Calculate the cost of equity using CAPM (risk-free rate, beta, market return) or the dividend discount model (Gordon Growth).
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The cost of equity is the minimum annual return shareholders require to hold a stock. It is a critical input for WACC, DCF valuations, and capital budgeting decisions.
Unlike debt, equity has no contractual interest payment. The cost of equity is an implied rate — the return investors demand given the stock’s risk profile. Companies that cannot earn above their cost of equity are destroying shareholder value.
Two standard models exist: the Capital Asset Pricing Model (CAPM) and the Dividend Discount Model (Gordon Growth). CAPM is more widely used because it applies to non-dividend-paying stocks.
CAPM derives cost of equity from systematic risk exposure.
Ke = Rf + β × (Rm − Rf)
Rf = risk-free rate (e.g. 10-year Treasury yield), β = stock beta, Rm = expected market return, (Rm − Rf) = equity risk premium.
The Gordon Growth Model derives cost of equity from expected dividends.
Ke = (D₁ / P₀) + g
D₁ = expected dividend per share next year, P₀ = current stock price, g = constant dividend growth rate.
Risk-free rate 4.5%, beta 1.2, market return 10%. Equity risk premium = 10% − 4.5% = 5.5%. Cost of equity = 4.5% + 1.2 × 5.5% = 11.1%.
CAPM assumes a single risk factor and relies on historical beta, which may not predict future risk. The DDM only works for companies paying steady, growing dividends. Both models are sensitive to input assumptions, especially the equity risk premium.
Frequently asked questions
For large-cap US equities, the cost of equity typically ranges from 7% to 12%, depending on beta and the prevailing risk-free rate. Smaller or riskier firms can have a cost of equity above 15%.
Use CAPM for any stock, including non-dividend payers. Use the DDM when the company pays stable, predictable dividends with a consistent growth rate — common for utilities and mature blue chips.
WACC blends the cost of equity and the after-tax cost of debt. If you underestimate the cost of equity, the resulting WACC is too low, and DCF valuations will be inflated.
In theory yes if beta is negative and the risk premium is large, but in practice this almost never occurs. A negative cost of equity would imply the asset is an insurance-like hedge rather than a return-seeking investment.
Related
These related calculators come from the same leaf category, nearby sibling categories, or the same top-level topic.
Calculate the weighted average cost of capital (WACC) from equity and debt weights, costs, and the corporate tax rate.
Calculate indicated dividend yield from share price and dividend amount by payment frequency, plus annualised dividend per share.
Estimate single-stage Gordon-growth intrinsic value from next-year dividend, required return, perpetual growth, and optional current market price comparison.
Calculate the maximum sustainable growth rate a company can achieve using only retained earnings, from return on equity and retention rate.
