Capital Asset Pricing Model Applied to Constant Contact

Advantages of CAPM: Easy to calculate, takes systematic market risk into account, and ability to provide a precise estimate of cost of equity.

In estimating the weighted average cost of capital, we used the cost of equity of 11.63% and the cost of debt of 2.25%. We calculated the weight of debt to be 2% and the weight of equity to be 98%. For the weight of debt we divided debt by the sum of debt and equity, and for the weight of equity we divided equity by the sum of debt and equity. Our estimated Company’s cost of capital is 11.44%, or 12%. The calculations for the cost of capital are shown in Appendix E.

This essay will highlight the use of Capital asset pricing model ( CAPM ) to be considered as a pricing theory model for assets . CAPM model helps investors to analyse the risk and what expectation to keep from an investment (Banz , 1981) . There are two types of risk

The security market line approach (aka CAPM) is another method of determining the firm's cost of equity. The SML equation is as follows:

Regarding cost of capital, the assumption made by Hudson Bancorp about equity investors somewhat oversimplifies the market. An increase in financial risk decreases a firm’s market value which

We estimated the cost of equity using both the capital-asset-pricing model (CAPM) and the dividend growth model (DGM). Two separate WACCs were calculated on separate sheets simply for comparison reasons. We choose to take the WACC using the cost of equity derived from the CAPM method however, since it is known to be the superior method.

The final model used to compute the cost of capital was the earning capitalization model. The problem with this model is that it does not take into consideration the growth of the company. Therefore we chose to reject this calculation. The earnings capitalization model calculations were found this way:

c. What do you think the Beta (ß) of your portfolio would be if you owned half of all the stocks traded on the major exchanges? Explain.

The main message of the Capital Asset Pricing Model (CAPM) attempts to find value in financial assets by connecting an asset's return and its risk. It is a simple analytical tool used to find a rather straightforward and simple question: How much risk is contained in this investment?

This summary provides a brief overview of Capital Asset Pricing Model (CAPM) as an alternative method for estimating expected returns. This paper also discusses the positive and negative effects of CAPM along with the risks of Beta and why this model has its share of drawbacks and critics in the marketplace. The first section will cover the basics of CAPM including its flaws and rewards. Next, the risks of beta and the strengths and weaknesses are discussed in conjunction with its relevance to CAPM and why it’s important to investors who are willing to take greater risks. Finally, an application is provided to show how beta affects CAPM from a financial manager’s perspective.

2c.If I owned half of all the stocks on major exchanges, I would expect that the portfolio's beta would be 1. It takes only around 30 stocks to have what is considered to be a fully diversified portfolio, so half the stocks would easily be a fully diversified portfolio (Investopedia, 2012).

The cost of equity refers to the minimum rate of return which a company must offer investors compensation in exchange for bearing risk and waiting for their returns (Pike et al., 2012). The return consists of two elements, the prospective dividend yield and the expected rate of growth in dividend (Pike et al., 2012). There are two ways to calculate the cost of equity which are Dividend Growth Model and Capital Asset Pricing Model (CAPM).

Capital asset pricing model (CAPM) first provide the coherent framework for answering the relationship of expected return and the risk of investments and how equilibrium price come out.(Perold, A. F. ,2004) The initial goal of CAPM is to assess the risky assets such as stock. And the stock value is mostly according to the degree of risk that the held shares might get the return. These properties are similar to venture capital and both of them discounted future earnings in accordance with risk premium. So that, CAPM can used to determine the discount rate of the venture investment project at the same time.

The CAPM bases the required rate of return on equity of a company based on an assumption of linearity between the level of risk a security carries and its returns. Variance has been widely used as a measure of risk, usually represented as the standard deviation of the returns of a given security. The relationship of risk and reward is the product of the security’s covariance divided by the covariance of the market,

Capital asset pricing model is a model, which was introduced in order to understand the relationship between the risk and the investment that is made. What businesspersons or investors tends to do is make return of their investment fairly equally with return of the risk that has been taken on their part. They want to be compensated for the risk they have taken with their investment. At this point, the time value of money is of great importance since it describes what the investment's value will be after the prescribed years from now (Korajczyk, 1999). This model explains how much of the return will be received by taking the risk and what are the chances that the return on investment compensates. Though its tests are difficult to be employed, results may differ or sometimes may come out as wrong assumptions and calculations. Every investment induces risk when it takes place and if the resulting conclusions propose that the return on investment and risk will not be made as desired then the investment