Angry Men

As of year-end of 1990:

Capital Structure:

Market value of debt = short-term debt +long-term debt $000 (million)

Market value of long term debt: 6,525.9

Short term borrowings: 1,626.5

Total market value of debt: 8,152.4

Less Cash and Cash Equivalents: 170.8

Less Short-term investments: 1,644.9

Net Market Value of debt: 8,152.4 – 170.8 – 1,644.9 = $ 6,336.7 million

Total Value of equity = Average shares outstanding * current market price per share

Total Value of equity = 788,400 * 25.75 = $ 20,301,300

Corporate Cost of Debt

Tax Rate: 38% (based on the given input from the case)

K = 9.6% (based on the given input from the case)

Kd = 9.6% * (1-0.38) = 5.95%

Corporate Cost of Equity

We can use CAPM to calculate the cost of equity Ke.

Beta = 1.1 (based on the given input from the case)

Risk Free Rate, Rf = 8.16% (Based on 10-year US Govt Interest rates: Exhibit 6)

Market Risk Premium (based on Average return of S&P 500 and US Govt T-Bill using Arithmetic mean: Exhibit 7) = 12.1 – 3.7 = 8.4%

Cost of Equity = Rf + b (market risk premium)

= 8.16% + 1.1(8.4%) = 17.4%

Corporate WACC

Debt to Equity Ratio = 6336.7/20566.5 = 30.81%

Debt to Total Ratio = 6336.7/ (6336.7 + 20566.5) = 6336.7/26903.2 = 0.2355 = 23.55%

Equity to Total Ratio = 20566.5/(6336.7 + 20566.5) = 20566.5/26903.2 = 0.7645 = 76.45%

WACC = (0.2355 * 0.0595) + (0.7645 * 0.174) = 14.7%

Cost of Capital for Individual Business Divisions

Beverage Division

Using Hamada’s equation, un-levering the beta of the proxy pure-play company Coca-Cola:

Debt to Equity Ratio = (535861 + 97272)/ (688239 * 46.5) = 633133/32003113.5 = 1.98%

Bu = 1/ (1 + (0.0198 * (1-0.38))) = 0.9878

Re-lever the beta using the capital structure of PepsiCo.

BL = Bu * (1 + 0.3081*0.62) = 1.1765

Adjusted Cost of Equity = 8.16% + 1.1765(8.4%) = 18.04%

Adjusted WACC = (0.2355 * 0.0595) + (0.7645 * 0.1804) = 15.19%

Snack Division

Using Hamada’s equation, un-levering the beta of the proxy pure-play company General Mills:

Debt to Equity Ratio = (785400 + 56700)/ (164734 * 44.38) = 842100/7310894.92 = 11.52%

Bu = 1.05/ (1 + (0.1152 * (1-0.38))) = 0.98

Re-lever the beta using the capital structure of PepsiCo.

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