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's widely used throughout finance for pricing risky securities and generating expected returns.

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 cost of equity equals the risk-free rate plus a risk premium based on the stock's beta.

3. Importance of Cost of Equity

Details: Cost of equity is a crucial component in corporate finance, used for capital budgeting decisions, valuation of companies, and determining the weighted average cost of capital (WACC).

4. Using the Calculator

Tips: Enter all values as decimals (e.g., 0.05 for 5%). Risk-free rate is typically the yield on government bonds. Beta can be found for public companies from financial data providers.

5. Frequently Asked Questions (FAQ)

Q1: What's a typical risk-free rate?
A: Often the 10-year government bond yield is used (e.g., 0.02-0.05 in decimal form).

Q2: How is beta determined?
A: Beta is calculated by regressing the stock's returns against market returns. A beta of 1 means the stock moves with the market.

Q3: What's a reasonable market risk premium (Rm - Rf)?
A: Historically about 0.05-0.08 (5-8%), though this varies by market and time period.

Q4: Are there limitations to CAPM?
A: Yes, it assumes markets are efficient, investors are rational, and that beta fully captures risk.

Q5: When should I use this calculation?
A: When valuing companies, evaluating investment projects, or determining required rates of return.