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Cost of Equity and beta

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1. I have selected a company for my project of Walmart. It has a beta coefficient of ( .2)
If I know that the present yield on US government bonds maturing in one year(about 4.5% annually) and an assessment that the market risk premiums 6.5% (the difference between the expected rate of return on the market portfolio and the risk free rate) If I used the CAPM equation what would be the cost of equity on my company WalMart (WMT)?

2. If I used my company WalMart (b=.2) and I picked 2 other companies and knew their betas, for example Starbucks(b=1.35) and McDonalds (b-=1) and i invested 1/3 of my money in each of these stocks of these companies, what would be the beta of my portfolio be? Would the 3 stock portfolio be sufficiently diversified or would it still have a diversified risk that can be diversified away?

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Solution Preview

1. Using CAPM the cost of equity Ke is given as
Ke = Rf + (Rm-Rf) X beta
where Rf is the risk free rate = 4.5%
(Rm-Rf) = market risk premium = 6.5%
beta = 0.2
Cost of equity = 4.5% + 6.5%X0.2 = 5.8%

2. Portfolio beta is the ...

Solution Summary

The solution explains how to calculate the cost of equity and beta of a portfolio

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