Final answer:
To calculate the appropriate cost of capital for the Powerade division, the Capital Asset Pricing Model (CAPM) is used. The formula includes the beta of the division, the market risk premium, and the risk-free rate, which we need to determine from additional information such as current government bond yields.
Step-by-step explanation:
To determine the appropriate cost of capital for the Powerade division of Coca-Cola, we can use the Capital Asset Pricing Model (CAPM), which calculates the expected return on equity or the cost of equity. The CAPM formula is given by:
E(R) = Rf + β(E(Rm) - Rf)
Where:
- E(R) is the expected return on equity or the cost of equity.
- Rf is the risk-free rate.
- β is the beta of the investment.
- E(Rm) is the expected market return.
- (E(Rm) - Rf) is the market risk premium.
Given that Powerade's beta is 1.08 and the market risk premium is 9.5%, and assuming that the risk-free rate is the difference between Coca-Cola's overall cost of equity and the market risk premium multiplied by its beta (which is 8.9% - 0.55 * 9.5%), we can calculate the risk-free rate and then use it in the CAPM formula to estimate the cost of equity for Powerade.
However, since the student question does not provide the risk-free rate explicitly, the final calculation cannot be completed without that piece of information. In practice, one would look up the current yield on a government treasury bill or bond as a proxy for the risk-free rate to complete this exercise.