Executive Summary of PepsicoThrough my research of Pepsico, I have calculated the cost of capital. Afirm’s cost of capital is imperative because it represents the funds used tofinance the firm’s assets and operations.
First you have to estimate the costof capital in order to minimize it. In estimating the cost of capital, you first have to find the cost ofeach capital component and then combine the component costs to find the weightedaverage cost of capital. First, I calculated the cost of debt. Pepsico’s bondconsisted of 7 5/8 coupon rate, maturing in 1998 at a price of $1023.
80. Ifigured the payments to be $38. 15(. 0763*1000/2).
I then used my financialcalculator to find the bond yield of 5. 16% by entering in 1023. 80=PV, 1000=FV, 2=N, 38. 15=PMT. The bond was calculated semi-annually, therefore I multiplied theanswer for I/Y times 2 to get 5. 16%.
The next step would be to calculate the preferred stock, however mystock had none. I then went to the third step of calculating cost of retainedearnings. First I found the three growth rates which were historical, forecast,and sustainable growth. The historical and forecast annual rates I simplypulled directly from Value Line under Past 10 years and estimated years of thedividends. They both were 14.
0%. The sustainable growth is calculated bytaking the retention rate (b) and multiplying it by the return on equity (r ). To find b, I first calculated the dividends payout ratio which is DPS/EPS. Ipulled DPS and EPS from value line under 1997. Then to find the retention rate,I subtracted the ratio from 1. Next, I calculated r, by taking net income anddividing it by net worth.
These figures I also pulled from Value Line. My b=. 352, and r=28. 68%.
Then the third growth rate was 10. 10(. 352*28. 68).
Still calculating the cost of retained earnings, I then calculated mycash flows by the discounted cash flow approach. For the first three cash flows,I took the dividend of the stock over the price of the stock, and then added thegrowth rate to it. My first cash flow equaled to 15. 38%, second was also 15. 38%,and the third one was 11. 45%.
To find the cash flow four, I used the CAPMapproach. This formula is Ks=Krf + (Km-Krf)bs. I found beta on Value Linewhich was . 95. The risk free rate was found by obtaining the current yield on a20yr. T-bond from the Wall Street Journal.
It equaled 6. 60%. The Km-Krf wasfound in the book, and equaled 7. 1%.
After plugging those numbers into theformula, I came up with 13. 35%. The last calculating was the weighted average cost of capital. Theformula for this is: WACC=WdKd(1-tax rate) + WpKpf + WsKs. I found the weightsof debt and equity on Value Line, and they were: Wd=55%, and Ws=45%.
The costof debt and equity were already calculated, and the tax rate of 40% was given tous. There was no preferred stock, so I did not use those numbers in mycalculation. After plugging in the values, my WACC came out to be 7. 71%. This number can be interpreted as the weighted average cost of each new dollarof capital raised at the margin. The capital is basically the entire right handside of the balance sheet, and the cost of capital must be minimized in order tomaximize the value of the firm.;
