In this report it has been critically done the analysis of financial statements of PepsiCo along with the comparison of close and distant competitors existing in the industry. In this report it has also been tried the way how to calculate financial statements ratios with definitions and their calculated ratios interpretations in an easy language to make this report easily understandable for any potential reader. I tried to explain how companies try to get tax benefits and the possibilities to reduce taxable amount paid to the government. I also provided suggestions how to maintain senior debt rating. Debt side of the balance sheet has been investigated critically in depth to provide sound knowledge to the actual and potential readers of financial statements of PepsiCo. The possible advantages and disadvantages of debts have also been listed. I am sure this report is easy to read and understand for those who do not have accounting and finance background knowledge.
L= Market value of total debt + present value of operating lease commitments – cash and marketable securities ÷ ( No. of common shares Aƒ- Common Stock Price ) + Market value of total debt + Present value of operating lease commitments – Cash and marketable securities L= (D + PVOL – CMS)__ (NP + D + PVOL – CMS) Where; D is the total market value of debt; $18,119,000,000 PVOL is the present value of operating lease commitments; 294,000,000 Aƒ- 5 = $1,470,000,000 CMS is cash and marketable securities; 382,000,000 + 116,000,000 = $498,000,000 N is the number of common shares 790,000,000 P is the common stock price $55.875 L= 18,119,000,000 + 1,470,000,000 – 498,000,000 (790,000,000 Aƒ- 55.875) + 18,119,000,000 + 1,470,000,000 – 498,000,000 L = 19,091,000,000 63,232,250,000 L = 0.301 Aƒ-100
D is the total market value of debt; $18,119,000,000 PVOL is the present value of operating lease commitments; 294,000,000 Aƒ- 5 = $1,470,000,000 Aƒ- 0.75 = 1,102,500,000 CMS is cash and marketable securities; 382,000,000 + 116,000,000 = $498,000,000 N is the number of common shares 790,000,000 P is the common stock price $55.875 L = 18,119,000,000 + 1,102,500,000 – 498,000,000 (790,000,000 Aƒ- 55.875) + 18,119,000,000 + 1,102,500,000 – 498,000,000 L = 18,723,500,000 62,864,750,000 L = 0.297Aƒ-100
This analysis tool is used to measure how many times a company can pay interest payments on its debts on its earnings before interests and taxes. If the interest coverage ratio is higher, the company has low debt load and there is a less chances of bankruptcy. This ratio is important for those who have provided debt to the company or they are going to provide debt to the company because by analyzing this ratio they can find that the company can make interest payments easily when debt is provided to them. The higher the ratio, the lesser the risk is supposed by the creditors. A company usually prefers to have debt in order to take tax benefit when deducting interest payments as expenses which decrease the income which has to be taxed. This ratio is dependent on earnings before taxes by a company. The higher the earnings, the higher the ratio and the lower the interest payments, the higher the ratio. Interest Coverage Ratio = Earnings before Interest & Taxes Interest Expenses
Senior debt ratings represent the opinions of the rating agencies with respect to the creditworthiness and financial ability of an obligor to meet its senior unsecured financial obligations and contracts. Ratings provide both industry participants and consumers with meaningful information on specific companies and have become an increasingly important factor in establishing the competitive position of companies in the industry. Rating agencies continually review the financial performance and condition of companies and higher ratings generally indicate financial stability and a strong ability to meet financial obligations. Each of the rating agencies reviews its ratings periodically and there can be no assurance that current ratings will be maintained in the future. (Humana, 2010)
The cost is limited and known and cheaper than the cost of equity (because it is less risky to the investor who therefore requires a lower required rate of return). The interest is tax-deductible, unlike dividend payments, which makes the cost even cheaper in comparison to equity. There is no dilution of control when debt is issued. The cost of acquiring equity financing is more than the cost of financing that is why debt financing is preferred. The debt can be terminated (if a call provision was included).
There is always the possibility of default if income is low. The company must pay interest, even if it means taking out additional debt to do so. The cost of equity rises as more debt is used. The higher leverage results in higher risk to shareholders who will require a higher rate of return. The net debt ratio target of PepsiCo of 29.7% exhibits that 29.7% of total assets provided by lenders or creditors. This ratio is useful for lenders which assist them to find out how much they are save if the PepsiCo is declared insolvent. According to my analysis, the method and the derived percentage of target senior debt rating is rational approach because it has the three out of five major elements which are assumed to impact on the capital structure decision making. The debt rating provides the information about the firm’s capacity to service its debt. It also provide sound information about the degree of protection afforded by the liquidity of the firm’s assets, and mainly find out the firm’s simplicity of access to the capital markets. A target senior debt rating of single-A is a sensible objective for PepsiCo because it is the lowest rating that has allowed historically the issuer to maintain constant access to the capital markets. Net debt ratio seems reasonable because of many reasons. One of them is the cost of equity is not clearly mentioned on the income statement, whereas, the cost of debt i.e. interest expense is recorded.
Debt financing is less expensive than equity financing because the debtors can claim firstly if the firm is declared to be insolvent. It is easy to forget that debt is a cheaper source of funding for the company than equity. Debt is less risky than equity that is why investors get low return; this interprets into anA interest rateA that is lower than the expectedA total shareholder returnA on equity. Firms get tax benefits because the amount of interest paid is tax deductible. Tax is one of the important areas for firms which monitor critically so that the firms can find out ways to decrease the taxable amount paid to the government authority. Debt ratio rated A has a strong capacity to pay interest and repay principal. One reason PepsiCo should adopt a lower percentage of financial leverage in the industry it could be more attractive for the stakeholders of PepsiCo. Another reason would be if the firm had a higher proportion of intangible assets than the cross section of firms. A third reason would be if the firm cannot fully use its interest tax credits. The net debt ratio of 29.7% is low leverage ratio which may decrease PepsiCo’s coverage to risk and business declination. This decrease in risk brings the potential for lower returns. PepsiCo is generally considered safer because it has a low net debt ratio, though a very low ratio indicates excessive caution.
Generally, lower net debt ratio is better because it means that the firm is using more of owner’s capital and retained earnings to finance its assets. It means less risk to creditors. Company can borrow additional funds with relative ease. Keeping the low net debt ratio is attractive to all the actual and potential users of financial statements of PepsiCo.
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