Financing New Ventures Assignment Example | Topics and Well Written Essays - 500 words

Financing New Ventures - Assignment Example This has paved way for diversification in investment According to (Harrington, 1987) it allows the investor to avoid unsystematic risks such as poor management of the company which will automatically lead to returns not being realized. From this model a linear relationship has been developed to show the relationship between systematic risk and the expected return. As compared to weighted average cost of capital (WACC) this model gives a robust discount rate that can be used for assessing the investment. Using WACC a project can be turned down when its internal rate of return is less that of WACC. This is because WACC is based on the assumption that any investment doesn’t have an effect to financial and business risk. Using CAPM, gives internal rate of return that is higher than the security market line and a return that can minimize or eliminate system risk. CAPM is considered as the best tool to calculate the cost of equity as compared Dividend Growth Model (DGM). This is because it takes into account the systematic risk level of the business relative to stock market. Portfolio effect refers to the addition of other investment into the portfolio with aim of reducing risk. This can be termed as diversification of portfolio such that change in the value of one investment e.g. bond in the portfolio there will be a response to change in the value of other assets in the portfolio. Portfolio effect has the ability to minimize a specific risk attached to an asset in a given portfolio, but this depends or lies on the degree of correlation of assets held in the portfolio (Hirt & Block, 1990). Diversifying portfolio can be achieved in either horizontal or vertical diversification both will help to reduce the risk associated to a given asset, vertical diversification occurs when an investor decides to add different form of assets or securities in his portfolio e.g. cash, corporate bonds, and building. This is advisable since whenever a