discussion

 Critique my analysis that I have listed below. Compare any similarities that you would have in analysis.

Capital asset pricing model (CAPM) defines the relationship between the expected return of an investment and the risk associated (eFinanceManagement, 2019). The CAPM assists in measuring both risk and return. The components of the CAPM equations includes the risk-free rate, the beta, and the expected return of the market. While the other two components are relatively self-explanatory, the beta coefficient refers to the risk of the investment in relation to the volatility of the market or systemic risk (Ross et al., 2020). The closer the beta of the investment is to a value of one, the more the investment will move with market trends. If the market goes up then the investment will go up at a rate equal to its beta, conversely if the market dips the investment will fall at the beta rate. By utilizing each of these components this equation allows the company to figure out the expected return of their investment.

CAPM assists in calculating the weighted average costs of capital (WACC) and its components. WACC represents the amount of return necessary on any investment. WACC can be used in discounted cash flow calculations as the cost of equity (Learn to Invest, 2018). The cost of equity can be calculated by using the CAPM equation and adjusting the formula to multiply the beta by the risk premium which is the estimated market return minus the risk-free rate.

Although this model and its variations in equations seem easy to implement and calculate some managers have difficulty applying CAPM in financial decision-making. There are both pros and cons to using the CAPM in financial management. One significant disadvantage is that the equations uses estimates and makes many assumptions (eFinanceManagement, 2019). One significant assumption made is that risk predicts the return. Each of the components within the equation are assumed to be static and that the level of risk associated will point directly to an expected return. When the market and rates this equation, uses are all volatile and can change, causing the equation to not be reliable. These assumptions and unreliability make it difficult for financial managers to apply and consistently use the CAPM equation as it represents an idealized version of the real world. On the flip side, CAPM has a major advantage because of its implied ease of use and the relationship it details between the required return and systemic risk.