# Capital Asset Pricing Model

Can you help me to understand what are the critical assumptions in the Capital Asset Pricing Model (CAPM)? How do these affect its validity as a way to estimate equity cost of capital?

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#### Solution Preview

The CAPM is relatively simple. The main assumptions of this model are great in theory, however, there are things that don't fit perfectly into the mix:

Zero transaction costs. CAPM assumes that trading is free so investments all fall on the capital market line. If they do not, investments would hover either below or above the line. However that isn't true because many investments involve some costs.

Zero ...

#### Solution Summary

CAPM's critical assumptions and how they affect its validity as a way to estimate equity cost of capital.

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