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Company Financial Analysis: Risk and Return

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Treasury Bill rate: 0.34 Market Yield: 8%

BETA: 0.87
0.34 + [ 0.87 x (0.08 - 0.34)]
0.34 + [ 0.87 x (-0.26)]
0.34 + [-0.226]
Kj= 0.1138

BETA: 1.31
0.34 + [1.31 x (0.08 - 0.34)]
0.34 + [1.31 x (-0.26)]
0.34 + [-0.341]
Kj= -0.001

Given the information provided by these two companies, Identify which company has the greater risk and the greater return. Is the risk consistent with the return for each company? By looking at each company's operations and their type of industry comment if the level of risk is justified for each company.

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Solution Preview

The company with the higher beta has the greater risk. This is because beta measures market risk, which is the risk that cannot be diversified. Therefore, Disney is riskier with beta value of 1.31 than Home Depot whose beta value is 0.87.

With regards to the Capital Asset Pricing Model (CAPM), the Kj in the calculation above is the required rate of return. Thus, Home Depot has greater required rate of return than Disney. This is interesting because higher risks usually go together with higher return. However, in this case it is the opposite. Though Disney is more risky than ...

Solution Summary

This solution compares two companies in terms of risk and return.