Cost of Equity Calculator

Cost of Equity Calculator

The cost of equity calculator helps you determine the minimum theoretical rate of return a company must offer to its shareholders in exchange for buying the stock and bearing the related risk.

What Is the Cost of Equity?

The rate of return that a company pays out to shareholders based on equity in certain shares is called the cost of equity.

It helps to compare different shares and offer the best one to the investor so that maximum ROI can be earned back for them.

How to Calculate Cost of Equity?

You can calculate the cost of equity using two different models, which include:

CAPM (Capital Asset Pricing Model):

Cost of Equity = Risk-free rate of return + Beta × (Market rate of return - Risk-free rate of return)

Where;

• The risk-free rate of return represents the risk-free ROI
• Beta shows the average return on a certain stock based on its market value
• The market rate of return is the parameter that indicates the volatility in the value of the stock

Dividend Capitalization Model:

This method of cost of equity calculation is suitable only for companies that pay dividends at a constant rate, such that:

Cost of Equity = (DPS / CSP) + GRD

Where;

• DPS stands for ‘Dividend Per Share’, which is the amount that will be paid next year
• CSP is the current share price
• GRD represents ‘Growth Rate of Dividend’, shows the change between the past and the current dividend in terms of percentage (%)

Cost of Equity Examples:

Example 1: Using the CAPM Model

Given:

• Risk-free rate of return = 4%
• Beta = 1.25
• Market rate of return = 10%

Solution: 

Using the CAPM formula:

Cost of Equity = Risk-free rate + Beta * (Market rate - Risk-free rate)

Cost of Equity = 4% + 1.25 * (10% - 4%)

Cost of Equity = 4% + 1.25 * 6%

Cost of Equity = 4% + 7.5%

Cost of Equity = 11.5%

Example 2: Using the Dividend Capitalization Model

Given:

• Dividend Per Share (DPS) = $6
• Current Share Price (CSP) = $10
• Growth Rate of Dividend (GRD) = 5%

Solution:

Using the Dividend Capitalization Model formula:

Cost of Equity = (DPS / CSP) + GRD

Cost of Equity = ($6 / $10) + 5%

Cost of Equity = $0.6 + 0.05

Cost of Equity = 0.65%