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Executive Summary of Pepsico

Through my research of Pepsico, I have calculated the cost of capital. A

firm's cost of capital is imperative because it represents the funds used to

finance the firm's assets and operations. First you have to estimate the cost

of capital in order to minimize it.

In estimating the cost of capital, you first have to find the cost of

each capital component and then combine the component costs to find the weighted

average cost of capital. First, I calculated the cost of debt. Pepsico's bond

consisted of 7 5/8 coupon rate, maturing in 1998 at a price of $1023.80. I

figured the payments to be $38.15(.0763*1000/2). I then used my financial

calculator 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 the

answer for I/Y times 2 to get 5.16%.

The next step would be to calculate the preferred stock, however my

stock had none. I then went to the third step of calculating cost of retained

earnings. First I found the three growth rates which were historical, forecast,

and sustainable growth. The historical and forecast annual rates I simply

pulled directly from Value Line under Past 10 years and estimated years of the

dividends. They both were 14.0%. The sustainable growth is calculated by

taking 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. I

pulled 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 and

dividing 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 my

cash 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 the

growth 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 CAPM

approach. This formula is Ks=Krf + (Km-Krf)bs. I found beta on Value Line

which was .95. The risk free rate was found by obtaining the current yield on a

20yr. T-bond from the Wall Street Journal. It equaled 6.60%. The Km-Krf was

found in the book, and equaled 7.1%. After plugging those numbers into the

formula, I came up with 13.35%.

The last calculating was the weighted average cost of capital. The

formula for this is: WACC=WdKd(1-tax rate) + WpKpf + WsKs. I found the weights

of debt and equity on Value Line, and they were: Wd=55%, and Ws=45%. The cost

of debt and equity were already calculated, and the tax rate of 40% was given to

us. There was no preferred stock, so I did not use those numbers in my

calculation. 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 dollar

of capital raised at the margin. The capital is basically the entire right hand

side of the balance sheet, and the cost of capital must be minimized in order to

maximize the value of the firm.

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