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Unformatted text preview: 1 Recommended Problem 13.19.a Calculate Cocacola’s discount factor for a residual income valuation of common stock. To use the CAPM we need 3 inputs: 1. Riskfree rate. 2. Either the market risk premium or the expected return on the market. 3. The firm’s Beta. 2 13.19.a continued These inputs are: Risk free rate. 4.0 percent. Market risk premium 5.0 percent. CocaCola Beta of 0.76. Solution: Discount factor = Expected return on common equity = .04 + 0.76 times .05 = 0.078. 3 Forecast Residual Income for Years +1 through +6 Input for this forecast comes from the forecasted financial statements of CocaCola: Income Statement Exhibit 12.13 Balance Sheet Exhibit 12.14 Statement of Cash Flows Exhibit 12.15 For Residual Income we turn to the Income Statement and Balance Sheet. 4 Forecast of Residual Income Year +1 Year +2 ….. Year +5 Net Income 4,255.8 4,385.2 5,024.4 Discount times BV 1,242.9 1,057.5 15,935 X 0.078 969.6 Residual Income 3,012.9 3,327.7 4,054.7. PV factor 0.928 0.861 0.687 PV Residual Income 2,794.0 2,863.5 2,785.3 5 Know How to Calculate a Present Value Factor Year +1 = 1/(1+R) = 1/1.078 = 0.92764 Year +2 = 0.92764 times 0.92764 = 0.8605 Year +3 = 0.92764 times 0.8605 = 0.79825 6 Present Value of Residual Income in Years +1 through +5 2,794.9 + 2,863.5 + 2,909.1 + 2,835.9 + 2,785.3 = 14,188.6. 7 Continuing Value Continuing value = Base year residual income times discount factor applicable to previous year times multiplier. Continuing value = Year +6 residual income times discount factor applicable to Year +5 times 1/(rg) Continuing value = 4,175 times 0.687 times 1/(0.078 – 0.03) = 59,747.9 8 Total Estimate of CocaCola’s Value Including MidYear Correction Total Value before Midyear Correction: 15,935. + 14,186.6 + 59,747.9 = 89,871....
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 Winter '09
 Miller
 Market Value, residual income, P/E ratio

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