Coke Vs Pepsi

Group Member Name PG ID

Shobhit Saxena 61920058
Ajay Agarwal 61920934
Siddhartha Mukherjee 61920202
Kaustav Mukherjee 61921071
Khushi Sahu 61920799
Background

 Following the merger announcement between PepsiCo Inc. and the Quaker Oats
Challenging the Conventional
Company, the implications of the merger for the rivalry between Coca-Cola Co. and
PepsiCo, and for value creation by each firm needs to be examined
 Because the merger would allow PepsiCo to control Gatorade, which held an 83%
share in the sports drink market, PepsiCo would further strengthen its already-wide
lead over Coca-Cola Co. in the non-carbonated drinks segment.
 Will the merger threaten Coca-Cola's historically stellar performance in terms of
value creation?
Economic Profit

EP = NOPAT – (WACC*Invested Capital)

Economic Profit is a non-GAAP
Challenging themetric that measures the intrinsic value of an investment while taking into account opportunity
Conventional
costs. It is calculated by subtracting the all the tangible costs and intangible costs of an investment. While tangible costs are
subtracted in accounting profit as well, economic profit takes into account a couple of other costs;

 Opportunity cost of making an investment and therefore foregoing the next best alternative

 Cost of invested capital, both debt and equity

The idea of economic profit is to evaluate investments while accounting for alternatives and risk. It is therefore considered, in some
circles, to be a “truer” measure of profitability.
Advantages and Disadvantages of Economic Profit

Advantages Disadvantages
 Taking cost of capital into account ensures that managers  Hard to calculate: It is extremely difficult to reliably measure
focus onChallenging the Conventional
creating operational value as opposed to opportunity cost of a hypothetical project that a firm
manipulating capital structure to generate financial value ultimately decided not to pursue
 Dis-incentivises reckless risk taking to generate short  Easy to manipulate: Because it is hard to reliably estimate
term profits EP, business managers can come up with forecasts that
are favorable to their cause but not necessarily accurate
 Great way to evaluate opportunities in situations where
one company has multiple options and the objective is to
maximize overall company value as opposed to a single
project value

 Efficiency metric measuring “alpha” generated by

businesses as opposed to absolute returns

(1) HDFC Securities, Research Report, May 28, 2019

Drivers of Economic Profit

Drivers
 NOPAT
 WACC Challenging the Conventional
 Invested Capital

The economic profit metric in Coke vs Pepsi had a few interesting observations
 Coke starts at an EP of $1.2 bil in 1996 and ends up at $1.01bil with a range of $1.01 – $1.8 bil, suggesting fairly limited volatility.
Pepsi in contrast has a range of -$0.91bil – $1.2bil.
 Coke’s spread goes from 13.4% to 6.4% driven entirely by increased investment capital requirements to generate the same absolute
return, suggesting inefficient use of capital
 Pepsi’s spread goes from -3.4% to 9.1% driven by decreasing capital requirements to generate the same absolute returns, suggesting
an increasingly efficient use of capital

Drivers of the changes include

 Sale of Taco Bell, KFC, Pizza Hut which likely permitted Pepsi to focus on its core business
 Sale of Pepsi’s bottling operations and focus on higher margin concentrate business
 Business mistakes by Doug Ivester, Coke CEO from 1997 to 1999 was a drag on returns
WACC
Cost of Debt Coke Pepsi
Semi Annual Coupon Rate 5.75% 5.75%
Maturity 4/30/2009 1/15/2008
Current Price $91.54 $93.26
Credit Rating A1 A2
Pre Tax Cost Of Debt 7.09% 6.92%
Effective Tax Rate (Income Tax / PreTax Income) 30% 32%
After Tax Cost of Debt 4.96% 4.70%

Cost of Equity Coke Pepsi

Risk Free Rate (10 year T bond) 5.73% 5.73%
Historic Beta 0.88 0.88
Equity Risk Premium 5.90% 5.90%
Cost of Equity as per CAPM 10.92% 10.92%

WACC Coke Pepsi

Market Value of Debt $4,377,387,400 $2,245,055,881
Diluted Shares Outstanding 2,487,000,000 1,475,000,000
Current Market Price $62.80 $43.81
Market Value of Equity $156,183,600,000 $64,619,750,000
Total Value $160,560,987,400 $66,864,805,881
% Debt to Value 2.73% 3.36%
% Equity to Value 97.27% 96.64%
WACC 10.76% 10.71%

12/4/2019 6
NOPAT

(in $ million) Coke Pepsi

2001E 2002E 2003E 2001E 2002E 2003E
Operating Income $5,399 $6,132 $6,633 $4,385 $4,885 $5,369
+ Goodwill Amortization $295 $295 $295 $236 $295 $295
- Actual Cash Taxes ($1,738) ($1,957) ($2,131) ($1,142) ($1,245) ($1,504)
NOPAT $3,956 $4,470 $4,797 $3,479 $3,935 $4,160

NOPAT  Net operating profit after taxes (NOPAT) is calculated with the aim of arriving at the actual cash generated by
the concern. Adjustments might include adding back goodwill amortization and other noncash expenses. Taxes must
similarly be adjusted to reflect only actual cash taxes. Depreciation is not added back to NOPAT despite being a noncash
expense, because of the assumption that depreciation represents a true economic cost

12/4/2019 7
Invested Capital
(in $ million) Coke Pepsi
2001E 2002E 2003E 2001E 2002E 2003E
Loans and notes payable 3,600 3,500 3,400 202 - -
+ Current portion of long- term debt 154 153 2 281 444 64
+ Long-term debt 681 528 526 2,106 1,825 1,381
+ Deferred income taxes 302 239 170 1,625 1,974 2,252
+ Accumulated other comprehensive losses 2,722 2,722 2,722 1,394 1,394 1,394
+ Total equity 11,267 11,898 12,368 9,282 11,648 11,382

+ Accumulated goodwill amortization 487 782 1077 987 1282 1577

– Marketable securities 2,364 2,364 2,364 - - -

Invested Capital 16,849 17,458 17,901 15,877 18,567 18,050

12/4/2019 8
Conclusion

 As per the EVA Calculation based on Estimated financials for 2001 to 2003, Coca-
Challenging the Conventional
Cola is a better financial option in the foreseeable future due to its ability to
generate more economic profit

Forecasted EVA
(in $ million) 2001E 2002E 2003E
Coke $2,143.12 $2,591.60 $2,870.93
Pepsi $1,778.06 $1,945.88 $2,226.27

(1) HDFC Securities, Research Report, May 28, 2019