Imbal Hasil Dan Biaya Modal

Imbal Hasil dan Biaya Modal
Manajemen Keuangan
Pertemuan ke-9
Chapter 5 dan 15
Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

Learning Plan
Chapter 5. Risk and Return Chapter 15. Required Returns and the
Students are able to define, explain, and Cost of Capital
analyze Risk and Return. Students are able to define, explain, and
Required Returns and the Cost of Capital
Sub-Materials:
➢ Defining Risk and Return Sub-Materials:
➢ Using Probability Distributions to ➢ Creation of Value
Measure Risk ➢ Overall Cost of Capital of the Firm
➢ Attitudes Toward Risk ➢ The CAPM: Project-Specific and
➢ Risk and Return in a Portfolio Context Group-Specific Required Rates of Return
➢ Diversification ➢ Evaluation of Projects on the Basis of
Their Total Risk
➢ The Capital-Asset Pricing Model (CAPM)
➢ Efficient Financial Markets
Risk and Return
Return
What ? Income received on an investment plus any change in

market price, usually expressed as a percentage of
the beginning market price of the investment.
Return
Formula ? For common stock we can define one-period return as:
R is the actual (expected) return when t refers to a particular

time period in the past (future); Dt is the cash dividend at the
end of time period t; Pt is the stock’s price at time period t ;
and Pt −1 is the stock’s price at time period t − 1.
Return
Example ? You buy for $100 a security that would pay $7 in cash to you
and be worth $106 one year later. How much the return?
Answer:
The return would be ($7 + $6)/$100 = 13%.

Risk
What ? The variability of returns from those that are

expected.
Example of Risk
US Treasury note (T-note) Vs Common Stock
● If you buy US Treasury note ● If you buy a share of common stock in

(T-note) with exactly one year any company and hold it for one year.
remaining until final maturity, to ● The cash dividend and the year-end
yield 8 percent. price of the stock may or may not
● If you hold it for the full year, you materialize as expected.
will realize a ● A common stock's actual return may
government-guaranteed 8 differ from the expected return due to
percent, return on your factors like unpredictable dividends
investment – not more, not less. and fluctuating stock prices, making it
● T-note is considered risk-free a risky investment.
because the return is certain. ● The more uncertain the outcome, the
riskier the investment.
Probability Distributions to Measure Risk
What ? Probability distribution is a set of possible values that a

random variable can assume and their associated
probabilities of occurrence.
Probability distribution can be summarized in terms of two parameters:
1. The expected return

2. The standard deviation
Expected Return
What ? The weighted average of possible returns, with the

weights being the probabilities of occurrence.
Expected Return
Formula ?
Where:
Ri is the return for the ith possibility,
Pi is the probability of that return occurring, and
n is the total number of possibilities
Standard deviation
What ? A statistical measure of the variability of a distribution

around its mean. It is the square root of the variance.
Standard deviation
Formula ?
Where:
Ri is the return for the ith possibility
R̄ is expected return
Pi is the probability of that return occurring
n is the total number of possibilities
Example of Expected Return and Standard deviation
Illustration of the use of a probability distribution of possible one-year returns to

calculate expected return and standard deviation of return
Coefficient of Variation
What ? The ratio of the standard deviation of a distribution to

the mean of that distribution. It is a measure of
relative risk.
Formula ?
Coefficient of Variation
The larger the CV, the larger the relative risk of the investment. Although
Investment B has a higher standard deviation, indicating higher absolute
risk, its CV (0.33) is lower than Investment A's CV (0.75), meaning
Investment A is riskier relative to its expected return.
Soal Latihan: Risk and Return





Tugas: Risk and Return
Tugas: Risk and Return
Attitudes Toward Risk
● The contestant has to choose between two doors:

one with $10,000 in cash and the other with a
worthless item (a "zonk").
● The expected value of choosing either door is
$5,000 (since there's a 50/50 chance of getting
$10,000 or nothing).
● Before revealing the prize, the host offers the
contestant a sum of money to forgo their choice.
● The contestant must decide how much money

would make them indifferent between accepting
the sure cash or risking the gamble behind the door.
Certainty equivalent (CE)

What is the certainty equivalent?

● The amount that gives the same satisfaction as the
risky bet.
● The amount of money a person would accept with
certainty rather than taking a gamble.
● The contestant decides that if offered $3,000 or more,

they would take the cash instead of the gamble,
showing risk aversion.
● Since the certainty equivalent ($3,000) is less than
the expected value ($5,000), the contestant prefers
the sure thing, highlighting that most individuals are
risk-averse.
● Certainty equivalent < expected value,

risk aversion is present.
● Certainty equivalent = expected value,
risk indifference is present.
● Certainty equivalent > expected value,
risk preference is present.

Portfolio
What ? A combination of two or more securities or assets.

Portfolio Return
?
● The expected return of a portfolio is simply a
weighted average of the expected returns of the
securities constituting that portfolio.
What
● The weights are equal to the proportion of total
funds invested in each security (the weights must
sum to 100 percent).

Portfolio Return
Formula ?
● Wj is the proportion, or weight, of total funds
invested in security j
● R̄j is the expected return for security j
● m is the total number of different securities in the
portfolio.

Example Portfolio Return
If equal amounts of money are invested in the two securities, the

expected return of the portfolio is:
(0.5)14.0% + (0.5)11.5% = 12.75%.

Soal Latihan: Portfolio Return
● Sebuah portofolio yang terdiri dari 3 jenis saham ADHI,

BBCA dan WSKT menawarkan return yang diharapkan
masing-masing sebesar 25%, 20% dan 15%.
● Persentase dana yang diinvestasikan pada saham ADHI
sebesar 40%, saham BBCA 35% dan saham WSKT 25%.
● Berapa return portofolio yang diharapkan?

Covariance
What ? ●
●
Covariance is a statistical measure of the degree to
which two variables (e.g., securities’ returns) move
together.
Covariance shows the relationship between the
returns on securities.

Covariance
● Positive covariance shows that, on average, the two

variables move together.
● Negative covariance suggests that, on average, the
two variables move in opposite directions.
● Zero covariance means that the two variables show
no tendency to vary together in either a positive or
negative linear fashion.

Covariance
Formula ?
● Rj,i and Rk,i are the returns for securities j and k for
the ith possibility
● R̄j and R̄k are the expected returns for securities j
and k
● Pi is the probability of the ith possibility occurring,
and n is the total number of possibilities

Portfolio Risk
The total risk of a portfolio is measured by the portfolio’s standard deviation, σp.
Formula:
● m is the total number of different securities in the portfolio, Wj is the

proportion of total funds invested in security j.
● Wk is the proportion of total funds invested in security k.
● σj,k is the covariance between possible returns for securities j and k.

Example Portfolio Standard Deviation
Stock 1 Stock 2
Expected Return 16% 14%
Standard Deviation 15% 12%
Weight 50% 50%
The correlation coefficient between the two stocks is 0.40.

Example Portfolio Standard Deviation
The standard deviation for the portfolio is found by summing up all the elements in
the following variance-covariance matrix and then taking the sum’s square root.
Soal Latihan: Portfolio Risk
● Portofolio yang terdiri dari saham A dan B

masing-masing menawarkan return sebesar 10% dan
25%; serta standar deviasi masing-masing sebesar 30%
dan 60%. Koefisien korelasi antara kedua saham
tersebut sebesar 0.20.
● Alokasi dana investor pada kedua aset tersebut
masing-masing sebesar 50% untuk setiap aset.
● Berapa standar deviasi untuk portofolio tersebut?

Diversification
“Don’t put all your eggs in one basket.”
● Purpose: Reduce risk by spreading investments across

different assets or securities.
● Meaningful Diversification: Combining securities with low
correlation to achieve better risk reduction,

Diversification
Effect of diversification on portfolio risk
● Returns for Security A are cyclical (moving with the economy), while
Security B's returns are countercyclical (moving opposite to the economy).
● Investing equally in both reduces the portfolio’s overall return variability
because their individual risks offset each other.
Systematic and Unsystematic Risk
Total portfolio risk comprises two components:
Systematic risk Unsystematic risk

Also known as non-diversifiable or Also known as diversifiable or avoidable risk, it
unavoidable risk, it affects the entire market is specific to a company or industry.
or economy. It arises from factors like It includes risks like company strikes, new
changes in the national economy, competitors, or technological changes that
government policies, or global events (e.g., make products obsolete.
energy crises).
Capital-Asset Pricing Model (CAPM)
What ? A model that describes the relationship between risk

and expected (required) return; in this model, a
security’s expected (required) return is the risk-free
rate plus a premium based on the systematic risk of
the security.
CAPM Assumptions
1. Capital markets are efficient

Investors are well informed, transactions costs are low, there are
negligible restrictions on investment, and no investor is large
enough to affect the market price of a stock.
2. Homogeneous investor expectations over a given period.
3. Risk-free rate asset return is certain.
4. All the risk associated with the market portfolio is unavoidable,
or systematic.

The Characteristic Line
What ? A line that describes the relationship between an

individual security’s returns and returns on the
market portfolio. The slope of this line is beta.

The Characteristic Line
Relationship between excess returns for a stock and excess returns for
the market portfolio based on 60 pairs of excess monthly return data
Beta: An Index of Systematic Risk
What ? ●
●
It measures the sensitivity of a stock’s returns to
changes in returns on the market portfolio.
The beta of a portfolio is simply a weighted average
of the individual stock betas in the portfolio.

Characteristic lines with different betas
Obtaining Beta
?
● Beta can be calculated using past data on excess
returns of the stock and the market.
How ● Historical betas are provided by financial services
like Merrill Lynch, Reuters, dan PEFINDO, based on
weekly or monthly returns over the past three to five
years.
Required Rates of Return
● R̄j is the required rate of return for stock j,

● Rf is the risk-free rate of return,
● R̄m is the expected return for the market portfolio.
● βj is the beta of stock j (measures systematic risk of
stock j)

Example Required Rates of Return
Suppose that the expected return on Treasury securities is 8 percent, the

expected return on the market portfolio is 13 percent, and the beta of
Savance Corporation is 1.3. The beta indicates that Savance has more
systematic risk than the typical stock (i.e., a stock with a beta of 1.0).
Required return on Savance stock

Security Market Line (SML)
What ? A line that describes the linear relationship between

expected rates of return for individual securities (and
portfolios) and systematic risk, as measured by beta.

Security Market Line (SML)
Returns and Stock Prices
Intrinsic value of stock
● Dt is the expected dividend in period t

● ke is the required rate of return for the stock
● Σ is the sum of the present value of future
dividends going from period 1 to infinity.
In the perpetual dividend growth model, it simplifies to:
● g is the expected annual future growth rate in

dividends per share
Example of Intrinsic value of stock
Savance Corporation’s expected dividend of $2, a required return of

14.5%, and a growth rate of 10%.
Value of the stock

Changes in Market Conditions
The required return and stock value can change with market conditions, such
as inflation, interest rates, and investor risk aversion.
Changes in Market Conditions
The required rate of return for Savance stock, based on systematic risk, becomes
Using this rate as ke, the new value of the stock is
Thus the combination of these events causes the value of the stock to increase
from $44.44 to $71.43 per share.
Underpriced and Overpriced Stocks
Challenges to the CAPM
01 Anomalies
02 Fama and French Study
03 Multifactor Models
Anomalies
● Small-Firm Effect:
Stocks of small-cap firms tend to offer higher returns than large-cap firms.
● Low P/E and Market-to-Book Ratios:
Stocks with lower price/earnings and market-to-book-value ratios generally
outperform those with higher ratios.
● January Effect:
Stock returns tend to be higher from December to January compared to
other periods, though this does not occur consistently every year.

Fama and French Study
● Eugene Fama and Kenneth French found that firm size and
market-to-book-value ratios were more effective in explaining
average stock returns than beta.
● Their analysis showed that after accounting for these variables, beta
had little additional explanatory power, leading to the conclusion that
beta alone is insufficient to explain stock returns.
● While beta may not be a good predictor of realized returns, it still serves
as a reasonable measure of systematic risk, helping investors set
minimum expected returns.

Multifactor Models
● Multifactor models introduce additional factors to better explain

security returns, considering multiple sources of risk beyond the
market index.
● An example is the Arbitrage Pricing Theory (APT), which posits that
asset prices depend on various factors and assumes arbitrage
efficiency.
● The CAPM is a single-factor model, focusing only on market risk,
which limits its explanatory power.
● While these models offer greater accuracy, the CAPM remains a
practical and foundational framework in finance, helping understand
concepts like systematic risk, diversification, and risk premiums.

Efficient Financial Markets
What ? A financial market in which current prices fully reflect

all available relevant information.
Three Forms of Market Efficiency
1 Weak-form efficiency
Current prices fully reflect the historical sequence of prices. In short, knowing
past price patterns will not help you improve your forecast of future prices.
2 Semistrong-form efficiency
Current prices fully reflect all publicly available information, including such
things as annual reports and news items.
3 Strong-form efficiency
Current prices fully reflect all information, both public and private (i.e.,
information known only to insiders).
Required Returns and
the Cost of Capital
“To guess is cheap. To guess wrong is expensive”
—CHINESE PROVERB
We need to understand how risk affects the valuation of the enterprise.
Its effect on value is shown through the returns that financial markets expect the
corporation to provide on debt, equity, and other financial instruments (cost of
capital).
The greater the risk, the higher the returns (the required return) the financial
markets expect from a capital investment.

Creation of Value
If the return on a project exceeds what the financial markets require,
it is said to earn an excess return (creation of value/positive NPV).
Industry attractiveness and competitive advantage are principal sources of value

creation.
• Industry Attractiveness: • Competitive Advantage:
The relative position of an industry in the A company’s relative position within an
spectrum of value-creating investment industry.
opportunities;
A successful company is one that continually
Such us: positioning in the growth phase of a identifies and exploits opportunities (such us:
product cycle, barriers to competitive entry, cost advantage, marketing and price advantage,
patents, temporary monopoly power, and/or perceived quality advantage, and superior
oligopoly pricing. organizational capability/corporate culture) for
excess returns.

Creation of Value

Cost of Capital
The required rate of return on the various types of financing.

The overall cost of capital is a weighted average of the individual required rates of return (costs).
• Cost of Equity Capital

The required rate of return on investment of the common shareholders of the company.
• Cost of Debt
The required rate of return on investment of the lenders of a company.
• Cost of Preferred Stock
The required rate of return on investment of the preferred shareholders of the company.

Cost of Debt
The concern is long term-debt.
The explicit cost of debt can be derived by solving for the discount rate, kd.
P0: the current market price of the debt issue
It: the interest payment in period
Pt: the payment of principal in period t
kd: required rate of return
By solving for discount rate (kd), we obtain the required rate of return of the lenders to the company.
This required return to lenders can be viewed as the issuing company’s before-tax cost of debt.
All costs will be expressed on an after-tax basis, so the after-tax cost of debt:
Tt: marginal tax rate

Cost of Preferred Stock
The cost of preferred stock is a function of dividend.
The dividend is not a contractual obligation of the firm but, rather, is payable at the discretion of the
firm’s board of directors. Consequently, unlike debt, it does not create a risk of legal bankruptcy.
The preferred stock is a security that takes priority over their securities when it comes to the payment of
dividends and to the distribution of assets if the company is dissolved.
The cost of preferred stock:
Kp: cost of preferred stock

Dp: the stated annual dividend
P0: the current market price of the preferredstock
For example:
If a company were able to sell a 10 percent preferred stock issue ($50 par value) at a current market
price of $49 a share.
The cost of preferred stock is $5/$49 = 10.20%

Cost of Equity: Dividend Discount Model Approach
Equity capital can be raised either internally by retaining earnings or externally by selling common stock
the cost of capital as the minimum rate of return that the company must earn on the equity-financed
portion of an investment project in order to leave the market price of the firm’s common stock unchanged.
If an expected return less than this required return, the market price of the stock will suffer over the
long run.
The cost of equity capital (ke) as the discount rate that equates the present value of all expected future
dividends per share with the current market price per share.
P0: the market price of a share of stock at time 0

Dt: the dividend per share expected to be paid at the end of time period t
Ke: the appropriate discount rate
Σ: the sum of the discounted future dividends from period 1 through infinity,
depicted by the symbol ∞

Estimating Future Dividend
The expected future dividends are not directly observable, they must be estimated.
Given reasonably stable patterns of past growth, one might project this trend into the future.
we must temper our projection with current market sentiment, reviewing various analyses about the company in financial
newspapers and magazines.
Constant Growth
For example:
If dividends are expected to grow constant at an 8 percent annual rate. If the expected dividend in the first year were $2 and the
present market price were $27.
The discount rate (ke):
This rate would then be used as an estimate of the firm’s required return on equity capital.

Growth Phase
The transition in dividend growth is from an above-normal growth rate.
For example:
If dividends were expected to grow at a 15 percent compound rate for five years, at a 10 percent rate for the next five years, and
then grow at a 5 percent rate
D0: the current dividend

P0: the market price per share
If the current dividend, D0, were $2 a share and the market price per share, P0, were $70, ke would be 10.42 percent.

Cost of Equity: Capital-Asset Pricing Model
Rather than estimating the future dividend stream of the firm and then solving for the cost of
equity capital, we may approach the problem directly by estimating the required rate of return
on the company’s common stock.
The calculation of required rate of return in CAPM:

Rf: the risk-free rate
Bm: the expected return for the market portfolio
Βj: the beta coefficient for stock j.
Beta (the slope of line) is a measure of the responsiveness of the

excess returns for a security to those of the market.
The greater the beta of a stock, the greater its required return.
In market equilibrium, security prices will be such

that there is a linear trade-off between the required
rate of return and systematic risk, as measured by
beta.
For the example:
The beta for Schlosky’s Paint Company was found to be 1.20, based on monthly excess return data over the
last five years. This beta value tells us that the stock’s excess return goes up or down by a somewhat greater
percentage than does the excess return for the market. Thus, the stock of Schlosky’s Paint Company has
more unavoidable, or systematic, risk than does the market as a whole.
Management believes that this past relationship is likely to hold in the future. Furthermore, assume that a rate
of return of about 13 percent on stocks in general is expected to prevail and that a risk-free rate of 8 percent is
expected.
The caltulation required rate of return:

Risk-Free Rate and Market Return
With an upward-sloping yield curve (graph of the

relationship between yields and maturity),
the longer the maturity, the higher the risk-free rate.
The expected return on the market portfolio has exceeded the risk-free rate by anywhere from 5 to 8 percent in
recent years.
Owing to changes in expected inflation, interest rates, and the degree of investor risk aversion in society, both
the risk-free rate and the expected market return change over time

Cost of Equity:
Before-Tax Cost of Debt plus Risk Premium Approach
The firm’s before-tax cost of debt will exceed the risk-free rate by a risk premium.
The greater the risk of the firm, the greater this premium, and the more interest the firm must pay in order to
borrow.
For an equity beta of βe , an expected return of ke is required

and that this percentage exceeds the company’s before-tax
cost of debt, kd .
On the horizontal axis, the firm’s debt is shown to have

systematic risk equal to βd. As a result, its required return is
kd, which exceeds the risk-free rate of Rf .
The common stock of a company must provide a higher expected return than the debt of the same company
because there is more systematic risk involved.

For the example:
Schlosky’s Paint Company’s bonds sell in the market to yield 9 percent. The cost of equity:
This percentage would then be used as an estimate of the cost of equity capital.
The advantage of this approach is that one does not have to use beta information.
One disadvantage is that it does not allow for changing risk premiums over time.
Because the 5 percent risk premium is based on an average for companies overall, the approach is not as
accurate as either of the other methods discussed for estimating the required return on equity capital for
a specific company.

Weight Average Cost of Capital
We would assign weights to each financing source according to some standard and then calculate a
weighted average cost of capital (WACC).
Overall cost of capital:
kx: the after-tax cost of the xth method of financing
Wx: the weight given to that method of financing as a percentage of the firm’s total
financing
Σ: the summation for financing methods 1 through n.
For example:
A firm had the following financing at the latest
balance sheet statement date, the amounts shown
in the table below represent market values.

The firm computed the following after-tax costs for the component sources of financing:
The weighted average cost of capital for this example problem is
Each component is weighted according to

market value proportions

Latihan Soal: WACC
Perusahaan Jaya Abadi memiliki beberapa sumber pendanaan dengan

struktur berikut:
● Utang sebesar $50 juta, dengan biaya modal setelah pajak 5%.
● Saham preferen sebesar $20 juta, dengan biaya modal 8%.
● Saham biasa sebesar $80 juta, dengan biaya modal 12%.
Total pendanaan perusahaan adalah $150 juta. Hitunglah Weight Average

Cost of Capital (WACC) dari perusahaan tersebut!

Latihan Soal: Cost of Capital and WACC
Perusahaan Sinar Abadi membutuhkan modal yang akan digunakan untuk
pendanaan investasinya sebesar 2 Miliar rupiah. Berikut adalah jumlah dari
masing-masing pendanaan tersebut :
1. Hutang
Jumlah hutang 300 juta dengan total bunga tahunan Rp 70 juta. Tingkat
pajak 30%.
2. Saham Preferen
Jumlah 400 juta. Harga jual saham preferen Rp 31.250 per lembar
dengan dividen Rp 4.500 per lembar.
3. Saham biasa
Jumlah 1.100.000.000. Harga jual saham Rp 22.500, dengan dividen
sebesar Rp 3.125 setiap lembar dengan pertumbuhan 5%.
Hitunglah biaya modal individual dari masing-masing pendanaan dan biaya
modal keseluruhan menggunakan WACC.
Limitations of WACC
The firm’s real cost of capital depends on how accurately we have measured the individual marginal
costs, on the weighting system, and on certain other assumptions.
Weighting System
When calculating WACC, it's important to use the same proportions of debt, equity, etc., that the firm
plans to use for future investments. If the actual future proportions differ from what was used to
calculate WACC, it could lead to errors in investment decisions.
Floating Costs
The costs associated with issuing securities, such as underwriting, legal, listing, and printing fees.
The flotation costs requires that an adjustment be made in the evaluation of investment proposals.

The adjustment to initial outlay (AIO) method:
Treats the flotation costs of financing as an addition to the initial cash outlay for the project.
CFt: the project cash flow at time t
ICO: the initial cash outlay required for the project
K: the firm’s cost of capital
Example:
An investment proposal costs $100,000 and that to finance the project the company must raise $60,000 externally.
Both debt and common stock are involved, and after-tax flotation costs (in present value terms) come to $4,000.
Therefore $4,000 should be added to $100,000, bringing the total initial outlay to $104,000.
If the project were expected to provide annual after-tax cash inflows of $24,000 for 20 years and the weighted average cost of
capital were 20 percent.
The project net present value:
This amount contrasts with a net present value of $116,870 − $100,000 = $16,870 if no adjustment is made for flotation costs.

The adjustment to discount rate (ADR) method:
An upward adjustment of the cost of capital when flotation costs are present. Thus adjusts a project’s
discount rate for flotation costs and not the project’s cash flows.
Under this procedure, each component cost of capital would be recalculated by finding the discount
rate that equates the present value of cash flows to the suppliers of capital with the net proceeds of a
security issue, rather than with the security’s market price.
The resulting “adjusted” component costs would then be weighted and combined to produce an overall
“adjusted” cost of capital for the firm.

Why Calculate WACC
By financing in the proportions specified and accepting projects yielding more than the weighted
average required return, the firm is able to increase the market price of its stock.
This increase occurs because investment projects are expected to return more on their equity-financed
portions than the required return on equity capital (ke).
The firm has accepted projects that are expected to provide a return greater than that required by
investors at the margin, based on the risk involved.

Economic Value Added (EVA)
EVA: the economic profit a company earns after all capital costs are deducted.
It is a firm’s net operating profit after tax (NOPAT) minus a dollar-amount cost of capital charge.
Adjustments are suggested to NOPAT to reflect more of a cash rather than accrual accounting
approach to performance.
For example:
Infosys Technologies Limited, one of India’s largest Information Technology companies, follows a Stern
Stewart & Co. style approach to EVA. Based on figures reported in Infosys Technologies 2007 annual
report, here is a condensed version of their EVA calculation for fiscal year 2007:

CAPM to Project Selection
The required return for an equity-financed project:
Βk: the slope of the characteristic line (the relationship between excess returns for
project k and those for the market portfolio)
Rk: the required return for the project (the project’s systematic risk).
Assuming that the firm intends to finance a project entirely with equity, the acceptance criterion is its expected
return met or exceeded the required return (Rk).
The line in the figure represents the security market line.

All projects with internal rates of return lying on or above the
line should be accepted, because they are expected to
provide returns greater than or equal to their respective
required returns.
All projects lying below the line, shown by theo’s, would be
rejected.

The greater the systematic risk of a project, the greater the return that is required.
If a project had no systematic risk, only the risk-free rate would be required.
For projects with more risk, however, a risk premium is demanded, and it increases with
the degree of systematic risk of the project.
The goal of the firm, in this context, is to search for investment opportunities lying above
the line.

CAPM to Group-Specific Required Rates of Return
Some companies categorize projects into roughly risk-equivalent groups and then apply the same
CAPM-determined required return to all projects included within that group.
If the products or services of the group are similar with respect to risk and new proposals are of the
same sort, a group-specific required return is an appropriate acceptance criterion.
The Advantage: not as time-consuming as computing required returns for each project.
Capital is allocated on a risk-return basis specific to the systematic risk of the group.
Projects from a group that provide expected returns

above their group-specific bar should be accepted.
Those below their respective bars should be rejected.

Evaluation of Project on the Basis of Total Risk
• Risk-Adjusted Discount Rate
A required return (discount rate) that is increased relative to the firm’s overall cost of capital for projects
or groups showing greater than “average” risk and decreased for projects or groups showing less than
“average” risk.
• Probability Distribution Approach

One set of information that can be generated for an investment proposal is the probability distribution of
possible net present values.
From the expected value of the distribution, we can determine the probability that the net present value
of the project will be zero or less.

• Risk-Adjusted Discount Rate
In the RADR method, the discount rate is “adjusted” for risk by increasing it relative to the overall cost of capital
to compensate for greater risk and lowering it to account for less risk.
To visualize the RADR approach is to make use of the NPV profile.

NPV profile slightly to highlight not only the use of the “average” risk RADR, but also what would happen to our
analysis under two other possible situations.
What if:
• The project is “below average” risk
• The project is of “above average” risk
With an IRR of approximately 17 percent and an NPV of

$10,768 at the firm’s cost of capital of 12 percent, we
recommended that the project be accepted.

• Probability Distribution Approach
The management would accept an investment proposal having an expected value of net present value of zero unless
the probability distribution had no dispersion.
A real problem with this approach is that we cannot relate it directly with the effect of project selection on share
price.
Thus, any success in using this method

depends entirely on the perceptiveness of
management in judging investors’ trade-off
between profitability and risk

TERIMA KASIH

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Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

What ? Income received on an investment plus any change in

Formula ? For common stock we can define one-period return as:

R is the actual (expected) return when t refers to a particular

The return would be ($7 + $6)/$100 = 13%.

What ? The variability of returns from those that are

● If you buy US Treasury note ● If you buy a share of common stock in

What ? Probability distribution is a set of possible values that a

Probability distribution can be summarized in terms of two parameters:

1. The expected return

What ? The weighted average of possible returns, with the

What ? A statistical measure of the variability of a distribution

Illustration of the use of a probability distribution of possible one-year returns to

What ? The ratio of the standard deviation of a distribution to

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

● The contestant has to choose between two doors:

● The contestant must decide how much money

Certainty equivalent (CE)

What is the certainty equivalent?

● The contestant decides that if offered $3,000 or more,

● Certainty equivalent < expected value,

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

What ? A combination of two or more securities or assets.

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

If equal amounts of money are invested in the two securities, the

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

● Sebuah portofolio yang terdiri dari 3 jenis saham ADHI,

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

● Positive covariance shows that, on average, the two

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

● m is the total number of different securities in the portfolio, Wj is the

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

The correlation coefficient between the two stocks is 0.40.

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

● Portofolio yang terdiri dari saham A dan B

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

“Don’t put all your eggs in one basket.”

● Purpose: Reduce risk by spreading investments across

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

Systematic risk Unsystematic risk

What ? A model that describes the relationship between risk

1. Capital markets are efficient

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

What ? A line that describes the relationship between an

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

● R̄j is the required rate of return for stock j,

Fakultas Ekonomika dan Bisnis | Universitas Diponegoro

Suppose that the expected return on Treasury securities is 8 percent, the

Required return on Savance stock