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 the risk of those assets and cost of capital.

2. How Does the Calculator Work?

The calculator uses the CAPM formula:

Where:

• \( Risk\ Free\ Rate \) — Typically the yield on 10-year government bonds (decimal form)
• \( Beta \) — Measure of a stock's volatility in relation to the market
• \( Market\ Premium \) — Expected return of the market minus the risk-free rate (decimal form)

Explanation: The model suggests that investors need to be compensated in two ways - time value of money (risk-free rate) and risk (beta times market premium).

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 all values in decimal form (e.g., 5% as 0.05). The risk-free rate and market premium should be consistent in terms of time horizon (typically long-term).

5. Frequently Asked Questions (FAQ)

Q1: What's a typical risk-free rate?
A: Usually the yield on 10-year government bonds. For US, this has historically been around 2-3%.

Q2: How do I find a company's beta?
A: Beta can be found on financial websites like Yahoo Finance or Bloomberg. It's calculated based on historical stock price movements relative to the market.

Q3: What's a reasonable market premium?
A: Historically, the US market premium has been about 5-6% over the risk-free rate, but this varies by market and time period.

Q4: Are there limitations to CAPM?
A: Yes, CAPM makes several simplifying assumptions and may not fully capture real-world market behavior. Alternatives like Fama-French three-factor model exist.

Q5: How often should I update these inputs?
A: For valuation purposes, inputs should be updated regularly as market conditions change, especially the risk-free rate and beta.