INTERPRETING PROFITABILITY RATIOS IN A CROSS-SECTIONAL SETTING. Coca-Cola Company is the principal competitor of PepsiCo in the soft drink beverage business. Coca-Cola engages almost exclusively in beverages, whereas, in addition to beverages, PepsiCo also engages in the manufacture and distribution of packaged foods such as chips, salsas, and cereals.

The value chain for beverages involves the following steps:

1. Manufacturing concentrate and syrup to be used in the beverages

2. Mixing syrup, water, and other ingredients and placing the finished beverage in a container (can or bottle), a relatively capital-intensive process

3. Distributing packaged beverages to food distributors, retail establishments, and restaurant chains, also a capital-intensive process
Coca-Cola and PepsiCo are engaged primarily in the manufacture of concentrate and syrup (Step 1). They both rely heavily on other entities to perform Steps 2 and 3.

The value chain for packaged foods involves the following steps:

1. Combining ingredients, cooking as appropriate, and packaging the finished food products

2. Distributing packaged food products to food distributors and retail establishments

Exhibit 4.36 presents ROA and its disaggregated components for Coca-Cola and PepsiCo for 2006-2008. Exhibit 4.37 (see page 324) presents ROCE and its disaggregated components, and Exhibit 4.38 (see page 324) presents segment data for these two com- panies. The ratio amounts for PepsiCo correspond to those discussed in the chapter but appear next to those for Coca-Cola to ease interpretation. No adjustments for unusual or nonrecurring items have been made for Coca-Cola. To ease computations, the segment computations of ROA and asset turnover use asset amounts at the end of the year instead of average assets during the year. (See the discussion under "Segment Data" in the chap- ter for an explanation of the use of end-of-year assets.) The segment profit margins and ROA are based on operating income before interest and income taxes. Thus, the aggre- gate profit margins and ROAs for the segments exceed those for the companies as a whole because the segment data do not subtract corporate-level overhead expenses. The seg- ment data disclosed by each company have been categorized in three geographic seg- ments, but there may be slight deviations from the actual segment data because of differences in the way each company defines its segments.

a. PepsiCo has shown a higher ROA than Coca-Cola for the last two years, but Coca- Cola has historically generated higher ROA than PepsiCo. Explain the current differ- ences in ROA between PepsiCo and Coca-Cola.

b. Why might PepsiCo have a higher cost of sales than Coca-Cola?

c. What are the likely reasons PepsiCo's inventory turnover ratio exceeds that for Coca- Cola? (Hint: Incorporate information from Exhibit 4.13 regarding PepsiCo's dis- closed segments.)

d. For which firm is financial leverage helping the common shareholders more? Explain in such a way as to demonstrate your understanding of financial leverage.

Text Book: Financial Reporting, Financial Statement Analysis and Valuation: A Strategic Perspective By James Wahlen, Stephen Baginski, Mark Bradshaw.