Pepsi Co And Competitors Example For Free - Free Essay Example

In this report it has been critically done the analysis of financial statements of PepsiCo along with the comparison of close and distant competitors existing in the industry. In this report it has also been tried the way how to calculate financial statements ratios with definitions and their calculated ratios interpretations in an easy language to make this report easily understandable for any potential reader. I tried to explain how companies try to get tax benefits and the possibilities to reduce taxable amount paid to the government. I also provided suggestions how to maintain senior debt rating. Debt side of the balance sheet has been investigated critically in depth to provide sound knowledge to the actual and potential readers of financial statements of PepsiCo. The possible advantages and disadvantages of debts have also been listed. I am sure this report is easy to read and understand for those who do not have accounting and finance background knowledge. 1. Calculate PepsiCos net debt ratio, assuming that the present value of operating leases is five times the annual rental expense and that remitting the cash and marketable securities to the United States reduces them by 25% due to taxes and transaction costs. 20 marks Net Debt Ratio (L): L= Market value of total debt + present value of operating lease commitments cash and marketable securities à · ( No. of common shares ÃÆ'Æ’- Common Stock Price ) + Market value of total debt + Present value of operating lease commitments Cash and marketable securities L= (D + PVOL CMS)__ (NP + D + PVOL CMS) Where; D is the total market value of debt; $18,119,000,000 PVOL is the present value of operating lease commitments; 294,000,000 ÃÆ'Æ’- 5 = $1,470,000,000 CMS is cash and marketable securities; 382,000,000 + 116,000,000 = $498,000,000 N is the number of common shares 790,000,000 P is the common stock price $55.875 L= 18,119,000,000 + 1,470,000,000 498,000,000______________________ (790,000,000 ÃÆ'Æ’- 55.875) + 18,119,000,000 + 1,470,000,000 498,000,000 L = 19,091,000,000 63,232,250,000 L = 0.301 ÃÆ'Æ’-100 L = 30.1% If the present value of operating lease is reduced by 25%: D is the total market value of debt; $18,119,000,000 PVOL is the present value of operating lease commitments; 294,000,000 ÃÆ'Æ’- 5 = $1,470,000,000 ÃÆ'Æ’- 0.75 = 1,102,500,000 CMS is cash and marketable securities; 382,000,000 + 116,000,000 = $498,000,000 N is the number of common shares 790,000,000 P is the common stock price $55.875 L = 18,119,000,000 + 1,102,500,000 498,000,000_____________________ (790,000,000 ÃÆ'Æ’- 55.875) + 18,119,000,000 + 1,102,500,000 498,000,000 L = 18,723,500,000 62,864,750,000 L = 0.297ÃÆ'Æ’-100 L = 29.7% 2. For each firm in Exhibit 5, calculate the interest coverage ratio, the fixed charge coverage ratio, the long-term debt ratio, the total debt to adjusted total capitalization (recall that adjusted capitalization includes short-term debt), the ratio of cash flow to long-term debt, and the ratio of cash flow to total debt. 20 marks Interest Coverage Ratio: This analysis tool is used to measure how many times a company can pay interest payments on its debts on its earnings before interests and taxes. If the interest coverage ratio is higher, the company has low debt load and there is a less chances of bankruptcy. This ratio is important for those who have provided debt to the company or they are going to provide debt to the company because by analyzing this ratio they can find that the company can make interest payments easily when debt is provided to them. The higher the ratio, the lesser the risk is supposed by the creditors. A company usually prefers to have debt in order to take tax benefit when deducting interest payments as expenses which decrease the income which has to be taxed. This ratio is dependent on earnings before taxes by a company. The higher the earnings, the higher the ratio and the lower the interest payments, the higher the ratio. Interest Coverage Ratio = Earnings before Interest Taxes Interest Expenses Pepsi: = 3,114 682 = 4.565 Times Cadbury Schweppes: = 661 135 = 4.896 Times Coca-Cola: = 4,600 272 = 16.911 Times Coca-Cola Enterprises: = 471 326 = 1.444 Times Mc Donalds: = 2,509 340 = 7.379 Times Interest Coverage Ratio-Summary: Pepsi Cadbury Schweppes Coca-Cola Coca-Cola Enterprises Mc. Donalds 4.565 Times 4.896 Times 16.911 Times 1.444 Times 7.379 Times Interpretation: Pepsi has competitive interest coverage ratio amongst the competitive firms. 4.565 exhibits that Pepsi can make 4.565 times payment of the total interest payment which are basically interest on debts acquired by Pepsi. Fixed charge coverage ratio: A measure of a companys ability to pay its  fixed expenses, such as  rent  and  interest, on debt without resorting to more  debt. A ratio over 1 indicates that the company is able to pay its fixed charges, while a ratio below one indicates the opposite.  (Farlex Financial Dictionary, 2009) This analysis tool is used to calculate how many times a company can pay its fixed interest payments. This ratio gives high value if the earning before taxes increases over the years. This ratio is important for those institutions which are planning to provide long term debt to the company and are supposed to receive fixed amount of payments i.e. interest over the years. Fixed Charge Coverage Ratio = Earnings before Interest Taxes + Fixed Charges (before taxes) Fixed Charges (before taxes) + Interest Expenses Pepsi: = 3,114 + 479 + 682 479 + 682 = 3.682 Times Cadbury Schweppes: = 661 + 25 + 135 25 + 135 = 5.131 Times Coca-Cola: = 4,600 + 272 272 = 17.911 Times Coca-Cola Enterprises: = 471 + 31 + 326 31 + 326 = 2.319 Times Mc Donalds: = 2,509 + 498 + 340 498 + 340 = 3.994 Times Fixed charge coverage ratio-Summary: Pepsi Cadbury Schweppes Coca-Cola Coca-Cola Enterprises Mc. Donalds 3.682 Times 5.131 Times 17.911 Times 2.319 Times 3.994 Times Interpretation: Pepsi has competitive fixed charge coverage ratio amongst the competitive firms. 3.682 exhibits that Pepsi can make 3.682 times payment of the fixed payment which are basically interest on long term debts. Long-term debt ratio: This analysis tool is used to measure a companys financial leverage. Long term debt is usually referred to debt acquired by the company for more than financial year of the company. Firms do debt financing to take tax benefits. This ratio is calculated by using data of previous financial year which is beneficial to the firms which are planning to provide long term debt to the firm. A firm has to maintain balance between debt financing and equity financing. Long-term debt ratio = Long term debt_________________ Long term debt + Preferred Stock + Common Stock Pepsi: = 8,747_____ 8,747 + 44,029.5 = 0.165 ÃÆ'Æ’- 100 = 16.5% Cadbury Schweppes: = 864_____ 864 + 8,702.2 = 0.090 ÃÆ'Æ’- 100 = 9% Coca-Cola: = 1,141______ 1,141 + 100,810.15 = 0.011 ÃÆ'Æ’- 100 = 1.11% Coca-Cola Enterprises: = 4,138____ 4,138 + 3,856.5 = 0.517 ÃÆ'Æ’- 100 = 51.7% Mc Donalds: = 4,258_____ 4,258 + 33,585.6 = 0.112 ÃÆ'Æ’- 100 = 11.2% Long-term debt ratio-Summary: Pepsi Cadbury Schweppes Coca-Cola Coca-Cola Enterprises Mc. Donalds 16.50% 9% 1.11% 51.70% 11.20% Interpretation: Pepsi has a good long term debt ratio which exhibits that 16.50% of total assets own by the creditors who provided long term debt to Pepsi. Although close competitor i.e. Coca-cola has less long term debt ratio than Pepsi which shows less risky long term debt financing obtained by Coca-Cola. The total debt to adjusted total capitalization: This analysis tool is used to measure a companys total equity contribution by the shareholders and creditors. Company raises total equities by offering shares to the market and by acquiring debt from the financial institutions. Total debt includes long term debt and short term debt. Long term debt is usually referred to debt acquired by the company for more than financial year of the company, whereas, short term debt is referred to debt acquired by the company for less than its financial year. Firms usually do debt financing to take tax benefits. This ratio is calculated by using data of previous financial year which is beneficial to the firms which are planning to provide long term and short term debt to the firm. A firm has to maintain balance between total debt and total shareholders equity. Lenders mostly want a firm to maintain low this ratio because it guards and decrease risk for both the company and lenders in order to efficiently meet liquidity situation easily. A company has to maintain this ratio which varies company to company and industry to industry. The total debt to adjusted total capitalization = Total debt____ Total debt + Equity Pepsi: = 9,453______ 9,453 + 44,029.5 = 0.176 ÃÆ'Æ’- 100 = 17.6% Cadbury Schweppes: = 1,490____ 1,490 + 8,702.2 = 0.146 ÃÆ'Æ’- 100 = 14.6% Coca-Cola: = 1,693______ 1,693 + 100,810.15 = 0.016 ÃÆ'Æ’- 100 = 1.6% Coca-Cola Enterprises: = 4,201____ 4,201 + 3,856.5 = 0.521 ÃÆ'Æ’- 100 = 52.1% Mc Donalds: = 4,836_____ 4,836 + 33,585.6 = 0.125 ÃÆ'Æ’- 100 = 12.5% The total debt to adjusted total capitalization-Summary: Pepsi Cadbury Schweppes Coca-Cola Coca-Cola Enterprises Mc. Donalds 17.60% 15% 1.60% 52.10% 12.50% Interpretation: Pepsi has more total debt ratio if compared with the close competitor i.e. Coca-Cola which has 1.60% total debt ratio. 17.60% exhibits that this percentage of total assets has been provided by the lenders. In other words, lenders own 17.60% assets of Pepsi or 17.60% of total equity is provided by the lenders. The ratio of cash flow to long-term debt: The  cash flow to long term debt ratio  appraises the adequacy of available funds to pay obligations. A cash flow coverage ratio that measures how much cash is available to pay for long-term debt. This ratio is a good indicator of potential bankruptcy. (Your Dictionary, 2010) The ratio of cash flow to long-term debt = Operating cash flow_____ Market value of long-term debt Pepsi: = 3,742 8,747 = 0.427 ÃÆ'Æ’- 100 = 42.7% Cadbury Schweppes: = 492 864 = 0.569 ÃÆ'Æ’- 100 = 56.9% Coca-Cola: = 3,115 1,141 = 2.730 ÃÆ'Æ’- 100 = 273% Coca-Cola Enterprises: = 644_ 4,138 = 0.155 ÃÆ'Æ’- 100 = 15.5% Mc Donalds: = 2,296 4,258 = 0.539 ÃÆ'Æ’- 100 = 53.9% The ratio of cash flow to long-term debt-Summary: Pepsi Cadbury Schweppes Coca-Cola Coca-Cola Enterprises Mc. Donalds 42.70% 57% 273.00% 15.50% 53.90% Interpretation: Pepsi has 42.70% of availability of cash flow to pay long term debt obligations. Pepsi has less cash flow to long term debt as compared with close competitor i.e. Coca-Cola which has a very good 273% of cash flow to pay long term debts. Pepsi should increase the percentage of cash flow to long term debt to maintain competitive percentage with the close and distant competitors of it in the industry. The ratio of cash flow to total debt: This analysis tool is used to explain the availability of cash flow to pay total debt acquired by a firm. According to me this is a rational way to consider the payments because companies cash flow statements changes drastically on the daily basis. This may be calculated to answer a question that something is better to evaluate than nothing. Ratio of cash flow to total debt = Operating cash flow Total debt Pepsi: = 3,742 9,453 = 0.395 ÃÆ'Æ’- 100 = 39.5% Cadbury Schweppes: = 492 1,490 = 0.330 ÃÆ'Æ’- 100 = 33% Coca-Cola: = 3,115 1,693 = 1.839 ÃÆ'Æ’- 100 = 183.9% Coca-Cola Enterprises: = 644_ 4,201 = 0.153 ÃÆ'Æ’- 100 = 15.3% Mc Donalds: = 2,296 4,836 = 0.474 ÃÆ'Æ’- 100 = 47.4% The ratio of cash flow to total debt-Summary: Pepsi Cadbury Schweppes Coca-Cola Coca-Cola Enterprises Mc. Donalds 39.50% 33% 183.90% 15.30% 47.40% Interpretation: Pepsi has 39.50% of availability of cash flow to pay total debt commitment. Pepsi has less cash flow to total debt as compared with close competitor i.e. Coca-Cola which has a very good 183.90% of cash flow to pay total debts acquired from lenders. Pepsi should increase the percentage of cash flow to total debt to maintain competitive percentage with the close and distant competitors of it in the industry. 3. Suppose PepsiCos real objective is to maintain a single-A senior debt rating. Does its net debt ratio target seem reasonable, or would you recommend a different target? 10 marks Senior debt ratings represent the opinions of the rating agencies with respect to the creditworthiness and financial ability of an obligor to meet its senior unsecured financial obligations and contracts. Ratings provide both industry participants and consumers with meaningful information on specific companies and have become an increasingly important factor in establishing the competitive position of companies in the industry. Rating agencies continually review the financial performance and condition of companies and higher ratings generally indicate financial stability and a strong ability to meet financial obligations. Each of the rating agencies reviews its ratings periodically and there can be no assurance that current ratings will be maintained in the future. (Humana, 2010) Advantages of Debt to the Company The cost is limited and known and cheaper than the cost of equity (because it is less risky to the investor who therefore requires a lower required rate of return). The interest is tax-deductible, unlike dividend payments, which makes the cost even cheaper in comparison to equity. There is no dilution of control when debt is issued. The cost of acquiring equity financing is more than the cost of financing that is why debt financing is preferred. The debt can be terminated (if a call provision was included). Disadvantages of Debt to the Company There is always the possibility of default if income is low. The company must pay interest, even if it means taking out additional debt to do so. The cost of equity rises as more debt is used. The higher leverage results in higher risk to shareholders who will require a higher rate of return. The net debt ratio target of PepsiCo of 29.7% exhibits that 29.7% of total assets provided by lenders or creditors. This ratio is useful for lenders which assist them to find out how much they are save if the PepsiCo is declared insolvent. According to my analysis, the method and the derived percentage of target senior debt rating is rational approach because it has the three out of five major elements which are assumed to impact on the capital structure decision making. The debt rating provides the information about the firms capacity to service its debt. It also provide sound information about the degree of protection afforded by the liquidity of the firms assets, and mainly find out t he firms simplicity of access to the capital markets. A target senior debt rating of single-A is a sensible objective for PepsiCo because it is the lowest rating that has allowed historically the issuer to maintain constant access to the capital markets. Net debt ratio seems reasonable because of many reasons. One of them is the cost of equity is not clearly mentioned on the income statement, whereas, the cost of debt i.e. interest expense is recorded. Debt financing is less expensive than equity financing because the debtors can claim firstly if the firm is declared to be insolvent. It is easy to forget that debt is a cheaper source of funding for the company than equity. Debt is less risky than equity that is why investors get low return; this interprets into an  interest rate  that is lower than the expected  total shareholder return  on equity. Firms get tax benefits because the amount of interest paid is tax deductible. Tax is one of the important areas for firms which monitor critically so that the firms can find out ways to decrease the taxable amount paid to the government authority. Debt ratio rated A has a strong capacity to pay interest and repay principal. One reason PepsiCo should adopt a lower percentage of financial leverage in the industry it could be more attractive for the stakeholders of PepsiCo. Another reason would be if the firm had a higher proportion of intangible assets than the cross section of firms. A third reason would be if the firm cannot fully use its interest tax credits. The net debt ratio of 29.7% is low leverage ratio which may decrease PepsiCos coverage to risk and business declination. This decrease in risk brings the potential for lower returns. PepsiCo is generally considered safer because it has a low net debt ratio, though a very low ratio indicates excessive caution. Conclusion: Generally, lower net debt ratio is better because it means that the firm is using more of owners capital and retained earnings to finance its assets. It means less risk to creditors. Company can borrow additional funds with relative ease. Keeping the low net debt ratio is attractive to all the actual and potential users of financial statements of PepsiCo.