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CAPM
Capital Asset Pricing Model
A formula to estimate the return shareholders expect, based on market risk.
Detailed explanation
CAPM adds a risk premium to the risk-free rate, scaled by the stock's beta.
Formula
Ke = Risk-free rate + Beta × (Market return − Risk-free rate)
Example
Rf 7%, beta 1.2, equity risk premium 6% → Ke = 7 + 7.2 = 14.2%.
Why it matters
Standard way to get cost of equity for WACC.
Key points
- Uses beta as the only risk measure.
- Risk-free rate often a government bond yield.
- Inputs are estimates.
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Educational content only. Definitions and examples are illustrative and are not investment, tax or legal advice.