CAPM & beta
The capital asset pricing model estimates a required return on equity as the risk-free rate plus equity beta times the market risk premium. Equity beta is the dimensionless sensitivity of equity returns to market returns. It is one cost-of-equity model, not a source for every valuation discount rate.
CAPM & beta in round numbers
Hypothetical: use annual US-dollar inputs of a 4% risk-free rate and 5% market risk premium, with an equity beta of 1.2 appropriate to the modeled equity risk. The estimated annual cost of equity is 4% + 1.2 × 5% = 10%. Align the currency, period and risk basis of the inputs.
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| Input / result | Value |
|---|---|
| Annual risk-free rate | 4% |
| Equity beta | 1.2 |
| Annual market risk premium | 5% |
| Annual cost of equity | 4% + 1.2 × 5% = 10% |
Terms Related to CAPM & beta
Discount rate · WACC · DCF · Sharpe ratio · All of the glossary