The course deals with calculating pepsico's net debt ratio,assuming that the present value of operating leases and that remitting the cash and marketable securities to united states redusing them by 25% due to taxes and transaction costs and to analyze the firm in exhibit 5, by calculating the intrest coverage ratio, fixed charge coverage ratio, long term debt ratio, to debt to adjusted total capitalization, the ratio of cash flow to long term debt and ratio of cash flow to total debt and to determine and recommend different target on its net debt ratio.
LITERATURE REVIEW
This paper draws from several disparate financial and economic literatures,beginning with the general determinants of corporate financial steucture.The first modern theory of the general determinants of corporate financial structure was the proof by Modiglian and Miller(1958) that under simplifying assumptions the balance sheet structure of the firm is irrelevant to the cost of capital. However,introducing differential microeconomic costs of bankruptey between equity holders and debt holders stimulates firms to issue only equity.Conversely,the tax deductibility of interest payments encourages debt finance, with firms consequently absorbing "unnecessary" levels of business cycle risk and raising the risk of default(Gertler and Hubbard, 1989).
The understanding of corporate balance sheet structure was further refined by the introduction of asymmetric information and consequent adverse selection and moral hazard in the context of incomplete contracts.The availability of internal financing may thus impact on real decisions(Fazzari,Hubbard, and Petersen, 1988) as firm prefer to- or are constrained to-finance themselves by internal rather than external funds. Internal funds are more plentiful for large and established firms than in small and new firms, where the latter may be more typical of emerging market countries. A corollary is that financial systems that cope better with agency costs will supply more external financing, all things being equal.
Financial system seem to go through stages of development in which corporate sources of financing are mainly: (1) internal, (2) banks due to information collection efficiencies, (3) equity issuance of more diversity , and (4) bonds when information collection costs become sufficiently low. Demirgue-Kunt and Levine(2000) showed the banks, nonbanks and stocks market are larger, more active and more efficient in richer countries; although Rajan and Zingales(2000) show financial development has not been monotonic over a long time horizon. Furthur more; in OECD countries, stock markets become more active and efficient relative tpo banks, and there is some tendency for financial systems to become more market oriented as they become richer. The legal system also helps shape the weight of bank versus nonbank financing. Rajan and Zingales(1998) found link from financial development to groeth via dependence of industries most dependent in external finance Levine(2000) found little evidence that bank-based system is "better" for overall economic performance.
The "financial accelerator" and credit channel" approaches to business cycles help set the stage for recent theories for the role of the corporate sector in financial crisis. The financial accelerator is the procyclicality of borrower net worth due to adverse selection and information asymmetries which amplifies the impact on the economy of changes in the stance of monetary policy by increasing risk premia(Bernanke Gertler 1995). An indicator of this "financial accelerator" which applies to debt in general is the debt-equity ratio. Other work on the related "credit channel" has focused on bank credit as such, implying a relevance for the bank loan/debt ratio(Gertler and Gilchrist, 1994, 1992).
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CORPORATE FINANCE
DEFINITION: The division of a company that is concerned with the financial operation of the company. In most businesses, corporate finance focuses on raising money for various projects or ventures. For investment banks and similar corporations, corporate finance focuses on the analysis of corporate acquisitions and other decisions
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Corporate finance is a extencive that is used to jointly recognize the different financial transactions undertaken by a corporation. Generally, the word also applies to the dissimilar type of procedures and configures of the financial operations employed by a given company. Generally corporations will have a definite financial division that is ardent with the task of managing corporate finance in each view of financial operation.
One of the core functions of proficient corporate finance is to make reasonable use of financial resourses accessible to the company. As a element of this operation, the financial plan of the corporation will be inclined to bulge an operation budget the ability or tact all the needs of the company in provisions of expences, and as well tend to work with unique departments to hunt income generated from various operations and investments in consign. Uttermost, the objective is to guarantee that the corporation is achieving the maximum benefits from available financial resourses, while incurring the lowest amount of expenditure necessary to achieve those benefits.
The factor of corporate finance can be sub-divided into short-term and long term techniques and decisions. Long-term choices about the project are considered under the Capital investment decisions while short-term decisions are considered under working capital management and cash management.
Capital Investment Decision:
The ability to analyse and make capital investment decisions allows you as the holder or manager of a business to make sure that your narrow resources are owed to the project or projects that will best attain your strategic goals (Therefore they are also every so often referred to as strategic investment decisions). Such decisions could relate to capital investments such as the construction of a new factory, development of a new website, commitment to a new marketing campaign or the attainment of a business.
The objective of a business is to maximise shareholder capital by generating profit and acquiring assets. In order to do so, you as the manager of your business want to be capable to determine which capital investment projects will produce a positive cash flow and when resources are constrained, as they frequently are in a small/start-up business or for main businesses in the existing credit-crunch, rank projects in order of priority based on the value they create.
How you carry out your capital investment assessment is important, get it wrong and you'll be eroding shareholder value and probably jeopardising the whole existence of the business. All capital investment projects must be predictable to provide returns in surplus of the cost of financing them. The difficulty is recognising the need for investment is complex, it's even complex to recognize what possible investments there are, establish how to estimate them and to collect adequate data to do that evaluation.
The Process of capital investment appraisal
The capital investment conclusion building process involves the following steps: project identification; project definition and screening; analysis and acceptance; implementation; monitoring and post audit. This essay deals with the analysis and acceptance of projects. In practice many decisions are made with partial time and information often omitting one or more steps in the process. The assessment may also be further affected by political activity within the organisation where groups or individuals have a vested interest in particular projects.
Capital investment appraisal techniques
There are a number of dissimilar approaches to the analysis of strategic investment decisions. The most common are: return on investment (ROI), accounting rate of return (ARR), payback and the discounted cash flow techniques of net present value (NPV) and internal rate of return (IRR).
A general first approach to investment evaluation is the use of the accounting ratio return on investment. The return on investment is calculated by dividing the net profit after tax by the value of the investment. It is still considered imperfect as an investment appraisal technique because it "ignores value and risk".
Another common technique is the accounting rate of return, which expresses the profit generated as a percentage of the investment. This is comparable to the return on investment but using the deprecated value of the investment rather than the total value of the investment.
Working capital and cash flow:
The objectiveof working capital management is to make sure that your business is capable to carry on its operations and that it has enough ability to convince both maturing short-term debt and upcoming operational expenses. Good management of working capital will generate cash, develop profits and decline risks.
If you have insufficient working capital and try to increase sales, you can effortlessly over-stretch the financial resources of the business. Some before time warning signs that you need to take action are;
Stress on obtainable cash
Exceptional cash generating activities e.g. contributing high discounts for early cash payment
Bank overdraft exceeds authorized limit or looking for greater overdrafts or lines of credit
Part-paying suppliers or other creditors
Paying bills in cash to make safe extra supplies
Management pre-occupation with surviving somewhat than managing
Frequent short-term emergency desires to the bank
The main fundamentals of working capital have been conventionally payables and receivables. But payables and recivables only represent the beginning and ending of the cash to cash conversion cycle. What's missing is the need of the process and that is inventory inorder to get more fore picture of working capital we have to consider inventory. If you bring together the payables and recievables and inventory we have what I woul have called operational working capital.
I think its very important to include inventory for complete picture of operational working capital. Finance people have traditionally looked at inventory some how being different, its something for the procurement or supply chain people to worry abt.thats to subject to same strict financial measurements that payables and recievables might be. However inventory is critical to a company success and efficient performance. Inventory has a large component of financial statements. Just is a important impact that payables and recievables has been treated differently. To get that complete understanding of operational working capital a more practice picture and more comprehensive picture for operational working capital to be more effective tool, inventory needs to be included as component.
SOURCES OF FINANCE
For several businesses, the problem about where to get funds from for starting up, development and expansion can be crucial for the success of the business. It is essential, therefore, that you recognize the different sources of finance open to a business and are capable to assess how appropriate these sources are in relation to the needs of the business.
Sourcing money might be completed for a variety of reasons. Traditional areas of need may be for capital asset attainment - new machinery or the construction of a new building or depot. The expansion of new products can be extremely costly and here again capital may be needed. generally, such developments are financed internally, whereas capital for the acquisition of machinery may come from external sources. In this day and age of tight liquidity, numerous organisations have to look for short term capital in the mode of overdraft or loans in order to provide a cash flow cushion. Interest rates can differ from organisation to organisation and also according to purpose.
Internal sources:
Personal savings: This is most frequently an option for small businesses where the owner has a few savings available to use as they wish.
Retained profit: This is profit previously made that has been set away to reinvest in the business. It might be used for new machinery, marketing and advertising, vehicles or a new IT system.
Working capital: This is short-term money that is held in reserve for day-to-day expenses such as stationery, salaries, rent, bills and invoice payments.
Sales of assets: There may be excess fixed assets, such as buildings and machinery that might be sold to produce money for new areas. Decisions to sell items that are still used ought to be made cautiously as it could have an effect on capacity to deliver existing products and services.
External sources:
Shares: Limited companies might seem to sell extra shares, to new or existing shareholders, in exchange for a return on their investment.
Loans: There are debenture loans, with fixed or variable interest, which are usually protected against the asset being invested in, so the loan company will have a legal joint interest in the investment. This means that the company would not be capable to sell the asset without the lender's prior agreement. In addition the lender will take precedence over the owners and shareholders if the business should fail and the cost will have to be repaid still if a loss is made.
There are other types of loan for fixed amounts with fixed repayment schedules. These may be considered a slight extra flexible than debenture loans.
Overdraft: A bank overdraft may be a fine source of short-term finance to help a business squash seasonal dips in cash-flow, which would not substantiate or need a long-term solution. The benefit here is that interest is calculated daily and an overdraft is thus cheaper than a loan.
Hire purchase: Hire purchase preparations allow a firm to attain an asset rapidly without paying the full-price for it. The company will have limited use of the item for a set period of time and then have the choice to either return it or buy it at a reduced price. This is frequently used to fund purchases of vehicles, machinery and printers.
Credit from suppliers: several invoices contain payment terms of 30 days or longer. A company can take the utmost amount of time to pay and utilize the money in the provisional period to finance other things. This system should be treated with caution to make sure that the invoice is still paid on time or else the firm might risk upsetting the supplier and jeopardise the future working relationship and terms of business. It should also be remembered that it's not 'found' money but relatively a careful balancing act of cash-flow.
Grants: Grants are frequently obtainable from councils and other Government bodies for specific issues. For example there may be a council priority to regenerate a particular area of a town and who are happy to help fund refurbishment of buildings. otherwise there may be an organisation that specialises in helping young entrepreneurs to launch new businesses. Assessment for grants can be very competitive, is very individual and not automatic.
Venture capital: This source is most frequently used in the premature stages of developing a new business. There may be a gigantic risk of failure but the potential returns may also be big. This is a high risk source as the venture capitalist will be looking for a share in the firm's equity and a strong return on their investment. On the other hand the significant skill these investors have in running businesses could show precious to the company. This is what the TV programme 'Dragon's Den' is all about!
Factoring: This involves a company outsourcing its invoicing preparations to an peripheral organisation. It instantly allows the company to obtain money based on the value of its wonderful invoices as well as to receive payment of future invoices more rapidly. It works by the firm building a sale, sending the invoice to the customer, copying the invoice to the factoring company and the factoring company paying an settled percentage of that invoice, usually 80% within 24 hours. There are fees caught up to cover credit management, administration charges, interest and credit protection charges. This must be weighed up against the benefit gained in maximising cash flow, a decline in the time spent chasing payments and access to a more refined credit control system. The negative aspect is that customers may desire to deal direct with the company selling the goods or services. In addition ending the affiliation could be tricky as the sales ledger would have to be repurchased
Question 1:
Net Debt Ratio =
(Total market value of debt +present value of operating leases-Cash and
Marketable securities) / (No of common shares * common stock price + total
market value of debt + present value of operating leases-Cash and Marketable
securities)
Total Market value of debt = market value of (Short term borrowings and long
term debt) i.e. $ 706 Million + $ 8747 Million = $ 9453 Million
Present Value of Operating Leases = 5 times of annual rental expense i.e.
5*(479) = $ 2397.5 Million
Cash and Marketable Securities = Cash and Cash Equivalents + Short term
marketable equivalents reduced by 25% i.e. (382+1116)*75%= $ 1123.5
Million
No of common shares = 788 Million Shares
Common stock price = $ 55.875
Market Value of stockholder's equity = 788* 55.875 = $ 44,029.5 Million
Net Debt Ratio = (9453+2397.5-1123.5)/ (44,029.5+9453+2397.5-1123.5) =
19.59%
Intrest coverage ratio:
The interest coverage ratio is exceptionally essential from the lender's point of view. It indicates the number of times interest is enclosed by the profits obtainable to pay interest charges.
It is an index of the financial strength of an enterprise. A high debt service ratio or interest coverage ratio assures the lenders a regular and periodical interest income. But the weakness of the ratio may create some problems to the financial manager in raising funds from debt sources.
Interest Coverage Ratio = EBIT/Interest Expense
Fixed charge coverage ratio:
It indicates a firm's capability to gratify fixed financing expenses, such as interest and leases.
Fixed Charge Coverage Ratio = EBIT+fixed charge(before tax)/fixed charge(befor tax)+Intrest
Long term debt ratio:
Debt-to-Equity ratio indicates the link between the external equities or outsiders funds and the internal equities or shareholders funds. It is also known as external internal equity ratio. It is resolute to make certain soundness of the long term financial policies of the company.
Following formula is used to calculate debt to equity ratio
[Debt Equity Ratio = External Equities / Internal Equities]
Or
[Outsiders funds / Shareholders funds]
As a long term financial ratio it may be calculated as follows:
[Total Long Term Debts / Total Long Term Funds]
Or
[Total Long Term Debts / Shareholders Funds]
Cash flow to long term debt ratio:
The cash flow to long term debt ratio appraises the sufficiency of available funds to pay obligations.
Cash Flow to Long Term Debt = cash flow / long term debt
Cash flow to total debt:
In this case, it is tough to know what the analyst was using for a formula.
Debt to cash ratio usually results in a percentage. It is often calculated this way:
Cash flow to debt ratio = operating cash flow / total debt
Table 1. Selected Information Concerning PepsiCo and Comparable Firms
(Dollars in millions)
Firm
Annual
EBIT(A)
Annual
Intrest(B)
Annual
Rental
Expenses(C)
Long
Term
Debt(D)
Common
Stock
Value(E)
Total
Debt(F)
Cash
Flow(G)
Pepsi Co
3,114
682
479
8,747
44,030
9,453
3,742
Cadbury Schwepps
661
135
25
864
8,702
1,490
492
Coca-Cola
4,600
272
-
1,141
100,810
1,693
3,115
Coca-Cola Enterprises
471
326
31
4,138
3,857
4,201
644
MCDonalds
2,509
340
498
4,258
33,586
4,836
2,296
Table 2. Various ratios calculated basis info given in Table 1.
Firm
Intrest
Coverage
Ratio(A/B)
Fixed charge coverage ratio
{(A+C)/(C+B)}
Longterm
Debt ratio
{(D/(D+E)}
Total debt to adjust total capitalization
{F/(F+E)}
Cash flow to long term debt
(G/D)
Cash flow to total debt
(G/F)
Pepsi Co
4.57
3.09
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
Question 3:
Net debt is a means of gauging the capability of a business to repay all its outstanding debt, if that debt were unexpectedly called. The reason behind the calculation is to assess the existing financial strength of the business, in terms of its capability to deal with debt even if the company encounters some kind of temporary financial turnaround. Investors often look closely at the debt-service coverage ratio, or DSCR, as a way of determining if investing in a given business is likely to produce equitable returns over the long-term.
A common approach to calculating this type of debt involves identifying the existing amounts owed all short-term and long-term debts, and adding those debts into one sum. After that, all cash on hand as well as all cash equivalents are totaled, representing the total amount of cash that a company can produce quickly if necessary. By subtracting the cash and cash equivalents from the total debt recognized, the rest constitutes net debt.
whereas identifying the existing amount of net debt is extremely useful in assessing the financial solidity of a company, there is no magic figure that automatically means a company is in admirable state. For this reason, it is regularly helpful to contrast the amount of the debt to that of another company that is related in extent and allied with the same industry. Doing so helps to place the number in perception, and put hope for what is a working standard for a given industry. From there, it is easier to calculate the figure and decide if the company is carrying an above average amount of debt, or has a comparatively low debt load.
Looking additional closely at the factors that determine net debt is also compassionate For example, knowing whether the larger division of the debt is short-term or long-term, or if some of the debt was produced due to refinancing older debt, might be essential for an investor. An study of this kind will regularly give up clues as to how well the company would handle its operations if demand for their products suddenly dropped, or a natural disaster crippled a section of the operating amenities.
20% -25% of net debt ratio signifies that Pepsico would use 20% -25% of debt financing and outstanding equity financing which looks safer if PepsiCo's actual purpose is to maintain a single debt rating .This can be supported by the fact that current year it has a net debt ratio of 18% which is not very unreliable from target and also debt rating is A1/A which is the targeted rating.
CONCLUSION
According to my termination that this course work provides an prologue to corporate finance to make know the corporate finance structure and financial ratios for the analysis. In my end of analysis that 20% -25% of net debt ratio objective of PepsiCo is companionable with the capital structure objective of senior single A debt rating as it declines within the industry average and also supported by the present rating given in the exhibit 5 at a given net debt ratio of 18% which is not very unreliable from the target.
