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

Risk and Return - Term Paper ExampleIt not only takes into account the luck free mark of return but also includes market lay on the line 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 personify of law for Wal-Marts while at the same comparing it with other firms. Other shams for caluclating approach of equity such as dividend discount model as swell up as trade price theory. 1) Calculations Name of the Comp some(prenominal) Wal-Mart Nestle McDonald Beta Value 0.371 0.582 0.363 US exchequer (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 following behavior Rate = RF + Beta x (RM-RF) = 3% + 0.37 (7%) Cost of equity = 5.59% Is this cost of equity high or lower than you expected? The above calculations suggest that the cost of equity for Wal-Mart is 5.59% which is below the average rate on S&P 500 for an average fi rm. This cost of equity however, may be considered as adequate 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 be satisfied with the overall strong historical performance of Wal-Mart. Beta determine of other companies For the purpose of equality with Wal-Mart, Nestle 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 Nestle 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 above shows that the cost of equity of three firms is roughly within a certain range. All three firms 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 bail 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(p) 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 just value of any security based on the dividends. (Investopedia.com ). According to this model, the future ca sh flows to be generated from any given security come in the form of future dividends therefore discounting such cash flows with an capture rate can provide a fair indication about the price of a security. The reflexion 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