Journal of Business Case Studies – Fourth Quarter 2014 Volume 10, Number 4 Copyright by author(s); CC-BY 357 The Clute Institute Computing Bottom-Up Betas For Companies In The Soft Drink Industry V. Reddy Dondeti, Norfolk State University, USA Carl B. McGowan, Jr., Norfolk State University, USA Susan E. Moeller, Eastern Michigan University, USA ABSTRACT In this paper, we decompose the CAPM equity beta for Coca-Cola and Pepsi (KOPEP) to show the industry component and the operating leverage and the financial leverage components for the period from 2004 to 2012. We compute the CAPM equity betas using a standard five year, sixty month, regression between returns for KOPEP using the S&P500 as the market index. We adjust for financial leverage using the Hamada (1969) methodology and we adjust for operating leverage using the degree of operating leverage (DOL). The average business beta for Coca-Cola is 0.1882 and the average business beta for Pepsico is 0.1369. Over the period of this analysis, Coca-Cola has had a business beta slightly higher than the business beta for Pepsico. Keywords: CAPM; Bottom-Up Beta; Equity Beta; Unlevered Beta; Business Beta; Coca-Cola; Pepsi INTRODUCTION he objective of corporate financial management is to maximize the value of the firm. The value of the firm is the market value of the firm determined by multiplying the number of shares outstanding times the price per share. The price of a share of stock in a corporation is the discounted present value of the future cash flows from the share including dividends and capital gains. Estimates of the future cash flows are based on the concept of free cash flow to equity such as developed in Damodaran (2006). Brigham and Ehrhardt (2008, pp. 287-288) and Ross, Westerfield, and Jordan (2008, pp. 235-238) both develop similar models for dividends. The required rate of return on the stock in a company is determined by the riskiness of the company’s future cash flows. The volatility of future cash flows is influenced by the industry in which the company functions, the degree of operating leverage which measures the extent to which the company uses fixed cost assets, and the degree of financial leverage which measures the extent to which the company uses fixed cost financing. The objective of this paper is to decompose the market determined beta coefficient for the company into the industry component, the operating leverage component, and the financial leverage component for a sample of companies in the soft drink industry, specifically KOPEP. Modern Portfolio Theory originated in Markowitz (1952) which showed how to determine the optimal set of efficient portfolios available for selection by investors. The CAPM (market) beta is derived from Sharpe (1963, 1964). Sharpe (1963, 1964) develops an asset pricing model for securities based on market risk only. The market beta is the regression coefficient of the characteristic line for the stock. The characteristic line is derived from the regression between the excess return on a specific stock for a period and the excess return on the stock market index. Gardner, McGowan, and Moeller (2010) show how to compute the beta coefficient for Coca-Cola and Harper, Jordan, McGowan, and Revello (2010) show how to collect data and compute the beta coefficient for DOW Chemical Corporation. Usually, beta is computed using five years of monthly returns data or sixty observations as in SBBI (2010, p. 69). R e = R f +  A (R m -R f ) [1] where, T