The cost of equity is a financial metric used to estimate the return required by investors to hold shares of a company’s stock. It represents the minimum rate of return a company must generate to satisfy its shareholders.
Page written by Ian Hawkins. Last reviewed on June 25, 2024. Next review due October 1, 2025.
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The cost of equity represents the return required by investors for holding a company’s stock. It reflects the opportunity cost of investing in the company’s equity rather than alternative investments with similar risk profiles.
To calculate the cost of equity, you can use the Capital Asset Pricing Model (CAPM) or the Dividend Discount Model (DDM). I’ll explain both methods:
Cost of equity = risk-free rate + beta × (market return – risk-free rate)
Here’s how to calculate it:
Cost of Equity = Dividends per share / stock price + dividend growth rate
Here’s how to calculate it:
Please note that both methods have their limitations and should be used in conjunction with other financial analysis tools when evaluating the cost of equity.
The cost of equity represents the return required by equity investors, while the cost of debt reflects the interest rate paid by a company on its borrowed funds. Equity investors bear more risk than debt holders and, and therefore require a higher return. The cost of equity is often higher than the cost of debt due to the increased risk associated with equity investments.
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