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Chapter 4: Q11-A-1DQ (page 379)

How does the capital asset pricing model help explain changing costs of capital?

Short Answer

Expert verified

The capital asset pricing model defines the asset鈥檚 price and expected return for the given cost of capital and helps explain the changing cost of capital.

Step by step solution

01

Definition of Capital structure

Capital structure can be defined as the proportion of the debt and equity elements present in the capital of the business entity. The business entity uses the debt-to-equity ratio to determine the risk associated with capital borrowings.

02

Capital asset pricing model

The link between the anticipated return on the asset and the risk associated with the asset is determined by the capital asset pricing model. This model also helps in pricing the risky assets and the generation of the expected return at a given cost of capital.

As the cost of capital changes, the asset鈥檚 price and expected returns will change. In this manner, the capital asset pricing model defines the change in the cost of capital

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Most popular questions from this chapter

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Question:Ecology Labs Inc. will pay a dividend of \(6.40 per share in the next 12 months (D1). The required rate of return (Ke) is 14 percent and the constant growth rate is 5 percent.

a. Compute P0. (For parts b, c, and d in this problem, all variables remain the same except the one specifically changed. Each question is independent of the others.)

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c. Assume the growth rate (g) goes up to 9 percent. What will be the new value of P0? Ke goes back to its original value of 14 percent.

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Question:Justin Cement Company has had the following pattern of earnings per share over the last five years:

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20X1 ................... $5.00

20X2 ................... 5.30

20X3 ................... 5.62

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