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There are various ways that Coca Cola Company can use to finance its new project in South Korea. The management can decide on whether the project should be financed by debt, equity or a mixture of both. Therefore, Coca Cola needs to establish the proportion of funds involved in its new project in South Korea. Working capital implications are also useful to be considered in addition to the international complexities facing the MNE. In the last section, the cost of capital for the project is calculated. This will be then used to calculate the Net Present Value (NPV) of the investment

In the established academic field of finance, the decision of the capital structure seemed to be irrelevant. (Miller and Modigliani ,1958) During the following years, authors have found that these theories are based on a series of assumptions, which are both: unrealistic and contradictory. Lately, Miller and Modigliani, focused on finding the optimal capital structure, which is defined as the point between debt and equity financing; where the overall firm’s value is maximized. This is also referred to the trade-off theory of leverage. This theory revises the tax benefit from interest payments. This is due to the fact that the interest paid for debt is tax deductible. This means that when the management issues bonds effectively, the company’s tax liability is also improved.

According to Shapiro (1989), the proportion of debt and equity for the subsidiary is relevant only if it has an effect on the capital structure of the parent company. That is because the financial risks faced by the subsidiary are the same as the ones incurred by the parent company. The parent company located in US acts as a guarantor to assist the subsidiary operating in South Korea when raising more debts. The debt raised can also be by an extension of loan from parent company in US. In addition, Eiteman (1969) has explained that the capital structure of local competitors operating in the same industry can be used to establish the proportion of capital structure for the subsidiaries. For this reason, the proportion which will be established in financing the new project will reflect the parent company’s current activities.

Debt funding involves borrowing finances by a company to help the company run its operations (Liesen et al. 2017). When involved in borrowing, Coca Cola has to assure lenders that it has a good flow of capital in and out the firm. For this reason, the company discloses its financial statements according to the number of assets it owns. Credit rating agencies such as Fitch, Moody’s and Standard & Poor’s rank the company based on the ability to pay interest and principal on time (Figure 1). The organisation has a high bond rating and this enables it to get access to short-term debts Moreover, debt financing always contain restrictions on a company’s activities, preventing the management from pursuing non-core business opportunities (Denis & McKeon, 2012). Finally, a firm must pledge its assets to the investor as collateral and shareholders are in some cases required to guarantee the repayment of debt (Buckley, 2016)

The firm’s strategy allows it to provide assured interests to most of its investors. The organisation is able to have got its debts from bonds that should be returned within a short period. The short-term bonds might require to be paid back within a period of between six and twelve months.(Eiteman, 2015) These might help the company grow faster as it gets easier access to capital in a shorter period of time (Nilsson and Sandahl 2018). Organisations that do not have good credit scores are less likely to get access to short-term bonds as they feel that it is a highly risky and insecure form of borrowing (Lanis, McClure, and Zirnsak 2017). The short-term bond debts constitute a 49 per cent of the total debts of the company (Reuters, 2018). This form of borrowing is considered to be highly risky especially by organisations that do not have a good flow of capital in and out of the firm (Lanis, McClure, and Zirnsak 2017). Just like the banks or the big institutions, Coca Cola considers taking the short-term bond debts since it has a regular flow of capital that allows the company to be able to repay the loans within the required time. The organisation has managed to have a good financial record of being able to finance its activities and this has helped it gain the trust of more creditors towards funding its projects (Lanis, McClure, and Zirnsak 2017).

On the other hand, shareholders investing in Coca Cola Company would provide additional cash that can be used to finance the new project in South Korea.

Coca Cola may use funds raised by equity holders to finance the implementation stage of the project in South Korea; as the project is not expected to produce any return during the first stage. As investors tend to have a long term view about the growth of the organization, immediate returns on investment are not expected (Brealey, Myers & Allen ,2017).This will allow Coca Cola Company to keep more cash in hand for business expansion instead of having to pay part of the profits to repay the loan. Equity financing also helps to confer legitimacy as it enables firms to tap into investor networks, which enhances their credibility (Scarborough and Cornwall, 2017).

One of the main advantages of equity financing is that investors would not reclaim their investment back in case the project does not produce positive cash flows. That is also because shareholders have higher tendency to risk compared to debt holders as they also expect to receive higher returns (Scarborough and Cornwall, 2017). Furthermore, equity financing offers additional advantages for the management of the firm. For instance, the credibility of the firm will be enhanced, which ultimately leads to a greater ability to borrow at a lower price in order to finance new projects such as the one in South Korea. However, equity financing is believed to be more challenging than engaging in borrowing as the firm does not have to comply with the state as well as the federal laws and regulations (Scarborough and Cornwall, 2017).The long-term debt to the total capital of the organisation ratio is 4:9 (Finance.yahoo.com, 2019). The ratio is determined by dividing the debts by the total assets. This indicates that the firm has a good total capital consideration to pay off its debts. The credibility of the organisation is more likely to help it have more debtors on its way to ensure that its activities run smoothly as required. Following the points mentioned above, the proportion established by Coca Cola for its new project in South Korea will be 30% equity and 70% debt. This is due to the fact that while using more debt financing will raise the risk borne by the stockholders, debt financing will increase the expected return on equity; and this would be raised from the United States.

Optimal management of an organization’s working capital is a critical financial decision that can contribute positively to value creation of a business. A business needs investment to buy fixed assets, which normally remain in use for long period of time. Money invested in fixed assets is referred to as long term funds. Business also requires funds for short term purposes in order to finance its current operations. These investments in short term assets such as cash, trade receivables and inventories are known as working capital (Sagner, 2014).

Working capital, as such, is the current assets used in operations and net working capital is the difference between current assets and current liabilities (Sharma & Kumar, 2011).

An analysis of Coca Cola Company’s financial results shows that the company’s current assets in the years 2017 and 2016 were $36,545 million and $34,010 million respectively . The company’s current assets for the years 2015 and 2014 were $33,395 million and $32,986 million, respectively (Stock Analysis on Net, 2019)

The total current liabilities for 2017 and 2016 were $27,194 million and $26,532 million. For the years 2015 and 2014, the company’s current liabilities were $26,930 million and $32,374 million, respectively (Stock Analysis on Net, 2019).

Net Working Capital = Current assets- Current liabilities

Coca Cola Company’s net working capital for 2017:

Net working capital = $36,545 million-$27,194million

= $9,351 million

Coca Cola Company’s net working capital for 2016;

Net working capital =$34,010 million-$26,532

=$7,478 million

Coca Cola Company’s net working capital for 2015;

Net working capital =$33,395million-$26,930million

=$6,465

From the calculations above, we can see that the Coca Cola has managed to have a positive working capital during the previous years; meaning that the firm has good capital to start a new project.

It also important to calculate the company’s working capital days, to determine the number of days it takes an organization to convert working capital into revenues.

Working Capital days= (Average working capital x 365)/Annual sales

Coca Cola’s working capital days for 2017;

Working capital days = ($9,351x365)/$35,410

= 96.38 days

According to Shapiro (2014), working capital can help in identifying the funds required for smooth operations of the business day to day activities. The management of working capital is important just as the management of an organization’s long term financial investments. Working capital is also concerned with maintaining liquidity in a firm for smooth running of daily operations and the ability to meet its financial obligations. Therefore, a mismatch in Coca Cola Company’s effective management of the company’s current assets to the current liabilities would negatively affect the company’s profitability and growth; causing financial distress of the business entity.

Given that Coca Cola is investing in a country which has never invested before, the company’s working capital may be affected by various international complexities. The main complexities facing Coca Cola will be the change in exchange rate, the country’s political risk, the foreign tax credits and the currency risk management (Shapiro, 2014). When subsidiary operates in a developing county such as South Korea, international development agencies such as the Word Bank and international finance corporations will assist the subsidiary in lowering its political risk to decrease the firm’s vulnerability to exchange exposure (Shapiro, 2014). According Eun & Resnick (2018), the subsidiary should also take advantage of loans whenever possible. The chance of expropriation can be diminished when the South Korean subsidiary is financed by local creditors as Coca Cola would be able to default on loan repayments when faced with high political instability.

In addition, the firm should take advantages of tax deduction of interest payment by borrowing more heavily than what is implied by the parents norms. That is because the corporate income tax rate is higher in South Korea rather than US. Therefore, the foreign tax credit should also be considered. In conclusion, since the parent enterprise will be legally responsible for the subsidiaries obligation it has to carefully consider its impact on the overall financial structure (Shapiro, 2005)

A company can decrease the foreign exchange experience by making use of the local currency. The company can do this by financing possessions that produce the foreign-currency flows of cash with liabilities controlled in those similar foreign currencies (Shapiro , 2005).

The cost of capital is the minimum rate of return and investment project must generate in order to pay its financing cost. The cost of capital for a multinational company is likely to change across different countries. The weighted average cost of capital (WACC) of a firm is the mean rate of interest the firm has to disburse to fund its possessions, augmentation and the working capital (Eiteman,2015). It can also be described as the minimum mean return rate a firm ought to receive on its present assets to fulfil its creditors and its stakeholders.

The cost of capital of Coca Cola is calculated by reviewing the present structure of the capital of a firm and its percentage of equity and debt.

Additionally, the ungearing formula and regearing formula are applied to find the value of beta. The value of beta assets is similar to the one of other investments as Coca Cola produces the same product across different regions. Successively, CAPM is found summing the risk free rate to beta asset and multiplying the result by 1 – the rate of corporate tax. On the other hand, sovereign premium has not been added to the cost of equity as South Korea is not considered to be a highly risking country where to raise debt. In fact, the South Korean government bond has a yield of only 1.965%(Reuters, 2019). According to the calculations, the cost of equity of the coca cola company is 26.53%. The cost of debt is the quotient of interest on debt and the book value of debt; and is determined to be 2%. The WACC is the required rate of return to debt and equity holders, which according to the calculation is 9%.

The WACC assumes that there is no change in the capital structure of a firm. The WACC is advantageous because it is simple and easy to calculate, a single hurdle calculates the rates of all projects and it helps in valuing the firm. However, there are some limitations when using WACC. The Kd found out is calculated net of taxes as it is multiplied by (1-t). Therefore, the formula can be applicable only if the flow of interest payment is tax deductible. The result of the WACC will be used as a discount rate for the third assignment to calculate the NPV.

Calculations

· Finding the proportion of Debt and Equity for the company

Debt’s weight= Value of Debt / (E+D)

Debt’s weight= 45.020/(192.565 + 45.020)

Debt’s weight= 45.020/237.585= 0.1894 (19%)

Equity weight= 100-19= 81%

· Apply ungearing formula

· ßa= ße x

· ßa= 0.52 x

· ßa= 0.52 x

· ßa= 0.52 x

· ßa= 0.52 x

· ßa= 0.52 x 0.8436= 0.44

· Find ße with proportion established (regearing)

ße= ßa x

ße= ßa x

ße= ßa x

ße= ßa x

ße= ßa x

ße= 0.44 x 2.84 = 1.2510

· Find Ke

Er = Rf + Be (Rm – Rf)

Er = 0.0253 + 1.251 (0.2183 – 0.0253)

Er = 0.0253 + 1.251 x 0.193

Er = 0.0253 + 0.24 = 0.2653 (26.53%)

· Find Kd

Kd= interest on debt / book value of debt

Kd= 919/45020 = 0.020 = 2%

· Calculate Weighted Average Cost of Capital

WACC= x Ke + x Kd x (1-Tc)

WACC= 0.3 x 0.2653 + 0.7 x 0.02 x (1-0.21)

WACC= 0.079 + 0.7 x 0.02 x 0.79

WACC= 0.079 + 0.011= 0.09 = 9%

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Financial statements for Coca Cola

Annual Balance sheet