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replies.docx1. Samantha Huebscher
Nov 15, 2019Nov 15 at 7:46pm
John Byrd, Kent Hickman, and Matthew McPherson explain “we need this [Capital Asset Pricing Model or CAPM] to quantify the relationship between investor's required rate of return and the risk of an investment” (Byrd, Hickman, McPherson, 2013). The formula for CAPM is Required return for an investment = Rf + Beta[E(Rmkt) – Rf], where Rf is the risk-free rate of return, E(Rmkt) is the expected return on the market portfolio, and Beta is the stock's beta. The CAPM equation allows us to find the return in Rf and also identifies the risk with Beta. CAPM is also a helpful component in the measurement of after-tax returns on bonds, stocks, and investments or WACC. In the case of calculating WACC, CAPM plays a role in determining the cost of equity or Ke. Financial managers have difficulty applying CAPM while making decisions because the formula depends on assumptions. Risk, rational behavior, and a perfectly functioning market are all assumed when using and calculating CAPM (O’Sullivan, 2018). However, in real scenarios, financial managers cannot assume these circumstances because it is unrealistic. The advantages of CAPM include its ease of use as the formula only requires an easy calculation and its ability to eliminate systematic risk.
2. April Mcintire
MondayNov 25 at 11:06am
Investor’s decisions regarding which projects to pursue and which companies to invest in are driven by their desire to maximize profits while minimizing risk. Virtually every investment opportunity has some level of risk associated with it. Investor’s need a way to evaluate opportunities considering the rate of return required and amount of risk involved. CAPM is a method used to calculate the required return for an investment when taking into account the investment’s level of risk. The CAPM is calculated by adding the risk free rate of return and the expected return on the market portfolio less the risk free rate of return times the beta (Byrd, Hickman & McPherson, 2013). The risk free rate of return is typically based on the rate the government is paying on U.S. Treasury bills with the same term as the life of the project or investment.
WACC or weighted average costs of capital takes the CAPM a step further. The WACC is the discount rate that will allow each class of investor to earn their required rate of return. Investors who purchase common stock are subject to more risk than bondholders or preferred stockholders and are going to expect a higher rate of return. The WACC is also factors in the amount of financing coming from each source so that the company’s mix of financing can be kept in proper proportion.
The difficulty applying CAPM is related to the drawbacks associated with it. The formula requires that financial decision makers form several assumptions and use data that has been estimated. Historical data has to be used in the calculations. The figures used for the calculation vary depending on the source of the historical data and time frames used. The WACC can be used when the project’s risk is comparable to the risk faced by the company. If the project’s risk is more or less than the company’s typical risk, the WACC will not be accurate. The adjustment made to the WACC can be subjective and somewhat arbitrary. CAPM has also been criticized as being inaccurate because humans are not always rational, and investment decisions are often driven more by emotions and speculation than calm and logical thoughts (O’Sullivan, 2018). One of the advantages of CAPM is that it takes into account the market risk. It provides a way to calculate the required rate of return considering the amount of risk associated with the investment.
3.Samantha Huebscher
Nov 16, 2019Nov 16 at 8:16pm
Boeing’s annual report includes ten pages of twenty-one different risk factors and how the company aims to minimize them. The company explains that the commercial airplane and global services sales depend on the commercial airline market conditions. This means that Boeing’s commercial airline partners must be performing in order to succeed. This creates a risk for the company, as they have no control over this market. The main factor that keeps commercial airlines in business is the demand for travel and cargo. As more commercial airlines are established these company’s pricing becomes competitive and creates more opportunity for consumers to travel or ship items, which increases demand for commercial airline services and keeps Boeing in business. Boeing also enters into buying contracts with their customers years before the product is actually delivered. This creates the risk of cutting into the profitability of the sale if Boeing exceeds its expenses for building the aircraft. Boeing could exceed its expenses due to the rise in the cost of its materials over time. To further minimize these risks that Boeing faces, I would suggest that Boeing provides financial resources to its commercial airline partners in order to advertise or offer more competitive pricing to their consumers and also creates contracts that would guarantee the company a certain price on their materials based on their forecasts. By offering its commercial airline partners financial support for advertising or competitive pricing strategies, Boeing can create a stronger relationship as well as indirectly fuel the commercial air travel and logistics market. Also, by creating contracts with its material suppliers, Boeing can more accurately estimate costs and profitability on its future aircraft. Boeing’s beta is 1.24, while the median beta for the industry is 1 and the company’s direct competitor Airbus’s beta is 1.16. If the economy experienced a 5% downturn, Boeing would endure a 6.25% loss in stock price (1.24*5=6.25) and Airbus would only have a 5.8% loss (1.16*5=5.8). This means that a turn in the economy would affect Boeing greater than its major competitor Airbus and carries a high risk.
4. Malek Qandil
Nov 22, 2019Nov 22 at 9:42am
After reviewing T-mobiles annual report, I have found out there are a few risks that they may face in the future. One big risk that I am going to focus on is The t-mobile transaction. With this transaction they are speaking about the acquisition of T-mobile purchasing Sprint. If this acquisition were to fall through it would hurt T-mobiles Stock price, future business, assets, liabilities, prospects, outlook, and financial condition. The major mitigation techniques are tough to use in a situation like this because the high risk is not in T-mobile's hands, but if we were to focus on one it would be the risk limitation. T-mobile can implement process that limit how much they are at risk for the merger. Instead of losing 20 billion they can limit it to only 10 billion if others were to agree. This risk is a major risk because there are so many different approves for an acquisition whether that is the FCC, DOJ, and the state attorney generals. There are a lot of hoops that an acquisition this big has to go through. Even though things look positive for T-mobile, it can turn upside down extremely fast for them. The profitability for this risk if it were to go through is un-measurable because of this major acquisition they could potentially earn billions and billions of dollars. At the same time, there are plenty of costs of purchasing another organization. The purchase itself is set to cost $26.5 billion.
