Pepsico, Inc. Case Study Solution
Cost of Capital
Based on the diagnosis, the WACC of each business segment of PepsiCo is computed separately. First the capital structure of each segment is calculated separately, to determine each segment’s debt & equity percentages. Corporate Tax rate, Risk free return, and Market return is already provided in the exhibits. As, each business is different in risk & return, comparable companies are taken for the asset beta. Then, the equity beta is calculated for each segment by using the debt & equity ratio, tax rate and the asset beta values. Cost of equity is calculated using the CAPM model, which are 10.94%, 11.35% & 12.11% for snacks, soft drinks and restaurants respectively. The cost of debt is provided in Exhibit 8, and is taken from the same comparable companies in the respective segments.
After the calculations of the required components, the WACC formula is applied on each business segment. WACC value of the snack sector is 9.43%, for soft drink 9.83%, and 9.84% for the restaurant sector. While the overall WACC of PepsiCo is calculated as 9.62% and the company is quoting it to be 11%. It is an important consideration for the investors the company as, its states the minimum rate required for investing in a company. Based, on the analysis the investors are earning more than they expected, while investing in the stock.
Recommendation
The company’s overall performance is promising, considering the numerous investments they have made in all their segments. According to this analysis, the WACC of PepsiCo is calculated as 9.62%. Whereas, the company uses 11% for its projection and is providing more return to the investors then it should. As, WACC is used by investors and analysts to analyze the company to make investment decisions, the company has to clearly define its cost of capital to avoid these situations. And each segment’s WACC should also be optimized to further trim down the costs.
Appendices
Exhibit 1 |
||||
| PepsiCo, Inc. (Cost of Capital) | ||||
| Financial Summary by Business Segment (In $ millions) | ||||
| 90' | 89' | 88' | 87' | |
| Snack Foods | ||||
| Net sales | $ 5,054.00 | $4,215.00 | $ 3,514.30 | $ 3,202.00 |
| Operating profit | 934.4 | 805.20 | 632.2 | 547.6 |
| Identifiable assets | 3,892.40 | 3310.00 | 1,608.00 | 1,632.50 |
| Depreciation | 232.5 | 189.30 | 156.8 | 154.1 |
| Capital expenditures | 381.6 | 257.90 | 172.6 | 195.6 |
| Soft Drinks | ||||
| Net sales | 6,523.00 | 5,776.70 | 4,638.20 | 3,975.60 |
| Operating profit | 767.6 | 676.2 | 455.3 | 409.6 |
| Identifiable assets | 6,465.20 | 6,198.10 | 3,994.10 | 2,779.80 |
| Depreciation | 338.1 | 306.3 | 195.7 | 166.5 |
| Capital expenditures | 334.1 | 267.8 | 198.4 | 202 |
| Restaurants | ||||
| Net sales | 6,225.70 | 5,250.70 | 4,380.70 | 3,840.50 |
| Operating profit | 522.4 | 414.3 | 340.3 | 319.4 |
| Identifiable assets | 3,448.90 | 3,070.60 | 3,061.00 | 2,782.90 |
| Depreciation | 306.5 | 269.9 | 271.3 | 237.1 |
| Capital expenditures | 460.6 | 424.6 | 344.2 | 370.8 |
| Corporate | ||||
| Corporate expenses | -557 | -545.2 | -300.6 | -331 |
| Identifiable assets | 3,336.90 | 2,548.00 | 2,472.20 | 1,827.50 |
| Depreciation | 6.9 | 6.5 | 5.5 | 5.3 |
| Capital expenditures | 21.9 | 9.2 | 14.9 | 6.6 |
| Totals (PepsiCo) | ||||
| Net sales | 17,802.70 | 15,242.40 | 12,533.20 | 11,018.10 |
| Operating profit | 1,667.40 | 1,350.50 | 1,127.20 | 945.6 |
| Identifiable assets | 17,143.40 | 15,126.70 | 11,135.30 | 9,022.70 |
| Depreciation | 884 | 772 | 629.3 | 563 |
| Capital expenditures | 1198.2 | 959.5 | 730.1 | 775 |
Exhibit 2 |
||
| PepsiCo, Inc. (Cost of Capital) | ||
| Consolidated Statements of Income | ||
| (in $ millions except per share amounts) | ||
| 90' | 89' | |
| Net sales | 17802.7 | 15242.4 |
| Costs and expenses | ||
| Cost of sales | 8609.9 | 7467.7 |
| Selling, administrative, and other | 6829.9 | 5841.4 |
| Amortization of goodwill | 189.1 | 150.4 |
| Interest expense | 688.5 | 609.6 |
| Interest income | -182.1 | -177.2 |
| 16135.3 | 13891.9 | |
| Income from continuing operations before income taxes | 1,667.40 | 1350.5 |
| Provision for income taxes | 576.8 | 449.1 |
| Income from continuing operations | 1,090.60 | 901.40 |
| Discontinued operation charge | -13.7 | -- |
| Net income | 1,076.90 | 901.40 |
| Income (charge) per share | ||
| Continuing operations | ||
| Discontinued operation | $ 1.37 | $ 1.13 |
| Net income/Loss per share | -0.02 | -- |
| $ 1.35 | $ 1.13 | |
| Average shares outstanding | 798.7 | 796 |
Exhibit 3 |
||
| PepsiCo, Inc. (Cost of Capital) | ||
| Consolidated Balance Sheets | ||
| (In $ millions except per-share amounts) | ||
| 90' | 89' | |
| Assets | ||
| Current assets: | ||
| Cash and cash equivalents | 170.80 | 76.20 |
| Short-term investments | 1,644.90 | 1,457.70 |
| Accounts receivable | 1,414.70 | 1,239.70 |
| Inventories | 585.80 | 546.10 |
| Prepaid expenses and other current | 265.20 | 231.10 |
| Total current assets | 4,081.40 | 3,550.80 |
| Investments in affiliates | 1,505.90 | 970.80 |
| Property, plant, and equipment, net | 5,710.90 | 5,130.20 |
| Goodwill and other intangibles | 5,845.20 | 5,474.90 |
| Total assets | $ 17,143.40 | $ 15,126.70 |
| Liabilities and Shareholders’ Equity | ||
| Current liabilities: | ||
| Short-term borrowings | 1626.5 | 866.3 |
| Accounts payable | 1116.3 | 1054.5 |
| Income taxes payable | 443.7 | 313.7 |
| Other current liabilities | 1584 | 1457.3 |
| Total current liabilities | 4770.5 | 3691.8 |
| Long-term debt | 6525.9 | 6686.9 |
| Deferred income taxes | 942.8 | 856.9 |
| Shareholders’ equity: | ||
| Capital stock @ par | 14.4 | 14.4 |
| Capital in excess of par | 365 | 323.9 |
| Retained earnings | 4753 | 3978.4 |
| Currency translation adjustment | 383.2 | 66.2 |
| 5515.6 | 4382.9 | |
| Less: Treasury stock | -611.4 | -491.8 |
| Total shareholders’ equity | 4904.2 | 3891.1 |
| Total liabilities and shareholders’ equity | $ 17,143.40 | $ 15,126.70 |
Exhibit 4 |
||||||||||
| PepsiCo, Inc. (Cost of Capital) | ||||||||||
| Summary of Operations | ||||||||||
| (In $ millions except per-share amounts) | ||||||||||
| 90' | 89' | 88' | 87' | 86' | 85' | 84' | 83' | 82' | 81' | |
| Net sales | 17802.7 | 15242.4 | 12533.2 | 11018.1 | 9017.1 | 7584.5 | 7058.6 | 6568.6 | 6232.4 | 5873.3 |
| Cost of sales and operating expenses | 15628.9 | 13459.5 | 11184 | 9890.5 | 8187.9 | 6802.4 | 6479.3 | 5995.7 | 5684.7 | 5278.8 |
| Gross Profit | 2173.8 | 1782.9 | 1349.2 | 1127.6 | 829.2 | 782.1 | 579.3 | 572.9 | 547.7 | 594.5 |
| Interest Expense | 688.5 | 609.6 | 344.2 | 294.6 | 261.4 | 195.2 | 204.9 | 175 | 163.5 | 147.7 |
| Interest income | 182.5 | 177.2 | 122.2 | 112.6 | 122.7 | 96.4 | 86.1 | 53.6 | 49.1 | 35.8 |
| Earnings from continuing operations before taxes | 1667.4 | 1350.5 | 1127.2 | 945.6 | 690.5 | 683.3 | 460.5 | 451.5 | 433.3 | 482.6 |
| Provision from income taxes | 576.8 | 449.1 | 365 | 340.5 | 226.7 | 256.7 | 180.5 | 169.5 | 229.7 | 213.7 |
| Income from continuing operations | 1090.6 | 901.4 | 762.2 | 605.1 | 463.8 | 426.6 | 280 | 282 | 203.6 | 268.9 |
| Net income | 1076.9 | 901.4 | 762.2 | 594.8 | 457.8 | 543.7 | 212.5 | 284.1 | 224.3 | 297.5 |
| Data Per Common Share: | ||||||||||
| Income per share from continuing operations | 1.37 | 1.13 | 0.97 | 0.77 | 0.59 | 0.51 | 0.33 | 0.33 | 0.24 | 0.32 |
| Net income per share | 1.35 | 1.13 | 0.97 | 0.76 | 0.58 | 0.65 | 0.25 | 0.33 | 0.27 | 0.36 |
| Cash dividends declared per share | 0.383 | 0.32 | 0.267 | 0.223 | 0.209 | 0.195 | 0.185 | 0.18 | 0.176 | 0.158 |
| Average shares and equivalents outstanding | 798.7 | 796 | 790.4 | 798.3 | 786.5 | 842.1 | 862.4 | 859.3 | 854.1 | 837.5 |
| Year-End Position: | ||||||||||
| Total assets | 17143.4 | 15126.7 | 11135.3 | 9022.7 | 8027.1 | 5889.3 | 4876.9 | 4446.3 | 4052.2 | 3960.2 |
| Total debt | 7526.1 | 6942.8 | 4107 | 3225 | 2865.3 | 1506.1 | 948.9 | 1073.9 | 1033.5 | 1214 |
| Shareholders’ equity | 4904.2 | 3891.1 | 3161 | 2508.6 | 2059.1 | 1837.7 | 1853.4 | 1794.2 | 1650.5 | 1556.3 |
| Book value per share | 6.22 | 4.92 | 4.01 | 3.21 | 2.64 | 2.33 | 2.19 | 2.13 | 1.96 | 1.89 |
| Market price per share | 25.75 | 21.375 | 13.125 | 11.25 | 8.75 | 7.875 | 4.625 | 4.25 | 3.75 | 4.125 |
| Shares outstanding | 788.4 | 791.1 | 788.4 | 781.2 | 781 | 789.4 | 845.2 | 842 | 840.4 | 824.4 |
| Cash-Flow Data: | ||||||||||
| Net cash generated by continuing operations | 2110 | 1885.9 | 1894.5 | 1334.5 | 1212.2 | 817.3 | 981.5 | 670.2 | 661.5 | 515 |
| Acquisitions and investments in affiliates for cash | 630.6 | 3296.6 | 1415.5 | 371.5 | 1679.9 | 160 | 0 | 0 | 130.3 | 0 |
| Purchases of ppe for cash | 1180.1 | 943.8 | 725.8 | 770.5 | 858.5 | 770.3 | 555.8 | 503.4 | 447.4 | 414.4 |
| Cash dividends paid | 293.9 | 241.9 | 199 | 172 | 160.4 | 161.1 | 154.6 | 151.3 | 142.5 | 126.2 |
Exhibit 6 |
|
| PepsiCo, Inc. (Cost of Capital) | |
| Prevailing Interest Rates and Yields as of December 31, 1990 | |
| U.S. Government Interest Rates: | |
| Maturity | Rate |
| 26 weeks | 6.57% |
| 1 year | 6.88% |
| 10 years | 8.16% |
| 30 years | 8.30% |
| Money Rates: | |
| Prime rate | 9.75% |
| 6-month certificate of deposit | 7.47% |
| Moody’s Corporate Bond Yield Averages by Rating Class: | |
| Moody’s Rating | Rate |
| Aaa | 9.05% |
| Aa | 9.39% |
| A | 9.64% |
| Baa | 10.43% |
Exhibit 7 |
|||
| PepsiCo, Inc. (Cost of Capital) | |||
| Report of Average Annual Returns for 1926–1990 | |||
| Series | Geometric Mean¹ | Airthmetic Mean¹ | Standard Deviation |
| S&P 500 | 10.10% | 12.10% | 20.80% |
| Small company stocks | 11.60% | 17.10% | 35.40% |
| Long-term corporate bonds | 5.20% | 5.50% | 8.40% |
| Long-term government bonds | 4.50% | 4.90% | 8.50% |
| U.S. Treasury bills | 3.70% | 3.70% | 3.40% |
Exhibit 8 |
|||||||||||
| PepsiCo, Inc. (Cost of Capital) | |||||||||||
| Financial Information on Snack-Food, Beverage, and Restaurant Companies | |||||||||||
| Company | Sales ($000) | Beta1 | Number of Shares (000) | Price per share | Long term debt (000) | Current Portion (000) | Capital Leases (000) | Notes Payable (000) | Total Debt (000) | Estimated cost of debt | |
| Market | Book | ||||||||||
| A&W Brands | 119,000 | 1.50 | 9,098 | 34.75 | 7.62 | - | - | - | 22,345.00 | 22,345 | 10.00% |
| Coca-Cola | 10,236,000 | 1.00 | 688,239 | 46.50 | 5.59 | 535,861 | 97,272 | - | 1,903,611.00 | 2,536,744 | 9.50% |
| Coca-Cola Bottling | 431,000 | 0.75 | 9,181 | 19.00 | 18.31 | 237,564 | 1,222 | - | - | 238,786 | 12.00% |
| Coca-Cola Enterprises | 4,034,000 | 1.00 | 114,835 | 15.50 | 14.16 | 1,960,164 | 576,630 | - | - | 2,536,794 | 10.00% |
| Flowers, Inc. | 835,000 | 0.90 | 33,617 | 14.00 | 6.00 | 52,691 | 4,857 | - | - | 57,548 | 10.00% |
| General Mills | 6,448,000 | 1.05 | 164,734 | 44.38 | 5.98 | 785,400 | 56,700 | - | 198,200.00 | 1,040,300 | 9.60% |
| Golden Ent., Inc. | 133,000 | 0.55 | 12,692 | 7.00 | 4.10 | 243 | 63 | - | - | 306 | 10.00% |
| Good mark Foods | 137,000 | 1.49 | 4,302 | 10.25 | 6.95 | 17,054 | 3,759 | - | - | 20,813 | 10.00% |
| Lance, Inc. | 445,000 | 0.70 | 31,252 | 20.75 | 7.42 | - | - | - | - | - | 10.00% |
| McDonald’s Corp. | 6,776,000 | 1.00 | 359,164 | 29.13 | 11.65 | 4,428,700 | 64,700 | - | 299,000.00 | 4,792,400 | 9.50% |
| National Pizza | 275,000 | 1.00 | 13,849 | 17.50 | 5.88 | 66,397 | 628 | 6,851.00 | - | 73,876 | 10.00% |
| PepsiCo | 17,803,000 | 1.10 | 788,400 | 25.75 | 6.22 | 5,600,100 | - | - | 1,626,500.00 | 7,226,600 | 9.64% |
| forRyan’s Family Steak House | 273,000 | 1.10 | 52,637 | 5.75 | 2.89 | - | - | - | 26,600.00 | 26,600 | 10.00% |
| TCBY | 151,000 | 1.15 | 26,162 | 7.63 | 4.06 | 18,973 | 2,893 | - | - | 21,866 | 10.00% |
| Wendy’s | 1,011,000 | 1.10 | 96,821 | 6.38 | 4.62 | 123,307 | 8,242 | 44,754.00 | - | 176,303 | 12.18% |
| 1 Betas as reported by Value Line Investment Survey, except for Coca-Cola Bottling and Goodmark Foods, which were obtained from Lotus One Source. | |||||||||||
| Ratio Analysis | ||||||||||
| 90' | 89' | 88' | 87' | 86' | 85' | 84' | 83' | 82' | 81' | |
| Profitability Ratios | ||||||||||
| Gross Profit Margin | 12.2% | 11.7% | 10.8% | 10.2% | 9.2% | 10.3% | 8.2% | 8.7% | 8.8% | 10.1% |
| Operating Profit Margin | 9.4% | 8.9% | 9.0% | 8.6% | 7.7% | 9.0% | 6.5% | 6.9% | 7.0% | 8.2% |
| Net Income | 6.0% | 5.9% | 6.1% | 5.4% | 5.1% | 7.2% | 3.0% | 4.3% | 3.6% | 5.1% |
| Return Ratios | ||||||||||
| Return on equity | 22.0% | 23.2% | 24.1% | 23.7% | 22.2% | 29.6% | 11.5% | 15.8% | 13.6% | 19.1% |
| Return on assets | 6.3% | 6.0% | 6.8% | 6.6% | 5.7% | 9.2% | 4.4% | 6.4% | 5.5% | 7.5% |
| Debt Ratios | ||||||||||
| Total debt to asset ratio | 43.9% | 45.9% | 36.9% | 35.7% | 35.7% | 25.6% | 19.5% | 24.2% | 25.5% | 30.7% |
| Interest coverage ratio | 2.42 | 2.22 | 3.27 | 3.21 | 2.64 | 3.50 | 2.25 | 2.58 | 2.65 | 3.27 |
| Activity Ratio | ||||||||||
| Asset turnover | 1.04 | 1.01 | 1.13 | 1.22 | 1.12 | 1.29 | 1.45 | 1.48 | 1.54 | 1.48 |
| Shareholder Ratios | ||||||||||
| Dividend payout ratio | 27.3% | 26.8% | 26.1% | 28.9% | 35.0% | 29.6% | 72.8% | 53.3% | 63.5% | 42.4% |
| Change in market price | 20.5% | 62.9% | 16.7% | 28.6% | 11.1% | 70.3% | 8.8% | 13.3% | -9.1% | |
| Snack Foods | Soft Drinks | Restaurants | |||
| Equity | 68% | Equity | 72% | Equity | 62% |
| Debt | 32% | Debt | 28% | Debt | 38% |
| Debt/equity ratio | 47% | Debt/equity ratio | 39% | Debt/equity ratio | 62% |
| Asset beta | 0.90 | Asset beta | 1.00 | Asset beta | 1.00 |
| Equity beta | 1.16 | Equity beta | 1.24 | Equity beta | 1.39 |
| Cost of equity for snack foods | 10.94% | Cost of equity for soft drinks | 11.35% | Cost of equity for restaurants | 12.11% |
| Cost of debt for snack foods | 10% | Cost of debt for soft drinks | 9.50% | Cost of debt for restaurants | 10.00% |
| WACC | 9.43% | WACC | 9.83% | WACC | 9.84% |
Cost of Capital
| Equity | 20,301,300 |
| Debt | 5,600,100 |
| Debt % | 22% |
| Equity % | 78% |
| Equity beta | 1.10 |
| COST OF EQUITY FOR PEPSI CO | 10.62% |
| COST OF DEBT FOR PEPSI CO | 9.64% |
| OVERALL WACC FOR PEPSI CO | 9.62% |
| COST OF CAPITAL | |
| Tax rate | 38.00% |
| Risk free rate | 4.90% |
| Market return | 10.10% |
| PepsiCo Inc. | |||
| Capital Structure | |||
| Description | Debt % | Equity % | Debt/Equity % |
| Snack Foods | 32% | 68% | 47% |
| Soft Drinks | 28% | 72% | 39% |
| Restaurants | 38% | 62% | 62% |
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