Next we need to find the value of debt for each company. Market value is generally the best way to achieve this, but because we were not given the number of outstanding shares the book value is sufficient. This is acceptable because neither company has experienced a significant change in credit ratings in the recent years. We look to the Balance Sheets of both companies and use the most recent year (2001). The main contributors to Book Value of Debt are Notes Payable, the Current Portion of Long Term Debt, and Long Term Debt. This is shown below.

Finding Book Value of Debt

The Coca-Cola Company:

Loans and Notes Payable: $3,600,000,000

Current Portion of long-term debt: $154,000,000

Long-term debt: $681,000,000

Book Value of Debt = $4,435,000,000

PepsiCo, Inc:

Current Portion of long-term debt: $281,000,000

Long-term debt: $2,106,000,000

Book Value of Debt = $2,387,000,000

Once both Debt and Equity values are calculated, we are able to determine the total value by simply adding the two together.

Finding Value (Market Value of Equity + Book Value of Debt)

The Coca-Cola Company:

Market Value of Equity = $156,059,250,000

Book Value of Debt = $4,435,000,000

Total Value = $160,494,250,000

PepsiCo, Inc:

Market Value of Equity = $64,619,750,000

Book Value of Debt = $2,387,000,000

Total Value = $67,006,750,000

Now we need to find the Cost of both debt and equity for each company. The Cost of Debt is equivalent to the YTM in Bond calculations. Here we are assuming $100 face value bonds. Calculations are shown below.

Finding the Cost of Debt (Kd)

The Coca-Cola Company:

FV: 100

PV: -91.54

N: (Matures in 2009) = 8 years paid semi-annually = 16

PMT: (.0575 x 100)/2 = 2.875

Compute YTM = 3.5785 x 2 = 7.157%

PepsiCo, Inc:

FV: 100

PV: -93.26

N: (Matures in 2008) = 7 years paid semi-annually = 14

PMT: (.0575 x 100)/2 = 2.875

Compute YTM = 3.491 x 2 = 6.984%

Finding the cost of equity requires more research on the risk assessment as well as market premiums. We will be using the current yield on a 10-year Treasury Bill as the Risk Free Rate (Rf). For the Betas of both the companies, we will be using the average because of the drastic changes from 1994 to year 2000. For the Market Risk Premium, we will be using the Geometric mean instead of the Arithmetic mean because it is more accurate in that it is a compounded average. The calculations are shown below.

Finding the Cost of Equity (Ke)

Ke = Rf + β (Rm – Rf)

The Coca-Cola Company:

Rf = 5.73%

β = 0.88

(Rm – Rf) = 5.90%

Ke = 10.922%

PepsiCo, Inc:

Rf = 5.73%

β = 0.88

(Rm – Rf) = 5.90%

Ke = 10.922%

In this case the cost of equity for both companies is the same because they both have an average beta of 0.88.

Now we have enough information to compute the WACC for both Coca-Cola Company and Pepsi Inc. (Assuming an effective marginal tax rate of 35%). The calculation for WACC is shown below.

Calculating WACC

WACC = (E/V) x Ke + (D/V) x Kd (1 - T)

The Coca-Cola Company:

(156,059,250,000 / 160,494,250,000) x 10.922% + (4,435,000,000 / 160,494,250,000) x 7.157% (1 – 35%) = 10.748%

PepsiCo, Inc:

(64,619,750,000 / 67,006,750,000) x 10.922% + (2,387,000,000 / 67,006,750,000) x 6.984% (1 – 35%) = 10.694%