Pepsi vs. Coke
...Coca-Cola remain at the same level as previous years whereas for PepsiCo we observe a slight increase. At this point we divide NOPAT by Invested Capital to find the return on invested capital (ROIC) (see Exhibit). Next step is to compute the cost of capital for Coca-Cola and PepsiCo. WACC Since both Coca-Cola and PepsiCo have debt and equity in their capital structure, we used the Weighted Average Cost of Capital (WACC) method. Our estimates of WACC for Coca-Cola and PepsiCo (see Exhibit 3 and 4) were based on the following assumptions: 1. Cost of debt The cost of debt for Coca-Cola and PepsiCo are 6.58% and 6.23% respectively. We arrived at these estimates by adding the spreads for companies with debt rating of A1 (Coca-Cola) and A2 (PepsiCo) to the yield on 10-year US Treasury bond (see Exhibit 3 and 4). The coupon rate on companies’ publicly traded debt can also be used as the cost of debt. But the coupon rate is a sunk cost and doest not fully reflect the market. 2. Cost of equity We calculated the cost of equity for both companies using the Capital Assets Pricing Model (CAPM). Other methods such as Constant dividend growth model can be used to estimate the cost of equity. However, in our opinion CAPM is the proper method because it reflects the risk of the particular company’s equity. Our estimate of both Coca-Cola’s and PepsiCo’s cost of equity is 10.9%. We used the yield on 10-year US Treasury bonds as the risk-free rate, and the compound average premium of the market over Treasury bonds (5.9%) as the risk premium. For beta, we took the average of companies’ beta from 1994 to 2000 (0.88). 3. Book or Market weights of debt and equity? In our calculation of weights we think that market values of debts and equity are more appropriate for measuring the cost of capital. We assume that the market value of debt is equal to its book value (see Exhibit 3 and 4) because the difference between the book and market values of debt is quite small. To compute market value of equity we discounted the Coca-Cola’s and PepsiCo’s equity free cash flows (EFCF) using companies’ cost of equity (see Exhibit 3 ...