FIN620 SHORT PAPER A project assessment study based on the combination of the CAPM model and the MM theory
A project assessment study based on the combination of the CAPM model and the MM theory
Dilina Kuerban
(FIN620 Long-term financial management)
11/15/2014
Abstract
1. Modigliani- Miller theorem……………………….......………..….………………
(1)Modigliani and Miller Proposition --No tax scenario……………………………
(2)Modigliani and Miller Proposition--with taxes scenario…………………………
2. Combination of CAPM model and MM theory…………………………………..
3. A case study………………………………………………………………………....
4. Limitation of combination of CAPM and MM theory………………..………….
5. Conclusion……………………………………………………………….………….
References
Abstract: When a firm invests in a new project, the risk of the project maybe higher than the current average risk level of the company. Therefore, adopting what kind of discount rate in evaluating a new project will be the key of whether or not to proceed with the project. The most recent studies on the combination of MM theory and CAPM model are based on the formula of cost of capital, which could get a beta equation of levered firm and unlevered firm. However, when we treat a company as an asset portfolio, the risk factor of the asset is the weighted average risk of equity and debt. From the definition of debt risk in MM theory, we also can get beta equation. It’s worthwhile to apply the combination of CAPM model and MM theory into the investment evaluations.
Key words: MM theory, CAPM model, project assessment, discount rate.
When a firm decides to invest a new project, how to determine discount rate becomes the most important factor. Usually firms adopt different discount rates to the different investment projects. However, how to determine specific discount rate is a critical decision. This paper will combine MM theory with CAPM model, to study how a firm determines appropriate discount rate when they invest a new project. Before we discuss combination of MM theory with CAPM model, let us begin with the assumption of MM proposition.
1.
Dilina Kuerban
(FIN620 Long-term financial management)
11/15/2014
Abstract
1. Modigliani- Miller theorem……………………….......………..….………………
(1)Modigliani and Miller Proposition --No tax scenario……………………………
(2)Modigliani and Miller Proposition--with taxes scenario…………………………
2. Combination of CAPM model and MM theory…………………………………..
3. A case study………………………………………………………………………....
4. Limitation of combination of CAPM and MM theory………………..………….
5. Conclusion……………………………………………………………….………….
References
Abstract: When a firm invests in a new project, the risk of the project maybe higher than the current average risk level of the company. Therefore, adopting what kind of discount rate in evaluating a new project will be the key of whether or not to proceed with the project. The most recent studies on the combination of MM theory and CAPM model are based on the formula of cost of capital, which could get a beta equation of levered firm and unlevered firm. However, when we treat a company as an asset portfolio, the risk factor of the asset is the weighted average risk of equity and debt. From the definition of debt risk in MM theory, we also can get beta equation. It’s worthwhile to apply the combination of CAPM model and MM theory into the investment evaluations.
Key words: MM theory, CAPM model, project assessment, discount rate.
When a firm decides to invest a new project, how to determine discount rate becomes the most important factor. Usually firms adopt different discount rates to the different investment projects. However, how to determine specific discount rate is a critical decision. This paper will combine MM theory with CAPM model, to study how a firm determines appropriate discount rate when they invest a new project. Before we discuss combination of MM theory with CAPM model, let us begin with the assumption of MM proposition.
1.
References: 1. Adrienn, H. (2014). SUMMARY OF THEORIES IN CAPITAL STRUCTURE DECISIONS. Annals Of The University Of Oradea, Economic Science Series, 23(1), 912-918. 2. Brusov, P., Filatova, T., Orehova, N., & Brusova, N.(2011). Weighted average cost of capital in the theory of Modigliani-Miller, modified for a finite lifetime company. Applied Financial Economics,21(11),815-824 doi:10.1080/09603107.2010.537635 3. Ross, T. A, Westerfield, R. W. & Jaffe, J. (2010). Corporate Finance. New York, NY: McGraw-Hill/Irwin; 4. Chen, W, (2011), Exercises of Corporate Finance. China, Shanghai: University of Shanghai Finance and Economics; 5. Shuisheng, Z, (2010),Relationship between corporate finance and investment. Modern commerce,12,207-208 ; 6. Modigliani-Miller Proposition I Theory. Retrieved from: http://www.ukessays.co.uk/essays/accounting/modigliani-miller-proposition-iory.php