Pepsico Case
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The overall cost of capital for PepsiCo, using a beta of 1.1, is 10.90% when using a market return of 12.1%, the arithmetic mean of the S&P 500 for 1926-1990. Similarly, based on industry segment pure play analysis, with unadjusted beta values, a WACC of 10.61% is calculated, also using the arithmetic mean of S&P returns, 12.1%. However, the geometric mean is likely a better benchmark, and yields a WACC for PepsiCo of 9.09% using a beta of 1.1, and 9.08% when performing a similar pure play analysis.
However, contrary to Fuller and Kerrs assumptions, I suspect the aggregate pure-play beta should be adjusted to compensate for different financial leverage in use at the different segment firms. This yields a calculated WACC of 9.87% when using the arithmetic mean, and 8.73% when using the geometric mean of S&P returns. As Pepsi is considered a very well-run financial operation, this lower value is likely more accurate, as they likely outperform their peers in each business segment.
Although, it is difficult to accurately estimate the individual business segments WACC without properly understanding their segment capital structure. That is, how much debt they require to continue operations. We have estimated this using % total capital expenditures. The WACC for the segments yields a value very close to the aggregate calculated WACC, and thus this estimate is credible.
This analysis has shown that the most capital intensive segment, restaurants, also possesses the lowest segment WAC. It is likely more projects will clear this benchmark, and be approved – but the potential returns for these projects may not be as high for other less capital intensive segments. In a world of unlimited capital this would not present a problem, but it must be addressed as a practicality. Otherwise, the restaurant segment could turn into a capital black-hole, limiting future growth.