1. What is the CAPM Model?

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 formula:

Where:

• \( Rf \) — Risk-free rate (decimal)
• \( \beta \) — Beta coefficient (decimal)
• \( Rm \) — Expected market return (decimal)
• \( (Rm - Rf) \) — Market risk premium

Explanation: The model shows that the expected return on equity is equal to the risk-free return 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 for making investment decisions, valuing companies, and determining the cost of capital. It represents the compensation investors require for bearing the risk of owning the stock.

4. Using the Calculator

Tips: Enter all values as decimals (e.g., 0.05 for 5%). Typical risk-free rates are based on government bond yields, beta is available from financial data providers, and market return is typically based on historical averages.

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.

Q2: How is beta determined?
A: Beta is calculated by regressing the stock's returns against the market's returns, typically using 3-5 years of monthly data.

Q3: What market return should I use?
A: Historical average returns of a broad market index (like S&P 500) are commonly used, typically 8-10% annually for US markets.

Q4: What are the limitations of CAPM?
A: Assumes markets are efficient, investors hold diversified portfolios, and beta remains stable over time - which may not always hold true.

Q5: Are there alternatives to CAPM?
A: Yes, including the Dividend Discount Model (DDM) and Arbitrage Pricing Theory (APT), though CAPM remains the most widely used.