CAPM vs. DDM vs. APT (General Mills Case Study)

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INTRODUCTION
The Capital Asset Pricing Model (CAPM) best serves the function of determining the cost of equity for General Mills Inc (NYSE: GIS). Using CAPM calculations, at $38.24 per share, GIS target security price for February 2013 is $39.57, (Reuters, 2012). If this security price becomes unrealistic within the year, then options to boost investor return through increased dividends should be explored. While less accurate than arbitrage pricing theory (APT) and dividend growth models, CAPM's ease of use, and the isolation of Beta assumptions into a single variable best fit the current state of General Mills Inc.
GENERAL MILLS INCâ?" COST OF EQUITY
CAPM would calculate the current cost of equity at 5.96%:
RE= RF + Beta(RM - RF)
RE= 3.15% + 0.18(5%-3.15%)
RE= 3.48%
CAPM VARIABLES AND ASSUMPTIONS
Expanding the above calculation from left to right, each variable introduces new assumptions, and becomes progressively more contentious. RF comprises the risk-free rate. In this case, the 3.15% yield on a 30-year US Treasury bond is used, (Bloomberg, 2012). Traditionally, RF would use a "zero coupon government bond matching the time horizon of the cash flow being analyzed," (Damodaran, nd). In the assessment for General Mills, however, the time horizon for consideration is flexible. Instead of a 12-month bondâ?"which yields almost zero (0.15%), the coupon on a 30-year Treasury bond represents a more realistic risk-free investment, (Bloomberg, 2012).
Next, and more contentious than RF, is Beta. Beta represents a "statistical analysis of past price movements of an individual stock (against) the market as a whole," (Investopedia, nd). In this calculation, 0.18 was used (Reuters, 2012). While Beta is purported to be a mathematical truth, the assumptions underpinning the concept are extremely fluid. For example, four separate sources were consulted for General Mills' Beta valueâ?"these returned four distinct values ranging from 0.18 to 0.24 (Google Finance, Fidelity, Reuters). The Reuters value was settled on based solely on the reputation of the source. The variance between these Beta values could be due to how each defined the "market as a whole." Just to scratch the surface, they could use: S&P 500 index, Wilshire 5000 index, Dow Jones Total Market Index, or any other infinite number of attempts to capture "the market." Then there is time horizon to consider. Should the entire life of the security be considered when calculating the regression? This, of course, also assumes that "the market" is comprised solely of the stock marketâ?" which further assumes that such stock market is limited to domestic securities of similar risk-adjusted expectations as the target security. In any case, Beta is a powerful variable used in CAPM, with results highly dependent on its selection. In selecting from the limited pool consulted, RE could vary between 3.59% and the settled upon 3.48%.
Lastly for CAPM, and clearly the most precarious assumption, is RM (expected aggregate market return). This represents expectations of the market as a whole across ...