How to use the CAPM calculator
- Choose the market input. Enter the equity risk premium directly, or enter your expected return for the whole stock market and let the calculator subtract the risk-free rate.
- Risk-free rate. The 10-year Treasury yield is the usual choice for valuing a company.
- Beta. Take it from a data provider or calculate it from returns with the beta calculator. A beta of 1.0 means the stock moves in line with the market.
- Premiums (optional). Add a size premium or a company-specific premium if you follow a build-up approach.
The results show the cost of equity, the stock’s own risk premium (beta times the equity risk premium) and how it compares with the expected market return. The table lists the cost of equity for betas from 0.5 to 2.0, and the chart draws the security market line.
The CAPM formula
Build-up: Re = Rf + β × ERP + Size premium + Company-specific premiumRe is the cost of equity, Rf the risk-free rate, β the stock's beta and Rm the expected market return. Rm − Rf is the equity risk premium (ERP).
The model says investors are paid for one kind of risk only: exposure to the market as a whole, measured by beta. Risk specific to one company can be diversified away by holding many stocks, so CAPM gives it no reward.
A worked example
A stock has a beta of 1.2. The 10-year Treasury yields 4.25% and you assume an equity risk premium of 5%, which puts the expected market return at 9.25%.
The stock’s risk premium is 1.2 × 5% = 6.00%, so its cost of equity is 10.25%, 1.00% more than the market because the stock amplifies market moves.
If you treat the business as a small company with concentrated risks and add a 2% size premium and a 1.5% company-specific premium, the build-up cost of equity becomes 13.75%.
Entering an expected market return of 10% instead of a premium implies an ERP of 5.75% and a cost of equity of 11.15%.
The security market line
The chart plots the required return for every beta. It starts at the risk-free rate, where beta is zero, and passes through the market return at a beta of 1.0. Its slope is the equity risk premium. A stock expected to return more than the line for its beta looks cheap under CAPM; one expected to return less looks expensive.
Which input moves the answer most
| Change from the example | Cost of equity |
|---|---|
| The example (beta 1.2, risk-free 4.25%, ERP 5%) | 10.25% |
| Beta 0.8 | 8.25% |
| Beta 1.6 | 12.25% |
| Risk-free rate 3.25% | 9.25% |
| Risk-free rate 5.25% | 11.25% |
| Equity risk premium 4% | 9.05% |
| Equity risk premium 6% | 11.45% |
A change in the risk-free rate passes through one for one, whatever the beta. A change in the equity risk premium is multiplied by beta, so it moves high-beta stocks most. Beta itself is the shakiest input: estimates for the same stock differ with the period, the frequency of returns and the index used. Many analysts use an adjusted beta, pulled toward 1.0, or the average beta of comparable companies.
Where the cost of equity is used
The result feeds the WACC, which discounts free cash flow to the whole firm in a DCF. It is also the discount rate for models that value the shares directly, such as the dividend discount model, and the hurdle for return on equity: a company whose ROE stays below its cost of equity is not earning what its shareholders require.
What this calculator does not include
CAPM is a single-factor model. Academic research, notably the Fama–French factor models, has found that size, value, momentum and profitability also help explain returns, and multi-factor models add premiums for them. The model assumes beta is stable and that investors are diversified, neither of which holds exactly. Size and company-specific premiums are judgment calls without a precise formula; published size premiums vary by source and period. Use the result as a reasoned estimate and test how much your valuation depends on it.