CAPM
There are three models that can be used calculate the cost of capital for the firm. The first such model is the capital asset pricing model (CAPM). The CAPM formula is: E (rj )= RRF + b (RM - RRF). This means that the company's cost of capital is a function of the risk free rate, the market premium and the firm-specific risk. In CAPM, the firm-specific risk is based on the correlation of the company's stock price to the broader market, a statistic known as the beta.
Another method is the dividend growth model. In this model, the assumption is that a stock's value derives solely from the dividends that it is paying, or that investors assume it will pay in the future. It is assumed that investors will not pay for capital gains, because those are uncertain. The formula for the dividend growth model is:
source: Investopedia.
This model assumes that the price of a stock is based on the current dividend being offered, the growth rate of dividends and the discount rate. Typically, the stock price is known, and the formula is used to solve for the discount rate, which is the cost of equity. It is assumed that if the company does not currently pay a dividend that it will pay one in the future and this is what investors are using as the basis of determining the stock price. That assumption is interesting, because there are a number of firms that do not have any intention of paying dividends, yet investors still put their money into these companies, clearly hoping for capita gains.
The third method of determining a company's cost of capital is the arbitrage pricing theory. APT is based on the same formula...
CAPM There are several different models that can be used to help determine the cost of capital for a company. Each is based on a model, and can be understood not only in terms of its formula but also in terms of its underlying assumptions. These assumptions will provide the foundation for the model, and will inform the financial manager about the strengths and weaknesses of each model. This report will
Capm, Dgm, APT There are three primary means by which a company's cost of equity can be calculated. These are the capital asset pricing model (CAPM), the dividend growth model (DDG) and the arbitrage pricing theory (APT). Each of these methods has certain advantages and disadvantages. This paper will analyze these three models in the context of their usefulness in determining the cost of capital. The first method, and the most popular,
CAPM The first scenario represents a diversifiable risk. The rate of inflation has an effect on the whole economy, but the nature and direction of that effect is something that will be different for each firm. Some firms may suffer more than others from the effects of a higher rate of inflation, depending on their business model, their capital structure and their strategy. In addition, inflation rates are a national phenomenon.
CAPM There are three different models for estimating the cost of capital -- the capital asset pricing model (CAPM), dividend discount model and arbitrage pricing theory (APT). Of these, CAPM is the best model. CAPM utilizes the returns on the company's stock to calculate the firm's cost of equity. The underlying theory is that the firm's cost of capital should "equal the rate on a risk-free security plus a risk premium"
CAPM The company I am going to use is Google. According to Yahoo! Finance (2012), the beta for Google is 1.18. This beta means that the company has a greater risk than the market overall (Investopedia, 2012). The market risk is 1.0, so a beta greater than this indicates that the firm's stock is more volatile than the broad market. A beta below 1.0 indicates that the firm's stock is less
CAPM For each of the scenarios below, explain whether or not it represents a diversifiable or undiversifiable risk. Explain your reasoning a. It is announced that a company is under investigation from the federal government for fraudulent accounting practices. This represents a diversifiable risk. This risk is unsystematic and is unique to the company that is under investigation. Hopefully, if this stock was part of a portfolio, the effect of this risk
Our semester plans gives you unlimited, unrestricted access to our entire library of resources —writing tools, guides, example essays, tutorials, class notes, and more.
Get Started Now