Capital Structure: CAPM Assumptions: Investors use the Capital Asset Pricing Model (CAPM) in order to calculate the rate of return of assets and securities. The CAPM takes into account the sensitivity of the assets to systematic risk. Systematic risk cannot be diversified; therefore CAPM only considers the systematic risk when calculating the value of the asset. An investors expected return for an asset is the risk free rate plus the risk premium. The CAPM model has various assumptions regarding the capital market and the investors. Under CAPM investors are looked upon as logical and utility maximizing individuals who dislike risk. Investors are seen as people who are trying to make themselves as better off as possible by making more money and avoiding as much risk as possible. This may not be the case for all investors as there are some investors who prefer riskier investments due to the higher returns, while there are others who are willing to take the least expected return at a lower risk. Such assumptions are essential to make sure that the investors act according to the portfolio theory in order to compose an efficient investment portfolio. It also assumes that all investors have the same expectation from the uncertain future and that all investors have a single period time horizon of the investment. If the investors had different expectations i.e. if some of them were pessimists and the others were optimists there would be no possibility of stable market in share price and returns. CAPM is built on a single period rate of return and therefore, the decision making by investors is limited to that specific time horizon. The capital market is assumed to be perfect with no taxes, no transactions, no costs for information and that investors can borrow and lend at the ...