FINANCE-A Critique of the Capital Asset Pricing Model

This Assignment is in 2 Parts

Part A – A Critique of the Capital Asset Pricing Model

Part B – Capital Budgeting and NPV Analysis

Part A is an Essay while Part B involves calculations.

The requirements for each Part are set out below.

PART A - Topic: CAPM

Your topic is:

“A Critical Assessment of The Capital Asset Pricing Model (CAPM)”

You are required to

- Describe the Capital Asset Pricing Model, including the assumptions underlying the theory

- Explain the relationship between the Security Market Line and the Capital Market Line, using diagrams and examples to illustrate your explanation

- Briefly set out arguments in favour of – and against - the theory, outline its uses and make a critique of its underlying assumptions

- Identify any alternatives which have been suggested in place of CAPM

- Conclude with an overall assessment of the theory and state any recommendations you may have from your study.

- Conclusion – a brief overall assessment of the CAPM theory.

Details of the Assignment requirements, suggested points for detailed examination and penalties for late lodgment are in the Subject Outline.

You are required to complete this essay in Groups of 2 or 3 or 4 or 5 people. All members of the Group should come from the same Tutorial class. You may consult and discuss the Assignment topic with others, but you must write up your Essay yourself/ves. Penalties for copying and plagiarism are severe.

You should follow the following typing conventions:

• Times New Roman font (at minimum , 12 pitch)
• 1.5 line spacing and A4 paper
• Top, bottom, left and right margins to be at least 2.5 cm from the edge of the page; and
• WORD LIMIT – 1,000 – 2,000 words.

Research and Referencing

You should begin by studying Chapter 11 of the text-book.

You will need to discover at least 5 references apart from the text-book.

Use Harvard referencing! Seehttp://en.wikipedia.org/wiki/Harvard_referencing

Marking Guide

Part A will be marked out of fifteen (15) and there will be four components.

Component 1 – 5 marks – ANALYSIS. Discussion and understanding of CAPM and the issues associated with the theory, including the advantages and shortcomings of the theory, along with outlining the underlying assumptions and application of the Security Market Line and the Capital Market Line (illustrated by graphs).

Component 2 – 4 marks – RESEARCH – EXTENT AND APPLICATION. Depth of research should be evident in developing a detailed understanding of CAPM, and its role in in financial management. Evaluate the theory, in the light of your discovered references. Source references of text and diagrams should be cited.

Component 3 – 3 marks – RECOMMENDATIONS / CONCLUSIONS. Following the above analysis and application of your research, state any recommendations which emerge for financial managers and investors and/or for government policy. In a separate section, briefly summarise your overall conclusions.

Component 4 – 3 marks – PRESENTATION. Clear and concise expression required, along with professional presentation, correct grammar and spelling, and the use of clearly labelled graphs, charts and tables. Appropriate source referencing of material, charts, tables, etc. is required

The purpose of Part A of this Assignment is to test your initiative as Master’s degree students, and your ability to discover information and apply your findings to key areas in financial management.

PART B – Capital Budgeting Analysis – Case Study

You are required to work the following problem, using a discounted cash flow (NPV) analysis. You should model your answer on the text approach in Chapter 8.

Harry Hill is considering replacing an old machine with a new one from Li Xu because one year ago a feasibility study on the new machine conducted for Harry by PQ Ltd, an external firm of consultants, costing Harry $20,000, concluded in favour of buying this new machine. The old machine (bought 5 years ago from Tom Kat) cost $280,000, while the new one will cost $320,000, fully financed by a 5 year 8% per annum interest only loan.

“The new machine will be depreciated prime cost to $50,000 over its 5 year life. Harry estimates that it will be worth $40,000 (salvage value) after 5 years. The old machine is being depreciated at prime cost to zero over its original expected life of 10 years. However, Harry can sell the old machine today for $90,000.

“The new machine will save Harry $80,000 a year in cooling costs. However, with the new machine, Harry will lose $10,000 per annum of existing sales to Tom Kat, which Tom has regularly bought each year over the past 5 years from Harry’s business.

“With the new machine, a one-off amount of cleaning supplies (current assets) at a cost of $12,000 will be required, and Harry estimates that accounts receivable (also current assets) will increase by $15,000. Both of these increases in working capital will be recouped at the end of the new machine’s life in five years time.

“Harry’s cost of capital is 10%. The tax rate is 30%. Tax is paid in the year in which earnings are received.

“REQUIRED

(a)Calculate the net present value of the proposed change, that is, the net benefit or net loss in present value terms of the proposed changeover.

(b)Should Harry purchase the new machine? State clearly why or why not.”

Research and Marking Guide

Unlike Part A, text-book and other references are not required for Part B. You should consult the text, Chapter 8, and other available references for guidance as to the setting out of the capital budgeting analysis and the basis for decisions.

Marking will follow generally the style used in marking examination questions, that is, 15 marks are allotted to this Part, from which deductions will be made for errors in calculation, incorrect treatment of items and lack of knowledge.

Submission of Assignments

A soft copy is not acceptable. Please submit to Lecturer a hard copy, including Cover Sheet (see Moodle) & Marks and Comments Page (see page 3 attached. If Marks and Comments page is not submitted or in-complete, 1 mark will be deducted from “Presentation”).Keep a soft copy.