FIN501 - Strategic Corporate Finance Mod 3 SLP Essay

FIN501 - Strategic Corporate Finance Mod 3 SLP - Essay Example But we might wonder what determines the rate of return that a shareholder would want on a particular stock? It would depend for one thing on the price of the stock (highs, lows and average) and the historical trend of dividend payouts that has been made in recent years. Though every stockholder would have his personal thoughts and opinions on this, we can be sure that it would be higher than the risk free rate- the rate on US Government bonds maturing in one year and guaranteed by the Government. It would also depend on the Beta coefficient for that particular stock. In fact a good estimate of the rate of return expected by a stockholder in relation to a particular stock would be given by the Capital Asset Pricing Model formula which goes as follows: Rj - RF = ÃŽ ²j [RM - RF]. By using this model, we can estimate the cost of equity or the rate of return that our companys shareholders require. Every financial manager must be aware of this because it will help to determine whether a particular course of action by the company will or will not add value to the shareholders. This is the minimum rate of return and may be regarded as the cost of equity. Given that the average cost of capital for a firm in the S&P 500 is 10.2 percent, I would have expected the Coca Cola Company to have a lower cost of capital than the average firm. This is because the Coca Cola Company is a good stock with consistency in performance and price. The price fluctuation for Coca Cola stock has not been too much, with a current price of $67.46, a low of $61.29 and a high of $71.77 in the last 12 months (Yahoo Finance, 2012). Now I will compare the Beta and compute the Required Rate of Return using the CAPM for Dr. Pepper and the Pepsi Corporation, two competing firms of the Coca Cola Corporation and in the same industry sector. For Dr. Pepper the Beta is 0.74 and for Pepsi Corporation, the Beta is 0.42 (Yahoo Finance, 2012). The required rates