1. What is the CAPM?

The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks. It is widely used throughout finance for pricing risky securities and generating expected returns for assets given their risk.

2. How Does the Calculator Work?

The calculator uses the CAPM equation:

Where:

• \( K_e \) — Cost of equity (decimal)
• \( R_f \) — Risk-free rate (decimal)
• \( \beta \) — Beta coefficient (unitless)
• \( R_m \) — Expected market return (decimal)

Explanation: The model shows that the expected return on equity is equal to the risk-free return plus a risk premium that depends on the asset's beta and the market risk premium.

3. Importance of Cost of Equity

Details: Cost of equity is a key component in calculating a company's weighted average cost of capital (WACC), which is used in financial modeling and valuation.

4. Using the Calculator

Tips: Enter all values as decimals (e.g., 5% = 0.05). Risk-free rate is typically the yield on government bonds. Market return is the expected return of the market portfolio.

5. Frequently Asked Questions (FAQ)

Q1: What is a typical risk-free rate?
A: Usually the yield on 10-year government bonds. For US companies, this would be the 10-year Treasury yield.

Q2: How is beta determined?
A: Beta is typically estimated by regressing the stock's returns against the market's returns over a period (usually 3-5 years).

Q3: What market return should I use?
A: Historical equity risk premium is often used, typically around 5-6% above the risk-free rate for US markets.

Q4: What are limitations of CAPM?
A: Assumes markets are efficient, investors hold diversified portfolios, and beta remains stable over time - none of which are perfectly true.

Q5: When should I use this calculation?
A: When valuing companies, evaluating investment projects, or determining hurdle rates for capital investments.