Certified Management Accountant Practice Exam

The Capital Asset Pricing Model (CAPM) is designed specifically as a single-period model, meaning it calculates expected returns based on a specified one-period investment timeframe. This is particularly relevant because CAPM's formulation relies on the idea that an investor will receive a certain risk-adjusted return on an asset over that single period.

When applying CAPM to longer-term projects, it becomes difficult to estimate the expected returns accurately, as various factors can change over time, including interest rates, market conditions, and the risk profile of the investment. A model tailored for short-term assessments may not adequately capture the complexities and variations inherent in longer-term investments.

The limitations of the model's approach increase with the time horizon, as longer projects face more significant uncertainties and changing variables, making the assumptions of CAPM less valid. Therefore, its effectiveness is significantly diminished when stretched beyond the one-year boundary for project evaluation.