Coco Cola

EXERCISES FOR CHAPTER 6

With Solutions

Exercise 1. Forecasting Earnings from a Market Price: The Coca Cola Company

The Coca-Cola Co (KO) traded at $43 per share at the close of trading on September 25, 2003. Coke had reported earnings per share (eps) of $1.23 for the year ending December 31, 2002, along with an annual dividend per share (dps) of 0.88. Analysts were estimating consensus eps of $1.90 for 2003 and $2.06 for 2004, and dividends of $0.90 each year. Use a cost of equity capital of 9% in calculations.

a. Calculate the forward traded P/E ratio. What is the normal forward P/E for this stock? Comparing the traded P/E with the normal P/E, what statements can you make about the market’s expectations of future earnings growth?

b. Calculate the trailing P/E. What is the normal trailing P/E for this stock? Why is the trailing P/E so much higher than the forward P/E?

c. The analysts’ forecasts indicate a growth rate for eps of 8.42% in 2004. What is the 2004 cum-dividend growth rate implied by the forecasts, and what is the abnormal earnings growth?

d. Calculate the forecasts of eps for 2005 and 2006 that are implicit in the market price of $43.

e. Calculate the forecasted cum-dividend eps growth rates for 2005 and 2006.

:

Forecasting Earnings from a Market Price, The Coca Cola Company: Solution

Price = $43; required return = 9%

Set up the pro forma to deal with the questions:

2002 2003 2004

Dps 0.88 0.90 0.90

Eps 1.23 1.90 2.060

Reinvested dividends (9%) 0.081

Cum-dividend eps 2.141

Normal eps (1.90 x 1.09) 2.071

Abnormal earnings growth 0.070

Now to the answers:

a. Forward P/E = $43/1.90 = 22.63

Normal forward P/E = [pic]= 11.11

The normal P/E implies (cum-dividend) eps growth of 9%. Accordingly, the market is forecasting that eps will grow at a higher rate than 9%.

b. Trailing P/E = [pic] = 35.67

(The trailing...