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

Answers to Exam Questions - Essay ExampleFirst, the model is simple and easy to understand as well as to implement. It should be tell that the variables in the formula can be easily accessed from public radicals except the beta-coefficient which is not usually available for small and non-publicly traded business organizations. Secondly, it can be underwriten that the CAPM does not rely on dividends or have any as shopping centerptions on the growth of dividend which makes it applicable to companies that do not pay dividend or are not pass judgment to experience a constant growth tell for dividends (Keown , et al. 2004).However, the CAPM is also widely criticized because it does not adequately explain the variation in stock returns. Empirical studies including the take a crap of Black, Jensen, and Scholes reveals that low beta stocks may offer higher returns than the model would predict. CAPM provide not also work for individuals which are risk averse as it assumes that investo rs will generally favor a stock with higher returns even if holding it entails more risks. Also, it can be seen that CAPM doesnt take into account the associated transaction costs and taxes (Capital asset Pricing Model 2006).It should be noted that in using CAPM, companies with different debt leverage will generate different cost of capital even if they pass away to the same industry. Debt leverage is reflected in the CAPM formula as the caller-outs 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, Upper 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 equity when an investme nt 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 teeming cash, it can promptly 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 compa ny 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