CFEA 2124:

BASIC MANAGERIAL FINANCE

Semester 1 Session 2015/2016

CASE STUDY 14:

COKE VERSUS PEPSI, 2001

Prepared for : Dr. Shahrin Saaid bin Shaharuddin

Date of submission : 8th December 2015

Name Matrix Num

Farhana Athirah binti Azly CEA140033

Noor Atiqah binti Badrul Shisham CEA140093
Nur Alya binti Mohamad Yusof CEA140097
Nurul Atikah binti Mat Zali CEA140107
 CONTENT

NUM ITEM PAGES

1. Introduction

(i) Company Background

 The Coca-Cola Company 1–3

 PepsiCo, Inc

(ii) Industry Overview and Competitive Events

2. Objective 4
3. Financial Analysis

 Economic Added Value(EVA) 5–6

 Weighted Average Cost of Capital(WACC)

4. Financial Comparison 7–8
5. Conclusion 9
6. Recommendation 10

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 COMPANY BACKGROUND: THE COCA-COLA COMPANY

In 2000, the Coca-Cola Company was the largest manufacturer,

distributer and marketer of soft-drink concentrates and syrups in the world. It

also marketed and distributed a variety of noncarbonated-beverage

products, including Minute Maid orange juice and Dasani bottled water.

From 1993 to 1998, the Coca-Cola Company had consistently garnered

the first or second spot in Fortune’s annual ranking of the top wealth

creators. One of the main reasons for this was the company’s strategy of

spinning off its bottling operations to avoid consolidation on its balance

sheet.

However, the company had run into difficulties at certain point in its

growth. Business mistakes by Doug Ivester, CEO from 1997 to 1999

aggravated the situation. During Ivester’s approximately two-year term, net

income fell by 41 percent. The company’s board of directors eased Ivester

out in December 2000.

Douglas Daft, head of Coca-Cola’s Middle and Far East and Africa

groups, was chosen to succeed Ivester. Daft and his executives worked hard

to bring back the glory days of the Coca-Cola Company by making few

changes to the company. Some analysts were optimistic that the change in

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management would return the Coca-Cola Company to the pre-1998 profit

margins. While other analysts were less enthusiastic as PepsiCo’s making its

rapid movement, the Coca-Cola Company need to get back on its feet as

quickly as it could.

COMPANY BACKGROUND: PEPSICO, INC.

During 2000, PepsiCo, Inc. was a company involved in the snack food,

soft drink and noncarbonated beverage businesses. The company sold and

distributed salty and sweet snacks under the Frito-Lay trademark and

manufactured concentrates of Pepsi, Mountain Dew and other brands to sell

to franchised bottlers. The company also produced and distributed juices and

other noncarbonated beverages.

Positioning PepsiCo as a focused snack-and-beverage company in 2000

was due mostly to the efforts of Roger Enrico, CEO from 1996 to 2000.

During Enrico’s term, PepsiCo’s return on equity almost doubled from 17

percent in 1996 to 30 percent in 2000. On Wall Street, analysts were upbeat

about PepsiCo’s prospects.

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 INDUSTRY OVERVIEW AND COMPETITIVE EVENTS

In 2000, the beverage industries was undergoing a rapid

transformation; the noncarbonated drinks segment, although still

representing only a small fraction of the beverage market, had grown by 62

percent in volume over the last five years, while soft-drink volume growth

had been sluggish.

Pepsi had launched aggressive and exciting marketing campaigns that

helped boost volume and visibility. In addition, Pepsi also launched the

campaign to entice shoppers to pick up a Pepsi when they bought chips,

which is the Pepsi drinks are located next to Frito-Lay chips on store shelves.

In response to the success of the Pepsi campaigns, Coca-Cola resorted to a

number of tactics, such as veering away from its traditional feel-good ads

and launching trendier ones. Unfortunately, the new ads were highly

unpopular and elicited negative reactions from customers. Coca-Cola pulled

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the ads and replaced them with the “Life Tastes Good” series, which marked

a return to Coke’s traditional “feel-good” themes, while being trendy at the

same time.

OBJECTIVE

1. To compare which companies between Coca-Cola Company and

PepsiCo, Inc to invest in.

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 FINANCIAL ANALYSIS

 ECONOMIC VALUE – ADDED (EVA)

Economic value-added (EVA) or also referred as “economic profit analysis”

is an indicator of performance measurement system in a company. EVA is

based on the residual income and determine by calculating the difference

between return on invested capital and weighted average cost of capital and

multiply it by the company’s invested capital.

The formula for computing EVA is as follows:

EVA = (Return on invested capital – Weighted average cost of capital) X

Invested capital

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 In a sense, EVA is the net present value generated from capital

budgeting of a company. The concept behind EVA is to measure financial

performance based on the value added during the period to create

shareholder’s wealth. EVA is a way of measuring an operation’s real

profitability and also build investor’s expectation on estimated the growth of

the business. It is better than conventional ways because it takes into

account the total cost of the operating capital.

 WEIGHTED AVERAGECOST OF CAPITAL (WACC)

Weighted average cost of capital (WACC) is cost of debt and cost of

common equity. Cost of capital used by the company is obtained from

weighted average of these two components. By calculating WACC, we can

see the firm’s equity value, debt value and hence firm value needs to be

derived. A firm's WACC is the overall required return of the company. It is

considered the appropriate discount rate to use for cash flows with risk that

is related to that of the firm. A firm’s WACC is formulated using the formula:

The WACC of a firm increase as if the beta and rate of return on equity

increases, this is a sign of a decrease in valuation and a higher risk.

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 When considering a feasible project, WACC is used to discount the cash

flows to get the NPV of the project. For a project to be feasible, it must

generate a return higher than the cost of raising debt and the cost of raising

equity. By computing WACC of an investment tool, the firm can have an idea

of the minimum rate of return are required to remain economical in the

future. Thus, WACC is an important instrument in making sound financial

decision at the corporate level.

From the description of WACC, it can be assumed that WACC is

dependent on the firm’s capital structure and the firm riskiness of market

valuation as reflected in the sources of the cost of capital, this is assuming

that the corporate tax rate is remain constant. It is within the right of the

firm’s decision makers to change the percentage of debt to equity ratio of

the firm. Thus, changing the firm’s capital structure can decrease WACC. In

general, debt is cheaper than equity but simultaneously, the higher the debt

means higher riskiness and could lead to higher cost of equity, Kd and cost of

debt, Ke.

FINANCIAL COMPARISON

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 Exhibit 1 shows that from the year 1994 to 2000, Coca-Cola has a

relatively stable EVA as compared to Pepsi Co. regardless of the fact that

Coca-Cola’s EVA is declining from year to year. On the other hand, Pepsi Co.

has gained negative EVA in the past but has been steadily growing and

surpassed Coca-Cola’s EVA in 2000.

The trend in Pepsi Co.’s EVA was the direct impact of its CEO, Roger’s

Enrico’s decision to sell off KFC, Taco Bell and Pizza Hut in 1997 as part of a

move to revamp the company and focus more on snack and beverage.

Business mistakes of its CEO, Doug Ivester, largely contributed Coca-Cola’s

low EVA more than the global economic environment during that period.

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During 1994 to 1998, both Coca-Cola and Pepsi have similar WACC values

but Coca-Cola had lesser capital investment with higher ROICs and EVAs than

Pepsi. By 2000, Pepsi Co. now has higher EVA which makes it stand almost

on the same level as Coca-Cola. Based on these observations, it can be

assumed that Return on Investment Capital (ROIC) is a prime deciding factor

for EVA analysis.

It is important to invest capital at a higher rate than the capital is

obtained at. In theory, as long as there are enough projects that produce

ROIC>WACC and enough capital supplied, EVA can grow indefinitely.

Based on Exhibit 8, it shows that Coca-Cola share price is much higher

than PepsiCo. There was almost a perfect correlation between the EVA and

their stock price.Goal of the firm is to maximize the shareholders wealth.

Therefore, it is better to invest in Coca-Cola’s stock over Pepsi’s stock

because it will create more EVA and hence add more value for the

shareholders over this period.

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 CONCLUSION

In conclusion, based on the Economic Value Added (EVA) analysis,

Coca-Cola is a better financial option in the foreseeable future as it would

create more value to the shareholders. On the other hand, it should be

noted that attempt of both Coca-Cola and Pepsi Co.’s to enter other market

segments is likely to be highly profitable. This is due to the changes in

customer orientation to a non-carbonated drink.

To have a more exact and clear view of the situation, we looked at the

EVA figures for both Coca-Cola and Pepsi Co from the year 1994 to 2000

together. It can be seen that in the long run, Coca-Cola can survive more

efficiently than Pepsi Co. since it has faced near bankruptcy cases and still

can be recovered from them whereas Pepsi Co. has not.

Besides, there was almost a perfect relation between Coca-Cola’s EVA

and stock price. EVA does a better job in telling the investors about the

things that has become their main interest which is the net cash return on

their capital. Therefore, it can be conclude that there will be a better

opportunity to invest in Coca-Cola’s stock over Pepsi’s stock as it will create

more Economic Value Added and hence create more value for the

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shareholders over the period.

RECOMMENDATION

Since Coca-Cola business is highly related to their cultural ties, it is

important for them to stay true with what they have been doing for years.

While on the other hand, for PepsiCo. Inc they may need to find ways to

make their brand more recognizable. For instance, Pepsi Co. Inc has to work

hard to relate their business with all people culturally, rather than just doing

it through the campaigns. Besides, for both of the companies, it is suggested

for them to also have a focus on their advertising and promotion in order to

differentiate themselves from their competitor besides changing the image

and perception of people towards cola into a fit healthy living trend.

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