Capital Asset Pricing Model

The capital asset pricing model, or CAPM, says a stock's required return equals the risk-free rate plus its beta times the equity risk premium. William Sharpe published it in 1964. It is the most common way to estimate cost of equity for a public company.

The formula is Ke = Rf + beta x ERP. With Rf at 5%, beta at 1.2 and ERP at 5%, Ke is 5% + 6% = 11%. The model prices only systematic risk, the part diversification cannot remove, and its graph is the security market line.

CAPM is simple, which is both its appeal and its main weakness. Real returns do not line up perfectly with beta, and every input involves judgment. The CAPM cost of equity guide covers each input, and the FAQ explains whether cost of equity is the same as CAPM. For a short overview, start with what cost of equity is.