ACC 318 Module Two Assignment Template

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Southern New Hampshire University *

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318

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Accounting

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Apr 3, 2024

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ACC 318 Module Two Assignment Template Complete this template by replacing the bracketed text with the relevant information. Debt-to-Assets Ratios 1. Calculate the quality of the debt-to-assets ratios for both companies. The Coca-Cola Company: Debt-to-Assets Ratio = ( Long − termdebt + Short − term debt ) Total Assets Debt-to-Assets Ratio = ( 40,125 + 2,183 ) 87,296 Debt-to-Assets Ratio ≈ 0.48 PepsiCo: Debt-to-Assets Ratio = Long − term Debt Obligations Total Assets Debt-to-Assets Ratio = 40,370 92,918 Debt-to-Assets Ratio ≈ 0.43 2. Explain the quality of the debt-to-assets ratios for both companies. The quality of the debt-to-assets ratios for both The Coca-Cola Company and PepsiCo can be assessed based on the calculated values: The Coca-Cola Company : Debt-to-Assets Ratio ≈ 0.48 Debt-to-Assets Ratio ≈ 0.48 PepsiCo: Debt-to-Assets Ratio ≈ 0.43 Debt-to-Assets Ratio ≈ 0.43 Analysis: a) The Coca-Cola Company (Debt-to-Assets Ratio: 0.48):  The debt-to-assets ratio of approximately 0.48 indicates that around 48% of The Coca- Cola Company's total assets are financed by debt.  This suggests that a significant portion of the company's assets is funded through borrowed capital. A ratio below 1 indicates that the company relies more on equity to finance its assets than on debt.  While the ratio is not excessively high, it's essential to consider industry benchmarks and the company's specific financial strategy. A higher ratio may indicate higher financial leverage and associated risks. b) PepsiCo (Debt-to-Assets Ratio: 0.43):

 PepsiCo's debt-to-assets ratio of approximately 0.43 implies that around 43% of its total assets are financed by debt.  Similar to The Coca-Cola Company, PepsiCo relies more on equity than debt for financing its assets. A ratio below 1 suggests a conservative approach to leverage.  As with any financial metric, the quality of the ratio depends on industry norms, company objectives, and risk tolerance. Comparing this ratio to PepsiCo's historical values and industry benchmarks can provide additional context. General Interpretation :  Generally, a lower debt-to-assets ratio is considered favorable as it signifies lower financial risk and a more conservative financial structure.  However, the ideal ratio can vary by industry and business strategy. Some industries naturally carry higher debt levels.  Investors and analysts often consider these ratios alongside other financial metrics and industry benchmarks to get a comprehensive view of a company's financial health and risk profile. It's important to note that debt ratios alone might not provide a complete picture, and a thorough analysis of a company's overall financial health, cash flow, and profitability is recommended for a comprehensive assessment. 3. Determine which company is more highly leveraged. To determine which company is more highly leveraged, we can compare their debt-to-assets ratios. The company with a higher debt-to-assets ratio is considered more leveraged. Let's compare the debt-to-assets ratios of The Coca-Cola Company and PepsiCo: 1. The Coca-Cola Company (Debt-to-Assets Ratio: 0.48) 2. PepsiCo (Debt-to-Assets Ratio: 0.43) Comparing the ratios, The Coca-Cola Company has a higher debt-to-assets ratio (0.48) compared to PepsiCo (0.43). Therefore, based on the debt-to-assets ratio, The Coca-Cola Company is more highly leveraged. Times-Interest-Earned Ratios 1. Calculate the times-interest-earned ratios for both companies. The Coca-Cola Company: Times-Interest-Earned Ratio = 8,997 1,437 ≈ 6.26 PepsiCo: Times-Interest-Earned Ratio = 10,080 1,128 ≈ 8.94

2. Explain the times-interest-earned ratios for both companies. Address the following questions in your response: A. Are the times-interest-earned ratios adequate? 1. The Coca-Cola Company (Times-Interest-Earned Ratio: 6.26):  The times-interest-earned ratio of 6.26 indicates that The Coca-Cola Company’s operating income covers its interest expenses approximately 6.26 times.  Adequacy depends on industry norms and the company’s risk tolerance. In general, a ratio above 1 suggests the ability to cover interest expenses, and 6.26 is considered reasonably adequate. 2. PepsiCo (Times-Interest-Earned Ratio: 8.94):  PepsiCo’s times-interest-earned ratio of 8.94 suggests that its operating income can cover interest expenses approximately 8.94 times.  This ratio is higher than The Coca-Cola Company’s, indicating a stronger ability to meet interest obligations. B. Is the times-interest-earned ratio greater than or less than 2.5? What does that mean for the companies' income? 1. The Coca-Cola Company (Times-Interest-Earned Ratio: 6.26):  The times-interest-earned ratio for The Coca-Cola company is greater than 2.5.  A ratio above 2.5 generally indicates that the company has a comfortable margin of safety to cover its interest expenses. In this case, with a ratio of 6.26, The Coca-Cola Company has a robust ability to meet its interest obligations. 2. PepsiCo (Times-Interest-Earned Ration: 8.94):  PepsiCo’s times-interest-earned ration is also greater than 2.5.  With a ratio of 8.94, PepsiCo exhibits a strong ability to cover its interest expenses, indicating a healthy financial position. C. Can the company afford the interest expense on a new loan? 1. The Coca-Cola Company (Times-Interest-Earned Ratio: 6.26):  With a times-interest-earned ratio of 6.26, The Coca-Cola Company demonstrates a strong ability to afford the interest expense on a new loan.  The ratio suggests a substantial margin of safety, indicating that the company’s operating income is more than sufficient to cover both existing and potential future interest expenses. 2. PepsiCo (Times-Interest-Earned Ratio: 8.94):  PepsiCo, with a times-interest-earned ratio of 8.94, exhibits an even stronger ability to afford the interest expense on a new loan.  The higher ratio implies a significant capacity to take on additional debt without jeopardizing its ability to meet interest obligations.  Both The Coca-Cola Company and PepsiCo, with their strong times-interest-earned ratios, can afford the interest expense on a new loan.  The higher the ratio, the more comfortably the companies can manage additional debt, providing flexibility for strategic financing decisions.  Before taking on new loans, companies typically assess their capital structure, cost of debt, and potential impact on future earnings.

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Foreign Debt 1. Explain why The Coca-Cola Company and PepsiCo, Inc. may use foreign debt to finance their operations. The Coca-Cola Company and PepsiCo, Inc. may use foreign debt to finance their operations for several strategic reasons: a) Currency Diversification:  Both companies operate globally and generate significant revenues from various countries. Using foreign debt allows them to match their debt with the currency in which they earn revenue.  This strategy helps in mitigating currency risk as it aligns the currency denomination of debt with the cash flows from local operations. b) Lower Interest Rates:  Foreign debt may offer lower interest rates compared to domestic debt in certain markets. By accessing international debt markets, companies can capitalize on favorable interest rate environments. c) Access to Larger Capital Markets:  Operating in multiple countries provides access to larger and diverse capital markets. The ability to tap into international debt markets allows these companies to raise substantial amounts of capital for their global operations. d) Tax Optimization:  Companies often structure their debt to optimize taxes. Using foreign debt may offer tax advantages, such as deductibility of interest payments, depending on the tax regulations in the countries where they operate. e) Market Presence and Expansion:  Accessing foreign debt markets can be part of a broader strategy for market presence and expansion. It may facilitate relationships with international financial institutions and investors, contributing to the companies’ global image. f) Strategic Acquisitions:  In the case of acquisitions or mergers in foreign markets, utilizing local debt can be a strategic approach. It aligns the financing structure with the acquired company’s operating environment. g) Interest Rate Arbitrage:  Companies may take advantage of interest rate differentials between countries. If interest rates are lower in a particular foreign market, they can borrow at a lower cost, leading to potential interest rate arbitrage. h) Optimal Capital Structure:  Maintaining an optimal capital structure involves a mix of equity and debt. Using foreign debt allows companies to diversify their sources of capital, optimizing the overall cost of capital. i) Financial Flexibility:  Access to a variety of debt markets enhances financial flexibility. The companies can choose the most favorable terms, including interest rates, maturity periods, and covenants, depending on the specific market conditions.

It’s important to note that the decision to use foreign debt is influenced by various factors, including economic conditions, exchange rate movements, regulatory environment, and the overall financial strategy of the companies. 2. Explain the risks involved in using foreign debt to finance operations. Using foreign debt to finance operations comes with various risks, and companies like The Coca- Cola Company and PepsiCo, Inc. need to carefully assess and manage these risks. Some of the key risks involved in using foreign debt include: a) Exchange Rate Risk:  One of the primary risks is exposure to fluctuations in exchange rates. As companies borrow in foreign currencies, changes in exchange rates can impact the cost of servicing the debt. If the local currency weakens against the currency in which the debt is denominated, the repayment amount in the company’s home currency increases. b) Interest Rate Risk:  Interest rates in foreign markets may differ from those in the company’s home country. Changes in foreign interest rates can affect the cost of debt servicing. Floating-rate foreign debt exposes companies to interest rate volatility, impacting overall interest expenses. c) Economic and Political Risk:  Borrowing in foreign markets exposes companies to economic and political uncertainties in those countries. Economic downturns, political instability, and changes in government policies can affect the ability to repay debt and impact the overall financial stability of the company. d) Country-Specific Regulatory Risks:  Different countries have varying regulatory environments. Changes in local regulations, tax policies, or legal frameworks can impact the terms and conditions of debt agreements. Companies need to stay abreast of regulatory changes in each jurisdiction. e) Liquidity Risk:  Operating with foreign debt may lead to liquidity challenges, especially during periods of currency volatility or economic crises. Difficulties in accessing funds or repatriating earnings can create liquidity constraints for debt repayment. f) Credit Risk:  The creditworthiness of a foreign borrower may differ from that of domestic borrowers. Lending standards, credit ratings, and default risks can vary across countries, affecting the terms and interest rates at which debt is issued. g) Cross-Border Legal and Tax Complexity:  Managing legal and tax complexities across borders can be challenging. Differing legal systems and tax regulations require careful consideration to ensure compliance and avoid legal disputes or unexpected tax liabilities. h) Unfavorable Economic Conditions:  Borrowing in foreign markets exposes companies to the economic conditions of those markets. Economic downturns or recessions in specific countries can impact the financial health of the companies and their ability to meet debt obligations.

i) Covenant Compliance Challenges:  Debt agreements often include covenants that companies must adhere to. Managing compliance with these covenants across different jurisdictions can be complex, and failure to meet them may result in financial penalties or default. j) Repatriation Restrictions:  Some countries may impose restrictions on the repatriation of funds, making it challenging for companies to transfer earnings back to their home country to service debt or distribute dividends. To mitigate these risks, companies often employ hedging strategies, conduct thorough risk assessments, and maintain a proactive approach to monitoring and managing their international debt portfolios. References Include any references used to complete this assignment. This section is for the full citation. Sources should be cited using APA style. Weygandt, J. J., Kieso, D. E., & Warfield, T. D. (2022). Intermediate Accounting (18th ed.). Wi- ley.

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