StudentShare
Contact Us
Sign In / Sign Up for FREE
Search
Go to advanced search...
Free

Module 4 BHS427 Health Care Finance Cost of Capital (CASE) - Essay Example

Cite this document
Summary
Under CAPM the expected return of a bond or security is equivalent to the sum of risk free rate and the risk premium implying that the…
Download full paper File format: .doc, available for editing
GRAB THE BEST PAPER96.5% of users find it useful
Module 4 BHS427 Health Care Finance Cost of Capital (CASE)
Read Text Preview

Extract of sample "Module 4 BHS427 Health Care Finance Cost of Capital (CASE)"

Capital Asset Pricing Model: CAPM Capital Asset Pricing Model: CAPM Introduction Capital Asset Pricing model (CAPM) is a model that is used to determine the viability of an investment based on the expected return of a bond. Under CAPM the expected return of a bond or security is equivalent to the sum of risk free rate and the risk premium implying that the investors are compensated for both time value of money and risk involved in the investment. Inclusion of the risk premium makes this model appropriate for risky investments.

Notably, an investment can only be viable if the expected return of the bond obtained by combining the risk and risk free rate is higher than the required return, otherwise the investor ought to use a different mode of financing. Advantages and disadvantages Despite being highly criticized, CAPM is commonly used by investors and managers, possibly due to its sundry advantages over other models. By using systematic risk only, CAPM tends to be not only more realistic but also simpler by eliminating the unsystematic risk.

Remarkably, the relationship between the market risk and expected rate of return is easily shown by the Security Market Line. Secondly, in addition to being empirically testable, CAPM compares the particular investments level of risk to the stock market risk unlike DGM. Moreover, CAPM overcomes WACC’s assumption that investment has no influence on financial risk hence making it better in project appraisal. Conversely, CAPM’s assumptions make it less viable in reality. In project appraisal, the use of a single-period time zone contradicts the nature major real investments, which cut across periods.

Moreover, it’s unrealistic to assume a constant beta for the periods as market conditions keep on fluctuating. Again, CAPM faces a problem in assigning values to the variables in the model. None of the variables is constant, with some such as yield on government debt (used to estimate risk free rate of return) changing on daily basis. Empirical FindingsDolde et al (2012) research was aimed at determining whether the two factors international CAPM (2F-ICAPM) gives a different cost of capital compared to the domestic CAPM mostly used by US companies.

Pre-studies had shown that the single global CAPM generated costs of equity not significantly different from the domestic CAPM despite the former model’s theoretical superiority, hence explaining why managers had not shifted from the domestic CAPM. To formulate the2F-ICAPM, Dolde et al incorporated the world market Index and currency index for chief currencies all expressed in US dollars, making this model theoretically superior to both global CAPM and domestic CAPM. Contrary to the expected, empirical findings showed that 2F-CAPM yielded estimates which were not significantly different from the domestic CAPM even for the firms exposed to extreme FX.

Note that, FX exposure was exogenously determined that represented a risk factor. Industry portfolios gave similar results, with the cost of equity obtained from 2F-ICAPM closer to domestic CAPM than that yielded by global CAPM. Importance of the findings Generally the study was not aimed at determining which model is better but rather determining whether the costs of equity produced by the two models differ. To managers, the fact that the two models yield similar results, as per the findings, it is of no importance to shift from the traditional model to the 2F-ICAMP.

The findings help the mangers confidently stick to domestic CAPM as the theoretical superiority of 2F-ICAMP is practically not real. Cost of equity across industries Dolde et al, findings show slight differences in the cost of equity obtained by 2F-ICAPM and the domestic CAPM across industries (2012). The implication is that Foreign exchange exposure slightly influences the cost of capital. As matter of fact, extraction industries whose products are valued using US dollars, hence large FX exposure risks to their returns portrayed showed a great variance from the rest.

Precisely, the findings show that FX exposure influences the cost of equity and industries operating with fixed currency are more vulnerable to the risk than others. ReferencesBond Yields. (n.d.). Retrieved from http://thismatter.com/money/bonds/bond-yields.htmComaford-Lynch, C. (2007). Rules for raising capital. Retrieved from http://www.businessweek.com/stories/2007-01-22/rules-for-raising-capitalbusinessweek-business-news-stock-market-and-financial-adviceDolde, W., Giaccotto, C., Mishra, D. R., & OBrien, T. (2012). Should managers estimate cost of equity using a two-factor international CAPM?

Managerial Finance, 38(8), 708-728.

Read More
Cite this document
  • APA
  • MLA
  • CHICAGO
(“Module 4 BHS427 Health Care Finance Cost of Capital (CASE) Essay”, n.d.)
Retrieved from https://studentshare.org/health-sciences-medicine/1656700-module-4-bhs427-health-care-finance-cost-of-capital-case
(Module 4 BHS427 Health Care Finance Cost of Capital (CASE) Essay)
https://studentshare.org/health-sciences-medicine/1656700-module-4-bhs427-health-care-finance-cost-of-capital-case.
“Module 4 BHS427 Health Care Finance Cost of Capital (CASE) Essay”, n.d. https://studentshare.org/health-sciences-medicine/1656700-module-4-bhs427-health-care-finance-cost-of-capital-case.
  • Cited: 0 times

CHECK THESE SAMPLES OF Module 4 BHS427 Health Care Finance Cost of Capital (CASE)

Health Care Delivery System

The health care systems from Canada and the US have been constantly assessed comparatively, with analysts traditionally favoring the Canadian model as being more efficient.... health care revolves around a majority private system with residual public service, like Medicare and Medicaid.... Hence the American approach to health care is market oriented.... health care system are faced with a challenging situation.... The health care systems from Canada and the US have been constantly assessed comparatively, with analysts traditionally favoring the Canadian model as being more efficient....
2 Pages (500 words) Case Study

Ratios for Inter-Company Comparisons

This paper tells that ratios are very useful for inter-company and time-based comparisons of a company over the years.... They are better than absolute figures as they provide the basis for comparison and we can safely predict whether the performance of the company is improving or declining.... hellip; This paper gives information that therefore, Rockies Breweries can use ratio analysis to determine the performance of the company both as compared to other companies and different years....
5 Pages (1250 words) Case Study

World Paper Company - Finance Case 18

(2) The company has a policy to utilize its corporate cost of capital to analyze investment opportunities (Tham & Pareja, 2004).... The… wide Paper Company (WPC) is planning to introduce a long wood woodyard to reduce the costs spent on the short wood, and to increase its competitive strength in the paper industry. The yearly cash flows that are relevant to this company include the initial outlay, the annual The initial outlay cash flow is the total cost of the investment which is set at $18 million....
3 Pages (750 words) Case Study

The Intuit Advantage

Secondly, cost of goods sold reduced significantly as shipping costs eliminated.... They started off with Quicken, a finance software package, which later accelerated the establishment of Intuit's other case study Business case Intuit is a company that develops one of the worlds best selling software.... They started off with Quicken, a finance software package, which later accelerated the establishment of Intuit's other innovations....
2 Pages (500 words) Case Study

The Coca-Cola Company Value Drivers

The table shows the cost of electricity used by the company as well as the effect on shareholders' value.... The second value adder available for the company is the efficiency in capital structure.... The table shows the metrics saved in the 2010 through to 2013, the average amount of dollar that is saved per year together with the total amount saved on average for the whole year 2012 from the low cost borrowing.... This value adder's metric was calculated using its financials of the years 2010 to 2014 as well as Atlanta's commercial user's electricity cost or price....
6 Pages (1500 words) Case Study

Financial Statements for Strong-Tie

In early January 2009, David Johnstone received the draft 2008 financial statements for Strong Tie and began to question the company's performance when compared to previous years.... How were profits holding up, given the intense price competition in the industry?... Were attempts… Were the current problems in the U....
4 Pages (1000 words) Case Study

Business Decision Making - Envy Rides

The company is, therefore, best suited to go for the loans since its gross margin The working capital loan will even bring more revenue to the company.... With this tremendous reduction in expenditure, the business is, therefore, expected to have more revenue on the retained earnings section to be used to reinvest in the working capital.... The business therefore has no reason to go for a loan for the working capital as it can be obtained from the retained earnings....
5 Pages (1250 words) Case Study

Health Care Delivery Structure in Georgia

The paper "Health Care Delivery Structure in Georgia" highlights that utility bills have to be cleared such as cost of medicines purchased that month in advance, payment of rent for the premise where the healthcare services are provided as well as assistants in that facility.... hellip; The health care organizations are overwhelmed with work and little money to spare for recruitment exercises.... In order to provide incentives for the healthcare workers, private recruitment services have been set up to solicit and hire assistants and additional physicians all at a free cost to the health care organizations....
6 Pages (1500 words) Case Study
sponsored ads
We use cookies to create the best experience for you. Keep on browsing if you are OK with that, or find out how to manage cookies.
Contact Us