The Pros And Cons Of Strategic Capital Structure
This linear relationship is being always argued. Thus, CAPM formula is developed based on number of assumptions that are criticized to be unrealistic (P9, 2015). One of the main assumption used is risk is systematically drown on a line which is called as Security Market Line (SML). However, the market factors such as political influence, social discrepancy, and dynamic technology movement will affect on the risk level of the market. This will comparatively shape the SML from linear to an exponential graph. So that, minimum return that the investors of the equity holders will not be the exact point that SML (Linear) would cut the β=0 giving rate. Similarly, when company’s risk is measured by the β value, hence the market return will be computed as wrong or approximate values which are not …show more content…
CAPM assumes that companies hold diversified risk in the capital structure. Therefore, it assumes company generate systematic risk and return. Therefore, CAPM enables companies to determine the most optimum capital structure complying with the existing dynamic environment. Β value of CAPM formula determines the risk level compared to the market risk. When the risk is higher compared to the market value, the return each stock grants to its stockholders will be higher (Çelik, 2012 ).
Cost of equity determines the viability of investing on a potential opportunity within different industries. For an example “Virgin Group” invests on different industries from transportation to hotel sector and restaurants. Recently it established the foundation to build space restaurants which is absolutely a different industry compared to what it is into right now. When measuring the financial feasibility, Ke provides a quantitative financial analysis. Since β value represents the market risk rather than industry risk, companies such as Virgin enables to determine relative risk level. Therefore, CAPM will be helpful for all most all the industries to determine the viability of a