StudentShare
Contact Us
Sign In / Sign Up for FREE
Search
Go to advanced search...

Risk and Return - Term Paper Example

Cite this document
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…
Download full paper File format: .doc, available for editing
GRAB THE BEST PAPER96.1% of users find it useful
Risk and Return
Read Text Preview

Extract of sample "Risk and Return"

Download file to see previous pages

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. Beta values of other companies For the purpose of comparison 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 approximately 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 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 this model, the future 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

...Download file to see next pages Read More
Cite this document
  • APA
  • MLA
  • CHICAGO
(“Risk and Return Term Paper Example | Topics and Well Written Essays - 750 words”, n.d.)
Retrieved from https://studentshare.org/finance-accounting/1430925-risk-and-return
(Risk and Return Term Paper Example | Topics and Well Written Essays - 750 Words)
https://studentshare.org/finance-accounting/1430925-risk-and-return.
“Risk and Return Term Paper Example | Topics and Well Written Essays - 750 Words”, n.d. https://studentshare.org/finance-accounting/1430925-risk-and-return.
  • Cited: 0 times

CHECK THESE SAMPLES OF Risk and Return

Intuitive Forecasts of Financial Risk and Return

Betting on trends: Intuitive forecasts of financial Risk and Return.... A Critical Appraisal Emily Giblin University of Newcastle Article sourced from a bibliography of behavioural finance by Mike Cox Introduction This exploration seeks to critically analyze the article “Betting on trends: Intuitive forecasts of financial Risk and Return” by De Bondt W....
5 Pages (1250 words) Essay

Financial Resource Management at Personal Level: Risk and Return

PT models an asset's return as a random variable, and models a portfolio as a weighted combination of assets; the return of a portfolio is thus the weighted combination of the assets' returns.... Moreover, a portfolio's return is a random variable, and consequently has an expected value and a variance.... Risk, in this model, is the standard deviation of the portfolio's return....
5 Pages (1250 words) Essay

Models Used to Calculate the Cost of Equity

Estimation of cost of equity therefore provides an estimate for the expected rate of return by incorporating all the risks which may be… Capital asset pricing model is one of the leading models for calculating cost of equity by taking into consideration the concept of Risk and Return.... apital asset pricing model is one of the leading models for calculating cost of equity by taking into consideration the concept of Risk and Return.... It takes into account the risk free rate of return as well as market risk premium along with beta to Introduction Cost of equity is considered as one of the most important indicators of the return earned by any investor on his or her shareholding....
3 Pages (750 words) Essay

Investment in Stocks

This allows you or an investment advisor to suggest the best investment plan for your plans since different investments have different return spreads and risk.... Mutual funds are less risky since the risk is diversified between owners and different instruments.... In knowing your goals, it will also allow one to know their risk appetite before investment.... The main reason of understanding the source of risk is to enable one know where to invest in order to diversify their investment portfolio....
2 Pages (500 words) Essay

Risk and Return Relationships Analysis

However, the stock market is neglecting one of its core aspects, the small companies and this has led to fewer companies Topic: Risk and Return Relationships Analysis Question The current financial markets have developed into huge trading factories that are dominated ultra-fast traders with an ability to swap stocks, futures as well as option and other aspects of the market in a matter of seconds (Saunders & White, 2003)....
2 Pages (500 words) Coursework

Risk and Return Journal

Risk and Return are directly proportional, the higher the risk, the higher, and the… An ordinary inaccurate understanding among investors is that higher level of risk guarantees high returns, but the reality is that high risk only increases the chance of getting high returns. In reference to the video, it is crucial to investors to maintain an Risk and Return Introduction Risk is the probability that business' projected income might not be the same as the real income....
2 Pages (500 words) Assignment

Risk and Return Relationship

This paper also analyzes the Risk and Return relationship which is fundamental to the potential investment decisions.... The essay "Risk and Return Relationship" talks about the characteristics that can influence risk as the probability of losing anything of value or uncertainty of a result.... This paper also analyzes the Risk and Return relationship which is fundamental to the potential investment decisions.... The relationship between Risk and Return is fundamental to the investment decisions, whether assessing a sole investment or selecting between different investments....
3 Pages (750 words) Essay

Accounting Risk and Return

… The paper "Accounting Risk and Return" is a good example of an essay on finance and accounting.... Accordingly, in this study, an effort has been made to analyze the importance of the relationship between Risk and Return.... rdquo; (K Scott Proctor, page 229) Relationship between risk and Returns In order to explain the relationship between risk and returns, we are considering financial assets in this write- up.... In the context of the portfolio, risk can be divided into two parts: Diversifiable risk and market risks....
3 Pages (750 words) Essay
sponsored ads
We use cookies to create the best experience for you. Keep on browsing if you are OK with that, or find out how to manage cookies.
Contact Us