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Corporate Finance Case Study Of Pepsico Inc Finance Essay

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Published: Mon, 5 Dec 2016

PepsiCO Inc is one the leading enterprises in the beverages and snack food industry, but before that history of the iconic brand begun in 1898 by the invention of Pepsi formula by the Caleb Bradham. Modern history of the PepsiCO Inc started in 1965 after merger of Frito-Lay, nowadays PepsiCO Inc include five main brands: Pepsi-Cola, Frito-Lay, Gatorade, Tropicana, Quaker brands and over 100 other consumer products, with revenue of $60 bln and 285,000 employees worldwide [1] .

Risk Exposure

The following list represents some of the most important risk factors that can affect the Company’s financial condition and operations:

PepsiCO Inc. Affected by the government regulations, international markets and economical condition.

Tense competition within beverages and snack food industry which may affect operations of the PepsiCO Inc.

PepsiCO Inc. International Operations are subject to possible loss due to international law and economic regulations

Entities performance and financial position is highly affected by the brands reputation and brand acceptance.

PepsiCO strategic acquisitions and investments may not be beneficially resulting

PepsiCO Inc showed strong ability to maintain market fluctuation that occurred past years and still has potential for future growth [2] .

PepsiCO Inc Net Debt Ratio Calculation

Each analysis emphasizes debt against equity as the most significant indicator of the company’s financial position and performance. Debt structure and related properties can be described for the instance by the terms (long-short period debts) and debt providers (it can be either market or financial institutions). Moreover debt structure can be crucial as for the developed companies and for companies that is still growing [3] .

Key feature for the clear presentation of the company’s financial position is the Net Debt Ratio. Analysis provided by the related ratio based on the overall debt position represented by the net value of entity’s liabilities along with cash equivalents and other liquid assets. Measure of the entity’s debt gave us an idea of potential risk carried by the company in terms of the debt load. This analysis has 4 main aspects to cover, in order to provide clear presentation of the Entities debt position:

Debt description (long/short in order of maturity terms)

Debt purpose

Debt load risk of the Entity

Comparative debt analysis of the competitor companies

Current analysis will gave us clear presentation of the company’s financial position in terms of debt structure and comparative review of competitors within beverages and snack food market [4] .

Debt description

Main aspect in order to get clear presentation of the debt position and market leverage is using of two main principals Historical Cost and Market Value of the debt. According to PepsiCO Inc entity apply all related methods, however most crucial for the company is market value of the debt, as current method provide real cost of debt which will gave us real position of company’s market performance and position as it provides present value of the expected cash flow.

According to FASB 157 valuation of the debt have to rely on open market data (fair value of the instrument), quotes and prices or similar open market traded bonds in order to provide more reliable information concerning the company [5] . However related method of debt valuation can be determined as the one of the causes that led to the 2008 Financial Crisis due to related method more relies on the market price rather than historical cost in terms of valuation.

Calculation of the Net Debt Ratio performed by the PepsiCO Inc based on the next formula using market value of the obligations:

L = (D + PVOL – CMS) / (NP + D + PVOL – CMS)

D – Total debt of the Entity (short term debt + long term debt) $9,453 mln

PVOL – present value of operating lease $2,395 mln (4 times higher than rent expenses)

CMS – cash and marketable securities $1,124 mln

NP – number of shares times price $43,959 mln

Market Leverage (L) = 0.19612 (20%)

Amount of 20% is comparatively higher than 18% of the Debt Ratio provided by the Entity despite additional 25% Tax Rate added by the US Government due to adjustment of the Present Value of Operating Lease. After installment of the adjustment Net Debt Ratio stays within 20% – 25% corridor assigned by the company. However Cash Flow of the Entity covers Market Value of the Long-Term Debt only on 43% (total market value of the long-term debt $8,747 mln, annual cash flow $3,742 mln).

Short-Term Debt of the PepsiCO Inc along with current liabilities totaled to amount of $5,230 mln against current assets with amount of $5,546 mln. Relating to current liabilities to current assets measurement Entity is considered as not very liquid (current ratio is 106%, due to represented acount are almost equal). Working Capital of the PepsiCO Inc is close to 100%, which can be explained by the industry specifications, however in order to achieve appropriate financial position I would sugest to increase cash and cash equivalents accounts. Moreover other current account balance is exciding 5% of total current account amount (72% of total amount), which is not in accordance with IFRS standards.

Debt Purpose

Long-Term Debt portion of the PepsiCO Inc. is twice higher comparing with other companies within industry. Highest amount of the Long-Term Debt can be explained by the investing policy in unconsolidated affiliates, as the PepsiCO expects to generate cash in excess of long-term cost of capital. PepsiCO Inc investing policy aimed on strategic acquisition in order to expand company’s position within beverage and fast food market.

Debt Load

One of the main insight points in order to get understanding of the company’s position is the debt amount compared to equity part of the statement of financial position. Total Liabilities of the PepsiCO Inc as of 31/12/2009 totalled to $18,119 mln against $43,959 mln in equity. Debt load of the Entity is 41% which can be identified as appropriate portion of the capital. However Current Ratio of the Entity shows shortage of the liquidity (current ratio is 106%), coverage of the long-term debt by annual cash-flow 43% [6] .

Competitors review

Debt structure of the PepsiCO Inc As of 31/12/2009 represented mostly by the Long-term Debt with total amount of $8,747 mln (93% of Total Debt), amount of Short-term borrowings totalled to $706 mln (7% of Total Debt). Comparing with prior year Long-Term Debt amount decreased on 4% ($332 mln), however current amount is highest within industry companies.

All amount in $ mln.

Company

Long-Term Debt

Total Debt

Coverage

PepsiCO

8,747

9,453

93%

Cadbury Schweppes

864

1,490

58%

Coca-Cola

1,141

1,693

67%

Coca-Cola Enterprises

4,138

4,201

99%

McDonalds

4,258

4,836

88%

Analisys Recomendation

PepsiCO Inc one of the oldest and respectable enterprises within beverages and fast food market industry, Entity constantly expand position on the market through strategic investments and acquisitions of the unconsolidated affiliates, however company’s position considered as not appropriately liquid (current ratio 106%). This disproportion can be explained by the company’s expectation to generate cash from strategic investments in excess of the long-term Cost of Capital.

I would sagest to decrease rate of the investments to the prior year level and raise level of current assets, in order to capitalise Entities excess cash. This manipulation can improve Entities current position which will help to raise market value of the equity (current market price of the Entities equity is 6 times exceeds book value $7.3 bln/$43.9 bln). Weighted Average Cost of Capital of the Entity is $8,406 bln, calculation based on next formula:

WACC = E/V * Re + D/V * Rd * (1 – Tc)

Re – Cost of Equity ($7.3 bln)

Rd – Cost of Debt ($18.1 bln)

E – Market value of the Entity’s Equity ($44.0 bln)

D – Market value of the Entity’s Debt ($9.4 bln)

V = E + D ($43.9 bln + $9.4 bln = $53.4 bln)

E/V – Equity percentage (82%)

D/V – Debt percentage (18%)

Tc – Tax rate (25%)

Major part of the Entity’s finance provided by the equity part of the company. Despite the liquidity shortage of the Entity comparing to competitive companies, PepsiCO Inc represented as the sustainable enterprise with leading position on the market.

PepsiCO Inc Ratio Verification

Financial ratios provide wide view on Entity’s market position and managerial decisions in order to analyze business welfare along with information on Company’s operations efficiency. Ratios often evaluate company’s financial data using market value of related equity and debt position. Financial ratios are main key points in terms of evaluation of share price value as well as verification of benchmarks for business, identification of managerial strategies and financial forecasting. Related calculations supply possible investors with data on business credit load and interest repayment ability in order to describe debt holder’s risks.

In current analysis we will review main basic ratios to get appropriate knowledge of PepsiCO Inc financial position, credit worthiness and provide analytical review of the company. Reviewed ratios represented in this report are:

Interest coverage ratio

Fixed charge coverage ratio

Long-term debt ratio

Total debt to adjusted total capitalization (includes short-term debt)

Ratio of cash-flow to short-term debt

Ratio of cash-flow to total debt

Below we will describe calculation of the represented financial ratios for the each company in the beverages and fast food market industry, provided explanations for them and analysis of the measurements.

Company

Interest Coverage

Fixed Charge Coverage

Long-Term Debt Ratio

Total Debt to Total Adjusted Capitalization

Cash-Flow to Long-Term Debt

Cash-Flow to Total Debt

PepsiCO Inc

4.57

1.79

0.17

0.18

0.43

0.40

Cadbury Schweppes

4.90

4.29

0.09

0.15

0.57

0.33

Coca-Cola

16.91

16.91

0.01

0.02

2.73

1.84

Coca-Cola Enterprises

1.44

1.41

0.52

0.52

0.16

0.15

McDonalds

7.38

3.59

0.11

0.13

0.54

0.47

Interest Coverage Ratio

Related Ratio verifies Entity’s ability to repay outstanding debt, current measurement calculated on the basis of earnings before interest and tax expenses (EBIT) for the reviewed period divided by the interest expenses for the same term:

Interest Coverage Ratio (ICR) = EBIT/Interest Expense [7] 

Earnings before interest and taxes for the period ended as of 31/12/2009 – $3,114 mln

Interest expenses for period ended as of 31/12/2009 – $682 mln

Interest Coverage Ratio (ICR) – 4.57

PepsiCO Inc interest coverage ratio shows ability to settle outstanding debt amount on approximate value of 5 times exceeding the current interest expenses. Low amount of interest expenses rely on small value of the debt part (18% against 82% of equity part investments). Related measurement can provide Entity increase of credit rating despite that company more interested in equity part of capital.

Average ICR within industry is 7.04, PepsiCO Inc below average measurement due to highest amount of interest expenses in the industry group; despite that fact company have strong position due to ICR coverage of outstanding liabilities and one of the highest operating incomes.

Fixed Charge Coverage Ratio

Fixed charge coverage ratio (FCCR) illustrates entity’s ability to cover fixed costs (interest) and expenses (lease). Current measurement calculates on the basis of earnings before interest and tax expenses, fixed charge for the period and interest expenses as following:

FCCR = (EBIT + Operating Lease (before tax)) / (Operating Lease (before tax) + Interest) [8] 

Earnings before interest and tax expenses for the period ended as of 31/12/2009 – $3,114 mln

Operating Lease PV for the period ended as of 31/12/2009 – $2,395 mln (5 times exceed rent expenses).

Interest expense for the period ended as of 31/12/2009 – $682 mln

Fixed charge coverage ratio – 1.79

PepsiCO Inc demonstrate proper ability to cover fixed charges for the period, however average FCCR indicator for the industry is 5.6, PepsiCO Inc ratio is one of the lowest in the group. Smallest amount of the FCCR rely on high amount of operating lease. Company have one of the highest fixed costs expenses in the industry which indicates non efficient cost management of the company, still Entity contain strong position regarding liability coverage.

Long-Term Debt Ratio

Current ratio reveals position of the Entity in terms of financial leverage through long-term debt and available capital. Long-term debt ratio show us real position of company’s credit risk exposure, and calculates using formula provided below:

LTDR = LTD / (LTD + Preferred Stock + Common Stock) [9] 

Long-term debt (LTD) for the period ended as of 31/12/2009 – $8,747 mln

Outstanding shares issued as of 31/12/2009 – $44.0 bln

Long-term debt ratio (LTDR) – 17%

Credit risk exposure of the PepsiCO Inc considered as the comparatively high within industry companies. PepsiCO’s long-term debt decreased on 4% comparing with prior period, however in order to improve entities risk exposure Entity need to decrease amount of debt part of financing.

Total Debt to Adjusted Total Capitalisation Ratio

Calculation of the total debt to adjusted capitalisation performed on the same basis as the long-term debt ratio with adjustment on the short-term debt, current measurement will provide broader view on the debt exposure of the PepsiCO Inc.

TDATCR = Total Debt / (Preferred Stock + Common Stock + Total Debt) [10] 

Short-term debt of the PepsiCO Inc. as of 31/12/2009 – $706 mln

Long-term debt of the PepsiCO Inc as of 31/12/2009 – $8,747 mln

Total market value of debt as of 31/12/2009 – $9,453 mln

Market value of shares outstanding as of 31/12/2009 – $44.0 bln

Total debt to adjusted total capitalisation ratio – 18%

Adjustment on short-term debt did not significantly increased amount of capitalisation ratio as the short-term portion of total debt is 7% from total obligations (long-term debt 93%). Average ratio for the industry is on the level of 20%, position of the reviewed Entity is comparatively good including appropriate level of the EBIT level of the company.

Cash-Flow to Long-Term Debt Ratio

Cash-flow to long-term debt ratio will show Entity’s ability to settle long-term obligations using annual cash-flow from operating activity of the company.

CFLTDR = Annual Cash-Flow / Long-Term Debt [11] 

Annual cash-flow of the Entity as of 31/12/2009 – $3,742 mln

Long-term debt of the Entity as of 31/12/2009 – $8,747 mln

Cash-flow to long-term debt ratio – 43%

Average cash-flow to long-term debt ratio for the industry is on the level of 88%, high benchmark for this measurement rely on the Coca-Cola cash-flow coverage of 2.73 (273%). Coca-Cola’s annual cash-flow is twice higher than the amount of the long-term obligations held by the company. PepsiCO’s ability to recover long-term debt from cash-flow is on the level of 43% which is considerably low and verified as risk bearing. Position of the company is additionally weekend by the low rate of the liquidity (close to 1).

In order to decrease risk exposure of the Entity, I would suggest reducing debt part of the capital and capitalising investments in non affiliate enterprises.

Cash-Flow to Total Debt Ratio

Basis of calculation for the current ratio is the same as for the previous measurement with adjustment on short-term obligations of the Entity. Main purpose of the reviewed ratio is to show ability of the company to settle net debt through annual cash-flow from operations.

CFTDR = Annual Cash-Flow / (Long-Term Debt + Short-Term Debt) [12] 

Annual cash-flow of the Entity as of 31/12/2009 – $3,742 mln

Long-term debt of the Entity as of 31/12/2009 – $8,747 mln

Short-term debt of the Entity as of 31/12/2009 – $706 mln

Total debt of the Entity – $9,453 mln

Cash-flow to total debt ratio (CFTDR) – 40%

Position of the Entity did not change sharply comparing with prior ratio calculations due to small portion of the short-term obligations (7%), still measurement mentioned above indicates credit risk exposure of the PepsiCO Inc, due to inability of the Entity to cover net debt by the annual cash-flow from operations.

PepsiCO Inc Ratio Analysis

Analysis of the PepsiCO Inc ratios covered comparative overview of major competitor companies in the industry represented by the Coca-Cola, Cadbury Schweppes and McDonalds. All of the listed companies showed constant growth in terms of earnings per share and revenue.

At the first look PepsiCO Inc is the best in terms of liquid assets (1,498 USD’mln in cash and marketable securities), Coca-Cola shows second result with amount of liquid securities equalled to 1,315 USD’mln. Comparison of total data provided by the ratio analysis exposed shortage of the liquidity of the Entity due to the increasing amount of the current liabilities. Interest coverage ratio revealed PepsiCO’s ability to settle interest expenses on more than 4 times, Cadbury Schweppes has approximately same result in interest coverage. However, average result for the industry is on the level of 7.04 which can represent PepsiCO as the least attractive investment. Coverage of debt capital by the cash-flow has the similar positioning between PepsiCO Inc and Cadbury with coefficients equals to 43% and 57% respectively. However, PepsiCO’s comparatively high debt figures are not enough to judge about efficiency of the entity activity, because high debts may be claimed ambiguously as negative result, as well as positive data.

To finalise, the comparison of the industry leaders PepsiCO Inc, Coca-Cola and McDonalds showed almost the equal results except Coca-Cola which performance is twice higher than industry average. However, PepsiCO Inc showed good results in terms of operating income and highest amount of liquid assets available.

Debt Rating Verification

Debt rating of the Company provides to investors data on Entities ability to repay its debt, possibility of default and credit worthiness of the business. Debt rating of the PepsiCO Inc. at the moment is on the level of A1/A, which is highest result for the industry. PepsiCO Inc show comparatively low cash-flow coverage in the market, however, above the half of the Company’s income generated by its snack-food division. Related issues represent Entity as the diversified company, which can cover possible market fluctuations.

Overall performance of the Company show appropriate level of cash inflows, which are offset by the highest portion of the debt (mostly represented by the long-term debt 97% from total portfolio) owned by the PepsiCO Inc. Moreover, Company’s market valuation for the prior year was affected by the 8% increase of the debt value.

Net Debt Ratio of the PepsiCO Inc after lease adjustment is still within 20%-25% trend which can be assessed by the Company as the signal to remain current debt rating. On the other hand, interest coverage, fixed charge coverage and cash-flow ratios of the Company are on appropriate level but lower of industry average indexes. Direct competitors of the PepsiCO Inc show higher results and better cash-flow coverage despite that rating of the current enterprises are lower. On my opinion debt rating of the PepsiCO Inc is overstated and has to be lowered to double A rating. In order to maintain single target rating, Company should decrease amount of the Net Debt on 10-15% and capitalise investment to non-affiliate enterprises which will increase market value of the Company stock.

To finalise, PepsiCO Inc is one of the most respectable and oldest company on the beverages and snack food market, with differential product line. The Company is still interested in market expand and invest to non affiliate companies. However, Company provide un-efficient debt policy which can affect its current rating and decline it to the single A mark.

Bibliography List

Brealey R.A., Myers S.C. (2000). Principles of Corporate Finance. Sixth Edition. New-York: McGraw-Hill international edition. (Ch. 17,18, 23,24).

Fridson M.S. (1995). Financial statement analysis. A practitioner’s guide. Second Edition. Canada: John Wiley & Sons. (Ch. 6).

McKenzie W. (1998). Unlocking company reports and accounts. London: Financial times/Pitman publishing. (Ch.6 )

Arnold G. (1998). Corporate financial management. London: Financial times, Prentice Hall. (Ch. 11)

Bromwich M. (1992). Financial reporting information and capital markets. London: Pitman publishing. (Ch. 5,6,7)

Pr. Penman S.H. (2007). Financial statement analysis and security valuation. Third Edition. New-York: McGraw-Hill international edition (Ch. 7,9,10,11,12,19)


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