In the US, Pepsi controls 30% market share while Coca-cola holds about 42%. Pepsi is heavily involved in sponsorship activities for sports teams (Pepsi, 2014). According to the Company’s website, the mission of the company is to be the world’s best provider of convenient foods and drinks and to share its financial success with investors in the company (Pepsi, 2014). The company’s long-term vision is to implement programs that will make a more sustainable company, one that cares for the environment and benefits the societies in which it operates.
The company also states the values and philosophy that have helped it grow continuously since the late 19th century. The company is especially omitted to helping its employees develop professionally, while teaching them the importance of acting responsibly and cultivating trust. Risk Factors- Operational Being a manufacturing company, there is always the risk that a firm’s products may fall out of favor in the eyes of the consumer. This possible reduction in demand is a major operational factor because it will force Pepsi to reduce the volume of production.
Further, the company is always entering new geographical markets and launching new products. The company has to choose the marketing strategy quite carefully because a poor marketing plan loud see a new product fail to be received as expected (Pepsi, 2014). The company also faces a tricky legal and regulatory environment because the company has operations in many countries. The company has business interests and partners in over 1 00 countries and any change in legislation would greatly affect the operating costs of the company.
Environmental and labor laws are perhaps the most volatile for Pepsi Inc and the company is always on the lookout for any of such impending changes in order to adjust operations accordingly. It is more expensive to react to changes in legislation marred to acting beforehand (Pepsi, 2014). Financial Risk The total assets of the company as at the end of 201 3 stood at $77. 748 billion, which has been a steady rise since 2010. Of these, 24389 represents equity while the rest,$ 53. 359 is debt capital. The debt to equity ratio therefore stand at 2. 2: 1 .
This means that the company is highly geared and is possibly incurring a lot in terms of interest expense (Pepsi, 2014). However, other financial analysts may argue that this is not dangerous for a company that is making profits and does not risk going into bankruptcy soon. Further, bet financing reduces the tax liability of a company because interest is an allowable expense in income tax determination. In conclusion, while the company is highly geared, this is not a cause for concern for the company because the company is in a strong financial position in terms of profitability and the confidence Of creditors is high in the company.
Capital Structure Of the Company As highlighted, $53 billion of the company’s assets are financed through debt and current liabilities. Short term liabilities that are payable within 1 year amount to $1 7 billion. These are unlikely to result in any extra interest expense for the company. They include taxes payable, trade credit from suppliers, and unpaid utilities. The rest of the amount- $billion is made up of long-term debt and the interest of the minority in the company. One can therefore conclude that the management of the company have a preference for long-term debt in the company.
The advantage of such debt is that it can finance projects that have a long life and probably take a while before starting to generate cash (Pepsi, 2014). In its notes on debt, the company reveals that uses commercial papers to obtain short-term debt for as low as 0. However, the outstanding commercial papers total to about $1 billion of the total debt the company owes. Long-term credit for the company comes from notes issued to investors. This is the biggest source of credit for the company and interests rate from 2% to 5% depending on the maturity date.
In a bid to keep in line with international financial reporting standards and Generally Accepted Accounting Principles, the company does not have any off-the-record borrowings. The equity section of Pepsi Inch’s balance sheet shows that the company indeed has preferred stock. The preferred shares are redeemable and it is evident that the company has been buying back preferred stock, perhaps replacing it with another form of stock. The rest of the amount comes in form of retained earnings and common stock for the company. Company’s Beta According to Bloomberg Inc (2014), Pepsin’s risk beta is rated as 0. 39.
This beta is used in valuing the company’s shares through the capital asset pricing model. Normally, a higher amount of debt is likely to increase the rockiness of investing in a company. This is because the company has contractual obligations with lenders, some of whom have lien on the company’s assets. As such, it is safe to conclude that a lower amount of debt would most likely result in a lower risk beta. Taxation Pepsi Company made a net profit of $8 billion in the last financial year. The marginal tax rate for the company s therefore 35%. This is the proportion of tax for every profit dollar above $million.
The income tax rates in a given country are very important because they influence the price of capital assets and also influence the cost of capital. For instance, the cost of debt for Pepsi differs when one disregards taxes and when one takes the effect of tax into mind. Cost of debt Pepsi gets its long-term debt in form Of notes issued at an average rate Of 4%. When taxes are ignored, this would be the company’s cost of debt. However, when taxes are considered, the formula for getting the cost of debt becomes Rd(1-T), where T is the marginal tax rate.
In this case, Rd-? 4% T: 35% Therefore, 2. 6% It is therefore clear to see that taxation essentially reduces the effective cost of capital for any firm. As such, even when Pepsi Co is highly geared, it is not always a negative thing to have more debt than equity. Cost of preferred stock As stated, the company indeed has preferred stock, although it has been aging efforts to eliminate this portion of equity by buying back such shares. This is revealed by the fact that the balance sheet has a section for redeemed preferred shares, which is basically meant to write off redeemed shares.
The formula for getting the cost of preferred share is Dips/Pent. This means that the dividend per share be divided against the net issuing price. Preference shares earn an annual dividend of $5. 46 per annum while their issuing price is $13. 67. The cost of preferred shares can therefore be given as 5. 46/13. 67= 39. 94%. This is relatively high return for the shareholder of preference stock. It is a high cost for the company and this may explain the efforts to repurchase preference shares over time. The shares also earn dividends on an accumulative basis, regardless of whether the company makes profits or not.
The Cost of Equity The cost of equity is major based on the dividends that a company pays the holders Of common shares as well as the market value of these shares. Currently, Pepsin’s shares are trading at $90. 10 at the stock exchange. The dividend declared in the last financial year was $2. 62 per share. According to Bloomberg (2014), the average growth rate for the company’s shares has en 6% for the last five years. This makes it possible to calculate the cost of equity using the formula Eke (Dividend per share/market price per share)+ share growth rate AS such, (2. 62/90. 10)+ 0. 6= 8. 91% The company’s cost of equity is therefore 8. 91%. As such, common stock is a much cheaper source of capital compared to other sources such as preferred stock. However, the cost of debt remains the cheapest option for the company and this could explain why Pepsi has more than 67% of its capital being in form of debt. Dividend yield This is calculated by simply dividing the dividend per share with the market rice of shares as illustrated below; 2. 62/90. 10= 2. 91% Weighted Average Cost of Capital This is found by averaging the various costs components of capital for the firm.