Capital Asset Pricing Model

Last updated: March 21, 2024

What Does Capital Asset Pricing Model Mean?

The capital asset pricing model is a theoretical model that compares risk and return. CAPM (pronounced as cap "m") is used to calculate an appropriate discount or capitalization rate, which is then used in the capitalized cash flow or discounted cash flow valuation methods.


Divestopedia Explains Capital Asset Pricing Model

CAPM is a calculation of the risk related to the equity of a business. The model takes into account the risk of the particular business and the industry it operates in. It also tasks into account movements in returns for the market as a whole.

The CAPM based rates of return represent a rate of return on equity, not a discount rate or WACC. To calculate the discount rate or WACC, the cost of debt and appropriate capital structure must be assess. A growth rate deducted from the WACC will result in a capitalization rate that can be applied to free cash flows before interest costs to determine enterprise value.


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