Vodafone
Introduction
This report seeks to assess the expected returns for Vodafone using the CAPM model. The CAPM model is based on three inputs: risk-free return, market return and company beta. Therefore, the report will estimate these three parameters and use them to find the expected return of Vodafone. Finally, it will provide a critique of the CAPM estimation technique.
The risk-free rate of return is often taken as the return of short term government securities. The 3-month treasury bill for UK is 0.48 . Therefore, we assume that the risk free rate.
Market Return
Expected market return are the average rate of returns of all stocks in the stock exchange market. There is no precise information on the market rate of return. This is because the future expectation of future stock prices is made based the expected future business growth, future dividends and anticipated market changes. All these variables are not known for certain as a priori. Therefore, they entail subjective judgement and depend on the assumptions made by the analyst. This section reviews analyst returns, historical returns and media reports to make a judgment of the market returns.
According to the an annual study conducted by the Credit Suisse Research Institute, the annual stock market return is 5.4 percent in 2016. The findings are collaborated by information provided by the financial website this is money which indicates that the annual market return for share investors in the UK after adjusting for inflation is 5.2 percent. I find the information reliable as the website is a leading financial website in the UK. If the historical market returns (as at 2012) was 5.2 percent. The website projected an upward movement in the market returns in subsequent years based on historical performance. Therefore, it plausible that it has increased to 5.4 percent. The FTSE 100 index has also improved significantly since 2012. As at 2012, the index was 5,650 whereas as 2015 the index was 6,262. Therefore, the stock prices in general increased. The expected market return is a combination of dividend yield and capital gains. A media report by BBC also indicates that the market recovered significantly in 2012 which is partly explained by the increase in oil prices as well expansionary monetary policies by central banks around the world to stimulate economic expansion. The DQYDJ market return calculator assuming a reinvestment of dividends provides a market return estimate of 5.32 percent. The estimate is based on the methodology developed by Professor Shiller. They use the average closing price based on the immediate last quarter. The calculator is reliable as it provides the methodology that it uses and discusses the assumption that it has applied to arrive at the reported estimate. The take the position of an average investor. The annual return estimate is the sum of dividend yield, business growth and change in valuation.
This report assumes a market return of 5.4 percent based on the information reviewed.
Vodafone Beta
Yahoo Finance indicates that the beta for Vodafone is 0.705. UK Reuters indicates that the beta for Vodafone is 0.74 . The Beta according to FT.com is 0.744 .
Estimating the Returns of Vodafone
Ra = Rf + βa (Rm - Rf)
Where:
Ra is the expected return of the company we are interested in estimating; in this case it is that of Vodafone.
Rf is the risk-free rate of return = 0.48 percent
βa is the company beta. Company beta for Vodafone = 0.705 (Yahoo Finance), 074 (UK Reuters) and 0.744 (FT.com)
Rm is the expected market return = 5.4 percent
Yahoo Finance
Ra = 0.48 + 0.705 (5.4 – 0.48) = 3.95 percent
UK Reuters
Ra = 0.48 + 0.74 (5.4 – 0.48) = 4.12 percent
FT.com
Ra = 0.48 + 0.744 (5.4 – 0.48) = 4.14 percent
Capital Budget Analysis
Yahoo Finance
UK Reuters
FT.com
Conclusion
This paper estimated the expected returns of Vodafone and used the estimate to conduct capital budgeting. From the experience of the study, there are various strengths and weakness of the CAPM model.
CAPM model provides a framework of estimating the expected returns of a company using measures that relate to the company as well as the overall market. It incorporates systemic risk by using market return but also considers company specific risk by using company beta.
There are numerous disadvantages. Firstly, the risk free rate is assumed to be the annualized three-month bill rates which change on a daily basis. Therefore, there is volatility which is not considered. Secondly, the market return is a subjective measure that is based on the researcher’s assumption and information considered. Therefore, different values are likely to be applied by different analysts. Thirdly, different financial websites provide different beta for the company that was considered. This means the estimation of beta is not always accurate.
References
BBC. (2016, January 22). Shares up as global stock market rally continues. Retrieved from http://www.bbc.com: http://www.bbc.com/news/business-35379549
Bond & Rates. (2016, June 03). Retrieved from http://markets.ft.com: http://markets.ft.com/research/Markets/Bonds
Credit Suisse Resaerch Institute. (2016). Credit Suisse Global Investment Returns Yearbook 2016. London: Credit Suisse.
DQYDJ. (2016, June 4). S&P 500 Return Calculator, with Dividend Reinvestment. Retrieved from https://dqydj.com: https://dqydj.com/sp-500-return-calculator/
FT.com. (2016, June 03). Vodafone Group PLC. Retrieved from http://markets.ft.com: http://markets.ft.com/research/Markets/Tearsheets/Summary?s=VOD:LSE
Laurance, B. (2012, February). Stock market returns since 1900: The 23-year spell when UK shares failed. Retrieved from http://www.thisismoney.co.uk: http://www.thisismoney.co.uk/money/investing/article-2097825/Credit-Suisse-stock-market-returns-1900-The-24-year-spell-UK-shares-failed.html
London Stock Exchange. (2016, June 04). FTSE 100. Retrieved from http://www.londonstockexchange.com: http://www.londonstockexchange.com/exchange/prices-and-markets/stocks/indices/summary/summary-indices.html?index=UKX
UK Reuters. (2016, June 03). Vodafone Group PLC (VOD.L). Retrieved from http://uk.reuters.com: http://uk.reuters.com/business/quotes/overview?symbol=VOD.L
Yahoo Finance . (2016, June 3). Vodafone Group Plc (VOD). Retrieved from http://finance.yahoo.com: http://finance.yahoo.com/q?s=VOD
