Which inputs are used in the CAPM example?

Which inputs are used in the CAPM example?

• A. Risk-free rate, expected market return, beta
• B. WACC and NOPAT
• C. Gross margin and operating expenses
• D. Net income and beta

Answer: (A)

CAPM estimates an asset’s expected return based on its risk relative to the market, so it relies on three inputs: the risk-free rate, the expected market return, and the asset’s beta. The idea is E[R] = Rf + beta × (E[Rm] − Rf), where Rf is the return on a risk-free asset, E[Rm] is the anticipated market return, and beta measures how much the asset’s returns move with the market. The term (E[Rm] − Rf) is the market risk premium, the extra compensation investors require for bearing market risk. Other options don’t fit because they mix concepts not used as CAPM inputs. WACC and NOPAT relate to corporate valuation and operating performance, not the CAPM input set. Gross margin and operating expenses are profitability measures, not factors in CAPM. Net income with beta is incomplete since CAPM needs both the risk-free rate and the market return in addition to beta.

CAPM estimates an asset’s expected return based on its risk relative to the market, so it relies on three inputs: the risk-free rate, the expected market return, and the asset’s beta. The idea is E[R] = Rf + beta × (E[Rm] − Rf), where Rf is the return on a risk-free asset, E[Rm] is the anticipated market return, and beta measures how much the asset’s returns move with the market. The term (E[Rm] − Rf) is the market risk premium, the extra compensation investors require for bearing market risk.

Other options don’t fit because they mix concepts not used as CAPM inputs. WACC and NOPAT relate to corporate valuation and operating performance, not the CAPM input set. Gross margin and operating expenses are profitability measures, not factors in CAPM. Net income with beta is incomplete since CAPM needs both the risk-free rate and the market return in addition to beta.