Calculating And Evaluating Pepsicos Net Debt Ratio Finance Essay
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Corporate finance is the field of finance dealing with financial decisions that business enterprises make and the tools and analysis used to make these decisions. Corporate finance is one of the most important areas of finance which takes into account all the financial decision taken by corporate enterprises.The primary goal of corporate finance is to maximize corporate value while managing the firm's financial risks. Although it is in principle different from managerial finance which studies the financial decisions of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms. It also deals with the tools and techniques used to make these decisions. One of the main objectives of corporate finance is to maximize the corporate value. Corporate finance also takes into account the financial risks faced by the firm while maximizing the corporate value. Corporate finance is different from managerial fiancé. Corporate finance deals only with the corporate whereas managerial finance deals with almost all the firms.
Capital Investment Decisions:
The goal of the corporate sector is to maximize return on investing in projects which have a positive Net Present Value.
Capital investment decision is composed of :
1. Investment Decision
2. The Dividend Decision
Working Capital Management:
This type of corporate finance is used the management of the current assets of the company. It also deals with short term financing such that the cash flows and return are acceptable.
Financial Risk Management:
Financial Risk Management is vital for Corporate Finance. It basically highlights the risks that are to be hedged by the use of different financial instruments. The financial instruments are changes in the commodity prices, interest rates, foreign exchange rates and stock prices. Derivatives like options, future contracts, forward contracts and swaps are used as instruments of financial risk management.
Introduction to Corporate Finance is simply dealt with acquisition of resources and allocation of resources. Get an introductory part on Corporate Finance. Corporate Financial Services are mainly of asset based lending, cash flow lending and second lien loans. Corporate Financial Management is an important tool in managing the working capital of a company. Find the process of managing the corporate finance.
PepsiCo
The world leading firm in snack food industry and the second in the soft drink industry. It has more than 200 product available in the market in and around the world. It invents many ideas and designs to promote and improve itself. The company is listed in the London stock exchange. The major competitor of pepsico is coca cola which is the leading brand in the soft drink industry and maintains a larger share than pepsico.
2.Net Debt Ratio of PEPSI CO
L*= (D+PVOL-CMS)/ (NP+D+PVOL-CMS)
D=Market value of Total Debt= $9453
PVOL=Present Value of Operating Lease (5 times the annual rental expense) =479*5= $2395
CMS=Cash and Marketable Securities=($1498*25%)+$1498= 1123.50
NP=No. Of common shares* common stock price=788*55.87=$44025.56
L*= (D+PVOL-CMS)/ (NP+D+PVOL-CMS)
L*= (9453+2395-1123.50)/ (44025.56+9453+2395-1123.50)
= 10724.50/ 54750.06
= 0.20
3.Ratio Calculation of PepsiCo and Comparable Firms
Interest Coverage Ratio
Interest coverage Ratio is used to analysis the firm's debt-servicing ability. The ratio indicates the number of times the company can make the payment of the interest charges are available funds. A higher ratio is desirable for every company, but as the ratio increases the risk also increases for the company indicating conservative nature of the firm in using debt. A lower ratio indicates excessive use of debt or inefficient operations.
Interest coverage is a financial ratio which helps the company in providing a quick glance of company's ability to pay the interest charges on its debt. It also tells the company about the number of times the company can pay interest from the available earnings which acts as a safety margin for a particular period for the company.
Pepsi Co
Interest Coverage Ratio= Earning before Interest and Tax(EBIT)/ Interest
= $3114/ $682
= 4.57
Cadbury Schweppes
Interest Coverage Ratio= Earning before Interest and Tax (EBIT)/ Interest
= $ 661/ $135
= 4.90
Coca- Cola
Interest Coverage Ratio= Earning before Interest and Tax(EBIT)/ Interest
= $4600/ $272
= 16.91
Coca- Cola Entreprises
Interest Coverage Ratio= Earning before Interest and Tax(EBIT)/ Interest
= $471/ $ 326
= 1.44
McDonald's
Interest Coverage Ratio= Earning before Interest and Tax(EBIT)/ Interest
= $2509/ $ 340
= 7.38
Comparing the Interest coverage ratio of PepsiCo with other companies, PepsiCo has a good ratio which is neither high nor low, which indicates that the company is operating efficiently and is not conservative in using Debt.
Fixed Charge Coverage Ratio
A ratio that indicates a firm's ability to satisfy fixed financing expenses, such as interest and leases. The fixed charge coverage ratio is especially important for firms that extensively lease equipment. EBIT, Taxes, and Interest Expense are taken from the company's income statement. Lease Payments are taken from the balance sheet and are usually shown as a footnote on the balance sheet. The result of the fixed charge coverage ratio is the number of times the company can cover its fixed charges per year.
A Ratio which is higher to 1 indicates that the company is able to payoff its fixed expenses and lower ratio shows that the company is unable clear its fixed expenses. It is calculated as follows:
EBIT + Fixed charge/ Fixed charge + Interest
Pepsi co
Fixed Charge Coverage Ratio = EBIT + Fixed charge/ Fixed charge + Interest
= $ 3114+ $479/ $479+ $ 682
=$ 3593/ $ 1161
=$ 3.09
Cadbury Schweppes
Fixed Charge Coverage Ratio = EBIT + Fixed charge/ Fixed charge + Interest
= $ 661+$25/ $25+$ 135
= $686/$ 160
=$ 4.29
Coca- Cola
Fixed Charge Coverage Ratio = EBIT + Fixed charge/ Fixed charge + Interest
=$ 4600+$ 0/$0 +$ 272
=$ 16.91
Coca- Cola Enterprise
Fixed Charge Coverage Ratio = EBIT + Fixed charge/ Fixed charge + Interest
=$ 471+$ 31/$ 31+$ 326
=$ 502/ $ 357
=$1.41
McDonalds
Fixed Charge Coverage Ratio = EBIT + Fixed charge/ Fixed charge + Interest
=$ 2509+$ 498/$ 498+$ 340
=$ 3009/ $ 838
=$ 3.59
The ratios indicate that all the companies are showing a positive sign that they are able to payoff the fixed expenses which they incur every year. The companies with higher than 1 indicates the ability to pay the fixed charges that the company incur.
Long Term Debt Ratio
This ratio is calculated to determine the company's leverage. Here the companies long term debt and the shareholders equity is taken into consideration for the calculation. Long term debt ratio shows what proportion of debt and equity the firm is using to finance its assets to run the operation of the company. If the company uses more debt finance to run the operations of the business, the company can generate more earnings. Higher the ratio, higher is the companies leverage, but the companies with more long term debt are a liability to the company and therefore it is risky. It is calculated as follows:
Long term debt / Shareholders Equity
Pepsi Co
Long Term Debt Ratio = Long term debt / Shareholders Equity
= $ 8747/ $ 1498
= 5.84
Cadbury Schweppes
Long Term Debt Ratio = Long term debt / Shareholders Equity
=$ 864/$ 129
=6.70
Coca- Cola
Long Term Debt Ratio = Long term debt / Shareholders Equity
=$ 1141/$ 1315
=0.87
Coca- Cola Enterprises
Long Term Debt Ratio = Long term debt / Shareholders Equity
=$ 4138/$ 8
= 517.25
McDonalds
Long Term Debt Ratio = Long term debt/ Shareholders Equity
=$ 4258/$ 335
=12.71
Here the comparison indicates that the only PepsiCo has an average level leverage of the company, which is neither too risky nor safe. This can also said as ideal leverage level compared to the risk that other companies bare. This ratio also indicates the risk which the company face while using the debt financing for investment activities. If the company is not able to generate enough cash flows, its risk of bankruptcy is higher which with shatter the business of the company.
Total debt to Adjusted Total Capitalisation
The long term debt to total capitalisation ratio indicates the proportion of long term debt invested in the total asset of the company. For the calculation, the total long term debt and the shareholders equity are taken into consideration. A major difference from the traditional debt-to-equity ratio is that, this ratio compares the proportion of a company's long-term debt compared to its available capital. With this ratio, investors can identify the amount of leverage utilized by the company and compare it to others to help analyze the company's risk exposure. Companies with a greater portion of their capital with the debt are considered riskier than those with lower leverage ratios. Total debt to adjusted total capitalization helps in measuring the performance of a company on a risk-adjusted basis calculation. This ratio helps the company in showing the financial leverage. This ratio is the variation of Long term debt ratio or the traditional debt-equity ratio.
Total debt to adjusted total capitalization computes the proportion of company's total debt with its available capital. By using this ratio, investors can identify the amount of leverage utilized by a specific company and compare it to others to help analyze the company's risk exposure. It is calculated as follows:
Total Debt/ Total Debt + Common Stock
Pepsi Co
Total Debt to Adjusted Total Capitalisation= Total Debt/ Total Debt + Common Stock
= $ 9453/ $9453+$ 1498
=$ 9453/ $ 10951
=0.86
Cadbury Schweppes
Total Debt to Adjusted Total Capitalisation= Total Debt/ Total Debt + Common Stock
=$ 1490/ $ 1490+ $ 129
=$ 1490/ $ 1619
=0.92
Coca-Cola
Total Debt to Adjusted Total Capitalisation= Total Debt/ Total Debt + Common Stock
=$ 1693/ $ 1693+ $1315
=$ 1693/ $ 3008
=0.56
Coca- Cola Enterprises
Total Debt to Adjusted Total Capitalisation= Total Debt/ Total Debt + Common Stock
=$ 4201/$ 4201 + $ 8
=$ 4201/ $ 4209
=1
McDonalds
Total Debt to Adjusted Total Capitalisation= Total Debt/ Total Debt + Common Stock
=$ 4836/ $ 4836+$ 335
=$ 4836/ $ 5171
=0.94
The ratios of the companies are having the same position with Cadbury with the ratio in highest position with 0.92 and Coca Cola with 0.56 as the lowest. It indicates that Coca Cola is the lowest riskier company among all in the list.
Ratio of Cash Flow to Long- term Debt
Ratio of Cash flow to long term debt indicates the available fund with the company payoff the companies long term debts. Higher is the ratio, higher will be the ability of the company to pay the total debt with the cash generation with its operations. A lower ratio will indicate debt or a weak cash flow generation of the company. This has to be investigated by the company to know the factor the low ratio and this ratio can be compared with the historic data so that the root cause can be found. It is calculated as follows:
Cash Flow/ Long Term Debt
Pepsi Co
Ratio of cash flow to long term debt=Cash Flow/ Long Term Debt
=$ 3742/ $ 8747
=0.43
Cadbury Schweppes
Ratio of cash flow to long term debt=Cash Flow/ Long Term Debt
=$ 492/ $ 864
=0.57
Coca-Cola
Ratio of cash flow to long term debt=Cash Flow/ Long Term Debt
=$ 3115/ $ 1141
=2.73
Coca- Cola Enterprises
Ratio of cash flow to long term debt=Cash Flow/ Long Term Debt
=$ 644/ $ 4138
= 0.16
McDonalds
Ratio of cash flow to long term debt=Cash Flow/ Long Term Debt
=$ 2296/ $ 4258
=0.54
The ratios indicates that the company need to investigate on the cause behind the lower ratio. other companies are also indicating a low ratio. This can be a serious issue for the company's in the future if this is not rectified in the initial stage of occurrence. The company are facing this situation for more year have to identify the cause with comparative study using the historical data of the company so as to get a clear picture of the scenario.
The Ratio of Cash Flow to Total Debt
Ratio of cash flow to total debt indicates the company's ability to pay the total debt with the cash available from its yearly operations. Total debt is the sum of short term and long term debt of the company. Higher is the ratio, higher will be the ability of the company to pay the total debt with the cash generation with its operations. A lower ratio will indicate debt or a weak cash flow generation of the company. This has to be investigated by the company to know the factor the low ratio and this ratio can be compared with the historic data so that the root cause can be found. It is calculated as follows:
Cash Flow/ Total Debt
Pepsi Co
The Ratio of cash flow to total debt=Cash Flow/ Total Debt
=$ 3742/ $ 9453
= 0.40
Cadbury Schweppes
The Ratio of cash flow to total debt=Cash Flow/ Total Debt
=$ 492/ $ 1490
=0.33
Coca-Cola
The Ratio of cash flow to total debt=Cash Flow/ Total Debt
=$ 3115/ $ 1693
=1.84
Coca- Cola Enterprises
The Ratio of cash flow to total debt=Cash Flow/ Total Debt
=$ 644/ $ 4201
=0.15
McDonalds
The Ratio of cash flow to total debt=Cash Flow/ Total Debt
=$ 2296/ $ 4836
=0.47
The ratios indicate that the company with lower ratio need to investigate on the cause behind the lower ratio. There are other companies also which have low ratio. This can be a serious issue for the company's in the future if this is not rectified in the initial stage of occurrence.
Net Debt Ratio of PEPSI CO
L*= (D+PVOL-CMS)/ (NP+D+PVOL-CMS)
D=Market value of Total Debt= $9453
PVOL=Present Value of Operating Lease (5 times the annual rental expense) =479*5= $2395
CMS=Cash and Marketable Securities=($1498*25%)+$1498= 1123.50
NP=No. Of common shares* common stock price=788*55.87=$44025.56
L*= (D+PVOL-CMS)/ (NP+D+PVOL-CMS)
L*= (9453+2395-1123.50)/ (44025.56+9453+2395-1123.50)
= 10724.50/ 54750.06
= 0.20 or 20%
PepsiCo measures a good financial leverage on the above ratios. Here, the company has a net debt ratio of 20% which states that the organization is maintaining a handle on their finances in a good manner which help them maintain a proper financial control of the activities. PepsiCo's objective to maintain a single A debt rating for the net debt ratio is satisfactory and reasonable since the standard is set in and between 20-25% and the net debt ratio falls in 20% for the firm.
4. Conclusion
A firm should maintain the corporate financial activities of the firm in the controllable and satisfactory manner so that the company is able to plan and workout its future activites in the current situations and plan which help the firm to carry out the activities.
The interest coverage ratio, the calculation indicates that coca cola is using higher level of their earnings for their operations. Though higher ratio is desirable but this also indicates that the company is conservative in using debt, which is a narrow idea or notion that the company has about itself.
In the fixed charge coverage ratio, the ability of the company or firm to clear its yearly fixed expenses that the company incur are to be cleared, here the ratios shows that coca cola enterprise is not able to pay off its expenses when compared to other four firms and the higher ability to payoff the expenses is coca cola with 16.91, which is highly a positive sign when compared with other companies. The company with the ratio in between the coca cola and coca cola enterprise are maintaining a kind of equilibrium with the expenses.
In the long term debt, the ratios show the company leverage, here the company leverage for the coca cola enterprise is with a risk that the company is having too many long term debt which is a risk for the firm operation. Company with lower long term debt indicates the higher leverage level for them to carryout the firms operations and also without any risk of bankruptcy.
Total debt to total capitalisation ratio indicates the total debt in the capitalisation of the company, the higher the portion will be the higher risk to the company. Here, the calculation shows that the coca cola is with lower risk of total debt to capitalisation. The higher portion is shared by the coca cola enterprises, which is a sign of risk to the company. The company should investigate the root cause of the problem so that the company can sustain itself from the risk in the market. The company take the historical data to calculate the cause and come out with solution for the risk.
Ratio of cash flow to long term debt shows the availability of the cash with the company to clear the long term debt of the company. Here in the calculation the coca cola is 2.73 ratio which indicates that the company is having sufficient amount of cash flow with which it an clear the long term debt of the company. And the lower ratio is shown by the coca cola enterprise, which is indeed at risk as the company will not be able to pay the older debt and will accumulate more of debt for running the operation. The company need to be careful about the new debt which they are going to take from the financial institutions etc.
Ratio of cash flow total debt indicates the ability to pay the total debt of the company with the cash flow from its operations. Here in the calculation, coca cola enterprise is making a ratio of 0.15, which indicates that the company is not able to pay its total debt with the cash generated from the yearly operation. The company needs to restructure its financial activities so that the company will be able to function properly and successfully. The coca cola company is making a higher ratio in the available firms which indicates the company is able to pay its total debt with the cash they generate every year.
Here the ratio shows the company is handling the financial activities in the right manner and controlling the activities. All the ratios calculated are in the average which shows that the ratios are average and companies are functioning with the single A debt rating which makes the investment decision in the right direction and also minimum with high returns.
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