Calculating the Cost of Equity Using an APT Model.
You have estimated the factor sensitivities of Johnson & Johnson, Inc. common stock (NYSE: JNJ) on BIRR factors. These are given in Table 2 4, with the factor sensitivities of the S&P 500 for comparison.
|
TABLE 2 4 Factor Sensitivities in the BIRR Model |
||
|
Risk Factor |
JNJ Factor Sensitivity |
S&P 500 Factor Sensitivities |
|
Confidence risk |
0.17 |
0.27 |
|
Time horizon risk |
0.74 |
0.56 |
|
Inflation risk |
0.15 |
0.37 |
|
Business cycle risk |
1.16 |
1.71 |
|
Market timing risk |
0.72 |
1 .OO |
Using the factor risk premiums estimated by Burmeister et al. and with a T bill rate of 5 percent, calculate the required rate of return for JNJ using the multifactor model.
The required rate of return for JNJ is
r=5.00% + (0.17×2.59%) (0.74×0.66%) ( 0.15×4.32%) + (1.16×1.49%)+(0.72×3.61%)=9.93%