The Advantages and Disadvantages of Capital Asset Pricing Model (Essay Sample)

Capital Asset Pricing Model (CAPM)
Name:
Institution:
1- What are the primary advantages and disadvantages of the Capital Asset Pricing Model (CAPM) compared with the Constant Dividend Growth Model for use in pricing common stock?
Advantages
CAPM help calculate financial risk variance since it takes into considerations other returns like weighted average cost of capital which DGM does not
It also takes into consideration element of systematic risk which helps to identify unforeseen risk
CAPM includes diverse portfolio in its calculation which help to eliminate aspect of unsystematic risk
CAPM is very easy to use while calculating the range of possible outcomes on the rate of return as compared by DGM
Disadvantages
CAPM-based its calculation on the principle of risk-free factors, however, this is not so since most markets are very volatile thus limiting this principle to only short-term government securities. CAPM mainly focuses its calculation on the return from the market; however, this is very unrealistic since it cannot predict clearly the future return
CAPM is based on principles that one can borrow and lend at a risk-free, however; this might lead into low return
CAPM does not clearly elaborate on how businesses can assess the investment outcome accurately
2- Can either or both of these two models be used to price the stock of Gamma Inc., a non-publicly traded company that does not pay dividends? Explain your answer. No. these two models rely on an assumption of; the known rate of return from and constant performance. However, this is not accurate since most company's returns are not known and they are neither constant due to high dynamics in the markets
3 - Why is it that the financial models for calculating the price of a stock cannot be reli