1. What is the Capital Asset Pricing Model (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:

• \( R_f \) — Risk-free rate (typically government bond yield)
• \( \beta \) — Beta coefficient (measure of systematic risk)
• \( R_m \) — Expected market return
• \( R_m - R_f \) — Market risk premium

Explanation: The model shows that the expected return on equity equals the risk-free return plus a risk premium based on the asset's systematic risk.

3. Importance of Cost of Equity Calculation

Details: The cost of equity is a key component in determining a company's weighted average cost of capital (WACC), which is used in capital budgeting and valuation. It represents the compensation investors require for bearing the risk of owning the stock.

4. Using the Calculator

Tips: Enter the risk-free rate (as percentage), beta coefficient (unitless), and expected market return (as percentage). All values must be non-negative.

5. Frequently Asked Questions (FAQ)

Q1: What is a typical risk-free rate?
A: Usually the yield on 10-year government bonds of the country where the investment is made (e.g., 10-year Treasury yield for US investments).

Q2: How is beta determined?
A: Beta is typically estimated by regressing the stock's 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 often used (typically 8-10% for US markets), but forward-looking estimates can also be used.

Q4: Are there limitations to CAPM?
A: Yes, CAPM makes several simplifying assumptions (efficient markets, rational investors, etc.) that may not hold in reality.

Q5: When should I use this calculation?
A: When valuing companies, determining discount rates for DCF analysis, or making investment decisions that require a hurdle rate.