This is because it stands for the extra return that is needed for investing in stocks more than investing in risk free assets. Beta An indirect quantifier that a compares the systematic risk linked with a company’s stocks with the systematic risk of the entire capital market. Additionally, beta has been defined as the index of responsiveness of the returns of a company’s stocks against the returns of the entire market. A beta value of one for a company reflects a systematic risk with the stock, and is the similar to the systematic risk of the entire capita market.
The value of beta is arrived through the application of capital asset pricing model on regression analysis to evaluate the return on stocks with that of the capital market. Pratt and Grabowski (2008) asserted that the beta from shares is the standards of the stock’s market risk, plus a standard to the level of which the stock’s returns move relative to that of the market. Stowe, Robinson, and Pinto (2008) provided a restrictive relationship between beta and realized returns by dividing periods of positive and negative market excess return, and in their report, they realized there is a significantly positive correlation between the realized returns and beta when their excess returns in the market is non-positive.
The calculation of the cost of capital applicable in very many situations, especially in investment appraisal is the weighted average cost of capital (WACC), though this is only applied when a company is involved in a project that is similar to their normal activities. When a company then diversifies, and operates in a business that is significantly different from the present operations, then the capital pricing asset model must be applied ahead of the WACC, and is so that the financial risk of the company, that the beta shall be considered is removed.
The capital asset pricing model is a method that is used in the calculation of the required return on investment based on the appraisal of the risk. Pratt and Grabowski (2008) have pointed out that the capital asset pricing model is used in estimating the cost of the retained earnings. To consider the application of the capital asset pricing model in the financial system, the risk free rate of return, which is the yield on short government debt, shall change and this depends on the country’s capital market that is being taken into consideration.
The consideration of Henkel A. G implies that for which the maturity and treasury rate is sufficient for its valuation.
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