Cost of Capital & Valuation Lab

CAPM & Cost of Equity Lab

Calculate Capital Asset Pricing Model (CAPM) expected returns, equity risk premium, levered vs unlevered beta with Hamada's formula, and Jensen's alpha.

CAPM Engine Beta Sensitivity Grid CAPM & Hamada Theory FAQ

Company Archetypes

Load benchmark risk & beta profiles.

Step 1: Enter Risk-Free Rate, Market Return & Beta

CAPM & Capital Structure Inputs

10-Year Government Treasury Yield.
Broad equity market benchmark return.
Total systematic equity volatility.
For Hamada unlevering.
Interest tax shield effect.
Micro-cap / private add-on.
For Jensen's Alpha & SML.
Cost of Equity (Ke / E(Ri))
13.09%
Required investor equity return
Jensen's Alpha (α)
+1.11%
Actual vs CAPM Expected
Unlevered Asset Beta (βU)
1.296
Hamada Pure Business Risk
Equity Risk Premium (ERP)
5.75%
E(Rm) - Rf Market Spread
Security Market Line (SML) Valuation: Undervalued / Above SML (+1.11% Alpha)
Generating positive excess risk-adjusted return

Cost of Equity Sensitivity Matrix: Beta vs. Market Risk Premium

Expected equity return ($K_e$) across varying market volatility and systematic risk environments.

Levered Beta (β) ERP = 4.00% ERP = 5.00% ERP = 5.75% (Base) ERP = 6.50% ERP = 7.50%

Portfolio Theory & Asset Pricing

Principles of CAPM & Beta

Core foundations of the Capital Asset Pricing Model:

  • Systematic vs. Unsystematic Risk: Investors are only compensated for systematic market risk (β) because company-specific idiosyncratic risk can be eliminated via diversification.
  • Equity Risk Premium (ERP): The incremental return that investors demand above risk-free sovereign debt to hold the broad equity market.
  • Hamada's Equation: Isolates fundamental business operating risk from the financial leverage risk created by debt financing ($D/E$).
  • Security Market Line (SML): Visual benchmark where fairly priced assets plot directly on the line; assets above provide positive Jensen's Alpha.

Calculate weighted cost of capital in the WACC Lab.

Mathematical Formulation

CAPM & Hamada formulas

E(R_i) = R_f + β_L × [ E(R_m) - R_f ] + s

β_U = β_L ÷ [ 1 + (1 - T) × (D / E) ]

β_L = β_U × [ 1 + (1 - T) × (D / E) ]

Jensen's Alpha (α) = R_actual - E(R_i)

WACC = (E/V)·K_e + (D/V)·K_d·(1 - T)

Decompose equity performance in the DuPont Analysis Lab.

FAQ

CAPM & cost of equity questions

What is the Capital Asset Pricing Model (CAPM)?

The Capital Asset Pricing Model (CAPM) is a foundational financial model that calculates the expected return on equity capital based on the risk-free rate, the asset's systematic risk (Beta), and the expected equity risk premium of the broader market.

What is the CAPM formula?

The standard CAPM formula is E(Ri) = Rf + Beta * (E(Rm) - Rf) + s, where Rf is the risk-free rate, Beta is the asset's sensitivity to market movements, E(Rm) is the expected market return, (E(Rm) - Rf) is the Equity Risk Premium (ERP), and s is an optional size or specific risk premium.

What is the difference between Levered Beta and Unlevered Beta?

Levered Beta (Beta_L) reflects both the fundamental business operational risk and the financial risk arising from debt obligations. Unlevered Beta (Beta_U or Asset Beta), calculated via Hamada's equation, removes the debt distortion to isolate pure operational business risk.

What is Jensen's Alpha?

Jensen's Alpha measures the excess return generated by an investment portfolio or stock over the expected return predicted by the CAPM. A positive alpha indicates outperformance and undervaluation (plotting above the Security Market Line), while a negative alpha indicates underperformance (plotting below the SML).

How does financial leverage (D/E) affect the cost of equity?

As a company takes on more debt (increasing its Debt-to-Equity ratio), equity holders bear increased financial distress risk. Hamada's equation shows that this elevates Levered Beta, which directly increases the required cost of equity (Ke).

Can I export the CAPM calculation audit to CSV?

Yes. You can export complete CAPM parameters, Hamada unlevered betas, Jensen's alpha, and sensitivity matrices as a UTF-8 CSV spreadsheet with formula defense.

Continue Exploring Corporate Finance Tools

Explore our Cash Flow & Finance Hub, calculate weighted capital costs in the WACC & Cost of Capital Lab, analyze ROE in the DuPont Analysis Lab, evaluate capital projects in the Capital Budgeting NPV & IRR Lab, or stress-test bankruptcy probability in the Altman Z-Score Lab.