Calculate the minimum return an investor expects using CAPM or Dividend Discount Model.
Capital Asset Pricing Model (CAPM)
Dividend Discount Model (DDM)
Typically the 10-year Treasury bond yield.
Average historical return of the market (e.g., S&P 500).
Measure of volatility relative to the market (1.0 = Market Average).
Dividend expected to be paid next year (D1).
Constant rate at which dividends are expected to grow.
Required Rate of Return
0.00%
What is the Required Rate of Return (RRR)?
The Required Rate of Return (RRR) is the minimum return an investor will accept for owning a company's stock, as compensation for a given level of risk associated with holding the stock. RRR is a key metric in corporate finance and equity valuation, used to analyze the potential profitability of investment projects.
Method 1: The Capital Asset Pricing Model (CAPM)
The most common way to calculate RRR is using the CAPM formula. This model assumes that investors need to be compensated for the time value of money (risk-free rate) and the risk taken (market risk premium multiplied by beta).
Risk-Free Rate: Usually the yield on government bonds (like the 10-year US Treasury).
Beta (β): A measure of a stock's volatility compared to the overall market. A beta greater than 1.0 implies higher volatility.
Market Risk Premium: The difference between the expected market return and the risk-free rate.
Method 2: The Dividend Discount Model (DDM)
Also known as the Gordon Growth Model, this approach calculates RRR based on the dividends the company pays and the rate at which those dividends are expected to grow.
This method works best for stable, dividend-paying companies (like utilities or consumer staples) where future growth rates can be reasonably estimated.
Example Calculation
Imagine a technology company with the following CAPM metrics:
Risk-Free Rate: 3%
Stock Beta: 1.5 (High volatility)
Expected Market Return: 10%
Using the calculator above, the math would be: 3% + 1.5 * (10% – 3%) = 13.5%.
This means an investor requires at least a 13.5% return to justify the risk of investing in this volatile tech stock compared to a risk-free bond.
Why is RRR Important?
Investors use RRR as a discount rate in valuation models (like Discounted Cash Flow) to determine the fair value of a stock. If the calculated fair value is higher than the current stock price, the stock might be undervalued. Conversely, if the potential return is lower than the RRR, the investment may carry too much risk for too little reward.
// Logic to toggle inputs between CAPM and DDM
function toggleInputs() {
var method = document.getElementById('calcMethod').value;
var capmDiv = document.getElementById('capmInputs');
var ddmDiv = document.getElementById('ddmInputs');
var resultArea = document.getElementById('result-area');
// Hide result when switching methods
resultArea.style.display = 'none';
if (method === 'capm') {
capmDiv.classList.remove('hidden');
ddmDiv.classList.add('hidden');
} else {
capmDiv.classList.add('hidden');
ddmDiv.classList.remove('hidden');
}
}
function calculateRRR() {
var method = document.getElementById('calcMethod').value;
var result = 0;
var explanation = "";
if (method === 'capm') {
// Get CAPM inputs
var rf = parseFloat(document.getElementById('riskFreeRate').value);
var rm = parseFloat(document.getElementById('marketReturn').value);
var beta = parseFloat(document.getElementById('beta').value);
// Validation
if (isNaN(rf) || isNaN(rm) || isNaN(beta)) {
alert("Please enter valid numeric values for Risk-Free Rate, Market Return, and Beta.");
return;
}
// Calculation: RRR = Rf + Beta * (Rm – Rf)
// Note: rm – rf is the Market Risk Premium
result = rf + (beta * (rm – rf));
explanation = "Calculation: " + rf + "% + " + beta + " × (" + rm + "% – " + rf + "%)";
} else {
// Get DDM inputs
var div = parseFloat(document.getElementById('nextDividend').value);
var price = parseFloat(document.getElementById('stockPrice').value);
var growth = parseFloat(document.getElementById('growthRate').value);
// Validation
if (isNaN(div) || isNaN(price) || isNaN(growth)) {
alert("Please enter valid numeric values for Dividend, Price, and Growth Rate.");
return;
}
if (price === 0) {
alert("Stock price cannot be zero.");
return;
}
// Calculation: RRR = (D1 / P0) + g
// div/price is decimal, growth is percentage input (e.g., 5)
// Convert dividend yield to percentage then add growth percentage
var dividendYield = (div / price) * 100;
result = dividendYield + growth;
explanation = "Calculation: ($" + div + " / $" + price + ") + " + growth + "%";
}
// Display Result
var resultArea = document.getElementById('result-area');
var resultValue = document.getElementById('resultValue');
var resultExpl = document.getElementById('resultExplanation');
resultArea.style.display = 'block';
resultValue.innerHTML = result.toFixed(2) + "%";
resultExpl.innerHTML = explanation;
}