This calculator uses the Capital Asset Pricing Model (CAPM) to estimate a company's cost of equity.
Your estimated Cost of Equity is: –%
Understanding the Cost of Equity
The cost of equity is a fundamental concept in corporate finance, representing the return a company requires to compensate its equity investors for the risk of owning its stock. It is a crucial component in various financial analyses, including capital budgeting (evaluating investment projects), company valuation, and determining the Weighted Average Cost of Capital (WACC).
The Capital Asset Pricing Model (CAPM)
The most widely used method for calculating the cost of equity is the Capital Asset Pricing Model (CAPM). The CAPM formula is as follows:
Risk-Free Rate (Rf): This represents the theoretical return on an investment with zero risk. In practice, it is often proxied by the yield on long-term government bonds (e.g., U.S. Treasury bonds) of a stable economy. It reflects the time value of money without any added risk premium.
Beta (β): Beta measures the volatility, or systematic risk, of a particular stock in comparison to the overall market.
A Beta of 1.0 means the stock's price tends to move with the market.
A Beta greater than 1.0 indicates the stock is more volatile than the market.
A Beta less than 1.0 suggests the stock is less volatile than the market.
Beta captures the risk that cannot be diversified away.
Market Risk Premium (MRP): This is the excess return that investors expect to receive for investing in the stock market over and above the risk-free rate. It's calculated as the expected return on the market minus the risk-free rate. It compensates investors for the additional risk they take by investing in equities rather than risk-free assets.
How to Use This Calculator
To estimate your company's or an investment's cost of equity using the CAPM:
Enter the current Risk-Free Rate: This is typically the yield on a long-term government bond.
Enter the Beta (β) for the company or stock: You can often find Beta values from financial data providers (like Yahoo Finance, Bloomberg, Refinitiv).
Enter the Market Risk Premium: This is an expected value, often estimated based on historical market returns and current economic conditions.
The calculator will then apply the CAPM formula to provide your estimated Cost of Equity.
Why is Cost of Equity Important?
Investment Decisions: Companies use the cost of equity as a benchmark hurdle rate. An investment project's expected return must exceed the cost of equity (and other costs of capital) to be considered financially viable.
Valuation: Discounting future cash flows at the cost of equity (or WACC) is a common method for valuing a company's equity.
Performance Evaluation: It can be used to assess whether a company is generating adequate returns for its shareholders relative to the risk taken.
Keep in mind that the CAPM is a model and relies on estimates and assumptions. The calculated cost of equity is therefore an approximation, and its accuracy depends heavily on the quality of the inputs.
function calculateCostOfEquity() {
var riskFreeRateInput = document.getElementById("riskFreeRate");
var betaInput = document.getElementById("beta");
var marketRiskPremiumInput = document.getElementById("marketRiskPremium");
var resultDiv = document.getElementById("result").getElementsByTagName("span")[0];
var riskFreeRate = parseFloat(riskFreeRateInput.value);
var beta = parseFloat(betaInput.value);
var marketRiskPremium = parseFloat(marketRiskPremiumInput.value);
// Input validation
if (isNaN(riskFreeRate) || isNaN(beta) || isNaN(marketRiskPremium)) {
resultDiv.textContent = "Please enter valid numbers for all fields.";
resultDiv.style.color = "#dc3545"; // Red for error
return;
}
// CAPM Formula: Cost of Equity = Rf + Beta * (Rm – Rf)
// In our input terms: Cost of Equity = Risk-Free Rate + Beta * Market Risk Premium
var costOfEquity = riskFreeRate + (beta * marketRiskPremium);
// Format the result to two decimal places and add the percentage sign
resultDiv.textContent = costOfEquity.toFixed(2) + "%";
resultDiv.style.color = "#28a745"; // Green for success
}