Companies undertaking similar business operations to a proposed investment are known as ‘proxy companies’. For example, if a food processing company was looking at an investment in coal mining, it would need to locate some coal mining companies. The first step in using the CAPM to calculate a project-specific discount rate is to look for companies whose business operations are similar to the proposed investment project. Instead, the CAPM can be used to calculate a project-specific discount rate that reflects the business risk of the investment project. This means that it is not appropriate to use the investing company’s existing cost of capital as the discount rate for the investment project. When the business risk of an investment project differs from the business risk of the investing company, the return required on the investment project is different from the average return required on the investing company’s existing business operations. The final article will look at the theory, advantages, and disadvantages of the CAPM.Īs mentioned in the first article in this series, the CAPM is a method of calculating the return required on an investment, based on an assessment of its risk. The first article in the series introduced the CAPM and its components, showed how the model could be used to estimate the cost of equity, and introduced the asset beta formula. This article, is the second in a series of three, and looks at applying the CAPM in calculating a project-specific discount rate to use in investment appraisal. Section E of the Study Guide for Financial Management contains several references to the Capital Asset Pricing Model (CAPM). An introduction to professional insights. Virtual classroom support for learning partners.Becoming an ACCA Approved Learning Partner.
0 Comments
Leave a Reply. |
AuthorWrite something about yourself. No need to be fancy, just an overview. ArchivesCategories |