Pepsi Co
With the assumptions given in the case, we estimated the WACC to be 12.23%. The cost of equity represented in the WACC was calculated using the geometric mean return on T-bonds and the long-term government bond rate (4.5%) as the appropriate risk free rate. We chose this over the arithmetic mean return using T-bills under the assumption that the geometric mean is more appropriate to use in estimating the expected return over longer time horizons, especially because as we go towards longer time horizon returns become more serially correlated. The difference in our estimated WACC from the 11% estimated could be attributed to the choice between arithmetic or geometric risk premiums and the short term/long-term risk free rates. (See exhibit 1) Since PepsiCo is comprised of three different business segment, we felt that it was in our best interest to calculate the cost of capital for each of the segments in order to achieve the appropriate WACC. We calculated the new WACCs via pure play method and used comparable companies for references (See Exhibit 2 for divisional segments). In order to use the pure play method, we averaged the betas, debt-equity ratios, and tax rates for all the related companies in each segment. We unlevered the betas and re-levered it to PepsiCo’s specifications. We arrived with the betas of .85, .83, and 1.19 for restaurants, snack foods, and soft drinks respectively. In the end we estimated 12.17%, 13.15%, and 15.74% as our new WACCs for the divisions respectively. After assigning weights to each segment based on how much they contribute to the net sales, we found that restaurants account for 34.97%, snack foods 28.39% and soft drinks 36.64%. We then applied the weights to the divisional WACCs and estimated a new company WACC of 13.75%, which is higher than PepsiCo’s current estimate of WACC and our initial estimate of 12.23%. For a