Part I:
Explain the challenge of estimating or coming with a good "feel" for the "cost of equity capital" or the rate of return that you feel your company investors require as the minimum rate of return that they expect of my company (Lowes Companies, Inc.) to earn on their investment in the shares of the company.
Which of the three models (dividend growth, CAPM, or APT) is the best for estimating the required rate of return (or discount rate) of Lowes? Based on your analysis and findings, what would you recommend to the board of directors of for Lowes?
In your paper, include discussion of the following issues:
1. Ease of use of these three models
2. Accuracy of each of these three models
3. How realistic the assumptions of each model are
For this paper I need to take a clear stand and pick one of these three models to defend to the Board of Directors. You cannot tell the Board of Directors that "I like all three models," they want you to come to them with a decisive choice of just one model.
Part II:
The cost of equity (discount rate) can also be determined by using the Capital Asset Pricing Model (CAPM). Calculating the cost of equity using CAPM model is often more difficult than using the dividend discount model. The companies' financial statements do not show the cost of equity.
The following table shows necessary (hypothetical) information to calculate the cost of equity by using CAPM model:
Company Listing RRF RM BJ
Nike Inc. NYSE: NKE 0.20% 7.50% 0.80
Sony Corporation NYSE: SNE 0.20% 8.50% 1.40
McDonald's Corporation NYSE: MCD 0.20% 9.50% 0.30
E(rj )= RRF + b(RM - RRF)
E(rj ) - The cost of equity
RRF - Risk free rate of return)
Bj - Beta of the security
RM - Return on market portfolio)
Based on the above information, which company has higher cost of equity? Why? Please explain your reasoning in brief.