Reference no: EM13695179
TASK: Use the Fama-French Three Factors model to estimate the cost of equity for Walmart.
An example lesson to refer to is below (for Costco). To use the CAPM approach for Costco, let's assume that the risk-free rate is about 2% (based on the 10-year Treasury yield in May 2013) and a Value Line β for Costco of 0.75 (as of May 2013). With a market risk premium of 5%, the cost of equity kE for Costco is: 2% + 0.75 • 5% = 5.75%.
The FF Three Factors model: this model was developed by Fama and French (1995) and uses a time series regression of monthly returns on 3 independent variables. Specifically, the regression model is as follows:
Equation: Ru - Rft = βi • (Rmt - Rft) + (si • SMBt) + (hi • HMLt) + εit
In Equation 3.13., the left hand side (dependent variable) is the monthly excess returns of stock i over risk-free rate of return. The first independent variable on the right hand side of Equation 3.13., (Rmt - Rft), is the monthly excess returns on the market index. The second independent variable, SMBt, is the difference between monthly returns of small-cap stocks and large-cap stocks. The third independent variable, HML t, is the difference in monthly returns between high book-to-market stocks and low book-to-market stocks. The coefficients βi, si, and hi measure the sensitivity of stock i's returns on these three factors.
1. Estimating the cost of equity using this model uses the following equation:
Equation 3.14: kE = Rf +(βi • MRP) + (si • SMBP) + (hi • HMLP)
MRP is the market risk premium. SMBP is the expected size premium estimated using historical average annual returns on the small-cap and large-cap stocks. HMLP is the expected value premium estimated using historical average annual returns on the high book-to-market and low book-to-market stock portfolios. The coefficientsβi, s i, and h i are estimated from the time series regression Equation 3.13.
2. The Ibbotson Beta Book (now published by Morningstar) contains an estimate of the FF β coefficient, the SMB premium, and the HML premium for each company. So, to compute kE using Equation 3.14., we only need to get Rfand market risk premium (MRP). Rf is the yield on the Treasury bond and is available from the Federal Reserve's website. The MRP is assumed to be between 4.5% and 5.5% based on the earlier recommendation by Koller, Goedhart, and Wessels.
3. If you have no access to the Ibbotson Beta Book, then you need to run the time series regression Equation 3.13. yourself. Five data series need to be collected: the monthly returns of stock i, market index, and risk-free rate, as well as the monthly SMB and HML factor returns. You may get the historical price data for stock i from Yahoo! Finance. Data on the other four series is available from Professor French's website. From his website, click the U.S. Research Returns on the left panel (the first bullet point under Data Library). You will be directed to the section that contains downloadable data files. Choose the Fama/French Factors, as shown by Figure 3.17., to download a zip file that contains monthly data for four series needed to run time series regression Equation 3.13.
4. Before running the time series regression, make sure that you have converted the historical price series that you downloaded from finance.yahoo.com into a monthly returns series. Then, combining this monthly return series with the monthly data for four series from Professor French's website into a single Excel file. Figure 3.18 displays the combined file for Costco:
5. Run the time series regression Equation 3.13. with monthly series in column H as the dependent variable, and the series in columns D, E, and F as the three independent variables.
|
Compare and contrast the internal rate of return
: Compare and contrast the internal rate of return approach to the net present value approach to capital rationing. Which is better? Support your answer with well-reasoned arguments and examples.
|
|
Find the firms marginal cost function
: A competitive firm has the following short-run cost function: c(y) = y^3-8y^2+30y+5. find the firm's marginal cost function. find the firm's average variable cost function. graph the marginal cost function and the average variable cost function
|
|
Similarities and differences between net present value
: Explain the similarities and differences between net present value (NPV), profitability index (PI), and economic value added (EVA) and how can current risk and political risk be minimized when one is making a foreign direct investment?
|
|
Model of profit maximization is applicable to activities
: What model of profit maximization is applicable to the activities of a multinational company? Explain How “perfectly” competitive do you think are the following markets: 1) stock market, 2) bond market, 3) foreign exchange market, 4) world sugar mar..
|
|
Estimate the cost of equity for walmart
: Fama-French Three Factors model to estimate the cost of equity for Walmart
|
|
What is the implied rate of return
: If a $24 per share stock has a P/E ratio of 20 and pays out 40 percent of its profits in dividends, How large is its dividend? What is the implied rate of return?
|
|
What is multicollinearity
: What is multicollinearity? What effects does it have on estimation and inference in the multiple regression models? Explain briefly why the consequences of omitting an important variable from a regression are typically more serious than including a r..
|
|
Labor is hired at a constant wage rate
: If a firm hires 312 workers it produces 4,522 computers. If it hires 313 workers it produces 4,786 computers. If computers sell at a constant price of $1 and labor is hired at a constant wage rate of $65 per worker:
|
|
Maximize consumption-wadgetland should produce-wadgets
: Widgetland has 60 workers. Each worker can produce 4 widget(s) or 4 wadget(s). Each resident in Widgetland currently consumes 2 widget(s) and 2 wadget(s). Wadgetland also has 60 workers. Each can produce 3 widget(s) or 12 wadget(s).
|