysis
ROA (return on assets) equals EAFCS (earnings available for common stock holders) divided by
total assets. EAFCS is better known as net profit or income. ROE (return on equity) equals EAFCS
divided by common stock holder’s equity. According to the DuPont Analysis, net profit margin and total
asset turnover are the two ratios driving the increase in ROA. In addition to net profit margin and total
asset turnover, financial leverage is the third driving factor behind the increase in ROE.
5
Part II: Risk and Return Analysis
Stand alone risk
The mean for Coca-Cola, .8%, represents the average gain for Coke over the ten week period.
The mean return for Coke is outperforming the industry average by almost 2 to 1, with the S&P having a
mean return of.49%. The standard deviation, which is .0247 for Coke, is the measure of possible change
that the mean return could experience in week eleven. The Standard deviation for the S&P, .0180,
represents that there is less risk overall compared with Coke. The coefficient of variation for Coke is
3.0727 which is lower than the S&P 500’s coefficient of variation at 3.6404. This exemplifies that the
S&P 500 is more risky and has greater potential for a higher return. Compared with the S&P 500, Coke’s
stock has a relatively strong correlation of returns. The S&P 500 and Coca-Cola are strongly positively
correlated and therefore move in the same direction.
Market risk
The computed beta value for Coca-Cola, .9734, represents the percentage change in Coke’s return
in response to a 1% change in the market’s return. So if the market return would increase by 1%, Coke’s
return would increase by .9734%. This number indicates that Coke has had relative nondiversifiable risk
and since they have an almost equal beta as the market, their returns can be predicted almost equally with
the market’s in the upcoming weeks, excluding effects from any firm specific events. The reported beta
at finance.yahoo.com is .58, which is much lower than our computed beta. By comparing the two beta’s,
it shows that over the 10-week period that Coke’s returns have been more responsive to the market’s
returns than in past periods. The beta’s differ because market factors, such as inflation, have been
increasing at a higher rate and have affected Coke more over the past 10 weeks than before. The reported
beta is a more comprehensive value and is better suited for determining the total market risk of Coke’s
stock.
6
Systematic and unsystematic risk
Based on our calculations, Coca-Cola’s stock has an almost equal share of systematic (market)
risk and unsystematic (firm-specific) risk. While 47% of its stock’s risk is systematic, 53% of the risk is
unsystematic. Coca-Cola most certainly has a large share of its risk associated with its internal activity,
which is unsystematic. Based on economic theory, since Coca-Cola holds the second largest market share
among the competitively monopolistic soft drink industry, little of its risk is associated with changes in
the market. Rather, more of its risk is associated with firm-specific activities like marketing, research &
development, and input prices. It is possible for a company to have lots of firm-specific risk and little
market risk. The fewer competitors in a market, the more risk will be associated with each competitor’s
firm-specific activity. Naturally, specific industries such as tech and those who venture capitalists target
will assume most of their risk through firm-specific activity.
Required rate of return
Based on our knowledge of the CAPM, we can deduce that the higher the beta value, the higher
the required rate of return will be. Using the data we compiled, the CAPM produced an estimated
required return of 14% for Coca-Cola. Our assumption is that Coke’s stock growth rate will remain
constant at 2.8% for the next five years. According to the constant growth model and our assumptions
about it, we arrived at an estimated required return of 5.6%. The difference between the two required
returns can be attributed to the fact that the CAPM is more of a short term tool based on current data and
the constant growth model is more long term using data that is forecasted for the future. The constant
growth rate assumes a five year period in this instance. We feel that the CAPM would be more reliable
due to the fact that it is based off of current data. Although we feel that it is more reliable, it produced a
required return that seems to be less realistic than the constant growth model due to it being so high. With
this in mind, we feel that the constant growth model is more realistic but less reliable due to the use of
data that is predicted, rather than already known.
7
Table 1: Financial Ratios of your Company
2006
2007
2008
2009
2010
Industry
Rival
(Firm)
2010
Current ratio
.95
.92
.94
1.28
1.17
1.3
1.11
Quick ratio
.76
.75
.77
1.11
1.02
1.1
.89
Inventory turnover
4.98
4.69
5.20
4.71
4.79
6.1
7.88
Total asset turnover
.81
.79
.76
.69
.58
.7
1.07
Debt ratio
.44
.50
.50
.49
.57
.61
.69
Debt/equity
.07
.15
.14
.20
.45
.73
.44
Financial leverage
1.77
1.99
1.98
1.96
2.35
2.40
3.20
Gross profit margin
.66
.64
.64
.64
.64
.59
.54
Operating profit margin
.27
.27
.23
.23
.41
.24
.14
Net profit margin
.21
.21
.18
.22
.34
.28
.11
EPS ($)
2.16
2.57
2.49
2.93
5.06
3.68
3.91
ROA
.17
.16
.14
.15
.19
.16
.12
ROE
.31
.31
.28
.30
.42
.37
.32
P/E ratio
22.3
23.9
18.2
13.0
12.4
20.0
16.7
Market/book ratio
6.70
6.58
5.17
5.35
4.95
4.35
4.97
Ratio
Liquidity
Activity
Debt
Profitability
Market
8
Table 2: DuPont System of Analysis
Year
ROE
ROA
Net profit margin
TA turnover
Financial leverage
2006
.31
.17
.21
.81
1.77
2007
.31
.16
.21
.79
1.99
2008
.28
.14
.18
.76
1.98
2009
.30
.15
.22
.69
1.96
2010
.42
.19
.34
.58
2.35
Table 3: Statistical Results for Stock and Market Returns
Date
1/28/2011
2/4/2011
2/11/2011
2/18/2011
2/25/2011
3/4/2011
3/11/2011
3/18/2011
3/25/2011
4/1/2008
Mean Return
Variance
Standard Deviation
Coefficient of Variation
Covariance
Correlation
Beta
Systematic Risk
Systematic Risk Share (%)
Unsystematic Risk
Unsystematic Risk Share (%)
Your stock
62.7
62.56
63.54
64.55
63.88
65.57
65.29
62.7
65.22
67.22
S&P 500
1276.34
1310.87
1329.15
1343.01
1319.88
1321.15
1304.28
1279.21
1313.8
1332.41
r for your stock
r for S&P 500
-0.0022
0.0157
0.0159
-0.0104
0.0265
-0.0043
-0.0397
0.0402
0.0307
0.008
0.0006
0.0247
3.0727
0.0003
0.7077
0.9734
0.000284
47%
0.000316
53%
0.0271
0.0139
0.0104
-0.0172
0.001
-0.0128
-0.0192
0.027
0.0142
0.0049
0.0003
0.018
3.6404
9
Table 4: Regression Output
Regression Statistics
Multiple R
0.707679416
R Square
0.500810156
Adjusted R
Square
0.429497321
Standard Error
0.018664953
Observations
9
ANOVA
df
Regression
Residual
Total
1
7
8
Coefficients
Intercept
S&P 500
Upper 95%
0.003237289
0.974423358
Lower
95.0%
Significance
SS
MS
F
F
0.002446579 0.002446579 7.022721183 0.032939696
0.002438663 0.00034838
0.004885242
Standard
Error
t Stat
P-value
Lower 95%
0.006480703 0.499527488 0.632723357 0.012087138
0.367701137 2.650041732 0.032939696 0.104948332
Upper
95.0%
0.018561716 0.012087138 0.018561716
1.843898384 0.104948332 1.843898384
Table 5: Estimates for Required Returns on Stock
CAPM:
Risk-free rate (%)
Beta
Market risk premium (%)
Estimate for the required return (%)
rj = rf + βj * (rm – rf)
.14= .07+.9734*(.072)
7%
.9734
7.2%
14%
Constant Growth Model:
rs = (D1/P0) + g
.056=(1.88/67.22)+.028
D1 (annual dividends in the next year period)
1.88
P0 (stock price at the end of the sample period) 67.22
G (annual growth rate, %)
2.8%
Estimate for the required return (%)
5.6%
10
Figure 1: Stock Returns vs. Market Returns
Scatter Plot
0.03
Coca-Cola Returns
0.02
0.01
0
-0.05
-0.04
-0.03
-0.02
-0.01
0
0.01
0.02
0.03
0.04
0.05
-0.01
-0.02
-0.03
S&P 500 Returns
11