Pepsico, Inc. Harvard Case Solution & Analysis

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 profit934.4805.20632.2547.6
Identifiable assets3,892.403310.001,608.001,632.50
Depreciation232.5189.30156.8154.1
Capital expenditures381.6257.90172.6195.6
Soft Drinks
Net sales6,523.005,776.704,638.203,975.60
Operating profit767.6676.2455.3409.6
Identifiable assets6,465.206,198.103,994.102,779.80
Depreciation338.1306.3195.7166.5
Capital expenditures334.1267.8198.4202
Restaurants
Net sales6,225.705,250.704,380.703,840.50
Operating profit522.4414.3340.3319.4
Identifiable assets3,448.903,070.603,061.002,782.90
Depreciation306.5269.9271.3237.1
Capital expenditures460.6424.6344.2370.8
Corporate
Corporate expenses-557-545.2-300.6-331
Identifiable assets3,336.902,548.002,472.201,827.50
Depreciation6.96.55.55.3
Capital expenditures21.99.214.96.6
Totals (PepsiCo)
Net sales17,802.7015,242.4012,533.2011,018.10
Operating profit1,667.401,350.501,127.20945.6
Identifiable assets17,143.4015,126.7011,135.309,022.70
Depreciation884772629.3563
Capital expenditures1198.2959.5730.1775

 

Exhibit 2

PepsiCo, Inc. (Cost of Capital)
Consolidated Statements of Income
(in $ millions except per share amounts)
90'89'
Net sales17802.715242.4
Costs and expenses
Cost of sales8609.97467.7
Selling, administrative, and other6829.95841.4
Amortization of goodwill189.1150.4
Interest expense688.5609.6
Interest income-182.1-177.2
16135.313891.9
Income from continuing operations before income taxes1,667.401350.5
Provision for income taxes576.8449.1
Income from continuing operations1,090.60901.40
Discontinued operation charge-13.7--
Net income1,076.90901.40
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 outstanding798.7796

 

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 borrowings1626.5866.3
Accounts payable1116.31054.5
Income taxes payable443.7313.7
Other current liabilities15841457.3
Total current liabilities4770.53691.8
Long-term debt6525.96686.9
Deferred income taxes942.8856.9
Shareholders’ equity:
Capital stock @ par14.414.4
Capital in excess of par365323.9
Retained earnings47533978.4
Currency translation adjustment383.266.2
5515.64382.9
Less: Treasury stock-611.4-491.8
Total shareholders’ equity4904.23891.1
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 sales17802.715242.412533.211018.19017.17584.57058.66568.66232.45873.3
Cost of sales and operating expenses15628.913459.5111849890.58187.96802.46479.35995.75684.75278.8
Gross Profit2173.81782.91349.21127.6829.2782.1579.3572.9547.7594.5
Interest Expense688.5609.6344.2294.6261.4195.2204.9175163.5147.7
Interest income182.5177.2122.2112.6122.796.486.153.649.135.8
Earnings from continuing operations before taxes1667.41350.51127.2945.6690.5683.3460.5451.5433.3482.6
Provision from income taxes576.8449.1365340.5226.7256.7180.5169.5229.7213.7
Income from continuing operations1090.6901.4762.2605.1463.8426.6280282203.6268.9
Net income1076.9901.4762.2594.8457.8543.7212.5284.1224.3297.5
Data Per Common Share:
Income per share from continuing operations1.371.130.970.770.590.510.330.330.240.32
Net income per share1.351.130.970.760.580.650.250.330.270.36
Cash dividends declared per share0.3830.320.2670.2230.2090.1950.1850.180.1760.158
Average shares and equivalents outstanding798.7796790.4798.3786.5842.1862.4859.3854.1837.5
Year-End Position:
Total assets17143.415126.711135.39022.78027.15889.34876.94446.34052.23960.2
Total debt7526.16942.8410732252865.31506.1948.91073.91033.51214
Shareholders’ equity4904.23891.131612508.62059.11837.71853.41794.21650.51556.3
Book value per share6.224.924.013.212.642.332.192.131.961.89
Market price per share25.7521.37513.12511.258.757.8754.6254.253.754.125
Shares outstanding788.4791.1788.4781.2781789.4845.2842840.4824.4
Cash-Flow Data:
Net cash generated by continuing operations21101885.91894.51334.51212.2817.3981.5670.2661.5515
Acquisitions and investments in affiliates for cash630.63296.61415.5371.51679.916000130.30
Purchases of ppe for cash1180.1943.8725.8770.5858.5770.3555.8503.4447.4414.4
Cash dividends paid293.9241.9199172160.4161.1154.6151.3142.5126.2

 

Exhibit 6

PepsiCo, Inc. (Cost of Capital)
Prevailing Interest Rates and Yields as of December 31, 1990
U.S. Government Interest Rates:
MaturityRate
26 weeks6.57%
1 year6.88%
10 years8.16%
30 years8.30%
Money Rates:
Prime rate9.75%
6-month certificate of deposit7.47%
Moody’s Corporate Bond Yield Averages by Rating Class:
Moody’s RatingRate
Aaa9.05%
Aa9.39%
A9.64%
Baa10.43%

 

Exhibit 7

PepsiCo, Inc. (Cost of Capital)
Report of Average Annual Returns for 1926–1990
SeriesGeometric Mean¹Airthmetic Mean¹Standard Deviation
S&P 50010.10%12.10%20.80%
Small company stocks11.60%17.10%35.40%
Long-term corporate bonds5.20%5.50%8.40%
Long-term government bonds4.50%4.90%8.50%
U.S. Treasury bills3.70%3.70%3.40%

 

Exhibit 8

PepsiCo, Inc. (Cost of Capital)
Financial Information on Snack-Food, Beverage, and Restaurant Companies
CompanySales ($000)Beta1Number of Shares (000)Price per shareLong term debt (000)Current Portion (000)Capital Leases (000)Notes Payable (000)Total Debt (000)Estimated cost of debt
MarketBook
A&W Brands               119,000          1.50             9,098        34.75          7.62                        -                    -                  -         22,345.00                 22,34510.00%
Coca-Cola         10,236,000          1.00         688,239        46.50          5.59             535,861           97,272                  -   1,903,611.00           2,536,7449.50%
Coca-Cola Bottling               431,000          0.75             9,181        19.00        18.31             237,564             1,222                  -                        -               238,78612.00%
Coca-Cola Enterprises           4,034,000          1.00         114,835        15.50        14.16         1,960,164         576,630                  -                        -           2,536,79410.00%
Flowers, Inc.               835,000          0.90           33,617        14.00          6.00               52,691             4,857                  -                        -                 57,54810.00%
General Mills           6,448,000          1.05         164,734        44.38          5.98             785,400           56,700                  -       198,200.00           1,040,3009.60%
Golden Ent., Inc.               133,000          0.55           12,692          7.00          4.10                     243                   63                  -                        -                       30610.00%
Good mark Foods               137,000          1.49             4,302        10.25          6.95               17,054             3,759                  -                        -                 20,81310.00%
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           4,792,4009.50%
National Pizza               275,000          1.00           13,849        17.50          5.88               66,397                 628     6,851.00                        -                 73,87610.00%
PepsiCo         17,803,000          1.10         788,400        25.75          6.22         5,600,100                    -                  -   1,626,500.00           7,226,6009.64%
forRyan’s Family Steak House               273,000          1.10           52,637          5.75          2.89                        -                    -                  -         26,600.00                 26,60010.00%
TCBY               151,000          1.15           26,162          7.63          4.06               18,973             2,893                  -                        -                 21,86610.00%
Wendy’s           1,011,000          1.10           96,821          6.38          4.62             123,307             8,242   44,754.00                        -               176,30312.18%
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 Margin12.2%11.7%10.8%10.2%9.2%10.3%8.2%8.7%8.8%10.1%
Operating Profit Margin9.4%8.9%9.0%8.6%7.7%9.0%6.5%6.9%7.0%8.2%
Net Income6.0%5.9%6.1%5.4%5.1%7.2%3.0%4.3%3.6%5.1%
Return Ratios
Return on equity22.0%23.2%24.1%23.7%22.2%29.6%11.5%15.8%13.6%19.1%
Return on assets6.3%6.0%6.8%6.6%5.7%9.2%4.4%6.4%5.5%7.5%
Debt Ratios
Total debt to asset ratio43.9%45.9%36.9%35.7%35.7%25.6%19.5%24.2%25.5%30.7%
Interest coverage ratio2.422.223.273.212.643.502.252.582.653.27
Activity Ratio
Asset turnover1.041.011.131.221.121.291.451.481.541.48
Shareholder Ratios
Dividend payout ratio27.3%26.8%26.1%28.9%35.0%29.6%72.8%53.3%63.5%42.4%
Change in market price20.5%62.9%16.7%28.6%11.1%70.3%8.8%13.3%-9.1%

 

Snack FoodsSoft DrinksRestaurants
Equity68%Equity72%Equity62%
Debt32%Debt28%Debt38%
Debt/equity ratio47%Debt/equity ratio39%Debt/equity ratio62%
Asset beta        0.90Asset beta          1.00Asset beta                      1.00
Equity beta1.16Equity beta1.24Equity beta1.39
Cost of equity for snack foods10.94%Cost of equity for soft drinks11.35%Cost of equity for restaurants12.11%
Cost of debt for snack foods10%Cost of debt for soft drinks9.50%Cost of debt for restaurants10.00%
WACC9.43%WACC9.83%WACC9.84%

Cost of Capital

Equity         20,301,300
Debt           5,600,100
Debt %22%
Equity %78%
Equity beta                      1.10
COST OF EQUITY FOR PEPSI CO10.62%
COST OF DEBT FOR PEPSI CO9.64%
OVERALL WACC FOR PEPSI CO9.62%

 

COST OF CAPITAL
Tax rate38.00%
Risk free rate4.90%
Market return10.10%
PepsiCo Inc.
Capital Structure
DescriptionDebt %Equity %Debt/Equity %
Snack Foods32%68%47%
Soft Drinks28%72%39%
Restaurants38%62%62%

 

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