W201 Module 3 Application of CAPM
FIN2101 BUSINESS FINANCE II Module 3 Application of CAPM
Student Activities Reading Text, Chapter 7(pp. 250-1 only) Text Study Guide, Chapter 7(part only) Study Book, Module 3(inc Appendix 3. 1) Tutorial work o Tutorial Workbook, Self Assessment Activity 3.1 o Text study Guide chapter 7, t/F7, Mc 12, 13
Student Activities Reading • Text, Chapter 7 (pp. 250-1 only) • Text Study Guide, Chapter 7 (part only) • Study Book, Module 3 (inc. Appendix 3.1) Tutorial Work • Tutorial Workbook, Self Assessment Activity 3.1 • Text Study Guide, Chapter 7, T/F 7, MC 12, 13
CAPM SML Equation: K -RF+b, x(kmR
CAPM SML Equation: k = R + b (k -R ) j F j m F
Applications of CAPM As a pricing model compare the required return from CAPM with the anticipated or expected return based on market prices o To calculate the cost of capital for a company, a division of a company, or even a specific project
Applications of CAPM • As a pricing model – compare the required return from CAPM with the anticipated or expected return based on market prices. • To calculate the cost of capital for a company, a division of a company, or even a specific project
CAPM As A Pricing Model Underpriced (above SML) Overpriced(below SML)
CAPM As A Pricing Model • Underpriced (above SML) • Overpriced (below SML)
Example- Overpriced Asset DATA D S0.20 11 4 5 s3.90 b 13
Example - Overpriced Asset DATA: D0 = $0.20 km = 11% g = 4% RF = 5% Ps = $3.90 b = 1.3
Solution- Step 1 Expected Return (Based on Market Price) D s020(1.04) +0.04 $390 0.093or9.3
Solution - Step 1 Expected Return (Based on Market Price): ( ) 0.093 or 9.3% 0.04 $3.90 $0.20 1.04 g P D k s 1 s = = + = +
Solution- Step 2 Required return (based on Systematic Risk): k,=R+b, x(km -) 005+[13×(0.11-005 0.128or12.8
Solution - Step 2 Required Return (Based on Systematic Risk): ( ) ( ) 0.128 or 12.8% 0.05 1.3 0.11- 0.05 k j RF bj km - RF = = + = +
Solution- Step 3 Compare the expected return ks and the required rate of return k <1 OVERPRICED
Solution - Step 3 Compare the expected return ks and the required rate of return kj : ks < kj , OVERPRICED
Solution- Step 4 Correct” Price D P 020(.04 0.128-0.04 $236
Solution - Step 4 “Correct” Price: ( ) $2.36 0.128 - 0.04 $0.20 1.04 k - g D P j 1 s = = =