Sample Essay
CAPM Model
Required rate of return = risk free rate + beta (market return – risk free return)
Risk free rate of return = YTM on one year US Government Treasury Bonds = 3%
Market Return – Risk Free Return = 7%
Beta = 1.2
Therefore, the required rate of return = 3 + 1.2 x 7
= 11.4%
This cost of capital for Tesla Motors is lower than the expectation, considering the company. Its required rate of return should be higher than the average for S&P 500 companies due to a variety of reasons. It operates in the market for electric cars which is not a highly developed commodity yet and is still undergoing massive research. Therefore, investing in the company is still a potentially risky proposition, although potential returns can also be high. Furthermore, the company has rarely turned a profit since its existence and has heavily invested in research and development which increases the time required for investors to bear fruits of their investments and may also increase uncertainty linked to the company.
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