# CAPM

## DCF - Beta & Expected Return

AMDoing a DCF of a mature retail company and have a couple of questions if you guys could help me out. They involve inputs to the CAPM in computing WACC...

The company's beta is not publicly available via free, public sources and I was curious if it would be appropriate to use an average of its peer group's betas as a proxy?

What are you guys typically using for the proxy for the expected return of the stock market? I was going to use a three or five year arithmetic average of the S&P's returns, but it seems like that may be a bit biased upward due to the crazy returns the past couple of years...

Thank you to anyone who can provide some insight!

## CAPM- Cost of Debt

IBHello,

I am currently in the middle of completing my Masters in corporate finance, and have come to a slight "roadblock" in terms of my Company valuation. In terms of background context, I am currently valuing a company on its 2004 IPO listing date.

This company did not yield any form of non-current liabilities, nor did the company prospectus mention any potential planning in this manner. Thus, in finding a suitable proxy for the firm (in terms of a DCF valuation and the CAPM model) I conducted a relative valuation between the firm and its four main industry competitors.

## What kind of WACC do you usually get?

ERHi everyone. I am doing stock valuations for my own investment portfolio, but what is bothering me is the WACC calculation. I red Graham's book and a book with Buffets's "essays". They both suggest that beta is not a reliable indicator of risk and they also kinda hint that CAPM is not a very good model for evaluation. I still use CAPM and the regular formula to get WACC, but sometimes I get a WACC as low as 3%, which is ridiculous if you ask me. The most of the cases I get a WACC between 7.5% and 9%. Can I get some of your opinions regarding this perspective on WACC and what kind of numbers you get? Thank you

## Notes for Technical Interview Questions

IBDuring a recent round of interviews with several banks, headhunters sent across a number of potential technical questions that they said I should be very comfortable with. However, through all of my interviews I was never actually asked any technical questions (although I did do a 3 hour modelling exam for one bank). Perhaps this is because I was coming from a couple of years already in IB and the interviewers assumed I knew what I was doing. Still, I took the time to put my thoughts in order. If any of you would like a refresher, you can find some of my notes below.

Just a small point to start with – Valuation is often an art and not an exact science. There are many different ways to approach the numbers, often depending on what you (and your client) want the numbers to show.

It is critical, however, that you can stand in front of a group of senior Japanese executives, for example, and confidently explain to them why your numbers stack up the particular way they do. Similarly, if you are preparing for an interview by simply memorizing the below formulas, but you cannot smoothly explain the function of each piece of each formula, you will not (or at least you should not) proceed to the next round.

## Deleveraging and leveraging Beta in CAPM

?Hi, I'm new here so apologies if this is in the wrong place. I was wondering why is it in the CAPM you have to delever and then lever the beta? And if someone could outline the process of how you would go about doing it?

Thanks.

## Capital Asset Pricing Model and MPT Intro

?Can anyone recommend a good text for introduction to CAPM and MPT for someone who is good with math but has little formal financial training?

## How to use CAPM in a sluggish market?

IBa quick question - how to value a company using CAPM to caculate cost of equity of a bad market. Take China's Shanghai stock market as an example, the index decreased from 6,000 in 2007, to 3,000 in 2010, to 1,990 in 2012. we could not use a negative risk premium, right?

thanks!

## Testing CAPM

?Hi guys,

I'm testing CAPM and Fama&French factors models but I got so much diverisfied portfolio that I don't know which proxy I should get. My portfolio (48 assets):

20 - equity indices for industry and countries

10 - fixed income

5 - futures on commodities

3 - actively managed mutual funds

6 - privately-owned equities

4 - alternative investments

I can't change the portfolio. What would you choose for market proxy?

## Finance Hipsters

OMorning Monkeys!

I'd like to take a moment to discuss the growing multitude of "finance hipsters" and why they annoy the crap out of me. No, I'm not talking about hipsters who happen to work in finance, I'm talking about all these bankers who love to hate on the more ubiquitous methodologies in finance like CAPM (or portfolio theory in general) and DCF models. You all know what I'm talking about, in fact, at some point, you (or someone you know) has probably had this conversation:

Banker #1:

Banker #2:

Oh, you still use CAPM and DCF? Man, that's so déclassé, you know the assumptions they use, right? You should use [insert any obscure, probably firm specific model], it's way better.

Replace "the cost of equity using CAPM" and "the intrinsic value from my DCF model" with "Modest Mouse's new CD" or "non-organic milk" and you have the quintessential hipster conversation.

## Hamada formula

IBHi guys,

When we use the Hamada formula to re-lever an unlevered beta, what do we use as Equity Value since it is the target of our valuation?

Should we use the average capital structure of our comparables sample? If we do it this way, wouldn't we end up with the same Levered beta we had at the beginning?

## What is a reasonable market return estimate for Pfizer Inc.?

?What would a reasonable market return (estimate) be for Pfizer Inc. be or any other comparable company? By comparable I mean a large cap, low beta, economically stable pharmaceutical firm (such as Merck & Co. etc.

But more importantly, how did you arrive at this figure? I'm doing a project in where I have to come up with a required rate of return for a certain company I'm investing in, but, I'm having a tough time figuring out where to begin when determining a reasonable market return (which is included in my equity risk premium) for my company (Pfizer).

Again, this is merely for a project, and I need advice on where to start when determining an appropriate figure for market return.

Help?

## CAPM question

?What do you use for the risk free rate when calculating the cost of equity using CAPM?

I have heard some different opinions, some places/guides say the 10 year US Gov Bond others say 3 month, etc.

I would imagine that the answer is that it depends, but what does it depend on?

Thanks.

## What Is The Capital Asset Pricing Model (CAPM)?

The **Capital Asset Pricing Model**, or **CAPM**, is one of the most commonly used models for calculating the expected return on an asset and is used to price securities.

The CAPM requires 3 data inputs:

- Beta of the asset (how much it moves relative to the market)
- Risk free rate (i.e. government bond yield)
- Expected return of the market (i.e. S&P return)

With all these figures, the calculation for the expected return is:

- Expected Return on Asset = Risk Free Rate + (Beta Asset x [Expected Market Return – Risk Free Rate])

For example, assume the following:

- Risk Free Rate = 2.5%
- Beta = 1.8
- Expected Market Return = 5%

## CAPM, WACC, Corp Finance Videos

IBI want to brush up on corporate finance and was wondering if there are any good video programs out there on the topic. Mainly concerned about getting the nitty gritty down about CAPM.

## Which Internship to choose from ( PWM) ?

?Hey guys,

I have been lurking on here for a while, and this is my first post.

I have two internship offers this fall ( couldn't find anything spectacular). There both at BB in PWM. I really can't decide which one would be more beneficial or rewarding, and was hoping to get some input.

The first internship would be me working under management. The financial advisers essentially would be our clients. I was told I would be putting on events, and would help scheduling conferences. I am not 100% sure what this would entail.

The second internship would be working with a team of financial advisers, helping with powerpoints, some excel work, and word. No cold calling. The prospects would essentially be our clients.

## Question on alpha and beta

?Hi,

Recent college graduate and new here to WSO, very excited to learn more about Finance. I have recently started creating an investing sort of tool in excel and I have a question regarding alpha and beta.

As I understand (correct me if I'm wrong), it is a widely debated topic, whether it is better practice, to maximize alpha or to minimize beta. Alpha equals the return of a stock over what it's risk warrants (as depicted by CAPM for example).

Putting this together I realized, by choosing to minimize beta, you are inadvertently maximizing alpha, since alpha is a function of beta (indirectly). Am I right in this theory and if so, should we direct our attention primarily towards stocks' betas?

Thanks!

## Beta in CAPM

OHi there,

I'm a little confused. I searched the net, and different sites said different things. In the CAPM formula to calculate the cost of equity, is the Beta levered or unlevered? Can someone clarify for me please?

Thanks

## Expected Market Returns

IBI can't figure out how the expected market return is calculated. I understand it's function in CAPM and in determining beta. But I don't see how any value for expected market return, market covariance with your stock, or variance of the market, that you're given is reliable.

Has someone ever calculated the expected return for each asset available, the SD for each asset, or correlation between every pair of assets?

To me this seems like the #1 flaw of CAPM because subjective probabilities are needed to even generate variance!!!

Sorry I've been studying for CFA recently.

## negative beta and Re

IBHad a superday at a bulge bracket…

In my first interview of the day, I was asked whether debt or equity is a more expensive form of capital. I answered equity because it’s less senior in the capital structure and thus more risky and because of the interest tax shield.

He followed up by asking if there were any situations in which equity would be less expensive than debt… I struggled for a bit and said I couldn’t think of any because debt is always senior to equity. He took me back to CAPM and told me that if a firm had a negative beta, that could make its cost of equity lower than its cost of debt.

## Most important part of a valuation???

IBOk everybody...I would love to get as much input on this from as many people from as many countries as possible.

I just spoke with a senior banker (remember I am in India), and he told me that in the entire valuation process significantly more importance is given to the creation of the Financial Statements etc. than to the actual valuation (i.e. finding beta, the cost of equity, CAPM, WACC and all that good stuff we learned about in school).

He says that there are certain standard assumptions which are used across the industry for things like beta, cost of equity etc. and that there is no point in making the model complex by digging into these things too much 'coz in the end they will only make a marginal difference.

## An easy CAPM question

IBHey guys,

This is probably obvious but I'm not seeing the answer. In CAPM and I guess you could generalize this to anytime you are using a tax shield, why do you just take the whole value of debt and multiply it by (1-t). I thought principal payments were not tax deductible, so in the CAPM formula they should just be multiplied by just the cost of debt and not (1-t). Is this just a classroom generalization and in banking models they account for this distinction, or is there something I am missing?

Thanks.

## CAPM and Cost of Capital

IBHey,

So I’ve started to study up on DCF valuation. I get the basics, however, why is CAPM used to estimate the cost of capital? I thought that empirical studies show that CAPM is a poor way of estimating returns. So the difference between companies is beta, which is the relative systematic risk compared to the market. Where does CAPM take into account liquidity, leverage, threat of substitutes etc? I guess my question is, is there a different way to estimate the cost of capital?