The Coca-Cola Company is a global soft drink beverage company (ticker: KO) that is a primary and direct competitor with PepsiCo . The data in Chapter 12’s Exhibits 12.14, 12.15, and 12.16 (pages 943–946) include the actual amounts for 2010, 2011, and 2012 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 2012 is 0.75. Assume that the risk-free interest rate is 3.0% and the market risk premium is 6.0%. Coca-Cola had 4,469 million shares outstanding at the end of 2012, when Coca-Cola’s share price was $35.48. 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 +6 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 +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 through +5. 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 +6 based on Coca-Cola’s continuing residual income in Year +6 and beyond. After computing continuing value as of the start of Year +6, discount it to present value at the start of Year +1. 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 2012, or the start of Year+1). (3) Adjust the total sum of the present value of residual income plus book value of common 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, recompute 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 calculated 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 2012, 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 shareholders valuation approach) with the value estimate you obtain here using the residual 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.

Lucas Hunter, president of Simmons Industries Inc., believes that reporting operating cash flow per share on the income statement would be a useful addition to the companys just completed financial statements. The following discussion took place between Lucas Hunter and Simmons controller, John Jameson, in January, after the close of the fiscal year: Lucas: Ive been reviewing our financial statements for the last year. I am disappointed that our net income per share has dropped by 10% from last year. This wont look good to our shareholders. Is there anything we can do about this? John: What do you mean? The past is the past, and the numbers are in. There isnt much that can be done about it. Our financial statements were prepared according to generally accepted accounting principles, and I dont see much leeway for significant change at this point. Lucas: No, no. Im not suggesting that we cook the books. But look at the cash flow from operating activities on the statement of cash flows. The cash flow from operating activities has increased by 20%. This is very good newsand, I might add, useful information. The higher cash flow from operating activities will give our creditors comfort. John: Well, the cash flow from operating activities is on the statement of cash flows, so I guess users will be able to see the improved cash flow figures there. Lucas: This is true, but somehow I think this information should be given a much higher profile. I dont like this information being buried in the statement of cash flows. You know as well as I do that many users will focus on the income statement. Therefore, I think we ought to include an operating cash flow per share number on the face of the income statementsomeplace under the earnings per share number. In this way, users will get the complete picture of our operating performance. Yes, our earnings per share dropped this year, but our cash flow from operating activities improved! And all the information is in one place where users can see and compare the figures. What do you think? John: Ive never really thought about it like that before. I guess we could put the operating cash flow per share on the income statement, underneath the earnings per share amount. Users would really benefit from this disclosure. Thanks for the ideaIll start working on it. Lucas: Glad to be of service. How would you interpret this situation? Is John behaving in an ethical and professional manner?

Analyze and compare Zynga, Electronic Arts, and Take-Two Data (in millions) from recent financial statements of Zynga Inc. (ZNGA), Electronic Arts Inc. (EA), and Take-Two Interactive Software, Inc. (TTWO) are as follows: a. Compute the working capital for Year 2 and Year 1 for each company. b. Which company has the largest working capital? c. Compute the current ratio for Year 2 and Year 1 for each company. Round to one decimal place. d. For Year 2, rank the companies from most liquid to least liquid based upon the current ratio.

Coca-Cola and PepsiCo both produce and market beverages that are direct competitors. Key financial figures for these businesses for a recent year follow. Which company is more successful in its total amount of sales to consumers?

You are the CFO for Tom & Jerry’s, Inc. Together with Tom Fheelein and Jerry Rhodeint, the company’s two shareholders, you are examining the following statement of cash flows which they prepared for Tom & Jerry’s, Inc. for the year ended January 31, 2015. TOM & JERRYS’S, INC. Statement of Cash Flows For the Year Ended January 31, 2015 Sources of cash From sales of merchandise $380,000 From sale of capital stock 410,000 From sale of investment (purchased below) 80,000 From depreciation 55,000 From issuance of note for truck 20,000 From interest on investments 6,000 Total sources of cash 951,000 Uses of cash For purchase of fixtures and equipment 320,000 For merchandise purchased for resale 258,000 For operating expenses (including depreciation) 160,000 For purchase of investment 75,000 For purchase of truck by issuance of note 20,000 For purchase of treasury stock 10,000 For interest on note payable 3,000 Total uses of cash…

Coca-Cola and PepsiCo both produce and market beverages that are direct competitors. Key financialfigures for these businesses for a recent year follow.Key Figures ($ millions) Coca-Cola PepsiCoSales . $46,542 $66,504Net income . 8,634 6,462Average assets . . . . . . . . . . . . . . . . . . . . 76,448 70,518Required Which company is more successful in returning net income from its assets invested?

Dell Technologies is a leading global end-to-end technology provider, with a portfolio of hardware, software and service solutions. In a recent annual report, the balance sheet included the following information ($ in millions): 2020 2019 Current assets: Receivables, less allowance of $94 in 2020 and $85 in 2019 $ 12,484 $ 12,371 In addition, the income statement reported sales revenue of $92,154 million for the current year. All sales are made on a credit basis. The statement of cash flows indicates that cash collected from customers during the current year was $91,868 million. There could have been significant recoveries of accounts receivable previously written off. Required: Compute the following ($ in millions): The amount of bad debts written off by Dell during 2020 (Hint: Treat it as a plug in the gross accounts receivable account). The amount of bad debt expense that Dell included in its income statement for 2020 (Hint: Treat it as a plug in the allowance…

Each of the following items is shown in the financial statements of Exxon Mobil Corporation:1. Accounts payable2. Cash equivalents3. Crude oil inventory4. Equipment5. Exploration expenses6. Income taxes payable7. Investments8. Long-term debt9. Marketable securities10. Notes and loans payable11. Notes receivable12. Operating expenses13. Prepaid taxes14. Sales15. Selling expensesa. Identify the financial statement (balance sheet or income statement) in which each item would appear.b. Can an item appear on more than one financial statement?c. Is the accounting equation relevant for Exxon Mobil Corporation?

JCPenney operates a chain of retail department stores, selling apparel, shoes, jewelry, and home furnishings. It also offers most of its products through catalog distribution. During fiscal Year 5, it sold Eckerd Drugs, a chain of retail drugstores, and used the cash proceeds, in part, to repurchase shares of its common stock. Exhibit 4.27 presents selected data for JCPenney for fiscal Year 3, Year 4, and Year 5. REQUIRED a. Calculate the rate of ROA for fiscal Year 3, Year 4, and Year 5. Disaggregate ROA into the profit margin for ROA and total assets turnover components. The income tax rate is 35%. b. Calculate the rate of ROCE for fiscal Year 3, Year 4, and Year 5. Disaggregate ROCE into the profit margin for ROCE, assets turnover, and capital structure leverage components. c. Suggest reasons for the changes in ROCE over the three years. d. Compute the ratio of ROCE to ROA for each year. e. Calculate the amount of net income available to common stockholders derived from the use of financial leverage with respect to creditors capital, the amount derived from the use of preferred shareholders capital, and the amount derived from common shareholders capital for each year. f. Did financial leverage work to the advantage of the common shareholders in each of the three years? Explain. Exhibit 4.27

Mattel, Inc., designs, manufactures, and markets toy products worldwide. Mattels toys include Barbie fashion dolls and accessories, Hot Wheels, and Fisher-Price brands. For a recent year, Mattel reported the following net cash flows from operating activities (in thousands): Explain why Mattel reported negative net cash flows from operating activities during the second and third quarters and a large positive cash flow for the fourth quarter, with overall net positive cash flow for the year.

Mattel, Inc., designs, manufactures, and markets toy products worldwide. Mattels toys include Barbie fashion dolls and accessories, Hot Wheels, and Fisher-Price brands. For a recent year, Mattel reported the following net cash flows from operating activities (in thousands): Explain why Mattel reported negative net cash flows from operating activities during the first and second quarters and a large positive cash flow for the fourth quarter, with overall net positive cash flow for the year.

At one time, the Coca-Cola Company reported a number called” economic profit” that is very similar to residual operating income. It also reported free cash flow in its annual summary of selected financial data. The respective numbers for 1992-1999 are given below (in millions of dollars), along with what Coke calls total capital (similar to net operating assets) and return on total capital (similar to return on net operating assets): 1992 1993 1994 1995 1996 1997 1998 1999 Economic Profit 1300 1549 1896 2291 2718 3325 2480 1128 Free Cash Flow 873 1623 2146 2102 2413 3533 1876 2332 Total Capital 7095 7684 8744 9456 10669 11186 13552 15740 Return on Capital 29.40% 31.20% 32.70% 34.90% 36.70% 39.40% 30.20% 18.20% a. Economic profit and free cash flow are similar, in most years, and their growth patterns are similar. Why? b. Based on this past history, would you be indifferent in valuing Coke using discounted cash flow methods or residual operating income methods?

Andrew Potter is comparing the cash- flow- generating ability of Microsoft with that of Apple Inc. He collects information from the companies’ annual reports and prepares the following table. Cash Flow from Operating Activities as a Percentage of Total Net Revenue 2017 (%) 2016 (%) 2015 (%) Microsoft 43.9 39.1 31.7 Apple Inc. 27.7 30.5 34.8 As a Percentage of Average Total Assets 2017 (%) 2016 (%) 2015 (%) Microsoft 18.2 18.1 17.1 Apple Inc. 18.2 21.5 31.1 What is Potter likely to conclude about the relative cash- flow- generating ability of these two companies?

Solution Summary: The author explains how to calculate the required rate of return on common equity capital for C using the residual income valuation approach.

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