Corporate Finance and Financial Markets (Part C): CAPM Analysis Report

This report presents a CAPM (Capital Asset Pricing Model) analysis comparing the financial performance of two companies, EDP and GAPL. The study focuses on determining the required rate of return for each company, using the CAPM formula which incorporates risk-free rate, market return, and beta values. The analysis reveals that GAPL offers a higher expected rate of return with a lower beta value compared to EDP, suggesting a potentially more favorable investment. Furthermore, the report benchmarks the returns of both companies against the S&P 500 index, highlighting the impact of global market conditions, particularly in the energy sector. The conclusion emphasizes GAPL as a better investment choice due to its higher return and lower risk profile as determined by the CAPM model, advising investors to consider GAPL for potentially higher returns. The report references key financial journals and online resources to support its findings.

CORPORATE FINANCE
AND FINANCIAL
MARKETS
(PART C)

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
TASK C...........................................................................................................................................1
CONCLUSION................................................................................................................................2
REFERENCES................................................................................................................................3

INTRODUCTION
When the investor going to make investment in any company then he always seeks
towards share prices. If the share of the firm are higher and profitable as well as continuously
increases then shareholders will purchase the stock. The present study emphasises on comparison
among share prices between EDP and GAPL business entities.
TASK C
The model which helps to the company as well as investors in order to determine required rate of
return of the potential avenue in which it makes investment, known as capital asset pricing model
(CAPM). Further, there are different types of assumptions of the CAPM are such as the investors
must make investment at the risk free rate as well as there are not any type of market costs are
considered (Chand, 2016). Main components of the CAPM are such as risk free rate of return,
market return as well as systematic risk of the stock that is beta value. In order to calculate
required rate of return with help of CAPM model respective formula is to be used:
CAPM = Rf + β (Rm – Rf)
Rate of return of EDP and GAPL company with help of capital asset pricing model
is given is as follows:
EDP GAPL
Rf 2.43% 2.43%
Β 0.96 0.90
Rm 3.6 3.6
CAPM = 2.43 + 0.96 (3.6-2.43)
= 2.43 +1.17
= 3.55%
= 2.43 + 0.90 (3.6-2.43)
= 2.43 + 1.053
= 3.48%
From the above mentioned CAPM model it can be interpreted that both the companies
are giving better rate of return when the investor make investment in such firms. In comparison
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to both the firms EDP is unable to give better return while GAPL provide higher expected rate of
return. Further, with visualizing beta value it can be analysed that EDP has 0.96 and GAPL has
0.90 beta which shows that when the investor put investment in the later firm then he has not to
bear more risk (Hoberg and Maksimovic, 2015). Higher the beta value of particular asset lead to
reduce return of the investment and increase risk. In the present case required rate of return of
EDP and GAPL is 3.55% and 3.48% respectively. Hence, the later company will give higher
return and beneficial for the investors for invest money in that stock or shares.
Comparison of return with S&P 500:
In the global stock market there are various kinds of index are available and on the basis
of pricing level and return of stock is to be determined. In the present scenario S&P 500 index is
to be selected and with this return of EDP and GAPL are to be compared. Return of the S&P 500
index which is considered as actual market return and given as below:
S&P 500 index: Actual market return 15.22%
On the basis of S&P 500 index it can be said that EDP and GAPL both are unable to
provide better return of the stock. Return of energy sector at S&P 500 index is 15.22% which is
very well and high as compare to the above mentioned firms. As per the CAPM model return of
EDP and GAPL is 3.55% and 3.48% respectively which is very poor. At the global level in the
energy sector prices of natural gases and reduce by which profit affects of both firms and lead to
reduce return.
CONCLUSION
It can be summarised that as per the CAPM model the GAPL has lower beta value and
higher rate of return in comparison to EDP firm. Hence, it can be analysed that GAPL is better to
make an investment which gives higher return with lower risk. Apart from this rate of return as
well as risk of GAPL is higher and lowest compare than another firm so shareholders and
investors needs to make investment in GAPL in order to get high return.
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REFERENCES
Journals and Books
Hoberg, G. and Maksimovic, V., 2015. Redefining financial constraints: A text-based analysis.
Review of Financial Studies. 28(5). pp. 1312-1352.
Online
Chand, S., 2016. 5 Assumptions Made by the CAPM. [Online]. Available through:
<http://www.yourarticlelibrary.com/investment/5-assumptions-made-by-the-capm/1788/>
[Accessed on 13th February 2017].
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