AAPL's live capital-structure inputs
Three CAPM flaws and their professional fixes
| CAPM Problem | Issue | Professional Fix |
|---|---|---|
| Unstable beta | Beta changes with time period and market conditions | Use 2–5 year weekly returns; compare to industry median |
| Risk-free rate debate | 10-year or 30-year Treasury? Current or normalized? | Match to investment horizon; current for near-term, normalized for terminal value |
| ERP estimation | Historical premium (5–7%) vs. implied forward (~4–5%) | Use Damodaran’s implied ERP, updated annually |
Cost-of-equity models beyond strict CAPM
Beyond CAPM, three alternative models capture risk CAPM misses: Fama-French (adds size and value factors), Build-up Method (adds company-specific risk premia), and the Implied Cost of Capital from current market prices. Note: these are practitioner adjustments, not extensions of CAPM theory. Strict CAPM only prices systematic risk via beta - adding idiosyncratic premia violates CAPM's diversifiability assumption. The size premium in particular has weakened or disappeared in some post-1980 datasets (Banz 1981 found it; Fama-French 1992 confirmed it; more recent SPIVA/AQR studies show it small or insignificant). Treat build-up adjustments as defensible practitioner judgment, not theoretical law.
Check whether a stock's beta is stable
Which beta to use when they diverge
Why the equity risk premium dominates every valuation
Sit with the ideas.
You are valuing a $500M market cap specialty chemical company. CAPM gives 11% cost of equity (4.5% Rf + 1.3 beta x 5% ERP). The company has one customer representing 35% of revenue and its CEO founded the business with no clear successor. How should you adjust?