Pepsi

PEPSICO VALUATION
28 April 2005
EMON SILA
emonsila@hotmail.com
MATT BALLARD
Mballard_806@hotmail.com
TABLE OF CONTENTS
Executive Summary……………………………………………………… 2
Business & Industry Analysis……………………………………… 5
Five Forces Model....... ……………6

Competitive Strategy Analysis…..…9
Key Success Factor…....……….... 10
Accounting Analysis………………………………. 13
Key Accounting Policies…..…… 14
Screening Ratios ………..……... 21
Ratio Analysis & Forecast Financial……………… 25

Firm Analysis……………………. .26
Cross Sectional Analysis……...….. 30
Financial Statements Forecasting… 46
Valuation Analysis………………………………..…48
Method of Comparables……………48
Free Cash Flow……………………..51
Discounted Dividend……………….53
Discounted Residual Income……….54
Long Run Residual Income………...56
Abnormal Earning Growth…………57
Appendix……………………………………………60
1
Executive Summary
I Executive Summary
Investment Recommendation: Slightly Overvalued Sell
PEP – NYSE $53.63

52 week price range $47.37 - 55.71 Valuation Ratio Comparison PEP Ind Avg
Revenue (2004) 29,261 (mill) Trailing P/E 22.1 19.4
Market Capitalization 89.99B Forward P/E 20.69 19.18
Forward PEG 1.88 2.19
Shares Outstanding 1.68B M/B 6.47 4.55
Dividend Yield 1.72% Valuation Estimates

3-month Avg Daily Trading Volume 3,251,909 Actual Current Price (April 1, 2005) $52.76
Percent Institutional Ownership 66.44%
Ratio Based Valuations
Book Value Per Share (mrq) 8.083 P/E Trailing $49.47
ROE 31.24% P/E Forward $48.92
ROS 53.68% PEG Forward $50.80
Dividend Yield $39.72
Cost of Capital Estimates Beta Ke M/B $37.07
Ke Estimated Ford Epic Valuation $71.33
5yr Beta .32 2.57% Intrinsic Valuations
3yr Beta .76 5.6% Discounted Div $43.18
2yr Beta .48 3.69% Free Cash Flows $47.90
Published Beta .65 4.88% Residual Income $51.80
Abnormal Earnings Growth $54.13
Kd 3.98% Long-Run Residual Income Perp $56.20
WACC 4.80%
2
Executive Summary
As we mention previously PepsiCo is a world leader in convenient food and

beverages, with revenues of about $29 billion in 2004. The company consists of the
snack business of Frito-Lay North America, PepsiCo Beverage Int’l, PepsiCo Beverages
North America and Quaker Foods North America. PepsiCo (PEP) shares are traded on
the NYSE in the United States. PepsiCo has implemented cash dividends since the
corporation was founded. Besides NYSE, this company is also listed on the Amsterdam,
Chicago, Swiss, and Tokyo stock exchange (www.pepsico.com). We have found that the
non-alcoholic beverage industry is dominated by three major players which are PepsiCo,
Coca-Cola and Cadbury Schweppes. There is tremendous competition within a relatively
slowing industry. This industry is known for the rivalry between Pepsi and Coke over the
years. PepsiCo currently controls nearly 21% of this industry. On the other hand Frito-
Lay controls 60% of the U.S snack-food market. Switching costs are virtually inexistent
in this industry. Within the industry there are large economies of scale and it is hard for
new entrants in this industry. PepsiCo has done a great job of building a great brand
name, rivaling that of Coca-Cola. In PepsiCo’s industry there is a considerable threat of
product substitution. PepsiCo has a low bargaining power of suppliers because like Coke
they own their bottling companies. PepsiCo’s competitive strategy is also based on
differentiation instead of cost leadership. This means that they have to highly invest in
new flavors, formulas, and packaging to compete with their competition. PepsiCo has a
flexible distribution network; products are brought to the market through vending
distribution networks, direct store delivery, and broker-warehouse.
After extensive review of PepsiCo’ accounting practices we feel highly

confident in their financial disclosures. We analyzed several aspects including: key
accounting policies, accounting flexibility, accounting strategy, quality of disclosures,
potential red flags, and screening ratios. While there were a few discrepancies, the
importance of the errors weighted very little on our analysis. By targeting these aspects
individually we were able to dissect and examine the underlying procedures of PepsiCo.
We determined that their key accounting policies and strategies are directly in line with
industry practices. Also, in dealing with account flexibility we determined that there was
some flexibility and changes in accounting procedures but these were in line with actions
3
Executive Summary
of regulation and industry standards. Quality of disclosures was adequate in regards to

voluntarily giving information to investors. After review we determined that there were
no main causes for alarm. While there were some activities that looked suspicious, after
further investigation we determined them to be of minor consequences. Finally,
screening ratios were used to determine if there were any potential manipulations.
Overall these ratios were fairly consistent over the years. Also, comparing PepsiCo to the
industry further supported our decisions, in that they were consistent with that of
competitor’s ratios.
We analyzed PepsiCo using the liquidity, profitability, and capital structure

categories of ratios. By doing this analysis we founded that PepsiCo is relatively liquid,
has a moderately favorable profitability and that capital structure has a moderately
positive analysis. PepsiCo financial statements are reasonably transparent. They are
reported on quarterly basis. These financial statements give their shareholders and
investors good and clear inside information about PepsiCo. The forecasting that we did
for PepsiCo financial statement showed a steady growth for the next 10 years. PepsiCo
has an excellent growth potential for the years to come because Frito-Lay, Pepsi-Cola,
Quaker Oats, Gatorade, and Tropicana brands all have strong market position in North
America. Our forecasted financial statements are free of errors and we don’t assume that
our forecast it is going to be accurate because as we know the longer the period of
forecast the less accurate the forecast will be.
We valued PepsiCo based on six valuation models. These models include the
following: Method of Comparables, Discounted Free Cash Flows, Discounted Dividends,
Discounted Residual Income, Abnormal Earning Growth and Long Run Average
Residual Income Perpetuity based on the P/B ratio. Valuation is the process of converting
the forecast that we did for the company into an estimate of the value of the firm. To use
this method we had to find the Kd, Ke and WACC of the company. We did this by
considering the risk of the company and by calculating how much of the firm is financed
with debt and equity. In all these models except the abnormal earning growth model, the
actual price exceeds our estimated price. These models show that PepsiCo as slightly
4
Business & Industry Analysis
overvalued by an average of $3.51 per share. In most of these models the change of the
growth rate was the most sensitive factor of change, besides the discounted residual
income where the cost of equity was the sensitive factor of change. Even though there
may be some errors in the models, we feel that PepsiCo stock price is slightly overvalued
and we recommend investors to sell this stock.
II Business & Industry Analysis
PepsiCo was founded in 1919 in Delaware and was reincorporated in North

Carolina in 1986. Now this company is one of the world leaders in snacks, foods and
beverages. (www.pepsico.com). PepsiCo produces and market different kind of salty,
convenient, sweet and grain-based snacks, carbonated and non-carbonated beverages.
PepsiCo had revenue of about $29 billion in 2004, 27 billion in 2003 and over 200,000
employees. The company is organized in four divisions which consist of the Frito-Lay
North America, PepsiCo Beverage North America (Pepsi-Cola America and
Gatorade/Tropicana North America), PepsiCo International, and Quaker Foods North
America. The international division operates in around 200 countries. The largest of
operations are held in United Kingdom and Mexico (www.pepsico.com). PepsiCo has
emerged as a vast and diverse company, involved in beverages as well as snack foods.
PepsiCo’s division Frito-Lay holds a significant leadership in the snack industry even
though is faced with different competition everyday. The company produces eight of the
ten best selling snacks in the nation. Frito-Lay controls 60% of the U.S. salty snack-food
market and has the number one position in corn chips, potato chips, tortilla chips and
pretzels (www.finance.yahoo.com). The beverage industry is dominated by three major
players which together control the global market. These players are Coca-Cola, PepsiCo,
and Cadbury Schweppes (Dr Pepper and Seven Up). For years this industry is known for
the war between Coke and Pepsi on the cola principals. Now this war has ended and the
industry’s giants have been focusing in on creating new product flavors to compete with
each other.
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Five Forces Model
Competitive Force 1: Rivalry Among Existing Firms
Due to the fact that this industry’s growth has had relevantly little growth over the
years, there is tremendous competition within the industry. This industry has low
concentration. Three major firms account for 80% of the global market. These firms
include PepsiCo, Coca-Cola, and Cadbury Schweppes. Coca-Cola has achieved 50% in
global market share, while PepsiCo controls 21%, and Cadbury Schweppes maintains 7%
(www.finance.yahoo.com). Competition amongst these firms is not mainly based on
price competition but rather product differentiation. Many firms rely on new flavors and
have also branched into non-carbonated beverages and snack foods to give there firm a
competitive advantage over others. PepsiCo has also been exceeding in this by acquiring
Quaker Oats which owns Gatorade. PepsiCo has also added Tropicana, Aquafina, and
Lipton into its product line making PepsiCo number one in the non-carbonated beverage
industry. Coca-Cola has also entered into this arena by emerging with Nestea, Powerade,
and Minute Maid brands to compete in this movement. PepsiCo has also branched into
the breakfast and snack food industry with Quaker Oats and Frito-Lay. While PepsiCo
has remained at number two in soft drinks, this diversification has helped make up the
difference in competition. Switching costs are virtually inexistent in this industry as there
are no costs for consumers to switch products. The only costs to switching would be a
different taste, appearance, and appeal. This is mainly due to the fact that firms have
cooperated to maintain the same price for there products. Consumers are faced with a
decision of choosing a product not based on price but rather on style, taste, and other
contributing factors. Under these circumstances, companies have spent considerable
energy to market there products to achieve brand awareness. There is also a tremendous
learning curve for these companies, resulting in extreme barriers to entrance of other
emerging companies. Most companies have developed extensive distribution systems
and have created relationships with suppliers and buyers. Also there are extensive
economies of scale resulting in companies with massive size. This has been created by
obtaining extreme amounts of capital and diversifying the company into other markets.
6
In this type of industry there are relatively few exiting barriers which have left only a few
companies to compete in.
Competitive Force 2: Threat of New Entrants
Within this industry there are large economies of scale. This results in an extreme
amount of capital to propel the company. Using capital for manufacturing isn’t much of
a concern as there are generic brands which cost less. Much capital is used to market and
advertise there products to achieve brand awareness and differentiate there products from
others. PepsiCo has done a tremendous job by creating a household name rivaling that of
Coca-Cola’s. Such common household names are Pepsi, Mountain Dew, Gatorade,
Tropicana, Lipton, and Quaker and Frito-Lay products. New companies trying to emerge
into the industry have a distinct disadvantage due to the fact that the top companies have
already developed such traits. This has caused new companies to not be able to compete
head on with rivals. Also companies within the industry have developed extensive
arrangements and relationships with manufactures and distributors. PepsiCo for example
has Pepsi Bottling Group. This independent entity makes, sells, and distributes Pepsi
brands around the world.
Competitive Force 3: Threat of Substitute Products
In PepsiCo’s industry there is a considerable threat of product substitution.

Products offering the same qualities and features at a lower price can initiate customers to
substitute. In this day of age of health consciousness, new products have been developed
to meet this trend. To meet this concern many of the companies offer healthier
alternatives that ultimately cut into their other brands profits. Brands such as Pepsi One,
Diet Pepsi, and Coca-Cola’s C2, and Diet Coke have been developed to meet this concern
head on. Another concern is that of generic brands such as grocery store brands. The
relative concern is based on price. For example most grocery stores have their own
brands of soda, juices, breakfast, and snack items. While the top companies have there
7
own distinct image, these generic brands offer a similar taste but at a much lower price.
This industry’s main concern is if customers become price conscious and stray away
from popular brands such as PepsiCo products. As long as consumers place value on
these companies products there shouldn’t be that much of a concern.
Competitive Force 4: Bargaining Power of Buyers
PepsiCo is more sensitive to price due to the fact that there are low switching
costs involved in producing their products. Because the total cost of manufacturing their
product comes from packaging, PepsiCo is more apt to search for the lowest price of their
raw materials being that are readily available and are a common material (i.e. plastics and
aluminum). Being that PepsiCo is such a large producer enables them to hold a strong
bargaining position. Since they buy so many raw materials they are able to get lower
prices for them buying in such bulk. Also the number of readily available materials to
PepsiCo increases their bargaining power due to the fact if a specific supplier can not
match a price or does not have the material available; it is not difficult to find it quickly
and inexpensively. However these packaging and distribution expenses are taken by
Pepsi Bottling Group which is a separate entity of PepsiCo and became publicly traded in
early 1999. Even though PBG is a separate company; PepsiCo owns 40% of PBG’s
equity interest. (www.msn.com)
Competitive Force 5: Bargaining Power of Suppliers
There are many different suppliers in PepsiCo’s industry. These suppliers are
the bottlers and metal can suppliers. PepsiCo is in a unique position in which it used to
own Pepsi Bottling Group. In 1999, Pepsi Bottling Group became independent and in
which PepsiCo retains 40% of its shares. Because of this suppliers of bottlers have a
relatively low bargaining power relative to PepsiCo because they are a continued vested
interest of PepsiCo. This makes PepsiCo able to have a distinct advantage over other
competitors in production and distribution. Pepsi Bottling Group also provides other
8
ingredients that are used in the food and beverage businesses, these include: almonds,
cocoa, corn, flavorings, flour, juice, oranges, potatoes, and different kind of
fruits.(www.pepsico.com) This gives PepsiCo the chance to produce low cost products
over competitors. PepsiCo also employs specialists to secure the best suppliers that are in
the market for many of these items in order to produce quality products too.
Competitive Strategy Analysis
The beverage and snack industry is very competitive. Their competitive strategy
is based on differentiation instead of cost leadership. This means that the giants of the
business like PepsiCo should explore new formulas, flavors and appearances to compete
with each other. This is what PepsiCo is already doing by introducing two different lime
flavor drinks by the end of this month. PepsiCo is known for producing a variety of
salty, sweet and grain-based snacks, carbonated and non-carbonated beverages and
foods. They invest many resources to produce superior products and in marketing for
brand awareness. This is one of the reasons that PepsiCo has been one of the leaders in
the beverage and snack industry.
Another competitive advantage that PepsiCo has is its non-carbonated beverage.

PepsiCo has lost the war against Coke for the carbonated beverages, but they are the
leader in the non-carbonated beverages category. They have done this by adding
Gatorade’s 73% share of the sports drink market to its Tropicana and Lipton tea holdings.
(www.finance.yahoo.com) This means that PepsiCo is not only focusing on competing
with Coke on the carbonated beverages but they are looking to win battles in other
competitive areas. This is going to make PepsiCo maintain a competitive advantage over
a wider array of its competitors.
Another competitive advantage of PepsiCo is their flexibility of their distribution

network. PepsiCo products are brought to the market through direct-store delivery,
vending distribution networks and broker-warehouse. This distribution system is
9
developed in a way to satisfy customer needs and to show product characteristic. By

having a flexible distribution network PepsiCo is going to maintain their great reputation
and their product are going to satisfy their customers.
The last competitive advantage that PepsiCo has is its capital. PepsiCo is number
one in the snack industry, number two in the non-alcoholic industry and they have
revenue of about $29 billion. This means that they have excess money to spend on
advertising, quality of products and differentiation. PepsiCo by having such great capital
provides advertising, sales and promotional support to their beverage and food
customers. That’s why PepsiCo has some of the most-recognized advertising in the
world. By having such extensive capital PepsiCo is making some research and
development to find new flavors and to produce an even higher quality product. In
conclusion PepsiCo believes that their capital, differentiation, flexibility of their
distribution network and their non-carbonated beverage is going to allow them to
compete efficiently.
Key Success Factor
Strengths:
One of the biggest strengths of PepsiCo is its Officers and Directors. They are a
master of being honest, having analytical assessment and they have no shyness in terms
doing what needs to be done. Minority Business News names PepsiCo Chairman and
CEO Steve Reinemund “Executive of the Year.” (www.Forbes.com). It is because of
them that the PepsiCo is one of the best companies in the beverage and food industry.
Another strength of this company is their division Frito-Lay which has surpassed
companies of all sizes through a combination of restructuring, new products, and lower
prices. While Coke is synonymous with soda, so are Frito-Lay’s Fritos is with corn chips
demonstrating its product-name association. Like James Stack an editor of InvesTech
Research says, “While the company trails Coca Cola on the soft-drink industry, in the
snack foods, Frito-Lay which controls 60% of the U.S. salty snack-food market, has the
number one position in corn chips, potato chips, tortilla chips and pretzels.” They are the
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best-run company in the food business. For the twelve months ended Sept, 4, 2004
PepsiCo earned $3.93 billion on sales of $16.49 billion. This shows that company is very
profitable, has a good financial footing, and is continuing to grow.
While the soft drink segment is, as ever, PepsiCo is number 2, but is an
extremely strong number 2. They control 21% of the soft-drink market. It is going to be
hard to compete with Coke in the soft drink industry but PepsiCo is not just staying and
accepting defeat. The company’s purchase of The Quaker Oats Company and its
Gatorade brand show that they are still highly competitive.
Weaknesses:
Pepsi maybe is one of the weaknesses of PepsiCo due that is really far from the
leader Coca-Cola in the international market. Coke is three times Pepsi's size in fountain
sales and has more than ten times as many salespeople as Pepsi. In the U.S., Pepsi's
market share lags behind Coke's by the widest margin in over two decades. The net sales
of PepsiCo had increase in the past years but it is important to notice that this increase is
only because of sales in USA. Internationally, Pepsi's drink business was a mess. They
still haven’t figured out a way to increase their sales in the international market. But
lately they have improved internationally and especially after Coke have lost a lot of sales
in Europe. But PepsiCo has showed difficulties in the past in the international market and
they are trying very hard to improve these weaknesses. Another weakness is their
historically late entrance into carbonated beverage industry. Coca-Cola entered the
market in 1886 while Pepsi emerged in 1919 giving Coca-Cola a three decade head
start.(www.pepsico.com) Regardless of PepsiCo’s size, diversification, business acumen
or bottom line, consumers still see the company as only Pepsi, a product. While Coke has
fans (collector’s clubs, items, Christmas tree ornaments, etc.), Pepsi has purchasers.
Opportunities:
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There are still some undeveloped markets in the world that PepsiCo should try
to penetrate. They need to look for these markets and get established there before their
competitors. PepsiCo traditional carbonated soft drinks and salty snacks continue to
symbolize the company and it is going to do so for a long time. But you have to be risky
to succeed in business and to beat your competition. PepsiCo is thinking about taking a
risky strategy to make at least half of its new-product offering “nutritious” (www.new-
nutrition.com). We know that we live in a society where many people are worried
about their nutrition. We hear about this topic through the media and we read it in
magazines all the time. New good-for-you products from PepsiCo are going to include
soon dairy products, more whole-grain items in its Frito-Lay line of salty snacks,
products based on olive oil and a soy-enhanced Tropicana orange juice. This is going to
be a great opportunity for PepsiCo to make healthier product and to expand its market.
The key for the beverage companies is differentiation. The giants of the industry have
different formulas and appearances. PepsiCo for being one of these giants has the
opportunity to make better formulas and appearances for their customers so they can beat
their competition. PepsiCo is going to introduce a lime-flavored soda that is going to
compete with a similar offering of their rival Coca-Cola. By using a better formula and
appearance and a great advertising plan in these new drinks, they have the opportunity to
beat Coca-Cola.
Threats:
The prices of the items that PepsiCo purchase are subject of fluctuation. For
example the increase the prices of the raw materials or the fuel can cause an increase of
the costs of the production of their product, and in the business environment that PepsiCo
operates, it is not possible to increase the product price because they are part in a very
competitive environment. In the marketing department the PepsiCo brand image is very
much linked to Pepsi image, which has label of second best brand. This can still give
them the label of ‘loser’, linking its image to the rest of firm’s company. This can give
them a bad brand image in their markets. They need to improve in their marketing
12
Accounting Analysis
department through advertising campaigns where they are appeared together with other
PepsiCo Brands.
Conclusion:
PepsiCo has established itself as a very stable and profitable company in North
America and all over the world. As we mentioned above they are number two in the non-
alcoholic beverage industry and number one in the snack industry by owning Frito-Lay.
PepsiCo, Inc operates four major businesses: Frito-Lay North America, 34% of the sales
and 41% of operating profit; PepsiCo Beverages 29% of sales and 30% of operating
profit; Quaker Food 5% of sales and 9% of operating profit; PepsiCo Int’l 32% of sales
and 20% of operating profit. (Value Line) All these brands have a strong market
position in North America and because of these PepsiCo has a growth potential for the
years to come.
III Accounting Analysis
The next process of analyzing PepsiCo was to look at their accounting

activities. The following sections contain both the qualitative and quantitative methods
to evaluate the credibility of PepsiCo financial statements. The qualitative method
consists of five steps: key accounting policies, potential accounting flexibility, strategy
analysis, quality of disclosures, and potential “red flags.” Based on our analysis we did
not undo any accounting distortions. After our evaluation of the financial statements and
footnotes, we feel confident that PepsiCo’s accounting practices are not misleading or
distorted. The quantitative method consists of evaluating ratios to see the reliability of
PepsiCo financial results.
13
Accounting Analysis
Key Accounting Policies
PepsiCo is a manufacturing company that must compete in research and

development, product defect after the sale and product quality and innovation. PepsiCo
key accounting policies are revenue recognition, brand and goodwill valuations, income
tax expense and accruals, stock compensation expense, and pension and retiree medical
plans. These policies require management to make difficult judgment about uncertainties
and these results may significantly impact their financial results. PepsiCo needs to focus
on these key accounting policies to maintain a competitive advantage over it competition.
One of the most important key accounting policy for PepsiCo is revenue
recognition. They recognize revenue upon delivery to their customers in accordance with
written sales agreements that do not allow for a right of return. PepsiCo wants to
maintain a high reputation for its superior products. This is achieved by implementing a
policy for direct-store delivery with chilled fresh products, to remove and replace
damaged and out-of-date products. This ensures that their customers receive the highest
of quality and freshness from their products.
Another key accounting policy for PepsiCo is brand and goodwill valuations.
Many of their brand names have been developed by PepsiCo management. They believe
that a brand has an indefinite life if it has significant market share in a stable economic
environment, and a strong revenue and cash flow performance. Brands that don’t meet
these criteria are amortized over their expected useful lives. PepsiCo purchases brands
and goodwill in acquisitions in which are not amortized. They are recorded annually to
ensure that estimated future cash flows continue to exceed their relative book value. As
of December 27, 2003 PepsiCo had $4.7 billion of perpetual brands and goodwill, of
which nearly 75% related to Tropicana and Walkers.
14
Accounting Analysis
Income Tax Expenses and Accruals is another key accounting policy for PepsiCo.
They determine their annual tax rate based on their income, tax planning opportunities,
statutory tax rates, and significant judgment. Their annual tax rate was 28.5% in 2003.
The annual tax rate reflected in PepsiCo financial statements is different from that
reported in their tax return. Also due to tax laws, timing differences that create deferred
tax assets and liabilities must be shown.
Stock Compensation Expense is another key success factor for PepsiCo. PepsiCo
believes that rewarding employees based on there performance will ensure a more
productive workforce. At the end of 2003, PepsiCo board put in effect a new
compensation program, which makes the link between pay and individual performance
stronger. They achieved this by varying the amount of long-term compensation for each
employee based on individual performance and responsibility. This new program
provided employees with the choice of being granted stock options or restricted stock
units (RSUs). This new program is expected to reduce the stock compensation expense
for 2004 from $407 million in 2003 to $360 million.
The last key accounting policy for PepsiCo is pension and retiree medical plan
expenses. Their pension plans cover employees in USA and certain international
employees. They measure their annual pension and retiree medical expense based on
many assumptions. These include: the interest rate used to determine the present value of
liabilities, the expected return on plan assets, the rate of salary increases of plans where
benefits are based on earnings. Also they use certain employee-related factors such as:
turnover, retirement age, mortality, retiree medical benefits, and health care cost trend
rate. In 2003 PepsiCo’s pension and retiree medical expense was $157 million and $116
million respectively. In 2004 they are estimated to be $245 million and $120 million.
15
Accounting Analysis
Accounting Flexibility:
For PepsiCo there are a few recently adopted new accounting standards, but are
not expected to have a material impact on the bottom line of the consolidated financial
statements. This company has historically implemented accounting methods that make
their financial statements to reflect the truest economic reality possible.
PepsiCo products are sold for cash or on credit terms. The credit terms require
that the payments arrive within 30 days of delivery and awards discounts to customers for
early payments. Revenue is recorded at the time of delivery to customers. PepsiCo
management develops their own brand name and they also purchase brands through
acquisitions. The brands developed costs are expensed as incurred, and the purchase
price of brands is allocated under identifiable assets and liabilities based on estimated fair
value. Any remaining purchase price is recorded as goodwill. If brands meet the
criteria, they have an indefinite life. If a brand cannot live up to the set of standards, it is
amortized over its expected useful life. Goodwill and perpetual brands are not amortized;
they are assessed for impairment. A perpetual brand is impaired if its book value exceeds
its fair value. On the other hand, goodwill is impaired if the book value of its reporting
unit exceeds its fair value. If the fair value of an evaluated asset is less than its book
value, the asset is written down to fair value based on its discounted future cash flow.
PepsiCo recently changed methods to account for employee stock options. Under
the intrinsic value method, they did not recognize any stock compensation expense
because they grant their stock options at the current stock price. So at the end of 2003,
PepsiCo changed their way of measuring employee stock options. They adopted the fair
value method for accounting for stock options as described in SFAS 148, Accounting for
Stock-Based Compensation- Transition and Disclosure. Now the accounting procedure
recognizes stock compensation expenses from the date of grant to the vesting date.
Under this method, the expected value that employees will receive from the options is
16
Accounting Analysis
going to be based on a number of assumptions like interest rate, employee exercises,

PepsiCo stock price, and dividend yield.
Pension and retiree medical plans are other areas that show flexibility. These
plans are recorded as long-term liabilities for PepsiCo. The pension or retiree medical
benefits that are expected to be paid are expenses that are based on estimates. These
estimates include: factors such as the expected return on assets in their funded plans, the
rate of salary increase for plans where benefits are based on earnings, how long a person
will live after they retire, and on the interest rate used to determine the present value of
liabilities. If these estimates are not done accurately, the company will have an
overstated or understated net income.
Evaluating Accounting Strategy:
In order to assess if PepsiCo’s accounting strategies reflect true economic reality,

we had to evaluate the accuracy of their accounting policies. By comparing PepsiCo’s
policies with that of other firms in the industry, we were able to determine the differences
in strategies that could mean potential distortions. After careful review we determined
that PepsiCo’s implemented accounting policies are within the standards of the current
industry.
PepsiCo’s accounting policies are very similar in many aspects to other industry
competitors such as Coca-Cola and Cadbury Schweppes. One policy similarity is
revenue recognition, in which all companies recognize revenue when product titles are
transferred upon delivery. Also, the credit terms which require payment within 30 days
of delivery, are created in accordance with industry practices. This credit term policy is a
good business transaction that PepsiCo uses to collect money from their customers in a
short period of time. Another important similarity is brand and goodwill valuations.
Interestingly, PepsiCo and Coca-Cola use the same three criteria for evaluating goodwill
and other intangible assets. These include that assets with indefinite lives not be
17
Accounting Analysis
amortized, and that definite intangible assets are subject to amortization. They also
implement the same procedures to test for impairments that may result from a change in
future operations, economic downturns, or conditions present to indicate that carrying
value may not be recoverable.
Pension and retiree medical plans are very similar to the industry as well. They
each use estimations of the plan’s expected returns and risk characteristics. They adjust
these estimations based on the interest rate used to calculate the present values of the plan
liabilities, estimations of the maturity of the benefits, and increases in salary. Also,
advertising, marketing, and research and development are crucial to this industry. Even
though future value is created in these expenditures, all costs associated with these
ventures are expensed appropriately. Finally, the last policy reflects the treatment for
stock option via the fair value method. Coca-Cola, Cadbury Schweppes, and PepsiCo Inc
all have established the fair value method to account for employee stock options.
PepsiCo policies and estimates have been mostly realistic, but the company did
have a mistake in the earning release for the fourth quarter in 2003. They revised the
2002 and 2003 earning per share because of overstatements for stock option expenses.
This was something that does not normally occur in this company, but they explained that
is was a computational error. The revision increased the previously reported earnings per
share for 2003 by $0.04 to $2.05 and for 2002 by $0.02 to $1.68. This revision did not
have any impact on the company’s previously reported cash flow or division operating
profit because stock option expense is a non-cash charge. Even though such mistakes can
easily happen, erroneous financial reporting can overstate or understate earnings.
The firm made some changes in it accounting policies during 2003. One of these
changes was measuring employee stock options. Until 2003, they were using the
intrinsic value to measure this expense. The method that they were using measured the
stock compensation expense as the amount by which the market price of the stock on the
date of grant exceeds the exercise price. By using this method, they were not recognizing
any stock compensation expense because they granted their stock option at the current
18
Accounting Analysis
stock price. So by the end of 2003, they changed their method from intrinsic value to fair
value method of accounting for stock options. Under this method, they measure the stock
option expense at the date of the grant using the Black-Scholes valuation model. This
model estimates the expected value that the employees will receive based on different
assumptions such as interest rate, employee exercises, stock price and dividend yield.
The firm also restated their results using the fair value method. The impact of this
change is going to be recorded as unallocated expenses in each of the years presented.
Refer to Table 1 to see how the restatements affected the firm.
Table 1
2003 2002 2001
Operating Profit 407 435 385
Net Income 293 313 262
Net Income per common share $0.16 $0.17 $0.14
Quality of Disclosure:
PepsiCo provides to its investors and analysts adequate disclosures to assess the
firm’s business strategy. The quality of financial statements, accounting methods, and
information disclosed provided by the firm gives a true picture about their business.
Reports have shown that carbonated soft drink growth has been slowing overall
and that the brand name “PepsiCo” was declining during 2003. PepsiCo did not show
adequate information to its investors to explain these declines. They wrote a brief
paragraph in the Letter to the Shareholders to inform analysts and investors about this
current information. The paragraph though did not give any explanation or any remedies
19
Accounting Analysis
for this discouraging information. Instead, they disclosed information regarding the fact
that the firm has been growing in the past and is expected to grow in the future. The
letter talks about commitments to growth and in what sectors PepsiCo has achieved
growth. They also give a good description of the firm’s industry condition, environment,
and competitive positioning, but they did not disclose relevant information to their
investors about “bad news.”
PepsiCo discloses economic factors that affect the company. For example, some
of these factors include the exchange rate and political conflict. PepsiCo’s operations
outside of the United States generated approximately 35% of their net revenue of which
almost 20% comes from Mexico, United Kingdom, and Canada. The other 15% comes
from the rest of the world. By operating worldwide, the company is exposed to foreign
currency risks and political unrest. To prevent any losses and reduce the effect of the
foreign exchange rate, PepsiCo enters into primarily forward contracts with terms of no
more than two years. In 2002, PepsiCo hedged $2.1 billion Mexican pesos related to
their net investment in Pepsi-Gemex which resulted in a $5 million gain upon the
disposal of this investment.
PepsiCo does a job showing disaggregated performance information based on

their business segments. In there footnotes they present each segments accounting
information and address their strengths and weaknesses. Also, PepsiCo thoroughly
explains the reason why performances in certain segments have increased or declined.
For example, in the Frito-Lay division managers give relative information regarding what
products have performed good/bad and give adequate reasoning for both. In the
footnotes, managers also adequately explain the key accounting policies and assumptions
logically. For example when there are some significant changes in the firm’s policies the
footnotes give a good explanation for the reason of these changes.
Potential Red Flags:
20
Accounting Analysis
Based on our accounting analysis that we performed, we did not find anything
alarming for potential severe distortions in their accounting policies. We also felt very
confident in their reported numbers. We looked into the firm’s financial statements to
assess any unexplained changes in accounting policies. There has been a steady increase
in accounts receivable and accounts payable that most likely has been caused by the
steady increases in sales. There was also a large decrease in cash and cash equivalents,
but this could have resulted from the increase in short-term investments. Also, they have
been very consistent with valuing the amortization of there intangible assets. Although,
there was one fourth-quarter adjustment during 2003, this was due to a computational
error and was corrected immediately. There isn’t much cause of alarm since there hasn’t
been a history of errors in the past five years for this company. Another item that might
be concerning is the fact that PepsiCo has certain accounts on their financial statements
missing. This hindered us from calculating certain screening ratios in the following
section. Although this may be alarming, we still feel comfortable in PepsiCo’s
accounting methods. After careful review, we also believe that these numbers are
accurate and reflect the truest economic value possible.
Screening Ratios
Sales Manipulation 2004 2003 2002 2001 2000

Net Sales/Cash from Sales 1.12 1.11 1.1 1.11 1.07
Net Sales/Net Account Receivables 9.53 9.92 11 10.5 14.7
Net
Sales/Inventory 19.1 18.7 18 18.7 27.9
Net Sales/Unearned Revenue NA NA NA NA NA
Net Sales/ Warranty
Liabilities NA NA NA NA NA
Core Expense
Manipulation
Declining Asset Turnover 1.06 1.07 1.08 1.08 1.43
CFFO/Operating Income 0.91 1.08 1.05 1.09 1.04
Pension Expense/SGA Expense 0.06 0.09 0.05 0.01 NA
CFFO/Net Operating Assets NA NA NA NA NA
Total Accruals/Change in Sales NA NA NA NA NA
Other Employment Exp/ SG&A NA NA NA NA NA
21
Accounting Analysis
In order to account for any possible manipulations of PepsiCo’s information we

calculated several screening ratios. The first three ratios test for sales manipulation with
in their accounting practices. The first ratio, net sales/cash from sales, indicates a slight
rise over the five-year period inferring that PepsiCo must be collecting less cash or is
increasing its account receivable form sales. The second ratio, net sales/net accounts
receivable, indicates a drastic drop in 2000 due to the fact that PepsiCo abandoned its
bottling operations when Pepsi Bottling Group was formed. Since 2000, accounts
receivable ratio has steadily decreased. This means accounts receivable has actually
increased in size, corresponding to the first ratio (net sales/cash from sales). The last
ratio, net sales/inventory, shows a slight decrease since 2000, which correlates with the
formation of the Pepsi Bottling Group in 2000. Other ratios were also selected to
evaluate PepsiCo’s accounting practices. These included net sales/ unearned revenues
and net sales/ warranty liabilities. Though, due to lack of information in the financial
statements these ratios could not be calculated. This may mean for a cause of alarm due
to the fact that PepsiCo could have purposely done this. One thing though that elevates
this concern is the fact that in PepsiCo’s sales agreements they do not allow for return
which would negate the net sales/ warranty liabilities.
Another set of ratios were analyzed to assess core expense manipulations. The
three ratios include: declining asset turnover, changes in cash flow from operations
divided by operating income, and pension expense in relation to selling and general
administration expenses. The declining asset turnover indicates a general level trend
since the formation of Pepsi Bottling Group that explains that assets are being used the
same relative to the sales generated. The next ratio is the change in cash flow from
operations divided by operating income. Pass levels were above one but in 2004 it fell
below; this indicates that PepsiCo’s accounts receivables are not being collected as
22
Accounting Analysis
quickly as they have previously been. This correlates with the sales screening ratios as
previously discussed. The last ratio is the pension expense in relation to the selling and
general administration expenses. On average since 2001, this has been on an upward
trend, although 2004 forecast are expected to decrease significantly. This is due to the
Medicare Prescription Drug Improvement and Modernization Act of 2003 (late
December 2003), which is forecasted to reduce pension liability by nearly $50 million.
As in the case of sales manipulation screening ratios, there were some ratios that could
not be calculated do to lack of information in the financial statements. This could also
mean a cause for alarm as well. One thing though is that PepsiCo actually might not have
these kinds of expenses in their financial statements.
By also looking at these key screening ratios compared to other competitors gave
a good description and benchmark of their accounting policies. By comparison of the
same ratios listed above to Coca-Cola we found some consistency in the numbers. The
reason for viewing only Coca-Cola was due to the fact that they are more highly
correlated with PepsiCo. This could be in size, operations, sales, and other factors
associated with their company.
Coca-Cola
Sales Manipulation 2004 2003 2002 2001 2000
Net Sales/Cash from Sales 3.85 3.85 4.13 4.89 5.7
Net Sales/Net Account Receivables 10.12 10.06 9.33 10.67 11.64
Net
Sales/Inventory 15.47 16.81 15.12 19.04 19.19
Core Expense
Manipulation
Declining Asset Turnover 0.71 0.78 0.81 0.9 0.99
CFFO/Operating Income 0.97 0.98 0.78 0.91 1.13
Pension Expense/SGA Expense 0.015 0.01 0.007 0.0068 0.0069
23
Accounting Analysis
First looking at net sales/ cash from sales indicates that PepsiCo is receiving more
cash from their sales than Coca-Cola. Although these numbers are substantially different,
on trend they seem very stable in comparison. Also net sales / net accounts receivable
seems very consistent as well. The show that both companies have had tremendous
decreases in their ratio’s over time. Another fairly good comparison is CFFO/ Operating
Income. By comparison both companies have very consistent ratios with both gradually
decreasing over time. This indicates that operating income is beginning to increase
relative to the cash flow from operations. By looking at these ratios across the industry
both companies seem very consistent with their accounting numbers. This evidence
further supports our claim that PepsiCo’s accounting methods are consistent with
industry practices.
Conclusion and Discussion:
After extensive review of PepsiCo’ accounting practices we feel highly

confident in their financial disclosures. We analyzed several aspects including: key
accounting policies, accounting flexibility, accounting strategy, quality of disclosures,
potential red flags, and screening ratios. While there were a few discrepancies, they were
of minor concern. By targeting these aspects individually we were able to examine the
underlying procedures of PepsiCo. We determined that their key accounting policies and
strategies are directly in line with industry practices. Also, in dealing with account
flexibility we determined that there was some flexibility and changes in accounting
procedures but these were in line with actions of regulation and industry standards.
24
Financial Analysis & Forecast Financials
Quality of disclosures was adequate in regards to voluntarily giving and posting

information to investors. After review we determined that there were no main causes for
alarm. While there were some activities that looked suspicious, after further investigation
we determined them to be of minor consequences. Finally, screening ratios were used to
determine if there were any potential manipulations. Overall these ratios were fairly
consistent over the years. Also, comparing PepsiCo to the industry further supported our
decisions, in that they were consistent with that of competitor’s ratios.
III. Financial Analysis and Forecast Financials
In this next phase of evaluating PepsiCo, we have computed financial ratios to

assess the performance of the company. We are going to forecast the financial statement
of the company for the next 10 years. From the financial ratio analysis we are going to be
able to benchmark against our competition in the non-alcoholic beverage industry as well
as compute the industry average. This step is very crucial since it can be used to evaluate
the company on an individual basis, or compare it against competitors. Another
implication is that is can address the company’s performance compared to the industry as
a whole. By establishing financial ratios we are able to get a more in depth look into the
company’s profitability, liquidity, and capital structure. This type of analysis is very
important to investors and shareholders because it going to show them more in depth the
strengths and weaknesses of PepsiCo.
25
Firm Analysis
2004 2003 2002 2001 2000

Liquidity Ratios
Current Ratio 1.28 1.08 1.06 1.17 1.17
Quick Asset Ratio 0.95 0.75 0.72 0.76 0.8
Inventory Turnover 9.76 8 7.84 7.51 7.87
Days Supply of Inventory 37.41 45.6 46.55 48.61 46.39
Receivables Turnover 7.97 9.53 9.92 12.57 11.36
Sales Outstanding 45.77 38.3 36.79 29.03 32.13
Working Capital Turnover 15.51 52.37 69.56 31.5 30.55
Profitability Ratios
Gross profit margin 53.68% 53.56% 53.67% 59.46% 60.46%
Operating Expense Ratio 35.20% 35.07% 33.94% 43.10% 44.68%
Net Profit Margin 14.40% 13.23% 13.19% 9.88% 10.68%
Asset Turnover 1.05 1.06 1.07 1.24 1.11
Return on Asset 15.05% 14.09% 14.11% 12.26% 11.90%
Return on Equity 31.24% 30.15% 35.81% 30.76% 30.11%
Capital Structure Ratios

Debt to Equity Ratio 1.07 1.14 1.53 1.51 1.53
Times Interest Earned 31.56 28.93 26.33 18.41 14.48
Debt Service Margin 0.75 0.67 0.76 0.84 0.99
Liquidity:
In order to assess the liquidity of PepsiCo several ratios were determined and
examined. Also by looking at the current year and past years we were able to get a clear
26
picture of the changes PepsiCo has faced. After careful examination of these ratios we
determined that PepsiCo is relatively liquid. We first examined the Current Ratio.
Overall PepsiCo had a favorable current ratio. This is shown by an increase from 1.17 in
2000 to 1.28 in 2004. This implies that current assets have grown more in relation to its
current liabilities. Although this picture looks good overall, PepsiCo has hit some speed
bumps along the way. This is shown in the decrease from 1.17 in 2001 to 1.06 in 2002.
This was the result of an increase in current liabilities by 21.1% with a relative minor
increase in current assets of 9.6%. An alternative ratio that captures a firm’s liquidity is
the Quick Ratio. This ratio analyzes the company’s ability to meet current obligations
based on higher liquid assets. Overall, the quick ratio has improved over the past five
years from .80 in 2000 to .95 in 2004. This indicates a favorable trend in which PepsiCo
has utilized more liquid assets relative to current liabilities, indicating that they can now
meet upcoming obligations quicker than in previous years. One factor constraining
liquidity is the declining Receivable Turnover of the past five years. This number has
decreased from 11.36 in 2000 to 7.97 in 2004. The reason of dramatic increase in 2001
of 12.57 was the result of the enormous increase in sales relative to the increase in
accounts receivables. Looking forward from 2001 shows how the ratio has declined in
other years, indicating that PepsiCo is collecting far less cash on sales than in previous
years. As a result this also indicates that PepsiCo has had reduced capability of turnover
in sales of credit. Seemingly, we were able to determine the Days Supply of Receivable;
which measures the performance of collecting receivables. Comparing past and present
performance also entails discouraging news for PepsiCo since the number of days until
accounts receivable are collected has steadily increased from 32.13 in 2000 to 45.77 in
2004. This can indicate that PepsiCo has had problems in credit terms and collecting
cash from customers. Another ratio implemented was Inventory Turnover, which has
increased slightly over the years. This number increased from 7.87 in 2000 to 9.76 in
2004 indicating that PepsiCo is more productive in using inventory. The major reason
for the decrease in 2001 to 7.51 was attributable to the tremendous increase in inventory
which increased an astonishing 44.75% from the previous years. This might have
occurred because of a increase in the estimate of expected sales for 2001. Corresponding
to inventory turnover is Days Supply of Inventory. This number has decreased rather
27
steadily from 46.39 in 2000 to 37.41 in 2004, although there was an increase in 2001 of
48.61. This infers that PepsiCo has been able to manage inventories effectively and
turnout more inventory relative to previous years. This could also imply a decrease in
storage costs and an increase in production efficiency. The last ratio used was the
Working Capital Turnover. This number has nearly been very erratic over the years,
implying volatile differences in working capital values compared to sales. This ratio
determines how effectively working capital is being used in terms of the turnover it can
help to generate. Currently there has been a negative impact on liquidity indicated by the
decrease in values from 30.55 in 2000 to 15.51 in 2004. This significance can further be
seen by the decrease from 69.56 in 2002 to 2004. This could hinder PepsiCo’s ability to
meet upcoming obligations if further operating performance decreased other sources of
liquidity.
Profitability:
By further assessing other ratios we were able to determine the performance of

profitability for PepsiCo. After careful review, we concluded that PepsiCo also has a
moderately favorable profitability analysis. Gross Profit Margin has decreased relatively
over the years indicating that that cost of goods sold has increased over the years of
which accounted for 42% of sales in 2004. This has a negative impact on the company
since it costs more to produce their products given their output. One positive outcome is
that PepsiCo is recovering a little, since the ratio is up from 53.56% in 2003 to 53.68% in
2004. Another positive affect has been the decrease in Operating Expense Ratio. This
ratio has decreased form 44.68% in 2000 to 35.2% in 2004. While although operating
expenses has increased slightly from 2003, the increase in sales have mitigated this
negative affect on the company. The reason for the sharp decline in 2002 was due to the
fact that operating expenses decreased while sales continued to increase. Changes in Net
Profit Margin have also lead to a positive impact on the company as well. Net profit
margin has increased from 10.68% in 2000 to 14.4% in 2004, although there was a
substantial decrease in 2001 of 9.88%. One discouraging aspect has been the descending
trend of Asset Turnover, in which has decrease from 1.11 in 2000 to 1.05 in 2004. This
28
indicates that PepsiCo has had trouble in utilizing their assets to generate sales in recent
years. The reduction, maybe due to the fact in which PepsiCo has been investing in long-
term assets such as plant, property, and equipment which takes longer to implement. The
major increase in 2001 was the direct result of the large increase in sales relative to the
increase in total assets. PepsiCo has also had a favorable steady increase in Return on
Assets which increases profitability. This is mainly achieved by the increase in the net
profit margin relative to the decrease in asset turnover. Currently, return on assets has
increased by 26.5% since 2000. Return on Equity has also slightly increased from
30.11% to 31.24% over five years with a slight deviation in 2002 of 35.81%. Overall, it
seems that there has been a relatively slight improvement which increases the
profitability of owner’s interest in total assets.
Capital Structure:
After further ratio analysis we concluded that PepsiCo’s capital structure has a
moderately positive analysis. The change in Debt to Equity ratio has meant positive news
for PepsiCo. There has been a relatively steady decrease from 1.53 to 1.07 over the five
years, indicating that the company utilizes more equity financing compared to debt than
in 2000. This a positive affect since financing business activities with debt can be more
expensive and increase the liabilities of the firm. By implementing more equity, PepsiCo
can fund activities cheaper within the firm. Times Interest Earned has also had positive
growth. This is attributed to the substantial decrease in interest expense caused by the
decrease in debt used for financing. This ratio has increased from 14.48 in 2000 to 31.56
in 2004. This indicates that PepsiCo has the ability to pay for current interest payments
fairly easily. One negative aspect is that Debt Service Margin has decreased from .99 to
.75, representing an increase in payment of notes payable currently due compared to
operating cash flows. This is somewhat disturbing news since this may raise some
questions is whether PepsiCo can meet these obligations.
29
Cross Sectional Analysis

Liquidity
Current Ratio:
Coca- Cadbury Industry

PepsiCo Cola Schweppes Avg
2000 1.17 0.71 0.62 0.66
2001 1.17 0.85 0.78 0.81
2002 1.06 1.00 0.76 0.88
2003 1.08 1.06 0.75 0.91
2004 1.25 1.05 0.81 0.93
Current Ratio
1.4
1.2
PepsiCo
1
Coca-Cola
0.8
0.6 Cadbury
Schw eppes
0.4 Industry Avg
0.2
0
2000 2001 2002 2003 2004
By comparing PepsiCo to the industry, viewers are able to see how this ratio
increases the value of PepsiCo’s liquidity. In each year, PepsiCo has had a higher current
ratio than any competitor in the industry, in which the values are dramatically higher than
the industry averages. This indicates that PepsiCo has effectively been able to meet
short-term obligations better than competitors.
30
Quick Asset Ratio:

PepsiCo Cola Schweppes Avg
2000 0.80 0.39 0.36 0.38
2001 0.76 0.45 0.43 0.44
2002 0.72 0.61 0.44 0.52
2003 0.75 0.71 0.41 0.56
2004 0.95 0.71 0.56 0.64
Quick Ratio
1.00
0.90
0.80 PepsiCo
0.70
0.60 Coca-Cola
0.50
Cadbury
0.40 Schw eppes
0.30 Industry Avg
0.20
0.10
0.00
2000 2001 2002 2003 2004
By also comparing the efficiency of companies to utilize higher liquid assets to

meet current obligations helps asses PepsiCo’s liquidity. Throughout the entire five years
PepsiCo has had a quick ratio higher than competitors. It is easy to see that while these
values are below one, PepsiCo values are dramatically higher than competitors. These
values are also correspondingly higher than each year’s industry averages, in which case
concludes that PepsiCo has higher liquidity in that it effectively manages higher liquid
assets in order to meet current liabilities.
31
Accounts Receivable Turnover:

Pepsi Cola Schweppes Avg
2000 11.36 11.64 6.11 8.87
2001 12.57 10.68 6.75 8.71
2002 9.92 9.33 6.26 7.80
2003 9.53 10.06 5.99 8.03
2004 9.76 10.64 5.92 8.28
Accounts Receivable Turnover
14.00
12.00
Pepsi
10.00
Coca-Cola
8.00
6.00 Cadbury
Schw eppes
4.00 Industry Avg
2.00
0.00
2000 2001 2002 2003 2004
PepsiCo’s accounts receivable turnover has varied with some respect to the
industry. This value was dramatically higher in 2001 indicating that PepsiCo had
considerably less accounts receivables than competitors. This trend has changed in 2004,
in which case this ratio has fallen below Coca-Cola’s but still above Cadbury Schweppes.
This concludes that Coca-Cola is currently gaining more cash from sales and is more
effective in gaining cash customers faster. While PepsiCo has accounts receivable below
Coca-Cola, this number is still above the industry average. This comparison helps to
indicate that PepsiCo’s current position isn’t a sign of a sever constraint on liquidity.
Another view supporting this is that PepsiCo’s accounts receivable turnover seems to be
rebounding, as this ratio rose from 9.53 in 2003 to 9.76 in 2004.
32
Inventory Turnover:

2000 7.87 5.09 4.25 4.67
2001 7.51 4.97 4.91 4.94
2002 7.84 4.87 4.79 4.83
2003 8.00 5.56 4.42 4.99
2004 7.97 5.57 3.67 4.62
Inventory Turnover
9.00
8.00
7.00 Pepsi
6.00
Coca-Cola
5.00
4.00 Cadbury
Schw eppes
3.00
Industry Avg
2.00
1.00
0.00
2000 2001 2002 2003 2004
PepsiCo has also been an industry leader in inventory turnover. For the past five
years, PepsiCo has had values greatly exceeding that of competitors. This indicates that
PepsiCo is efficiently capable of moving and controlling inventories better than
competitors. Due to this trait, this greatly increases PepsiCo’s position in liquidity
compared to the industry.
33
Working Capital Turnover:

2000 30.55 -7.57 -4.06 -5.82
2001 31.5 -15.97 -10.28 -13.13
2002 69.56 18.55 -8.61 -8.61
2003 52.37 41.26 -8.42 16.42
2004 15.51 -2.77 -12.83 -7.80
Working Capital Turnover
80
70
60 Pepsi
50
40 Coca-Cola
30
20 Cadbury
10 Schw eppes
0 Industry Avg
-10 2000 2001 2002 2003 2004
-20
-30
By comparing competitors within the industry enable viewers to see that the
values for PepsiCo given the five years have been relatively stable. On average, PepsiCo
has been relatively efficient in managing working capital compared to the industry. This
helps alleviate the concern for the decrease in liquidity regarding PepsiCo current values
since they are well above the competitors and industry average.
34
Profitability
Gross Profit Margin:

2000 60.46% 69.67% 53.86% 61.77%
2001 59.46% 69.92% 52.93% 61.43%
2002 53.67% 63.68% 47.89% 55.79%
2003 53.56% 62.87% 48.63% 55.75%
2004 53.68% 64.69% 49.27% 56.98%
Gross Profit Margin
80.00%
70.00%
Pepsi
60.00%
50.00% Coca-Cola
40.00%
Cadbury
30.00% Schw eppes
20.00% Industry Avg
10.00%
0.00%
2000 2001 2002 2003 2004
Compared to the industry, PepsiCo has had relatively poor performance in

managing their gross profit margin. This implies some concern in the profitability of the
company since PepsiCo’s values have always been less than the industry average. Coca-
Cola clearly is able to gain more profit on sales relative to other competitors. This raises
some concerns to the extent of PepsiCo’s ability to manage the costs of production.
While PepsiCo’s numbers have increased in 2004, this is still currently less than the
industry average.
35
Operating Expense Ratio:

2000 44.68% 44.58% 36.89% 40.74%
2001 43.10% 42.85% 37.54% 40.20%
2002 33.94% 41.23% 30.21% 35.72%
2003 35.07% 35.64% 34.23% 34.94%
2004 35.20% 39.83% 37.18% 38.51%
Operating Expense Ratio
50.00%
45.00%
40.00% Pepsi
35.00%
30.00% Coca-Cola
25.00%
Cadbury
20.00% Schw eppes
15.00% Industry Avg
10.00%
5.00%
0.00%
2000 2001 2002 2003 2004
Alone, PepsiCo has had positive improvement in controlling operating expenses.

But by comparing these ratios with other competitor provides a different picture. By
looking at the whole industry PepsiCo dominates Coca-Cola and Cadbury Schweppes in
operating an efficiently run business. This evidence greatly increases PepsiCo’s
profitability compared to competitors of the industry.
36
Net Profit Margin:

2000 10.68% 10.64% 10.84% 10.74%
2001 9.88% 19.80% 9.82% 14.81%
2002 13.19% 17.47% 10.34% 13.91%
2003 13.23% 20.66% 5.68% 13.17%
2004 14.39% 20.88% 6.40% 13.64%
Net Profit Margin
25.00%
20.00%
15.00% Pepsi
Coca-Cola
Cadbury Schweppes
10.00% Indust ry Avg
5.00%
0.00%
2000 2001 2002 2003 2004
PepsiCo’s net profit margin has change a lot over the five years period, although
they have had some moderate improvement into 2004. This improvement enabled
PepsiCo to be above the industry average, indicating that they are able to retain a
moderate percentage of sales. Compared to the industry, PepsiCo is lagging behind
Coca-Cola by 6.5%. This indicates that Coca-Cola is far more profitable in the sense of
sales. Although of its current position, PepsiCo is in every sense profitable in the
industry.
37
Asset Turnover:

2000 1.11 0.99 0.71 0.85
2001 1.24 0.91 0.77 0.84
2002 1.07 0.81 0.69 0.75
2003 1.06 0.78 0.63 0.71
2004 1.05 0.76 0.68 0.72
Asset Turnover
1.40
1.20
Pepsi
1.00
Coca-Cola
0.80
0.60 Cadbury
Schw eppes
0.40 Industry Avg
0.20
0.00
2000 2001 2002 2003 2004
By industry standards, PepsiCo is very effective in producing a high volume of

sales in relation to its size of assets. PepsiCo is the leading company in this respect,
provided that they have outperformed the industry every year. Although their current
number has declined, this information alleviates some of the concerns of their ability to
mange their assets.
38
Return on Assets:

2000 11.90% 10.58% 7.68% 9.13%
2001 12.26% 18.08% 7.54% 12.81%
2002 14.11% 14.15% 7.17% 10.66%
2003 14.09% 16.16% 3.59% 9.88%
2004 15.05% 15.82% 4.34% 10.08%
Return on Assets
20.00%
18.00%
16.00% Pepsi
14.00%
12.00% Coca-Cola
10.00%
Cadbury
8.00% Schw eppes
6.00% Industry Avg
4.00%
2.00%
0.00%
2000 2001 2002 2003 2004
By comparison, PepsiCo’s return on assets has increased steadily throughout the

five years. PepsiCo for the most part has exceeded the industry average and is currently
slightly below Coca-Cola. Cadbury Schweppes has dramatically lagged the industry in
respect to this ratio. This is a good indication that PepsiCo is highly profitable in regard
to the industry.
39
Return on Equity:

2000 30.11% 23.37% 17.87% 20.62%
2001 30.76% 35.01% 18.40% 26.71%
2002 35.81% 28.96% 17.90% 23.43%
2003 30.15% 30.85% 12.28% 21.57%
2004 31.24% 31.16% 15.43% 23.30%
Return on Equity
40.00%
35.00%
Pepsi
30.00%
25.00% Coca-Cola
20.00%
Cadbury
15.00% Schw eppes
10.00% Industry Avg
5.00%
0.00%
2000 2001 2002 2003 2004
PepsiCo has had some deviations in their return on equity over the years, mainly
in 2002. This is quite normal considering the changes in values of other competitors.
PepsiCo currently has the same return as Coca-Cola indicating that these two firms are
very profitable in terms of owner’s interests in assets. This further provides evidence that
PepsiCo is highly profitable in the current industry.
40
Capital Structure
Debt to Equity Ratio:

2000 1.53 1.21 1.49 1.35
2001 1.51 0.94 1.61 1.28
2002 1.53 1.05 1.64 1.35
2003 1.14 0.91 2.64 1.78
2004 1.07 0.97 2.47 1.72
Debt to Equity Ratio
3.00
2.50 Pepsi
2.00
Coca-Cola
1.50
Cadbury
Schw eppes
1.00
Industry Avg
0.50
0.00
2000 2001 2002 2003 2004
PepsiCo is currently slightly below Coca-Cola. Coca-Cola on average has had a

ratio less than the industry. This shows that PepsiCo has made substantial improvement
in reducing the amount of debt used to finance business activities. These improvements
seem to have a decreasing trend indicating further reduction may occur.
41
Times Interest Earned:

2000 14.14 11.49 5.67 8.58
2001 19.86 18.52 5.75 12.14
2002 27.37 27.43 6.78 17.11
2003 29.86 32.19 3.39 17.79
2004 31.56 32.85 4.10 18.48
Tim es Interest Earned
35.00
30.00
Pepsi
25.00
Coca-Cola
20.00
15.00 Cadbury
Schw eppes
10.00 Industry Avg
5.00
0.00
2000 2001 2002 2003 2004
This trend indicates that PepsiCo and Coca-Cola can pay interest payments on
current and long-term liabilities rather easily. Cadbury Schweppes on the other hand
seems to struggle in meeting these current obligations. While Coca-Cola is in reality
better to meet these interest charges, PepsiCo still adequately provides income from
operations to cover these expenses. Given this environment there is a dramatic difference
between the top and low performing firms.
42
Debt Service Margin:

2000 (0.99) (0.74) (0.56) (0.65)
2001 (0.84) (1.05) (1.25) (1.15)
2002 (0.76) (1.79) (1.03) (1.41)
2003 (0.67) (1.88) (0.67) (1.28)
2004 (0.75) (2.77) (0.26) (1.52)
Debt Service Margin
0.00
2000 2001 2002 2003 2004
(0.50)
Pepsi
(1.00)
Coca-Cola
(1.50)
Cadbury
Schw eppes
(2.00)
Industry Avg
(2.50)
(3.00)
Given this picture, Coca-Cola is clearly more efficient in providing cash from
operations to cover current notes payables. As shown in the previous section, PepsiCo
has negative performance in this ratio. This is further supported by the fact that PepsiCo
has remained below the industry average throughout most of the five years. This is
clearly adds a negative position in its capital structure.
43
Level II Ratios
Level Two Ratios for PepsiCo
2004 2003 2002 2001 2000
Dividend Payout 0.3155 0.2999 0.3143 0.3737 0.3646

ROE 0.3124 0.3015 0.3581 0.3076 0.3011
SGR 21.38% 21.11% 24.55% 19.26% 19.13%
PepsiCo’s Dividend Payout Ratio decreased from 2001 to 2002 from 0.37 to 0.31
and also from 2002 to 2003 from 0.31 to 0.29. This is not a big decrease for PepsiCo but
it still has a negative impact on the company because it shows that PepsiCo hasn’t had
stable earnings because they are not paying a high portion of earning as dividends. But
from 2000 to 2001 and from 2003 to 2004 the dividend payout ratio has increased from
0.36 to 0.37 and 0.29 to 0.31. This increase shows that PepsiCo has had stable earning
during these years and are more likely to pay a big portion of their earnings as dividend
to their shareholders. PepsiCo has already been able established themselves as a stable
and profitable company throughout the world.
PepsiCo’s Sustainable Growth Rate has been increased from 2000 to 2001 from
19.13 to 19.26, also 2001 to 2002 from 19.26 to 24.55, and from 2003 to 2004 from 21.11
to 21.38. The growth of this rate shows that PepsiCo has been affected by the firms’
ability to improve it ROE. PepsiCo sustainable growth rate also declined only from
2002 to 2003 from 24.55 to 21.11. This probably occurred because of the decline of
dividend payout ratio.
44
Common Size
Income
Statement for
PepsiCo 2004 2003 2002 2001 2000
Sales 100.00% 100.00% 100.00% 100.00% 100.00%
Cost of Goods
Sold 42.00% 41.91% 41.90% 36.52% 34.84%
Amortization 4.32% 4.53% 4.43% 4.02% 4.70%
Gross Income 53.68% 53.56% 53.67% 59.46% 60.46%
Selling & Admin
Expenses 35.20% 35.07% 33.94% 43.10% 44.68%
Income from
Operation 18.49% 18.49% 19.73% 16.37% 15.78%
Interest Expense 0.58% 0.62% 0.72% 0.82% 1.12%
Pretax Income 17.65% 17.31% 18.27% 14.36% 15.07%
Income Taxes 4.69% 5.28% 6.19% 5.08% 5.02%
Net Income 14.39% 13.23% 13.19% 9.88% 10.68%
45
Financial Statements Forecasting
PepsiCo’s fiscal year ends on Dec 31. This company just released to the public
their latest financial statements for 2004. In terms of forecasting PepsiCo’s financial
statements for the next 10 years (Balance Sheet, Income Statement and Statement of Cash
Flow) we used all the financial statements for the past 5 years (Refer to Exhibit A, B
and C). PepsiCo is number two company in the non-alcoholic beverages, currently
behind Coca-Cola, while they are number one in the snack industry due to Frito Lay.
After careful analysis of this company we have concluded that PepsiCo is not affected by
seasonality. Because of this we decided to uses the moving weighted average to forecast
PepsiCo’s financial statements for the next 10 years (Refer to Exhibit AA, BB and CC).
We did this by computing the percentage increase or decrease for each line item
from 2000 to 2004. After getting this percentage we computed the average of these four
numbers to get an expected future change. We then multiplied this number with the 2004
financial statements line to get the forecasted information for 2005. To find 2006, we just
did the same thing, but we didn’t include the percentage increase or decrease from 2000
to 2001 and we included the percentage increase or decrease from 2004 to 2005. We
used the same approach for most of the lines on the Balance Sheet, Income Statement and
Statement of Cash Flow to arrive to the forecasted numbers for each year till the year
2014. For example when we forecasted Total Sales we first found the increase or
decrease from year 2000 to 2001, 2001 to 2002, 2002 to 2003 and 2003 to 2004 which
were 31.7%, -6.8%, 7.4% and 8.4% respectively. Then we find the average which was
10.1% and we multiplied this number with the total sales of 2004 to find the forecasted
number for 2005 which was $32,238 (in millions) So we did the same thing to forecast
2006 but this time we didn’t take the average of the increase from year 2000 to 2001 but
instead we substitute it with the increase from year 2004 to 2005 that we forecasted. And
we multiplied this new average with the forecasted total sale of 2005 to find 2006. We
didn’t use the weighted moving average to calculate the income taxes rate for PepsiCo.
We took the average of the four income tax rate that we founded to be 3% and we
multiplied each year till 2014 with 1.03 to obtain the forecasted income taxes. There was
46
another line that we didn’t use the moving weighted average because of the percentage
increase or decrease during the years. One of these lines was Cash Flow from Investing
Activities. In this line we saw a big decrease from 2001 to 2002 from 2,367 million to
527 million and increase from 2002 to 2003 from 527 million to 2,271 million. This
happened because PepsiCo during 2002 didn’t have any big investment and the increase
in the investment line in the financial statement was very small during this year. This big
decrease and increase would have caused our future Cash Flow from Investing Activities
not be forecasted in a smooth way. So the forecast for this line was not going to have a
normal growth in the next 10 years. Instead to forecast this number we just measured the
percentage increase from 2003 to 2004 and we calculated a growth of 8%. After that we
multiplied this line with 1.08 to find the Cash Flow from Investing Activities for the next
10 years.
Based on our forecast we conclude that PepsiCo is going to have a steady growth
during the next 10 years. The firm has the potential for growth in the next years and
history has shown this trait. PepsiCo used to own Pizza Hut and Taco Bell but they
didn’t realize any profit on their acquisition, so they decided to sell them. This has been
shown as a good decision for the company for the future. But at the same time, they have
made some good decision by acquiring good company like Gatorade and Frito Lay that
have good profits and sales. So our forecasted financial statements are free of errors and
we don’t assume that our forecast it is going to be accurate. The longer the period of the
forecast the less accurate the forecast will be and the past economic practices have shown
this. PepsiCo can buy other bad companies like Pizza Hut and Taco Bell and this is
going to decrease their reputation and decrease their net income. Maybe during the next
10 years they can win the war against Coke and increase their global reputation. Another
reason that PepsiCo will not perform as forecasted is if there is the change of economic
fluctuations. For example the decrease of the economy or the decrease of the value of the
dollar may turn the growth of sales the other way around. Competition is another reason
that PepsiCo might not perform as forecasted. During the next 10 years other companies
can surge and gain more market share in the non-alcoholic beverage. This is going to
decrease the market share for PepsiCo and decrease their sales and reputation as well.
47
Valuation Analysis
IV Valuation Analysis
The valuation process is of importance since this is integrated into every aspect of
the economy. The financial market is highly dependent on such valuations since this
represents much of the underlining activities. Investment companies use such tactics to
value other firms; Insurance companies utilize such information to make sure they have
enough money to cover certain events. Also this information is important to retirement
programs, since companies want to make sure that they can cover current pension benefit
obligations. Finally, this is important for such things as IPO’s, firm takeovers, and
investment decisions.
The purpose of this section is to value PepsiCo Inc. We achieved this by

considering risk and by calculating how much of the firm is financed with debt and
equity. Valuation is the process of converting the forecast for a company into an estimate
of the value of the firm or some component of the firm. We used six different models to
value PepsiCo, which include the following: method of comparables, discounted free
cash flows, discounted dividends, discounted residual income, abnormal earning growth,
and long run average residual income perpetuity based on the P/B ratio. All of these
models helped us to find if the share price of PepsiCo is overvalued, undervalued, or
reasonably valued.
Method of Comparables Valuation:
This section is going to value PepsiCo by using the average multiple of

competitors in the industry. The ratios used are price to book, price to earnings, dividend
to price, price to sales, and price earning growth (PEG). These multiple models were the
simplest to implement since forecasted numbers are not necessary in the calculations.
48
Valuation Analysis
PepsiCo currently has two direct competitors in the industry, which are Coca-Cola and
Cadbury Schweppes. Due to the fact that PepsiCo only has two main competitors, we
found that it would be unnecessary to trim down the averages calculated below. Also,
since these three competitors represent the majority of the industry, we felt it necessary to
use both in our calculations. From our calculations we found that the price-earning
multiple and the PEG multiple were the best estimation the PepsiCo’s price since they
were both at $48.92 and $50.80 respectively compared to the actual stock price of
$52.76. The trailing P/E ratio yielded a higher price, which is based of the current
published P/E ratios. We decided to focus on the forecasted ratio since this section
focuses on forecasted numbers. The market to book value indicated a smaller price at
$37.07. Cadbury Schweppes could have been considered an outlier, but do to the
relatively small sample of competitors and the fact that the average just would have been
Coca-Cola’s number; we utilized their value as well. If we did trim off Cadbury
Schweppes, the estimated price would have been much in line of the actual price at
$52.73. The dividend yield also revealed a lower price at $39.72. This may have been
due to the fact that PepsiCo doesn’t declare dividends as much as competitors, as well as
support PepsiCo’s higher growth. This would seemingly indicate why it would have a
lower value. The price to sales multiple indicated a higher price relative to the actual
price. This is due to the fact that Coca-Cola pays out more than any other company
having a direct affect on the average, which would achieve this higher price of $57.38. In
actuality, PepsiCo has a lower price to sales ratio, which would indicate that it pays out
less then the industry average. This would conclude a much higher price than actually
would occur. The reason for not trimming Cadbury Schweppes in the model was the fact
that only including Coca-Cola would result in even a higher estimated price. (See
EXHIBIT 4)
Although these models are simple to implement and calculate, they are only
estimates based on the industry averages. Some discrepancies can and have occurred in
the estimation of our prices. Our sample size was relatively small, only having three
main competitors. Trimming the competitors would have a negative affect on these
averages, only representing one company. Based on whether this company was above or
below the industry norm would have a negative effect on our calculations. Also since
49
Valuation Analysis
outliers were not eliminated, true representation of the averages could have been affected
as well as in the case of the P/S and P/B averages, in which case Cadbury Schweppes
could have been possible outliers.
EXHIBIT 4
Method of Comparables
2005 EPS BPS DPS PPS SPS

PepsiCo 2.55 8.15 0.98 52.76 18.90
Coca-Cola 2.05 6.40 1.08 41.38 9.40
Cadbury S 2.20 15.20 0.93 40.00 23.95
P/E Ratio (PPS/EPS)

PepsiCo 20.69 (Not Included in Average)
Coca-Cola 20.19
Cadbury S 18.18
Avg 19.18
Price 48.92
P/B Ratio (PPS/BPS)

Coca-Cola 6.47
Cadbury S 2.63
Avg 4.55
Price 37.07
Dividend Yield (DPS/PPS)

Coca-Cola 0.03
Cadbury S 0.02
Avg 0.025
Price 39.72
P/S Ratio (PPS/SPS)

Coca-Cola 4.40
Cadbury S 1.67
Avg 3.04
Price 57.38
PEG Ratio
Coca-Cola 2.17
Cadbury S 2.20
Avg 2.19
Price 50.80
50
Valuation Analysis
Discounted Free Cash Flow Model
The first intrinsic valuation model used to value PepsiCo was the discounted free
cash flow model. To use this model we need to calculate the weighted average cost of
capital (WACC) in which our cost of equity (Ke) and cost of debt (Kd) will be found.
We derived the cost of capital (Ke) by using historical data over the past 60 months of the
return on the market (Rm) of the S&P 500, and the risk-free rate (Rf) of the T-Bill returns
for 5 years. To find the beta for our company we used the regression analysis using the
percentage return of the firm (Y-variable) and the market spread (X-variable) data from
the past 61 months (April 1 2000 – April 1 2005). With this analysis we found an
estimated beta for the company equaling 0.32. (See Exhibit 1). We believe that this beta
is low comparing it with the published beta of 0.65 (Value Line). We also founded the
estimated beta for the past 2 and 3 years, which were 0.48 and 0.76 respectively.
We calculated the CAPM (Ke) by using the estimated beta for 5 years, 3 years, 2
years and the published beta. The CAPM (Ke) equaled 2.57%, 5.65%, 3.69% and 4.88%
respectively. We believe that the Ke of 4.88% found using the published beta represent
PepsiCo better that any other beta. Formulating the WACC was the next valuation step.
To find the WACC we first had to find the (Kd). We calculated (Kd) by using the
balance sheet notes for 2004 to find the Weighted Average Cost of Debt. (See Exhibit 2).
We then found the value of equity of the firm by multiplying the firms PPS with the share
outstanding. Also, we then found the value of the debt of the firm by finding the sum of
the current maturity of long debt with the long-term debt. (See Exhibit 3).
By implementing these numbers, the value of equity equals to

$52.76*1,687,000,000 shares outstanding =$89,006,120,000 and the value of debt is
equal to $2,397,000,000 + $1,054,000,000 = $3,451,000,000. The value of the firm is
equal to the value of debt (Vd) + value of equity (Ve). By plugging into the equation the
value of firm (Vf) is equal to $92,457,120,000. Now we have the entire components to
51
Valuation Analysis
find WACC. We found the firm’s tax rate by finding the average of the firm’s tax rate
for the previous five years. The average calculated tax rate was 31.66%. (See Exhibit 3).
To find the WACC we did the following calculation:
WACC=(3451000000/92457120000)*(0.0398)*(1- .166) +
(89006120000/92457120000)*(0.0488). We calculated a WACC of 4.8%.
Using the WACC calculated above, we performed the discounted free cash flow.
Next, we used and implied a growth rate of 2% after 2014 for the Free Cash Flow to the
Firm. Our analysis found an estimated price of $47.90. Comparing the estimated price
with the actual price of $52.76 we think that PepsiCo is slightly overvalued. This is
reasonable to infer since the actual price is bigger than that of our estimated price. We
also performed a sensitivity analysis for this model. During this analysis we founded a
high amount of sensitivity. For example if the firm had no growth after 2014 in the free
cash flow to the firm the estimated price was going to be $30.85; but if we had a higher
growth of 0.04 the estimated price was going to be $150.21. This is a very high price
because the difference between WACC and growth is very small. This number is
probably very unrealistic. The sensitivity analysis shows that a change in WACC without
a corresponding change in growth and vice versa will change the estimated price greatly
compared to the actual price. (See Exhibit 5).
Sensitivity Analysis
g
0 0.01 0.02 0.04
WACC 0.02 $81.45 $154.56 N/A N/A
0.03 $52.46 $74.78 $141.75 N/A
0.048 $30.85 $37.13 $47.90 $150.21
0.06 $23.71 $27.15 $32.32 $58.18
52
Valuation Analysis
Discounted Dividend Model
The other valuation model that we used was the Discounted Dividend Model.
(See Exhibit 6). The discounted dividend model was performed using a new (Ke) that
we found from the discounted free cash flow model by using the WACC formula. This
new Ke that we found was equal to 4.84%. To forecast the dividend per share for the
next 10 years we used the moving weighted average like of that in our forecast. We
assumed that after 2014 dividend per share would be $2.23 with no growth. This model
gave us a price of $43.18. Comparing this price with the actual price $52.76 we still
think that PepsiCo is still overvalued.
The discounted dividend model has the highest sensitivity to change compared
with the other models. In the sensitivity analysis we used the new Ke and the (Ke) that
we found for the estimated beta for 5 and 3 years. For example if we had a growth of 2%
after 2014 the estimated price was going to be $65.53. On the other hand if we used the
(Ke)=0.0257 that we found by using the estimated beta for 5 years with no growth and
with 0.01 growth after 2014 the estimated price was going to be $70.79 and $108.71
respectively. This shows a very big change and unrealistic prices for PepsiCo. The
primary reason for these high prices is because our firm has a low (Ke). Also, we see in
the sensitivity analysis that if we have a high (Ke) like 0.056 with no growth or a growth
of 2% the prices are going to be $38.91 and $54.02 respectively. Since this model has the
highest sensitivity to change compared to other models we believe that the estimated
price of $43.18 doesn’t represent the fundamental value of PepsiCo stock price in April 1,
2005.
53
Valuation Analysis
g
0 0.01 0.02 0.05
Ke 0.02 $87.86 $164.01 N/A N/A
0.0257 $70.79 $108.71 $278.90 N/A
0.0484 $43.18 $51.37 $65.53 N/A
0.056 $38.91 $44.82 $54.02 $265.54
0.07 $33.47 $37.09 $42.17 $87.86
Discounted Residual Income Model
The next model that we used to value PepsiCo was the Discounted Residual
Income Model. In the discounted residual income model, we analyzed a stream of
residual incomes from the next 10 years, including a terminal value, and we then
discounted all the numbers back to the present time. (See Exhibit 7). To find the book
value for the next 10 years we used the same method that we used in our forecast. We
used the moving weighted average. We begin this model by finding the ending book
value of equity which we found by adding the book value of equity with the earning per
share, and then subtracting the dividends per share. Then, we found the Normal Income
by multiplying (Ke) with the beginning book value of equity from the previous years.
The difference between earnings per share and normal income is the residual income.
After that we calculate perpetuity of the continuing terminal value based on a growth that
is going to be variable in the sensitivity analysis. We assumed that after 2014 Residual
Income would be 1.91 with no growth. The residual income is then discounted back to
the present time. To find the estimated value per share we add the book value equity for
54
Valuation Analysis
2005, with the present value of residual income in 2005, and also with the present value
of terminal value in 2005. By using a (Ke) of 4.84% and assuming no growth after 2014,
this model gives us a price of $51.80 which is very close to the actual price of $52.76.
But by comparing the actual price with the estimated price we see that the firm is
overvalued slightly.
The discounted residual income model has a moderate sensitivity to changes in

cost of equity and growth. We can see this in the sensitivity analysis of this model. For
example is we have a growth after 2014 of 1% the estimated price is going to be $58.85,
but if we increase the (Ke) and use the one that we calculated by our estimated beta for 3
years we and still 1% growth, the price of the stock is going to be $48.92. From the
sensitivity analysis we learned that the estimated price per share is much more sensitively
to changes in cost of equity than to changes in the growth rate. For example if we use the
cost of equity( Ke) 2.57% that we found by using the beta estimated for 5 years with no
growth, we have an estimated price per share of $100. If we compare this number with
the estimated price per share that we found using (Ke) of 4.84% with no growth that is
$51.80 we see a big difference. This is a very high number because the cost of equity is
very low.
g
0 0.01 0.02 0.05
Ke 0.02 $129.53 $230.53 N/A N/A
0.0257 $100.00 $146.01 $353.42 N/A
0.0484 $51.80 $58.85 $70.79 N/A
0.056 $44.45 $48.92 $55.88 $215.86
0.07 $35.07 $37.23 $40.24 $67.37
55
Valuation Analysis
Long Run Average Residual Income Based on the P/B Ratio
This model is based off the estimations in the Residual Income model addressed
in the previous section. By allowing PepsiCo to grow over an infinite life, we can solve
for values based off of the perpetuity. This model can also compare different results of
prices by implementing different cost of equities and growth rates into the equation.
(a) Exhibit 9
(b) P= BE + BE[ROE-Ke]/[Ke-G]
(i) Sensitivity Analysis

g
0 0.01 0.02 0.05
Ke 0.02 $127.30 $246.46 N/A N/A
BE 8.15 0.0257 $99.07 $156.98 $418.08 N/A
ROE 0.3124 0.0484 $52.60 $64.18 $83.91 N/A
0.056 $45.47 $53.58 $66.20 $356.43
0.07 $36.37 $41.08 $47.66 $106.93
56
Valuation Analysis
The current book value of equity for PepsiCo is 8.15, which is much smaller than
Cadbury’s 15.20 and slightly larger than Coca-Cola’s of 6.40. We also found PepsiCo’s
ROE of .3124 from the forecasting section. Given different scenarios of Ke and growth,
we were able to derive different prices based on the information. In the Residual Income
section we discovered that a cost of equity of 4.84 achieved a price of $51.80, which was
slightly less than the actual current price. Consistent with this valuation, the price of the
perpetuity at a growth rate of zero and a Ke of 4.84 was considerably close as well at
$52.60. Also examining the Ke of 2.57, which was calculated using the estimated beta
and risk free interest rate, yield a much higher price of $127.30. This would infer that the
PepsiCo is undervalued by 74 dollars. This result could have been the result of the
estimated beta previously described. By assuming growth in this equation, it revealed
that a cost of equity of 5.6 and a growth of 1% calculated a price of $53.58, which is
slightly above the current price. Also by assuming a Ke of 7% and a growth of 2%
revealed a price of $47.66. By looking at these assumptions it may infer that PepsiCo is
slightly overvalued.
By examining the sensitivity analysis above, can give a clear picture of the effect
on price based on changes on cost of equity and growth assumptions. Only by predicting
a fairly accurate estimate of cost of equity will give a fairly accurate assumption of the
price. This model is also fairly easy to implement and easy to understand. The only
downside to this model is the estimation of the cost of equity and growth. It is very hard
to believe that our Ke estimation of 4.84% is entirely accurate since this reflects a growth
rate of zero, which is hard to believe. This in conclusion, it could be fair to assume that
the Ke could be in the range of 5.6% to 7% based on the growth rates of 1 and 2%
.
Abnormal Earning Growth Model
The AEG model takes into consideration the present value of the investment
opportunities of the dividend paid to the shareholders. (See Exhibit 8). This model does
not only include the dividend payment themselves, but it implies that they are included in
57
Valuation Analysis
the earnings per share. The value of the investment opportunities, assuming that you are
going to invest at the current cost of equity, is also part of the model. The Abnormal
earnings are calculated by subtracting the cum-dividend earnings with the normal
earnings. These abnormal earnings are then discounted back to the present time. We
then set up perpetuity of AEG for the firm to find the value of each share. In our case we
assumed that after 2014 the AEG will be 0.023 with no growth. We still used the cost of
equity of 4.84% and this model gave us a price per share of $54.13. This is the first
model that shows that the company is undervalued because all the other models showed
that our company as overvalued. This model requires a very accurate cost of equity
because many components of the model are affected by it. For example as we see on the
sensitivity analysis for this model if we used the cost of equity estimated by using the five
year beta that is 2.57% with no growth the price per share is $74.36. The change of the
growth doesn’t make big changes and we see this if we had a growth after 2014 of 1 % or
2% with a cost of equity of 4.84% the price per share was going to be $55.9 and $58.93
respectively. We believe that our estimated cost of equity of 4.84% that we found by
using the WACC formula with the numbers taken from the discounted free cash flow
model is very accurate.
g
0 0.01 0.02 0.05
Ke 0.02 $86.18 $120.47 N/A N/A
0.0257 $74.36 $89.31 $156.69 N/A
0.0484 $54.13 $55.90 $58.93 N/A
0.056 $50.81 $51.80 $53.35 $88.87
0.07 $46.41 $46.74 $47.12 $51.34
58
Valuation Analysis
Discussion and Summary of Overall Results:
In all of our valuation models except abnormal earning growth model, the actual
price exceeded our estimated price. We believe that the abnormal earning growth model
is not a very accurate model because just the word abnormal means that something is not
normal. We think that this model doesn’t represent the fundamental value of PepsiCo
stock price in April 1, 2005.
By computing the average of the difference between estimated price and the
actual price from our entire valuation models we determined that the stock price of
PepsiCo is overvalued by an average of $3.51 per share. The residual income model was
the model that come the closest to the price of the stock on April 1, 2005. The difference
between the actual price per share and the estimated price per share in this model was 96
cents overvalued. We feel that the discounted dividend model is the least accurate
because it showed that the stock price of PepsiCo as April 1, 2005 is $9.58 overvalued
compared to the estimated price per share that this model estimated. If we don’t consider
this model the stock price of PepsiCo is overvalued only by an average of $1.48 per
share. Throughout most of these models the change of the growth rate was the most
sensitive factor of change, besides the discounted residual income where the cost of
equity was very sensitive to the change of the price per share.
59
Appendix
V Appendix
Exhibit A Income Statement for PepsiCO
5 YR ANNUAL INCOME
STATEMENT 12/31/2004 12/31/2003 12/31/2002 12/31/2001 12/31/2000
Sales 29,261.00 26,971.00 25,112.00 26,935.00 20,438.00
Cost of Goods Sold 12,289.00 11,303.00 10,523.00 9,837.00 7,121.00
Depreciation, Depletion &
Amortization 1,264.00 1,221.00 1,112.00 1,082.00 960
Gross Income 15,708.00 14,447.00 13,477.00 16,016.00 12,357.00
Selling, General & Admin
Expenses 10,299.00 9,460.00 8,523.00 11,608.00 9,132.00
Total Operating Expenses 23,852.00 21,984.00 20,158.00 22,527.00 17,213.00
Operating Income 5,409.00 4,987.00 4,954.00 4,408.00 3,225.00
Extraordinary Charge - Pretax 150 206 224 387 0
Non-Operating Interest Income 74 51 36 67 76

Earnings Bef Interest & Taxes 5,333.00 4,832.00 4,766.00 4,088.00 3,301.00
Interest Expense on Debt 169 167 181 222 228
Interest Capitalized 2 4 3 3 7
Pretax Income 5,166.00 4,669.00 4,588.00 3,869.00 3,080.00
Income Taxes 1,372.00 1,424.00 1,555.00 1,367.00 1,027.00
Equity Interest Earnings 380 323 280 160 130
Net Income Bef Extraordinary Items & Disc
Ops 4,212.00 3,568.00 3,313.00 2,661.00 2,183.00
Preferred Dividends 3 3 4 4 0
Net Income Bef Preferred
Dividends 4,212.00 3,568.00 3,313.00 2,661.00 2,183.00
Preferred Dividend
Requirements 3 3 4 4 0
Net Income Available To
Common 4,212.00 3,568.00 3,312.00 2,660.00 2,183.00
Income Statement for Pepsi Co provided by Thomson Analytics for Accounting (Amounts In Millions)
60
Appendix
Exhibit B Balance Sheet for PepsiCo
5 YR ANNUAL BALANCE
SHEET 12/31/2004 12/31/2003 12/31/2002 12/31/2001 12/31/2000
Assets
Cash & Equivalents 3,445.00 2,001.00 1,845.00 1,649.00 1,330.00
Receivables Net 2,999.00 2,830.00 2,531.00 2,142.00 1,799.00
Inventories 1,541.00 1,412.00 1,342.00 1,310.00 905
Other Current Assets 654 687 695 641 570
Total Current Assets 8,639.00 6,930.00 6,413.00 5,853.00 4,604.00
Investments in Unconsol
Subsidiaries 3,284.00 2,920.00 2,611.00 2,871.00 2,978.00
Property, Plant & Equipment
- Gross 15,930.00 14,755.00 13,395.00 12,180.00 9,539.00
Accumulated Depreciation 7,781.00 6,927.00 6,005.00 5,304.00 4,101.00
Property, Plant & Equipment
- Net 8,149.00 7,828.00 7,390.00 6,876.00 5,438.00
Other Assets 7,915.00 7,649.00 7,060.00 6,095.00 5,319.00
Total Assets 27,987.00 25,327.00 23,474.00 21,695.00 18,339.00
Liabilities
Accounts Payable 1,731.00 1,638.00 1,543.00 1,238.00 1,000.00
ST Debt & Current Portion
Due LT Debt 1,054.00 591 562 354 72
Accrued Payroll 961 851 806 789 673
Income Taxes Payable 99 611 492 183 48
Dividends Payable 387 274 259 255 202
Other Current Liabilities 2,520.00 2,450.00 2,390.00 2,179.00 1,940.00
Total Current Liabilities 6,752.00 6,415.00 6,052.00 4,998.00 3,935.00
Long Term Debt 2,397.00 1,702.00 2,187.00 2,651.00 2,346.00
Deferred Taxes 1,216.00 1,261.00 1,718.00 1,496.00 1,361.00
Other Liabilities 4,099.00 4,075.00 4,226.00 3,876.00 3,448.00
Total Liabilities 14,464.00 13,453.00 14,183.00 13,021.00 11,090.00
Shareholders' Equity
Preferred Stock 41 41 41 26 0
Common Equity 13,482.00 11,833.00 9,250.00 8,648.00 7,249.00
Total Liabilities &
Shareholders' Equity 27,987.00 25,327.00 23,474.00 21,695.00 18,339.00
Balance Sheet for Pepsi Co provided by Thomson Analytics for Accounting (Amount in Millions)
61
Appendix
Exhibit C Statement of Cash Flow for PepsiCo
5 YEAR ANNUAL CASH

FLOW STATEMENT 12/31/2004 12/31/2003 12/31/2002 12/31/2001 12/31/2000
Operating Activities
Income Bef Extraordinary
Items 4,212.00 3,568.00 3,313.00 2,661.00 2,183.00
Depreciation, Depletion &
Amortization 1,264.00 1,221.00 1,112.00 1,082.00 960
Investment Tax Credit 17 -323 288 162 63
Other Cash Flow -126 -63 -399 212 187
Funds From Operations 5,367.00 4,403.00 4,314.00 4,117.00 3,393.00
Funds From/For Other
Operating Activities -313 -75 313 84 518
Net Cash Flow From
Operating Activities 5,054.00 4,328.00 4,627.00 4,201.00 3,911.00
Investing Activities
Capital Expenditures 1,387.00 1,345.00 1,437.00 1,324.00 1,067.00
Increase In Investments 1,071.00 1,052.00 427 3,010.00 4,643.00
Decrease In Investments 38 31 833 2,078.00 4,171.00
Disposal of Fixed Assets 38 49 89 0 86
Other Use/(Source) -
Investing 52 46 415 n/a 260
Net Cash Flow From
Investing Activities 2,330.00 2,271.00 527 2,637.00 1,713.00
Financing Activities
Com/Prf
Purchased,Retired,Converte
d,Redeemed 3,055.00 1,945.00 2,190.00 1,731.00 1,430.00
Long Term Borrowings 504 52 11 324 130
Inc(Dec) In ST Borrowings 1,112.00 13 -62 -92 34
Reduction In Long Term
Debt 512 641 353 573 795
Cash Dividends Paid - Total 1,329.00 1,070.00 1,041.00 994 796
Net Cash Flow From

Financing Activities -2,315.00 -2,902.00 -3,179.00 -1,919.00 -2,298.00
Exchange Rate Effect 51 27 34 n/a n/a
Cash & Cash Equivalents -
Inc(Dec) 460 -818 955 -355 -100
Cash Flow for PepsiCo provided by Thomson Analytics for Accounting (Amounts In Millions)
62
Appendix
Exhibit AA
INCOME STATEMENT FOR PEPSICO (Amounts in millions of dollars)
Current Years Forecasted Years
Years 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Total Sales 20,438 26,935 25,112 26,971 29,261 32,238 33,796 36,499 39,054 41,788 44,713 47,843 51,192 54,775 58,609
Cost of Good Sold 7,121 9,837 10,523 11,303 12,289 14,132 15,545 17,099 18,809 20,690 22,759 25,035 27,538 30,292 33,321
Amortization 960 1,080 1,112 1,221 1,264 1,365 1,447 1,548 1,641 1,739 1,844 1,954 2,072 2,196 2,328
Gross Income 12,357 16,016 13,477 14,447 15,708 16,741 16,804 17,852 18,604 19,359 20,110 20,854 21,582 22,287 22,961
Selling,Adm Expense 9,132 11,608 8,523 9,460 10,299 10,814 10,706 11,241 11,690 12,040 12,401 12,773 13,156 13,551 13,958
Earning Bef Interest&Taxes 3,301 4,088 4,766 4,832 5,333 5,927 6,098 6,611 6,914 7,319 7,709 8,081 8,426 8,736 9,003
Interest expense 228 222 181 167 169 157 144 135 128 120 113 106 100 94 88
Pretax Income 3,080 3,869 4,588 4,669 5,166 5,770 5,954 6,476 6,786 7,199 7,596 7,975 8,326 8,643 8,915
Income Taxes 1,027 1,367 1,555 1,424 1,372 1,413 1,456 1,499 1,544 1,591 1,638 1,687 1,721 1,773 1,826
Net Income 2,183 2,660 3,312 3,568 4,212 4,357 4,498 4,977 5,242 5,608 5,958 6,287 6,605 6,870 7,089
63
Appendix
Exhibit BB
BALANCE SHEET FOR PEPSICO (Amounts in millions of dollars)
Years 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Cash Equivalent 1,330 1,649 1,845 2,001 3,445 4,437 5,768 6,114 6,603 7,065 8,479 10,174 11,192 13,430 16,116
Receivable Net 1,799 2,142 2,531 2,830 2,999 3,388 3,794 4,173 4,590 4,820 5,301 5,832 6,123 6,735 7,409
Inventory 905 1,310 1,342 1,412 1,541 1,623 1,720 1,823 1,914 2,010 2,110 2,216 2,326 2,443 2,565
Total Current Asset 4,034 5,101 5,718 6,243 7,985 9,448 11,282 12,110 13,107 13,895 15,890 18,222 19,641 22,608 26,090
Investments 2,978 2,871 2,611 2,920 3,284 3,378 3,667 3,850 4,120 4,532 4,305 4,564 4,929 4,732 5,001
Gross Property Plant&Equ 9,539 12,180 13,395 14,755 15,930 18,142 19,938 21,513 24,482 26,930 28,546 32,485 35,701 38,200 43,472
Accumulated Depreciation 4,101 5,304 6,005 6,927 7,781 9,104 10,224 11,450 12,733 14,936 16,907 18,987 21,835 24,520 27,536
Net Property Plant&Equ 5,438 6,876 7,390 7,828 8,149 9,006 9,366 10,022 10,523 11,154 11,601 12,819 13,716 13,990 14,690
Other Assets 5,319 6,095 7,060 7,649 7,915 8,725 8,987 9,706 10,696 11,230 11,567 12,129 12,614 13,497 14,037
Total Asset 18,339 21,695 23,474 25,327 27,987 30,995 33,474 36,151 39,404 42,556 45,876 50,005 53,230 57,488 62,662
Account Payable 1,000 1,238 1,543 1,638 1,731 1,973 2,209 2,407 2,647 2,912 3,145 3,459 3,805 4,109 4,520
Other Current Liabilities 1,940 2,179 2,390 2,450 2,520 2,691 2,766 2,836 2,921 3,029 3,319 3,545 3,971 4,026 4,187
Total Current Liabilities 3,935 4,998 6,052 6,415 6,752 7,697 8,543 9,226 10,056 10,860 11,729 12,668 13,681 14,912 16,105
Long Term Debt 2,346 2,651 2,187 1,702 2,397 2,476 2,105 2,399 2,087 1,879 2,893 3,125 3,562 2,992 3,710
Other Liabilities 3,448 3,876 4,226 4,075 4,099 4,279 4,309 4,783 4,496 4,721 5,051 5,607 5,775 5,255 5,571
Total Liabilities 11,090 13,021 14,183 13,453 14,464 15,331 15,790 16,105 16,749 17,369 17,890 18,426 19,108 19,586 20,311
Total Shareholder Equity 7,249 8,648 9,250 11,833 13,482 15,664 17,684 20,046 22,655 25,188 27,986 31,578 34,122 37,902 42,352
64
Appendix
Exhibit CC
CASH FLOW FOR PEPSICO (Amounts in millions of dollars)
Years 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Income Bef Extraordinary 2,183 2,661 3,313 3,568 4,212 4,955 5,351 5,887 6,946 7,293 7,585 8,116 9,090 9,726 10,407
Depreciation&Amortization 960 1,082 1,112 1,221 1,264 1,352 1,406 1,547 1,670 1,771 1,850 1,906 2,001 2,141 2,216
Funds From Operations 3,393 4,117 4,314 4,403 5,367 6,024 6,325 6,610 7,337 7,850 8,533 9,011 9,282 9,746 10,214
Cash Flow OP Activities 3,911 4,201 4,627 4,328 5,054 5,357 5,678 5,961 6,437 6,887 7,300 7,738 8,203 8,613 9,129
Capital Expenditures 1,067 1,324 1,437 1,345 1,387 1,486 1,534 1,442 1,499 1,604 1,732 1,784 1,695 1,831 1,922
Increase in Investments 4,643 3,010 427 1,052 1,071 1,142 959 1,065 1,150 966 811 974 1,052 1,199 959
Cash Flow INV Activities 1,713 2,637 527 2,271 2,330 3,261 4,040 4,242 4,581 4,810 5,099 5,303 5,674 6,071 6,193
Com/Prf Redeemed 1,430 1,731 2,190 1,945 3,055 3,768 3,316 3,714 4,605 5,250 4,620 5,682 5,114 5,881 7,116
Cash Dividend Paid 796 994 1,041 1,070 1,329 1,513 1,574 1,658 1,874 1,927 2,194 2,297 2,412 2,702 2,864
Cash Flow Fin Activities -2,298 -1,919 -3,179 -2,902 -2,315 -2,429 -2,179 -1,991 -2,787 -2,926 -2,458 -2,311 -3,928 -3,300 -2,772
65
Appendix
EXHIBIT 1
Adj. Price Adj. S&P 500 T-Bill (Rm -
Date Price Return Price Return return Rf)
1 4/1/05 52.76 -0.51% 1172.92 -0.65% 0.32% -0.97%
2 3/1/05 53.03 -1.12% 1180.59 -1.91% 0.31% -2.22%
3 2/1/05 53.63 0.30% 1203.6 1.89% 0.31% 1.58%
4 1/3/05 53.47 2.87% 1181.27 -2.53% 0.31% -2.84%
5 12/1/04 51.98 5.07% 1211.92 3.25% 0.30% 2.95%
6 11/1/04 49.47 0.67% 1173.82 3.86% 0.29% 3.57%
7 10/1/04 49.14 1.91% 1130.2 1.40% 0.28% 1.12%
8 9/1/04 48.22 -2.27% 1114.58 0.94% 0.28% 0.66%
9 8/2/04 49.34 0.00% 1104.24 0.23% 0.29% -0.06%
10 7/1/04 49.34 -7.19% 1101.72 -3.43% 0.31% -3.74%
11 6/1/04 53.16 1.37% 1140.84 1.80% 0.33% 1.47%
12 5/3/04 52.44 -2.05% 1120.68 1.21% 0.32% 0.89%
13 4/1/04 53.54 1.19% 1107.3 -1.68% 0.28% -1.96%
14 3/1/04 52.91 4.07% 1126.21 -1.64% 0.23% -1.87%
15 2/2/04 50.84 9.81% 1144.94 1.22% 0.26% 0.97%
16 1/2/04 46.3 1.38% 1131.13 1.73% 0.26% 1.47%
17 12/1/03 45.67 -2.79% 1111.92 5.08% 0.27% 4.80%
18 11/3/03 46.98 0.62% 1058.2 0.71% 0.27% 0.44%
19 10/1/03 46.69 4.36% 1050.71 5.50% 0.27% 5.23%
20 9/2/03 44.74 3.25% 995.97 -1.19% 0.27% -1.46%
21 8/1/03 43.33 -3.32% 1008.01 1.79% 0.28% 1.51%
22 7/1/03 44.82 3.53% 990.31 1.62% 0.24% 1.38%
23 6/2/03 43.29 1.05% 974.51 1.13% 0.19% 0.94%
24 5/1/03 42.84 2.12% 963.59 5.09% 0.21% 4.88%
25 4/1/03 41.95 8.20% 916.92 8.10% 0.24% 7.86%
26 3/3/03 38.77 4.78% 848.18 0.84% 0.23% 0.60%
27 2/3/03 37 -5.32% 841.15 -1.70% 0.24% -1.94%
28 1/2/03 39.08 -4.12% 855.7 -2.74% 0.25% -3.00%
29 12/2/02 40.76 -0.27% 879.82 -6.03% 0.25% -6.29%
30 11/1/02 40.87 -3.68% 936.31 5.71% 0.25% 5.45%
31 10/1/02 42.43 19.35% 885.77 8.64% 0.25% 8.40%

-
32 9/3/02 35.55 -6.20% 815.29 -11.00% 0.25% 11.25%
33 8/1/02 37.9 -7.90% 916.07 0.49% 0.27% 0.21%
34 7/1/02 41.15 -10.91% 911.62 -7.90% 0.32% -8.22%
35 6/3/02 46.19 -7.01% 989.81 -7.25% 0.35% -7.60%
36 5/1/02 49.67 0.16% 1067.14 -0.88% 0.37% -1.26%
37 4/1/02 49.59 0.77% 1076.64 -6.17% 0.39% -6.55%
38 3/1/02 49.21 2.27% 1147.39 3.67% 0.40% 3.28%
66
Appendix
39 2/4/02 48.12 0.84% 1106.73 -2.08% 0.36% -2.43%

40 1/2/02 47.72 2.87% 1130.2 -1.56% 0.36% -1.92%
41 12/3/01 46.39 0.41% 1148.08 0.76% 0.37% 0.39%
42 11/1/01 46.2 -0.15% 1139.45 7.60% 0.33% 7.26%
43 10/1/01 46.27 0.43% 1059.01 1.74% 0.33% 1.41%
44 9/4/01 46.07 3.50% 1040.94 -8.17% 0.34% -8.52%
45 8/1/01 44.51 0.79% 1133.58 -6.41% 0.38% -6.79%
46 7/2/01 44.16 5.49% 1211.23 -1.08% 0.40% -1.47%
47 6/1/01 41.86 -0.92% 1224.42 -2.50% 0.40% -2.90%
48 5/1/01 42.25 2.47% 1255.82 0.51% 0.41% 0.10%
49 4/2/01 41.23 -0.63% 1249.46 7.68% 0.40% 7.28%
50 3/1/01 41.49 -4.33% 1160.33 -6.42% 0.39% -6.81%
51 2/1/01 43.37 4.56% 1239.94 -9.23% 0.41% -9.64%
52 1/2/01 41.48 -11.06% 1366.01 3.46% 0.41% 3.06%
53 12/1/00 46.64 9.56% 1320.28 0.41% 0.43% -0.03%
54 11/1/00 42.57 -6.32% 1314.95 -8.01% 0.48% -8.48%
55 10/2/00 45.44 5.31% 1429.4 -0.49% 0.48% -0.98%
56 9/1/00 43.15 8.23% 1436.51 -5.35% 0.49% -5.84%
57 8/1/00 39.87 -6.93% 1517.68 6.07% 0.51% 5.56%
58 7/3/00 42.84 3.10% 1430.83 -1.63% 0.52% -2.15%
59 6/1/00 41.55 9.57% 1454.6 2.39% 0.53% 1.87%
60 5/1/00 37.92 10.91% 1420.6 -2.19% 0.56% -2.75%
61 4/3/00 34.19 1452.43
Average 0.33%
BETA INTERCEPT R^2

0.32 0.01055 0.06781
Cost of Equity (Estimated Beta) 2.57%

Ke = Rf + B(Rm - Rf)
Ke = 0.33% + 0.32(7%)
Cost of Equity (Published Beta) 4.88%
Ke = Rf + B(Rm - Rf)
Ke = 0.33% + 0.65(7%)
BETA 2 years 3 years

0.48 0.76
Ke 3.69% 5.65%
67
Appendix
Exhibit 2
PEPSICO 10-K 2004/12/25: Balance Sheet
LIABILITIES 12/25/2004 ( Percent of Total Liabilities Computed Interest Rate Value Weighted Rate
Current Liabilities:
Accounts payable $1,731 11.97% 0.00% 0.00%
Current portion of long-term debt $1,054 7.29% 6.01% 0.44%
Notes payable $0 0.00% 0.00% 0.00%
Other current liabilities $2,520 17.42% 4.38% 0.76%
Total Current Liabilities $6,752 46.68%
Long-term Debt $2,397 16.57% 6.01% 1.00%
Deferred Income Taxes $1,216 8.41% 0.00% 0.00%
Other Liabilities $4,099 28.34% 6.30% 1.79%
Total Non-Current Liabilities $7,712 53.32%
Total Liabilities $14,464 100.00%
Weighted Averaged Cost of Debt 3.98%
Short Term Liabilities Principal (Millions) Rate Weight Value Weighted Rate
Current Maturity of Long Term Debt 160 6.79% 8.87% 0.60%
Other Borrowings, 3.2% and 5.1% 1644 4.15% 91.13% 3.78%
1804 4.38%
Amount Reclassified to Long Term Debt (750)
Total Principal 1054

Long Term Debt Principal (Millions) Rate Weight Value Weighted Rate
Short Term Borrowings Reclassified 750 4.15% 29.33% 1.22%
Notes Due: (2005-2026) 4.7% and 5.7% 1274 5.20% 49.82% 2.59%
Zero Coupon Note, Yield 13.4% $575 Mill due (2005-2012) 321 13.40% 12.55% 1.68%
Other, Due (2005-2014), 6.2% and 6.4% 212 6.30% 8.29% 0.52%
2557 6.01%
Less Current Maturity of Long Term Debt Obligations (160)
Total Long Term Debt 2397
68
Appendix
Exhibit 3
Weighted Average Cost of Capital

Value of Equity:
PPS Shares Outstanding
$52.76 1,687,000,000
$89,006,120,000.00
Value of Debt
Current Maturity of Long Term Debt $2,397,000,000
Long Term Debt $1,054,000,000
$3,451,000,000.00
Value of Firm $92,457,120,000.00
WACC= (Vd/Vf)*(1-Tx)*Kd+(Ve/Vf)*Ke 4.80%

Tx= 31.66%
69
Appendix
EXHIBIT 4
Method of Comparables
2005 EPS BPS DPS PPS SPS

PepsiCo 2.55 8.15 0.98 52.76 18.90
Coca-Cola 2.05 6.40 1.08 41.38 9.40
Cadbury
Schweppes 2.20 15.20 0.93 40.00 23.95
P/E Ratio (PPS/EPS)

Coca-Cola 20.19
Cadbury
Schweppes 18.18
Avg 19.18
Price 48.92
P/B Ratio (PPS/BPS)

Coca-Cola 6.47
Cadbury
Schweppes 2.63
Avg 4.55
Price 37.07
Dividend Yield (DPS/PPS)

Coca-Cola 0.03
Cadbury
Schweppes 0.02
Avg 0.025
Price 39.72
P/S Ratio (PPS/SPS)

Coca-Cola 4.40
Cadbury
Schweppes 1.67
Avg 3.04
Price 57.38
PEG Ratio
Coca-Cola 2.17
Cadbury
Schweppes 2.20
Avg 2.19
Price 50.80
70
Appendix
The discounted free cash flow method. EXHIBIT 5

WACC = 0.048 Kd = 0.0398 Ke = 0.0488 Growth = 0.02
PepsiCo
(Amounts in millions of dollars except per share data)
Years from valuation date 1 2 3 4 5 6 7 8 9 Per
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Cash Flow from Operations 5,678 5,961 6,437 6,887 7,300 7,738 8,023 8,613 9,129
Cash Provided by Investing Activities (4,040) (4,242) (4,581) (4,810) (5,099) (5,303) (5,674) (6,071) (6,193)
Free Cash Flow (to firm) 1,638 1,719 1,856 2,077 2,201 2,435 2,349 2,542 2,936 2,995
discount rate (4.8% WACC) 0.95 0.91 0.87 0.83 0.79 0.75 0.72 0.69 0.66
Present Value of Free Cash Flows 1562.98 1565.14 1612.48 1721.83 1741.06 1837.94 1691.82 1746.97 1925.33
Total PV of Annual Cash Flows 15,406
Continuing (Terminal) Value 106954
PV of Continuing (Terminal) Value 70,137
Value of the Firm (end of 2005) 85,542 Sensitivity Analysis

Book Value of Debt $3,451 g
Value of Equity (end of 2005) 82,091 0 0.01 0.02 0.04
Estimated Value per Share 12-31-05 48.66 WACC 0.02 $81.45 $154.56 N/A N/A
Estimated Value per Share 04-01-05 47.90 0.03 $52.46 $74.78 $141.75 N/A
48.66/(1+(WACC/12)^(9/12) 0.048 $30.85 $37.13 $47.90 $150.21
Actual Price per share $52.76 0.06 $23.71 $27.15 $32.32 $58.18
WACC 0.048
Growth 0.02
0.048=(3451/85542)*0.0398+(82091/85542)new Ke
New Ke = 0.0484
71
Appendix
Discounted Dividend Method EXHIBIT 6

WACC = 0.048, Kd =0.0398, Ke(new) = 0.0484, Growth =0
PepsiCo
Years from valuation date 1 2 3 4 5 6 7 8 9 Perp
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Dividends per share $1.12 $1.28 $1.39 $1.50 $1.72 $1.86 $1.97 $2.10 $2.23 $2.23
Present Value Factor 0.954 0.909 0.868 0.828 0.789 0.753 0.718 0.685 0.653
Present Value of Future Dividends $1.07 $1.16 $1.21 $1.24 $1.36 $1.40 $1.41 $1.44 $1.46
Total PV of Forecast Future Dividends $11.75

Continuing (Terminal Value) (growth of 0.02) $46.07
Present Value of Continuing (Terminal) Value $31.56
46.04*0.685 Sensitivity Analysis
Estimated Value per Share 12-31-05 $43.31 g
Estimated Value per Share 04-01-05 43.18 0 0.01 0.02 0.05
54.44/(1+(Ke/12))^(9/12) Ke 0.02 $87.86 $164.01 N/A N/A
0.0257 $70.79 $108.71 $278.90 N/A
Actual Price per share $52.76 0.0484 $43.18 $51.37 $65.53 N/A
New Cost of Equity 0.0484 0.056 $38.91 $44.82 $54.02 $265.54
growth rate 0 0.07 $33.47 $37.09 $42.17 $87.86
72
Appendix
Discounted Residual Income EXHIBIT 7

WACC= 0.048, Kd =0.0398, New Ke= 0.0484 Growth =0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Beginning BE (per share) 8.15 9.59 11.55 12.58 13.56 14.42 15.18 15.76 16.31
Earnings Per Share $2.56 $2.60 $2.42 $2.53 $2.58 $2.62 $2.55 $2.65 $2.70
Dividends per share $1.12 $1.28 $1.39 $1.55 $1.72 $1.86 $1.97 $2.10 $2.23
Ending BE (per share) 8.15 9.59 10.91 12.58 13.56 14.42 15.18 15.76 16.31 16.78
"Normal" Income 0.39 0.46 0.53 0.61 0.66 0.70 0.73 0.76 0.79
Be *Ke
Residual Income (RI) 2.17 2.14 1.89 1.92 1.92 1.92 1.82 1.89 1.91 1.91
EPS - NI
Present Value Factor 0.95 0.91 0.87 0.83 0.79 0.75 0.72 0.69 0.65
Present Value of RI 2.07 2.04 1.80 1.83 1.83 1.83 1.73 1.80 1.82
BV Equity (per share) 2005 8.15

Total PV of RI (end 2005) 16.76
Continuation (Terminal) Value 39.48 Sensitivity Analysis
PV of Terminal Value (end 2005) 27.05
39.48*0.69 g
Estimated Value per share 12-31-05 $51.96 0 0.01 0.02 0.05
Estimated Value per share 04-01-05 $51.80 Ke 0.02 $129.53 $230.53 N/A N/A
51.96/(1+(Ke/12)^(9/12) 0.0257 $100.00 $146.01 $353.42 N/A
0.0484 $51.80 $58.85 $70.79 N/A
Actual Price per share $52.76 0.056 $44.45 $48.92 $55.88 $215.86
Ke 0.0484 0.07 $35.07 $37.23 $40.24 $67.37
Growth 0
73
Appendix
Abnormal Earning Growth Model EXHIBIT 8

WACC= 0.048, Kd =0.0398, New Ke= 0.0484 Growth =0
PepsiCo
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
EPS 2.55 $2.56 $2.60 $2.42 $2.53 $2.58 $2.62 $2.55 $2.65 $2.70
DPS 0.98 $1.12 $1.28 $1.39 $1.55 $1.72 $1.86 $1.97 $2.10 $2.23
DPS invested at 4.84% 0.047 0.054 0.062 0.067 0.075 0.083 0.090 0.095 0.102
Cum-Dividend Earnings 2.607 2.654 2.482 2.597 2.655 2.703 2.640 2.745 2.802
Normal Earnings 2.673 2.684 2.726 2.537 2.652 2.705 2.747 2.673 2.778
Abnormal Earning Growth (AEG) (0.066) (0.030) (0.244) 0.060 0.003 (0.002) (0.107) 0.072 0.023 0.023
PV Factor 0.954 0.910 0.868 0.828 0.790 0.753 0.718 0.685 0.654
PV of AEG (0.063) (0.027) (0.212) 0.050 0.002 (0.001) (0.077) 0.049 0.015
Core EPS 2.560
Total PV of AEG -0.263
Continuing (Terminal) Value $0.48
PV of Terminal Value 0.331
Total PV of AEG
Average Perpetuity 2.628 Sensitivity Analysis
Capitalization Rate (perpetuity) 0.048 g
Estimated Value per Share 12-31-05 54.294 0 0.01 0.02 0.05
Estimated Value per share 04-01-05 54.130 Ke 0.02 $86.18 $120.47 N/A N/A
54.29/(1+Ke/12)^9/12 0.0257 $74.36 $89.31 $156.69 N/A
Actual price per share 52.76 0.0484 $54.13 $55.90 $58.93 N/A
Ke 0.0484 0.056 $50.81 $51.80 $53.35 $88.87
g 0 0.07 $46.41 $46.74 $47.12 $51.34
74
Appendix
Exhibit 9
Long Run Average Residual Income Perpetuity based on the P/B Ratio
Sensitivity
Analysis
g
0 0.01 0.02 0.05
Ke 0.02 $127.30 $246.46 N/A N/A
BE 8.15 0.0257 $99.07 $156.98 $418.08 N/A
ROE 0.3124 0.0484 $52.60 $64.18 $83.91 N/A
0.056 $45.47 $53.58 $66.20 $356.43
0.07 $36.37 $41.08 $47.66 $106.93
75
Appendix
Sources
1. www.finance.yahoo.com
2. www.pepsico.com
3. www.moneycentralmns.com
4. http://edgarscan.pwcglobal.com
5. www.morningstar.com
6. www.stlouisfed.org
7. http://tabseacct.swlearning.com
8. Epic Software
9. Value Line
10. www.forbes.com
11. www.new-nutrition.com
76

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PEPSICO VALUATION

Business & Industry Analysis……………………………………… 5

Five Forces Model....... ……………6

Ratio Analysis & Forecast Financial……………… 25

Investment Recommendation: Slightly Overvalued Sell

PEP – NYSE $53.63

Dividend Yield 1.72% Valuation Estimates

As we mention previously PepsiCo is a world leader in convenient food and

After extensive review of PepsiCo’ accounting practices we feel highly

of regulation and industry standards. Quality of disclosures was adequate in regards to

We analyzed PepsiCo using the liquidity, profitability, and capital structure

II Business & Industry Analysis

PepsiCo was founded in 1919 in Delaware and was reincorporated in North

Five Forces Model

Competitive Force 1: Rivalry Among Existing Firms

Competitive Force 2: Threat of New Entrants

Competitive Force 3: Threat of Substitute Products

In PepsiCo’s industry there is a considerable threat of product substitution.

Competitive Force 4: Bargaining Power of Buyers

Competitive Force 5: Bargaining Power of Suppliers

Competitive Strategy Analysis

Another competitive advantage that PepsiCo has is its non-carbonated beverage.

Another competitive advantage of PepsiCo is their flexibility of their distribution

developed in a way to satisfy customer needs and to show product characteristic. By

Key Success Factor

III Accounting Analysis

The next process of analyzing PepsiCo was to look at their accounting

Key Accounting Policies

PepsiCo is a manufacturing company that must compete in research and

going to be based on a number of assumptions like interest rate, employee exercises,

Evaluating Accounting Strategy:

In order to assess if PepsiCo’s accounting strategies reflect true economic reality,

PepsiCo does a job showing disaggregated performance information based on

Potential Red Flags:

Sales Manipulation 2004 2003 2002 2001 2000

In order to account for any possible manipulations of PepsiCo’s information we

Conclusion and Discussion:

After extensive review of PepsiCo’ accounting practices we feel highly

Quality of disclosures was adequate in regards to voluntarily giving and posting

III. Financial Analysis and Forecast Financials

In this next phase of evaluating PepsiCo, we have computed financial ratios to

2004 2003 2002 2001 2000

Quick Asset Ratio 0.95 0.75 0.72 0.76 0.8

Inventory Turnover 9.76 8 7.84 7.51 7.87

Days Supply of Inventory 37.41 45.6 46.55 48.61 46.39

Receivables Turnover 7.97 9.53 9.92 12.57 11.36

Sales Outstanding 45.77 38.3 36.79 29.03 32.13

Working Capital Turnover 15.51 52.37 69.56 31.5 30.55

Operating Expense Ratio 35.20% 35.07% 33.94% 43.10% 44.68%

Net Profit Margin 14.40% 13.23% 13.19% 9.88% 10.68%

Asset Turnover 1.05 1.06 1.07 1.24 1.11

Return on Asset 15.05% 14.09% 14.11% 12.26% 11.90%

Return on Equity 31.24% 30.15% 35.81% 30.76% 30.11%

Capital Structure Ratios

Times Interest Earned 31.56 28.93 26.33 18.41 14.48

Debt Service Margin 0.75 0.67 0.76 0.84 0.99

By further assessing other ratios we were able to determine the performance of

Cross Sectional Analysis

Coca- Cadbury Industry

Quick Asset Ratio:

Coca- Cadbury Industry

By also comparing the efficiency of companies to utilize higher liquid assets to

Accounts Receivable Turnover: