Stock Discount Rate Calculator (CAPM)
Equity Risk Premium: %
Formula Used: Rf + β × (Rm – Rf)
Understanding the Stock Discount Rate
The discount rate is one of the most critical components in stock valuation, particularly when using Discounted Cash Flow (DCF) analysis. It represents the required rate of return an investor expects to earn for the risk taken by investing in a specific stock. In financial modeling, this rate is used to discount future cash flows back to their present value to determine the intrinsic value of a company.
This calculator uses the Capital Asset Pricing Model (CAPM) to determine the Cost of Equity, which is the standard proxy for the discount rate when analyzing stocks from a shareholder's perspective.
The CAPM Formula Breakdown
The calculation relies on three distinct inputs to estimate the cost of equity:
- Risk-Free Rate (Rf): This is the theoretical return of an investment with zero risk. In practice, the yield on the 10-Year US Treasury Note is the standard benchmark. If the 10-year yield is 4%, the Risk-Free Rate is 4%.
- Beta (β): Beta measures a stock's volatility in relation to the overall market. A beta of 1.0 means the stock moves in sync with the market. A beta of 1.5 implies the stock is 50% more volatile than the market, requiring a higher discount rate to justify the risk.
- Expected Market Return (Rm): This is the average historical return of the stock market (often represented by the S&P 500). Historically, this ranges between 8% and 12%.
The formula is expressed as:
Discount Rate = Risk-Free Rate + Beta × (Expected Market Return – Risk-Free Rate)
Why is the Discount Rate Important?
The discount rate acts as a hurdle rate. If you are analyzing a high-growth tech stock with a high Beta (e.g., 2.0), your calculated discount rate might be 15% or higher. This means the company's future cash flows are worth significantly less today because of the high risk involved. Conversely, a stable utility company with a Beta of 0.5 might have a discount rate of 6%, making its future cash flows more valuable in present terms.
How to Use This Calculator
- Find the Risk-Free Rate: Look up the current yield for 10-Year Treasury Bonds on a financial news site.
- Locate the Beta: Search for the stock ticker symbol on a finance portal (like Yahoo Finance or Google Finance) to find the "Beta (5Y Monthly)".
- Estimate Market Return: Enter your expectation for the overall market return. A conservative estimate is usually around 8-9%, while an optimistic estimate is 10-12%.
The resulting percentage is the annual return you should demand to justify holding that specific stock, and the rate you should use to discount future cash flows in a valuation model.