The capital asset pricing model estimates the return equity investors require for bearing market risk. Combine the risk-free rate, beta and equity risk premium, with optional premiums for size and company-specific risk.
How it works
Estimate the cost of equity with the capital asset pricing model, using either an equity risk premium or an expected market return, with optional beta relevering and size or company-specific premiums.
Cost of equity = Rf + β × ERP + Size premium + Specific premium
ERP = Expected market return − Rf
Relevered β = Unlevered β × [1 + (1 − Tax rate) × D/E] (Hamada)Common uses
- Cost of equity input for WACC and DCF valuations
- Hurdle rates for equity investments
- Valuations of private companies and business units
Worked example
The calculator above opens with this example. Change any input to see the results update instantly, or select Reset to return to these figures.
| Risk-free rate | 4.25% |
| Beta input | Levered (observed) beta |
| Beta | 1.1 |
| Market input | Equity risk premium |
| Equity risk premium | 5.5% |
| Size premium | 0% |
| Company-specific premium | 0% |
| Cost of equity | 10.30% |
| Beta used | 1.10 |
| Equity risk premium | 5.50% |
| Equity risk premium × beta | 6.05% |
Interpreting the results
- Match the risk-free rate to the cash-flow horizon; long-term valuations commonly use a 10- or 20-year government bond yield.
- Use the target capital structure when relevering beta for a private company or a project.
- Document the source of the equity risk premium and size premium, since both are judgment calls reviewers will test.
Frequently asked questions
How is the CAPM cost of equity calculated?
Cost of equity equals the risk-free rate plus beta multiplied by the equity risk premium. For example, with a 4.25% risk-free rate, a beta of 1.10 and a 5.5% premium, the cost of equity is 4.25% + 1.10 × 5.5% = 10.30%.
Why relever beta?
Observed betas reflect each company’s own debt level. To value a company with a different capital structure, unlever the peer betas to remove the effect of debt, then relever them at the target debt-to-equity ratio using the Hamada formula.
When should a size premium be added?
Smaller companies have historically earned returns above what CAPM predicts. Valuation practitioners often add a size premium from a recognized data provider for small and private companies, and document the source.
Related calculators
- WACC Calculator: Weighted average cost of capital with CAPM cost of equity.
- DCF Valuation Calculator: Enterprise value, equity value and value per share from free cash flow.
- NPV & IRR Calculator: NPV, IRR, MIRR, profitability index and payback for any cash-flow stream.
- Bond Price & Yield Calculator: Bond price from yield or yield to maturity from price, with duration and convexity.
- Comparable Company Multiples Valuation: Implied enterprise value, equity value and share price from peer multiples.