What is Capital asset pricing model?
In short
The capital asset pricing model estimates the cost of equity as the risk-free rate plus beta multiplied by the market risk premium (expected market return minus the risk-free rate).
Key takeaways
- Beta measures a stock's sensitivity to market movements, its systematic risk.
- The result feeds into the weighted-average cost of capital.
- Diversifiable risk isn't rewarded in the model.
Example
A risk-free rate of 4%, beta of 1.2 and market risk premium of 6%: cost of equity is 4% + 1.2 × 6% = 11.2%.
Where it's tested
BAR: Financial Forecasting, Budgeting & Valuation — study notes, a five-minute revision sheet and practice questions.
Practise: 3 questions
Question 1 of 3 · 0 answered
A product sells for $80 with variable costs of $50 per unit. Fixed costs are $360,000. How many units must be sold to earn a target operating profit of $90,000?