π CAPM Calculator β Capital Asset Pricing Model
Calculate the expected return on any asset using the Capital Asset Pricing Model (CAPM).
CAPM Formula
CAPM is the foundation of modern portfolio theory. It says you should be compensated for: (1) time value of money (risk-free rate), plus (2) market risk (beta Γ market risk premium). Idiosyncratic (firm-specific) risk earns no premium.
>The Capital Asset Pricing Model Explained
CAPM: Expected Return = Rf + Ξ² Γ (Rm β Rf). Where Rf is the risk-free rate (typically 3-month T-bill or 10-year Treasury yield), Ξ² (beta) is the stock's sensitivity to market movements, and (Rm β Rf) is the equity risk premium β the additional return investors demand for taking on stock market risk over risk-free assets. The historical US equity risk premium is approximately 4β6% above the risk-free rate.
CAPM in Practice: Cost of Equity
CAPM is the most widely used method for estimating cost of equity in WACC calculations. CFOs and investment bankers use it daily: "Our beta is 1.2, T-bill rate is 5%, equity risk premium is 5.5%, so our cost of equity is 5% + 1.2 Γ 5.5% = 11.6%." This feeds directly into discounted cash flow valuations. Small errors in beta or risk premium assumptions can move valuations by 15β20%.
People Also Ask
Use the current yield on 10-year US Treasury bonds for long-horizon analysis (DCF valuation). Use the 3-month T-bill rate for short-horizon expected returns. In 2024, the 10-year Treasury yield was approximately 4.2β4.8%. Always use a current rate β using historical averages when rates have changed dramatically produces materially wrong results.
Aswath Damodaran (NYU) publishes monthly equity risk premium estimates. The geometric historical premium (1928βpresent) is ~4.5%; the arithmetic premium is ~6.5%. Most practitioners use 4.5β5.5% for WACC purposes. The implied ERP from current market prices fluctuates more β Damodaran estimated ~4.6% as of early 2024.
CAPM assumes a single risk factor (market beta), but empirical research shows that size (small-cap premium), value (book-to-market), momentum, and profitability factors also explain returns. The Fama-French three-factor and five-factor models extend CAPM to capture these additional risk premiums. CAPM also assumes normally distributed returns and rational investors β both questionable in practice.