# Cost of Equity and beta

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

Toy's Things, Inc: Estimate net income, operating leverage, equity beta, cost change

Please see and use the attched excel spreadsheet! Thank you!

Assume that Jason Kidwell is able to purchase Toy's Things, Inc., for $2.2 million. Jason estimates that after initiating his changes in the company's operations, the firm's cost of goods are 55% of firm revenues and operating expenses are equal to a fixed component of $250,000 plus a variable cost component equal to 10% of revenues.

a. Under the above circumstances, estimate the firm's net operating income for revenue levels of $1 million, $2 million, and $4 million. What is the percent change in operating income if revenues go from $2 million to $4 million? What is the percent change in operating income if revenues change from $2 million to $1 million?

b. Assume now that Jason is able to modify the firm's cost structure such that the fixed component of operating expenses declines to $50,000 per year, but the variable cost rises to 30% of firm revenues. Answer Part a above under this revised cost structure. Which of the two cost structures generates the highest level of operating leverage? What should be the effect of the change in cost structure on the firm's equity beta?

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