CAPM Calculator

The CAPM formula is elegant in its simplicity:

Expected Return (Ke) = Rf + β × (Rm − Rf)

Where:

• Rf (Risk-Free Rate) — The return on a "riskless" investment, typically the 10-year government bond yield. This compensates the investor for the time value of money.
• β (Beta) — A measure of how sensitive the stock's returns are to overall market movements. A beta of 1.0 means the stock moves in lockstep with the market.
• Rm (Expected Market Return) — The expected return of the broad market (e.g., S&P 500). Historically around 9–10% annualized for U.S. equities.
• (Rm − Rf) = ERP (Equity Risk Premium) — The extra return investors demand for holding risky stocks instead of risk-free bonds. This is the "price of risk" in the market.

Worked example: Suppose the 10-year Treasury yields 4.25%, you expect the market to return 9.5% annually, and the stock has a beta of 1.2. The equity risk premium is 9.5% − 4.25% = 5.25%. The expected return is 4.25% + 1.2 × 5.25% = 10.55%.

This means investors in this stock require at least a 10.55% annual return to be adequately compensated for the risk. If you're building a DCF, this is the cost of equity you'd plug into your WACC calculation.

The risk-free rate (Rf) represents the return on an investment with zero default risk. In practice, no investment is truly risk-free, but government bonds from creditworthy sovereigns are the closest proxy.

Which maturity to use:

• 10-year Treasury yield (most common) — This is the standard choice for equity valuation because it roughly matches the duration of typical investment horizons. As of early 2026, this sits around 4.0–4.5%.
• 20- or 30-year Treasury yield — Some analysts prefer longer maturities for very long-duration assets or infrastructure projects. The 30-year yield is typically slightly higher than the 10-year.
• Match the currency — If you're valuing a European company in euros, use the German Bund yield, not the U.S. Treasury. Always match the risk-free rate to the currency of your projected cash flows.

Common mistake: Using a stale or historically low risk-free rate. Interest rates change constantly — a CAPM calculation built on a 1% risk-free rate from 2020 will dramatically understate the required return compared to today's environment. Always use the current yield on the valuation date.

Tip: You can find the current 10-year Treasury yield on the U.S. Treasury Department website, FRED (Federal Reserve Economic Data), or any financial data provider. Update it every time you build a new model.

Beta (β) measures a stock's sensitivity to market-wide movements. It quantifies systematic risk — the risk that can't be diversified away by holding more stocks.

How to interpret beta:

• β = 1.0 — The stock moves in line with the market. If the market goes up 10%, the stock is expected to go up 10%.
• β > 1.0 (e.g., 1.5) — The stock is more volatile than the market. It amplifies market moves — rising more in up markets and falling more in down markets. Tech stocks and growth companies often have betas above 1.0.
• β < 1.0 (e.g., 0.6) — The stock is less volatile than the market. Utilities, consumer staples, and healthcare companies typically have lower betas.
• β = 0 — The asset has no correlation to the market. Treasury bills are the classic example.

Impact on expected return: Beta is the multiplier on the equity risk premium. A stock with a beta of 1.5 and an ERP of 5.25% adds 7.88% of risk premium to the risk-free rate, while a beta of 0.7 only adds 3.68%. Higher beta means a higher required return, which in a DCF model means a higher discount rate and a lower present value.

Where to find beta: Yahoo Finance shows a "Beta (5Y Monthly)" on each stock's statistics page. Bloomberg and Capital IQ offer customizable calculations. For companies with limited trading history, use the median beta from comparable companies in the same industry.

Levered vs. unlevered beta: The beta you see on data providers is the levered beta, which includes the effect of the company's debt. If you're comparing companies with very different capital structures, you may want to unlever the beta, compare at the asset level, and re-lever for your target company's debt load.

The equity risk premium (ERP) is the extra return investors demand for holding stocks over risk-free government bonds. In the CAPM formula, it's calculated as the expected market return minus the risk-free rate (Rm − Rf). It's one of the most debated numbers in finance.

Common approaches to estimating ERP:

• Historical average (5.0–6.5%) — Based on the long-run excess return of U.S. equities over Treasury bonds since the 1920s. Simple and widely cited, but assumes the future will resemble the past.
• Implied ERP (4.0–6.0%) — Derived from current stock prices and expected earnings using a reverse-engineered dividend discount model. Professor Aswath Damodaran at NYU publishes a monthly estimate. This approach is forward-looking and reflects today's market pricing.
• Survey-based (4.5–5.5%) — Based on what practitioners actually use in their models. Most investment banks and equity research teams use 5.0–6.0%.

Practical guidance: A 5.0–5.5% ERP is a solid starting point for U.S. equities. If you're valuing a company in an emerging market, you should add a country risk premium (typically 1–5% depending on the country's credit rating and volatility) on top of the base ERP.

Consistency is key: Whatever ERP you choose, use the same number across all the companies you're comparing. The absolute level matters less than being consistent within your analysis.

CAPM is elegant and widely used, but it's far from perfect. Understanding its limitations will make you a better analyst.

Key criticisms:

• Single-factor model — CAPM assumes that market risk (beta) is the only risk factor that matters. Decades of academic research have shown that other factors — size, value, momentum, profitability — also explain stock returns. The Fama-French three-factor and five-factor models address this.
• Beta instability — Beta is estimated from historical data and changes over time. A company's beta during a bull market may look very different from its beta during a crisis. The lookback period and benchmark choice affect the result significantly.
• Assumes efficient markets — CAPM assumes all investors have the same information and rational expectations. In reality, markets are not perfectly efficient, and investor behavior introduces anomalies that CAPM can't explain.
• Risk-free rate is not truly risk-free — Government bonds carry inflation risk, reinvestment risk, and (for non-U.S. sovereigns) some default risk. The "risk-free" rate is an approximation.
• ERP disagreement — There is no consensus on the "correct" equity risk premium. Reasonable estimates range from 4% to 7%, and even small differences significantly affect the cost of equity.

Despite these limitations, CAPM remains the industry standard because it's simple, intuitive, and provides a reasonable starting point. Most practitioners use CAPM as a baseline and then apply judgment — adjusting for company-specific risks, illiquidity, or size premiums that the model doesn't capture.

CAPM is the engine inside the WACC formula, which is the discount rate for most DCF models. Here's how the pieces connect:

The chain from CAPM to fair value:

• Step 1: CAPM gives you the cost of equity (Ke) — Using the risk-free rate, beta, and equity risk premium, you calculate the return shareholders demand.
• Step 2: Ke feeds into WACC — The WACC formula blends the cost of equity with the after-tax cost of debt, weighted by the company's capital structure: WACC = (E/V) × Ke + (D/V) × Kd × (1 − T).
• Step 3: WACC discounts future cash flows — In the DCF model, each year's projected free cash flow is divided by (1 + WACC)^n to get its present value. The terminal value is also discounted using WACC.
• Step 4: Sum of present values = enterprise value — Subtract net debt to get equity value, then divide by shares outstanding to get fair value per share.

Why small changes in CAPM inputs matter so much: Because the WACC compounds across every year of the projection and the terminal value (which often represents 60–80% of total value), even a 0.5% change in the cost of equity can shift the fair value by 5–15%. This is why getting your CAPM inputs right — or at least understanding their range — is critical.

Sensitivity analysis: Every good DCF should include a sensitivity table showing how the fair value changes across a range of WACC values (and terminal growth rates). This helps you understand the range of outcomes rather than relying on a single point estimate.

While CAPM is the most common approach, several alternative models address its known shortcomings. Here are the main ones used by professional analysts:

• Fama-French Three-Factor Model — Adds two factors beyond market risk: size (small-cap stocks tend to outperform) and value (high book-to-market stocks tend to outperform). This explains more of the variation in stock returns than CAPM alone.
• Fama-French Five-Factor Model — Extends the three-factor model by adding profitability (more profitable firms earn higher returns) and investment(firms that invest conservatively outperform aggressive investors).
• Build-Up Method — Instead of using beta, this approach adds individual risk premiums for different risk components: equity risk premium + size premium + industry premium + company-specific risk premium. It's commonly used for private company valuation where beta isn't observable.
• Dividend Discount Model (DDM) — For companies that pay dividends, you can back into the cost of equity from the current stock price: Ke = (D1 / P0) + g, where D1 is next year's expected dividend, P0 is the current price, and g is the dividend growth rate.
• Arbitrage Pricing Theory (APT) — A multi-factor model that doesn't specify which factors matter — the analyst selects them. More flexible than CAPM but requires more judgment and data to implement.

Practical recommendation: For most equity valuation work, start with CAPM. It's what everyone expects to see, and it provides a clean, defensible baseline. If you're valuing a small-cap or private company, consider adding a size premium(typically 1–3%) on top of the CAPM result. If you're an academic or doing detailed factor research, the Fama-French models provide richer explanations of expected returns.

The important thing is to be transparent about your methodology. Whatever model you use, document your assumptions and show how sensitive the final valuation is to changes in the cost of equity.