Assignement_2-Stock_Valuation

Assignement_2-Stock_Valuation - BUS 172A Marco Pagani...

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BUS 172A Marco Pagani December 10, 2007 ASSIGNMENT 2
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To Buy, Sell or Hold Coca-Cola Stocks In order for us to decide whether or not to purchase Coca-Cola stocks, we computed the reward-to-risk ratios of the company and its competitor, Pepsico Inc. Referring to our book on page 177, “the market as a whole over the past 75 or so years has averaged about 9.0 percent. The risk-free rate of return that we will be using is from a U.S. Treasury Bill, which is 5.0 percent. Using the formula below, we obtain the expected return. The betas listed for both Coca-Cola and Pepsi are from Reuters.com Investing website (1). Expected rate of return = ( 29 A f A β R R E - Stock Beta Expected Return Coca-Cola (KO) .60 .60 5.0 9.0 - = 6.66 % Pepsico Inc. (PEP) .33 .33 5.0 9.0 - = 12.12 % Referring to page 404, we conclude that Coca-Cola offers an insufficient expected return for its level of risk, compared to Pepsico, Inc. Because of its expected return is too low, the company’s price is too high. Therefore, Coca-Cola is overvalued. The U.S. Economy The economic growth rate provides the directions and scale of growth for the overall economy. According to the Bureau of Economic Analysis, the expected growth rate of the US economy is 2.9 percent as of 2006. We believe that the expected growth in the US will be slow but stable due to the impact of the housing decline. According to WTOP News, the expected
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growth rate for the world economy is 3.2 percent, down from average 3.6 percent a year because the world’s largest economy, USA and their housing market is weakening and it affects the world’s economy (3). The expected growth in for the world can increase if the US’s economy is increasing with their house market. For the corporate profits, the BEA states that the profits from current production has decreased $19.3 billion in the third quarter compared to last quarter’s increase of $94.7 billion. The world of profits in the third quarter has increased $21.9 billion from $16.7 billion in the second quarter (5). The graph above is from the Bureau of Labor Statistics Data. It depicts the US unemployment rate as of Nov. 2007, which is 4.7 percent. The annual average for unemployment rate is 4.6 percent for 2006. The unemployment rate is increasing by about .1 percent. We believe that in the future situation, the unemployment rate will increase by about .1 percent - .3 percent in 2008 (5). The inflation rate is a measure of inflation, which is the rate of increase of consumer
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Assignement_2-Stock_Valuation - BUS 172A Marco Pagani...

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