Use CAPM With Humility
Calculate a CAPM-based cost of equity and explain why beta and premium inputs require judgment.
Estimate cost of equity for a cyclical equipment company whose historical beta may understate future risk. CAPM cost of equity = risk-free rate + beta x equity risk premium Using a single raw historical beta as if it were an objective truth. Risk-free rate Use 4.2 percent based on the relevant currency and long-duration cash-flow horizon. The risk-free rate should match the currency and horizon of the cash flows. A mismatch creates valuation noise. Beta Peer-adjusted beta = 1.25 after unlevering and relevering comparable companies. Peer beta can be more informative when the company's own history reflects unusual capital structure…
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