Discussion: Beta & Capital Budgeting

Part 1: Beta 

Beta (β) is an integral element of the Capital Asset Pricing Model (CAPM) that measures an investment’s volatility of returns relative to the market. It is a regression of a stock’s total return compared to the market’s benchmark (Faisal et al., 2018). Beta can be estimated based on weekly, monthly, quarterly, or annual data, depending on the management’s investment needs.

Beta indicates a stock’s performance relative to the market’s benchmark, making it a critical tool when making investment decisions. A beta equal to one (β=1) shows that stock volatility equals that of the market, implying that the stock price moves with market trends. A beta greater than one (β>1) means that the company’s stock is more volatile than the market, implying that any movement in the market creates a more significant change in the stock’s price. A beta less than one and greater than zero (β<1>0) means the company’s security is less volatile than the market, implying that a change in the market creates a less proportionate change in the stock price. A beta equal to zero (β=0) means that the stock and market volatility are uncorrelated; hence, changes in the market do not affect the stock price. 

The selected companies in the same industry as Keurig Dr Pepper Inc. (β=0.62) include Philip Morris International Inc. (β=0.87), Mondelez International Inc. (β=0.68), and Coca Cola Company (β=0.63). These firms might have a different beta because of differences in the capital structure (Pan et al., 2014). A company with lower debt financing has a lower beta than those with higher debt financing. For instance, Keurig Dr Pepper has the lowest beta at 0.62, and Philip Morris International has a beta of 0.87, indicating that the companies have different capital structures with a lower debt ratio but are very sensitive to market trends. Keurig Dr Pepper has a higher debt ratio averaging 0.53 in the past five years. Therefore, differences in capital structure cause the difference in beta values.

Differences in market risks could also explain the difference in beta values of companies in the same industry (Pan et al., 2014). Companies in the same industry could have different risks due to operational strategies. For instance, Coca-Cola has a beta of 0.63, and Keurig Dr Pepper has 0.62. While Coca-Cola’s operational strategy focuses on brand building, innovation, revenue growth management, and asset optimization, Keurig Dr Pepper’s involves the environment, supply chain, health and wellbeing, and communities. Therefore, Keurig Dr Pepper has a lower beta, implying lesser volatility in stock price than Coca-Cola Company, which maximizes shareholder value. 

Furthermore, operational risks influence a stock’s beta value. A company operating in a risky environment is likely to have a higher beta than others in the same industry (Pan et al., 2014). For instance, Philip Morris International operates a risky business of producing cigars, which are susceptible to health and policy campaigns, has a beta of 0.87. Keurig Dr Pepper, which produces healthy beverages, is less vulnerable to market changes and has a beta of 0.62. Thus, beta values depend on the company’s operational risks.  

Part 2: Capital Budgeting - Capital Budgeting Decision Methods, Principles & Techniques

Internal rate of return (IRR) is a measure of estimating the financial profitability of any potential investment. In contrast, net present value (NPV) refers to the future cash flows of an investment for a given period discounted at present values. NPV and IRR are useful in capital budgeting, including estimating the value of an enterprise, investment security, cost reduction programs, and capital projects.

NPV is a better measure of a project’s investment potential than IRR. NPV generates a dollar value of an investment, offering the basis for making an investment decision (Jory et al., 2016). Investors prefer to see the financial values and figures than ratios generated in the IRR approach. Also, investors are concerned with the profits and surpluses that only NPV provides (Jory et al., 2016). IRR only yields breakeven points of investments that do not offer sufficient justification for pursuing an investment option. Therefore, NPV is more practical and easy to interpret when making investment evaluations. 

Maximization of shareholder value is ethical because it is the ultimate goal of establishing an enterprise. Maximizing shareholder value and business profits go hand in hand. However, companies would be unethical if their profit maximization initiatives fall short of socially responsible behavior, trashing the interests of business stakeholders such as customers, suppliers, government, and investors (Harrison et al., 2015). For instance, a company becomes unethical when it dumps wastes products on the environment without caring about their effects on third parties. In most instances, business managers with longevity to enhance shareholder value are objective and impersonal, consistently using accurate information to make ethical business decisions (Harrison et al., 2015). Therefore, the wealth-maximizing goal of companies is ethical. 

Ethical companies benefit from the lower cost of capital because of higher stakeholder satisfaction. Without this level of confidence in ethical companies, investors cannot provide resources at a cheaper cost. Essentially, the ethical conduct of companies guarantees investors that their money would be safe (Lewin & Sardy, 2017). The investors might also provide funds cheaply because they want to increase the amount of good a society derives from the company’s ethical activities. Although these investors might seek to maximize the positive outcomes of these ethical companies, they seek to earn returns based on market risk (Sepe et al., 2015). As a result, companies might access cheaper capital than less ethical companies, which investors are hesitant of their capital investment’s security. 

Outline

Discussion: Beta & Capital Budgeting

Part 1: Beta 

1. Beta (β) is an integral element of the Capital Asset Pricing Model (CAPM) that measures an investment’s volatility of returns relative to the market
2. Beta indicates a stock’s performance relative to the market’s benchmark, making it a critical tool when making investment decisions.
3. The selected companies in the same industry as Keurig Dr Pepper Inc. (β=0.62) include Philip Morris International Inc. (β=0.87), Mondelez International Inc. (β=0.68), and Coca Cola Company (β=0.63).
4. Differences in market risks could also explain the difference in beta values of companies in the same industry (Pan et al., 2014).
5. Operational risks influence a stock’s beta value. A company operating in a risky environment is likely to have a higher beta than others in the same industry

Part 2: Capital Budgeting - Capital Budgeting Decision Methods, Principles & Techniques

1. NPV and IRR are useful in capital budgeting, including estimating the value of an enterprise, investment security, cost reduction programs, and capital projects.
2. NPV is a better measure of a project’s investment potential than IRR.
3. Maximization of shareholder value is ethical because it is the ultimate goal of establishing an enterprise.
4. Ethical companies benefit from the lower cost of capital because of higher stakeholder satisfaction.