Capital Asset Pricing Model

How the parameters of CAPM like Rf, Rm, Beta been considered to calculate the cost of equity?

2 Answer(s)


Used to calculate cost of equity from company's perspective and shareholder's return from investor's perspective.
Rf= Risk free return or the return on Govt securities like T-bills, municipal bonds etc
Rm= Market return
So, Rm-Rf= Risk premium
Beta for a company varies from time to time and is given on any stock website like money control


The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to the market premium (Rm-rf).