Cost of Equity Calculator
Calculate the required return on equity using multiple methods including CAPM, Dividend Discount Model, and Bond Yield Plus Risk Premium. This calculator helps determine the minimum return expected by equity investors.
CAPM Method
Dividend Discount Model (DDM)
Bond Yield Plus Risk Premium
Cost of Equity Results
CAPM Cost of Equity:
0.00%
DDM Cost of Equity:
0.00%
Bond Yield + Premium:
0.00%
Method Comparison
Average Cost:
0.00%
Range:
0.00%
Recommended Method:
N/A
Business Insights
Investor Expectations:
N/A
Valuation Impact:
N/A
Capital Budgeting:
N/A
Understanding Cost of Equity
Cost of equity represents the minimum return that shareholders require for investing in a company's stock. It is a critical component in business valuation, capital budgeting, and investment decision-making.
Cost of Equity Methods
CAPM (Capital Asset Pricing Model)
- Most widely used method
- Re = Rf + ß × (Rm - Rf)
- Accounts for systematic risk
- Requires beta estimation
Dividend Discount Model (DDM)
- Based on dividend payments
- Re = (D1/P0) + g
- Suitable for dividend-paying stocks
- Requires stable dividend policy
Bond Yield Plus Risk Premium
Method Overview
- Uses company's bond yield as base
- Adds equity risk premium
- Re = Bond Yield + Risk Premium
- Simple and intuitive approach
When to Use
- Company has publicly traded bonds
- CAPM inputs are unreliable
- Quick estimate needed
- Private company valuation
CAPM Components
Key Inputs
Understanding CAPM variables
Risk-Free Rate (Rf)
- Return on risk-free investments
- Typically government bond yields
- 10-year Treasury bond rate
- Adjusts for maturity matching
Beta (ß)
- Measure of systematic risk
- Stock volatility relative to market
- ß = 1: Market risk level
- ß > 1: Higher risk than market
Market Risk Premium (Rm - Rf)
- Extra return for market risk
- Historical average: 4-6%
- Varies by market conditions
- Forward-looking estimates
Expected Market Return (Rm)
- Anticipated market portfolio return
- Rf + Market Risk Premium
- Historical averages: 7-10%
- Based on economic forecasts
Dividend Discount Model
Gordon Growth Model
- Re = (D1/P0) + g
- D1 = Next year's dividend
- P0 = Current stock price
- g = Dividend growth rate
Multi-Stage DDM
- Accounts for changing growth rates
- High growth phase
- Stable growth phase
- More complex calculations
Method Selection Guidelines
| Situation | Best Method | Reason | Considerations |
|---|---|---|---|
| Public Company | CAPM | Beta available, market data | Requires reliable beta |
| Dividend Stock | DDM | Based on actual dividends | Requires stable dividends |
| Private Company | Bond Yield + Premium | Simple, comparable data | May not have bonds |
| High Growth | CAPM | Accounts for risk | Beta may be volatile |
Cost of Equity Applications
Business Valuation
- Discount rate in DCF models
- Terminal value calculations
- Comparable company analysis
- Private company valuations
Capital Budgeting
- Hurdle rate for projects
- Risk-adjusted discount rates
- NPV calculations
- Project evaluation
Factors Affecting Cost of Equity
Market Factors
- Interest rate changes
- Market volatility
- Investor risk appetite
- Economic conditions
Company Factors
- Business risk changes
- Leverage adjustments
- Growth opportunities
- Dividend policy
Key Takeaways for Cost of Equity
- Cost of equity is the minimum return required by shareholders
- CAPM is the most widely used method: Re = Rf + ß × (Rm - Rf)
- DDM is suitable for dividend-paying stocks: Re = (D1/P0) + g
- Bond yield plus risk premium provides a simple alternative
- Method selection depends on company characteristics and data availability
- Cost of equity is used as a discount rate in valuation and capital budgeting
- Higher cost of equity reduces company valuation
- Regular updates are needed as market conditions change