PepsiCo, a Major Soft Drink Company, Had a Restaurant Division

question 8

Essay

PepsiCo, a major soft drink company, had a restaurant division consisting of Kentucky Fried Chicken, Taco Bell, and Pizza Hut. The only cola beverage these restaurants served was Pepsi. Assume that the major reason PepsiCo owned fast food restaurants is an attempt to increase its share of the cola market. Under this assumption, some Pizza Hut patrons who order a cola at the restaurant and are told they are drinking a Pepsi will switch and become Pepsi drinkers instead of Coke drinkers on other purchase occasions. However, studies have shown that some customers refuse to eat at restaurants unless they can get a Coke.
PepsiCo sells Pepsi Cola to non-PepsiCo restaurants at $0.53 per gallon. This is the market price of Pepsi-Cola. Pepsi-Cola's variable manufacturing cost is $0.09 per gallon and its total (fixed and variable) manufacturing cost is $0.22 per gallon. PepsiCo produces Pepsi-Cola in numerous plants located around the world. Plant capacity can be added in small increments (e.g., a half-million gallons per year). The cost of additional capacity is approximately equal to the fixed costs per gallon of $0.13.
Required:
What transfer price should be set for Pepsi transferred from the soft drink division of PepsiCo to a PepsiCo restaurant such as Taco Bell? Justify your answer.

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Definitions:

Present Value

The current worth of future money or cash flow streams, estimated with a specific rate of return.

Annuity

A financial product that pays out a fixed stream of payments to an individual, typically used as an income stream for retirees.

Discount Rate

The discount rate utilized in DCF analysis for assessing the present worth of upcoming cash flows.

Rate of Return

The gain or loss on an investment over a specified period, expressed as a percentage of the investment's initial cost.