Financial Accounting (FI015) Group Assignment 1

by Dony Fabian Suratno (1040002300) Sunggono Prayugo (1040002383) Yossy Suyono (0700680406) (Class: MA 6)

Bina Nusantara Business School

December 2010

ID 5-14 (page 221): a. Review the Pepsi Co annual report, and analyze the financial statement by assessing PepsiCos earning power and solvency, and provide support for your assessment. Start by using the ratio framework illustrated in Figure 5-3. b. Use the ROE model to analyze the financial statements. Comment on whether PepsiCo created shareholder value and identify the primary value drivers. Answer: a. PepsiCo Earning Power: Return on Equity (ROE) Net income Average
Shareholders Equity

2006: ROE = $ 5,642 2005: ROE = $ 4,078 2004: ROE = $ 4,212 Return on 2006: ROA = mio = 2005: ROA = mio = 2004: ROA = mio =

mio $ 15,447 mio mio $ 14,320 mio

= =

36.52% 28.48%

mio $ 13,572 mio = 31.03% Assets (ROA) {Net income + [Interest

Average Total Assets

Expense (1-Tax Rate)]}

${5,642 mio + [239 mio (1-0.193)]} $ 29,930 19.50% ${4,078 mio + [256 mio (1-0.361)]} $ 31,727 13.37% ${4,212 mio + [167 mio (1-0.247)]} $ 27,987 15.50%

Return on Sales (profit margin) {Net income + [Interest

Expense (1-Tax Rate)]} Net Sales

2006: ROS = mio = 2005: ROS = mio = 2004: ROS = mio =

${5,642 mio + [239 mio (1-0.193)]} $ 35,137 16.61% ${4,078 mio + [256 mio (1-0.361)]} $ 32,562 13.03% ${4,212 mio + [167 mio (1-0.247)]} $ 29,261 14.82%

PepsiCo Solvency: Current Ratio Current Assets Current Liabilities 2006: CR = $ 9,130 mio $ 6,860 mio = 133.09 2005: CR = $ 10,454 mio $ 9,406 mio = 111.14

Quick Ratio (Cash + Marketable Securities + Net Account

Receivable) Current Liabilities

2006: QR = $(1,651 mio + 145 mio + 3,725 mio) $ 6,860 mio = 80.48 2005: QR = $(1,716 mio + 124 mio + 3,261 mio) $ 9,406 mio = 54.23

Interest Coverage (Net Income + Tax Expense +Interest

Expense) Interest Expense

2006: IC = $(5,642 mio + 1,347 mio + 239 mio) $ 239 mio = 30.24 2005:

IC = $(4,078 mio + 2,304 mio + 256 mio) $ 256 mio = 25.93

Account Payable Turnover Cost of Good Sold Average

Account Payable

2006: APT = $ 15,762 mio $ 6,496 mio = 2.43 2005: APT = $ 14,176 mio $ 5,971 mio = 2.37 b. ROE Model Effective sales and expense management: This value driver is represented by Profit Margin figure, which are 16.61% for 2006 and 13.03% for 2005 respectively. Effective working capital and long term asset management This value driver is represented by Asset Turnover, Current Ratio, and Quick Ratio, as follows: Asset Turnover 1.17 in 2006 (35,137 29,930) and 1.03 in 2005 respectively (32,562/31,727) Current Ratio 133.09 in 2006 and 111.14 in 2005 Quick Ratio 80.48 in 2006 and 54.23 in 2005. Effective capital structure management This value driver is represented by Long Term Debt Ratio and Interest Coverage, as follows: Long Term Debt Ratio 0.085 in 2006 (2,550/29,930) and 0.073 in 2005 (2,313/31,727). Interest Coverage 30.24 in 2006 and 25.93 in 2005 Return on Asset. ROA = Profit margin x Asset Turnover ROA2006 = 16.61% x 1.17 = 19.43 ROA2005 = 13.03% x 1.03 = 13.42 Common Equity Leverage
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The formula: Net Income (Net Income + Interest Expense) 2006 5,642 (5,642 + 239) = 0.96 2005 4,078 (4,078 + 256) = 0.94 Capital Structure Leverage The formula: Assets Equity 2006 29,930 15,447 = 1.94 2005 31,727 14,320 = 2.22 Return on Equity 2006 36.52% 2005 28.48% Cost of Equity 2006 4.5% (assumption using Risk free interest rate) 2005 3.8% (assumption using Risk free interest rate) Conclusion: By assuming the cost of equity is the risk free interest rate, which is the rate the investor can obtain in investing in risk free asset, and comparing it with ROE, we conclude that PepsiCo has been created value for its shareholder. The primary value drivers for creating this shareholders value are: Profit Margin, Asset Turnover, Current Ratio, and Quick Ratio, Long Term Debt Ratio and Interest Coverage.

ID 6-9 (page 272): a. Compute the change in PepsiCos current ratio and working capital from 2005 to 2006. Which accounts are the most important in explaining that change? b. What is included in PepsiCos balance sheet cash account? c. How large are PepsiCo receivables relative to current assets and total assets? How important is receivables

management to PepsiCos operations? How large is the reserve (allowance) for bad debts? Explain. d. What percent of revenue comes from international sales? What strategies does PepsiCo employ to mitigate risks related to foreign currency? Answer: a. Current Ratio Current Assets Current Liabilities 2006: CR = $ 9,130 mio $ 6,860 mio = 133.09 2005: CR = $ 10,454 mio $ 9,406 mio = 111.14 Current ratio is increased by 19.75% from 111.14 in 2005 to 133.09 in 2006 Working Capital Current Assets Current Liabilities 2006: WC = $ 9,130 mio - $ 6,860 mio = $ 2,270 mio 2005: WC = $ 10,454 mio - $ 9,406 mio = $ 1,048 mio The working capital of PepsiCo in 2006 compared to 2005 is increased by $ 1,222 mio The account which gives the most significant contribution to the change is the decrease of current liabilities by 37.12%, compared to current assets which only decreased by 14.50% b. Cash Account in PepsiCos balance sheet consist of cash in hand (petty cash & account in the bank) and also cash equivalent (which includes investments with original maturities of three months or less which PepsiCo does not intend to rollover beyond three months) Receivable relative to Current Asset: 2006: $ 3,725 mio $ 9,130 mio = 40.80% 2005: $ 3,261 mio $ 10,454 mio = 31.19% Receivable relative to Total Asset: 2006: $ 3,725 mio $ 29,930 mio = 12.45%
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c.

d.

2005: $ 3,261 mio $ 31,727 mio = 10.28% Management for account receivable is very important especially for company like PepsiCo, where its receivable size relative to its current asset considerably high, which in effect inappropriate management of receivable will give high negative impact to companys operation, for example high amount of uncollectible receivable will influence companys revenue/sales/income. By maintaining a good management of its receivable, PepsiCo will be able to manage and maintain its production, sales, and profit. Allowance for bad debt expenses: 2006: $ 64 mio 2005: $ 75 mio Revenue from international sales: 2006: $ 12,959 mio $ 35,137 mio = 36.88% 2005: $ 11,376 mio $ 32,562 mio = 34.94% Strategies to mitigate risk related to foreign currency: PepsiCo enter into hedges, primarily forward contracts with terms of no more than 2 years, to reduce the effect of foreign currency rates. The position of forward contracts: 2006: Short $ 16 mio 2005: Long $ 4 mio ID 7-9 (page 312): a. How large inventory compared to other assets on PepsiCos balance sheet? Did inventory increase, decrease, or remain the same as a percent of total assets in 2006? b. Did PepsiCo appear to pay off its suppliers faster or slowing during 2006 compared to 2005? c. See Note 14. Does PepsiCo use the LIFO, FIFO, or averaging assumption? Discuss some

reasons that would explain why PepsiCo use the LIFO, FIFO, or averaging assumption? Discuss some reasons that would explain why PepsiCo discloses that the differences between LIFO and FIFO were immaterial. Answer: a. In term of size, inventory is ranked at 5th largest asset in PepsiCos 2006 balance sheet. The size rank of asset as follows: 1. Property, Plant, and Equipment ($ 9,687) 2. Goodwill ($ 4,594) 3. Accounts and notes receivable ($ 3,725) 4. Investments in Noncontrolled Affiliates (3,690) 5. Inventories ($ 1,926) Inventory/Total Asset: 2006: $ 1,926 mio $ 29,930 mio = 6.44% 2005: $ 1,693 mio $ 31,727 mio = 5.34% As percentage of total assets, inventory in 2006 has been increased. b. Account Payable Turnover COGS Average Account Payable 2006: $ 15,762 6,496 = 2.43 (365 days/2.43 = 150 days) 2005: $ 14,176 5,971 = 2.37 (365 days/2.37 = 154 days) Compared to 2005, in 2006 PepsiCo payoff its suppliers faster. c. Based on the notes, PepsiCo using all 3 methods (Average, FIFO, and LIFO) for determining inventory cost. Probably, the reason why PepsiCo using the 3 methods altogether, because it has many overseas affiliates which used different methods for determining inventory cost. For immateriality between LIFO and FIFO, maybe due to the inflation rate and input price between 2005 and 2006 is stable, so that it would not too much affect the methods difference. Another possibility is that the company mostly

uses Average method, which as a result will not affect too much on FIFO-LIFO difference. ID 8-9 (page 361): a. Does PepsiCo carry investment portfolios in trading and available-for-sale securities? b. How much goodwill did PepsiCo report on its 2006 and 2005 balance sheet? From 2005 to 2006. PepsiCo had an increase in goodwill. What does this indicate about PepsiCos growth strategy, and where on the statement of cash flow might you be able to find evidence of it? c. Does PepsiCo have significant investments in companies in which it does not have control? How much does Pepsi have invested in these companies? What do these investments tell you about Pepsis business model and its industry? Answer: a. It seems the investment portfolios carried by PepsiCo are categorized as trading, since the unrealized gain on securities can only found in Consolidated Statement of Shareholders Equity. All differences between balance sheet value and current market value for trading securities are affect shareholders equity and not income statement. b. Goodwill: 2006: $ 4,594 mio 2005: $ 4,088 mio The increase in goodwill indicates that PepsiCo may acquire another interest in a subsidiary that exceeds the fair market value of subsidiarys net assets. This acquisition can be seen in the statement of cash flow from Investing Activities, which we can see that there is an increase of cash outflow for other

acquisitions and investments in non controlled affiliates from $ 345 million in 2005 to $ 522 million in 2006. c. Yes, PepsiCo has interest in Pepsi Bottling Group (PBG) about 38% and 41 % in 2006 and 2005 respectively. And the investment in this company amounting to $1,842 mio in 2006 and $ 1,738 mio in 2005. It has also interest in Pepsi Americas approximately 44% for $ 1,028 mio and 43% for $ 968 mio in 2006 and 2005 respectively. By acquiring these companies, PepsiCo tried to obtain efficiency, in form of vertical integration, which is by acquiring its suppliers, which has related business industry.