Question

Exercise 8A: Perform an EPS/EBIT Analysis for Coca-Cola

Instructions

Amount Coca-Cola needs: $5,000 million to build four new manufacturing plants outside the United States

• Interest rate: 5%

• Tax rate: 21%

• Stock price: $45.54 as of January 2, 2018

• Number of shares outstanding: 4,255 million

• EBIT: Pessimistic: $7,000 million, Realistic: $9,000 million, Optimistic: $11,000 million

Steps

1. Prepare an EPS/EBIT analysis for Coca-Cola. Determine whether the company should use all debt, all stock, or a 50-50 combination of debt and stock to finance this market-development strategy.

2. Develop an EPS/EBIT chart after completing the EPS/EBIT table.

3. Next, give a three-sentence recommendation for Coca-Cola’s CFO.

Answer 1

100% debt scenario
(in $ million)	Pessimistic	Realistic	Optimistic
EBIT	7000	9000	11000
Less:
Interest (5000 @ 5%)	-250	-250	-250
PBT	6750	8750	10750
Less:
Tax @ 21% on PBT	-1417.5	-1837.5	-2257.5
PAT	5332.5	6912.5	8492.5
Number of shares outstanding	4255	4255	4255
EPS	1.25	1.62	2.00

EPS-EBIT 12000 10000 8000 In $ million 6000 in $ 4000 0.50 0.00 Pessimistic Realistic Optimistic 100% Debt Scenario EBIT — EPS

100% stock scenario
(in $ million)	Pessimistic	Realistic	Optimistic
EBIT	7000	9000	11000
Less:
Interest	0	0	0
PBT	7000	9000	11000
Less:
Tax @ 21% on PBT	-1470	-1890	-2310
PAT	5530	7110	8690
Number of shares outstanding	4255	4255	4255
EPS	1.30	1.67	2.04

EPS-EBIT 12000 10000 8000 In $ million 6000 in $ 4000 0.50 0.00 Pessimistic Optimistic Realistic 100% Stock Scenario EBIT — EPS

50-50 combination of debt and stock
(in $ million)	Pessimistic	Realistic	Optimistic
EBIT	7000	9000	11000
Less:
Interest (2500 @ 5%)	-125	-125	-125
PBT	6875	8875	10875
Less:
Tax @ 21% on PBT	-1443.75	-1863.75	-2283.75
PAT	5431.25	7011.25	8591.25
Number of shares outstanding	4255	4255	4255
EPS	1.28	1.65	2.02

EPS-EBIT 12000 10000 8000 In $ million 6000 in $ 4000 0.50 0.00 Pessimistic Optimistic Realistic Equal Debt & Stock Scenario EBIT — EPS

From the above illustrations, it is evident that a 100% stock scenario yields the highest EPS (Earnings per share) for all the instances. The next best option would be an equal debt and equity scenario. The reason behind the higher EPS is that debt capital leads to higher interest expense which lowers the PBT (Profit Before Tax) leading to a lower EPS.