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Puritan Motors has a capital structure consisting almost entirely of equity.
a) If the beta of Puritan stock equals 1.6, the risk-free rate equals 6%, and the expected return on the market portfolio equals 11%, then what is its cost of equity?
b) Suppose that a 1% increase in expected inflation causes a 1% increase in the risk-free rate. Holding all other factors constant, what will this do to the firm’s cost of equity? Is it reasonable to hold all other factor’s constant? What other part of the calculation of the cost of equity is likely to change if expected inflation rises?
10-3) In its 2009 annual report, the Coca-Cola Company reported sales of $30.99 billion for fiscal year 2009 and $31.94 billion for fiscal year 2008. The company also reported operating income (roughly equivalent to EBIT) of $8.23 billion in 2009 and $8.45 billion in 2008. Meanwhile, arch rival PepsiCo, Inc., reported sales of $43.23 billion in 2009 and 43.25 billion in 2008. PepsiCo’s operating income was $8.04 billion in 2009 and $6.96 billion in 2008. Based on these figures, which company had higher operating leverage?
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