Investment Valuation in India

There are basically two methods for computing the market values of the future cash flows of risky investment projects - Certainty Equivalent Approach and Risk Adjusted Discount Rate (RADR) method. The RADR method obtains the discount rates from widely used theories of risk and return such as Capital Asset Pricing Model (CAPM) and is thus impractical when Betas of comparison firms are difficult to estimate. In such cases where comparison firms do not exist and risk is required to be estimated, practical considerations suggest that Certainty Equivalent Method is a better valuation tool. The Present Value formula under Certainty Equivalent Method is given by: PV = SUM(Expected Future Cash Flows) - Beta (Risk of Tangency portfolio - Risk Free Rate)                                                          (1+ Risk Free Rate)

Capital asset pricing model The Security Market Line , seen here in a graph, describes a relation between the beta and the asset's expected rate of return. An estimation of the CAPM and the Security Market Line (purple) for the Dow Jones Industrial Average over the last 3 years for monthly data. The Capital Asset Pricing Model (CAPM) is used in finance to determine a theoretically appropriate required rate of return (and thus the price if expected cash flows can be estimated) of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset's non-diversifiable risk. The CAPM formula takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk), in a number often referred to as beta (β) in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset. The model was introduced by Jack Treynor, William Sharpe, John Lintner and...