The original Seven Essays, in a cool, new outfit ...
Email - [email protected]

All posts in General Questions

Risk & Return and the CAPM.

Categories: General Questions
Comments Off

1. Risk & Return and the CAPM.

Based on the following information, calculate the required return based on the CAPM:
Risk Free Rate = 3.5%
Market Return =10%
Beta = 1.08

2. Risk and Return, Coefficient of Variation

Based on the following information, calculate the coefficient of variation and select the best investment based on the risk/reward relationship.

Std Dev. Exp. Return
Company A 10.4 15.2
Company B 14.6 22.9

3. Risk and Return, Coefficient of Variation

Based on the following information, calculate the coefficient of variation and select the best investment based on the risk/reward relationship.

Std Dev. Exp. Return
Company A 7.4 13.2
Company B 11.6 18.9

4. Portfolio Theory Risk.

What is portfolio theory and why is it important to investing behavior? 250 words

5. Sources of Risk.

Identify sources of risk and contrast them (include examples) and explain why investors should be concerned with them 250 words

I have chosen the following 3 companies to invest stock in

Ford Motors (Automotive)
Johnson & Johnson (Drug company)
Target (Retail Chain)

I need help finding the current yield of the 10-year treasury bond and calculating the required rate of return for each of them. I need to be able to show my work and explain how the risk affects your expectations. In the end I want to earn 15% in the market despite the market risks.

If Wild Widgets, Inc. were an all-equity company it would have a beta of 1.55. The company has a target debt-equity ratio of 0.4. The expected return on the market portfolio is 12.9 percent, and Treasury bills currently yield 5.9 percent. The company has one bond issue outstanding that matures in 23 years and has an 6.8 percent coupon rate. The bond currently sells for $984. The corporate tax rate is 30 percent.

Question #1:
What is the company’s cost of debt? (Do not include the percent sign (%). Round your answer to 2 decimal places. (e.g., 32.16))

Cost of debt:_____%

Question # 2:
What is the company’s cost of equity? (Do not include the percent sign (%). Round your answer to 2 decimal places. (e.g., 32.16))

Cost of equity:_____%

Question # 3:
What is the company’s weighted average cost of capital? (Do not include the percent sign (%). Round your answer to 2 decimal places. (e.g., 32.16))

Weighted average cost of capital:______%

Please check CAPM calculations for Nike, Sony and McDonalds.

CAPM would calculate Nike’s current cost of equity at 2.859%
RE = RF + Beta(RM – RF)
RE = 20% + 0.91(7.50% – 20%)
RE = 2.859%

This calculation is based on a variable market rate of return and a risk free rate. Using a variable market rate of return may be appropriate in comparing companies assuming the market rate is risk-adjusted.

CAPM would calculate Sony’s current cost of equity at 2.148%
RE = RF + Beta(RM – RF)
RE = 20% + 1.48(8.50% – 20%)
RE = 2.148%

CAPM would calculate McDonald Corporation current cost of equity at 2.036%
RE = RF + Beta(RM – RF)
RE = 20% + 0.36(9.50% – 20%)
RE = 2.036%

Explain the challenge of estimating or coming with a good “feel” for the “cost of equity capital” or the rate of return that you feel your company investors require as the minimum rate of return that they expect of my company (Lowes Companies, Inc.) to earn on their investment in the shares of the company.

Which of the three models (dividend growth, CAPM, or APT) is the best for estimating the required rate of return (or discount rate) of Lowes? Based on your analysis and findings, what would you recommend to the board of directors of for Lowes?

In your paper, include discussion of the following issues:
1. Ease of use of these three models
2. Accuracy of each of these three models
3. How realistic the assumptions of each model are

For this paper I need to take a clear stand and pick one of these three models to defend to the Board of Directors. You cannot tell the Board of Directors that “I like all three models,” they want you to come to them with a decisive choice of just one model.

Part II

The cost of equity (discount rate) can also be determined by using the Capital Asset Pricing Model (CAPM). Calculating the cost of equity using CAPM model is often more difficult than using the dividend discount model. The companies’ financial statements do not show the cost of equity.

The following table shows necessary (hypothetical) information to calculate the cost of equity by using CAPM model:

Company Listing RRF RM BJ

Nike Inc. NYSE: NKE 0.20% 7.50% 0.80

Sony Corporation NYSE: SNE 0.20% 8.50% 1.40

McDonald’s Corporation NYSE: MCD 0.20% 9.50% 0.30

E(rj )= RRF + b(RM – RRF)

E(rj ) – The cost of equity

RRF – Risk free rate of return)

Bj – Beta of the security

RM – Return on market portfolio)

Based on the above information, which company has higher cost of equity? Why? Please explain your reasoning in brief.