Walmart Cost of Equity: CAPM and Dividend Growth Model
This paper calculates and assesses Walmart's cost of equity using the Capital Asset Pricing Model (CAPM), applying a risk-free rate of 0.13%, a market portfolio return of 5%, and Walmart's beta of 0.3 to arrive at a cost of equity of 1.591%. The paper evaluates this result in the context of the average S&P 500 cost of capital, then extends the analysis to competing retailers Target and Sears using their respective betas. It concludes with an overview of the dividend discount model (DDM) as an alternative valuation approach and a brief reflection on the financial assessment tools covered throughout the course.
- Introduction to CAPM and Required Inputs: CAPM formula, inputs, and Walmart calculation
- Interpreting Walmart's Cost of Equity: Why Walmart's 1.591% result is low
- Comparing Competitor Cost of Equity: Target and Sears: Target and Sears beta-based equity cost comparison
- The Dividend Growth Model as an Alternative Approach: DDM as alternative cost of equity method
- Reflection on Financial Assessment Tools: Learning outcomes across financial assessment tools
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What makes this paper effective
- The paper methodically walks through each CAPM input before assembling the equation, making the calculation easy to follow step by step.
- Competitor comparisons (Target and Sears) add meaningful industry context and highlight how dramatically beta differences affect the cost of equity outcome.
- The introduction of the dividend discount model as an alternative approach demonstrates awareness of multiple valuation frameworks without overclaiming their equivalence.
Key academic technique demonstrated
The paper demonstrates applied quantitative reasoning in finance — translating a theoretical model (CAPM) into a concrete calculation and then critically interpreting the result against a real-world benchmark (the S&P 500 average cost of capital). The side-by-side competitor analysis is an effective use of relative benchmarking to validate and contextualize findings.
Structure breakdown
The paper is organized into five short sections: (1) CAPM mechanics and Walmart's calculation, (2) interpretation of the 1.591% result and its relationship to beta and risk, (3) the same CAPM applied to Target and Sears with commentary on differences, (4) a conceptual explanation of the dividend discount model, and (5) a brief reflective conclusion on learning outcomes. The structure is linear and problem-set-style, typical of an undergraduate finance assignment.
Introduction to CAPM and Required Inputs
To calculate the cost of equity using the Capital Asset Pricing Model (CAPM), the equation requires the collection of specific data regarding the firm and the market. The formula is as follows:
Cost of Equity = RF + β(RM − RF)
Here, RF is the risk-free rate, RM is the return on a market portfolio, and β (beta) is a measure of volatility or risk.
The first input is the risk-free rate (RF). The risk-free rate is typically the current rate for government bonds. There is some flexibility in choosing the term, as government bonds are issued over different periods; a commonly used figure is the one-year bond rate. The rate recorded for 20 December 2013 was 0.13% (U.S. Department of Treasury, 2013).
The next input is the return on the market portfolio, which is assumed to be 5%. The final input is beta — a measure of the volatility or risk of a share relative to the broader market. A beta of one means the share's volatility matches that of the stock market; a higher beta indicates greater volatility, while a lower beta indicates less. Walmart's beta is 0.3 (Yahoo Finance, 2013), meaning the share is considerably less volatile than the overall stock market.
With these inputs established, the equation can be assembled:
Risk-free rate = 0.13%
Return on market portfolio = 5%
Beta = 0.3
0.13% + 0.3(5% − 0.13%) = 1.591%
This calculation gives Walmart a cost of equity of 1.591%.
Interpreting Walmart's Cost of Equity
The result of 1.591% may appear lower than expected. The low rate of return is primarily attributable to Walmart's very low beta. Walmart's share price is notably stable, which reflects a comparatively lower level of investment risk. The relationship between risk and return is a foundational principle in finance: the higher the risk, the higher the expected rate of return, due to the risk premium — the potential reward investors require for accepting greater uncertainty. Because Walmart offers relatively little risk to the investor, the associated risk premium is very low.
This result may be surprising when considered alongside the average cost of capital for S&P 500 firms, which stands at 8.2%. The cost of capital is composed of both the cost of equity and the cost of debt. Given Walmart's low beta, however, it is reasonable to expect its cost of equity to fall well below the S&P 500 average, which may be elevated by the inclusion of significantly riskier companies alongside safer ones.
Comparing Competitor Cost of Equity: Target and Sears
When assessing any firm, it is often useful to compare it against similar firms operating in the same industry. For Walmart, relevant comparators include Target and Sears. Target has a beta of 0.65, and Sears has a beta of 2.9 (Yahoo Finance, 2013). Applying the CAPM equation to each firm yields the following results:
Target: 0.13% + 0.65(5% − 0.13%) = 3.296%
Sears: 0.13% + 2.9(5% − 0.13%) = 14.253%
Target's higher expected return on equity reflects its higher beta, though it still falls below the average S&P 500 cost of capital of 8.2%. It may be surprising that Target's expected return is roughly twice that of Walmart, given how similar the two retailers appear on the surface. The most striking result, however, is Sears's expected return on equity of 14.253%. This high figure is a direct consequence of its high beta, which signals substantially greater share price volatility. Given the movement in Sears's share price, a correspondingly high expected return on equity is to be expected.
References
Beck, C. H. (2013). Fundamentals of Corporate Finance. Prentice Hall.
U.S. Department of the Treasury. (2013). Daily Treasury Yield Curve Rates. Accessed 22 December 2013.
Yahoo Finance. (2013). Sears Holdings. Accessed 22 December 2013.
Yahoo Finance. (2013). Target. Accessed 22 December 2013.
Yahoo Finance. (2013). Walmart. Accessed 22 December 2013.
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