Limitations of CAPM and Fama-French three-factor model

Limitations of CAPM and Fama-French three-factor model

 No introduction and conclusion needed
 Straight into discussion
 Please include the links from the other document as references
 The first part (275 words):
o Limitations of CAPM: Security Market Line (SML) using a single
factor (beta) when calculating investors' required returns, debt
cost of capital, the cost of capital (the appropriate discount rate
to calculate the net present value of Company A’s new
investment project)
for example The formula for required return using CAPM: r=����+β*(����-
����), where average ����= 0.136%, market risk premium ����-����=0.593%,
and the estimated beta β= 0.447. Therefore, the monthly equity cost of
capital using the Security Market Line is r=0.00136+0.447*0.593=0.446%.
Please state the limitations of using SML for calculating these
variables
o Limitations of the Fama-French (1997) three-factor model when
calculating investors' required returns, debt cost of capital, the
cost of capital (the appropriate discount rate to calculate the net
the present value of Company A’s new investment project)

For example: By using the Fama-French method, r= ����+�����(����-����)+
�������(SMB)+ ���������(HML), where ����=0.136%, ����-����=0.593%, and
the �����=0.447, �������=0.159, size risk premium SMB=0.339%,
���������=0.0792, value risk premium HML=0.169%.
Therefore, the monthly required return on Company A’s equity
r=0.00136+0.447*0.00593+0.159*0.00339+0.0792*0.00169=0.454%.
Yearly equity cost of capital ����= (1+monthly rate)^12-1=
(1+0.00446)^12-1=5.49%.
Please state the limitations of using the Fama-French method for calculating
these variables

 The second part (275 words): How to refine the above analysis given more
time and information, give suggestions

*PLEASE REMEMBER TO DISCUSS LIMITATIONS OF CAPM (SML) AND FAMA-
FRENCH THREE FACTOR MODEL IN CALCULATING INVESTORS' REQUIRED
RETURNS, DEBT COST OF CAPITAL AND THE COST OF CAPITAL IN FIRST
PART, DISCUSS HOW TO MAKE THE ANALYSIS BETTER IN SECOND PART

ANSWER.

PAPER DETAILS
Academic LevelMaster’s
Subject AreaFinance
Paper Type Critical thinking
Number of Pages1 Page(s)/550 words
Sources5
Paper FormatHarvard
SpacingSingle spaced
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