Module II· Cost of Equity & CAPMAdvanced
Question
How did you calculate the CoE in the negative-rate environment of 2014–2022?
Answer
Problem
The 10-year government bond yield was often negative in 2016–2021 (e.g. −0.5%). Naive CAPM: CoE = −0.5% + 1.0 × 5.5% = 5.0% — absurdly low for an equity investment. Practical adjustments:
- 'Normalized Rf': a 10Y average (e.g. 2.0%) instead of the current spot.
- Floor at 0%: don't let Rf go below 0%.
- Damodaran method: reconstruct from a country default spread plus a risk-free element. IB standard 2018–2021: normalized Rf at 1.5–2.0%.
Deep diveShow more details
Pitch tip
'In a negative-rate environment we take Rf based on a 10-year average, not spot — otherwise it's inconsistent with the long-term valuation horizon.' Less relevant again post-2022 — spot Rf is back to normal.