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CAPM Formula for Retained Earnings:
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The Capital Asset Pricing Model (CAPM) calculates the cost of retained earnings by considering the risk-free rate, the stock's beta (volatility compared to the market), and the expected market return. It represents the return shareholders expect for investing in the company.
The calculator uses the CAPM formula:
Where:
Explanation: The formula calculates the minimum return investors require to hold the company's stock, considering both the time value of money (risk-free rate) and the risk premium for investing in equities.
Details: This calculation is crucial for corporate finance decisions, helping determine whether to reinvest profits or distribute them as dividends. It's a key component in weighted average cost of capital (WACC) calculations.
Tips: Enter the risk-free rate (as percentage), beta coefficient, and expected market return (as percentage). All values must be non-negative.
Q1: What's a typical risk-free rate?
A: Usually the yield on 10-year government bonds (e.g., 2-5% depending on economic conditions).
Q2: How is beta determined?
A: Beta is calculated by regressing stock returns against market returns. A beta of 1 means the stock moves with the market.
Q3: What market return should I use?
A: Historical average market returns are typically 7-10% annually, but forward-looking estimates may differ.
Q4: Why use CAPM for retained earnings?
A: Retained earnings represent equity capital, so their cost equals shareholders' required return, which CAPM estimates.
Q5: What are limitations of CAPM?
A: Assumes perfect markets, single-period horizon, and that beta fully captures risk. May not account for all risk factors in reality.