Cost
of Equity Formula
Equity Holder expectation of return on their investment
is termed as cost of capital. There are basically two ways of determine the
cost of cost capital
1. Dividend Valuation Model:
Dividend
valuation model is based on yield provided (dividend) on the investment.
Cost
of Capital = Dividend (p.a)
Share
Price
Share price is $ 20 and Dividend offered is $ 2. Then cost
of capital would be
=
2/20
=10%
2. Capital Asset Pricing Model:
Capital asset pricing model takes into account the
relative risk of market.
Rf + β (Rm- Rf)
Rf=
Risk Free Return
Rm=
Market Return
Β
=Risk Factor
Government bond offer 3 % return while the stock exchange
offer a return of 8%, beta factor is 1.2, then cost of capital would be as
under
=
3% + 1.2(8%-3%)
=3%
+ 1.2(5%)
=.03+.06
=.09
=
9%
