Corporate Finance

Cost of Equity (CAPM)

Calculate the expected return required by shareholders using the Capital Asset Pricing Model. Essential for DCF valuations and WACC calculations.

CAPM Variables

E.g., 10-Year Govt Bond Yield.

Market Volatility Multiplier.

Historical average return of the broad market (e.g. S&P 500 or Nifty 50).

Cost of Equity

Expected Return (Ke)

15.38%

Equity Risk Premium6.90%
Asset Classification:
Aggressive (Higher Volatility than Market)

Understanding CAPM Variables

  • Risk-Free Rate: This is the theoretical return of an investment with zero risk. In practice, the yield of a 10-year government bond is used (e.g., the US Treasury yield or the Indian G-Sec yield).
  • Beta (β): Beta measures a stock's volatility in relation to the overall market. A beta of 1.0 means the stock moves exactly with the market. A beta of 1.5 means it is 50% more volatile (risky) than the market. A beta of 0.5 means it is 50% less volatile (defensive).
  • Equity Risk Premium (ERP): This is the extra return that investors demand for taking on the risk of investing in the stock market instead of buying risk-free government bonds. (Market Return minus Risk-Free Rate).
  • Cost of Equity (Ke): The final output. This is the rate of return that a company must offer to compensate equity investors for the risk they undertake. It is a critical component in calculating a company's WACC (Weighted Average Cost of Capital).