Sola Cola Corporation is undertaking a capital budgeting analysis. The rate on 10-year U.S. Treasury bonds is 3.60%, and the return on the S & P 500 index is 11.6%. If the cost of Sola Cola's common equity is 19.6%, calculate their beta.

Question

Quizplus · Accepted Answer

We can use the Capital Asset Pricing Model (CAPM) to calculate the beta of Sola Cola Corporation.

CAPM formula: 
rA = RF + βA (RM – RF)
where,
rA = expected return on asset A
RF = risk-free rate (10-year U.S. Treasury bond rate)
βA = beta of asset A
RM = expected market return (S&P 500 index return)

Given information:
RF = 3.60%
RM = 11.6%
rA = 19.6%

Substituting the values in the CAPM formula, we get:
19.6% = 3.60% + βA (11.6% – 3.60%)
or, 15% = 7.96% βA
or, βA = 15% / 7.96%
or, βA = 1.88

Therefore, the best choice is C) 2.0 (rounding off the answer to the nearest tenth).

Sola Cola Corporation Is Undertaking a Capital Budgeting Analysis