You should always worry about something you have overlooked or that does not fit together. In Section 20.5A on page 751, for example, PepsiCo’s bonds were rated A+ in 2001. Such bonds carried an average interest rate of 7.5%.

(a) Would it be better to use 7.5% in the CAPM formula to obtain PepsiCo’s cost of capital?

(b) Estimate PepsiCo’s historical average interest rate. Use the income statement’s interest expense and the balance sheet’s debt (short-term and long-term). Is such an estimate in line with the prevailing interest rate on A+ bonds?

(c) Does it make sense for bonds to have a higher cost of capital than equity? In light of the 7.5% interest rate on A+ bonds, should you change your 7% estimate for PepsiCo’s cost of capital?