Final answer:
The correct answer is that the capital asset pricing model assumes the reward-to-risk ratio is constant. It relies on the systematic risk represented by beta and can be applied to all firms, irrespective of dividend payment.
Step-by-step explanation:
The capital asset pricing model (CAPM) approach to equity valuation assumes the reward-to-risk ratio is constant (option E). The CAPM is a model that is used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio. It takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk), often represented by the quantity beta (β) in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset.
The model does not focus on unsystematic risk, since this type of risk can be largely mitigated through diversification. Instead, it is dependent upon systematic risk of a security (option A is incorrect). The CAPM does not assume that the reward-to-risk ratio increases as beta increases; it assumes the expected additional return from increased risk (higher beta) is linear, meaning the reward-to-risk ratio stays the same (option B is incorrect). CAPM can be applied to firms regardless of whether they pay dividends (option C is incorrect) and does not assume that a firm’s future risks will necessarily be higher than its current risks (option D is incorrect).