CAPM - What is the Capital Asset Pricing Model
Summary
This video provides a comprehensive overview of the Capital Asset Pricing Model (CAPM) and its components like risk-free rate, beta, and expected stock market return. It explains beta's role in assessing stock movement in comparison to the market using examples of Apple and Facebook. The step-by-step calculation of CAPM is demonstrated for both companies, followed by the application of CAPM in determining Weighted Average Cost of Capital (WACC) and as a discount factor for stock valuation. Through practical examples with Apple and Facebook, the video showcases how CAPM can be utilized to calculate the present value of future cash flow expectations.
Introduction to CAPM
Introduction to the Capital Asset Pricing Model (CAPM) and its key components: risk-free rate, beta, and expected return of the stock market.
Understanding Beta
Explanation of beta and its relation to how a stock moves compared to the market, using Apple and Facebook as examples.
Calculating CAPM Formula
Step-by-step calculation of CAPM formula using inputs like risk-free rate, beta, and expected market return for Apple and Facebook.
Application in Valuation
Utilizing CAPM to calculate the Weighted Average Cost of Capital (WACC) and as a discount factor for stock valuation using an example with Apple and Facebook.
Using CAPM for Valuation
Demonstration of how to use CAPM results as a discount factor to calculate the present value of future cash flow expectations for Apple and Facebook.
FAQ
Q: What is the Capital Asset Pricing Model (CAPM) and what are its key components?
A: The Capital Asset Pricing Model (CAPM) is a model that describes the relationship between risk and expected return. Its key components include the risk-free rate, beta, and the expected return of the stock market.
Q: How is beta defined in the context of the CAPM model?
A: Beta, in the context of the CAPM model, measures the volatility or systematic risk of a stock in relation to the overall market. A beta of 1 indicates that the stock's price will move with the market, while a beta greater than 1 indicates higher volatility.
Q: Can you explain how the CAPM model is used to calculate the Weighted Average Cost of Capital (WACC)?
A: The CAPM model is used to calculate the cost of equity component of WACC by using the beta of a stock, the risk-free rate, and the expected market return. The formula is: Cost of Equity = Risk-Free Rate + Beta * (Expected Market Return - Risk-Free Rate).
Q: How can the results from CAPM be utilized as a discount factor for stock valuation?
A: The results from CAPM, specifically the cost of equity, can be used as a discount factor to calculate the present value of future cash flow expectations for a stock. By discounting future cash flows using the cost of equity, one can determine the intrinsic value of the stock.
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