Capital Asset Pricing Model and Equity Financing
It is important to note the fact that each theory has its advantages and disadvantages. The main strength of the capital asset pricing model (CAPM) is the mathematical apparatus formulated by the given theoretical framework, which makes it possible to automate and simplify the process of forming an investment portfolio, as well as the ability to graphically present information about a portfolio set. For example, the small market line allows to visually and graphically illustrate the underlying theory of CAPM. The main weakness of the theory of investment portfolio is its complexity in terms of practical application. This theory does not define the criteria for the inclusion and exclusion of financial instruments from the portfolio. In addition, the methodology of this theory is based on a retrospective analysis without forecasting. For example, it can be noted that portfolio theory is not applicable in situations of the general deterioration of the market situation (Bao et al., 2018). Despite the rather significant shortcomings, this portfolio theory is still used today as part of the investor’s tools.
The best option is equity financing because it does not involve the refund process, and there is a smaller risk factor. Debt’s main strength is that no portion of a company or organization is sold, whereas equity financing does include the latter part. However, debt also requires a full refund with interest, which means that net cash flow will be determined by the profits made by the borrowed sum. In the case of equity financing, no such refund takes place, and therefore, there always will be a certain degree of profitability (Drover et al., 2017). In addition, one can determine what portion of an organization will be sold, which means that key decision-making power and ownership degree can still be significant after selling a small portion of a company. Equity financing does not remove any money from a business, which is always beneficial, especially during risk-averse approaches. Debt involves a certain degree of risk of being able to repay the sum. The interest rates can also be substantially high, which will inevitably put a severe strain on the business.
Bao, T., Diks, C., & Li, H. (2018). A generalized CAPM model with asymmetric power distributed errors with an application to portfolio construction. Economic Modelling, 68, 611–621.
Drover, W., Busenitz, L., Matusik, S., Townsend, D., Anglin, A., & Dushnitsky, G. (2017). A review and road map of entrepreneurial equity financing research: Venture capital, corporate venture capital, angel investment, crowdfunding, and accelerators. Journal of Management, 43(6), 1820-1853.