1. An investor is considering an investment in Coca Cola stock. The risk free rate of return is 1.5%, the market rate of return is 9% and Coke’s beta is 0.57.
a. Based on the CAPM, what is the investor’s required rate of return on the stock? Show all calculations using Excel formulas.
b. Coca cola stock is currently selling at a price of $44 a share. The investor strongly believes that a year from now the stock will be worth $50 a share. The investor also expects that Coke will pay a dividend of $1.56 a share during the coming year. If the investor buys the stock today and holds if for a year, what will her holding period return for the year be if her predictions come true? Show all work using Excel formulas.
c. If the investor is absolutely convinced that her predictions in part b will come true, based on solely your calculations in parts a and b, above, does it make sense for the investor to invest in Coke stock at this time? Explain your reasoning.
d) Pier 1 Imports has a beta of 2.3. Would a rational investor require a higher or lower return from an investment in Pier 1 as opposed to Coke? Why?