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:

• \( \text{Risk-Free Rate} \) — Typically the yield on government bonds (%)
• \( \beta \) — Measure of a stock's volatility relative to the market (unitless)
• \( \text{Market Return} \) — Expected return of the market (%)

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: Cost of equity is a crucial component in corporate finance for making investment decisions, evaluating projects, and determining a company's weighted average cost of capital (WACC).

4. Using the Calculator

Tips: Enter risk-free rate as a percentage (e.g., 2.5), beta coefficient (e.g., 1.2), and expected market return as a 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. For US, typically 2-5% depending on economic conditions.

Q2: How is beta determined?
A: Beta is calculated via regression analysis against a market index. A beta of 1 means the security's price 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 long-term.

Q4: What are CAPM's limitations?
A: Assumes markets are perfectly efficient, all investors hold diversified portfolios, and that beta remains stable over time.

Q5: Can CAPM be used for private companies?
A: Yes, but you'll need to estimate beta based on comparable public companies.