Question

Coca-Cola Corp. needs to purchase new plastic moulding machines to meet the demand for its product. The cost of the equipment is $3,028,000. It is estimated that the firm will increase after tax cash flow (ATCF) by $611,671 annually for the next 5 years. The firm is financed with 40% debt and 60% equity, both based on current market values, though the firm has announced that it wants to quickly change its debt to equity ratio to 1.5. The firm's beta is 1.24, the risk free rate is 3.82% and the expected market return is 7.23%. Coca-Cola Corp.'s semi-annual bonds have 11.80% coupons, 22 years to maturity, and a quoted price of 91.547. Assume the firm's tax rate is 34%. The firm's last 5 dividends (the last in the list is D0) are 1.23, 1.60, 2.04, 2.51, and 2.87. Its current market price is $107.06.

Question 3, Math A: What is Coca-Cola Corp.'s historic rate of dividend growth based on the last 5 dividends?

Question 3 Math B: What is the firm's required return on equity based on the DDM model?

Coca-Cola Corp. needs to purchase new plastic moulding machines to meet the demand for its product. The cost of the equipment is $3,028,000. It is estimated that the firm will increase after tax cash flow (ATCF) by $611,671 annually for the next 5 years. The firm is financed with 40% debt and 60% equity, both based on current market values, though the firm has announced that it wants to quickly change its debt to equity ratio to 1.5. The firm's beta is 1.24, the risk free rate is 3.82% and the expected market return is 7.23%. Coca-Cola Corp.'s semi-annual bonds have 11.80% coupons, 22 years to maturity, and a quoted price of 91.547. Assume the firm's tax rate is 34%. The firm's last 5 dividends (the last in the list is D0) are 1.23, 1.60, 2.04, 2.51, and 2.87. Its current market price is $107.06.

Question 3, Math A: What is Coca-Cola Corp.'s historic rate of dividend growth based on the last 5 dividends?

Question 3 Math B: What is the firm's required return on equity based on the DDM model?

Coca-Cola Corp. needs to purchase new plastic moulding machines to meet the demand for its product. The cost of the equipment is $3,028,000. It is estimated that the firm will increase after tax cash flow (ATCF) by $611,671 annually for the next 5 years. The firm is financed with 40% debt and 60% equity, both based on current market values, though the firm has announced that it wants to quickly change its debt to equity ratio to 1.5. The firm's beta is 1.24, the risk free rate is 3.82% and the expected market return is 7.23%. Coca-Cola Corp.'s semi-annual bonds have 11.80% coupons, 22 years to maturity, and a quoted price of 91.547. Assume the firm's tax rate is 34%. The firm's last 5 dividends (the last in the list is D0) are 1.23, 1.60, 2.04, 2.51, and 2.87. Its current market price is $107.06.

Question 3, Math A: What is Coca-Cola Corp.'s historic rate of dividend growth based on the last 5 dividends?

Question 3 Math B: What is the firm's required return on equity based on the DDM model?

Answer 1

Question 3, Math A

The timeline of last 5 dividend are as below:

D-4 = $1.23; D-3 = $1.60; D-2 = $2.04; D-1 = $2.51; D0 = $2.87

we need to calculate historic rate of dividend growth from D-4 to D0.

historic rate of dividend growth = (D0/D-4)1/no. of years - 1 = ($2.87/$1.23)1/5 - 1 = 2.3333333333333333333333333333333‬0.2 - 1 = 1.1847 - 1 = 0.1847 or 18.47%

Question 3 Math B

firm's required return on equity based on the DDM model:

required return on equity = (D1/P0) + historic rate of dividend growth

D1 = D0*(1+historic rate of dividend growth) = $2.87*(1+01847) = $2.87*1.1847 = $3.400089‬

P0 is current market price of the stock which is $107.06.

required return on equity = ($3.400089‬/$107.06) + 0.1847 = 0.0318 + 0.1847 = 0.2165‬ or 21.65‬%