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Investopedia, a noteworthy financial website designed by Forbes Media and aiming to sustain investing decisions, defines the cost of equity as "the return that stockholders require for a company […]. A firm's cost of equity represents the compensation that the market demands in exchange for owning the asset and bearing the risk of ownership."
The CAPM equitation:
ra = rf + ?a x (rm - rf) (Investopedia)
In our scenario, the risk free rate is of 4.5, the risk of the security is of 0.5542 and the expected market return on the Coca Cola share is of 11. Given this situation, the cost of equity (ra) can be computed as follows: 4.5 + 0.5442 x 6.5 = 8.0373
3. Portfolio Beta
Knowing the risks associated with each investment in the portfolio, the beta of the portfolio can be computed by summing up the multiplications...
(WMT) = 0.2203 (PC Quote, 2009)
Beta for the entire portfolio = 0.33 x 0.5542 + 0.33 x 1.5645 + 0.33 x 0.2203 = 0.7718
With this new beta, the prospective investor can calculate the expected rate of return on this portfolio, according to the following computation:
4.5 + 0.7718 x 6.5 = 9.5167
Overall, the portfolio reveals a safe level of risk as its beta is lower than 1. Yet, it would be possible to further increase its stability by including shares with lower betas.
References:
2009, Portfolio Beta, Farlex, the Free Dictionary, http://financial-dictionary.thefreedictionary.com/portfolio+beta last accessed on September 3, 2009
2009, Investopedia, http://www.investopedia.com last accessed on September 3, 2009
2009, PC Quote, http://www.pcquote.com last accessed on September 3, 2009
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