Risk and return, portfolio diversification and the Capital Asset Essay

Risk and return, portfolio diversification and the Capital Asset Pricing Model; The cost of equity (Starbucks Co.) - Essay Example (Valuebasedmanagement.net, 2011) This paper will therefore provide computation and will also discuss the cost of equity of Starbucks besides computing the cost of equity for Nestle and McDonalds to make a comparison. Further, cost of equity will also be calculated by using dividend discount model as well as arbitrage pricing theory. The above calculations show that the overall cost of equity for Starbucks is 11.82% based on the data provided. This value is higher than the cost of equity of an average firm on the S&P 500 index thus indicating that the overall risk profile of Starbucks may be higher than an average firm. It may be due to the fact that the investors, considering the dynamics of the industry and particular performance of the firm in the industry, may not be willing to put their bets on Starbucks. The cost of equity should have been lower than an average firm on the S&P considering the overall market strength of Starbucks and brand power. The above comparison between McDonalds, Nestle as well as Starbucks shows that the return on equity for other two firms is lower as compared to Starbucks. The lower cost of equity of these firms suggests that these firms have relatively stable risk profile due to their stronger financial performance as well as fundamentals. What is also important to note that these firms are diversified in nature whereas Starbucks is only relatively focused on the sale of coffee only? It is therefore of no surprise that the cost of equity of such firms is relatively lower than Starbucks Dividend discount model is another important model to find out the fair values of the stock based on the dividends. (Investopedia.com, 2011 ). This model considers dividends as the future cash flows to be received and accordingly the price of the stock is calculated by using following formula: Thus the expected rate of return is obtained by considering a linear combination of different macroeconomic factors combined with