What Are the Costs of Capital for the Individual Business Segment

What are the costs of capital for the individual business segments? (Use LT Govt rates as inputs to CAPM)

PepsiCo Inc., which is a multi-division firm, possesses three segments of business. There are beverages, snack foods and restaurants. According to an article by Russell Fuller and Halbert Kerr , “each division is matched with a publicly traded company having a single line of business that was as similar as possible to the division’s” . Exhibit 5 represents a list of companies with publicly traded securities which own the same business segments as PepsiCo Inc.. The comparable company who has the same line of business is called “pure-play” company. In Exhibit 5, the pure-play companies in beverages segment are A&W Brands, Coca-Cola, Coca-Cola Bottling and Coca-Cola Enterprises. The pure-play companies in snack foods segment are Flowers, Inc., General Mills, Golden Enterprises, Inc., Goodmark Foods and Lance, Inc.. The pure-play companies in restaurants segment are McDonald’s Corp., National Pizza, Ryan’s Family Steak House, TCBY and Wendy’s International, Inc.. Michael McCartt assumed that PepsiCo Inc. estimates its cost of equity by CAMP model, the formula for which is:

Ke  Rf  (Rm  Rf).

Exhibit 6, 7 and 8 report respectively the appropriate risk-free rate, Rf, the market return, Rm and the betas, , of the pure-play companies. A thirty-year U.S. Government Interest Rate (long-term) of 8.30% is used as Rf, the S&P 500 of 12.1% is used as Rm and the mean betas of each segment are 1.0625(beverages), 0.938(snack foods) and 1.07(restaurants). The COE of each segment is 12.3375%, 11.8644% and 12.366%.

Then the hurdle rates of each business segment can be calculated using the WACC formula:

WACC = Kd  (1  )  D/(D + E) + Ke  E/(D + E)

where