The equity risk premium (ERP) is the additional return investors expect for holding stocks over risk-free assets. It's one of the three inputs in the capital asset pricing model (CAPM), which is used to estimate the cost of equity in absolute valuation models. If you get the ERP...
The risk-free rate (rf) is one of the most important inputs in finance. It's the baseline return investors expect from an investment with "zero risk," and it feeds directly into the capital asset pricing model (CAPM), which is central to absolute valuation models. If you get the risk-free...
Preferred stock serves as a hybrid financing option for companies, combining features of both debt and equity. As a hybrid security, it offers regular dividends and holds a higher priority than common stock, yet ranks below bonds in the claims hierarchy. Understanding the cost of preferred stock is...
This article will show you how to calculate and interpret the cost of debt for a company. The cost of debt is a fundamental concept in corporate finance, affecting a company's capital structure and financial health by representing the effective interest rate on its debt obligations. Additionally, it...
Beta, as a measure of a stock or portfolio's volatility relative to the market, offers valuable insights into implied risk for investors. We'll explore the formula for calculating beta and provide detailed, step-by-step instructions on computing and interpreting this figure in Excel for both individual stocks and portfolios....
Often referred to as the "discount rate," the required rate of return represents the minimum return that an investor seeks to make an investment worthwhile. The discount rate essentially indicates the expected annual return from a stock, derived by discounting the stock's future projected cash flows to their...
This article will show you how to calculate and interpret the Arbitrage Pricing Theory (APT). Developed by economist Stephen Ross in 1976, the APT presents a multifactorial approach to asset pricing, which extends beyond the Capital Asset Pricing Model (CAPM). The CAPM is a fundamental model in finance...
This article will show you how to calculate and interpret the build-up method. This method is essential for determining the discount rate (aka required rate of return or capitalization rate) in absolute valuation models, such as the discounted cash flow (DCF) model. The discussion will also cover the...
The Single Index Model (SIM) claims that the returns on a stock are driven largely by its sensitivity and responsiveness to the returns on the market index. For investors interested in asset pricing, understanding the SIM is important, given that it offers one of the most simplest approaches...