Capital Asset Pricing Model (CAPM)

The capital asset pricing model is a model for determining the cost of equity capital (common stock or retained earnings) or pricing risk. The CAPM assumes that investors must be compensated for the time value of money plus systematic risk, as measured by the stock's beta. The primary conclusion of the CAPM is that the risk of an individual stock is its contribution to the risk of a well-diversified portfolio. The CAPM can be used to determine the cost of common stock and retained earnings in determining the weighted average cost of capital. CAPM is computed as the risk-free rate plus (beta times the difference between the market rate and the risk-free rate). See also beta coefficient and nondiversifiable risk and bond yield plus risk premium method and dividend yield plus growth?rate method.