Equity the Yield to Maturity

¶ … Equity

The yield to maturity on a one-year government treasury note (maturity July 30, 2009) is 2.32%, according to Bloomberg.com, as of July 30, 2008. Another source had listed a composite 1-year rate at 2.33%, so we will simply use the 2.32% rate since the rates are in line with one another.

If Rm-Rf = 7%, the market risk rate is RF + 7%

% + 7% = Rm

Rm = 9.32%

The beta of Johnson & Johnson (NYSE: JNJ) is 0.36, according to Reuters, as of July 30, 2008.

The cost of equity for Johnson & Johnson is equal to the risk free rate plus the beta multiplied by the market risk, as per CAPM.

So Rj = Rf + B (Rm-Rf)

Rj = 2.32 + 0.36 (9.32-2.32)

Rj = 4.84%

Thus, 4.84% is considered to be the cost of equity for Johnson & Johnson. This represents a lower risk than that of the market as a whole, but more than the risk-free rate. This risk premium is used to determine the return that shareholders must from JNJ on the company's investments. JNJ's core businesses are relatively stable, and the company has diversified away some of its market risk through multiple business lines and strong geographic diversification. Therefore, the cost of equity is relatively low.

4. The tax rate of JNJ is assumed to be 34%.

The debt-to-equity ratio by market value, as calculated from the previous report, is 21.9%

Therefore the asset beta of Johnson & Johnson is as follows:

Ba = [1+ (1-T)(D*/E*) / Be Ba = [1+(1-.34)(.219)] / 0.36

Ba = 3.179