Answers to Exam Questions Essay Example | Topics and Well Written Essays - 1250 words

Answers to Exam Questions - Essay frameworkFirst, the moulding is simple and easy to understand as well as to implement. It should be noted that the variables in the formula can be easily accessed from public sources except the beta-coefficient which is not usually available for teentsy and non-publicly traded business organizations. Secondly, it can be seen that the CAPM does not rely on dividends or throw away any assumptions on the growth of dividend which makes it applicable to companies that do not pay dividend or are not expected to get it on a constant growth rate for dividends (Keown , et al. 2004).However, the CAPM is also widely criticized because it does not adequately explain the alteration in stock reachs. Empirical studies including the work of Black, Jensen, and Scholes reveals that low beta stocks may offer higher returns than the model would predict. CAPM will not also work for individuals which are risk averse as it assumes that investors will mostly favor a stock with higher returns even if holding it entails more risks. Also, it can be seen that CAPM doesnt organise into account the associated transaction cost and taxes (Capital Asset Pricing Model 2006).It should be noted that in victimisation CAPM, companies with diffe conduct debt supplement will generate different cost of capital even if they belong to the same(p) industry. Debt leverage is reflected in the CAPM formula as the keep companys beta coefficient. Accordingly, higher debt leverage will yield to a higher as debt is seen a riskier source of financing. ReferencesCapital Asset Pricing Model 2006, Retrieved 14 October 2006, from http//en.wikipedia.org/wiki/Capital_asset_pricing_modelKeown, A., Martin, J., Petty, W., & Scott, D. 2004, Foundations of Finance, pep pill Saddle River, New Jersey McCracken, M. E. 2005, CAPM, Retrieved 14 October 2006, from http//teachmefinance.com/capm.html2. Debt leverage is the amplification of the return earned on rectitude when an inves tment or firm is financed partially through borrowed money (Walker n.d.). In order to illustrate how debt leverage works, lets look at a company who wants to buy a building as an investment which costs $1,000,000. In turn, it wishes to find customers who would want to rent the spaces. It expects to generate $15,000 per month. If the company has enough cash, it can immediately buy the building find tenants and can sell it at $1,200,000 after one year. Thus, the company will have a total gain of $380,000 from the sum of the rents and appreciation in the buildings market value. This represents a 38% return on investment. However, if the company has only paid $200,000 and opted to borrow the remaining $800,000 with a mortgage rate of 12%, then the company will be paying $8,000 per month. Since interest payments are tax deductible, the companys monthly rent income of $15,000 will be more than enough to cover the expenses. Even taking only the $200,000 appreciation of the building, the c ompany is already able to recoup 100% of its initial investment.In the illustration above, we can see that debt leverage helps the company to maximize the gains of its