Arden wants to invest in a fashion brand. What discount rate should she use to compute the PV of her expected cash flows from her investment? They have this data: Expected avg annual return on 3 month- 4.1% Expected avg annual return on 30 year- 4.6% Expected avg annual return on other beauty product shares- 7.2% Expected avg annual return on other fashion shares- 13.0%
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Arden wants to invest in a fashion brand. What discount rate should she use to compute the PV of her expected cash flows from her investment? They have this data:
Expected avg annual return on 3 month- 4.1%
Expected avg annual return on 30 year- 4.6%
Expected avg annual return on other beauty product shares- 7.2%
Expected avg annual return on other fashion shares- 13.0%
The pure play approach is an approach used to find the weighted average cost of capital (WACC) or discount rate for a particular project based on the cost of capital of companies that are in the same line of business and have publicly traded securities. For example if ABC power engineering company wants to find out a discount rate for its project, it has to identify power engineering companies that have publicly traded securities. Based on the equity beta and debt equity ratio of a typical power engineering company, we can compute the WACC for the ABC power engineering company
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