Theme Park Proposal Finance Essay: Net Present Value

Corporate finance over the last few years has really evolved, decisions regarding economic growth, resource allocation in projects by organiation requires a through systematic, analytical approach along with sound judgment. Investment (projects) appraisals and capital budgeting involves in-depth assessing of financial feasibility of the projects and the best recommended financials tools are Discounted Cash Flow (DCF), as this technique can effective be used to calculate the and carry out a costs and benefits analysis in different time periods and moreover most importantly the calculation of Net present value (NPV) uses DCF to project decisions, which would focus on the ones that generate maximum revenue and create value for the organisation undertaking the project. The costs and benefits associated with development programs can be either be social, environmental or economic in nature, but as often found has the involvement of all the three elements.

This investment review report, would look into the investment proposal made by Wonderland confectionaries Ltd, and involves diversification in business and investment in a theme park. Wonderland intends investing a total of £500 million in the project and wants to ensure the feasibility of the investment both in terms of financial and non-financial terms.

This report on the basis of the information provided by Wonderland would be using the Net Present Value (NPV) as the financial tool to calibrate the financial feasibility of the project, undertake and consider the project appraisal options and at the end recommend and comment on the overall feasibility of the proposed investment.The key objective of this report is to analyse, calculate and comment on the overall cost, in terms of employee cost, operations and insurance cost along with other overheads, also considering the source and cost of finance and its returns in regards to the expected revenue generated and the cola reflect and comment on the feasibility of the investment.

Introduction:

PepsiCo is found in the 1965 through the merger of the pepsi-cola and Frito Lays. Tropicana was acquired in 2001and PepsiCo merged with the Quaker Oats company including Gatorade, in 2001. PepsiCo’s main headquarter in New York. Now at present time there are around 200 brands available in the market. All around the world it is the 2nd number company in soft drinks. In 1987 it PepsiCo was ranked 29th in the fortune 500 whereas the cola was at 54th ranked. It is the most successful consumer product company in the world. Now it consist of Frito lays, Pepsi colas company and Tropicana products. Some of the established consumed brands are Doritos, Fritos, ruffles and lays (snacks food) and Pepsi cola; diet Pepsi and mountain dew (soft drinks).

Divisions

We report our operations results as follows, by six segments:PepsiCo Americas Beverages (PAB)Frito-Lay North America (FLNA)Quaker Foods North America (QFNA)Latin America Foods (LAF)EuropeAsia, Middle East & Africahttp://www.pepsico.com/Investors/Corporate-Profile.htmlPepsiCo mission is:”To be the world’s premier consumer Products Company focused on convenient foods and beverages. We seek to produce financial rewards to investors as we provide opportunities for growth and enrichment to our employees, our business partners and the communities in which we operate. And in everything we do, we strive for honesty, fairness and integrity”.

Pepsico’s capital structure Objectives:-

To evaluate the standard of behavior and general directions in the corporate finance.To find out and assess the nature of different sources of corporate finance.To express deep and proper knowledge in the area of corporate finance development.To express effective pathway to examine the corporate finance students.Possess the ability to plan and effective tools at professional level; make decisions in complex and able to frhold context of using reasonable decision making approach.Brief introduction to the PepsiCo capital structure:

PepsiCo is the world leader in convenient food, snacks and beverages with revenue more than $60 billion and over 285,000 employees. It generates sales at the retail level of $98 billion. Over the next 30 years, net sale grew up at an average compound rate 15% per year, with the sale doubling about every five years.PepsiCo has book liability of $18.1billionand book value for stockholders’ equity of $7.3 billion. The market value of stockholders’ equity is much greater. With the 788million common shares outstanding and a market share price is of $55.875,the market value of its stockholders’ equity is $44.0 billion, roughly six times its book value.Pepsico’s capital investing has reflects strategic investment in both industry segments as well as acquisition and investment in unconsolidated affiliates.pepsico expects its investments to generate cash returns in excess of its long term cost of capital, which is estimates to be approximates 10%. About 75% of PepsiCo’s total acquisition and investment activity represents international transactions.

PepsiCo’s vision and mission:-

Our Mission

Our mission is to be the world’s premier consumer Products Company focused on convenient foods and beverages. We seek to produce financial rewards to investors as we provide opportunities for growth and enrichment to our employees, our business partners and the communities in which we operate. And in everything we do, we strive for honesty, fairness and integrity.

Our Vision

“PepsiCo’s responsibility is to continually improve all aspects of the world in which we operate – environment, social, economic – creating a better tomorrow than today.”

Our vision is put into action through programs and a focus on environmental stewardship, activities to benefit society, and a commitment to build shareholder value by making PepsiCo a truly sustainable company.http://www.pepsico.com/Company/Our-Mission-and-Vision.html

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Financial leverages:-

Leverage is the relationship between debt financing and equity financing, also known as the debt-to-equity ratio. A method of corporate funding in which a higher proportion of funds is raised through borrowing then stock issue, the use of fixed costs in order to increase the rate of return from an investment.Financial leverage is the ability of the firm to use fixed financial charges to magnify the effect of change in earning per share. It indicates the effects on earning due to rise of fixed cost funds.financial leverage: operating income/net incomeThe tool which we used to identify the fianancial leverage of pepsico’s are the market value and historical cost and net debt play a prominent role in quantifying the financial leverage .Question :-

Calculate PepsiCo’s net debt ratio, assuming that the present value of operating leases is five times the annual rental expense and that remitting the cash and marketable securities to the United States reduces them by 25% due to taxes and transaction costs.

The most important factor before investing the money in a company is to consider that how much debt a company is carrying. It is helpful to find out the net debt of a company. After calculating the net debt ratio people who will be able to find out the financial position of the company in which they going to invest in.As per given in the statement:-The net debt ratio, L*, is defined as

L* = (D + PVOL – CMS)/(NP + D + PVOL – CMS)

Where D is the total market value of debt,PVOL is the present value of operating leases commitments which is five times the annual rental expense,CMS is cash and marketable securities (net of the cost of remitting these funds to the United States),N is the number of common shares,And P is the price of common stock.In order to determine the net debt ratio, we have to put the values in the formula mentioned above.L* = (D + PVOL – CMS)/(NP + D + PVOL – CMS)L* = ($9453 + [$479 x 5] – $1498)/([788.00 x $55.875] + $9453 + [$479 x 5] – $1498)

L* = ($9453 + $2395 – $1498)/($44029.5 + $9453 + $2395 – $1498)L* = ($10350)/(54379.5)L* = $0.19After ascertaining the net debt ratio, we can say that it has increased by 1% from last year and if we look at debt ratio graph above, we see that PepsiCo’s net debt ratio kept on fluctuating at a higher rate in last few years. But this year it has increased only by 1% which is good for the company.

Question 2

For each firm in the table above, calculate the interest coverage ratio, the fixed charge coverage ratio, the long term debt ratio, the total debt to adjusted total capitalization (recall that adjusted capitalization includes short term debt), the rate of cash flow to long term debt, and the ratio of cash flow to total debt.

FIRM

ANNUAL EBIT

ANNUAL RENTAL EXPENSE

ANNUAL INTEREST

CASH AND MARKETABLE SECURITIES

MARKET VALUE OF LONG-TERM DEBT

MARKET VALUE OF TOTAL DEBT

ANNUAL CASH FLOW

MUNBER OF SHARES (MILLIONS)

YEAR-END SHARE PRICE

PepsiCo

$ 3,114.00

$ 479.00

$ 682.00

$ 1,498.00

$ 8,747.00

$ 9,453.00

$ 3,742.00

788.00

$ 55.875

Cadbury Shweepes

$ 661.00

$ 25.00

$ 135.00

$ 129.00

$ 864.00

$ 1,490.00

$ 492.00

247.75

$ 35.125

Coca-Cola

$ 4,600.00

$ 272.00

$ 1,315.00

$ 1,141.00

$ 1,693.00

$ 3,115.00

2,504.60

$ 40.250

Coca-Cola Enterprises

$ 471.00

$ 31.00

$ 326.00

$ 8.00

$ 4,138.00

$ 4,201.00

$ 644.00

385.65

$ 10.00

McDonald

‘s

$ 2,509.00

$ 498.00

$ 340.00

$ 335.00

$ 4,258.00

$ 4,836.00

$ 2,296.00

609.70

$ 48.00

Interest Coverage Ratio = EBIT / Interest Expense

Where EBIT is Earning before interest and tax which is written as Annual EBIT in the Table1,And Interest expense is Annual Interest.”Interest Coverage Ratio is a calculation of company’s ability to meet its interest payments on outstanding debt. Interest Coverage Ratio is calculated by dividing earning before interest and taxes with interest expense. The lower the interest coverage is, larger the debt burden on the company.”[3]

Fixed Charge Coverage Ratio = EBIT + Fixed Charge(before tax)/Fixed Charge(before tax + interest)

Where is Earning before interest and tax which is written as Annual EBIT in Table1,And Fixed Charge is present value of operating lease commitments (PVOL).Fixed Charges are the expenses which a company has to bear like rent, electricity, stationery, machinery repairs, etc. The ability of the company to meet al these expenses is known as fixed charge coverage. This ratio is calculated by dividing EBIT and fixed charge(before tax) by fixed charge (before tax + interest). The higher the ratio is, higher is the capacity of the company to meet the expenses.

Long Term Debt Ratio = long term debt / long term debt + equity

Where equity is equals to number of shares x year-end share price (NP)Long-Term Debt Ratio is a way to determine the company’s leverage. It is calculated by taking Long-Term Debt and dividing it by the sum of its long-term debt and equity. The greater the company’s leverage, higher the ratio will be and also it is seen that the companies with higher ratios are thought to be more risky because they have more liabilities and less equity.[2]

Total Debt to Adjusted Capitalization = Total Debt / Adjusted Capitalization

In order to ascertain the total debt to adjusted capitalization, first, we have to determine the adjusted capitalization which can be calculated as:Adjusted Capitalization = Net Debt + Shareholders Equitywhere net debt is total debt minus cash and marketable securities (CMS), and also shareholders equity is NP.

Ratio of Cash Flow to Long Term Debt = Cash flow / Long term Debt

Every company wants to know the amount of the funds available to pay the obligations. The ratio of cash flow to long term debt is the tool to determine the amount of the company’s available funds to meet up the obligations. There has been a saying that the future is uncertain, so every company wants to prepare itself to meet the uncertainties in the future. By calculating this ratio a company can judge its financial position(available funds) to survive in the market.

Ratio of Cash Flow to Total Debt = Cash flow / Total Debt

The Cash Flow to Total Debt Ratio is use to measure the amount of time required by the company to pay its total debt by using only the cash flow. But this is something unreal because company can’t use its all cash flow to pay the total debts. It also states that the higher or increasing ratio is a indicator of positiveness, which tells that the company is sound enough to pay it debts.

1) PepsiCo:

Interest Coverage Ratio = $3114 / $682 = $4.565Fixed Charge Coverage Ratio = $3114 + ($479×5)/($479×5) = $2.3002Long Term Debt Ratio = $8747 / $8747+$44029.5 = $0.1657Total Debt to Adjusted Capitalization:Adjusted Capitalization = Net Debt + Shareholders Equity= (Total Debt – CMS) + NP= ($9453 – $1498) + (788.00x$55.875)= $51984.5Therefore,Total Debt to Adjusted Capitalization = Total Debt/Adjusted Capitalization= $9453 / $51984.5= $0.1818Ratio of Cash Flow to Long Term Debt = $3742 / $8747 = $0.4278Ratio of Cash Flow to Total Debt = $3742 / $9453 = $0.3958.Table 2. Shown the calculation of the firm:-

Question 3

Suppose PepsiCo’s real objective is to maintain a single-A senior debt rating. Does its net debt ratio target seem reasonable, or would you recommend a different target?

Senior debt means a type of debt which carries higher priority over the other types debts at the time dissolution of firms. It means if the company goes bankrupt the holder of senior debts will be paid before the payment of subordinate debts. It is considered to be less risky than other types of debts. Debt has different forms. It can be loan from bank, private investor, etc.

Debt Reimbursement

Debt reimbursement means repayment of debt. Most types of debt comes with a promise or obligation to repay it. The borrowers have to repay the amount borrowed, and also sometimes there is a interest on loans which comes as a profitto lender. There are many lenders available in the market to lend money to the borrowers. But the company chooses the lender who offers them low rate of interest.Every company wants to maintain their financial rating in the market.

Conclusion and recommendations:

In the law of the conservation of value works when you add up cash flow, it must also work when you subtract them. Therefore, financing decisions that simply divide up operating cash flow don’t increase over all firm value. This is the basic idea behind Modigliani and millers famous propositions 1: in perfect markets changes in capital structure do not affect value.as long as total cash flow generated by the firm’s assets in unchanged by the capital structure, Value is independent of capital structure. The value of whole pie does not depend on how it is sliced.Obviously MM’s proposition is not the answer, but it does tell us where to look for reasons why capital structure decisions may matter. Taxes are one possibility. Debt provides a corporate interest tax shield may more than compensate for any extra personal tax that the investor has to pay on debt Interest. Also, high debt levels may spur managers to work harder and to run a tighter ship. But debt has its drawbacks if it leads to costly financial distress.

Critical reflection on learning outcomes:

This report has been of great learning to me, it has given me the opportunity to bring my academic understanding to practical implementation, calculations and thought process involved in evaluating and recommending my views has really broadened my horizon and further developed my interest in corporate finance and in the business world.If given an opportunity in my academic life, I would definitely like to take more in-depth study in this area of finance either through my dissertation or further case studies and reading of literature in the related field

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