In comparing the constant-growth model and the capital asset pricing model (CAPM) to calculate the cost of common stock equity, ________.
A) the CAPM ignores risk, while the constant-growth model directly considers risk as reflected in the beta
B) the CAPM directly considers risk as reflected in the beta, while the constant-growth model uses the market price as a reflection of the expected risk-return preference of investors
C) the CAPM directly considers risk as reflected in the beta, while the constant growth model uses dividend expectations as a reflection of risk
D) the CAPM indirectly considers risk as reflected in the market return, while the constant growth model uses dividend expectations as a reflection of risk

Question

Quizplus · Accepted Answer

The CAPM considers risk through the use of beta, while the constant-growth model uses market price as a reflection of expected risk-return preferences of investors. The constant-growth model does not directly consider risk, but rather incorporates it into the required rate of return through the use of the market price. Therefore, choice B is the correct answer. The other options either contain inaccuracies or are not entirely correct.

In Comparing the Constant-Growth Model and the Capital Asset Pricing