28 April 2005
emonsila@hotmail.com
Mballard_806@hotmail.com

Five Forces Model....... ……………6
Competitive Strategy Analysis…..…9
Key Success Factor…....……….... 10
Key Accounting Policies…..…… 14
Screening Ratios ………..……... 21
Firm Analysis……………………. .26
Cross Sectional Analysis……...….. 30
Financial Statements Forecasting… 46
Method of Comparables……………48
Free Cash Flow……………………..51
Discounted Dividend……………….53
Discounted Residual Income……….54
Long Run Residual Income………...56
Abnormal Earning Growth…………57
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Executive Summary
PEP – NYSE $53.63
52 week price range $47.37 - 55.71
Revenue (2004) 29,261 (mill)
Market Capitalization 89.99B
Shares Outstanding 1.68B
Dividend Yield 1.72%
3-month Avg Daily Trading Volume 3,251,909
Percent Institutional Ownership 66.44%
Book Value Per Share (mrq) 8.083
ROE 31.24%
ROS 53.68%
Cost of Capital Estimates
Ke Estimated
Beta Ke
5yr Beta .32
3yr Beta .76
2.57%
5.6%
2yr Beta .48 3.69%
Published Beta .65 4.88%
Kd 3.98%
WACC 4.80%
Valuation Ratio Comparison PEP Ind Avg
Valuation Estimates
Actual Current Price (April 1, 2005)
Ratio Based Valuations
P/E Trailing
P/E Forward
PEG Forward
Dividend Yield
M/B
Ford Epic Valuation
Intrinsic Valuations
Discounted Div
Free Cash Flows
Residual Income
Abnormal Earnings Growth
Long-Run Residual Income Perp
$52.76
$49.47
$48.92
$50.80
$39.72
$37.07
$71.33
$43.18
$47.90
$51.80
$54.13
$56.20
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Executive Summary
As we mention previously PepsiCo is a world leader in convenient food and beverages, with revenues of about $29 billion in 2004. The company consists of the snack business of Frito-Lay North America, PepsiCo Beverage Int’l, PepsiCo Beverages
North America and Quaker Foods North America. PepsiCo (PEP) shares are traded on the NYSE in the United States. PepsiCo has implemented cash dividends since the corporation was founded. Besides NYSE, this company is also listed on the Amsterdam,
Chicago, Swiss, and Tokyo stock exchange ( www.pepsico.com
). We have found that the non-alcoholic beverage industry is dominated by three major players which are PepsiCo,
Coca-Cola and Cadbury Schweppes. There is tremendous competition within a relatively slowing industry. This industry is known for the rivalry between Pepsi and Coke over the years. PepsiCo currently controls nearly 21% of this industry. On the other hand Frito-
Lay controls 60% of the U.S snack-food market. Switching costs are virtually inexistent in this industry. Within the industry there are large economies of scale and it is hard for new entrants in this industry. PepsiCo has done a great job of building a great brand name, rivaling that of Coca-Cola. In PepsiCo’s industry there is a considerable threat of product substitution. PepsiCo has a low bargaining power of suppliers because like Coke they own their bottling companies. PepsiCo’s competitive strategy is also based on differentiation instead of cost leadership. This means that they have to highly invest in new flavors, formulas, and packaging to compete with their competition. PepsiCo has a flexible distribution network; products are brought to the market through vending distribution networks, direct store delivery, and broker-warehouse.
After extensive review of PepsiCo’ accounting practices we feel highly confident in their financial disclosures. We analyzed several aspects including: key accounting policies, accounting flexibility, accounting strategy, quality of disclosures, potential red flags, and screening ratios. While there were a few discrepancies, the importance of the errors weighted very little on our analysis. By targeting these aspects individually we were able to dissect and examine the underlying procedures of PepsiCo.
We determined that their key accounting policies and strategies are directly in line with industry practices. Also, in dealing with account flexibility we determined that there was some flexibility and changes in accounting procedures but these were in line with actions
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Executive Summary of regulation and industry standards. Quality of disclosures was adequate in regards to voluntarily giving information to investors. After review we determined that there were no main causes for alarm. While there were some activities that looked suspicious, after further investigation we determined them to be of minor consequences. Finally, screening ratios were used to determine if there were any potential manipulations.
Overall these ratios were fairly consistent over the years. Also, comparing PepsiCo to the industry further supported our decisions, in that they were consistent with that of competitor’s ratios.
We analyzed PepsiCo using the liquidity, profitability, and capital structure categories of ratios. By doing this analysis we founded that PepsiCo is relatively liquid, has a moderately favorable profitability and that capital structure has a moderately positive analysis. PepsiCo financial statements are reasonably transparent. They are reported on quarterly basis. These financial statements give their shareholders and investors good and clear inside information about PepsiCo. The forecasting that we did for PepsiCo financial statement showed a steady growth for the next 10 years. PepsiCo has an excellent growth potential for the years to come because Frito-Lay, Pepsi-Cola,
Quaker Oats, Gatorade, and Tropicana brands all have strong market position in North
America. Our forecasted financial statements are free of errors and we don’t assume that our forecast it is going to be accurate because as we know the longer the period of forecast the less accurate the forecast will be.
We valued PepsiCo based on six valuation models. These models include the following: Method of Comparables, Discounted Free Cash Flows, Discounted Dividends,
Discounted Residual Income, Abnormal Earning Growth and Long Run Average
Residual Income Perpetuity based on the P/B ratio. Valuation is the process of converting the forecast that we did for the company into an estimate of the value of the firm. To use this method we had to find the Kd, Ke and WACC of the company. We did this by considering the risk of the company and by calculating how much of the firm is financed with debt and equity. In all these models except the abnormal earning growth model, the actual price exceeds our estimated price. These models show that PepsiCo as slightly
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Business & Industry Analysis overvalued by an average of $3.51 per share. In most of these models the change of the growth rate was the most sensitive factor of change, besides the discounted residual income where the cost of equity was the sensitive factor of change. Even though there may be some errors in the models, we feel that PepsiCo stock price is slightly overvalued and we recommend investors to sell this stock.
PepsiCo was founded in 1919 in Delaware and was reincorporated in North
Carolina in 1986. Now this company is one of the world leaders in snacks, foods and beverages. ( www.pepsico.com
). PepsiCo produces and market different kind of salty, convenient, sweet and grain-based snacks, carbonated and non-carbonated beverages.
PepsiCo had revenue of about $29 billion in 2004, 27 billion in 2003 and over 200,000 employees. The company is organized in four divisions which consist of the Frito-Lay
North America, PepsiCo Beverage North America (Pepsi-Cola America and
Gatorade/Tropicana North America), PepsiCo International, and Quaker Foods North
America. The international division operates in around 200 countries. The largest of operations are held in United Kingdom and Mexico ( www.pepsico.com
). PepsiCo has emerged as a vast and diverse company, involved in beverages as well as snack foods.
PepsiCo’s division Frito-Lay holds a significant leadership in the snack industry even though is faced with different competition everyday. The company produces eight of the ten best selling snacks in the nation. Frito-Lay controls 60% of the U.S. salty snack-food market and has the number one position in corn chips, potato chips, tortilla chips and pretzels ( www.finance.yahoo.com
). The beverage industry is dominated by three major players which together control the global market. These players are Coca-Cola, PepsiCo, and Cadbury Schweppes (Dr Pepper and Seven Up). For years this industry is known for the war between Coke and Pepsi on the cola principals. Now this war has ended and the industry’s giants have been focusing in on creating new product flavors to compete with each other.
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Business & Industry Analysis
Competitive Force 1: Rivalry Among Existing Firms
Due to the fact that this industry’s growth has had relevantly little growth over the years, there is tremendous competition within the industry. This industry has low concentration. Three major firms account for 80% of the global market. These firms include PepsiCo, Coca-Cola, and Cadbury Schweppes. Coca-Cola has achieved 50% in global market share, while PepsiCo controls 21%, and Cadbury Schweppes maintains 7%
( www.finance.yahoo.com
). Competition amongst these firms is not mainly based on price competition but rather product differentiation. Many firms rely on new flavors and have also branched into non-carbonated beverages and snack foods to give there firm a competitive advantage over others. PepsiCo has also been exceeding in this by acquiring
Quaker Oats which owns Gatorade. PepsiCo has also added Tropicana, Aquafina, and
Lipton into its product line making PepsiCo number one in the non-carbonated beverage industry. Coca-Cola has also entered into this arena by emerging with Nestea, Powerade, and Minute Maid brands to compete in this movement. PepsiCo has also branched into the breakfast and snack food industry with Quaker Oats and Frito-Lay. While PepsiCo has remained at number two in soft drinks, this diversification has helped make up the difference in competition. Switching costs are virtually inexistent in this industry as there are no costs for consumers to switch products. The only costs to switching would be a different taste, appearance, and appeal. This is mainly due to the fact that firms have cooperated to maintain the same price for there products. Consumers are faced with a decision of choosing a product not based on price but rather on style, taste, and other contributing factors. Under these circumstances, companies have spent considerable energy to market there products to achieve brand awareness. There is also a tremendous learning curve for these companies, resulting in extreme barriers to entrance of other emerging companies. Most companies have developed extensive distribution systems and have created relationships with suppliers and buyers. Also there are extensive economies of scale resulting in companies with massive size. This has been created by obtaining extreme amounts of capital and diversifying the company into other markets.
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Business & Industry Analysis
In this type of industry there are relatively few exiting barriers which have left only a few companies to compete in.
Competitive Force 2: Threat of New Entrants
Within this industry there are large economies of scale. This results in an extreme amount of capital to propel the company. Using capital for manufacturing isn’t much of a concern as there are generic brands which cost less. Much capital is used to market and advertise there products to achieve brand awareness and differentiate there products from others. PepsiCo has done a tremendous job by creating a household name rivaling that of
Coca-Cola’s. Such common household names are Pepsi, Mountain Dew, Gatorade,
Tropicana, Lipton, and Quaker and Frito-Lay products. New companies trying to emerge into the industry have a distinct disadvantage due to the fact that the top companies have already developed such traits. This has caused new companies to not be able to compete head on with rivals. Also companies within the industry have developed extensive arrangements and relationships with manufactures and distributors. PepsiCo for example has Pepsi Bottling Group. This independent entity makes, sells, and distributes Pepsi brands around the world.
Competitive Force 3: Threat of Substitute Products
In PepsiCo’s industry there is a considerable threat of product substitution.
Products offering the same qualities and features at a lower price can initiate customers to substitute. In this day of age of health consciousness, new products have been developed to meet this trend. To meet this concern many of the companies offer healthier alternatives that ultimately cut into their other brands profits. Brands such as Pepsi One,
Diet Pepsi, and Coca-Cola’s C2, and Diet Coke have been developed to meet this concern head on. Another concern is that of generic brands such as grocery store brands. The relative concern is based on price. For example most grocery stores have their own brands of soda, juices, breakfast, and snack items. While the top companies have there
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Business & Industry Analysis own distinct image, these generic brands offer a similar taste but at a much lower price.
This industry’s main concern is if customers become price conscious and stray away from popular brands such as PepsiCo products. As long as consumers place value on these companies products there shouldn’t be that much of a concern.
Competitive Force 4: Bargaining Power of Buyers
PepsiCo is more sensitive to price due to the fact that there are low switching costs involved in producing their products. Because the total cost of manufacturing their product comes from packaging, PepsiCo is more apt to search for the lowest price of their raw materials being that are readily available and are a common material (i.e. plastics and aluminum). Being that PepsiCo is such a large producer enables them to hold a strong bargaining position. Since they buy so many raw materials they are able to get lower prices for them buying in such bulk. Also the number of readily available materials to
PepsiCo increases their bargaining power due to the fact if a specific supplier can not match a price or does not have the material available; it is not difficult to find it quickly and inexpensively. However these packaging and distribution expenses are taken by
Pepsi Bottling Group which is a separate entity of PepsiCo and became publicly traded in early 1999. Even though PBG is a separate company; PepsiCo owns 40% of PBG’s equity interest. ( www.msn.com
)
Competitive Force 5: Bargaining Power of Suppliers
There are many different suppliers in PepsiCo’s industry. These suppliers are the bottlers and metal can suppliers. PepsiCo is in a unique position in which it used to own Pepsi Bottling Group. In 1999, Pepsi Bottling Group became independent and in which PepsiCo retains 40% of its shares. Because of this suppliers of bottlers have a relatively low bargaining power relative to PepsiCo because they are a continued vested interest of PepsiCo. This makes PepsiCo able to have a distinct advantage over other competitors in production and distribution. Pepsi Bottling Group also provides other
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Business & Industry Analysis ingredients that are used in the food and beverage businesses, these include: almonds, cocoa, corn, flavorings, flour, juice, oranges, potatoes, and different kind of fruits.( www.pepsico.com
) This gives PepsiCo the chance to produce low cost products over competitors. PepsiCo also employs specialists to secure the best suppliers that are in the market for many of these items in order to produce quality products too.
The beverage and snack industry is very competitive. Their competitive strategy is based on differentiation instead of cost leadership. This means that the giants of the business like PepsiCo should explore new formulas, flavors and appearances to compete with each other. This is what PepsiCo is already doing by introducing two different lime flavor drinks by the end of this month. PepsiCo is known for producing a variety of salty, sweet and grain-based snacks, carbonated and non-carbonated beverages and foods. They invest many resources to produce superior products and in marketing for brand awareness. This is one of the reasons that PepsiCo has been one of the leaders in the beverage and snack industry.
Another competitive advantage that PepsiCo has is its non-carbonated beverage.
PepsiCo has lost the war against Coke for the carbonated beverages, but they are the leader in the non-carbonated beverages category. They have done this by adding
Gatorade’s 73% share of the sports drink market to its Tropicana and Lipton tea holdings.
( www.finance.yahoo.com
) This means that PepsiCo is not only focusing on competing with Coke on the carbonated beverages but they are looking to win battles in other competitive areas. This is going to make PepsiCo maintain a competitive advantage over a wider array of its competitors.
Another competitive advantage of PepsiCo is their flexibility of their distribution network. PepsiCo products are brought to the market through direct-store delivery, vending distribution networks and broker-warehouse. This distribution system is
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Business & Industry Analysis developed in a way to satisfy customer needs and to show product characteristic. By having a flexible distribution network PepsiCo is going to maintain their great reputation and their product are going to satisfy their customers.
The last competitive advantage that PepsiCo has is its capital. PepsiCo is number one in the snack industry, number two in the non-alcoholic industry and they have revenue of about $29 billion. This means that they have excess money to spend on advertising, quality of products and differentiation. PepsiCo by having such great capital provides advertising, sales and promotional support to their beverage and food customers. That’s why PepsiCo has some of the most-recognized advertising in the world. By having such extensive capital PepsiCo is making some research and development to find new flavors and to produce an even higher quality product. In conclusion PepsiCo believes that their capital, differentiation, flexibility of their distribution network and their non-carbonated beverage is going to allow them to compete efficiently.
Strengths:
One of the biggest strengths of PepsiCo is its Officers and Directors. They are a master of being honest, having analytical assessment and they have no shyness in terms doing what needs to be done. Minority Business News names PepsiCo Chairman and
CEO Steve Reinemund “Executive of the Year.” ( www.Forbes.com
). It is because of them that the PepsiCo is one of the best companies in the beverage and food industry.
Another strength of this company is their division Frito-Lay which has surpassed companies of all sizes through a combination of restructuring, new products, and lower prices. While Coke is synonymous with soda, so are Frito-Lay’s Fritos is with corn chips demonstrating its product-name association. Like James Stack an editor of InvesTech
Research says, “While the company trails Coca Cola on the soft-drink industry, in the snack foods, Frito-Lay which controls 60% of the U.S. salty snack-food market, has the number one position in corn chips, potato chips, tortilla chips and pretzels.” They are the
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Business & Industry Analysis best-run company in the food business. For the twelve months ended Sept, 4, 2004
PepsiCo earned $3.93 billion on sales of $16.49 billion. This shows that company is very profitable, has a good financial footing, and is continuing to grow.
While the soft drink segment is, as ever, PepsiCo is number 2, but is an extremely strong number 2. They control 21% of the soft-drink market. It is going to be hard to compete with Coke in the soft drink industry but PepsiCo is not just staying and accepting defeat. The company’s purchase of The Quaker Oats Company and its
Gatorade brand show that they are still highly competitive.
Weaknesses:
Pepsi maybe is one of the weaknesses of PepsiCo due that is really far from the leader Coca-Cola in the international market. Coke is three times Pepsi's size in fountain sales and has more than ten times as many salespeople as Pepsi. In the U.S., Pepsi's market share lags behind Coke's by the widest margin in over two decades. The net sales of PepsiCo had increase in the past years but it is important to notice that this increase is only because of sales in USA. Internationally, Pepsi's drink business was a mess. They still haven’t figured out a way to increase their sales in the international market. But lately they have improved internationally and especially after Coke have lost a lot of sales in Europe. But PepsiCo has showed difficulties in the past in the international market and they are trying very hard to improve these weaknesses. Another weakness is their historically late entrance into carbonated beverage industry. Coca-Cola entered the market in 1886 while Pepsi emerged in 1919 giving Coca-Cola a three decade head start.( www.pepsico.com
) Regardless of PepsiCo’s size, diversification, business acumen or bottom line, consumers still see the company as only Pepsi, a product. While Coke has fans (collector’s clubs, items, Christmas tree ornaments, etc.), Pepsi has purchasers.
Opportunities:
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Business & Industry Analysis
There are still some undeveloped markets in the world that PepsiCo should try to penetrate. They need to look for these markets and get established there before their competitors. PepsiCo traditional carbonated soft drinks and salty snacks continue to symbolize the company and it is going to do so for a long time. But you have to be risky to succeed in business and to beat your competition. PepsiCo is thinking about taking a risky strategy to make at least half of its new-product offering “nutritious” ( www.newnutrition.com
). We know that we live in a society where many people are worried about their nutrition. We hear about this topic through the media and we read it in magazines all the time. New good-for-you products from PepsiCo are going to include soon dairy products, more whole-grain items in its Frito-Lay line of salty snacks, products based on olive oil and a soy-enhanced Tropicana orange juice. This is going to be a great opportunity for PepsiCo to make healthier product and to expand its market.
The key for the beverage companies is differentiation. The giants of the industry have different formulas and appearances. PepsiCo for being one of these giants has the opportunity to make better formulas and appearances for their customers so they can beat their competition. PepsiCo is going to introduce a lime-flavored soda that is going to compete with a similar offering of their rival Coca-Cola. By using a better formula and appearance and a great advertising plan in these new drinks, they have the opportunity to beat Coca-Cola.
Threats:
The prices of the items that PepsiCo purchase are subject of fluctuation. For example the increase the prices of the raw materials or the fuel can cause an increase of the costs of the production of their product, and in the business environment that PepsiCo operates, it is not possible to increase the product price because they are part in a very competitive environment. In the marketing department the PepsiCo brand image is very much linked to Pepsi image, which has label of second best brand. This can still give them the label of ‘loser’, linking its image to the rest of firm’s company. This can give them a bad brand image in their markets. They need to improve in their marketing
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Accounting Analysis department through advertising campaigns where they are appeared together with other
PepsiCo Brands.
Conclusion:
PepsiCo has established itself as a very stable and profitable company in North
America and all over the world. As we mentioned above they are number two in the nonalcoholic beverage industry and number one in the snack industry by owning Frito-Lay.
PepsiCo, Inc operates four major businesses: Frito-Lay North America, 34% of the sales and 41% of operating profit; PepsiCo Beverages 29% of sales and 30% of operating profit; Quaker Food 5% of sales and 9% of operating profit; PepsiCo Int’l 32% of sales and 20% of operating profit. (Value Line) All these brands have a strong market position in North America and because of these PepsiCo has a growth potential for the years to come.
The next process of analyzing PepsiCo was to look at their accounting activities. The following sections contain both the qualitative and quantitative methods to evaluate the credibility of PepsiCo financial statements. The qualitative method consists of five steps: key accounting policies, potential accounting flexibility, strategy analysis, quality of disclosures, and potential “red flags.” Based on our analysis we did not undo any accounting distortions. After our evaluation of the financial statements and footnotes, we feel confident that PepsiCo’s accounting practices are not misleading or distorted. The quantitative method consists of evaluating ratios to see the reliability of
PepsiCo financial results
.
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Accounting Analysis
PepsiCo is a manufacturing company that must compete in research and development, product defect after the sale and product quality and innovation. PepsiCo key accounting policies are revenue recognition, brand and goodwill valuations, income tax expense and accruals, stock compensation expense, and pension and retiree medical plans. These policies require management to make difficult judgment about uncertainties and these results may significantly impact their financial results. PepsiCo needs to focus on these key accounting policies to maintain a competitive advantage over it competition.
One of the most important key accounting policy for PepsiCo is revenue recognition. They recognize revenue upon delivery to their customers in accordance with written sales agreements that do not allow for a right of return. PepsiCo wants to maintain a high reputation for its superior products. This is achieved by implementing a policy for direct-store delivery with chilled fresh products, to remove and replace damaged and out-of-date products. This ensures that their customers receive the highest of quality and freshness from their products.
Another key accounting policy for PepsiCo is brand and goodwill valuations.
Many of their brand names have been developed by PepsiCo management. They believe that a brand has an indefinite life if it has significant market share in a stable economic environment, and a strong revenue and cash flow performance. Brands that don’t meet these criteria are amortized over their expected useful lives. PepsiCo purchases brands and goodwill in acquisitions in which are not amortized. They are recorded annually to ensure that estimated future cash flows continue to exceed their relative book value. As of December 27, 2003 PepsiCo had $4.7 billion of perpetual brands and goodwill, of which nearly 75% related to Tropicana and Walkers.
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Accounting Analysis
Income Tax Expenses and Accruals is another key accounting policy for PepsiCo.
They determine their annual tax rate based on their income, tax planning opportunities, statutory tax rates, and significant judgment. Their annual tax rate was 28.5% in 2003.
The annual tax rate reflected in PepsiCo financial statements is different from that reported in their tax return. Also due to tax laws, timing differences that create deferred tax assets and liabilities must be shown.
Stock Compensation Expense is another key success factor for PepsiCo. PepsiCo believes that rewarding employees based on there performance will ensure a more productive workforce. At the end of 2003, PepsiCo board put in effect a new compensation program, which makes the link between pay and individual performance stronger. They achieved this by varying the amount of long-term compensation for each employee based on individual performance and responsibility. This new program provided employees with the choice of being granted stock options or restricted stock units (RSUs). This new program is expected to reduce the stock compensation expense for 2004 from $407 million in 2003 to $360 million.
The last key accounting policy for PepsiCo is pension and retiree medical plan expenses. Their pension plans cover employees in USA and certain international employees. They measure their annual pension and retiree medical expense based on many assumptions. These include: the interest rate used to determine the present value of liabilities, the expected return on plan assets, the rate of salary increases of plans where benefits are based on earnings. Also they use certain employee-related factors such as: turnover, retirement age, mortality, retiree medical benefits, and health care cost trend rate. In 2003 PepsiCo’s pension and retiree medical expense was $157 million and $116 million respectively. In 2004 they are estimated to be $245 million and $120 million.
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Accounting Analysis
Accounting Flexibility:
For PepsiCo there are a few recently adopted new accounting standards, but are not expected to have a material impact on the bottom line of the consolidated financial statements. This company has historically implemented accounting methods that make their financial statements to reflect the truest economic reality possible.
PepsiCo products are sold for cash or on credit terms. The credit terms require that the payments arrive within 30 days of delivery and awards discounts to customers for early payments. Revenue is recorded at the time of delivery to customers. PepsiCo management develops their own brand name and they also purchase brands through acquisitions. The brands developed costs are expensed as incurred, and the purchase price of brands is allocated under identifiable assets and liabilities based on estimated fair value. Any remaining purchase price is recorded as goodwill. If brands meet the criteria, they have an indefinite life. If a brand cannot live up to the set of standards, it is amortized over its expected useful life. Goodwill and perpetual brands are not amortized; they are assessed for impairment. A perpetual brand is impaired if its book value exceeds its fair value. On the other hand, goodwill is impaired if the book value of its reporting unit exceeds its fair value. If the fair value of an evaluated asset is less than its book value, the asset is written down to fair value based on its discounted future cash flow.
PepsiCo recently changed methods to account for employee stock options. Under the intrinsic value method, they did not recognize any stock compensation expense because they grant their stock options at the current stock price. So at the end of 2003,
PepsiCo changed their way of measuring employee stock options. They adopted the fair value method for accounting for stock options as described in SFAS 148, Accounting for
Stock-Based Compensation- Transition and Disclosure. Now the accounting procedure recognizes stock compensation expenses from the date of grant to the vesting date.
Under this method, the expected value that employees will receive from the options is
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Accounting Analysis going to be based on a number of assumptions like interest rate, employee exercises,
PepsiCo stock price, and dividend yield.
Pension and retiree medical plans are other areas that show flexibility. These plans are recorded as long-term liabilities for PepsiCo. The pension or retiree medical benefits that are expected to be paid are expenses that are based on estimates. These estimates include: factors such as the expected return on assets in their funded plans, the rate of salary increase for plans where benefits are based on earnings, how long a person will live after they retire, and on the interest rate used to determine the present value of liabilities. If these estimates are not done accurately, the company will have an overstated or understated net income.
Evaluating Accounting Strategy:
In order to assess if PepsiCo’s accounting strategies reflect true economic reality, we had to evaluate the accuracy of their accounting policies. By comparing PepsiCo’s policies with that of other firms in the industry, we were able to determine the differences in strategies that could mean potential distortions. After careful review we determined that PepsiCo’s implemented accounting policies are within the standards of the current industry.
PepsiCo’s accounting policies are very similar in many aspects to other industry competitors such as Coca-Cola and Cadbury Schweppes. One policy similarity is revenue recognition, in which all companies recognize revenue when product titles are transferred upon delivery. Also, the credit terms which require payment within 30 days of delivery, are created in accordance with industry practices. This credit term policy is a good business transaction that PepsiCo uses to collect money from their customers in a short period of time. Another important similarity is brand and goodwill valuations.
Interestingly, PepsiCo and Coca-Cola use the same three criteria for evaluating goodwill and other intangible assets. These include that assets with indefinite lives not be
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Accounting Analysis amortized, and that definite intangible assets are subject to amortization. They also implement the same procedures to test for impairments that may result from a change in future operations, economic downturns, or conditions present to indicate that carrying value may not be recoverable.
Pension and retiree medical plans are very similar to the industry as well. They each use estimations of the plan’s expected returns and risk characteristics. They adjust these estimations based on the interest rate used to calculate the present values of the plan liabilities, estimations of the maturity of the benefits, and increases in salary. Also, advertising, marketing, and research and development are crucial to this industry. Even though future value is created in these expenditures, all costs associated with these ventures are expensed appropriately. Finally, the last policy reflects the treatment for stock option via the fair value method. Coca-Cola, Cadbury Schweppes, and PepsiCo Inc all have established the fair value method to account for employee stock options.
PepsiCo policies and estimates have been mostly realistic, but the company did have a mistake in the earning release for the fourth quarter in 2003. They revised the
2002 and 2003 earning per share because of overstatements for stock option expenses.
This was something that does not normally occur in this company, but they explained that is was a computational error. The revision increased the previously reported earnings per share for 2003 by $0.04 to $2.05 and for 2002 by $0.02 to $1.68. This revision did not have any impact on the company’s previously reported cash flow or division operating profit because stock option expense is a non-cash charge. Even though such mistakes can easily happen, erroneous financial reporting can overstate or understate earnings.
The firm made some changes in it accounting policies during 2003. One of these changes was measuring employee stock options. Until 2003, they were using the intrinsic value to measure this expense. The method that they were using measured the stock compensation expense as the amount by which the market price of the stock on the date of grant exceeds the exercise price. By using this method, they were not recognizing any stock compensation expense because they granted their stock option at the current
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Accounting Analysis stock price. So by the end of 2003, they changed their method from intrinsic value to fair value method of accounting for stock options. Under this method, they measure the stock option expense at the date of the grant using the Black-Scholes valuation model. This model estimates the expected value that the employees will receive based on different assumptions such as interest rate, employee exercises, stock price and dividend yield.
The firm also restated their results using the fair value method. The impact of this change is going to be recorded as unallocated expenses in each of the years presented.
Refer to Table 1 to see how the restatements affected the firm.
Table 1
2003 2002 2001
407 435 385
293 313 262
Net Income per common share $0.16 $0.17 $0.14
Quality of Disclosure:
PepsiCo provides to its investors and analysts adequate disclosures to assess the firm’s business strategy. The quality of financial statements, accounting methods, and information disclosed provided by the firm gives a true picture about their business.
Reports have shown that carbonated soft drink growth has been slowing overall and that the brand name “PepsiCo” was declining during 2003. PepsiCo did not show adequate information to its investors to explain these declines. They wrote a brief paragraph in the Letter to the Shareholders to inform analysts and investors about this current information. The paragraph though did not give any explanation or any remedies
19

Accounting Analysis for this discouraging information. Instead, they disclosed information regarding the fact that the firm has been growing in the past and is expected to grow in the future. The letter talks about commitments to growth and in what sectors PepsiCo has achieved growth. They also give a good description of the firm’s industry condition, environment, and competitive positioning, but they did not disclose relevant information to their investors about “bad news.”
PepsiCo discloses economic factors that affect the company. For example, some of these factors include the exchange rate and political conflict. PepsiCo’s operations outside of the United States generated approximately 35% of their net revenue of which almost 20% comes from Mexico, United Kingdom, and Canada. The other 15% comes from the rest of the world. By operating worldwide, the company is exposed to foreign currency risks and political unrest. To prevent any losses and reduce the effect of the foreign exchange rate, PepsiCo enters into primarily forward contracts with terms of no more than two years. In 2002, PepsiCo hedged $2.1 billion Mexican pesos related to their net investment in Pepsi-Gemex which resulted in a $5 million gain upon the disposal of this investment.
PepsiCo does a job showing disaggregated performance information based on their business segments. In there footnotes they present each segments accounting information and address their strengths and weaknesses. Also, PepsiCo thoroughly explains the reason why performances in certain segments have increased or declined.
For example, in the Frito-Lay division managers give relative information regarding what products have performed good/bad and give adequate reasoning for both. In the footnotes, managers also adequately explain the key accounting policies and assumptions logically. For example when there are some significant changes in the firm’s policies the footnotes give a good explanation for the reason of these changes.
Potential Red Flags:
20

Accounting Analysis
Based on our accounting analysis that we performed, we did not find anything alarming for potential severe distortions in their accounting policies. We also felt very confident in their reported numbers. We looked into the firm’s financial statements to assess any unexplained changes in accounting policies. There has been a steady increase in accounts receivable and accounts payable that most likely has been caused by the steady increases in sales. There was also a large decrease in cash and cash equivalents, but this could have resulted from the increase in short-term investments. Also, they have been very consistent with valuing the amortization of there intangible assets. Although, there was one fourth-quarter adjustment during 2003, this was due to a computational error and was corrected immediately. There isn’t much cause of alarm since there hasn’t been a history of errors in the past five years for this company. Another item that might be concerning is the fact that PepsiCo has certain accounts on their financial statements missing. This hindered us from calculating certain screening ratios in the following section. Although this may be alarming, we still feel comfortable in PepsiCo’s accounting methods. After careful review, we also believe that these numbers are accurate and reflect the truest economic value possible.
Sales Manipulation
Net Sales/Cash from Sales
2004 2003 2002 2001 2000
1.12 1.11 1.1 1.11 1.07
Net Sales/Net Account Receivables
Net
9.53 9.92 11 10.5 14.7
Sales/Inventory
Net Sales/Unearned Revenue
Net Sales/ Warranty
Liabilities
19.1 18.7 18 18.7 27.9
NA NA NA NA NA
NA NA NA NA NA
Core Expense
Manipulation
Asset
CFFO/Operating
1.06 1.07 1.08 1.08 1.43
0.91 1.08 1.05 1.09 1.04
0.06 0.09 0.05 0.01 NA
CFFO/Net Operating Assets
Total Accruals/Change in Sales
Other Employment Exp/ SG&A
NA NA NA NA NA
NA NA NA NA NA
NA NA NA NA NA
21

Accounting Analysis
In order to account for any possible manipulations of PepsiCo’s information we calculated several screening ratios. The first three ratios test for sales manipulation with in their accounting practices. The first ratio, net sales/cash from sales, indicates a slight rise over the five-year period inferring that PepsiCo must be collecting less cash or is increasing its account receivable form sales. The second ratio, net sales/net accounts receivable, indicates a drastic drop in 2000 due to the fact that PepsiCo abandoned its bottling operations when Pepsi Bottling Group was formed. Since 2000, accounts receivable ratio has steadily decreased. This means accounts receivable has actually increased in size, corresponding to the first ratio (net sales/cash from sales). The last ratio, net sales/inventory, shows a slight decrease since 2000, which correlates with the formation of the Pepsi Bottling Group in 2000. Other ratios were also selected to evaluate PepsiCo’s accounting practices. These included net sales/ unearned revenues and net sales/ warranty liabilities. Though, due to lack of information in the financial statements these ratios could not be calculated. This may mean for a cause of alarm due to the fact that PepsiCo could have purposely done this. One thing though that elevates this concern is the fact that in PepsiCo’s sales agreements they do not allow for return which would negate the net sales/ warranty liabilities.
Another set of ratios were analyzed to assess core expense manipulations. The three ratios include: declining asset turnover, changes in cash flow from operations divided by operating income, and pension expense in relation to selling and general administration expenses. The declining asset turnover indicates a general level trend since the formation of Pepsi Bottling Group that explains that assets are being used the same relative to the sales generated. The next ratio is the change in cash flow from operations divided by operating income. Pass levels were above one but in 2004 it fell below; this indicates that PepsiCo’s accounts receivables are not being collected as
22

Accounting Analysis quickly as they have previously been. This correlates with the sales screening ratios as previously discussed. The last ratio is the pension expense in relation to the selling and general administration expenses. On average since 2001, this has been on an upward trend, although 2004 forecast are expected to decrease significantly. This is due to the
Medicare Prescription Drug Improvement and Modernization Act of 2003 (late
December 2003), which is forecasted to reduce pension liability by nearly $50 million.
As in the case of sales manipulation screening ratios, there were some ratios that could not be calculated do to lack of information in the financial statements. This could also mean a cause for alarm as well. One thing though is that PepsiCo actually might not have these kinds of expenses in their financial statements.
By also looking at these key screening ratios compared to other competitors gave a good description and benchmark of their accounting policies. By comparison of the same ratios listed above to Coca-Cola we found some consistency in the numbers. The reason for viewing only Coca-Cola was due to the fact that they are more highly correlated with PepsiCo. This could be in size, operations, sales, and other factors associated with their company.
Sales Manipulation 2004 2003 2002 2001 2000
3.85 3.85 4.13 4.89 5.7
10.12 10.06 9.33 10.67 11.64 Net Sales/Net Account Receivables
Net
Sales/Inventory
Core Expense
Manipulation
Declining Asset Turnover
CFFO/Operating Income
Pension Expense/SGA Expense
15.47 16.81 15.12 19.04 19.19
0.71 0.78 0.81 0.9 0.99
0.97 0.98 0.78 0.91 1.13
23

Accounting Analysis
First looking at net sales/ cash from sales indicates that PepsiCo is receiving more cash from their sales than Coca-Cola. Although these numbers are substantially different, on trend they seem very stable in comparison. Also net sales / net accounts receivable seems very consistent as well. The show that both companies have had tremendous decreases in their ratio’s over time. Another fairly good comparison is CFFO/ Operating
Income. By comparison both companies have very consistent ratios with both gradually decreasing over time. This indicates that operating income is beginning to increase relative to the cash flow from operations. By looking at these ratios across the industry both companies seem very consistent with their accounting numbers. This evidence further supports our claim that PepsiCo’s accounting methods are consistent with industry practices.
Conclusion and Discussion:
After extensive review of PepsiCo’ accounting practices we feel highly confident in their financial disclosures. We analyzed several aspects including: key accounting policies, accounting flexibility, accounting strategy, quality of disclosures, potential red flags, and screening ratios. While there were a few discrepancies, they were of minor concern. By targeting these aspects individually we were able to examine the underlying procedures of PepsiCo. We determined that their key accounting policies and strategies are directly in line with industry practices. Also, in dealing with account flexibility we determined that there was some flexibility and changes in accounting procedures but these were in line with actions of regulation and industry standards.
24

Financial Analysis & Forecast Financials
Quality of disclosures was adequate in regards to voluntarily giving and posting information to investors. After review we determined that there were no main causes for alarm. While there were some activities that looked suspicious, after further investigation we determined them to be of minor consequences. Finally, screening ratios were used to determine if there were any potential manipulations. Overall these ratios were fairly consistent over the years. Also, comparing PepsiCo to the industry further supported our decisions, in that they were consistent with that of competitor’s ratios.
In this next phase of evaluating PepsiCo, we have computed financial ratios to assess the performance of the company. We are going to forecast the financial statement of the company for the next 10 years. From the financial ratio analysis we are going to be able to benchmark against our competition in the non-alcoholic beverage industry as well as compute the industry average. This step is very crucial since it can be used to evaluate the company on an individual basis, or compare it against competitors. Another implication is that is can address the company’s performance compared to the industry as a whole. By establishing financial ratios we are able to get a more in depth look into the company’s profitability, liquidity, and capital structure. This type of analysis is very important to investors and shareholders because it going to show them more in depth the strengths and weaknesses of PepsiCo.
25

Financial Analysis & Forecast Financials
2004
2003 2002 2001 2000
Liquidity Ratios
Current Ratio
Quick Asset Ratio
Inventory Turnover
Days Supply of Inventory
1.28
0.95
9.76
37.41
1.08
0.75
8
45.6
1.06
0.72
7.84
46.55
1.17
0.76
7.51
48.61
1.17
0.8
7.87
46.39
Receivables Turnover
Sales Outstanding
Working Capital Turnover
Profitability Ratios
Gross profit margin
Operating Expense Ratio
Net Profit Margin
Asset Turnover
Return on Asset
7.97
45.77
15.51
53.68%
35.20%
14.40%
1.05
15.05%
9.53
38.3
52.37
53.56%
35.07%
13.23%
1.06
14.09%
9.92
36.79
69.56
53.67%
33.94%
13.19%
1.07
14.11%
12.57
29.03
31.5
59.46%
43.10%
9.88%
1.24
12.26%
11.36
32.13
30.55
60.46%
44.68%
10.68%
1.11
11.90%
Return on Equity 31.24% 30.15% 35.81% 30.76% 30.11%
Capital Structure Ratios
Debt to Equity Ratio
Times Interest Earned
1.07
31.56
1.14
28.93
1.53
26.33
1.51
18.41
1.53
14.48
Debt Service Margin 0.75
0.67
0.76
0.84
0.99
Liquidity:
In order to assess the liquidity of PepsiCo several ratios were determined and examined. Also by looking at the current year and past years we were able to get a clear
26

Financial Analysis & Forecast Financials picture of the changes PepsiCo has faced. After careful examination of these ratios we determined that PepsiCo is relatively liquid. We first examined the Current Ratio .
Overall PepsiCo had a favorable current ratio. This is shown by an increase from 1.17 in
2000 to 1.28 in 2004. This implies that current assets have grown more in relation to its current liabilities. Although this picture looks good overall, PepsiCo has hit some speed bumps along the way. This is shown in the decrease from 1.17 in 2001 to 1.06 in 2002.
This was the result of an increase in current liabilities by 21.1% with a relative minor increase in current assets of 9.6%. An alternative ratio that captures a firm’s liquidity is the Quick Ratio . This ratio analyzes the company’s ability to meet current obligations based on higher liquid assets. Overall, the quick ratio has improved over the past five years from .80 in 2000 to .95 in 2004. This indicates a favorable trend in which PepsiCo has utilized more liquid assets relative to current liabilities, indicating that they can now meet upcoming obligations quicker than in previous years. One factor constraining liquidity is the declining Receivable Turnover of the past five years. This number has decreased from 11.36 in 2000 to 7.97 in 2004. The reason of dramatic increase in 2001 of 12.57 was the result of the enormous increase in sales relative to the increase in accounts receivables. Looking forward from 2001 shows how the ratio has declined in other years, indicating that PepsiCo is collecting far less cash on sales than in previous years. As a result this also indicates that PepsiCo has had reduced capability of turnover in sales of credit. Seemingly, we were able to determine the Days Supply of Receivable ; which measures the performance of collecting receivables. Comparing past and present performance also entails discouraging news for PepsiCo since the number of days until accounts receivable are collected has steadily increased from 32.13 in 2000 to 45.77 in
2004. This can indicate that PepsiCo has had problems in credit terms and collecting cash from customers. Another ratio implemented was Inventory Turnover , which has increased slightly over the years. This number increased from 7.87 in 2000 to 9.76 in
2004 indicating that PepsiCo is more productive in using inventory. The major reason for the decrease in 2001 to 7.51 was attributable to the tremendous increase in inventory which increased an astonishing 44.75% from the previous years. This might have occurred because of a increase in the estimate of expected sales for 2001. Corresponding to inventory turnover is Days Supply of Inventory . This number has decreased rather
27

Financial Analysis & Forecast Financials steadily from 46.39 in 2000 to 37.41 in 2004, although there was an increase in 2001 of
48.61. This infers that PepsiCo has been able to manage inventories effectively and turnout more inventory relative to previous years. This could also imply a decrease in storage costs and an increase in production efficiency. The last ratio used was the
Working Capital Turnover . This number has nearly been very erratic over the years, implying volatile differences in working capital values compared to sales. This ratio determines how effectively working capital is being used in terms of the turnover it can help to generate. Currently there has been a negative impact on liquidity indicated by the decrease in values from 30.55 in 2000 to 15.51 in 2004. This significance can further be seen by the decrease from 69.56 in 2002 to 2004. This could hinder PepsiCo’s ability to meet upcoming obligations if further operating performance decreased other sources of liquidity.
Profitability:
By further assessing other ratios we were able to determine the performance of profitability for PepsiCo. After careful review, we concluded that PepsiCo also has a moderately favorable profitability analysis. Gross Profit Margin has decreased relatively over the years indicating that that cost of goods sold has increased over the years of which accounted for 42% of sales in 2004. This has a negative impact on the company since it costs more to produce their products given their output. One positive outcome is that PepsiCo is recovering a little, since the ratio is up from 53.56% in 2003 to 53.68% in
2004. Another positive affect has been the decrease in Operating Expense Ratio . This ratio has decreased form 44.68% in 2000 to 35.2% in 2004. While although operating expenses has increased slightly from 2003, the increase in sales have mitigated this negative affect on the company. The reason for the sharp decline in 2002 was due to the fact that operating expenses decreased while sales continued to increase. Changes in Net
Profit Margin have also lead to a positive impact on the company as well. Net profit margin has increased from 10.68% in 2000 to 14.4% in 2004, although there was a substantial decrease in 2001 of 9.88%. One discouraging aspect has been the descending trend of Asset Turnover , in which has decrease from 1.11 in 2000 to 1.05 in 2004. This
28

Financial Analysis & Forecast Financials indicates that PepsiCo has had trouble in utilizing their assets to generate sales in recent years. The reduction, maybe due to the fact in which PepsiCo has been investing in longterm assets such as plant, property, and equipment which takes longer to implement. The major increase in 2001 was the direct result of the large increase in sales relative to the increase in total assets. PepsiCo has also had a favorable steady increase in Return on
Assets which increases profitability. This is mainly achieved by the increase in the net profit margin relative to the decrease in asset turnover. Currently, return on assets has increased by 26.5% since 2000. Return on Equity has also slightly increased from
30.11% to 31.24% over five years with a slight deviation in 2002 of 35.81%. Overall, it seems that there has been a relatively slight improvement which increases the profitability of owner’s interest in total assets.
Capital Structure:
After further ratio analysis we concluded that PepsiCo’s capital structure has a moderately positive analysis. The change in Debt to Equity ratio has meant positive news for PepsiCo. There has been a relatively steady decrease from 1.53 to 1.07 over the five years, indicating that the company utilizes more equity financing compared to debt than in 2000. This a positive affect since financing business activities with debt can be more expensive and increase the liabilities of the firm. By implementing more equity, PepsiCo can fund activities cheaper within the firm. Times Interest Earned has also had positive growth. This is attributed to the substantial decrease in interest expense caused by the decrease in debt used for financing. This ratio has increased from 14.48 in 2000 to 31.56 in 2004. This indicates that PepsiCo has the ability to pay for current interest payments fairly easily. One negative aspect is that Debt Service Margin has decreased from .99 to
.75, representing an increase in payment of notes payable currently due compared to operating cash flows. This is somewhat disturbing news since this may raise some questions is whether PepsiCo can meet these obligations.
29

Financial Analysis & Forecast Financials
Liquidity
Current Ratio:
PepsiCo
Coca-
Cola
2000 1.17 0.71
2001 1.17 0.85
2002 1.06 1.00
2003 1.08 1.06
2004 1.25 1.05
Cadbury
Schweppes
0.62
0.78
0.76
0.75
0.81
Industry
Avg
0.66
0.81
0.88
0.91
0.93
Current Ratio
1.4
1.2
1
0.8
0.6
0.4
PepsiCo
Coca-Cola
Cadbury
Schw eppes
Industry Avg
0.2
0
2000 2001 2002 2003 2004
By comparing PepsiCo to the industry, viewers are able to see how this ratio increases the value of PepsiCo’s liquidity. In each year, PepsiCo has had a higher current ratio than any competitor in the industry, in which the values are dramatically higher than the industry averages. This indicates that PepsiCo has effectively been able to meet short-term obligations better than competitors.
30

Financial Analysis & Forecast Financials
Quick Asset Ratio:
PepsiCo
Coca-
Cola
2000 0.80 0.39
2001 0.76 0.45
2002 0.72 0.61
2003 0.75 0.71
2004 0.95 0.71
Quick Ratio
Cadbury
Schweppes
0.36
0.43
0.44
0.41
0.56
Industry
Avg
0.38
0.44
0.52
0.56
0.64
1.00
0.90
0.80
0.70
0.60
0.50
0.40
0.30
0.20
0.10
0.00
PepsiCo
Coca-Cola
Cadbury
Schw eppes
Industry Avg
2000 2001 2002 2003 2004
By also comparing the efficiency of companies to utilize higher liquid assets to meet current obligations helps asses PepsiCo’s liquidity. Throughout the entire five years
PepsiCo has had a quick ratio higher than competitors. It is easy to see that while these values are below one, PepsiCo values are dramatically higher than competitors. These values are also correspondingly higher than each year’s industry averages, in which case concludes that PepsiCo has higher liquidity in that it effectively manages higher liquid assets in order to meet current liabilities.
31

Financial Analysis & Forecast Financials
Accounts Receivable Turnover:
Pepsi
Coca-
Cola
2000 11.36 11.64
2001 12.57 10.68
2002 9.92 9.33
2003 9.53 10.06
2004 9.76 10.64
14.00
12.00
10.00
Cadbury
Schweppes
6.11
6.75
6.26
5.99
5.92
Accounts Receivable Turnover
8.00
6.00
4.00
2.00
0.00
2000 2001 2002 2003 2004
Pepsi
Coca-Cola
Cadbury
Schw eppes
Industry Avg
Industry
Avg
8.87
8.71
7.80
8.03
8.28
PepsiCo’s accounts receivable turnover has varied with some respect to the industry. This value was dramatically higher in 2001 indicating that PepsiCo had considerably less accounts receivables than competitors. This trend has changed in 2004, in which case this ratio has fallen below Coca-Cola’s but still above Cadbury Schweppes.
This concludes that Coca-Cola is currently gaining more cash from sales and is more effective in gaining cash customers faster. While PepsiCo has accounts receivable below
Coca-Cola, this number is still above the industry average. This comparison helps to indicate that PepsiCo’s current position isn’t a sign of a sever constraint on liquidity.
Another view supporting this is that PepsiCo’s accounts receivable turnover seems to be rebounding, as this ratio rose from 9.53 in 2003 to 9.76 in 2004.
32

Financial Analysis & Forecast Financials
Inventory Turnover:
Pepsi
Coca-
Cola
2000 7.87 5.09
2001 7.51 4.97
2002 7.84 4.87
2003 8.00 5.56
2004 7.97 5.57
Inventory Turnover
Cadbury
Schweppes
4.25
4.91
4.79
4.42
3.67
9.00
8.00
7.00
6.00
5.00
4.00
3.00
2.00
1.00
0.00
2000 2001 2002 2003 2004
Pepsi
Coca-Cola
Cadbury
Schw eppes
Industry Avg
Industry
Avg
4.67
4.94
4.83
4.99
4.62
PepsiCo has also been an industry leader in inventory turnover. For the past five years, PepsiCo has had values greatly exceeding that of competitors. This indicates that
PepsiCo is efficiently capable of moving and controlling inventories better than competitors. Due to this trait, this greatly increases PepsiCo’s position in liquidity compared to the industry.
33

Financial Analysis & Forecast Financials
Working Capital Turnover:
Pepsi
2000 30.55
2001 31.5
2002 69.56
2003 52.37
2004 15.51
Coca-
Cola
-7.57
-15.97
18.55
41.26
-2.77
Cadbury
Schweppes
-4.06
-10.28
-8.61
-8.42
-12.83
Industry
Avg
-5.82
-13.13
-8.61
16.42
-7.80
Working Capital Turnover
20
10
0
-10
-20
-30
80
70
60
50
40
30
2000 2001 2002 2003 2004
Pepsi
Coca-Cola
Cadbury
Schw eppes
Industry Avg
By comparing competitors within the industry enable viewers to see that the values for PepsiCo given the five years have been relatively stable. On average, PepsiCo has been relatively efficient in managing working capital compared to the industry. This helps alleviate the concern for the decrease in liquidity regarding PepsiCo current values since they are well above the competitors and industry average.
34

Financial Analysis & Forecast Financials
Profitability
Gross Profit Margin:
Pepsi
Coca-
Cola
2000 60.46% 69.67%
2001 59.46% 69.92%
2002 53.67% 63.68%
2003 53.56% 62.87%
2004 53.68% 64.69%
Gross Profit Margin
Cadbury
Schweppes
53.86%
52.93%
47.89%
48.63%
49.27%
80.00%
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
2000 2001 2002 2003 2004
Industry
Avg
61.77%
61.43%
55.79%
55.75%
56.98%
Pepsi
Coca-Cola
Cadbury
Schw eppes
Industry Avg
Compared to the industry, PepsiCo has had relatively poor performance in managing their gross profit margin. This implies some concern in the profitability of the company since PepsiCo’s values have always been less than the industry average. Coca-
Cola clearly is able to gain more profit on sales relative to other competitors. This raises some concerns to the extent of PepsiCo’s ability to manage the costs of production.
While PepsiCo’s numbers have increased in 2004, this is still currently less than the industry average.
35

Financial Analysis & Forecast Financials
Operating Expense Ratio:
Pepsi
Coca-
Cola
2000 44.68% 44.58%
2001 43.10% 42.85%
2002 33.94% 41.23%
2003 35.07% 35.64%
2004 35.20% 39.83%
Cadbury
Schweppes
36.89%
37.54%
30.21%
34.23%
37.18%
Operating Expense Ratio
50.00%
45.00%
40.00%
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
2000 2001 2002 2003 2004
Industry
Avg
40.74%
40.20%
35.72%
34.94%
38.51%
Pepsi
Coca-Cola
Cadbury
Schw eppes
Industry Avg
Alone, PepsiCo has had positive improvement in controlling operating expenses.
But by comparing these ratios with other competitor provides a different picture. By looking at the whole industry PepsiCo dominates Coca-Cola and Cadbury Schweppes in operating an efficiently run business. This evidence greatly increases PepsiCo’s profitability compared to competitors of the industry.
36

Financial Analysis & Forecast Financials
Net Profit Margin:
Pepsi
Coca-
Cola
2000 10.68% 10.64%
2001 9.88% 19.80%
2002 13.19% 17.47%
2003 13.23% 20.66%
2004 14.39% 20.88%
Net Profit Margin
25.00%
Cadbury
Schweppes
10.84%
9.82%
10.34%
5.68%
6.40%
20.00%
15.00%
10.00%
Pepsi
Coca-Cola
Cadbury Schweppes
Indust ry Avg
5.00%
0.00%
2000 2001 2002 2003 2004
Industry
Avg
10.74%
14.81%
13.91%
13.17%
13.64%
PepsiCo’s net profit margin has change a lot over the five years period, although they have had some moderate improvement into 2004. This improvement enabled
PepsiCo to be above the industry average, indicating that they are able to retain a moderate percentage of sales. Compared to the industry, PepsiCo is lagging behind
Coca-Cola by 6.5%. This indicates that Coca-Cola is far more profitable in the sense of sales. Although of its current position, PepsiCo is in every sense profitable in the industry.
37

Financial Analysis & Forecast Financials
Asset Turnover:
Pepsi
Coca-
Cola
2000 1.11 0.99
2001 1.24 0.91
2002 1.07 0.81
2003 1.06 0.78
2004 1.05 0.76
Asset Turnover
1.40
Cadbury
Schweppes
0.71
0.77
0.69
0.63
0.68
1.20
1.00
0.80
0.60
0.40
Pepsi
Coca-Cola
Cadbury
Schw eppes
Industry Avg
0.20
0.00
2000 2001 2002 2003 2004
Industry
Avg
0.85
0.84
0.75
0.71
0.72
By industry standards, PepsiCo is very effective in producing a high volume of sales in relation to its size of assets. PepsiCo is the leading company in this respect, provided that they have outperformed the industry every year. Although their current number has declined, this information alleviates some of the concerns of their ability to mange their assets.
38

Financial Analysis & Forecast Financials
Return on Assets:
Pepsi
Coca-
Cola
2000 11.90% 10.58%
2001 12.26% 18.08%
2002 14.11% 14.15%
2003 14.09% 16.16%
2004 15.05% 15.82%
Return on Assets
Cadbury
Schweppes
7.68%
7.54%
7.17%
3.59%
4.34%
20.00%
18.00%
16.00%
14.00%
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
2000 2001 2002 2003 2004
Industry
Avg
9.13%
12.81%
10.66%
9.88%
10.08%
Pepsi
Coca-Cola
Cadbury
Schw eppes
Industry Avg
By comparison, PepsiCo’s return on assets has increased steadily throughout the five years. PepsiCo for the most part has exceeded the industry average and is currently slightly below Coca-Cola. Cadbury Schweppes has dramatically lagged the industry in respect to this ratio. This is a good indication that PepsiCo is highly profitable in regard to the industry.
39

Financial Analysis & Forecast Financials
Return on Equity:
Pepsi
Coca-
Cola
2000 30.11% 23.37%
2001 30.76% 35.01%
2002 35.81% 28.96%
2003 30.15% 30.85%
2004 31.24% 31.16%
Cadbury
Schweppes
17.87%
18.40%
17.90%
12.28%
15.43%
Industry
Avg
20.62%
26.71%
23.43%
21.57%
23.30%
40.00%
35.00%
30.00%
25.00%
Return on Equity
Pepsi
Coca-Cola
20.00%
15.00%
Cadbury
Schw eppes
Industry Avg
10.00%
5.00%
0.00%
2000 2001 2002 2003 2004
PepsiCo has had some deviations in their return on equity over the years, mainly in 2002. This is quite normal considering the changes in values of other competitors.
PepsiCo currently has the same return as Coca-Cola indicating that these two firms are very profitable in terms of owner’s interests in assets. This further provides evidence that
PepsiCo is highly profitable in the current industry.
40

Financial Analysis & Forecast Financials
Capital Structure
Debt to Equity Ratio:
Pepsi
Coca-
Cola
2000 1.53 1.21
2001 1.51 0.94
2002 1.53 1.05
2003 1.14 0.91
2004 1.07 0.97
Debt to Equity Ratio
Cadbury
Schweppes
1.49
1.61
1.64
2.64
2.47
3.00
2.50
2.00
1.50
1.00
0.50
Industry
Avg
1.35
1.28
1.35
1.78
1.72
Pepsi
Coca-Cola
Cadbury
Schw eppes
Industry Avg
0.00
2000 2001 2002 2003 2004
PepsiCo is currently slightly below Coca-Cola. Coca-Cola on average has had a ratio less than the industry. This shows that PepsiCo has made substantial improvement in reducing the amount of debt used to finance business activities. These improvements seem to have a decreasing trend indicating further reduction may occur.
41

Financial Analysis & Forecast Financials
Times Interest Earned:
Pepsi
Coca-
Cola
2000 14.14 11.49
2001 19.86 18.52
2002 27.37 27.43
2003 29.86 32.19
2004 31.56 32.85
Cadbury
Schweppes
5.67
5.75
6.78
3.39
4.10
Tim es Interest Earned
35.00
30.00
25.00
20.00
15.00
Industry
Avg
8.58
12.14
17.11
17.79
18.48
Pepsi
Coca-Cola
10.00
5.00
0.00
2000 2001 2002 2003 2004
Cadbury
Schw eppes
Industry Avg
This trend indicates that PepsiCo and Coca-Cola can pay interest payments on current and long-term liabilities rather easily. Cadbury Schweppes on the other hand seems to struggle in meeting these current obligations. While Coca-Cola is in reality better to meet these interest charges, PepsiCo still adequately provides income from operations to cover these expenses. Given this environment there is a dramatic difference between the top and low performing firms.
42

Financial Analysis & Forecast Financials
Debt Service Margin:
Pepsi
Coca-
Cola
2000 (0.99) (0.74)
2001 (0.84) (1.05)
2002 (0.76) (1.79)
2003 (0.67) (1.88)
2004 (0.75) (2.77)
0.00
(0.50)
Cadbury
Schweppes
(0.56)
(1.25)
(1.03)
(0.67)
(0.26)
Debt Service Margin
2000 2001 2002 2003 2004
(1.00)
(1.50)
(2.00)
(2.50)
(3.00)
Industry
Avg
(0.65)
(1.15)
(1.41)
(1.28)
(1.52)
Pepsi
Coca-Cola
Cadbury
Schw eppes
Industry Avg
Given this picture, Coca-Cola is clearly more efficient in providing cash from operations to cover current notes payables. As shown in the previous section, PepsiCo has negative performance in this ratio. This is further supported by the fact that PepsiCo has remained below the industry average throughout most of the five years. This is clearly adds a negative position in its capital structure.
43

Financial Analysis & Forecast Financials
Level Two Ratios for PepsiCo
2004 2003 2002 2001 2000
Dividend Payout 0.3155
0.2999
0.3143
0.3737
0.3646
ROE 0.3124
0.3015
0.3581
0.3076
0.3011
SGR 21.38% 21.11% 24.55% 19.26% 19.13%
PepsiCo’s Dividend Payout Ratio decreased from 2001 to 2002 from 0.37 to 0.31 and also from 2002 to 2003 from 0.31 to 0.29. This is not a big decrease for PepsiCo but it still has a negative impact on the company because it shows that PepsiCo hasn’t had stable earnings because they are not paying a high portion of earning as dividends. But from 2000 to 2001 and from 2003 to 2004 the dividend payout ratio has increased from
0.36 to 0.37 and 0.29 to 0.31. This increase shows that PepsiCo has had stable earning during these years and are more likely to pay a big portion of their earnings as dividend to their shareholders. PepsiCo has already been able established themselves as a stable and profitable company throughout the world.
PepsiCo’s Sustainable Growth Rate has been increased from 2000 to 2001 from
19.13 to 19.26, also 2001 to 2002 from 19.26 to 24.55, and from 2003 to 2004 from 21.11 to 21.38. The growth of this rate shows that PepsiCo has been affected by the firms’ ability to improve it ROE. PepsiCo sustainable growth rate also declined only from
2002 to 2003 from 24.55 to 21.11. This probably occurred because of the decline of dividend payout ratio.
44

Financial Analysis & Forecast Financials
Common Size
Income
Statement for
PepsiCo
Sales
Cost of Goods
Sold
2004 2003 2002 2001 2000
100.00% 100.00% 100.00% 100.00% 100.00%
42.00% 41.91% 41.90% 36.52% 34.84%
Amortization
Gross Income
4.32% 4.53% 4.43% 4.02% 4.70%
53.68% 53.56% 53.67% 59.46% 60.46%
Selling & Admin
Expenses 35.20% 35.07% 33.94% 43.10% 44.68%
Income from
Operation 18.49% 18.49% 19.73% 16.37% 15.78%
Interest Expense 0.58% 0.62% 0.72% 0.82% 1.12%
Pretax Income 17.65% 17.31% 18.27% 14.36% 15.07%
Income Taxes
Net Income
4.69%
14.39%
5.28%
13.23%
6.19%
13.19%
5.08% 5.02%
9.88% 10.68%
45

Financial Analysis & Forecast Financials
PepsiCo’s fiscal year ends on Dec 31. This company just released to the public their latest financial statements for 2004. In terms of forecasting PepsiCo’s financial statements for the next 10 years (Balance Sheet, Income Statement and Statement of Cash
Flow) we used all the financial statements for the past 5 years (Refer to Exhibit A, B and C). PepsiCo is number two company in the non-alcoholic beverages, currently behind Coca-Cola, while they are number one in the snack industry due to Frito Lay.
After careful analysis of this company we have concluded that PepsiCo is not affected by seasonality. Because of this we decided to uses the moving weighted average to forecast
PepsiCo’s financial statements for the next 10 years ( Refer to Exhibit AA, BB and CC ).
We did this by computing the percentage increase or decrease for each line item from 2000 to 2004. After getting this percentage we computed the average of these four numbers to get an expected future change. We then multiplied this number with the 2004 financial statements line to get the forecasted information for 2005. To find 2006, we just did the same thing, but we didn’t include the percentage increase or decrease from 2000 to 2001 and we included the percentage increase or decrease from 2004 to 2005. We used the same approach for most of the lines on the Balance Sheet, Income Statement and
Statement of Cash Flow to arrive to the forecasted numbers for each year till the year
2014. For example when we forecasted Total Sales we first found the increase or decrease from year 2000 to 2001, 2001 to 2002, 2002 to 2003 and 2003 to 2004 which were 31.7%, -6.8%, 7.4% and 8.4% respectively. Then we find the average which was
10.1% and we multiplied this number with the total sales of 2004 to find the forecasted number for 2005 which was $32,238 (in millions) So we did the same thing to forecast
2006 but this time we didn’t take the average of the increase from year 2000 to 2001 but instead we substitute it with the increase from year 2004 to 2005 that we forecasted. And we multiplied this new average with the forecasted total sale of 2005 to find 2006. We didn’t use the weighted moving average to calculate the income taxes rate for PepsiCo.
We took the average of the four income tax rate that we founded to be 3% and we multiplied each year till 2014 with 1.03 to obtain the forecasted income taxes. There was
46

Financial Analysis & Forecast Financials another line that we didn’t use the moving weighted average because of the percentage increase or decrease during the years. One of these lines was Cash Flow from Investing
Activities. In this line we saw a big decrease from 2001 to 2002 from 2,367 million to
527 million and increase from 2002 to 2003 from 527 million to 2,271 million. This happened because PepsiCo during 2002 didn’t have any big investment and the increase in the investment line in the financial statement was very small during this year. This big decrease and increase would have caused our future Cash Flow from Investing Activities not be forecasted in a smooth way. So the forecast for this line was not going to have a normal growth in the next 10 years. Instead to forecast this number we just measured the percentage increase from 2003 to 2004 and we calculated a growth of 8%. After that we multiplied this line with 1.08 to find the Cash Flow from Investing Activities for the next
10 years.
Based on our forecast we conclude that PepsiCo is going to have a steady growth during the next 10 years. The firm has the potential for growth in the next years and history has shown this trait. PepsiCo used to own Pizza Hut and Taco Bell but they didn’t realize any profit on their acquisition, so they decided to sell them. This has been shown as a good decision for the company for the future. But at the same time, they have made some good decision by acquiring good company like Gatorade and Frito Lay that have good profits and sales. So our forecasted financial statements are free of errors and we don’t assume that our forecast it is going to be accurate. The longer the period of the forecast the less accurate the forecast will be and the past economic practices have shown this. PepsiCo can buy other bad companies like Pizza Hut and Taco Bell and this is going to decrease their reputation and decrease their net income. Maybe during the next
10 years they can win the war against Coke and increase their global reputation. Another reason that PepsiCo will not perform as forecasted is if there is the change of economic fluctuations. For example the decrease of the economy or the decrease of the value of the dollar may turn the growth of sales the other way around. Competition is another reason that PepsiCo might not perform as forecasted. During the next 10 years other companies can surge and gain more market share in the non-alcoholic beverage. This is going to decrease the market share for PepsiCo and decrease their sales and reputation as well.
47

Valuation Analysis
The valuation process is of importance since this is integrated into every aspect of the economy. The financial market is highly dependent on such valuations since this represents much of the underlining activities. Investment companies use such tactics to value other firms; Insurance companies utilize such information to make sure they have enough money to cover certain events. Also this information is important to retirement programs, since companies want to make sure that they can cover current pension benefit obligations. Finally, this is important for such things as IPO’s, firm takeovers, and investment decisions.
The purpose of this section is to value PepsiCo Inc. We achieved this by considering risk and by calculating how much of the firm is financed with debt and equity. Valuation is the process of converting the forecast for a company into an estimate of the value of the firm or some component of the firm. We used six different models to value PepsiCo, which include the following: method of comparables, discounted free cash flows, discounted dividends, discounted residual income, abnormal earning growth, and long run average residual income perpetuity based on the P/B ratio. All of these models helped us to find if the share price of PepsiCo is overvalued, undervalued, or reasonably valued.
This section is going to value PepsiCo by using the average multiple of competitors in the industry. The ratios used are price to book, price to earnings, dividend to price, price to sales, and price earning growth (PEG). These multiple models were the simplest to implement since forecasted numbers are not necessary in the calculations.
48

Valuation Analysis
PepsiCo currently has two direct competitors in the industry, which are Coca-Cola and
Cadbury Schweppes. Due to the fact that PepsiCo only has two main competitors, we found that it would be unnecessary to trim down the averages calculated below. Also, since these three competitors represent the majority of the industry, we felt it necessary to use both in our calculations. From our calculations we found that the price-earning multiple and the PEG multiple were the best estimation the PepsiCo’s price since they were both at $48.92 and $50.80 respectively compared to the actual stock price of
$52.76. The trailing P/E ratio yielded a higher price, which is based of the current published P/E ratios. We decided to focus on the forecasted ratio since this section focuses on forecasted numbers. The market to book value indicated a smaller price at
$37.07. Cadbury Schweppes could have been considered an outlier, but do to the relatively small sample of competitors and the fact that the average just would have been
Coca-Cola’s number; we utilized their value as well. If we did trim off Cadbury
Schweppes, the estimated price would have been much in line of the actual price at
$52.73. The dividend yield also revealed a lower price at $39.72. This may have been due to the fact that PepsiCo doesn’t declare dividends as much as competitors, as well as support PepsiCo’s higher growth. This would seemingly indicate why it would have a lower value. The price to sales multiple indicated a higher price relative to the actual price. This is due to the fact that Coca-Cola pays out more than any other company having a direct affect on the average, which would achieve this higher price of $57.38. In actuality, PepsiCo has a lower price to sales ratio, which would indicate that it pays out less then the industry average. This would conclude a much higher price than actually would occur. The reason for not trimming Cadbury Schweppes in the model was the fact that only including Coca-Cola would result in even a higher estimated price. (See
EXHIBIT 4)
Although these models are simple to implement and calculate, they are only estimates based on the industry averages. Some discrepancies can and have occurred in the estimation of our prices. Our sample size was relatively small, only having three main competitors. Trimming the competitors would have a negative affect on these averages, only representing one company. Based on whether this company was above or below the industry norm would have a negative effect on our calculations. Also since
49

Valuation Analysis outliers were not eliminated, true representation of the averages could have been affected as well as in the case of the P/S and P/B averages, in which case Cadbury Schweppes could have been possible outliers.
EXHIBIT 4
Method of Comparables
2005
PepsiCo
Coca-Cola
Cadbury S
EPS
2.55
2.05
2.20
BPS
8.15
6.40
15.20
DPS
0.98
1.08
0.93
PPS
52.76
41.38
40.00
SPS
18.90
9.40
23.95
P/E Ratio (PPS/EPS)
PepsiCo 20.69
Coca-Cola
Cadbury S
20.19
18.18
Avg
Price
19.18
48.92
P/B Ratio (PPS/BPS)
PepsiCo 6.47
Coca-Cola 6.47
Cadbury S
Avg
Price
2.63
4.55
37.07
Dividend Yield (DPS/PPS)
PepsiCo 0.02
Coca-Cola
Cadbury S
0.03
0.02
Avg
Price
0.025
39.72
P/S Ratio (PPS/SPS)
PepsiCo 2.79
Coca-Cola
Cadbury S
Avg
4.40
1.67
3.04
Price 57.38
PEG Ratio
PepsiCo
Coca-Cola
Cadbury S
Avg
Price
1.88
2.17
2.20
2.19
50.80
(Not Included in Average)
(Not Included in Average)
(Not Included in Average)
(Not Included in Average)
(Not Included in Average)
50

Valuation Analysis
The first intrinsic valuation model used to value PepsiCo was the discounted free cash flow model. To use this model we need to calculate the weighted average cost of capital (WACC) in which our cost of equity (Ke) and cost of debt (Kd) will be found.
We derived the cost of capital (Ke) by using historical data over the past 60 months of the return on the market (Rm) of the S&P 500, and the risk-free rate (Rf) of the T-Bill returns for 5 years. To find the beta for our company we used the regression analysis using the percentage return of the firm (Y-variable) and the market spread (X-variable) data from the past 61 months (April 1 2000 – April 1 2005). With this analysis we found an estimated beta for the company equaling 0.32. (See Exhibit 1). We believe that this beta is low comparing it with the published beta of 0.65 (Value Line). We also founded the estimated beta for the past 2 and 3 years, which were 0.48 and 0.76 respectively.
We calculated the CAPM (Ke) by using the estimated beta for 5 years, 3 years, 2 years and the published beta. The CAPM (Ke) equaled 2.57%, 5.65%, 3.69% and 4.88% respectively. We believe that the Ke of 4.88% found using the published beta represent
PepsiCo better that any other beta. Formulating the WACC was the next valuation step.
To find the WACC we first had to find the (Kd). We calculated (Kd) by using the balance sheet notes for 2004 to find the Weighted Average Cost of Debt. (See Exhibit 2).
We then found the value of equity of the firm by multiplying the firms PPS with the share outstanding. Also, we then found the value of the debt of the firm by finding the sum of the current maturity of long debt with the long-term debt. (See Exhibit 3).
By implementing these numbers, the value of equity equals to
$52.76*1,687,000,000 shares outstanding =$89,006,120,000 and the value of debt is equal to $2,397,000,000 + $1,054,000,000 = $3,451,000,000. The value of the firm is equal to the value of debt (Vd) + value of equity (Ve). By plugging into the equation the value of firm (Vf) is equal to $92,457,120,000. Now we have the entire components to
51

Valuation Analysis find WACC. We found the firm’s tax rate by finding the average of the firm’s tax rate for the previous five years. The average calculated tax rate was 31.66%. (See Exhibit 3).
To find the WACC we did the following calculation:
WACC=(3451000000/92457120000)*(0.0398)*(1- .166) +
(89006120000/92457120000)*(0.0488).
We calculated a WACC of 4.8%.
Using the WACC calculated above, we performed the discounted free cash flow.
Next, we used and implied a growth rate of 2% after 2014 for the Free Cash Flow to the
Firm. Our analysis found an estimated price of $47.90. Comparing the estimated price with the actual price of $52.76 we think that PepsiCo is slightly overvalued. This is reasonable to infer since the actual price is bigger than that of our estimated price. We also performed a sensitivity analysis for this model. During this analysis we founded a high amount of sensitivity. For example if the firm had no growth after 2014 in the free cash flow to the firm the estimated price was going to be $30.85; but if we had a higher growth of 0.04 the estimated price was going to be $150.21. This is a very high price because the difference between WACC and growth is very small. This number is probably very unrealistic. The sensitivity analysis shows that a change in WACC without a corresponding change in growth and vice versa will change the estimated price greatly compared to the actual price. (See Exhibit 5).
WACC
0 g
0.01
0.02
0.02 $81.45 $154.56 N/A N/A
0.04
0.03 $52.46 $74.78 $141.75 N/A
0.048 $30.85 $37.13
$47.90 $150.21
0.06 $23.71 $27.15 $32.32 $58.18
52

Valuation Analysis
The other valuation model that we used was the Discounted Dividend Model.
(See Exhibit 6). The discounted dividend model was performed using a new (Ke) that we found from the discounted free cash flow model by using the WACC formula. This new Ke that we found was equal to 4.84%. To forecast the dividend per share for the next 10 years we used the moving weighted average like of that in our forecast. We assumed that after 2014 dividend per share would be $2.23 with no growth. This model gave us a price of $43.18. Comparing this price with the actual price $52.76 we still think that PepsiCo is still overvalued.
The discounted dividend model has the highest sensitivity to change compared with the other models. In the sensitivity analysis we used the new Ke and the (Ke) that we found for the estimated beta for 5 and 3 years. For example if we had a growth of 2% after 2014 the estimated price was going to be $65.53. On the other hand if we used the
(Ke)=0.0257 that we found by using the estimated beta for 5 years with no growth and with 0.01 growth after 2014 the estimated price was going to be $70.79 and $108.71 respectively. This shows a very big change and unrealistic prices for PepsiCo. The primary reason for these high prices is because our firm has a low (Ke). Also, we see in the sensitivity analysis that if we have a high (Ke) like 0.056 with no growth or a growth of 2% the prices are going to be $38.91 and $54.02 respectively. Since this model has the highest sensitivity to change compared to other models we believe that the estimated price of $43.18 doesn’t represent the fundamental value of PepsiCo stock price in April 1,
2005.
53

Valuation Analysis
Ke 0.02
0.0257
0.0484
0.056
0.07
g
0 0.01
0.02
0.05
$87.86
$164.01 N/A N/A
$70.79
$108.71
$278.90 N/A
$43.18
$51.37
$65.53 N/A
$38.91
$44.82
$54.02
$265.54
$33.47
$37.09
$42.17
$87.86
The next model that we used to value PepsiCo was the Discounted Residual
Income Model. In the discounted residual income model, we analyzed a stream of residual incomes from the next 10 years, including a terminal value, and we then discounted all the numbers back to the present time. (See Exhibit 7). To find the book value for the next 10 years we used the same method that we used in our forecast. We used the moving weighted average. We begin this model by finding the ending book value of equity which we found by adding the book value of equity with the earning per share, and then subtracting the dividends per share. Then, we found the Normal Income by multiplying (Ke) with the beginning book value of equity from the previous years.
The difference between earnings per share and normal income is the residual income.
After that we calculate perpetuity of the continuing terminal value based on a growth that is going to be variable in the sensitivity analysis. We assumed that after 2014 Residual
Income would be 1.91 with no growth. The residual income is then discounted back to the present time. To find the estimated value per share we add the book value equity for
54

Valuation Analysis
2005, with the present value of residual income in 2005, and also with the present value of terminal value in 2005. By using a (Ke) of 4.84% and assuming no growth after 2014, this model gives us a price of $51.80 which is very close to the actual price of $52.76.
But by comparing the actual price with the estimated price we see that the firm is overvalued slightly.
The discounted residual income model has a moderate sensitivity to changes in cost of equity and growth. We can see this in the sensitivity analysis of this model. For example is we have a growth after 2014 of 1% the estimated price is going to be $58.85, but if we increase the (Ke) and use the one that we calculated by our estimated beta for 3 years we and still 1% growth, the price of the stock is going to be $48.92. From the sensitivity analysis we learned that the estimated price per share is much more sensitively to changes in cost of equity than to changes in the growth rate. For example if we use the cost of equity( Ke) 2.57% that we found by using the beta estimated for 5 years with no growth, we have an estimated price per share of $100. If we compare this number with the estimated price per share that we found using (Ke) of 4.84% with no growth that is
$51.80 we see a big difference. This is a very high number because the cost of equity is very low.
g
Ke 0.02 $230.53 N/A N/A
0.0257
$100.00 $146.01 $353.42 N/A
0.0484 $51.80 $58.85 $70.79 N/A
0.056 $44.45 $48.92 $55.88 $215.86
0.07 $35.07 $37.23 $40.24 $67.37
55

Valuation Analysis
This model is based off the estimations in the Residual Income model addressed in the previous section. By allowing PepsiCo to grow over an infinite life, we can solve for values based off of the perpetuity. This model can also compare different results of prices by implementing different cost of equities and growth rates into the equation.
(a) Exhibit 9
(b) P= BE + BE[ROE-Ke]/[Ke-G]
g
0 0.01
BE 8.15
Ke
0.02
0.0257
$127.30
$99.07
$246.46 N/A
$156.98
N/A
$418.08 N/A
ROE 0.3124 0.0484
0.056
0.07
$52.60
$45.47
$36.37
$64.18
$53.58
$41.08
$83.91 N/A
$66.20
$47.66
$356.43
$106.93
56

Valuation Analysis
The current book value of equity for PepsiCo is 8.15, which is much smaller than
Cadbury’s 15.20 and slightly larger than Coca-Cola’s of 6.40. We also found PepsiCo’s
ROE of .3124 from the forecasting section. Given different scenarios of Ke and growth, we were able to derive different prices based on the information. In the Residual Income section we discovered that a cost of equity of 4.84 achieved a price of $51.80, which was slightly less than the actual current price. Consistent with this valuation, the price of the perpetuity at a growth rate of zero and a Ke of 4.84 was considerably close as well at
$52.60. Also examining the Ke of 2.57, which was calculated using the estimated beta and risk free interest rate, yield a much higher price of $127.30. This would infer that the
PepsiCo is undervalued by 74 dollars. This result could have been the result of the estimated beta previously described. By assuming growth in this equation, it revealed that a cost of equity of 5.6 and a growth of 1% calculated a price of $53.58, which is slightly above the current price. Also by assuming a Ke of 7% and a growth of 2% revealed a price of $47.66. By looking at these assumptions it may infer that PepsiCo is slightly overvalued.
By examining the sensitivity analysis above, can give a clear picture of the effect on price based on changes on cost of equity and growth assumptions. Only by predicting a fairly accurate estimate of cost of equity will give a fairly accurate assumption of the price. This model is also fairly easy to implement and easy to understand. The only downside to this model is the estimation of the cost of equity and growth. It is very hard to believe that our Ke estimation of 4.84% is entirely accurate since this reflects a growth rate of zero, which is hard to believe. This in conclusion, it could be fair to assume that the Ke could be in the range of 5.6% to 7% based on the growth rates of 1 and 2%
.
The AEG model takes into consideration the present value of the investment opportunities of the dividend paid to the shareholders. (See Exhibit 8). This model does not only include the dividend payment themselves, but it implies that they are included in
57

Valuation Analysis the earnings per share. The value of the investment opportunities, assuming that you are going to invest at the current cost of equity, is also part of the model. The Abnormal earnings are calculated by subtracting the cum-dividend earnings with the normal earnings. These abnormal earnings are then discounted back to the present time. We then set up perpetuity of AEG for the firm to find the value of each share. In our case we assumed that after 2014 the AEG will be 0.023 with no growth. We still used the cost of equity of 4.84% and this model gave us a price per share of $54.13. This is the first model that shows that the company is undervalued because all the other models showed that our company as overvalued. This model requires a very accurate cost of equity because many components of the model are affected by it. For example as we see on the sensitivity analysis for this model if we used the cost of equity estimated by using the five year beta that is 2.57% with no growth the price per share is $74.36. The change of the growth doesn’t make big changes and we see this if we had a growth after 2014 of 1 % or
2% with a cost of equity of 4.84% the price per share was going to be $55.9 and $58.93 respectively. We believe that our estimated cost of equity of 4.84% that we found by using the WACC formula with the numbers taken from the discounted free cash flow model is very accurate.
0 g
0.01
0.02
0.05
Ke 0.02
$120.47 N/A N/A
0.0257 $74.36 $89.31 $156.69 N/A
0.0484
$54.13 $55.90 $58.93 N/A
0.056 $50.81 $51.80
$53.35 $88.87
0.07 $46.41 $46.74 $47.12 $51.34
58

Valuation Analysis
Discussion and Summary of Overall Results:
In all of our valuation models except abnormal earning growth model, the actual price exceeded our estimated price. We believe that the abnormal earning growth model is not a very accurate model because just the word abnormal means that something is not normal. We think that this model doesn’t represent the fundamental value of PepsiCo stock price in April 1, 2005.
By computing the average of the difference between estimated price and the actual price from our entire valuation models we determined that the stock price of
PepsiCo is overvalued by an average of $3.51 per share. The residual income model was the model that come the closest to the price of the stock on April 1, 2005. The difference between the actual price per share and the estimated price per share in this model was 96 cents overvalued. We feel that the discounted dividend model is the least accurate because it showed that the stock price of PepsiCo as April 1, 2005 is $9.58 overvalued compared to the estimated price per share that this model estimated. If we don’t consider this model the stock price of PepsiCo is overvalued only by an average of $1.48 per share. Throughout most of these models the change of the growth rate was the most sensitive factor of change, besides the discounted residual income where the cost of equity was very sensitive to the change of the price per share.
59

Appendix
Income Statement for PepsiCO Exhibit A
5 YR ANNUAL INCOME
STATEMENT
Sales
Cost of Goods Sold
Depreciation, Depletion &
Amortization
Gross Income
Selling, General & Admin
Expenses
Total Operating Expenses
Operating Income
Extraordinary Charge - Pretax
12/31/2004 12/31/2003 12/31/2002 12/31/2001 12/31/2000
29,261.00
26,971.00
25,112.00
26,935.00
20,438.00
12,289.00
11,303.00
10,523.00
9,837.00
7,121.00
1,264.00
1,221.00
1,112.00
1,082.00
960
15,708.00
14,447.00
13,477.00
16,016.00
12,357.00
10,299.00
9,460.00
8,523.00
11,608.00
9,132.00
23,852.00
21,984.00
20,158.00
22,527.00
17,213.00
5,409.00
4,987.00
4,954.00
4,408.00
3,225.00
150 206 224 387 0
Non-Operating Interest Income
Earnings Bef Interest & Taxes
Interest Expense on Debt
Interest Capitalized
Pretax Income
Income Taxes
Equity Interest Earnings
Net Income Bef Extraordinary Items & Disc
Ops
Preferred Dividends
Net Income Bef Preferred
Dividends
Preferred Dividend
Requirements
Net Income Available To
Common
74 51 36 67 76
5,333.00
4,832.00
4,766.00
4,088.00
3,301.00
169
2
167
4
181
3
222
3
228
7
5,166.00
4,669.00
4,588.00
3,869.00
3,080.00
1,372.00
1,424.00
1,555.00
1,367.00
1,027.00
380 323 280 160 130
4,212.00
3,568.00
3,313.00
2,661.00
2,183.00
3 3 4 4 0
4,212.00
3,568.00
3,313.00
2,661.00
2,183.00
3 3 4 4 0
4,212.00
3,568.00
3,312.00
2,660.00
2,183.00
Income Statement for Pepsi Co provided by Thomson Analytics for Accounting (Amounts In Millions)
60

Appendix
Exhibit B Balance Sheet for PepsiCo
5 YR ANNUAL BALANCE
SHEET
Assets
Cash & Equivalents
Receivables Net
Inventories
Other Current Assets
Total Current Assets
Investments in Unconsol
Subsidiaries
Property, Plant & Equipment
- Gross
Accumulated Depreciation
Property, Plant & Equipment
- Net
Other Assets
12/31/2004 12/31/2003 12/31/2002 12/31/2001 12/31/2000
3,445.00
2,001.00
1,845.00
1,649.00
2,999.00
2,830.00
2,531.00
1,541.00
1,412.00
1,342.00
1,310.00
654
8,639.00
3,284.00
15,930.00
7,781.00
8,149.00
7,915.00
687
6,930.00
2,920.00
14,755.00
6,927.00
7,828.00
7,649.00
695
6,413.00
2,611.00
13,395.00
6,005.00
7,390.00
7,060.00
2,142.00
641
5,853.00
2,871.00
12,180.00
5,304.00
6,876.00
6,095.00
1,330.00
1,799.00
905
570
4,604.00
2,978.00
9,539.00
4,101.00
5,438.00
5,319.00
27,987.00
25,327.00
23,474.00
21,695.00
18,339.00
Total Assets
Liabilities
Accounts Payable
ST Debt & Current Portion
Due LT Debt
Accrued Payroll
Income Taxes Payable
Dividends Payable
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Deferred Taxes
1,731.00
1,054.00
961
99
1,638.00
591
851
611
1,543.00
562
806
492
387 274 259
2,520.00
2,450.00
2,390.00
1,238.00
354
789
183
1,000.00
255 202
2,179.00
1,940.00
6,752.00
6,415.00
6,052.00
4,998.00
2,397.00
1,702.00
2,187.00
2,651.00
1,216.00
1,261.00
1,718.00
1,496.00
72
673
48
3,935.00
2,346.00
1,361.00
Other Liabilities
Total Liabilities
Shareholders' Equity
Preferred Stock
Common Equity
Total Liabilities &
Shareholders' Equity
4,099.00
4,075.00
4,226.00
3,876.00
3,448.00
14,464.00
13,453.00
14,183.00
13,021.00
11,090.00
41
13,482.00
27,987.00
41
11,833.00
25,327.00
41
9,250.00
23,474.00
26
8,648.00
21,695.00
0
7,249.00
18,339.00
Balance Sheet for Pepsi Co provided by Thomson Analytics for Accounting (Amount in Millions)
61

Appendix
Exhibit C Statement of Cash Flow for PepsiCo
5 YEAR ANNUAL CASH
FLOW STATEMENT
Operating Activities
Income Bef Extraordinary
Items
Depreciation, Depletion &
Amortization
Investment Tax Credit
Other Cash Flow
Funds From Operations
Funds From/For Other
Operating Activities
Net Cash Flow From
Operating Activities
Investing Activities
Capital Expenditures
Increase In Investments
Decrease In Investments
Disposal of Fixed Assets
Other Use/(Source) -
Investing
Net Cash Flow From
Investing Activities
Financing Activities
Com/Prf
Purchased,Retired,Converte d,Redeemed
Long Term Borrowings
Inc(Dec) In ST Borrowings
Reduction In Long Term
Debt
12/31/2004 12/31/2003 12/31/2002 12/31/2001 12/31/2000
4,212.00
1,264.00
17
-126
5,367.00
-313
5,054.00
1,387.00
1,071.00
1,052.00
38
38
52
2,330.00
3,055.00
504
1,112.00
512
3,568.00
1,221.00
-323
-63
4,403.00
-75
4,328.00
1,345.00
31
49
46
2,271.00
1,945.00
52
13
641
3,313.00
2,661.00
1,112.00
1,082.00
288
-399
2,183.00
4,314.00
4,117.00
3,393.00
313
4,627.00
1,437.00
89
415
527
2,190.00
11
-62
353
162
212
84
4,201.00
1,324.00
n/a
2,637.00
1,731.00
324
-92
573
960
63
187
518
3,911.00
427 3,010.00
4,643.00
833 2,078.00
4,171.00
0
1,067.00
86
260
1,713.00
1,430.00
130
34
795
1,329.00
1,070.00
1,041.00
994 796 Cash Dividends Paid - Total
Net Cash Flow From
Financing Activities
Exchange Rate Effect
Cash & Cash Equivalents -
Inc(Dec)
-2,315.00
51
460
-2,902.00
27
-818
-3,179.00
34
955
-1,919.00
n/a
-355
-2,298.00
n/a
-100
Cash Flow for PepsiCo provided by Thomson Analytics for Accounting (Amounts In Millions)
62

Appendix
Exhibit AA
INCOME STATEMENT FOR PEPSICO (Amounts in millions of dollars)
Current Years Forecasted Years
Years
Total Sales
Cost of Good Sold
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
20,438 26,935 25,112 26,971 29,261 32,238 33,796 36,499 39,054 41,788 44,713 47,843 51,192 54,775 58,609
7,121 9,837 10,523 11,303 12,289 14,132 15,545 17,099 18,809 20,690 22,759 25,035 27,538 30,292 33,321
Amortization
Gross Income
960 1,080 1,112 1,221 1,264 1,365 1,447 1,548 1,641 1,739 1,844 1,954 2,072 2,196 2,328
12,357 16,016 13,477 14,447 15,708 16,741 16,804 17,852 18,604 19,359 20,110 20,854 21,582 22,287 22,961
Selling,Adm Expense 9,132 11,608 8,523 9,460 10,299 10,814 10,706 11,241 11,690 12,040 12,401 12,773 13,156 13,551 13,958
Earning Bef Interest&Taxes 3,301 4,088 4,766 4,832 5,333 5,927 6,098 6,611 6,914 7,319 7,709 8,081 8,426 8,736 9,003
Interest expense
Pretax Income
Income Taxes
Net Income
228 222 181 167 169 157 144 135 128 120 113 106 100 94 88
3,080 3,869 4,588 4,669 5,166 5,770 5,954 6,476 6,786 7,199 7,596 7,975 8,326 8,643 8,915
1,027 1,367 1,555 1,424 1,372 1,413 1,456 1,499 1,544 1,591 1,638 1,687 1,721 1,773 1,826
2,183 2,660 3,312 3,568 4,212 4,357 4,498 4,977 5,242 5,608 5,958 6,287 6,605 6,870 7,089
63

Appendix
BALANCE SHEET FOR PEPSICO (Amounts in millions of dollars)
Years
Cash Equivalent
Receivable Net
Inventory
Total Current Asset
Investments
Gross Property Plant&Equ
Accumulated Depreciation
Net Property Plant&Equ
Other Assets
Total Asset
Account Payable
Other Current Liabilities
Total Current Liabilities
Long Term Debt
Other Liabilities
Total Liabilities
Total Shareholder Equity
2000 2001
Current Years
2002 2003
Exhibit BB
2004 2005 2006 2007
Forecasted Years
2008 2009 2010 2011 2012 2013 2014
1,330 1,649 1,845 2,001 3,445 4,437 5,768 6,114 6,603 7,065 8,479 10,174 11,192 13,430 16,116
1,799 2,142 2,531 2,830 2,999 3,388 3,794 4,173 4,590 4,820 5,301 5,832 6,123 6,735 7,409
905 1,310 1,342 1,412 1,541 1,623 1,720 1,823 1,914 2,010 2,110 2,216 2,326 2,443 2,565
4,034 5,101 5,718 6,243 7,985 9,448 11,282 12,110 13,107 13,895 15,890 18,222 19,641 22,608 26,090
2,978 2,871 2,611 2,920 3,284 3,378 3,667 3,850 4,120 4,532 4,305 4,564 4,929 4,732 5,001
9,539 12,180 13,395 14,755 15,930 18,142 19,938 21,513 24,482 26,930 28,546 32,485 35,701 38,200 43,472
4,101 5,304 6,005 6,927 7,781 9,104 10,224 11,450 12,733 14,936 16,907 18,987 21,835 24,520 27,536
5,438 6,876 7,390 7,828 8,149 9,006 9,366 10,022 10,523 11,154 11,601 12,819 13,716 13,990 14,690
5,319 6,095 7,060 7,649 7,915 8,725 8,987 9,706 10,696 11,230 11,567 12,129 12,614 13,497 14,037
18,339 21,695 23,474 25,327 27,987 30,995 33,474 36,151 39,404 42,556 45,876 50,005 53,230 57,488 62,662
1,000 1,238 1,543 1,638 1,731 1,973 2,209 2,407 2,647 2,912 3,145 3,459 3,805 4,109 4,520
1,940 2,179 2,390 2,450 2,520 2,691 2,766 2,836 2,921 3,029 3,319 3,545 3,971 4,026 4,187
3,935 4,998 6,052 6,415 6,752 7,697 8,543 9,226 10,056 10,860 11,729 12,668 13,681 14,912 16,105
2,346 2,651 2,187 1,702 2,397 2,476 2,105 2,399 2,087 1,879 2,893 3,125 3,562 2,992 3,710
3,448 3,876 4,226 4,075 4,099 4,279 4,309 4,783 4,496 4,721 5,051 5,607 5,775 5,255 5,571
11,090 13,021 14,183 13,453 14,464 15,331 15,790 16,105 16,749 17,369 17,890 18,426 19,108 19,586 20,311
7,249 8,648 9,250 11,833 13,482 15,664 17,684 20,046 22,655 25,188 27,986 31,578 34,122 37,902 42,352
64

Appendix
Exhibit CC
CASH FLOW FOR PEPSICO (Amounts in millions of dollars)
Current Years
Years
Income Bef Extraordinary
2000 2001 2002 2003 2004 2005 2006 2007
Forecasted Years
2008 2009 2010 2011 2012 2013 2014
2,183 2,661 3,313 3,568 4,212 4,955 5,351 5,887 6,946 7,293 7,585 8,116 9,090 9,726 10,407
Depreciation&Amortization
Funds From Operations
960 1,082 1,112 1,221 1,264 1,352 1,406 1,547 1,670 1,771 1,850 1,906 2,001 2,141 2,216
3,393 4,117 4,314 4,403 5,367 6,024 6,325 6,610 7,337 7,850 8,533 9,011 9,282 9,746 10,214
Cash Flow OP Activities
Capital Expenditures
Increase in Investments
Cash Flow INV Activities
Com/Prf Redeemed
Cash Dividend Paid
Cash Flow Fin Activities
3,911 4,201 4,627 4,328 5,054 5,357 5,678 5,961 6,437 6,887 7,300 7,738 8,203 8,613
1,067 1,324 1,437 1,345 1,387 1,486 1,534 1,442 1,499 1,604 1,732 1,784 1,695 1,831
4,643 3,010
1,713 2,637
427
527
1,052
2,271
1,071
2,330
1,142
3,261
959
4,040
1,065
4,242
1,150
4,581
966
4,810
811
5,099
974
5,303
1,052
5,674
1,199
6,071
1,430 1,731 2,190 1,945 3,055 3,768 3,316 3,714 4,605 5,250 4,620 5,682 5,114 5,881
796 994 1,041 1,070 1,329 1,513 1,574 1,658 1,874 1,927 2,194 2,297 2,412 2,702
-2,298 -1,919 -3,179 -2,902 -2,315 -2,429 -2,179 -1,991 -2,787 -2,926 -2,458 -2,311 -3,928 -3,300
9,129
1,922
959
6,193
7,116
2,864
-2,772
65

Appendix
Date
Adj.
Price
Price
Return
Adj.
Price
1 4/1/05 52.76 -0.51% 1172.92
S&P 500
Return
T-Bill return
(Rm -
Rf)
2 3/1/05 53.03 -1.12% 1180.59
3 2/1/05 53.63 0.30% 1203.6 1.89% 0.31%
4 1/3/05 53.47 2.87% 1181.27
5 12/1/04 51.98 5.07% 1211.92
6 11/1/04 49.47 0.67% 1173.82
7 10/1/04 49.14 1.91% 1130.2 1.40% 0.28%
8 9/1/04 48.22 -2.27% 1114.58
9 8/2/04 49.34 0.00% 1104.24
10 7/1/04 49.34 -7.19% 1101.72
11 6/1/04 53.16 1.37% 1140.84
12 5/3/04 52.44 -2.05% 1120.68
13 4/1/04 53.54 1.19% 1107.3 -1.68% 0.28%
14 3/1/04 52.91 4.07% 1126.21
15 2/2/04 50.84 9.81% 1144.94
16 1/2/04 46.3 1.38% 1131.13
17 12/1/03 45.67 -2.79% 1111.92
18 11/3/03 46.98 0.62% 1058.2 0.71% 0.27%
19 10/1/03 46.69 4.36% 1050.71
20 9/2/03 44.74 3.25% 995.97 -1.19% 0.27%
21 8/1/03 43.33 -3.32% 1008.01
22 7/1/03 44.82 3.53% 990.31 1.62% 0.24%
23 6/2/03 43.29 1.05% 974.51 1.13% 0.19%
24 5/1/03 42.84 2.12% 963.59 5.09% 0.21%
25 4/1/03 41.95 8.20% 916.92 8.10% 0.24%
26 3/3/03 38.77 4.78% 848.18 0.84% 0.23%
27 2/3/03 37 -5.32% 841.15 -1.70% 0.24%
28 1/2/03 39.08 -4.12% 855.7 -2.74% 0.25%
29 12/2/02 40.76 -0.27% 879.82 -6.03% 0.25%
30 11/1/02 40.87 -3.68% 936.31 5.71% 0.25%
31 10/1/02 42.43 19.35% 885.77 8.64% 0.25%
-
32 9/3/02 35.55 -6.20% 815.29 -11.00% 0.25%
33 8/1/02 37.9 -7.90% 916.07 0.49% 0.27%
34 7/1/02 41.15 -10.91% 911.62 -7.90% 0.32%
35 6/3/02 46.19 -7.01% 989.81 -7.25% 0.35%
36 5/1/02 49.67 0.16% 1067.14
37 4/1/02 49.59 0.77% 1076.64
38 3/1/02 49.21 2.27% 1147.39
66

Appendix
39 2/4/02 48.12 0.84% 1106.73
40 1/2/02 47.72 2.87% 1130.2 -1.56% 0.36%
41 12/3/01 46.39 0.41% 1148.08
42 11/1/01 46.2 -0.15% 1139.45
43 10/1/01 46.27 0.43% 1059.01
44 9/4/01 46.07 3.50% 1040.94
45 8/1/01 44.51 0.79% 1133.58
46 7/2/01 44.16 5.49% 1211.23
47 6/1/01 41.86 -0.92% 1224.42
48 5/1/01 42.25 2.47% 1255.82
49 4/2/01 41.23 -0.63% 1249.46
50 3/1/01 41.49 -4.33% 1160.33
51 2/1/01 43.37 4.56% 1239.94
52 1/2/01 41.48 -11.06% 1366.01
53 12/1/00 46.64 9.56% 1320.28
54 11/1/00 42.57 -6.32% 1314.95
55 10/2/00 45.44 5.31% 1429.4 -0.49% 0.48%
56 9/1/00 43.15 8.23% 1436.51
57 8/1/00 39.87 -6.93% 1517.68
58 7/3/00 42.84 3.10% 1430.83
59 6/1/00 41.55 9.57% 1454.6 2.39% 0.53%
60 5/1/00 37.92 10.91% 1420.6 -2.19% 0.56%
61 4/3/00
Average
34.19 1452.43
0.33%
BETA INTERCEPT R^2
Cost of Equity (Estimated Beta)
Ke = Rf + B(Rm - Rf)
2.57%
Ke = 0.33% + 0.32
(7%)
Cost of Equity (Published Beta)
Ke = Rf + B(Rm - Rf)
4.88%
Ke = 0.33% + 0.65
(7%)
BETA 2 years 3 years
0.48 0.76
67

Appendix
PEPSICO 10-K 2004/12/25: Balance Sheet
LIABILITIES
Current Liabilities:
Accounts payable
Current portion of long-term debt
Notes payable
Other current liabilities
Total Current Liabilities
Long-term Debt
Deferred Income Taxes
Other Liabilities
Total Non-Current Liabilities
Total Liabilities
Short Term Liabilities
Current Maturity of Long Term Debt
Other Borrowings, 3.2% and 5.1%
Amount Reclassified to Long Term Debt
Less Current Maturity of Long Term Debt Obligations
Total Long Term Debt
12/25/2004 ( Percent of Total Liabilities Computed Interest Rate
Total Principal
Long Term Debt
Short Term Borrowings Reclassified
Notes Due: (2005-2026) 4.7% and 5.7%
Zero Coupon Note, Yield 13.4% $575 Mill due (2005-2012)
Other, Due (2005-2014), 6.2% and 6.4%
$1,731
$1,054
$0
$2,520
$6,752
$2,397
$1,216
$4,099
$7,712
$14,464
11.97%
7.29%
0.00%
17.42%
46.68%
16.57%
8.41%
28.34%
53.32%
100.00%
Weighted Averaged Cost of Debt
0.00%
6.01%
0.00%
4.38%
6.01%
0.00%
6.30%
Rate
6.79%
4.15%
Principal (Millions)
160
1644
1804
(750)
1054
Principal (Millions)
750
1274
321
212
2557
(160)
2397
Rate
4.15%
5.20%
13.40%
6.30%
Value Weighted Rate
0.00%
0.44%
0.00%
0.76%
1.00%
0.00%
1.79%
3.98%
Weight
8.87%
91.13%
Weight
29.33%
49.82%
12.55%
8.29%
Value Weighted Rate
0.60%
3.78%
4.38%
Value Weighted Rate
1.22%
2.59%
1.68%
0.52%
6.01%
68

Appendix
Value of Equity:
Value of Debt
Value of Firm
PPS
$52.76
Shares Outstanding
1,687,000,000
$89,006,120,000.00
Current Maturity of Long Term Debt
Long Term Debt
$2,397,000,000
$1,054,000,000
$3,451,000,000.00
$92,457,120,000.00
WACC= (Vd/Vf)*(1-Tx)*Kd+(Ve/Vf)*Ke
Tx= 31.66%
4.80%
69

Appendix
EXHIBIT 4
Method of Comparables
2005 EPS
0.98
1.08
52.76
41.38
18.90
9.40
Cadbury
Schweppes
P/E Ratio (PPS/EPS)
2.20 15.20
PepsiCo 20.69
0.93
40.00
23.95
(Not Included in Average)
Coca-Cola 20.19
Cadbury
Schweppes 18.18
Avg
Price 48.92
P/B Ratio (PPS/BPS)
PepsiCo 6.47 (Not Included in Average)
Coca-Cola 6.47
Cadbury
Schweppes 2.63
Avg
Price 37.07
Dividend Yield (DPS/PPS)
PepsiCo 0.02
Coca-Cola 0.03
Cadbury
Schweppes 0.02
(Not Included in Average)
Avg
Price 39.72
P/S Ratio (PPS/SPS)
PepsiCo 2.79
Coca-Cola 4.40
Cadbury
Schweppes 1.67
(Not Included in Average)
Avg
PEG Ratio
PepsiCo
Price 57.38
1.88 (Not Included in Average)
Coca-Cola 2.17
Cadbury
Schweppes 2.20
Avg
Price 50.80
70

Appendix
WACC = 0.048 Kd = 0.0398 Ke = 0.0488 Growth = 0.02
PepsiCo
Years from valuation date
(Amounts in millions of dollars except per share data)
Cash Flow from Operations
Cash Provided by Investing Activities
Free Cash Flow (to firm)
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
5,678 5,961 6,437 6,887
1,638 1,719 1,856 2,077
7,300
2,201
7,738
2,435
8,023
2,349
8,613 9,129
(4,040) (4,242) (4,581) (4,810) (5,099) (5,303) (5,674) (6,071) (6,193)
2,542 2,936 2,995 discount rate (4.8% WACC)
Present Value of Free Cash Flows
Total PV of Annual Cash Flows
Continuing (Terminal) Value
PV of Continuing (Terminal) Value
15,406
0.95 0.91 0.87 0.83 0.79 0.75 0.72 0.69 0.66
1562.98
1565.14
106954
1612.48
1721.83 1741.06 1837.94 1691.82 1746.97
70,137
1925.33
Value of the Firm (end of 2005)
Book Value of Debt
Value of Equity (end of 2005)
85,542
$3,451
82,091
g
0.02
0.04
Estimated Value per Share 12-31-05
Estimated Value per Share 04-01-05
48.66/(1+(WACC/12)^(9/12)
Actual Price per share
48.66
47.90
$52.76
WACC $81.45 $154.56 N/A
0.03
0.048
0.06
$52.46
$30.85
$23.71
N/A
$74.78 $141.75 N/A
$37.13
$27.15
$47.90 $150.21
$32.32 $58.18
WACC
Growth
0.048
0.02
0.048=(3451/85542)*0.0398+(82091/85542)new Ke
New Ke = 0.0484
71

Appendix
WACC = 0.048, Kd =0.0398, Ke(new) = 0.0484, Growth =0
Years from valuation date
PepsiCo
(Amounts in millions of dollars except per share data)
1 2
2005 2006 2007
3
2008
4
2009
5
2010
6
2011
7
2012
$1.12
$1.28
$1.39
$1.50
0.954
0.909
0.868
0.828
$1.72
0.789
$1.86
0.753
$1.97
0.718
8
2013
9
2014
$2.10
$2.23
0.685
0.653
Perp
$2.23
Dividends per share
Present Value Factor
Present Value of Future Dividends $1.07
$1.16
$1.21
$1.24
Total PV of Forecast Future Dividends
Continuing (Terminal Value) (growth of 0.02)
$11.75
Present Value of Continuing (Terminal) Value $31.56
$46.07
46.04*0.685
Estimated Value per Share 12-31-05
Estimated Value per Share 04-01-05
54.44/(1+(Ke/12))^(9/12)
$43.31
43.18
Ke
Actual Price per share
New Cost of Equity growth rate
$52.76
0.0484
0
$1.36
$1.40
$1.41
$1.44
$1.46
0.02
0.0257
0.0484
0.056
0.07
g
0 0.01
0.02
0.05
$87.86
$164.01 N/A N/A
$70.79
$108.71
$278.90 N/A
$43.18
$51.37
$65.53 N/A
$38.91
$44.82
$54.02
$265.54
$33.47
$37.09
$42.17
$87.86
72

Appendix
WACC= 0.048, Kd =0.0398, New Ke= 0.0484 Growth =0
Years from valuation date
Beginning BE (per share)
Earnings Per Share
Dividends per share
Ending BE (per share)
"Normal" Income
Be *Ke
Residual Income (RI)
EPS - NI
Present Value Factor
Present Value of RI
BV Equity (per share) 2005
Total PV of RI (end 2005)
Continuation (Terminal) Value
PV of Terminal Value (end 2005)
39.48*0.69
Estimated Value per share 12-31-05
Estimated Value per share 04-01-05
51.96/(1+(Ke/12)^(9/12)
Actual Price per share
Ke
Growth
2005
8.15
1 2
2006
8.15
2007
9.59
$2.56
$2.60
$1.12
$1.28
9.59
0.39
10.91
0.46
2.17
0.95
2.07
2.14
0.91
2.04
3
2008
11.55
$2.42
$1.39
12.58
0.53
1.89
0.87
1.80
4
2009
12.58
$2.53
$1.55
13.56
0.61
1.92
0.83
1.83
5
2010
13.56
$2.58
$1.72
14.42
0.66
1.92
0.79
1.83
6
2011
14.42
$2.62
$1.86
15.18
0.70
1.92
0.75
1.83
7
2012
15.18
$2.55
$1.97
15.76
0.73
1.82
0.72
1.73
8
2013
15.76
$2.65
$2.10
16.31
0.76
1.89
0.69
1.80
9
2014
16.31
$2.70
$2.23
16.78
0.79
1.91
0.65
1.82
8.15
16.76
27.05
$51.96
$51.80
$52.76
0.0484
0
39.48
Ke g
0 0.01
0.02
0.02
$129.53
$230.53 N/A
0.05
N/A
0.0257
$100.00
$146.01
$353.42 N/A
0.0484
$51.80
$58.85
$70.79 N/A
0.056
0.07
$44.45
$48.92
$35.07
$37.23
$55.88
$215.86
$40.24
$67.37
Perp
1.91
73

Appendix
WACC= 0.048, Kd =0.0398, New Ke= 0.0484 Growth =0
Years from valuation date
EPS
DPS
DPS invested at 4.84%
Cum-Dividend Earnings
Normal Earnings
Abnormal Earning Growth (AEG)
PV Factor
2005
2.55
0.98
PepsiCo
(Amounts in millions of dollars except per share data)
1 2 3 4 5 6
2006 2007 2008 2009 2010 2011
$2.56
$2.60
$1.12
$1.28
0.047
0.054
2.607
2.654
2.673
2.684
$2.42
$1.39
0.062
2.482
2.726
$2.53
$1.55
0.067
2.597
2.537
(0.066) (0.030) (0.244) 0.060
0.954
0.910
0.868
0.828
$2.58
$1.72
0.075
2.655
2.652
0.003
0.790
$2.62
$1.86
0.083
2.703
(0.002)
0.753
7
2012
$2.55
$1.97
0.090
2.640
2.705
2.747
(0.107)
0.718
8
2013
$2.65
$2.10
0.095
2.745
2.673
0.072
0.685
9
2014
$2.70
$2.23
0.102
2.802
2.778
0.023
0.654
PV of AEG
Core EPS
Total PV of AEG
Continuing (Terminal) Value
PV of Terminal Value
Total PV of AEG
2.560
-0.263
0.331
Average Perpetuity
Capitalization Rate (perpetuity)
2.628
0.048
Estimated Value per Share 12-31-05 54.294
Estimated Value per share 04-01-05 54.130
54.29/(1+Ke/12)^9/12
Actual price per share
Ke
52.76
0.0484
g 0
(0.063) (0.027) (0.212) 0.050
$0.48
Ke
0.002
(0.001) (0.077) 0.049
g
0 0.01
0.02
0.05
0.02
$86.18
$120.47 N/A N/A
0.0257
$74.36
$89.31
$156.69 N/A
0.0484
$54.13
$55.90
$58.93 N/A
0.056
$50.81
$51.80
$53.35
$88.87
0.07
$46.41
$46.74
$47.12
$51.34
0.015
Perp
0.023
74

Appendix
Long Run Average Residual Income Perpetuity based on the P/B Ratio
Sensitivity
Analysis
.
g
0 0.01 0.02 0.05
BE 8.15
ROE 0.3124
Ke
0.02
0.0257
0.0484
0.056
0.07
$127.30
$99.07
$52.60
$45.47
$36.37
$246.46 N/A N/A
$156.98 $418.08 N/A
$64.18
$53.58
$83.91 N/A
$66.20 $356.43
$41.08 $47.66 $106.93
75

Appendix
1.
2.
3.
4.
5.
6.
7.
8.
Epic Software
9.
Value Line
10.
11.
76