Another technique of calculating the cost of your equity is what we call CAPM, the capital asset pricing model. CAPM says that you're rate of return on your equity is a function of the rate of return of investing in your own stock. How do we calculate that? Well, the formula for CAPM is that our expected return for our own stock, for our own equity, is the sum of what we call the risk free rate + the product of the company's beta (Rm-Rf). So let me explain what each one of these components mean. The risk free rate of capital, that's the interest rate that you will receive by owning a risk free asset. Here, we always use Treasury securities as a risk free asset. T-Bonds, they may be 10-year, 20-year notes, 60-day notes, sort of depending on what your time horizon is. The reason we have identified these as risk free is because, literally, there is no risk involved in owning these assets. If you own a Treasury security, you will get paid. You will always get paid, there is no risk. As a result, the interest rate that's associated with owning that asset is a risk free rate. There's no risk, you're going to get paid. But it's pretty low. The company's beta, the beta is a measurement of volatility of your company relative to the volatility of the market. Depending on which beta you are using, and which website you're tracking, you might find slight differentiations in what the beta is. For example, Yahoo Finance versus Google Finance. Both of these companies look at the rate of return of an individual organization, say UPS or Nike, relative to the S&P. One organization looks at it over 20 years, the other one looks at it over 25 years. And so your beta is going to be slightly different. So, if your company increases value the same time that the market does. Let's say that the market changes by 10% and your company changes by 10%. And then the market decreases by 10% and your company's value decreases by 10%. Your lock-step with the market, you would have a beta of one. But let's suppose that your company is much more volatile than the market. So the market increases by 10% and your value or your company increases by 12 or 15%. The S&P decreases by 10% but your company decreases by 12% or 15%, then you would have a beta of greater than one. Let's suppose you have a company whose value is really stable regardless of what's happening in the market. The S&P increases by 10%, your company goes up by one. The whole market decreases by 10%, your company goes down by one. You might have a beta of 0.2, 0.3, 0.17. The beta identifies how volatile your company is relative to the rest of the market. The market risk premium. This is the difference between the return of the market and the risk-free rate. So, over maybe the last 10 years, 12 years, 15 years, the market risk premium is going to change based on the general trends of the market. The current market risk premium is somewhere in the neighborhood of let's say, 8 to 10%. The current risk-free rate is somewhere around 2.5%. So, what you have to do is you take your 2.5 to 3%, and add that to your beta times a market risk premium of, let's say, 9% to find out the cost of your capital. That's the CAPM. Let's show you how to do this using an example. Here, I'm using Yahoo finance to look at UPS, United Parcel Service. I'm looking at the summary statistics of what's going on here. In the summary statistics, you'll notice that it has the current price of UPS, $97.15. It tells you where it was closed, the target, and about fifth or sixth line down, you'll see this beta. Right there, 0.90. So UPS has a beta of 0.90. So if I was going to calculate CAPM of beta, I would say, 2.5%, which is my risk-free rate, plus 0.9, times my market risk premium of about 8, 9%. So when I take 0.9 times 9, I get 8.1, add that to 2.5, and I get a CAPM of 10.6%. Now, you'll notice that my dividend growth model was giving me a cost of equity in the neighborhood of about 12%, 12.7%. My CAPM gives me a cost of equity in the neighborhood of 10.6%, 11%. Both are giving me a fairly reasonable cost of equity. I use both techniques to give me an idea of about what the cost of equity is. Remembering that these numbers, these calculations, are very sensitive to growth rates, very sensitive to risk free rates, very sensitive to the market risk premium. And so, if I make an assumption about a slightly higher market risk premium, 11%, now I'm talking about a CAPM of somewhere in the neighborhood of 11.5. If I have a growth rate that's closer to 8% or 9%, now I've got a cost of equity that's maybe closer to 9.5%. Really, we're trying to identify the difference between a cost of equity of 10 or 11 versus cost of equity 15 or 18 or 27%. Both these calculations give us a cost of equity that is in a relatively small range. They're both very useful and they help you get started on understanding, what is the cost of your equity? What is the start of your hurdle rate for your organization? See if you can, using the CAPM, calculate the cost of equity for your company or a company in your industry.