Question

You are looking to evaluate Coca Cola (KO) in terms of their capital structure based on the following information. If their ROIC is 16.8%, are they destroying or creating value for their shareholders? Be sure to first calculate KO’s WACC, and then explain your rationale.

Risk Free Rate: 3%
Market Risk Premium 5.50%
Beta: 0.43
Cost of Debt: 2.00%
% of Debt: 20%
% of Equity: 80%
Tax Rate: 21%

Answer 1

Solution:-

First calculate Cost of Equity using Capital Assest Pricing Model-

Cost of equity = Risk Free rate + Beta * Market Risk Premium

Cost of equity = 0.03 + 0.43 * 0.055

Cost of equity = 5.365%

Cost of Debt after Tax = Cost of debt * (1-tax)

Cost of Debt after Tax = 0.02 * (1-0.21)

Cost of Debt after Tax = 0.02 * 0.79

Cost of Debt after Tax = 1.58%

WACC is Weighted Average Cost of Debt-

WACC = Cost of Debt * Weight of Debt + Cost of Equity * Weight of Equity

WACC = 0.0158 * 0.20 + 0.05365 * 0.80

WACC = 0.00316 + 0.04292

WACC = 4.608%

If Their is ROIC is 16.80% then it is creating values to their shareholders. If ROIC is less than WACC then It is Destroying the Value of Shareholders.

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