Risk and Return Term Paper Example | Topics and Well Written Essays - 750 words

Risk and Return - Term Paper ExampleIt not only takes into bank bill the risk open rove of return but also includes market risk premium while at the same time taking beta of the stock into account too. (Valuebasedmanagement.net, 2011) This paper will discuss as to how to compute the equal of justness for Wal-Marts while at the same comparing it with other firms. Other shapes for caluclating cost of equity such as dividend discount model as well as arbitrage pricing theory. 1) Calculations Name of the Company Wal-Mart draw near McDonald Beta Value 0.371 0.582 0.363 US Treasury (RF) 3% 3% 3% RM-RF 7% 7% 7% Cost of Equity 5.59% 7.06% 5.52% Cost of equity for Wal-Mart is computed in fol let looseing manner assess = RF + Beta x (RM-RF) = 3% + 0.37 (7%) Cost of equity = 5.59% Is this cost of equity higher or downcaster than you expected? The in a higher place calculations suggest that the cost of equity for Wal-Mart is 5.59% which is below the average value on S&P 500 for an ave rage firm. This cost of equity however, may be considered as tolerable or right considering the overall fundamentals of Wal-Mart, its brand image, its global presence as well as the overall industry dynamics. Such low rate of cost of equity therefore indicates that investors are satisfied with the overall strong historical performance of Wal-Mart. Beta look ons of other companies For the purpose of comparison with Wal-Mart, go up as well as McDonalds have been considered as a case study. The tabular calculations are provided in following table Name of the Company Wal-Mart go up McDonald Beta Value 0.374 0.585 0.366 US Treasury (RF) 3% 3% 3% RM-RF 7% 7% 7% Cost of Equity 5.59% 7.06% 5.52% Cost of equity for Nestle Rate = RF + Beta x (RM-RF) = 3% + 0.58(7%) = 7.06% Cost of equity for McDonalds Rate = RF + Beta x (RM-RF) = 3% + 0.36 (7%) = 5.52% The comparison made in a higher place shows that the cost of equity of three firms is approximately within a certain range. All three fir ms have cost of equities which are less than 10% suggesting that the low beta values may have an impact on their overall valuation. Beta values always suggest the correlation between the market returns as well as the individual security returns therefore low beta value suggest that the market and the security go hands in hand. The above comparison also shows that these firms are mature firms and are industry leaders with low risk profile therefore investors are relatively satisfied on their ability to operate as a going concern. Further, these firms are mature with stable patterns of earning therefore the overall cost of equity is low due to their low risk. 4) Capital asset pricing model is not the only model to compute the cost of equity as models such as dividend discount model as well as arbitrage pricing theory are other alternatives. Dividend Discount Model is based on the computation of the fair value of any security based on the dividends. (Investopedia.com ). According to th is model, the next cash flows to be generated from any given security come in the form of future dividends therefore discounting such cash flows with an appropriate rate can provide a fair indication about the price of a security. The formula is P0 = D1 / (R-G) D1 is the dividends in the future period 1 whereas R is the required rate of return whereas G suggests the historical growth rate of the dividends. Through manipulation of the above formula, the rate of return through dividend discount model can be computed in following manner R = D1/P0 + G The required rate o