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Cost of Equity Calculator
The Cost of Equity Calculator is a user-friendly tool designed to help businesses and investors calculate the rate of return required by equity investors. This rate compensates investors for the risk of investing their capital in a company. Whether the company pays dividends or not, this tool simplifies the calculation process using two popular methods: the Dividend Capitalization Model and the CAPM (Capital Asset Pricing Model).
What is the Cost of Equity?
The cost of equity represents the return shareholders expect for investing in a company. It’s essentially the market’s compensation for the risks associated with owning shares. Companies use this figure to evaluate how attractive their investments are and the associated risks.
The relationship is straightforward:
- Higher risk = Higher cost of equity
- Lower risk = Lower cost of equity
For businesses, understanding the cost of equity is crucial in managing capital from two primary sources:
- Equity Investors: Who expect returns through dividend payouts or share price appreciation.
- Debt (Loans): This involves fixed costs like interest payments.
How to Calculate the Cost of Equity
This calculator uses two methods depending on the company’s dividend policy:
- Dividend Capitalization Model (For companies paying dividends)
2. CAPM Model (For companies not paying dividends)
Cost of Equity= Risk-Free Rate of Return+Beta×(Market Rate of Return−Risk-Free Rate of Return)
Why Use the Cost of Equity Calculator?
- Evaluate Investment Risk: Understand the level of risk associated with an investment.
- Analyze Attractiveness: Determine whether a company’s shares are worth investing in.
- Accurate Results: Get precise calculations for informed decision-making.
- Convenience: Easily switch between models depending on the company’s dividend policy.
Example Calculation
Imagine a company with:
- A current share price of $70
- A dividend per share of $2
- A growth rate of 3%
Using the Dividend Capitalization Model:
This means to raise an additional $100, the company would need to provide a return of $105.86.