Any study of organisation and management inevitably covers several aspects, and each study can be used to a greater or lesser extent to confirm generalisations made about particular topic areas. The use of the same studies to illustrate different aspects of management and organisational behaviour serves as useful revision and reinforcement, and helps to bring about a greater awareness and understanding of the subject.
In the study of management and organisational behaviour you will come across many theories. However, you should not be put off by the use of the word 'theory'. Most rational decisions are based on some form of theory. Theory contains a message on how managers might behave. This will influence attitudes towards management practice and lead to changes in actual patterns of behaviour.
Organizations are extremely complex systems. As one observes them they seem to be composed of human activities on many different levels of analysis. Personalities, small groups, intergroups, norms, values, attitudes all seem to exist in an extremely complex multidimensional pattern. The complexity seems at times almost beyond comprehension.
Introduction:
PepsiCo's Capital Structure:
PepsiCo is the world leader in convenient food, snacks and beverages with revenue more than $60 billion and over 285,000 employees. It generates sales at the retail level of $98 billion. Over the next 30 years, net sale grew up at an average compound rate 15% per year, with the sale doubling about every five years.
PepsiCo has book liability of $18.1billionand book value for stockholders' equity of $7.3 billion. The market value of stockholders' equity is much greater. With the 788million common shares outstanding and a market share price is of $55.875, the market value of its stockholders' equity is $44.0 billion, roughly six times its book value.
PepsiCo's capital investing has reflects strategic investment in both industry segments as well as acquisition and investment in unconsolidated affiliates. PepsiCo expects its investments to generate cash returns in excess of its long term cost of capital, which is estimates to be approximates 10%. About 75% of PepsiCo's total acquisition and investment activity represents international transactions.
There are some factors given below which influence the mix of debt and equity of a firm which gives the direction that how a company uses to finance their operations.
Taxes:-
Debt is tax deductible: increase in debt will reduce the income tax paid if the company is in a tax paying position.
The company will make more money after paying the taxes.
Remember the equation presented earlier from miller which shows that adwantage is less as corporations have to "gross up" the interest paid on bonds to compensate personal investor for a tax advantage.
Risks:-
There are two types of risks:
Financial risks: This is directly controlled by the managers.
Operating or assets risks: It can also be controlled by the managers but through their choices of scales or size of fixed assets.
Financial slacks:-
Financial slacks can be defined as the amount of funds a firm has available to invest without visiting the external financial markets. after paying interest and before paying the dividends+ depreciations..
Cost of financial distress:-
There are two types of cost of financial distress:
Direct cost of bankruptcy:
A) Lawyers and accounting,
B) On taxes.
Indirect costs of bankruptcy:
On sale and customers,
On firms opportunities.
Operating costs,
On flexibility.
Leverages:-
Leverage is the relationship between debt financing and equity financing, also known as the debt-to-equity ratio. A method of corporate funding in which a higher proportion of funds is raised through borrowing then stock issue, the use of fixed costs in order to increase the rate of return from an investment. There are three types of leverages.
Operating leverage.
Financial leverage.
Combined leverage.
Financial leverage is the ability of the firm to use fixed financial charges to magnify the effect of change in earning per share. It indicates the effects on earning due to rise of fixed cost funds.
Financial leverage:
Operating income /net income
The tool which we used to identify the financial leverage of PepsiCo's are the market value and historical cost and net debt play a prominent role in quantifying the financial leverage .
Question1:-
Calculate PepsiCo's 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.
The most important factor before investing the money in a company is to consider that how much debt a company is carrying. It is helpful to find out the net debt of a company. After calculating the net debt ratio because the business firm's or company's who want to invest will be able to find out the financial position of the company in which they going to invest in.
As per given in the statement:-
The net debt ratio, L*, is defined as
L* = (D + PVOL - CMS)/(NP + D + PVOL - CMS)
Where D is the total market value of debt,
PVOL is the present value of operating leases commitments which is five times the annual rental expense,
CMS is cash and marketable securities (net of the cost of remitting these funds to the United States),
N is the number of common shares,
And P is the price of common stock.
In order to determine the net debt ratio, we have to put the values in the formula mentioned above.
L* = (D + PVOL - CMS)/(NP + D + PVOL - CMS)
L* = ($9453 + [$479 x 5] - $1498)/([788.00 x $55.875] + $9453 + [$479 x 5] - $1498)
L* = ($9453 + $2395 - $1498)/($44029.5 + $9453 + $2395 - $1498)
L* = ($10350)/ (54379.5)
L* = $0.19, 19%
Coca cola:-
L*= 0.0037.
So that after calculating the net debt ratio of PepsiCo's which is 19% and it is good for the company because when we compared it with previous year Net debt Ratio was 18% as this shows that PepsiCo Net debt ratio is Increasing by making an assumption of reducing cash and marketable securities by 25%. Net debt ratio was fluctuating very rapidly and by small margin but for the current year it has only increased it by 1% which states that PepsiCo is relying on debt for the expansion of their business, which is a positive sign for the company and for the investors.
Question 2:-
For each firm in the table above, 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 rate of cash flow to long term debt, and the ratio of cash flow to total debt.
FIRM
DEBT RATING (MOODY'S/S&P)
ANNUAL EBIT
ANNUAL RENTAL EXPENSES
ANNUAL INTREST
CASH AND MARKET ABLE SECURITES
MARKET VALUE OF LONG-TERM DEBT
MARKET VALUE OF TOTAL DEBT
ANNUAL CASH FLOW
NUMBER OF SHARES (MILLIONS)
YEAR-END SHARE PRICE
PepsiCo
A1/A
$3114
$479
$682
$1498
$8747
$9453
$3742
788.00
$55.875
Cadbury Schweppes
A2/A
661
25
135
129
864
1490
492
247.75
35.125
Coca-Cola
Aa3/AA
4600
__
272
1315
1141
1693
3115
2504.60
40.250
Coca-Cola Enterprises
A3/AA-
471
31
326
8
4138
4201
644
385.65
10.000
McDonald's
Aa2/AA
2509
498
340
335
4258
4836
2296
699.70
48.000Interest Coverage Ratio = EBIT / Interest Expense
Where EBIT is Earning before interest and tax which is written as Annual EBIT in the Table1,
And Interest expense is Annual Interest.
"Interest Coverage Ratio is a calculation of company's ability to meet its interest payments on outstanding debt. Interest Coverage Ratio is calculated by dividing earning before interest and taxes with interest expense. The lower the interest coverage is, larger the debt burden on the company."[3]
Fixed Charge Coverage Ratio = EBIT + Fixed Charge (before tax)/Fixed Charge(before tax + interest)
Where is Earning before interest and tax which is written as Annual EBIT in Table1,
And Fixed Charge is present value of operating lease commitments (PVOL).
Fixed Charges are the expenses which a company has to bear like rent, electricity, stationery, machinery repairs, etc. The ability of the company to meet al these expenses is known as fixed charge coverage. This ratio is calculated by dividing EBIT and fixed charge(before tax) by fixed charge (before tax + interest). The higher the ratio is, higher is the capacity of the company to meet the expenses.
Long Term Debt Ratio = long term debt / long term debt + equity
Where equity is equals to number of shares x year-end share price (NP)
Long-Term Debt Ratio is a way to determine the company's leverage. It is calculated by taking Long-Term Debt and dividing it by the sum of its long-term debt and equity. The greater the company's leverage, higher the ratio will be and also it is seen that the companies with higher ratios are thought to be more risky because they have more liabilities and less equity.[2]
Total Debt to Adjusted Capitalization = Total Debt / Adjusted Capitalization
In order to ascertain the total debt to adjusted capitalization, first, we have to determine the adjusted capitalization which can be calculated as:
Adjusted Capitalization = Net Debt + Shareholders Equity
Where net debt is total debt minus cash and marketable securities (CMS), and also shareholders equity is NP.
Ratio of Cash Flow to Long Term Debt = Cash flow / Long term Debt
Every company wants to know the amount of the funds available to pay the obligations. The ratio of cash flow to long term debt is the tool to determine the amount of the company's available funds to meet up the obligations. There has been a saying that the future is uncertain, so every company wants to prepare itself to meet the uncertainties in the future. By calculating this ratio a company can judge its financial position(available funds) to survive in the market.
Ratio of Cash Flow to Total Debt = Cash flow / Total Debt
The Cash Flow to Total Debt Ratio is used to measure the amount of time required by the company to pay its total debt by using only the cash flow. But this is something unreal because company can't use its all cash flow to pay the total debts. It also states that the higher or increasing ratio is an indicator of positiveness, which tells that the company is sound enough to pay its debts.
1) PepsiCo:
Interest Coverage Ratio = $3114 / $682 = $4.565
Fixed Charge Coverage Ratio = $3114 + ($479x5)/($479x5) = $2.3002
Long Term Debt Ratio = $8747 / $8747+$44029.5 = $0.1657
Total Debt to Adjusted Capitalization:
Adjusted Capitalization = Net Debt + Shareholders Equity
= (Total Debt - CMS) + NP
= ($9453 - $1498) + (788.00x$55.875)
= $51984.5
Therefore,
Total Debt to Adjusted Capitalization = Total Debt/Adjusted Capitalization
= $9453 / $51984.5
= $0.1818
Ratio of Cash Flow to Long Term Debt = $3742 / $8747 = $0.4278
Ratio of Cash Flow to Total Debt = $3742 / $9453 = $0.3958.
Table2. Shown the calculation of the firm:-
FIRM
INTEREST COVERAGE RATIO
THE FIXED CHARGE COVERAGE RATIO
LONG-TERM DEBT RATIO
THE TOTAL DEBT TO ADJUSTED TOTAL CAPITALIZATION
THE RATIO OF CASH FLOW TO LONG-TERM DEBT
THE RATIO OF CASH FLOW TO TOTAL DEBT
Pepsico
$ 4.57
$ 2.3
$ 0.17
$ 0.18
$ 0.43
$ 0.40
Cadbury Schweppes
$ 4.90
$ 6.28
$ 0.09
$ 0.15
$ 0.57
$ 0.33
Coca-cola
$ 16.91
$ 0.011
$ 0.01
$ 0.016
$ 2.73
$ 1.84
Coca-cola enterprises
$ 1.44
$ 4.038
$ 0.52
$ 0.52
$ 0.16
$ 0.15
Mcdonald's
$ 7.38
$ 2.007
$ 0.11
$ 0.12
$ 0.54
$ 0.47
Summary question 2:
1. Company Interest coverage ratio should not be lower than 1.5 if it is lower than company is not good; As we can see that PepsiCo interest coverage ratio is 4.56 which is good for the company and reflects that company has an ability to pay interest on their outstanding debt but on the other side we compare it with Coca Cola which is 16.91 which shows Coca Cola superiority over PepsiCo's.
But Coca Cola enterprise Interest coverage ratio is 1.44 by which we can say that about that the company ability to pay interest on their outstanding debt is not good for company.
2. As we can see Fixed charge coverage ratio of PepsiCo is 2.3 which is adequate as comparing it with Coca Cola beverage their ratio is more than to sustain which is 0.011 and of Cadbury and McDonald's which are 6.3 and 2.007 respectively which shows that Cadbury is in a better situation than that of McDonald's and PepsiCo But Problem seems to be reflecting in Coca Cola Enterprise as their Fixed coverage ratio is close to 1 which is 1.41 that is not good for an organization Coca Cola enterprise has to raise their Fixed Charge Coverage ratio because company is nearly using all of its cash flow to cover fixed financing costs and if profit decreases is future then they would be in a problem.
3. as per shown in the calculation the most least riskier company is Coca Cola which has 0.01 followed by Cadbury and McDonald's which has 0.09 and 0.112 which shows that they are riskier than Coca Cola .but in case of PepsiCo which is 0.165 which shows paying ability of their debt in future. PepsiCo are in a sound Financial position for Coca Cola Enterprise is 0.517 which means that they are taking more risk than other companies.
4. As PepsiCo is growing its debt for expansion which shows that Cash flow to long term debt low as compare to Cadbury, McDonald's and Coca Cola which means company has to maintain their debt .The Cash flow to total debt ratio determines the amount of time required by the company to pay its total debt with the help of cash flow .PepsiCo and McDonald's have almost same ratio which are 0.40 and 0.47 respectively. While Coca Cola is in better situation than PepsiCo or any other Company because their ratio is quite higher than other which is a good point towards company paying their debts.
Question 3
Suppose PepsiCo's 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?
Senior debt means a type of debt which carries higher priority over the other types debts at the time dissolution of firms. It means if the company goes bankrupt the holder of senior debts will be paid before the payment of subordinate debts. It is considered to be less risky than other types of debts. Debt has different forms. It can be loan from bank, private investor, etc.
Debt Reimbursement
Debt reimbursement means repayment of debt. Most types of debt comes with a promise or obligation to repay it. The borrowers have to repay the amount borrowed, and also sometimes there is an interest on loans which comes as a profit to lender. There are many lenders available in the market to lend money to the borrowers. But the company chooses the lender who offers them low rate of interest.
Every company wants to maintain their financial rating in the market strong and high and also we can say would like to get the top position in the market to make their reputation. It is only can be possible by maintaining financial position in the market.
Conclusion and recommendations:
In the law of the conservation of value works when you add up cash flow, it must also work when you subtract them. Therefore, financing decisions that simply divide up operating cash flow don't increase over all firm value. This is the basic idea behind Modigliani and millers famous propositions 1: in perfect markets changes in capital structure do not affect value.as long as total cash flow generated by the firm's assets in unchanged by the capital structure, Value is independent of capital structure. The value of whole pie does not depend on how it is sliced.
Obviously MM's proposition is not the answer, but it does tell us where to look for reasons why capital structure decisions may matter. Taxes are one possibility. Debt provides a corporate interest tax shield may more than compensate for any extra personal tax that the investor has to pay on debt Interest. Also, high debt levels may spur managers to work harder and to run a tighter ship. But debt has its drawbacks if it leads to costly financial distress.
Optimal capital structure involves "trading off" costs and benefits.
Advantage to debt:
Reduction on taxes through tax shield.
Reduction managerial discretion when firm has more investment opportunities.
Disadvantage of debt:
Bankruptcy costs may be significant and may effect operation of business.
Advantage to equity:
Increase managerial discretion when firm has more positive investment opportunities and outside investors have poor ability to choose good firms.
After the calculation of Net debt ratio of PepsiCo; one can say that PepsiCo is achieving its target net debt ratio which is 20 to 25% which is a good sign for the company and it is feasible for the company we have also analyzed PepsiCo interest paying ability and compare it with different Organisation which are in same business and realized that PepsiCo is doing better than most company but Coca Cola is far ahead of others. PepsiCo are moving in right direction and near future we will not be surprised to see that PepsiCo is matching pace or gone ahead of its competitors; By this assignment I have analyzed capital structure of PepsiCo which shows that company is determined to move on fast lane they are expanding their Business mostly by debt and company paying ability is good and net debt ratio is also low, so after all PepsiCo has managed their capital structure in a right direction
Critical reflection on learning outcomes:
This report has been of great learning to me, it has given me the opportunity to bring my academic understanding to practical implementation, calculations and thought process involved in evaluating and recommending my views has really broadened my horizon and further developed my interest in corporate finance and in the business world.
If given an opportunity in my academic life, I would definitely like to take more in-depth study in this area of finance either through my dissertation or further case studies and reading of literature in the related field.
