1. What is the Cost of Equity?

The cost of equity represents the return a company must offer investors to compensate for the risk of investing in its stock. It's a key component in calculating a company's weighted average cost of capital (WACC).

2. How Does the Calculator Work?

The calculator uses the Capital Asset Pricing Model (CAPM) formula:

Where:

• \( Ke \) — Cost of equity (decimal)
• \( Rf \) — Risk-free rate (decimal)
• \( \beta \) — Beta coefficient (unitless)
• \( ERP \) — Equity risk premium (decimal)

Explanation: The formula accounts for the time value of money (risk-free rate) and the risk associated with the specific investment (beta × ERP).

3. Importance of Cost of Equity

Details: Cost of equity is crucial for corporate finance decisions, including capital budgeting, valuation, and determining optimal capital structure.

4. Using the Calculator

Tips: Enter all values as decimals (e.g., 0.05 for 5%). Typical risk-free rates are government bond yields. Beta can be found from financial data providers. ERP is typically 3-6% for developed markets.

5. Frequently Asked Questions (FAQ)

Q1: What's a typical risk-free rate?
A: Usually the yield on 10-year government bonds, e.g., ~3-5% for US Treasuries depending on market conditions.

Q2: How is beta determined?
A: Beta is calculated by regressing stock returns against market returns, typically using 3-5 years of monthly data.

Q3: What affects the equity risk premium?
A: Market volatility, economic conditions, and investor risk appetite. Historical ERP for US markets is ~5-6%.

Q4: Are there limitations to CAPM?
A: Yes, it assumes perfect markets and that beta fully captures risk. Other models like Fama-French may be more comprehensive.

Q5: How often should cost of equity be recalculated?
A: Regularly, as market conditions change. At least quarterly for financial analysis purposes.