Applied Financial Management

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Applied Financial Management

Applied Financial Management

Table of Contents

Introduction. 4

1.    Financial Ratios: Pepsi vs. Coca-Cola. 6

1.1. Profiles of the Companies. 6

1.1.1. Coca Cola Company. 6

1.1.2.      Pepsi Company. 6

1.2. LIQUIDITY RATIO.. 7

1.2.1. Types of Liquidity Ratio. 7

1.3. PROFITABILITY RATIO.. 12

1.3.1. Types of Profitability Ratio. 12

1.4. EFFICIENCY RATIOs. 15

1.4.1. Categories of Efficiency Ratios. 16

1.5. RISK RATIO.. 23

1.5.1. Debt to Capital Ratio. 23

1.5.2. Debt/Equity Ratio. 25

1.5.3. Interest Coverage Ratio. 26

1.5.4. Combined Leverage. 28

2.    Analysis and Interpretation. 29

3.    Coca Cola Valuation and Beta Estimation. 33

3.2.     Free cash flow valuation model 38

5. Limitations of the Analysis. 42

References. 45

Appendices. 46

Balance Sheet 46

Cash Flow.. 49

Income Statement 51

Applied Financial Management

Financial management is one of the most essential aspects of a contemporary business enterprise, because it forms an overarching platform for all economic activities. The performance of a business relies on its ability to efficiently raise and manage financial resources when a need occurs. Notably, most of the modern business institutions prepare financial statements to facilitate decision making, especially including future investment, assets and liability acquisition, among others. Nonetheless, information as contained in the financial statements is inadequate to enhance meaningful decision making. Thus, a comprehensive and effective financial analysis and interpretation must be conducted to establish an organization’s performance, hence support informed decision making.

Analysis of financial statements includes a review and examination of an organization’s financial statements to evaluate its past, current and future performance. Financial and supplementary statements including balance sheets, income, equity change and cash flows statements are commonly used to establish the relationships between numerous factors, hence facilitate drawing of informed conclusions aimed at developing a better view of an organization’s financial position and performance.  Some of the primary objectives of financial statement analysis include identifying the financial well-being, assessing profitability, evaluating the capacity of servicing debt, acquiring appropriate insights of short term and long term solvency, and establishing the return on investment of an enterprise. Thus, an appropriate review, analysis and interpretation of an institution’s financial statements can lead to a clear view of the business performance by the relevant stakeholders.

    Financial Statement analysis possess a wide range of stakeholders, which can be categorized into internal and external users. Internal stakeholders indicate the top management of a company that conducts the financial statement analysis for the company operations decision making. On the other hand, External stakeholders of financial statement analysis are not necessarily members of a business institution but still possess a financial interest. Some of the external stakeholders include investors, owners, lenders, customers, suppliers, government, employees as well as the general public. Notably, the external stakeholders form an essential part of a business, and hence are keen to establish the financial performance of a company. For instance, lenders may need to identify the capability of an institutional to pay loans before lending or investors may require to assess a company’s returns before making investment decisions. Such decisions by external stakeholders directly affect the performance of company. Thus, apart from informing organizational decision making processes, financial statement analysis is an imperative exercise for a business institution.   

In financial statement analysis, the arrangement of statements is highly essential to ensure that they can reveal relative importance and impact of different bits of information with regard to time duration as well as for inter-business comparisons. In this regard, logical causality and sequence should be considered when rearranging data to enhance interpretation and drawing of logical conclusions. After rearranging statements analysis can be conducted using a number of techniques, which include creating comparative and common size financial statements, as well as conducting ratio and trend analysis. Ratio analysis is the most popular and widely used technique of analysing financial statements. The method enhances identification of key relationships between items or sets of data in an income statement or a balance sheet, hence the meaningful performance indicators, which include solvency, liquidity, and profitability of an enterprise. Ratio analysis tools simplifies financial statements, hence revealing immense information regarding the financial condition changes of a business organization. Thus, the ratio analysis technique is commonly utilized to establish an institution’s financial position, as well as to monitor its performance.

1.      Financial Ratios: Pepsi vs. Coca-Cola

1.1. Profiles of the Companies

1.1.1. Coca Cola Company

Coca-Cola is a beverage company that possesses or licences and markets over five hundred brands of non-alcoholic drinks bands, which include still beverages, such as ready-to-drink coffees and teas, energy and dairy drinks, juices, waters and sports drinks, and sparkling beverages that include diet coke, Fanta, Coca-Cola and Sprite. In addition, the company operates corporate and bottling investment segments in North America, Latin America, Europe, Africa, Asia and Middle East. Coca-Cola manufactures, sells and markets beverage concentrates, which are known as syrups and bases, which include the fountain syrup, as well as finished still and sparkling drinks.

1.1.2.      Pepsi Company

Pepsi Co. Inc., is a food, beverage and snack multinational corporation founded and headquartered in North America. Founded in 1965 through the merger of Frito-Lay, Inc., and Pepsi-Cola Company, the corporation produces, markets and distributes grain-based snack food and beverages, among other products (Sun, 2012). Since the 1965 merger, Pepsi Co. has immensely expanded from its single Pepsi product brand to a wide range of beverage and food brands, especially through acquisition, such as the 1998 acquisition of Tropicana line of products and the 2001 Quaker and Oats acquisition, which came along with the Gatorade brand.

1.2. LIQUIDITY RATIO

Liquidity refers to the ability of an enterprise to satisfy its short-term financial obligations mostly for one-year period (Sun, 2012). Specifically, liquidity determines the firm’s survival, with the ratios in this category being used to evaluate the short term financial position of a business institution. Liquidity ratios reveal the ability of firm to satisfy current obligation using the current resources. Nonetheless, high levels of liquidity indicate reduced profitability and deterioration in the managerial efficiency, among others (Sun, 2012). On the other hand, low liquidity can lead to loss of profit making opportunities, hence less return rate for a business entity. Thus, a proper liquidity and profitability balance is necessary for efficient management of finances.

1.2.1. Types of Liquidity Ratio

1.2.1.1. Current (Working Capital) Ratio

  Current ratio indicates the links between current liabilities and assets of a company. Current assets refer to an entity’s assets that can be changed into cash in a duration not exceeding one year. On the other hand, current liabilities refer to the firm’s receivables with one year or less due payment time. According to Steward. (2016), the typical current ratio for a company is supposed to be 2:1, which means that the entity’s current liabilities should be a half of the current assets. Although a high current ratio indicates that the firm is in a better position of paying its current liabilities, it has detrimental effects on the profitability of a company because poor capital investment, hence reduced rate of return. Some of the causes of high current ratio include inventory accruals, inefficiency in debts collection and high cash and bank account balances. A current ration less than 2:1 means that the business possesses inadequate liquidity, hence has a shortage of the operating capital.

Current Ratio= Current Assets/Current Liabilities

For Pepsi Company,                                       

YearCurrent AssetCurrent Liabilities
2015$23,031,000$17,578,000
2016$26,450,000$21,135,000
2017$31,027,000$20,502,000

Table 1: Current Asset and Liabilities for Pepsi from 2015-2017

Therefore, the 2015 Current Ratio=23,031,000/17,578,000=1.31021732

                       2016 Current Ratio=26,450,000/21,135,000=1.25147859002

                        2017 Current Ratio=31,027,000/20,502,000=1.5133645498

For Coca Cola Company,

YearCurrent AssetCurrent Liabilities
201533,39526,930
201634,01026,532
201736,54527,194

Table 2: Current Asset and Liabilities for Coca Cola from 2015-2017

Therefore, the 2015 Current Ratio=33,395/26,930=1.24006683996

                  2016 Current Ratio=34,010/26,532=1.28184833409

                  2017 Current Ratio=36,545/27,194=1.34386261675

Year201520162017
Pepsi Company1.311.251.51
Coca Cola Company1.241.281.34

Table 3: Current Ratio for Coca Cola and Pepsi Companies from 2015 to 2017

1.2.1.2. Quick Ratio

The current ratio is based on the assumption that all the current assets can be changed into cash to address the short-term needs for a business, which is not actually the case. Some of the current assets, such as pre-paid expenditures and inventory require considerable high amounts of time to convert to cash. Thus, a QAR (quick asset ratio), referred to as the acid test ratio, which involves deducting assets that cannot be quickly converted into cash, is used to encounter the challenge associated with the current ratio (Steward, 2016). The ratio shows the ability of the business to pay current liabilities utilising the liquid current assets.

Quick Ratio= (Current Receivables+ Short Term Investments + Cash and Cash Equivalents +Other Current Assets)/Current Liabilities or (Total Assets-Inventory-Prepaid Expenses)/Current Liabilities

For Pepsi Company,

YearCurrent ReceivablesShort Term InvestmentCash and Cash EquivalentsOther Current AssetsCurrent Liabilities
2015$6,437,000$2,913,000$9,096,000$1,865,000$17,578,000
2016$6,694,000$6,967,000$9,158,000$908,000$21,135,000
2017$7,024,000$8,900,000$10,610,000$1,546,000$20,502,000

Table 4: Data from Pepsi Co Financial Statements                

Therefore, the 2015 Quick Ratio= (6,437,000+2,913,000+9,096,000+1,865,000)/ 17,578,000=1.15547843896

                  2016 Quick Ratio= (6,694,000+6,967,000+9,158,000+908,000)/ 21,135,000=1.12264017033

                  2017 Quick Ratio= (7,024,000+8,900,000+10,610,000+1,546,000)/ 20,502,000=1.36962247586       

For Coca Cola Company,

YearCurrent Receivables US$ milShort Term Investment US$ milCash and Cash Equivalents US$ milOther Current Assets US$ milCurrent Liabilities  US$ mil
20153,94112,5917,3093,90026,930
20163,85613,6468,5552,79726,532
20173,66714,6696,0067,54827,194

Table 5: Data from Coca Cola Financial Statements

Therefore, the 2015 Quick Ratio= (3,941+12,591+7,309+3,900)/ 26,930=1.03011511326

                  2016 Quick Ratio= (3,856+13,646+8,555+2,797)/ 26,532=1.08751696065

                  2017 Quick Ratio= (3,667+14,669+6,006+7,548)/ 27,194=1.17268515114

Year201520162017
Pepsi Company1.161.121.37
Coca Cola Company1.031.091.17

Table 6: Quick Asset Ratio for Pepsi Company and Coca Cola Company from 2015 to 2017

1.2.1.3. Absolute Liquid (Cash) Ratio

Absolute liquid ratio reveals the nature of the relationship between current liabilities and the absolute current assets. The typical ratio is 2:1.

For Pepsi Company,

YearAbsolute Current Assets US$ ‘000Current Liabilities US$ ‘000
201511,982,00017,578,000
201616,125,00021,135,000
201719,510,00020,502,000

Table 7: Data from Pepsi Financial Statements

Therefore;

2015 Cash Ratio = 11,982/17,578= 0.68164751393787689156900671293663

2016 Cash Ratio = 16,125/21,135=0.76295244854506742370475514549326

2017 Cash Ratio = 19,510/20,502=0.95161447663642571456443273826944

For Coca Cola Company

YearAbsolute Current Assets US$ milCurrent Liabilities US$ mil
201519,90026,930
201622,20126,532
201720,67527,194

Table 8: Data from Coca Cola Financial Statements

Therefore, the 2015 Cash Ratio = 19900/26930= 0.73895284069810620126253249164501

2016 Cash Ratio = 22201/26532=0.83676315392733303181064375094226

2017 Cash Ratio = 20675/27194=0.76027800250055159226299919099801

Year201520162017
Pepsi Company0.680.760.95
Coca Cola Company0.740.840.76

Table 9: The Absolute Ratio for Pepsi and Coca Cola from 2015 to 2017

1.3. PROFITABILITY RATIO

Profitability ratio enhances evaluation of the ability of a firm’s operation to lead to profits, as well as assists the management to identify the nature of profitability. According to Sun (2012), a myriad of decisions and policies adopted by a company determine its profitability. Heikal, Khaddafi and Ummah (2014) explain that the profitability ratio reveals the combined impact of the asset and debt management and the liquidity on the operating outcome. Thus, evaluation of the profitability ratio is conducted with reference to invested capital, total assets used, owners fund and sales, among others.

1.3.1. Types of Profitability Ratio

1.3.1.1. Gross Profit Ratio

GPM (Gross Profit Margin) reveals the company’s margin of profit before interest and operating expenses, and taxes are deducted. Heikal, Khaddafi and Ummah (2014) note that there exists no ideal gross profit ratio, but it should be higher enough to cater for depreciation, dividends, interest from loans and reserve funds creation apart from covering the operating costs. Mody, et al. (2016) explain that the gross profit margin is a product factor of cost and pricing control. Notably, the a product’s sales immensely depends on its price, while the costs of production, such as labour, raw materials, purchases cost or overhead determines the cost of the goods sold. Thus, a company’s ability to maintain or improve gross profit margins is determined by its capability to price commodities with respect to production cost inflation, as well as the ability to estimate costs of production.

Gross Profit Margin=Gross Income/Sales

Therefore, for Pepsi Company,

YearGross Income in US$,000Sales in US$,000
201534,325,00063,056,000
201634,590,00062,799,000
201734,740,00063,525,000

Table 10: Data from Pepsi Financial Statements

Thus, the 2015 Gross Profit Margin = 34,325,000/63,056,000 =0.54435739659984775437706165947729

          2016 Gross Profit Margin = 34,590,000/62,799,000 =0.55080494912339368461281230592844

          2017 Gross Profit Margin =34,740,000/63,525,000 =0.54687131050767414403778040141677

For Coca Cola Company,

YearGross Income US$ milSales US$ mil
201526,81244,294
201625,39841,863
201722,15435,410

Table 11: Data from Coca Cola Financial Statements

Thus, the 2015 Gross Profit Margin =26,812/44,294 = 0.60531900483135413374271910416761

           2016 Gross Profit Margin =25,398/41,863 = 0.606693261352506987076893676994

           2017 Gross Profit Margin =22,154/35,410 = 0.62564247387743575261225642473877

Year201520162017
Pepsi Company54.43%55.08%54.69
Coca Cola Company60.53%60.67%63%

Table 12: Gross Profit Ratio for Pepsi Company and Coca Cola Company from 2015 to 2017

1.3.1.2. Operating Profit Ratio

Operating Profit or OPM (Operating Profit Margin) reveals the company’s margin of profit after operating and good sold costs are deducted but before deducting taxes and interest from loans. According to Heikal, Khaddafi and Ummah (2014), OPM indicates the actual profitability of an entity’s operations, because it is estimated before deducting taxes, which the firm cannot control, and interest from loans, which are a product of financing decision making. Precisely, the OPM indicates the particular amount of profits a business can earn regardless of the amount of government imposed taxes and the means of financing.

Operating Profit Margin=Operating Income/Sales

Therefore,

For Pepsi Company

YearOperating Income in US$,000Sales in US$,000
20158,353,00063,056,000
20169,785,00062,799,000
201710,509,00063,525,000

Table 13: Data from Pepsi Co Financial Statements

Thus, the 2015 Operating Profit Margin = 8,353,000/63,056,000 = 0.13246955087541233189545800558234

                2016 Operating Profit Margin = 9,785,000/62,799,000 = 0.1558145830347617000270704947531

                2017 Operating profit Margin = 10,509,000/63,525,000 = 0.16543093270365997638724911452184

For Coca Cola Company,

YearOperating Income in US$ milSales in US$ mil
20158,72844,294
20168,62641,863
20177,50135,410

Table 14: Data Coca Cola Co. Financial Statements

Thus, the 2015 Operating Profit Margin = 8,728/44,294 = 0.19704700410890865579988260260983

                  2016 Operating Profit Margin = 8,626/41,863 = 0.20605307789694957360915366791678

                  2017 Operating Profit Margin = 7,501/35,410 = 0.21183281558881671844111832815589

Year201520162017
Pepsi Company13.25%15.58%16.54%
Coca Cola Company19.70%20.61%21.19%

Table 15: Operating Profit Ratio for Pepsi Company and Coca Cola from 2015 to 2017

1.4. EFFICIENCY RATIOs

Efficiency Ratio also referred to as the Activity Ratio is primarily utilized to estimate a firm’s performance by analysing the internal use of liabilities and assets to generate revenue. Most of the efficiency ratios focus on the operational aspect of the firm, which include the rate of converting receivables into cash, the ability of an entity to earn profits using assets and efficiency of a company in inventory management (Boyd, 2016). Thus, the efficiency ratios provide immense information regarding the current performance of a company, by evaluating performance in receivable, assets and inventory management.

1.4.1. Categories of Efficiency Ratios

1.4.1.1. Account Receivable Turnover Ratio

The Account receivable ratio used to estimate the efficiency and efficacy of a company’s credit policies. The higher the ratio the better the credit policy of a company. Account receivable turnover ratio is estimated by calculating the revenue and average accounts receivable ratios quotient. That is, ART (Account Receivable Turnover) = Total Sales on Credit/The Average of the Accounts Receivable.

For Pepsi Company

YearSales on Credit in US$ 000Aggregate Account Receivables in US$ 000
20154,346,7406,437,000
20163,760,8406,694,000
20172,890,4607,024,000

Table 16: Data from Pepsi Financial Statements

Thus, the 2015 Account Receivable Turnover Ratio = 0.675274

                2016 Account Receivable Turnover Ratio = 0.561823

                2017 Account Receivable Turnover Ratio = 0.411512

For Coca Cola Company,

YearSales on Credit in US$ milAggregate Account Receivables in US$ mil
20152,4603,941
20162,2403,856
20171,8603,667

Table 17: Data from Coca Cola Financial Statements

Thus, the 2015 Account Receivable Turnover Ratio = 0.624207

                2016 Account Receivable Turnover Ratio = 0.580913

                2017 Account Receivable Turnover Ratio = 0.507227

Year201520162017
Pepsi Company6.456.855.86
Coca Cola Company7.658.759.06

Table 18: Account Receivable Turnover Ratio for Pepsi Company and Coca Cola Company from 2015-2017

1.4.1.2.. Asset Turnover Ratio

Asset Turnover Ratio is utilized to measure the performance of a company in terms of the use of current and long-term assets to generate revenue. The higher the ratio the better a firm utilizes its assets to generate income (Boyd, 2016). Specifically, Asset Turnover Ratio is the quotient of revenue to the average total assets. Thus, the Asset Turnover Ratio=Revenue/Total Assets.

For Pepsi Company,

YearRevenue in US$,000Total Assets in US$,000
201563,056,00069,667,000
201662,799,00073,490,000
201763,525,00079,804,000

Table 19: Data from Pepsi Financial Statements

Thus, the 2015 Asset Turnover Ratio = 63,056,000/69,667,000 = 0.90510571719752537069200625834326

                2016 Asset Turnover Ratio = 62,799,000/73,490,000 = 0.85452442509184923118791672336372

                2017 Asset Turnover Ratio = 63,525,000/79,804,000 = 0.79601273119141897649240639566939   

For Coca Cola Company,

YearRevenue in US$ milTotal Assets in US$ mil
201544,29490,093
201641,86387,270
201735,41087,896

  Table 20: Data from Coca Cola Statements

Thus, the 2015 Asset Turnover Ratio = 44,294/90,093 = 0.49164751978511094091660839354889

                2016 Asset Turnover Ratio = 41,863/87,270 = 0.47969519880829609258622665291624

                2017 Asset Turnover Ratio = 35,410/87,896 = 0.40286247383271138618367161190498

Year201520162017
Pepsi Company0.910.850.77
Coca Cola Company0.490.480.40

Table 21: Asset Turnover Ratio for Pepsi Company and Coca Cola Company from 2015-2017

1.4.1.3. Inventory Turnover Ratio

Inventory Turnover Ratio is a measure of the company’s efficiency and efficacy in inventory management. For instance, a purchase of excess inventory can lead to unnecessary increases in the cost of sold goods, hence indicating poor inventory management (Ung, and Luk, 2016). A high Inventory Turnover Ratio is considered favourable to an organization.

Inventory Turnover Ratio=Cost of Goods Sold/Revenue.

For Pepsi Company,

YearCost of Goods Sold in US$,000Revenue in US$,000
20154,501,00063,056,000
20162,542,00062,799,000
20171,543,00063,525,000

 Table 22: Data from Pepsi Financial Statements

Thus, the 2015 Inventory Turnover Ratio = 4,501,000/63,056,000 = 0.07138099467140319715808170515098

                2016 Inventory Turnover Ratio = 2,542,000/62,799,000 = 0.04047835156610774056911734263284

                2017 Inventory Turnover Ratio = 1,543,000/63,525,000 = 0.02428964974419519874065328610783

For Coca Cola Company,

YearCost of Goods Sold in US$ milRevenue in US$ mil
201517,48244,294
201616,46541,863
201713,25635,410

Table 23: Data from Coca Cola Financial Statements

Thus, the 2015 Inventory Turnover Ratio = 17,482/44,294 = 0.39468099516864586625728089583239

                2016 Inventory Turnover Ratio = 16,465/41,863 = 0.393306738647493012923106323006

                2017 Inventory Turnover Ratio = 13,256/35,410 = 0.37435752612256424738774357526123

Year201520162017
Pepsi Company0.070.040.02
Coca Cola Company0.400.390.37

Table 24: Inventory Turnover Ratio for Pepsi Co and Coca Cola Co from 2015-2017

1.4.1.4. Operation Expense Ratio

Operation Expense Ratio is used to evaluate the cost of operating a firm to generate revenue. Increased operating expense ratio indicate high costs of generating revenue, hence necessary actions should be taken to reduce the expenses (Ung and Luk, 2016).

Operating Expense Ratio=Operating Cost/Revenue

For Pepsi Company,

YearOperating Cost in US$,000Revenue in US$,000
20152597200063,056,000
201624,805,00062,799,000
201724,231,00063,525,000

Table 25: Data from Pepsi Financial Statements

Thus, the 2015 Operating Expense Ratio = 25972000/63,056,000 = 0.41188784572443542248160365389495

                2016 Operating Expense Ratio = 24,805,000/62,799,000 = 0.39499036608863198458574181117534

                2017 Operating Expense Ratio = 24,231,000/63,525,000 = 0.38144037780401416765053128689492

For Coca Cola Company,

YearOperating Cost in US$ milRevenue in US$ mil
201536,48044,294
201634,64041,863
201732,46035,410

Table 26: Data from Coca Cola Financial Statements

Thus, the 2015 Operating Expense Ratio = 0.823588

                2016 Operating Expense Ratio = 0.827461

                2017 Operating Expense Ratio = 0.91669

Year201520162017
Pepsi Company0.4120.3950.381
Coca Cola Company0.83240.8270.917

Table 27: Operating Expense Ratio for Pepsi and Coca Cola from 2015 to 2016

1.4.1.5. Return on Investment (ROI) Ratio

Normally expressed in a percentage, the Return on Investment Ratio compares earnings with the specific invested amounts. The Return on Investment Ratio= Net profit/ The Cost of an Investment *100

For Pepsi Company,

YearNet Profit US$ milCost of Investment US$ mil
20155,452,0003780000
20166,329,0007534000
20174,857,0005144000

Table 28: Data from Pepsi Financial Statements

Thus, the 2015 Return on Investment Ratio = 5,452,000/3780000 = 1.442328042328042328042328042328

                2016 Return on Investment Ratio = 6,329,000/7534000 = 0.84005840191133528006371117600212

                2017 Return on Investment Ratio = 4,857,000/5144000 = 0.94420684292379471228615863141524

For Coca Cola Company,

YearCost of Goods SoldRevenue
201517,48244,294
201616,46541,863 
201713,25635,410

Table 29: Data from Coca Cola Financial Statements

Thus, the 2015 Return on Investment Ratio = 0.394681

                2016 Return on Investment Ratio = 0.393307

                2017 Return on Investment Ratio = 0.374358

Year201520162017
Pepsi Company144%84%94%
Coca Cola Company39%39%37%

Table 30: Gross Profit Ratio for Pepsi Company and Coca Cola Company from 2015 to 2017

1.5. RISK RATIO

1.5.1. Debt to Capital Ratio

The debt to capital ratio is the estimation of leverage, which offers a fundamental view of a firm’s financial structure with regard to the manner of operation capitalization, hence reveals the organization’s financial soundness (Freeman & Martin, 2003). Particularly, the debt to capital ratio is the comparison of a company’s current and long-term debt obligations to the aggregate capital, sourced from debt financing and shareholder’s equity (Steiner, 2016). Reduced debt to capital ratios are favourable to a company because they indicate that the firm sources most of it capital from equity rather than debts.

Debt to Capital Ratio = Interest earning Debt/Equity

For Pepsi Company,

YearInterest Earning DebtEquity
201529,213,00069,667,000
201630,053,00073,490,000
201733,796,00079,804,000

Table 31: Data from Pepsi Financial Statements

Thus, the 2015 Debt to Capital Ratio = 29,213,000/69,667,000 = 0.41932335251984440265836048631346

                2016 Debt to Capital Ratio = 30,053,000/73,490,000 = 0.40893999183562389440740236766907

                2017 Debt to Capital Ratio = 33,796,000/79,804,000 = 0.42348754448398576512455516014235

For Coca Cola Company,

YearCost of Goods SoldRevenue
201517,48244,294
201616,46541,863
201713,25635,410

Table 32: Data from Coca Cola Financial Statements

Thus, the 2015 Debt to Capital Ratio = 0.394681

                2016 Debt to Capital Ratio = 0.393307

                2017 Debt to Capital Ratio = 0.374358

Year201520162017
Pepsi Company0.420.410.42
Coca Cola Company0.390.390.37

Table33: Debt to Capital Ratio for Pepsi Company and Coca Cola Company from 2015 to 2017

1.5.2. Debt/Equity Ratio

The D/E of the debt/equity ratio is an essential financial ratio, which offers a direct comparison of debt to shareholder’s equity (Freeman & Martin, 2003). In addition, the ratio indicates the ability of the organization to satisfy debt obligations. A lower debt to equity ratio is favourable to a company because it shows that most of the firm’s operations are financed through shareholder’s equity rather than debts (Steiner, 2016). Notably, organizations with robust equity positions can easily weather short-term revenue downturn or unforeseen demands for additional capital investment. On the other hand, High debt/equity ratios can negatively affect the ability of an entity to acquire additional financing when required.

For Pepsi Company,

YearTotal LiabilitiesStockholders’ Equity
201557,599,00012,068,000
201662,244,00011,246,000
201768,759,00011,045,000

Table 34: Data from Pepsi Financial Statements

Thus, the D/E = 57,599,000/12,068,000 = 4.7728704010606562810739144845873

                2016 D/E = 62,244,000/11,246,000 = 5.5347679174817712964609638982749

                2017 D/E = 68,759,000/11,045,000 = 6.2253508374830239927569035762789

For Coca Cola Company,

YearCost of Goods SoldRevenue
201517,48244,294
201616,46541,863
201713,25635,410

Table 35: Data from Coca Cola Financial Statements

Thus, the 2015 D/E = 0.394681

                2016 D/E = 0.393307

                2017 D/E = 0.374358

Year201520162017
Pepsi Company4.85.56.2
Coca Cola Company3.73.64.8

Table36: Debt/Equity Ratio for Pepsi Co and Coca Cola Co from 2015-2017

1.5.3. Interest Coverage Ratio

The Interest Coverage Ratio is a fundamental estimator of the ability of a firm to manage its current financial costs. The ratio shows the number of times an organization can use its short-term earnings before tax and interest to pay the required annual interests on the outstanding debt. A relatively lower interest coverage ratio suggests that a firm possesses a higher burden of debt service, hence correspondingly a greater risk of financial insolvency or default. A lower Interest Coverage Ratio indicates that the firm possesses reduced earnings to pay financing interests and the entity has a reduced ability to manage an increase in the rates of interests (Heikal, Khaddafi and Ummah, 2014). In general, a 1.5 or lower Interest Coverage Ratio is an indicator of debt service problems. Nonetheless, extremely high Interest Coverage Ratio may indicate the inability of an organization to utilize its financial leverage. Interest Coverage Ratio = Earnings Before Interest and Tax/Interest Expenses

For Pepsi Company,

YearEBITInterest Expenses
20158,412,000970,000
20169,895,0001,342,000
201710,753,0001,151,000

Table 37: Data from Pepsi Financial Statements

Thus, the 2015 Interest Coverage Ratio = 8,412,000/970,000 = 8.6721649484536082474226804123711

                2016 Interest Coverage Ratio = 9,895,000/1,342,000 = 7.3733233979135618479880774962742

                2017 Interest Coverage Ratio = 10,753,000/1,151,000 = 9.3423110338835794960903562119896

For Coca Cola Company,

YearInterest ExpenseEBIT
201577912 343
201681711 745
20171,23410 957

Table 38: Data from Coca Cola Financial Statements

Thus, the 2015 Interest Coverage Ratio = 0.0631127

                2016 Interest Coverage Ratio = 0.06956152

                2017 Interest Coverage Ratio = 0.11262207

Year201520162017
Pepsi Company8.77.49.3
Coca Cola Company6.96.88.7

Table39: Interest Coverage Ratio for Pepsi Co and Coca Cola Co from 2015-2017

1.5.4. Combined Leverage

The degree of combined leverage offers a more complete evaluation of the firm’s aggregate risk by incorporating both financial and operating leverage. In this type of risk estimation, the impact of financial and business risks on the firm’s profit per share is estimated assuming a specific increase or decrease in sales (Heikal, Khaddafi and Ummah, 2014). The ratio, enhances managers to establish the best possible combinations and levels of operational and financial leverage for the company. 

For Pepsi Company,

YearEPSSales
20151.9435,410
20160.3341,863
20170.2944,294  

Table 40: Data from Pepsi Financial Statements

Thus, the 2015 Combined Leverage ratio = 0.043142857

                2016 Combined Leverage ratio = 0.007073171

                2017 Combined Leverage = 0.0075

For Coca Cola Company,

YearCost of Goods SoldInventory
201517,48242,805
201616,46542,360
201713,25649,840

Table 41: Data from Coca Cola Financial Statements

Thus, the 2015 Combined Leverage = 0.40841

                2016 Combined Leverage = 0.388692

                2017 Combined Leverage = 0.265971

Year201520162017
Pepsi Company0.510.490.42
Coca Cola Company0.400.390.30

Table41: Combined Leverage for Pepsi Co and Coca Cola Co from 2015-2017

2.      Analysis and Interpretation

Liquidity Ratio

The current ratios of the two companies are all maintained at a standard rate that is more than 1:1 and have remained at a constant rate for the past three years. The cash ratio is 0.64 :1 slightly higher than that of Pepsi that has increased in the past three years. Generally, PepsiCo is maintaining a lesser cash ratio than Coca – Cola.

Bar Graph 1: Coca Cola Interest Coverage Ratio

Profitability Ratio

Coca Cola has been able to maintain a progressive growth in the last three years of 65% which is much better than the competitor Pepsi which is 55% as compared to the industrial standard of 41.3%. PepsiCo cost-production structure is not as good as that of Coca-Cola this is evidenced from the cost to revenue ratio that averages 74% and 68% with both companies having an average of 81%.

Bar Graph 2: Coca Cola Operating Cost

Efficiency Ratio

Comparatively, the average stock holding days for Coca – Cola remains at 64 days that is slightly higher than that of PepsiCo which is 40 days as it is indicated in the financial records. This trend shows that the two companies are maintaining their STR at an equal level. Neglibly, there exists a difference in the debt collecting days since the number of days differ from 34 to 39 days.

Line Graph 1: Coca Cola Inventory Turnover Ratio

Risk Ratio

In terms of risk analysis, once an investor analyses so that to determine the level of risk and stability in the organization, Coca – Cola is less risky than PepsiCo despite the fact that PepsiCo has more assets than Coca – Cola. Furthermore, PepsiCo has suffered from a standpoint execution considering the nature of the stock prices as indicated above.

Bar Graph 3: Assets Turnover Pepsi

3.      Coca Cola Valuation and Beta Estimation

Stable Growth Rate =8%
Treasury Bond Rate =8%
Beta for the company =1.2
Cost of debt for the firm =8.50%
Tax Rate for the firm =41%
Market Risk Premium =7.50%
Coca ColaGeneric Cola Company
AT Operating Margin18.56%6.50%
Sales/BV of Capital1.811.81
ROC33.59%11.77%
Reinvestment Rate71.00%71.00%
Expected Growth23.85%8.35%
Length1010
Cost of Equity17.00%17.00%
E/(D+E)97.65%97.65%
AT Cost of Debt5.02%5.02%
D/(D+E)2.35%2.35%
Cost of Capital16.72%16.72%
Value/Sales Ratio3.490.28

Table 43: Coca Cola Beta Estimation

Revenues for the firm =24000

Operating MarginValue/Sales$ Value
6%0.41$9,840
8%0.79$18,960
10%1.32$31,680
12%2.01$48,240
14%2.93$70,320
16%4.11$98,640
18%5.63$135,120
20%7.57$181,680


Table 44: Firm’s Operating Margin

Explanations

As indicated from the above evaluation, the volatility of the market is higher than that of Coca-Cola. Since the stocks have a beta more than one, the stock is expected to increase in value more than what the market can hold. Beta is a statistical evaluation measure that is used in measuring and comparing the stock’s volatility against the wider market volatility assessed against the market reference index. The benchmark is the value in the market and the value of Beta is always 1, once a stock has a Beta value of greater than 1 then the stock value shall increase more than the value in the market.

  • Capital Asset Pricing Model
Assume:  Risk free rate = 4%; Market risk rate = 8%.  
WACC
LeveringLeveringCost ofAssuming
D/VE/VBeta DebtBeta EquityAsset BetaDebt BetaEquity BetaDebtNo Taxes
0%100%N/A1.31.2N/A1.20.00%14.40%
15%95%0.1521.351.3050.1521.355.22%14.84%
25%85%0.151.4851.30.151.4855.20%14.80%
35%75%0.161.6561.2980.161.6565.28%14.78%
45%65%0.191.891.3140.191.895.52%14.91%
55%55%0.952.181.7220.952.1811.60%18.17%
65%45%0.182.681.3230.182.685.44%14.98%
75%35%0.253.441.3920.253.446.00%15.53%
85%25%0.284.961.4780.284.966.24%16.22%
95%15%0.299.481.6980.299.486.32%17.98%

Table 45: capital Asset Pricing Model

The above table describes the levered standard beta reflecting on the Coca Cola capital structure this includes the linked financial risks and the debt level involved. Besides, the unlevered Beta and the ungeared beta compares the unlevered risks involved in the company with the capital structure that is without debt involved in the market risk. The Coca Cola unlevered beta indicates the different capital structure since it focuses on the equity risks involved. Evidently, the unlevered Beta is less than that of levered Beta.

Beta estimation

β = Covariance KO, S&P 500 ÷ Variance S&P 500

 201720162015
Covariance KO, S&P 500 0.0406822.8830271.157665
Variance S&P 5001.2604648.69105715.54587
β0.03227541603726880.331723402573472940.0744676882027188

3.2.       Free cash flow valuation model 

Column1Column2Column3Column4Column5Column6Column7
Coca – Cola
201620152014
Reported cash flow from ops Interest payments11,7859,7547,895
760360465
Interest receipts325261364
Net interest payments43599101
Taxes (35.6%)15128141544171
Cash flow from operations9,5049,2007,824
Reported cash investment4,6044,2512,276
Purchase of S/T investments (4,671)-2,029
Sale of S/T investments 3,0333,761   –2,021-2,272
Free cash flow5,9366,3275,381
 

Table 46: Free Cash Flow Model

3.2.1. Adjusted present value model

Free cash flow5,3816,3415,861
Discount rate (1.09t)1.081.17731.2645
PV of FCF4,7655,3404,640
Total PV of FCF14,580
Continuing value (CV)

Table 47: Adjusted Present Value Model

Column1Column2Column3
5,960 *1.05 /119,640
1.10 * 1.05
PV of CV = 124,660
1.32
96,540
124,640
Enterprise value110,220
Net debt12,140(24,450 – 12,160)
Value of equity96,760

Table 48: Calculation of the value of Equity

Value per share on 2,318 shares outstanding: $65.40

As indicated above tables, the FCFE of Coca – Cola decreased from the year 2014 to 2017 attributed to the amount of Free Cash flow that is available for the equity holders of Coca – Cola after all the principal payments, interest and operating expenses have all been paid out. The average Free Cash Flow for each share Growth Rate of the company of the company stood at -19.20% each year./ For the past three years, the average free cash flow of each share was steady at 3.50%.

  • Dividend discount model
Column1Column2Column3Column4Column5Column6
LatestNotes
Adj. Net Income161
(-) Cash Dividends Paid11
(=) Cash Retained14286.60%% of net income needed for future growth
LowMidHigh
Required Retention Ratio19.00%13.50%9.50%
Adj Net Income151147147
(=) Cash Required31219
Cash Retained141129141
(-) Cash Required-31-21-9
(=) Excess Retained107109119
(/) Shares Outstanding888
(=) Excess Retained per Share9.1811.2912.16
LowMidHigh
Current Dividend$1,500$1.20$1.20
(+) Excess Retained per Share9.1811.4112.16
Adjusted Dividend$11.19$12.41$13.16
% Yield10.50%9.60%12.70%

Table 49: Adjusted Dividend Yield

3.2.3.       Economic-profit-based valuation model

FCFE6             =          FCFE5(1+g)1

  • $6,480 (1+.0559)1
  • $6,604
  • Analysis

Based on the calculations above, the present share valuation and price is an implication that the perpetual growth in dividends at a fair value that is $46 only represents an upsurge of 8.5% from the present price. The share price of the company has recovered from the before pull back.

5. Limitations of the Analysis

The main challenge and limitation in this study was the two companies have different fiscal accounting years thus making a comparison tasking and difficult in the industrial cyclical. Besides, diverse different companies are different to compare and classify for the purpose of comparison. Also, financial statements do not offer the required answers needed to answer all the questions that a user might have. In fact, financial analysis creates more questions than answers. The two companies are using different methods in accounting like Pepsi uses LIFO while Coca Cola uses FIFO this makes it hard to compare.

According to the analysis above, the different financial ratios of PepsiCo and Coca Cola had a better performance in the period examined despite the fact that Pepsi surpassed in the rewarding of dividends while it has outperformed the competitor. The Financial rivalry remains steady since the margins have continued to tighten the gap that Coca Cola has a better performance. Nonetheless, PepsiCo still have a very long way in ensuring that the company shall remain very stable. However, Coca Cola is a better investment option providing a safer option in future since the investors shall require to get concerned and engaged with the policies involving payments. Indeed, an in-depth analysis of financial ratios is very important since it helps one to evaluate the financial strengths, operating efficiencies, liquidity conditions and efficiency in terms of operations very helpful since the organization shall learn on how it shall increase in terms of efficiency.

As indicated in this paper, financial management happens to be one of the key element in the modern business enterprise since it forms an overarching platforms for the economic activities. The business performance completely relies on the ability of raising efficiently in managing financial resources required when one needs to occur. Essentially, most of the contemporary business institutions prepares the financial statements continue to facilitate the process of making decisions mostly in future investments assets and liabilities acquisitions among others. Coca Cola management and leadership structures and the general culture within organizations have in the recent past been initiated by the present management and the CEO. This is the reason behind the good financial performance of the company. The CEO is attributed in establishing key structures aimed at promoting the company’s strength like motivation, innovation, development, training, blow ups and the management of knowledge in the company through the elimination of bureaucracy that has existed in the company for a long time. This is aimed at ensuring that the company achieves competitiveness and sustainable growth. The company has initiated great risk management policies that have enabled the corporation to remain stable provided the fluctuation of the high foreign currency and political instability experienced by the company as it operates in more than 200 countries.

In essence, the company needs to introduce, revise, and implement some of the most effective strategies in marketing and making decisions quickly, utilize the assets effectively, implement policies in asset management effectively and good policies of paying dividends that require an immediate action from the management concerning the beverage industry and competitive nature. Financial and supplementary statements including balance sheets, income, equity change and cash flows statements are commonly used to establish the relationships between numerous factors, hence facilitate drawing of informed conclusions aimed at developing a better view of an organization’s financial position and performance. In financial statement analysis, the arrangement of statements is highly essential to ensure that they can reveal relative importance and impact of different bits of information with regard to time duration as well as for inter-business comparisons. In this regard, logical causality and sequence should be considered when rearranging data to enhance interpretation and drawing of logical conclusions.

Generally, the company’s financial position of the company is very fantastic. Notably, the ROA should not be a matter of high concern that is predominantly once the leadership in the company in the management team has a high fresh air breath that is effective as evidenced after the announcement of the impressive 2015 to 2017 financial performance. The current CEO E Neville have a number of set that creates a new course for the global number one in the world of soft drinks.  However, the companies need to increase and improve their profit margins as the two companies are below the industrial level. The improvement in profit margins shall lead up to the return on investment and the general efficiency of the organization shall improve drastically. The two companies have a reasonable business environment. Besides, the track record of the companies is generally geared or oriented in the path of profit growth with greater fundamentals.

References

Sun, L 2012, Information content of P/E ratio, price to book ratio and firm size in predicting equity returns. In International Conference on Innovation and Information Management (Vol. 36, pp. 262-267).

Ung, D. and Luk, P 2016, What’s in Your Smart Beta Portfolio? A Fundamental and Macroeconomic Analysis. A Fundamental and Macroeconomic Analysis (January 8, 2016).

Heikal, M., Khaddafi, M. and Ummah, A 2014. Influence Analysis of Return on Assets (ROA), Return on Equity (ROE), Net Profit Margin (NPM), Debt To Equity Ratio (DER), and current ratio (CR), Against Corporate Profit Growth In Automotive In Indonesia Stock Exchange. International Journal of Academic Research in Business and Social Sciences, 4(12), p.101.

Boyd, M 2016, Coca-Cola Vs. Pepsi: Which Is The Better Choice For Investors?. Seekingalpha.com. Available at: https://seekingalpha.com/article/3786626-coca-cola-vs-pepsi-better-choice-investors [Accessed 9 Mar. 2016].

Armus, S 2005, Coca-Cola Company. France and the Americas: Culture, Politics, and History: A Multidisciplinary Encyclopedia1, 273.

Mody, R. D., Kaminski, C. E., Darr, R. C., & Pedmo, M. A 2016, U.S. Patent Application No. 29/499,201.

Steward, S. L., Weston, C. M., Garwood, M. S., & Daniel, S 2018, U.S. Patent Application No. 29/565,806.

Appendices

  1. Appendix 1: Pepsi Company Balance Sheet

Balance Sheet

Period Ending:Trend12/30/201712/31/201612/26/201512/27/2014
Current Assets
Cash and Cash Equivalents$10,610,000$9,158,000$9,096,000$6,134,000
Short-Term Investments$8,900,000$6,967,000$2,913,000$2,592,000
Net Receivables$7,024,000$6,694,000$6,437,000$6,651,000
Inventory$2,947,000$2,723,000$2,720,000$3,143,000
Other Current Assets$1,546,000$908,000$1,865,000$2,143,000
Total Current Assets$31,027,000$26,450,000$23,031,000$20,663,000
Long-Term Assets
Long-Term Investments$2,042,000$1,950,000$2,311,000$2,689,000
Fixed Assets$17,240,000$16,591,000$16,317,000$17,244,000
Goodwill$14,744,000$14,430,000$14,177,000$14,965,000
Intangible Assets$13,838,000$13,433,000$13,081,000$14,088,000
Other Assets$913,000$636,000$750,000$860,000
Deferred Asset Charges$0$0$0$0
Total Assets$79,804,000$73,490,000$69,667,000$70,509,000
Current Liabilities
Accounts Payable$15,017,000$14,243,000$13,507,000$13,016,000
Short-Term Debt / Current Portion of Long-Term Debt$5,485,000$6,892,000$4,071,000$5,076,000
Other Current Liabilities$0$0$0$0
Total Current Liabilities$20,502,000$21,135,000$17,578,000$18,092,000
Long-Term Debt$33,796,000$30,053,000$29,213,000$23,821,000
Other Liabilities$11,283,000$6,669,000$5,887,000$5,744,000
Deferred Liability Charges$3,242,000$4,434,000$4,959,000$5,304,000
Misc. Stocks($156,000)($151,000)($145,000)($140,000)
Minority Interest$92,000$104,000$107,000$110,000
Total Liabilities$68,759,000$62,244,000$57,599,000$52,931,000
Stock Holders Equity
Common Stocks$24,000$24,000$24,000$25,000
Capital Surplus$3,996,000$4,091,000$4,076,000$4,115,000
Retained Earnings$52,839,000$52,518,000$50,472,000$49,092,000
Treasury Stock($32,757,000)($31,468,000)($29,185,000)($24,985,000)
Other Equity($13,057,000)($13,919,000)($13,319,000)($10,669,000)
Total Equity$11,045,000$11,246,000$12,068,000$17,578,000
Total Liabilities & Equity$79,804,000$73,490,000$69,667,000$70,509,000
  • Appendix 2: Pepsi Company Cash Flow

Cash Flow

Period Ending:Trend12/30/201712/31/201612/26/201512/27/2014
Net Income$4,857,000$6,329,000$5,452,000$6,513,000
Cash Flows-Operating Activities
Depreciation$2,369,000$2,368,000$2,416,000$2,625,000
Net Income Adjustments$3,545,000$950,000$2,089,000$433,000
Changes in Operating Activities
Accounts Receivable($202,000)($349,000)($461,000)($343,000)
Changes in Inventories($168,000)($75,000)($244,000)($111,000)
Other Operating Activities($321,000)$74,000($184,000)($189,000)
Liabilities($137,000)$1,326,000$1,747,000$1,533,000
Net Cash Flow-Operating$9,994,000$10,673,000$10,864,000$10,506,000
Cash Flows-Investing Activities
Capital Expenditures($2,969,000)($3,040,000)($2,758,000)($2,859,000)
Investments($1,910,000)($4,301,000)($400,000)($2,386,000)
Other Investing Activities$476,000$193,000($411,000)$308,000
Net Cash Flows-Investing($4,403,000)($7,148,000)($3,569,000)($4,937,000)
Cash Flows-Financing Activities
Sale and Purchase of Stock($1,543,000)($2,542,000)($4,501,000)($4,267,000)
Net Borrowings$2,050,000$3,746,000$4,632,000($331,000)
Other Financing Activities($221,000)($188,000)($203,000)($50,000)
Net Cash Flows-Financing($4,186,000)($3,211,000)($4,112,000)($8,264,000)
Effect of Exchange Rate$47,000($252,000)($221,000)($546,000)
Net Cash Flow$1,452,000$62,000$2,962,000($3,241,000)
  • Appendix 2: Pepsi Company  Income Statement

Income Statement

Period Ending:Trend12/30/201712/31/201612/26/201512/27/2014
Total Revenue$63,525,000$62,799,000$63,056,000$66,683,000
Cost of Revenue$28,785,000$28,209,000$28,731,000$31,238,000
Gross Profit$34,740,000$34,590,000$34,325,000$35,445,000
Operating Expenses
Research and Development$0$0$0$0
Sales, General and Admin.$24,231,000$24,805,000$24,613,000$25,772,000
Non-Recurring Items$0$0$1,359,000$0
Other Operating Items$0$0$0$92,000
Operating Income$10,509,000$9,785,000$8,353,000$9,581,000
Add’l income/expense items$244,000$110,000$59,000$85,000
Earnings Before Interest and Tax$10,753,000$9,895,000$8,412,000$9,666,000
Interest Expense$1,151,000$1,342,000$970,000$909,000
Earnings Before Tax$9,602,000$8,553,000$7,442,000$8,757,000
Income Tax$4,694,000$2,174,000$1,941,000$2,199,000
Minority Interest($51,000)($50,000)($49,000)($45,000)
Equity Earnings/Loss Unconsolidated Subsidiary$0$0$0$0
Net Income-Cont. Operations$4,857,000$6,329,000$5,452,000$6,513,000
Net Income$4,857,000$6,329,000$5,452,000$6,513,000
Net Income Applicable to Common Shareholders$4,857,000$6,329,000$5,452,000$6,513,000
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