Capital Assets Pricing Model

The Capital Assets Pricing Model is used to determine the necessary rate of return for an investment should it be determined worthwhile. This model factors in the sensitivity of an investment to risk in addition to the anticipated returns of the market and the investment. This model also recognizes the importance of an investor developing a market portfolio. The concept of the market portfolio demonstrates that in order to find financial success, an investor must diversify his investments.

The following equation represents the key concept of the Current Assets Pricing Model.

Rj - RF = ОІj [RM - RF]

In this equation, Beta is an estimated constant that describes the suspected risk that a company expects to incur. The variable RF represents the expected rate of return on the asset. The risk free interest rate is represented by RF. RM is the market’s expected rate of return.

Through the use of the above equation, one may determine the rate of return necessary on Dell’s stock that will encourage investment. Dell’s beta coefficient is 1.57. Because an online search did not reveal a risk-free rate on a government bond that matures in one year, I used the standard 10 year maturity government bond. This is the bond which is used to measure risk-free rates in real-world applications. At present, the yield to maturity on this bond is 4.19%. This will be used in this module’s applications. Also, as stated in the module’s instructions, for our purposes, the difference between the expected rate of return and the risk-free rate of return is 7.0%. With this value, the market rate of return is 11.19%. By plugging in these values in the above formula, we solve for a necessary rate of return equal to 15.18%. This is also known as the cost of equity for the company.

There is also value in studying the