Risk and Return - Term Paper Example

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Risk and Return

It not only takes into account the risk free rate 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 cost of equity for Wal-Marts while at the same comparing it with other firms. Other models for caluclating cost of equity such as dividend discount model as well as arbitrage pricing theory. 1) Calculations Name of the Company Wal-Mart Nestle 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 following manner: Rate = RF + Beta x (RM-RF) = 3% + 0.37 (7%) Cost of equity = 5.59% Is this cost of equity higher 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 firm. 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 are satisfied with the overall strong historical performance of Wal-Mart. ...Show more

Summary

Introduction Cost of equity is one of the critical and important tools through which investors can estimate the expected returns to be earned on any proposed investment. Cost of equity therefore not only provides the expected returns figure but also takes into consideration any particular risks associated with any particular stock…
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