CORPORATE FINANCE OVERVIEW Essay Example | Topics and Well Written Essays - 500 words

CORPORATE FINANCE OVERVIEW - Essay Example Even though the company has a secure stream of income from a long term contract, it still bears a default risk, albeit rather small. My estimation of the discount rate has to reflect all this information. It will be definitely higher than discount rate of government securities. d) This security has substantial default risk as the issuing company is a start-up without proven history of operations and no secure stream of income. Therefore, the discount rate will be higher than for the company with secured stream of income (from the previous question). 2. Capital Asset Pricing Model (CAPM) can be used to quickly estimate the expected rate of return on a certain security. In an essence, it provides the best guess market can provide for future return on a particular security in a simple but powerful way. It was estimated that nearly 3/4 of financial managers use CAPM to estimate the cost of capital (Brealey, Myers & Allen, 192). CAPM reflects two crucial points. First, investors require extra return for extra risk (as shown in risk premium component). Second, investors are concerned with the risk that they cannot eliminate by diversification (as shown in beta component). Therefore, when used to estimate expected return on a particular security, CAPM accounts for the overall additional risk premium historically required by investors for this type of security (risk premium) and for the systematic risk that this particular security adds to the diversified portfolio (security’s beta). 3. a) It is possible to estimate net present value of this project rather accurately. Buying new equipment for a factory line at Ford is a part of regular established operations of Ford. Therefore, the expected rate of return estimated for the Ford as a company is appropriate for this particular project. Since Ford is a mature company, with its stock having being traded for many years, its expected rate of return