CAPM Calculator
Cost of equity from the risk-free rate, beta, and the expected market return.
A β of 1.2 on an equity risk premium of 6.00% adds 7.20% above the risk-free rate.
The extra return the market is expected to deliver over the risk-free rate. Everything beta scales is this number.
CAPM prices only market risk, on the argument that firm-specific risk can be diversified away. It is the standard textbook model and the usual input to WACC, but its empirical record is mixed — treat the output as one estimate, not a measurement.
CAPM sets the required return as the risk-free rate plus beta times the equity risk premium. With a 4% risk-free rate, a beta of 1.2, and a 10% expected market return, the cost of equity is 4% + 1.2 × 6% = 11.2%.
One number for the price of risk
The Capital Asset Pricing Model answers a single question: what return should an investor demand for holding this particular share rather than a risk-free government bond? Its answer is that only one kind of risk deserves compensation.
The argument is that firm-specific risk — a factory fire, a failed product — can be diversified away by holding many shares, so the market will not pay you to bear it. What cannot be diversified away is exposure to the market as a whole, and beta measures exactly that: how much this share moves when the market moves.
Reading beta
A beta of 1.0 means the share tracks the market. Above 1.0 it amplifies market moves, which is typical of cyclical businesses such as construction or luxury goods. Below 1.0 it dampens them, which is typical of utilities and consumer staples that people buy regardless of the economy. Beta can even be negative for an asset that rises when markets fall, though this is rare.
Whatever beta is, CAPM scales the equity risk premium by it. That premium — the market return minus the risk-free rate — is the entire compensation for bearing market risk, and beta decides what share of it applies to this stock.
Re is the cost of equity, Rf the risk-free rate, β the stock’s beta, and (Rm − Rf) the equity risk premium. All rates are annual.
Worked example: β = 1.2
Find the premium first, then scale it:
- 1 Take the risk-free rate. A government bond yield matched to your horizon — 4% here.
- 2 Work out the equity risk premium. 10% expected market return − 4% risk-free = 6%.
- 3 Scale it by beta. 1.2 × 6% = 7.2%. This stock carries 20% more market risk than average, so it earns 20% more premium.
- 4 Add the risk-free rate back. 4% + 7.2% = 11.2% cost of equity.
- 5 Use it as a discount rate. This is the return shareholders require, and the equity input to WACC.
Cost of equity at different betas
Calculated with a 4% risk-free rate and a 6% equity risk premium. Beta is the only thing changing.
| Beta | Typical business | Cost of equity |
|---|---|---|
| 0.5 | Regulated utility | 7.0% |
| 0.8 | Consumer staples | 8.8% |
| 1.0 | Tracks the market | 10.0% |
| 1.2 | Broad industrial | 11.2% |
| 1.5 | Cyclical manufacturer | 13.0% |
| 2.0 | Speculative growth | 16.0% |
Where the inputs come from, and where they fail
None of the three inputs is observable without judgement. The risk-free rate is usually a government bond yield, but which maturity matters — a ten-year yield suits a long project better than a three-month bill. Beta is estimated by regressing past returns against the market, so it describes history rather than the future, and it moves with the period and index chosen. The equity risk premium is the most contested of all: estimates commonly range from about 4% to 7%, and that spread alone swings the answer by several points.
The model itself has a mixed empirical record. Decades of testing have found that low-beta stocks tend to outperform what CAPM predicts and high-beta stocks to underperform, which is why multi-factor models adding size and value factors exist. CAPM survives anyway because it is transparent, needs only three inputs, and gives a defensible starting number.
Treat the output as an estimate with a range around it rather than a measurement. If a valuation flips from attractive to unattractive on a 0.1 change in beta, the honest conclusion is that the valuation is too close to call.