Question

What are the pros and cons of using risk-adjusted costs of capital for individual investments?

Answer 1

The pros and cons of using risk-adjusted costs of capital for individual investments are as follows

Pros are that

1. It considers only and only systemmatic risk which shows the reality or facts. In this there is totally no use of unsystemmatic risk.

2. It is derived or based on the risk and return relationships of the market.

3. It is far better than the dividend growth model for calculating the ke that is cost of equity.

4. It is calculated taking the proportionate weights of all the securities

Cons are as follows :-

1. In this the risk free rate is fixed while the risk free rate is also changed time to time as per the economic condotoons.

2. The another disadvantage of it is that it is very difficult to find out the market risk premium. And also there is a uncertainity of the expected returns as the value or Beta that is systematic risk changes time to time.