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Capital Asset Pricing Model: Coca-Cola CAPM Analysis

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Abstract

This paper applies the Capital Asset Pricing Model (CAPM) to analyze the Coca-Cola Company's estimated beta coefficient of 0.5442, interpreting its significance in terms of market volatility and investor risk. The paper then uses the CAPM formula to calculate Coca-Cola's cost of equity given a risk-free rate of 4.5% and an expected market return of 11%. Finally, it constructs a three-stock portfolio comprising Coca-Cola, Emerson Radio Corp, and Walmart, computing the portfolio beta and expected rate of return, concluding that the combined portfolio carries a below-market level of systematic risk.

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What makes this paper effective

The paper moves logically from a single-stock beta analysis to cost of equity calculation and then to portfolio-level assessment, demonstrating a coherent application of CAPM theory.
Numerical computations are presented transparently, showing each step of the CAPM formula so the reader can follow and verify the results.
The interpretation of beta values is consistently connected to practical investor implications, grounding abstract financial metrics in real decision-making contexts.

Key academic technique demonstrated

The paper demonstrates applied quantitative analysis in finance: it takes a theoretical formula (CAPM) and applies it to real stock data, showing how beta and market return assumptions translate into actionable estimates for cost of equity and portfolio risk. This technique of formula-driven calculation paired with interpretive commentary is standard in undergraduate finance coursework.

Structure breakdown

The paper is organized into three numbered analytical sections. The first introduces and interprets the Coca-Cola beta. The second applies the CAPM equation to derive the cost of equity. The third aggregates individual betas into a portfolio beta and calculates the portfolio's expected rate of return, ending with a brief evaluative conclusion. The structure mirrors a standard financial analysis report format.

Introduction: Estimated Beta for the Coca-Cola Company

PC Quote (2009) estimated the beta coefficient for the Coca-Cola Company — the world's leading beverage company — at 0.5442. This value provides investors with the important information that Coca-Cola stock is less volatile than the broader market and will therefore experience fewer price fluctuations. Had the company's beta been equal to 1, it would have indicated that the stock moves in the same rhythm as the market. Had it been higher than 1, it would have indicated that the Coca-Cola share price was more volatile than the market. Given that the company's beta is only 0.54, this can be understood as the Coca-Cola stock being approximately 46% less volatile than the market (Investopedia, 2009).

The fact that the KO share is less volatile than the market also means that the income opportunities available to shareholders are reduced compared to the gains they could register by investing in a stock with a higher beta. Despite this reduced upside, a beta of 0.54 for the Coca-Cola Company indicates that placements are safer and risks are less intense. With respect to the inclusion of this stock in a portfolio, the investor should note that the evolution of the KO stock is only slightly likely to impact the performance of the overall portfolio, at least in terms of its systematic risk.

The cost of equity is generally understood as the return a company must provide to its shareholders in exchange for their capital and for bearing the risks associated with ownership. Investopedia 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 equation used to calculate the cost of equity is:

Cost of Equity Using CAPM

r_a = r_f + β_a × (r_m − r_f)

In this scenario, the risk-free rate is 4.5%, the beta of the security is 0.5442, and the expected market return is 11%. The market risk premium (r_m − r_f) is therefore 6.5%. The cost of equity (r_a) is computed as follows:

4.5 + 0.5442 × 6.5 = 8.0373%

1 Locked Section · 120 words remaining

Portfolio Beta and Expected Rate of Return · 120 words

"Three-stock portfolio beta computed and interpreted"

Conclusion and Portfolio Risk Assessment

Beta for the Coca-Cola Company (KO) = 0.5542
Beta for the Emerson Radio Corp (MSN) = 1.5645
Beta for the Walmart Stores Inc. (WMT) = 0.2203 (PC Quote, 2009)

Assuming each stock represents an equal one-third (33%) share of the portfolio, the portfolio beta is calculated as:

0.33 × 0.5542 + 0.33 × 1.5645 + 0.33 × 0.2203 = 0.7718

With this portfolio beta, the prospective investor can calculate the expected rate of return using the CAPM formula:

4.5 + 0.7718 × 6.5 = 9.5167%

Overall, the portfolio reveals a safe level of risk, as its beta is lower than 1. This means the portfolio is expected to be less volatile than the overall market. It would, however, be possible to further increase its stability by including additional stocks with lower betas. The analysis demonstrates how CAPM can be used not only to assess individual securities but also to evaluate and manage the risk profile of a multi-stock portfolio.

Farlex. (2009). Portfolio Beta. Farlex Free Dictionary. http://financial-dictionary.thefreedictionary.com/portfolio+beta

Investopedia. (2009). http://www.investopedia.com

PC Quote. (2009). http://www.pcquote.com

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Key Concepts in This Paper

Beta Coefficient CAPM Formula Cost of Equity Portfolio Beta Systematic Risk Market Volatility Risk-Free Rate Expected Return Coca-Cola Stock Stock Portfolio