its a finance question 1

This DQ 2 is to estimate the cost of equity (required return for equity) for your assigned two companies in DQ 1, by using CAPM model: k = kf + beta * (km -kf), where “k” is the cost of equity (required return for equity). Remember, your two companies for this DQ 2 are the same as those in DQ 1.

Follow the instructions below closely in order to find k for each of your two companies:

In order to find k, you need to first find kf, km and beta, respectively.

(1) Find kf (risk-free rate):

A commonly used proxy for the risk-free rate, kf, is the 3-Month T-Bill Rates. You may find the current 3-month T-bill rate from the following link: (Use the most current rate)

https://ycharts.com/indicators/3_month_t_bill

(2) Find km (stock market average return):

Find the attached file “Market Data from Robert Shiller.xlsx“, and look at the “Return on S&P” column which has been highlighted in yellow. Calculate the average number of that series by selecting a period of time, e.g., from 1990 to 2016, by using the Excel function “Average”. Use that average as the average market return, i.e., km.

(**Note that you will be asked in one of the questions below why you selected to use that specific time period for calculating the average return for the market.)

(3) Find beta:

You may find the beta for each of your companies by logging in to Yahoo Finance website: https://finance.yahoo.com/quote/TGT?p=TGT (Here it is shown Target’s data. You would need to key in your company’s ticker symbol to find your company’s beta), just like what you did in DQ 2.

(4) Plug in all of those three numbers to the CAPM to find the cost of equity (required return for equity), k.

Answer the following questions:

1. In the estimate for the market average return, km, why do you think the time period that you selected for calculating the average return is more appropriate to be used as the average return for the market?

2. The graph representation of the CAPM model is called Security Market Line (SML). So, in your case, what did you get for the slope (in number) of the SML. And, what that slope represents?

3. From DQ 1 you know that a company’s beta can be quite different from its S.D. (standard deviation) in terms of the numbers being high or low. Why do you think CAPM only includes beta risk while ignoring S.D. risk, in calculating a company’s required return for (cost of) equity?

3. What is the beta for each of your companies? What is the “k” (cost of equity) for each of your companies? Did you expect higher beta would lead to higher “k”? Why or why not?

 

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