Capital Asset Pricing Model (Capm) Versus the Discounted Cash Flows Method

The Capital Assets Price Model (CAPM), is a model for pricing an individual security or a portfolio. Its basic function is to describe the relationship between risk and expected return, which is often used to estimate a cost of equity (Wikipedia, 2009). It serves as a model for determining the discount rate which is used in calculating net present value. The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium. The formula is:

In FCFE approach, the required rate of return by shareholders is required and can be calculated using the CAPM model, which the information showed that the risk free rate (derived from yield from treasury notes) and the estimated market risk premium are 5%, the beta implemented in the CAPM model cannot be directly obtained since JetBlue has never been listed before hence a medium has to be used which the Southwest beta of 1.6 is chosen given the characteristics and nature of the two companies are similar hence is expected to be affected by similar systematic risk. The calculated required rate of return therefore would be 5%+1.6(5%)=14%. In contrast, in the FCFF approach, a weighted cost of capital (WACC) is required to use, which can be determined as the percentage of debt to equity multiply by the cost of debt plus one minus the percentage of debt to equity multiply by the cost of capital, or the required rate of return. The percentage of debt to equity is derived from the balance sheet of JetBlue as 99%. The cost of debt can only be indirectly obtained from the current debt structure of Southwest Airlines, the 7.375 debenture (with yield to maturity of 8.68%) is chosen given it is a long term debt and to remain conservative. It is assumed that the long term debt of JetBlue worth of $300m is separately obtained from three different sources. Thus the WACC is calculated as

SECTION 1: OVERVIEW DCF in theory and in practice Unlevered vs. levered DCF SECTION 2: MODELING THE DCF Modeling unlevered free cash flows Discounting to reflect stub year and mid-year adjustment Terminal value using growth in perpetuity approach Terminal value using exit multiple approach Calculating net debt Shares outstanding using the treasury stock method Modeling the weighted average cost of capital (WACC) Sensitivity analysis using data tables Modeling synergies

Discounted Cash Flow Valuation is based upon the notion that the value of an asset is the present value of the expected cash flows on that asset, discounted at a rate that reflects the riskiness of those cash flows. Specify whether the following statements about discounted cash flow valuation are true or false, assuming that all variables are constant except for the variable discussed (Rubinstein, 2003). As described by Emhjellen and Alaouze (2003), the discounted net cash flow is one of the most popular tool used for finance valuation.

Abstract The purpose of this thesis is to compare the practical use of the DCF model with the theoretical recommendations. The empirical study is based on eight different DCF models performed by American, European and Nordic investment banks on the Swedish retail company Hennes & Mauritz (H&M). These models are currently being used internally by the corresponding equity research departments to determine the fair value of the H&M stock. The aspects that are studied are regarded as the basic theoretical requirements of the DCF model. The discrepancies

arumugam, t.t. (2007) 'An analysis of discounted cash flow (DCF) approach', An analysis of discounted cash flow (DCF) approach, vol. 1, no. 57, Sep, p. 290.

For one thing, the DCF approach is just on a par with its data suspicions. Dependent upon what they understand regarding how a business will perform and how the corporate sector will develop, DCF assessments can differ overwhelmingly. On the off chance that their inputs - free income expectations, discount rates and perpetuity development rates are wide of the imprint, the logical quality made for the business won't be perfect, and it won't be respected when assessing stock cots (Barmeyer & Mayrhofer., 2015).

3. The main message of the capital asset pricing model is that risk and return are related. Under CAPM, the expected return of an asset is directly correlated to the beta, so the higher the beta the higher the expected return of the asset. This is the risk-return relationship. Under CAPM, an investor cannot "beat" the market on a risk-adjusted basis. To corporations, the principle is the same. CAPM is a way to calculate the cost of equity, but again the cost of equity is related to the volatility of the firm's stock price, and therefore a company with a more volatile stock price is one that will have

The CAPM states that the securities plot on the Security Market Line (SML) in equilibrium. We do cross-sectional test is to identify whether the above statement is true with our two data set and whether or not it rejects the hypothesis that the slope is zero. In the equation 3, the gamma 0 is the excess return on a zero beta portfolio and gamma 1 (the slope of the regression) is the market portfolio's average risk premium.

Ever wonder if generating alpha is a zero-sum game or if quotes like the below hold:

Capital Asset Pricing Model (CAPM) was developed in 1964 based on Modern Portfolio Theory. CAMP widely used in investment decisions and financial areas of the company. The main research of CAMP are the relationship between expected rate of return and risk assets in the stock market, as well as how the equilibrium price formation. In terms of the valuation of assets, CAPM primarily used to determine whether the securities market be mispricing. Capital Asset Pricing Model measure risk by non-diversified variance, it linked risk and expected return, any non-diversified risk assets can be described by the value of β, then calculate the expected rate of return. Rate of return

CAPM is considered to be an important device in financial management having been developed by

We took this data and ran regressions for each. We found that weekly gave us the most accurate beta under these conditions to use for CAPM. The beta that the regression gave us is .74 EXHIBIT 3. After choosing the beta, we wanted to use both approaches of CAPM to calculate the cost of equity and compare. When using the arithmetic approach, we found that the cost of equity is: 10.97%. When using the geometric approach we found that the cost of equity is: 9.78% EXHIBIT 8 PART 2. We also wanted to include in our analysis finding the cost of equity using the dividend growth model as well as the earnings of capitalization method. When using the dividend growth model we found that the cost of equity is: 6.64% EXHIBIT 9. The earnings of capitalization method gave us 5.51% EXHIBIT 10. Both of these methods DGM and ECM are irrelevant to our analysis of Nike for the reason that given the recent history of Nike we aren’t dealing with a stable better yet mature company, therefore the choosing of those methods would be inaccurate.

This essay will illustrate the practicability of the capital asset pricing model (the CAPM). Before 30 years ago, the capital asset pricing model was a significant development. This theoretical model has been used in many large companies. Yet, many economists argue that this model has its own drawbacks. In 1992, Fama and French said that the application of CAPM could be useless which against empirical tests of the CAPM. For instance, the CAPM was seen as an obsolete theory because of the limitation of its assumptions. Main assumptions can be categorized into six aspects. First, the CAPM assumption was built on that the capital market is always in equilibrium. This assumption is difficult to achieve in the real world. Second, there are a numeral of investors who hold the same period of their asset in the market and no considering of the outcome after the investment plan. However, there are too many investors in the market, it is impossible that their time of holding the asset could be exactly the same. Therefore, the second assumption is also unachievable. The third hypothesis is that investors have unrestricted of borrowing and lending at fixed risk-free rate which is also very difficult. The fourth of assumption is assumed that there are no transaction costs and taxes. But in fact, these factors are all existed in the real market. Then, the fifth and sixth assumption shows all investors have the same expectation on their investment portfolio. Obviously, these two

The advantage of CAPM is that it provide a clear and intuitively explicit forecast in regard to how to measure risk and the connection between risk and expected return(Fama & French , 2004).Accordance to the provisions of CAPM, Beta coefficient is used to measure an asset systemic risk, it is used to measure the