CAPM Calculator

Last modified 17:11, 1 Oct 2012

CAPM Calculator

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The Capital Asset Pricing Model (CAPM) explores the relationship that exists between risk and return.

It basically says that investors should be rewarded for the time value of money and the risk that they take.

The CAPM model uses beta to measure the risk of a stock. The time value of money is the “risk free” rate of investment. For example, if you put your money in cash, there would be no risk at a rate of return of around 5.75%. Hence, the risk free rate would be 5.75%.

William Sharpe

The CAPM model is the work of William Sharpe. He outlined the CAPM in his 1970's book “Portfolio Theory and Capital Market”. He later won a Nobel Prize in economics with Harry M Markowitz and Merton M Miller.

User Defined Parameters

Parameters that can be changed by users to change the selected formula's result include the following:

Earnings Growth Rate

This percentage amount represents the amount of average annual growth anticipated in the period selected in the Years to Forecast setting.

The value is an average of analysts forecasts for EPS growth over 5 years which is then averaged.

Terminal Earnings Growth

This percentage amount represents the growth in earnings after the number of years forecast to infinity.

The default value is 0%, which means that after the number of years forecast, it is assumed that earnings will stay the same from year to year.

Risk Free Rate

This percentage amount represents the risk free rate which is usually taken to be the cash rate or the yield from AAA bonds.

The default value is the current yield from AAA bonds.

Stock Beta

This percentage amount represents the volatility of the stock compared to the market.

The default value is different of each stock, according to a stock's volatility in comparison to the market.

Results

Fair Value

The Fair Value calculation results are displayed after the calculator name in the Calculator Selection List.

Users cannot directly alter the resulting Fair Value, however changing the highlighted parameters (yellow background and blue outline) will normally result in a change in results for that calculator and any other calculators that use those parameters.

Results in Table and Graphs

Some of the results for the individual stock can be displayed in tables and graphs in the Results Display area on the right side of the work page.

For a detailed description of these tables and graphs, go to the Results Display topic.

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