Ch 12. Cost of Capital and CAPM: The Price of Risk

One of the most important questions in corporate management is: “What is the minimum return investors expect in exchange for committing capital to this business?” From the company’s perspective, this is called the Cost of Capital. Misjudging it leads to flawed investment decisions.

1. Cost of Equity and CAPM

The cost of equity is the return required by shareholders. The most widely used model for calculating it is the Capital Asset Pricing Model (CAPM).

CAPM Formula

K_e = R_f + \beta (R_m - R_f)

Rf: risk-free rate, β: beta (systematic risk), Rm: expected market return

CAPM (자본자산가격모형) 계산기

무위험수익률 (Rf, %)

베타 (Beta, β)

시장기대수익률 (Rm, %)

자기자본비용 (Ke)

11.30%

Ke = 3.5% + 1.2 × (10% - 3.5%)

What Beta (β) Means: A beta greater than 1 means the asset is more volatile than the market; a beta less than 1 means it is more stable. The greater the risk, the higher the return ( $K_e$ ) investors will demand.

2. Weighted Average Cost of Capital (WACC)

Companies typically finance themselves with a mix of equity (stock) and debt (bonds/loans). WACC calculates the firm’s overall average cost of capital by weighting each source according to its proportion.

WACC (가중평균자본비용) 계산기

자기자본 (E)

타인자본 (D)

자기자본비용 (Ke, %)

세전 부채비용 (Kd, %)

법인세율 (Tax, %)

가중평균자본비용 (WACC)

8.80%

부채비율: 40.0% | 자기자본비율: 60.0%

3. Practical Application: The Investment Hurdle Rate

The cost of capital serves as the discount rate when evaluating the viability of an investment.

IRR (Internal Rate of Return) > WACC: The investment returns more than it costs to fund — accept the project
ROA/ROE > WACC: The firm’s profitability exceeds the cost of using capital — successful management

Accurately pricing risk is the foundation of financial strategy. Through CAPM and WACC, you can gain the insight needed to optimize your firm’s capital structure.

Finance Ch12. Cost of Capital and CAPM — Pricing the Risk