Disscuss the relevance of the capital asset pricing model (CAPM) to a Essay - 1

Disscuss the relevance of the capital asset pricing model (CAPM) to a telephoner seeking to evaluate its be of capital - Essay ExampleThe securities industry risk or systematic risk is the unavoidable risk brought in by the economy wide perils (Brealy et al, 2005).The CAPMs focus is on the method of measuring systematic risk and its effect on the required return and share prices. though it was initially evolved for investment in equity, it is also used for evaluating company investments in capital projects now (Davis & Pain, 2002).Capital Asset Pricing Model (CAPM) attempts to bring out(p) a linkage between risk and return for the assets (Gitman,2006). The CAPM is built on the premise that well diversified investors dominate the stock market and their paramount perplexity being the market risk. The assumption is plausible in a situation in which large institutions and small investors can diversify at a blue cost (Brealy et al, 2007).The CAPM builds on the proposition that addi tional risk requires a higher return. This return has two components (1) what may be earned on a riskless asset, such as a U.S. Treasury bill, plus (2) a premium for bearing risk. Since unsystematic risk is reduced through diversification, a stocks risk premium is the additional return required to bear the non-diversifiable, systematic risk associated with the stock (Mayo 2007).The key input for the CAPM is therefore the excess return of the market over the risk free rate, which is the market (equity) risk premium. The practice adopted commonly has been to apply the historical average return over a farseeing period as a measure of what investors expect to earn. As a substitute for the market portfolio, a broad equity market index is applied.Ke is the cost of equity capital, Rf is the risk free rate of return usually measured by the rate of return on US treasury securities, Rm is the market return of a diversified portfolio and I is the Beta co-efficient of the firms portfolio.The beta coefficient shows the volatility of the stock relative to that of an average stock. If it is 0.5, it is half as