CAPM model

a) In obtaining or valuing stocks, bonds and other investments of a company, a valuing model is used. The future value of any investment is more important. A valuing model is CAPM, in model beta is a measure of volatility. Beta measures the volatility or sensitivity of any investment. A company with a higher beta is more volatile than a company with lower Beta. Higher beta means that a company has a higher cost of raising capital. As beta affects the cost of capital, also the present value of the company.

This company, IBM has a beta of 1. 6302. This is higher beta which is in a wide sense greater than 1 meaning that the shares of IBM are highly volatile or sensitive to any change of any factor. Although the company has high returns of $ 6. 88 and a good market capitalization. The shareholder’ main concern is always what will be the returns tomorrow and since the IBM has a beta 1. 6302, the overall risk is high. The shareholders of IBM will view the investment in an IBM as a risky investment with a good return.

For those shareholders who are risk averse will tend to sell off their stocks for a company with fewer risks. But those shareholders with a preference of risk will keep their holdings and even attempt to acquire more. The Implications of Raising Capital Based On This Beta Beta is used in valuing stock and helps in portfolio decision making, through estimating the discount rates or the cost of raising equity. IBM Beta of 1. 6302 is high meaning a high discount rate. If the company decides to raise equity capital, the cost of equity will be very high.

The shareholders will receive high returns for their money since the discount rate will be high. Apart from the cost of raising this form capital being high other implications are: The price of the stock will be very high as compared to other stocks. Secondly, the shareholders will try to avoid the shares since they have a high price and even the capital intended to    be raised may not be raised. b) IBM being an innovation company, serving enterprises and institutions and have her presence worldwide, the company will merge with companies with similar products and services.

I will therefore choose Hewlett-Packard Development Company/Compaq. The said company has her presence worldwide and her Beta of IBM. Beta being a measure of volatability or sensitivity of stock, IBM shareholders will wish their mergers to have les risk as compared to theirs. Dell although a low beta with similar services and products her loan stock is higher. IBM has entered contracts that are likely to immerse its revenue base. also HP the same this will help the two merged companies. The merger  will also see the reduction of competition.

In IBM case the number of institutions holding shares is higher than that of HP. Among other factors to be considered in merging apart from the Beta cost of capital, politics that is how we will go around convincing shareholders of the importance of merging while most share held by institutions. If one mergers IBM with a company of high beta than 1. 6302 her prices will be very high and the cost of capital will also be very high making it very expensive when trying raising extra capital for investment.


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