2.9  Modified Form of CAPM

Whereas CAPM provides a technique for the calculation of the required return for a given investment, the modified form of CAPM is a refinement to the approach for the specific circumstances of assessing the Discount Rate applicable to PSC and PPP cash flows.  Starting with the assumption that the PSC cash flows contain no Systematic Risk and the PPP cash flows contain 50 per cent of the overall Systematic Risk for the project, then, if the Risk Free Rate is 5 per cent and the overall Systematic Risk of the project is 2 per cent then the following Discount Rates will apply:

•  PSC:  Risk Free Rate applies, i.e. 5 per cent

•  PPP:  Risk Free Rate plus Systematic Risk transferred, i.e. 6% (5% + (50% x 2%))

The modified form of CAPM looks to equate the risks reflected in the cash flows, in this case the PPP cash flows which contain a price inclusive of Systematic Risk, with the Discount Rate.