Cost of Equity
The return shareholders require for bearing the risk of owning a company's shares.
Formula
Cost of Equity = Risk-Free Rate + Beta x Equity Risk Premium
Unit
%
In depth
Cost of equity is an opportunity cost, not a payment: no cheque is written, but capital that earns less than shareholders could get elsewhere at the same risk is being wasted. It is always higher than the cost of debt, because equity ranks last in a winding-up and has no contractual return. It cannot be observed directly, so it is estimated — usually through the capital asset pricing model, whose inputs are themselves contested. Small changes in it move a DCF valuation substantially, which is why any single-point valuation deserves a sensitivity table around this number.
Worked example
A risk-free rate of 7%, a beta of 1.0 and an equity risk premium of 5% give a cost of equity of 7% + 1.0 x 5% = 12%. A company earning 20% on equity is creating value at 8 points above what its owners require.
Illustrative figures, chosen so the arithmetic is easy to follow. Not a live price and not a valuation of any company.
Educational reference only
This entry explains what “Cost of Equity” means. It is not investment advice and not a recommendation to buy or sell any security. Any numbers above are illustrative, not live prices, and nothing here predicts price direction or rates a stock. Consider your own circumstances and consult a SEBI-registered investment adviser before acting.