CAPM, WACC, and Cost of Capital
CFA/corp-fin cards on beta, CAPM expected return, WACC components, and when to use them.
12 cards· by GuruOwl
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Try it- 01What is the CAPM formula for expected return on equity?E(R) = R_f + β × (E(R_m) − R_f), where (E(R_m) − R_f) is the equity market risk premium.capm
- 02What does beta measure in CAPM?Systematic (market) risk — sensitivity of the asset’s returns to market returns.capm
- 03What risk does diversification eliminate in theory?Idiosyncratic / unsystematic risk — CAPM prices only non-diversifiable risk.capm
- 04What is WACC?Weighted average cost of capital: blended required return on debt and equity financing (after-tax cost of debt).wacc
- 05Write a basic WACC formula.WACC = E/V · r_e + D/V · r_d · (1 − T_c) (plus preferred if any).wacc
- 06Why is the cost of debt after-tax in WACC?Interest is tax-deductible, so the effective cost is r_d(1 − T).wacc
- 07When is WACC the appropriate discount rate for a project?When the project has similar risk to the firm and similar financing; otherwise adjust for project risk/capital structure.wacc
- 08What happens to WACC if equity beta rises (ceteris paribus)?Cost of equity rises → WACC rises.wacc
- 09Market value vs book value weights in WACC?Prefer market-value weights for target capital structure when available.wacc
- 10What is the risk-free rate typically proxied by?Yield on government securities matching the cash-flow horizon (often T-bills/T-bonds).capm
- 11If a project’s return > WACC (same risk), what is the NPV implication?Positive NPV — project earns more than capital providers require.decision
- 12What is levered vs unlevered beta (idea)?Levered beta includes financial leverage; unlevered beta reflects asset/business risk only.beta