Capital Asset Pricing Model ( Capm )

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INTRODUCTION

Firm has a range of projects to be invested in or finance in to increase the value of the company. However, to increase the value of the company, firm need to choose the worth pursuing project. In this case, firm need to evaluate the projects which the evaluation of a project can be done by cash flow method.
The paper depicts how weight average of cost capital is used as a source of a discount rates for capital budgeting. In this paper, the discount rate in the weight average of cost capital (WACC) will be used in the net present formula. To calculate the WACC, most company use the after tax WACC as the formula is much closer the reality events. Then, the paper will discuss which formula that will be applied on the project
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As can be seen on the formula the weight of the cost capital includes debt and equity market value, cost of debt and equity, and the deduction of the corporate tax. The weight of average cost of capital formula:

source: Kaplan Financial Knowledge Bank
Figure 1

Regarding to the figure 1, the figure depicts the relationship between cost of equity, cost of debt times(1-t) and the cost of WACC with the value of company. The is the rate of return on levered equity, is the interest rate that been charge for debt, the weight average cost of capital decrease, this is because the occurrence of the corporate tax, reduce the tax payment which decrease the interest rates of the borrowing. The value of company (D+E) is increase due to increase in cost of equity which the (Mitra,2011). The traditional formula of Weight average cost of capital (WACC) by the Modigliani and Miller is simple to use and it is close to the reality. The projects or investment that been evaluated need to have same risk and same capital structure in terms of using the weight average cost of capital formula. Furthermore, the simplicity of the traditional formula is because the using of only one single discount rate. However, different projects with different risk of the debt capacity require different discount rate for project evaluation. The alternative of Modigliani and Miller formula for the difference in project debt level is
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