CAPM is a financial model that defines the relationship between systematic risk and expected return for an asset. In stock valuation, CAPM is used to calculate the cost of equity — the return required by equity investors given the stock's market risk (beta).
With a risk-free rate of 4.5% (10-year US Treasury), a market risk premium of 5.5%, and a beta of 1.2, CAPM gives a cost of equity of 4.5% + 1.2 × 5.5% = 11.1%. This becomes the equity component of WACC in stock valuation.
CAPM provides a theoretically grounded, systematic way to estimate the required return on equity. Without it, the discount rate used in DCF stock valuation would be arbitrary. CAPM links risk and return in a quantifiable way.
MiniValuator uses CAPM to estimate the cost of equity when computing WACC. Users can adjust the risk-free rate and market risk premium in the advanced settings to fine-tune their stock valuation assumptions.
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