There are many strategies one must consider to successfully maintain his or her financial needs. When it comes to finances one can get lost in the enormity of the amount of options that are available. When starting an organization the type of capital structure and long-term financing strategies must be taken into consideration to successfully run the company. In doing so, the organization will have to compare and contrast the capital asset pricing model (CAPM) with the discounted cash flows method (DCFM). The skill of comparing and contrasting financial options will help evaluate and organize the debt/equity mix and dividend policy. Realizing the major constituents of the financial market, the cost of various debt and equity instruments will in turn help with in an organization to make better decisions. The organization must then decide what type of long-term finance alternatives will most likely benefit it.
CAPM vs DCFM
The main idea behind the capital asset pricing model (CAPM) is the investor's requirement to be compensated. This occurs in two ways: first, the time-value of money; and two, the risk involved in the investment. The CAPM states that the expected return of an investment must equal or surpass the risk-free rate of return. An additional return is required by investors for undertaking additional risk. In other words, there is an expected return of a security or portfolio which equals the rate on a risk-free security plus a risk premium (Investopedia, 2006). If this investment does not meet or beat the required return, then the investment should not be undertaken. The formula for this, including beta inputs, reads as follows:
The beta factor in the formula reflects the overall risk in investing in a large market, such as the NY Stock exchange. Individual companies also have a beta, which is that company's risk compared to the overall market. Beta is a measure of the... [continues]
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