Pepsi Bottling Group and Coca Cola Enterprises Case Solution

  1. How does PBG’s gross profit margin and operating profit margin for 2000 compare to that for 1999?  What would these ratios have been if PBG had not changed their depreciation policy? Allocate the reduction in depreciation expense in the same proportion as PBG reported for the first quarter.

Gross Profit Margin and Operating Profit Margin

The gross profit margin and the operating profit margin for year 2000 of the Pepsi Bottling group had been improved in comparison with the year 1999. If the Pepsi bottling group had not changed their depreciation policy, the gross profit margin would not be affected because depreciation expense is reported under operating expenses. However, the operating profit margin for the year 2000 would have been reduced if the company had not changed their depreciation policy because increasing the number of estimated life of fixed assets reduced the depreciation expense and therefore the operating income of the company had increased in 2000 which can be seen from the below mentioned table.

Dollar in millions 2000 1999
 Sales               7,982.00           7,505.00
 Gross profit               3,577.00           3,209.00
 Operating Profit                   590.00               412.00
 Net income                   229.00               118.00
 Depreciation                   340.00               374.00
     
 Gross profit margin 44.81% 42.76%
 Operating profit margin 7.39% 5.49%

Reduction in Depreciation

The allocation of depreciation expense for first year after the implementation of change in useful life had reduced by $11.14 million. The reason for this reduction in depreciation expense was due to the fact that estimated life of the fixed assets had been increased which led the depreciation expense of that particular equipment to decrease which overall decrease the accumulated depreciation for the year. Therefore, the depreciation expense of the first quarter had decreased which can be seen from the table mentioned below.

Reduction in first quarter Before change estimated useful life After change estimated useful life
 Manufacturing Equipment                   218.60               211.20
 Building and improvement                   112.88               106.50
 Other                     17.80                 16.80
 Marketing equipment                   349.00               319.20
                    698.28               653.70
     
 Quarterly depreciation                   174.57               163.43
 Reduction in first quarter                   11.14

 

  1. Estimate the fraction of fixed assets PBG depreciated in 2000.  In other words, compute depreciation expense as a percent of the average gross book value of depreciable fixed assets.  What would this fraction have been if PBG had not changed their depreciation policy?

Depreciation Expense as a Percentage of Fixed Assets of PBG

If the depreciation policy by the Pepsi Bottling Group had not changed, the depreciation expense as a percentage of fixed assets would be higher in comparison with the change policy i.e. increase in estimated life of the fixed assets which reduced the depreciation expense for the company. Hence, the depreciation expense as the percentage of fixed assets are mentioned in the table below.

  Before change estimated useful life in year 2000 After change estimated useful life in year 2000
Manufacturing Equipment 218.60 211.20
Building and improvement 112.88 106.50
Other 17.80 16.80
Marketing equipment 349.00 319.20
Depreciation expense 698.28 653.70
Fixed assets value 5,068.00 5,068.00
Dep. Expense as % of Fixed assets 13.78% 12.90%
  1. What effect, if any, does the change in depreciation policy have on PBG’s fixed asset turnover ratio and cash from operations?  No calculations are necessary, but explain the direction of the effect.

Effect on Fixed Assets Turnover Ratio

The change in depreciation policy i.e. increase in the number of estimated life will reduce the depreciation expense which in turn will increase the net property, plant and equipment in comparison with the depreciation policy implied previously by the company. Hence, the increase in value of property, plant and equipment had reduced the fixed asset turnover ratio which imply that fixed assets were being utilized less efficiently to generate revenue in comparison with the previous policy of lesser estimated life implied by the company.

Effect on Cash from Operations

The change in depreciation policy had decrease the cash flow from operations because the policy of increase in estimated number of life of fixed assets reduce the depreciation expense which is a non-cash item and is added back to the net income for the calculation of cash flow from operations. Hence, the reduced depreciation expense will decrease the cash flow from operations of the company which could be higher if the company had implied the previous policy which could result in higher depreciation expense…………

 

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