The CAPM Cost of Capital in the Present Value Formula Assignment Help
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It is also known as discounted value is the current worth of a future cash flow. Future flow of money is discounted and the higher the rate, the lower the present value. For example, If you receive $5000 in the future then its current value won’t be $5000 as it is not at hand in the present. To determine the present value of a future cash flow of $5000 we have to find out what needs to be invested today in obtaining a future cash flow of $5000.
To determine the present value, we must subtract the accumulated interest over a particular period.
By Formulae: PV=FV/ (1+I)^n.
Where PV=Present Value,
I=Rate of Interest
N=No of years.
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What is Cost of Capital?
It is the return rate that the suppliers of capital that is the bondholders and owners require as compensation for their contributions towards the capital.
The Cost of Capital shows the opportunity costs of investors of capital.
It is also referred as the marginal cost which is the cost of raising more capital.
What is Capital Asset Pricing Model (CAPM)?
The Capital Asset Pricing Model is used to determine the rate of return on a risky asset. It ascertains the relation between systemic risk and expected rate of returns. It determines expected returns of assets with the risk of those assets and also calculates the cost of capital. It can be used both for pricing a portfolio or an individual security. This basic understanding is pivotal to The CAPM Cost of Capital in the Present Value Formula Homework help.
How to use CAPM Cost of Capital to determine the present value factor of equity:
The CAPM Pricing Model defines the required return for a specified level of risk.
The CAPM Pricing Model requires three inputs, and they are:
- Risk Free Return
- The Rate of Return from the Market- the market where the stock in question is being traded
- The beta value the risk level-b>1 signifies risk higher than the market average and b<1 implies risk below market average. Most companies lie in the 0.75 to 1.50 range.
Equity Cost = Risk-Free Rate + Beta * (Rate of Return from market- Risk-Free Rate). This formula will be very useful with The CAPM Cost of Capital in the Present Value Formula Assignment help.
Consider the following information:
Risk-free rate of return = 5%
Average Market Return = 6%
Beta value of RD Co = 1.3
Using the CAPM formulae:
r* = KRF + b(KM – KRF)= 5 + (1.3 x 6) = 12.8%
The CAPM predicts that the cost of equity at 12.8%.
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