The authors use very long-term ranges to estimate risk free rate and market premium?

What are the benefits and risks of this? Would you use a different range of number?  

 

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The required rate of return for Coca-Cola is the risk-free rate of return plus the risk premium for Coca- Cola. The risk premium is the beta for Coca-Cola time the market price of risk. COMPUTING THE REQUIRED RATE OF RETURN FOR COCA-COLA (KO) USING THE CAPM' The risk free rate is the total return (income plus capital appreciation) on Long-term Government Bonds taken from SBBI 20078. For the years from 1926 to 1976, SBBI uses the Government Bond File from the Center for Research in Security Prices. For the period from 1976 to 2006, the returns in SBBI 2007 are computed from data taken from the Wall Street Journal. The yield for the bond is the discount rate that equates the expected future cash flows, coupon payments and maturity value, to the current price. Table 2 contains a summary of the input data and sources of that data. Variable Betako R₁ Rm Ke Table 2: Input Data and Sources Value 0.7650 0.0580 0.1230 0.1077 Source Computed SBBI, 2007, page 31 SBBI, 2007, page 31 Computed We use the security market line to compute the required rate of return for Coca-Cola. We use the long- term bond rate taken from SBBI (2007) which equals 5.8% and the long-term market return of 12.3%. The market risk premium is 6.5%. This yields a cost of equity for Coca-Cola of 10.77%. The required rate of return for Coca-Cola is the risk-free rate of return plus the risk premium for Coca- Cola. The risk premium is the beta for Coca-Cola time the market price of risk. COMPUTING THE REQUIRED RATE OF RETURN FOR COCA-COLA (KO) USING THE CAPM' The risk free rate is the total return (income plus capital appreciation) on Long-term Government Bonds taken from SBBI 20078. For the years from 1926 to 1976, SBBI uses the Government Bond File from the Center for Research in Security Prices. For the period from 1976 to 2006, the returns in SBBI 2007 are computed from data taken from the Wall Street Journal. The yield for the bond is the discount rate that equates the expected future cash flows, coupon payments and maturity value, to the current price. Table 2 contains a summary of the input data and sources of that data. Variable Betako R₁ Rm Ke Table 2: Input Data and Sources Value 0.7650 0.0580 0.1230 0.1077 Source Computed SBBI, 2007, page 31 SBBI, 2007, page 31 Computed We use the security market line to compute the required rate of return for Coca-Cola. We use the long- term bond rate taken from SBBI (2007) which equals 5.8% and the long-term market return of 12.3%. The market risk premium is 6.5%. This yields a cost of equity for Coca-Cola of 10.77%.

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The benefits of using very longterm ranges to estimate riskfree rates and market premiums include 1 ... View the full answer