can the capital asset pricing model serves as the basis for discounting multi-period risky cash flows?

Question

explain the above problem, and state and justify your answer

CAN ANYBODY PLEASE ANSWER THIS TO ME IN DETAIL AND GIVE PROPER REFRENCES FROM WHERE I CAN GET THE RELATED INFORMATION... FOR EG CASES, BOOKS AND JOURNALS

Answer 1

Risky cash flow means it is probablistic. You can take the weighted average of the risky cash flow for each year projected, that is if p1, p2, p3 are the probabilities of cash flow w1,w2, w3 for year one then the weighted average becomes, p1w1+p2w2+p3w3 = c1. This can be the expected cash flow for the first year. Like this all the probable cash flows can be calculated and capm discount rate applied to value capital assets. Again a weighted average will be a better proposition, like the effect of debt can be taken into consideration. That part of debt in the capital structure x cost of debt + (1-debt in capital structure)xcapm discount rate. This will be more rational denominator. Of course if the market is perfect and efficient capm works better. In other economies some times anomalies are encountered in calculating discount rate since some times some complain about negative Po being reached with growth rate larger than discount rate in the Po=d1/ks-g equation. This can be avoided in such markets by calculating the expected return first and then using that ks as the discount rate to calculate the prior period price.
The justification is this risk turns out to be non systeatic which can be diversified away in the portfolio. So expected cash flow is a good surrogate for the risk involved and one is not taking undue risk since the industry/companay specific risk is diversifiable.

Answer 2

Because there are multi periods, assume that there are differing levels of risk attached to each and that risk is significant so a straightforward WACC will not properly price for risk. Multi-period risky cash flows are better assessed using the project financing approach which (from memory now!) is based on the capital asset pricing model but with adjustments to the beta to compensate.

Hope that helps, or at least sounds like something you have spoken about. If not tell me and I will remove it.