Q1.
CAPM
The capital asset pricing model (CAPM states that the relationship between risk and expected return is useful in the pricing of risky securities (Barberis et al., 2015; p. 1-7). According to the two assumptions of modern financial theory, the first assumption states that market securities are very competitive and efficient; that is, relevant information of the multi-physician clinic must be universal and quick in there absorption and distribution; and second, the markets must be dominated by risk-averse, rational investors seeking to maximize satisfaction from returns on their investments (Adesokan, Ngare, & Kilishi, 2017). The first assumption presumes that the financial market is overwhelmed by highly sophisticated, well-informed sellers and buyers while the second describes how investors care about wealth thereby preferring more to less. Moreover, the modern financial theory hypothetical investors’ demand for premium is in the form of higher expected returns for their assumed risks.
Despite the cornerstone of these assumptions, CAPM formal development involves more specialized limiting assumptions including restrictions on borrowing and short selling and frictionless markets without imperfections like transaction taxes and costs (Barberis et al., 2015; p. 24). Therefore, I see good strength in CAPM if the organization is using the CAPM in their organization where it has its advantages as explained below
Ease-of-use- this is because CAPM is simple to calculate and that it can be easily stress-tested thus deriving possible range outcomes thereby providing confidence around the required return rates.
Diversified portfolio-as CFO, the assumption is holding a diversified portfolio which is similar to the market portfolio that can be used to eliminate unsystematic risk.
Financial and business risk variability- the multi-physician clinic can decide to investigate opportunities, and if the financing and business mix differ from the current business, and then the other required return calculations, like the WACC, cannot be used but only CAPM.
Systematic risk (beta)- the company can use CAPM which takes into account systematic risk, which is left out of other return models including the dividend discount model (DDM). Thus, market or systematic risk is an essential variable since it is unforeseen and often cannot be wholly mitigated because it is not entirely expected.
The security market line (SML) is a line that graphs the market or systematic risk versus return of the whole market at a particular time reflecting all risky marketable securities. The SML essentially graphs the results from the capital asset pricing model (CAPM) formula. The x-axis represents the risk (beta), and the y-axis represents the expected return. The market risk premium is determined from the slope of the SML.
Q2.
Equity financing
The funding is committed to your business and your intended projects. Investors only realize their investment if the business is doing well, for example through stock market flotation or a sale to new investors.
You will not have to keep up with the costs of servicing bank loans or debt finance, allowing you to use the capital for business activities.
Outside investors expect the business to deliver value, helping you explore and execute growth ideas.
All these decisions will help the organization in the future (Drover et al., 2017)
Conclusion
Neither CAPM nor other models are entirety perfect. However, every model need have to a few characteristics that make it applicable and useful. Therefore, while CAPM is criticized for unrealistic assumptions, it provides a useful outcome than either the WACC or DDM in various situations. This is because it can be easily calculated and stress-tested, and when used in conjunction with other aspects of an investment mosaic, it can provide unparalleled yield data that can support or eliminate a potential investment.
References
Adesokan, I., Ngare, P., & Kilishi, A. (2017). Analyzing the Expected Returns of a Stock Using The Markov Chain Model and the Capital Asset Pricing Model. Applied Mathematical Sciences, 11(56), 2777-2788.
Barberis, N., Greenwood, R., Jin, L., & Shleifer, A. (2015). X-CAPM: An extrapolative capital asset pricing model. Journal of financial economics, 115(1), 1-24.
Drover, W., Busenitz, L., Matusik, S., Townsend, D., Anglin, A., & Dushnitsky, G. (2017). A review and road map of entrepreneurial equity financing research: venture capital, corporate venture capital, angel investment, crowdfunding, and accelerators. Journal of Management, 43(6), 1820-1853.