Question

1. A quick history: When I was taking finance classes in the early 1990s, My finance professor, an intimidating guy from Rochester, NY, impressed upon us all that we'd have to be fools not to be earning 10% in the market. This was largely due to the times. Everyone made money in the early 90s. The way you measure your gains against everyone else is by using CAPM. Your text mentions some shortfalls of CAPM that have popped up over the years. If we assume the problems with CAPM were always there, how might the prevalent use of CAPM have led to irrational capital pricing decisions and how might that affect the value of a company?

3. What are the advantages/disadvantages of financing an expansion with debt rather than equity? Does this change if you are financing a replacement project?

Answer 1

Capital Asset pricing model is a model that describe the relationship between systematic risk and expected return for assets particularly stocks Capital Asset pricing model is widely used throughout finance for the pricing of Yashi securities generating accepted returns for assets given the risk of those essays and calculating cost of capital. The general idea behind Capital Asset pricing model is that investors needs to be compensated in to waste time value of money and raised the time value of money is represented by the risk-free rate in the formula and compensators for placing money in any investment over a period of time registry rate is customer really built on Government Bonds like us treasuries the other half of this Capital Asset pricing model formula represent risk and calculate the amount of compensation that the investors needs for taking an additional dress this is called by taking a risk measure that compares The returns of the Asset to the market over a period of time and to the market premium the return of the market in access to risk free rate beta reflex how SKN is it is compared to overall markets risk and is a function of volatility of the assets the market is well as the correlation between the two for stocks the market is usually represented but can be represented by more robust indexes as well. The model says that the expected return of security or a Portfolio equals the rate on a risk free security + risk free premium if this expected return does not meet Orbit the required return then the investment should not be undertaken the security market line plots the result of Capital Asset pricing model for different risk. Capital Asset pricing model deals with the risk and return of financial securities and define them precisely the rate of return on invested ECS from wind stop and holding it for a given period of time is equal to cash dividends received plus the capital gain during the holding period divided by the purchase price of the security all the investors may expect a particular return when they get by a particular stock they may be disappointed or pleasantly surprised because fluctuations in stock prices resulting in fluctuating returns therefore common stocks are considered risky securities financial theory define risk as the possibility that accural Returns will deviate from expected returns and the degree of potential fluctuation determines the degree of risk. Which its insight into the fundamental market sizing of securities and the determination of expected return Capital Asset pricing model has cleared applications in investment management its use in the field has advanced level of sophistication far beyond the scope of this Anshul akshari exposure Capital Asset pricing model has important application and corporate finance as well the finance literature to find the cost of equity as the expected return on companies Thomas talk expected return is a shareholders opportunity cost of equity fund employed by the company. Capital Asset pricing model has 7 potential sources of error exist first the simple model may be an inadequate description of behaviour of Finance markets intense to improve its realism researchers have developed a variety of extensions to the model II problem is that beat us are unstable through time this fact creates difficulties will be does estimated from historical data I used to calculate cost of equity in evaluating future cash flows beta should change as both company fundamentals and capital structure change in addition beta estimated from past data are subject to statistical estimation error several techniques are available to help deal with these instability the estimate of the future risk free rate and the expected return on the market are also subject to error research has focused on developing techniques to reduce the potential error associated with the inputs efficiency of Capital Asset pricing model severe. they can be just horrible relative to other approaches estimating the cost of capital the most commonly used is discounted cash to technique which is also known as dividend growth model approach is based on proportion of price of the company's stock equals to the value of future dividends per share discounted by the companies cost of equity capital. the Capital Asset pricing model is an idealized portrayal of how financial markets crisis securities and thereby determine expected returns on capital investments the model provides methodology for quantifying waste in translating that reason to estimates of expected return on equity.

Advantage and disadvantage of debt

small business owners are constantly face with decision of how to finance the business how to expand using debt or equity. The decisions involve many factors including how much debt the company already has its own books the predictability of the company's cash flow and how comfortable the owner is providing working with its partners

Debt financing borrowing money to finance the operations and growth of a business can be the right decision under the proper circumstances the owner does not have to give up control of his business but too much that can inhibit the growth of economy.

Advantages

control taking out alone is temporary the relationship ends when the debt is paid back the lender does not have any say in how the owner runs his business

Taxes loan interest is tax deductible where is dividend paid to shareholders or not.

predictability principal and interest payments as stated in advance so it easier to work these into the company's cash flow loans can be short medium or long term

Disadvantages

fixed payment principal and the interest payments must be made on specified dates cashflow taking on too much that makes the business more likely to have problems meeting loan payments if cash flow declines Collateral lenders with typical demand that certain Assets of the company be held as Collateral and the owner is often required to guarantee the loan personally

Less risky equity financing is less risky as compared to debt financing credit problems if you have a Credit problems equity financing maybe the only choice for funds to finance growth even if debt financing is offered the interest rate maybe Tu Hi and the payments to steep to be acceptable

Cash flows equity financing does not take funds out of businesses that loan repayments take funds out of companies cash flow reducing the money needed to the finance growth

long term planning equity investors do not expect to receive an immediate return on their investment they have a long term view and also face the possibility of losing their money if the business risk fails