The Application of the capital asset pricing model (CAPM): A south african perspective

Abstract

The focus of this paper is the capital asset pricing model (CAPM), with a specific emphasis on two of its main components, namely the risk-free rate and beta. The CAPM is used extensively in practice to calculate the cost of equity, which, in turn, is used to calculate the weighted average cost of capital for equity valuation and investment appraisal purposes. The aim of this paper is to investigate how well valuation theory regarding the CAPM in particular, as advocated by academia, is aligned with the CAPM and alternative models that leading financial analysts and corporate financiers apply in practice. No study has yet compared the methods of choice of investment practitioners when calculating the cost of equity to that of academia. The research results revealed that, although both academia and investment practitioners favor the CAPM, they disagree significantly with regard to the components of the CAPM and the use of alternative models. Key words: Academia, investment practitioners, capital asset pricing model, discount rate, arbitrage pricing theory, risk-free rate, beta.