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UMUC FINC495 PepsiCo Case Study

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UMUC FINC495 PepsiCo Case Study International Research Journal of Applied Finance ISSN 2229 – 6891 Vol. VII Issue – 3 March, 2016 Case Study Series Using the Dividend Discount Model in Valuation: The Case of PepsiCo Halil D. Kaya* Julia S. Kwok As modified by Professor Keller Abstract This case is an application of a valuation method, the dividend discount model, for PepsiCo. In this case, students will learn how to use a company’s dividend estimates in the coming years to estimate its share value. Students will first discuss the three possible scenarios for dividend growth: the zero-growth model, the constant growth model, and the supernormal growth model. They will discuss each model’s advantages and disadvantages. Then, theywill proceed with their valuation using the assumptions given in the case. PepsiCo’s most recent financial statements are provided in the case for students’ use. After estimating the company ’s share value; students willcompare it to the company’s current share price to reach an investment decision. It is a real-world application for students who want to learn how to use dividends in valuation. Introduction John was a newly hired security analyst of AJJ Minnesota Investment Company. His job was to evaluate financial securities based on asset pricing models and fundamental analysis. He worked with portfolio managers to support their buy, hold or sell decisions on financial securities. It was 2:30 p.m. in the afternoon; John really needed some boost after the long meeting with his clients. Headed towards the staff’s lounge, he was looking forward to grab his favorite Coca Cola. To his disappointment, he found the whole refrigerator was filled with low calories, healthy drinks. As he pushed through those low sodium V8, Naked Juice, Gatorade and La CroixSparkling Water with natural flavors, he managed to find a can of Pepsi Cola at the back of the rack. Fierce Competition While John was indulging in his favorite Doritos, his Pepsi rival, Mary Ann, walked in. Mary Ann was a senior security analyst, and she was a devoted Pepsi fan. “Hi Polar bear, I am glad that you finally take the Pepsi Challenge! Be young, have fun and drink Pepsi,” said Mary Ann. John replied, “Nothing can beat the real thing.” “The decade old cola war has a new front. Those healthy products, thatare occupying our fridge right now, are pushing down the demand for carbonated soft drinks. It went from 46 to 38 gallons per capita in the past 10 years. May be it’s time to re-evaluate your Pepsi stocks,” John added (StreetAuthority 2014). John continued: “Have you noticed the sudden increase in PepsiCo’s sharesfrom February to November 2014? It jumped from a low of $78.09 on February 10, 2014 to $100.10 on November 24, 2014. When I checked Coke’s shares for the same period, I noticed that there was only a 7% increase in Coke shares. It was $88.42 on March 9 and later it went up to only $94.56 on November 24. The S&P500 ETF went up by only 10%, from 188.26 to 207.20”. “Pepsi is a much bigger company, with more than twice as many employees as Coke globally. Even though the predicted soft drink consumption per capita going down each year, I am glad that soda is only 25% of Pepsi’s US sales,” Mary Ann exclaimed (Flanagan 2013). “Moreover, Pepsi has the edge of understanding the changing consumer taste. The new CEO has Pepsi refocused on water, tea, juice and sports drinks as well as Quaker Oats and Gatorade. (StreetAuthority 2014). “Numbers don’t lie. Let us take a look at the value of Pepsi’s stock and compared to its price,” John suggested. “John, my portfolio holds quite a bit of Pepsi stocks, our discussion made me a bit nervous about my investment. Let us run some valuation models to figure out whether it is a good time to buy, sell or hold those Pepsi st

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