Pepsico, inc. : cost of capital Harvard Case Solution & Analysis

Pepsico Performance over Last 10 Years

In 1919,PepsiCo started with the name of Loft Inc, but in 1941 it emerged as Pepsi Cola company. After the acquisition of fruit lay and the merger of loft and PepsiCola, itgave the name of PepsiCo in 1965.

In the past 10 years, the company has made a series of acquisitions and mergers in the fast food industry and beverage industry in order to make PepsiCo a leading brand all around the world. It has acquired world famous fast food chain named Pizza Hut as a subsidiary. It also purchased KFC for 841 million dollars and Seven up in 1986 in order to expand the brand. For the purpose to expand its bottling operations, PepsiCo bought two more companies named General Cinema and Grand Metropolitan.

For the purpose to expand its brand globally, PepsiCo purchased two famous snack companies in the Europe named, Smith Crisp and Walkers Crisps Holding. These two companies are also the leading brands in the United kingdom. PepsiCo also purchased Games a a famous and number one manufacturer of cookies in Mexico in order to expand its operation throughout the world.

By the end of 1990, PepsiCo hadeight famous brands, which have been generating more than one billion dollar revenue from retail stores. In the last five years, its sales increased significantly by a compound annual rate of 19% and its annual income also increased continuously with a compound annual rate of approximately 21 %, which makes PepsiCo a leading brand in the food industry in the supermarkets of United State and in the other European countries as well.

By the end of 1990, PepsiCo was among the top ten and leading brands of the year with a vast variety of beverages, worldwide pizza and fast food chains and snack bars, which are almost four times greater in size as compared to its competitors. Its beverages, snacks, and fast food chains are the leading brands within the industry not only in the USA, but all around the world as well. Its market share is expected to increase in the US market and the markets outside the US. Its current market shares of all its products in respective industries are greater than its competitors, which makes PepsiCo the leading brand of the world.

From the comparison of PesiCo Financials between the years of 1990 and 1981, it is clear that PepsiCo has expanded its operations and products throughout the world in order to create value in its shareholders’ wealth. The value of its shareholders has been increased by 624% because its shares are being traded now at 624% percentage that is higher than the share price of the year 1981.Its assets, sales, net income per share, operating profit margin and acquisitions increased by a hundred times in last ten years(Refer Excel Sheet).

Due to the increase in the percentage of acquisitions in the last few years, the cash flow from operations is showing negative figures. Its two divisions, snacks and beverages, have been showing positive cash flows,how ever due to heavy purchases in restaurants and corporate divisions, the over all free cash flows are showing negative figure.

However,it doesn’t mean that it is not adding value in shareholders’ wealth. The increase in net earnings per share, sales and net income over the last ten years clearly indicate that the current operations of the PepsiCo have been adding value in shareholders’ wealth both in terms of dividend and capital gain.

Question 2

WACC of Individual Segments

In order to calculate WACC of each individual segment, the cost of equity is calculated by using the CAPM formula. Debt ratio, equity ratio and Beta are assumed to be taken from the given data of comparative industries.

Its risk free rate is assumed to be 10 year Treasury Bond’s final rate, which is 8.16%. The market risk premium is also not given in the case.By incorporating the standard deviation of US Treasury bills into the publicly traded debt, it is expected that the market rate included risk will be 9.93%.

WACC of Snacks segment is calculated by incorporating the above values and comparable industry debt, equity and beta values of General Mills. It is assumed that the size and the other characteristics of General Mills are comparable to Snack division. By adjusting all value into the WACC formula, it is expected that the cost of capital of snacks division will be approximately 6.28%.

The WACC of beverages division is also calculated similar to that of snacks division. However,instead of General Mills,the value of debt, equity and beta are taken from Coca Cola’s figures by considering that both are comparable industries. Therefore,the cost of capital of Beverages division is 6.80%. Its value of WACC is slightly higher than snacks division because its equity ratio is greater than the snacks division, therefore its cost of equity is greater than that of snack division..........................

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