Pepsico - Wacc

As PepsiCo has grown and evolved since incorporating in 1919 the need for more analysis continues to grow. Over the years PepsiCo has identified 3 major segments of operations; snack foods, soft drinks, and restaurants. PepsiCo however is traded and judged as a company with all these segments, but as we review new projects we must look at the risk of each specific project as it pertains to the business segment it involves.

PepsiCo’s annual report shows that our WACC is 11% based on our current financial structure. Exhibit 1 shows an analysis, which supports the 11% number. It also however shows a 11.45% WACC based on a target debt to equity ratio of .25 instead of our current ratio of .36. I do agree with using the current 11% WACC as a hurdle rate for new projects. However as debt decreases this hurdle rate may need to be re-evaluated to address the change in debt to equity ratio.

Exhibit 1

PepsiCo WACC - Overall

Cost of Debt 5.98%

A Rated Bond Yield 9.64%

Tax Rate 38%

Cost of Equity 12.82%

Beta 1.1

Long Term Bond (arithmetic) 4.90%

S&P 500 (arithmetic) 12.10%

WACC

Current D/E, .36 10.97%

Target D/E, .25 11.45%

Since PepsiCo has evolved we have operations in 3 major sections. Exhibit 2 shows the individual business segments cost of capital and an overall WACC based on sales by segment. Starting with snack foods, the pure play method was used here to evaluate the cost of equity and WACC for all 3 segments. General Mill’s beta of 1.05 was used in order to determine the beta of PepsiCo’s snack food segment, 1.16. This gives a cost of equity of 13.25% and WACC of 11.28%. Soft drinks segment uses Coca-Cola with beta of 1.0 in order to determine the beta of PepsiCo’s soft drink segment, 1.15. This gives a cost of equity of 13.18% and WACC of 11.23%. Last the restaurant segment uses McDonald’s beta of 1.0 to determine the beta of PepsiCo’s restaurant segment, .94. This gives a cost of equity of 11.67% and WACC of 10.13%. This analysis shows that the restaurant segment has the lowest WACC. Using the amount of sales each segment carries as a weight measure, the overall WACC based on each segment is 10.86%. This is slightly lower than the overall WACC of 10.97%, which is due to the lower risk level in our restaurant segment. Although both numbers support the annual report 11% WACC, it must be noted that if using 11% for decisions regarding projects in the restaurant