CAPM
Capital Asset Pricing Model
Short definition
CAPM sets the cost of equity as the risk-free rate plus beta times the equity risk premium. It is a one-factor skeleton; country, size and liquidity premia are separate, single-count add-ons.
Detailed explanation
Assumptions (full diversification, one beta) fail in practice; it remains the common language for Ke. Currency must be the same in Rf, ERP and the cash flows.
Levered beta enters Ke. CRP is added when Rf is not local. CAPM output is WACC’s equity leg and the FCFE discount rate.
Why it matters for the CFO
The valuation committee debates Ke from this line. A silent change in Rf, β or ERP moves EV; the source footnote is mandatory.
How it is calculated
Ke = Rf + β × ERP
Only systematic risk is priced. If CRP or a size premium is added, the same risk is not repeated in Rf or a cash haircut.
Variables in the formula
- Ke: Cost of equity
- Rf: Risk-free rate
- β: Levered beta
- ERP: Equity risk premium
How to read it
Rf 18%, β 1.1, ERP 5% → Ke 23.5%. A “high Ke” is often a high Rf, not a high beta. The model does not price undiversifiable idiosyncratic risk with a premium.
Numerical example
Rf 18%, β 1.10, ERP 5% → Ke = 18 + 1.10×5 = 23.5%.
Related calculators
Güven Sayılgan’s writing on this topic
Challenges in Determining Company Value in Türkiye
In Türkiye, company valuation becomes more complex because of inflation, interest-rate and exchange-rate uncertainty, limited access to sector data, and an unde
3 min read
Read → FinansWhy Did Debt Become More Expensive than Equity in Some Periods in Türkiye?
In financial theory the cost of equity normally exceeds the cost of debt; in Türkiye, in tight-money episodes such as 2018 and 2023–25, the spot cost of new deb
6 min read
Read →Read these first
Related terms
What to learn next
Definitions are educational. They are not investment, credit or tax advice.