Use this tool to easily calculate the Cost of Equity ($R_e$) for any company using the widely accepted Capital Asset Pricing Model (CAPM). The Cost of Equity represents the return a company must earn to compensate its equity investors for the risk they take.
Cost of Equity (CAPM) Calculator
Calculated Cost of Equity ($R_e$)
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Cost of Equity Formula: CAPM
$R_e = R_f + \beta \times (R_m - R_f)$
Variables Explained
- Risk-Free Rate ($R_f$): The return on a theoretical investment with zero risk, usually represented by the yield on long-term government bonds (like 10-year US Treasury bonds).
- Stock Beta ($\beta$): A measure of the stock’s volatility (systematic risk) in relation to the overall market. A beta of 1 means the stock moves with the market; >1 means it is more volatile.
- Market Risk Premium ($R_m – R_f$): The additional return investors expect for holding a diversified market portfolio over the risk-free rate.
- Cost of Equity ($R_e$): The final calculated minimum rate of return a company must provide to its equity investors.
Related Calculators
What is the Cost of Equity?
The Cost of Equity is a critical component in financial valuation and capital budgeting, representing the return required by shareholders to compensate them for the risk associated with investing in a company’s stock. It is typically calculated using the Capital Asset Pricing Model (CAPM).
This metric is essential for discounting a company’s future cash flows back to their present value (Net Present Value or NPV) and determining whether a project or investment is financially viable. A higher Cost of Equity means the investment is riskier, thus requiring a higher expected return.
How to Calculate Cost of Equity (Example)
Imagine we need to calculate the Cost of Equity for “TechCorp” using the following data:
- Identify the Risk-Free Rate ($R_f$): The current 10-year Treasury yield is 4.0%.
- Determine the Stock Beta ($\beta$): TechCorp’s beta is found to be 1.5.
- Estimate the Market Risk Premium ($R_m – R_f$): The general market risk premium is 6.0%.
- Apply the CAPM Formula: $R_e = R_f + \beta \times (R_m – R_f)$
- Substitute Values: $R_e = 4.0\% + 1.5 \times 6.0\%$
- Calculate the Premium: $1.5 \times 6.0\% = 9.0\%$
- Calculate the Final Result: $R_e = 4.0\% + 9.0\% = 13.0\%$
The Cost of Equity for TechCorp is 13.0%.
Frequently Asked Questions (FAQ)
What is the difference between Cost of Equity and WACC? The Cost of Equity ($R_e$) is the return required by *equity* investors only. The WACC (Weighted Average Cost of Capital) is the average rate of return a company expects to pay to *all* its capital providers (both debt and equity), weighted by the proportion of each source in the capital structure.
Why do I use the Beta ($\beta$) value? Beta measures systematic risk—the risk that cannot be diversified away. It accounts for how sensitive a stock’s price is to changes in the overall market. It is the primary input used in CAPM to determine the risk premium specific to that asset.
What is a typical Market Risk Premium? The Market Risk Premium is highly debated, but historical estimates in developed markets typically fall between 4% and 6.5%. Analysts often use a forward-looking estimate or a historical average based on decades of market data.
Does the Cost of Equity change? Yes, it changes constantly, primarily due to fluctuations in the Risk-Free Rate (which changes with central bank policy and economic outlook) and the company’s Beta (which changes with market perception of the company’s risk).