This task is dedicated to studying PepsiCo’s (PEP) and International Business Machines Corporation (IBM) capital structures and the time value of money with respect to an individual’s retirement plan. In the case of 2A, the analysis considers two influential organizations and assess their interest tax savings and how they contribute to long-term debts. Furthermore, the study compares the debt to equity ratios of the selected organizations to better understand the firms’ stability in the industry. The second part considers Ryan’s salary and how the earnings can be used in retirement planning, considering the time value of money based on the rates of value addition.
Case 2A: The Capital Structure
The current value of interest tax savings is a critical element determined from the balance sheet in the capital structure. It is important to note that cash flows resulting from tax savings do not account for debts but goes back to the firm irrespective of whether it is leveraged or not (Obuya, 2017). Various approaches can be used to determine a company’s current value of interest tax savings, depending on the choice of data used to calculate it. The most commonly used approach is Myers’ model, which uses the Adjusted Present Value (Aggelopoulos & Grypeos, 2016). According to Myers, a leveraged company’s value can be determined by summing the value of an organization free from debt (Vu) and the current value of the tax saving, which results from the payment of interest (VTS) (Nguyen et al., 2020). Thus, based on the model, VTS can be calculated as follows:
- VTS = PV(Kd; D T Kd).
The author also concluded that tax shield’s value creation is the current value of interest tax savings, which is discounted at the cost of debt (Kd). Based on this argument, using debt to finance tax savings has a similar effect on debt risks. Luehrman (as cited in Beyer (2018), recommended valuing businesses using their adjusted present value and using the Myers model to calculate a company’s current VTS.
- For PepsiCo, Inc. (PEP)
- Debt = $3 trillion
- Assuming an interest rate = 8% per annum.
This shows that the company will have an annual interest expense of $0.24 trillion. Also, assuming a tax rate of 39%, which is the mostly used rate for large companies.
The annual current value of interest tax savings will be given by;
- Tax rate multiplied by annual interest expense,
- 39%*0.24 trillion = 9.36 trillion dollars.
Case 2B: The Time Value of Money: Retirement Planning
The question about the Time Value of Money (TVM) occupies a central part among workers and organizations. For instance, one would ask if they would want, for instance, $1,000,000 at this time, or $10,000 as long as they live. This decision can be challenging to take unless one understands the rationale behind their choice (Lusardi & Mitchell, 2017). Thus, before one decides which offer they can take, it is crucial to understand the concept of the time value of money given by the Net Present Value (NPV). In particular, NPV is used to give ideas about the type of questions asked around financial management (Irena & Mariana, 2017). NPV enables one to calculate and compare the money they receive current and its equivalent in the future, considering time and interest. It is also critical for one to understand TVM as it outlines both advantages and disadvantages of different financial planning decisions. Based on the case study about Ryan, different implications can arise. These are provided in the analysis conducted below, both in the table and calculations.
Ryan’s initial salary was $54,847, which reveals he could have saved $6,033 during the first employment year. The values above were obtained from the five-year determination of the present value.
|RATE||NPR||FV||PV||CONTRIBUTION TO SAVINGS PLAN|
Had Ryan taken the retirement plan advantage, he would have, at the time of this calculation, accumulated a total of $13,430, assuming that a rate of 7% is used in this case. However, if a rate of 12% is assumed, then he would have been considered to have a worth of $58,798, as revealed in the table and calculations below.
|YEAR||SALARIES||CONTRIBUTION||CONTRIBUTION TO SAVINGS PLAN|
The Present Value (PV) formula is given as:
Using 7%, and given;
NPER: 5, Rate:.07, PV: -33364, and PMT: 0
The present accumulated money in the retirement account is:
Thus, $46,794- $33,364 = $13,430
Using 12%, and given;
- NPER: 5, Rate:.12 , PV: -33364, and PMT: 0
- Net worth of the retirement account is $58,798
A company’s capital structure is a critical element in assessing its financial standing, particularly in the future. The current value of interest tax savings enables an organization to analyze the impacts of different interest rates and how they can affect the company’s debt management. The same concept applies to an individual’s retirement savings plan, where the time value of money is critical. Essentially, the analyses conducted reveal the behavior of money: its value increases when the money is invested or saved and reduces if it is in terms of debts.
Aggelopoulos, E., & Grypeos, D. (2016). A new approach for measuring shareholder value creation. Journal of Modern Accounting and Auditing, 12(7), 388-396. Web.
Beyer, D. (2018). A matrix approach to valuation and performance measurement based on accounting information considering different financing policies. Journal of Management Control, 29(1), 37-61. Web.
Irena, M., & Mariana, B. (2017). The time value of money in financial management. Ovidius University Annals, Economic Sciences Series, 17(2), 593-597. Web.
Lusardi, A., & Mitchell, O. S. (2017). How ordinary consumers make complex economic decisions: Financial literacy and retirement readiness. Quarterly Journal of Finance, 7(03), 1750008. Web.
Nguyen, C. D. T., Dang, H. T. T., Phan, N. H., & Nguyen, T. T. T. (2020). Factors affecting financial leverage: The case of Vietnam firms. The Journal of Asian Finance, Economics, and Business, 7(11), 801-808. Web.
Obuya, D. O. (2017). Debt financing option and financial performance of micro and small enterprises: a critical literature review. International Journal of Business and Management, 12(3), 221-231. Web.