ABSTRACT
The picture of individual equilibrium valuation within a wider model of general equilibrium is known as the capital asset pricing model (CAPM). Capital market theory holds that the market offers no premium for risks that the individual investor is perfectly capable of neutralising by his own actions in diversifying his portfolio. The comparison of CAPM and traditional cost of capital lines highlights two kinds of error to which the traditional approach may be subject. Quite apart from the risk of business bankruptcy, the failure of investors to achieve full elimination of diversifiable risk constitutes a serious reservation in its own right about the validity of the CAPM in capital budgeting. Because of transactions costs, and information costs, investors may place additional value on the shares of firms that have undertaken the elimination of diversifiable risk on their behalf.
