How to Calculate CAPM?

CAPM or Capital Asset Pricing Model helps to calculate the cost of equity for an investment. Using the CAPM formula we can find the expected return for an asset. It can further be used for financial ratio like – Sharpe Ratio and others.

CAPM Formula with its components

E_r = R_f + [B_i x (R_m – R_rf)]

E_r = expected return of investment
R_f = risk free rate
B_i – beta of investment
R_m = Expected return on the market
R_m – R_rf – market risk premium

Step 1: Input the values which act as input for the CAPM Model. The details of the input will be available online as mentioned in the sources.

capm input

Step 2. Calculate Expected Return using the CAPM Formula.

Expected Return: Risk Free Rate + Beta *(Expected Market Return – Risk Free rate)

expected return

Expected return = 8,7%

CAPM with Country Risk premium(CRP) – For Foreign Investments

Country Risk premium is the addition return that an investor can expect if he is investing in a foreign company.

When to use CRP?

If the investment is done in foreign land, overseas investment
If there is higher political and geographical risk associated with this risk
CRP for developing / turbulent countries is higher than developed countries. The higher the risk of a country the higher the value of CRP.

capm for foreign investment

Formula:

Expected Return: Risk Free Rate + Beta *(Expected Market Return – Risk Free rate) + Country Risk Premium

capm expected return for foreign investment

Expected return = 24,7%