Cost of Equity Calculator

Calculation Method:
CAPM DCM

Risk-Free Rate (%):

Beta:

Market Rate of Return (%):

Dividend per Share ($):

Current Share Price ($):

Dividend Growth Rate (%):

1. What is the Cost of Equity Calculator?

Definition: The Cost of Equity Calculator computes the rate of return a company must offer its equity investors to compensate for the risk of their investment. It uses either the Capital Asset Pricing Model (CAPM) for any stock or the Dividend Capitalization Model (DCM) for dividend-paying companies.

Purpose: Used by investors to assess the expected return on a stock and by companies to evaluate the cost of raising equity capital, aiding in investment decisions and financial planning.

2. How Does the Calculator Work?

The calculator uses two formulas:

$ C_e = R_f + \beta \times (R_m - R_f) \quad (\text{CAPM}) $

$ C_e = \frac{DPS}{CSP} + GRD \quad (\text{DCM}) $

Where:

$ C_e $: Cost of Equity (%);
$ R_f $: Risk-Free Rate (%);
$ \beta $: Beta (stock volatility relative to market);
$ R_m $: Market Rate of Return (%);
$ DPS $: Dividend per Share ($);
$ CSP $: Current Share Price ($);
$ GRD $: Dividend Growth Rate (%).

Steps:

Select the calculation method (CAPM or DCM).
For CAPM:
- Enter the risk-free rate (e.g., 2.4 for 3-month Treasury bills).
- Enter the beta (e.g., 0.47 for Walmart).
- Enter the market rate of return (e.g., 8).
For DCM:
- Enter the dividend per share (e.g., $2).
- Enter the current share price (e.g., $70).
- Enter the dividend growth rate (e.g., 3).
Calculate the cost of equity using the selected formula.
Display the cost of equity (%), formatted in scientific notation if less than 0.001, otherwise with 4 decimal places.

3. Importance of Cost of Equity Calculation

Calculating the cost of equity is essential for:

Investment Decisions: Helps investors determine if a stock’s expected return justifies its risk.
Capital Budgeting: Assists companies in setting hurdle rates for projects, ensuring returns exceed equity costs.
Valuation: Used in models like Discounted Cash Flow (DCF) to estimate a company’s stock value.

4. Using the Calculator

Example 1 (CAPM): Calculate the cost of equity for Walmart with $ R_f = 2.4\% $, $ \beta = 0.47 $, $ R_m = 8\% $:

$ R_f $: 2.4%;
$ \beta $: 0.47;
$ R_m $: 8%;
$ C_e $: $ 2.4 + 0.47 \times (8 - 2.4) = 2.4 + 0.47 \times 5.6 = 2.4 + 2.632 = 5.032\% $.

Result: Cost of Equity = 5.0320%.

Example 2 (DCM): Calculate the cost of equity for a company with $ DPS = \$2 $, $ CSP = \$70 $, $ GRD = 3\% $:

$ DPS $: $2;
$ CSP $: $70;
$ GRD $: 3%;
$ C_e $: $ \frac{2}{70} \times 100 + 3 = 2.8571 + 3 = 5.8571\% $.

Result: Cost of Equity = 5.8571%.

5. Frequently Asked Questions (FAQ)

Q: What is the cost of equity?
A: The cost of equity ($ C_e $) is the return a company must provide to equity investors to compensate for the risk of their investment, calculated using CAPM or DCM.

Q: When should I use the Dividend Capitalization Model?
A: Use DCM only for companies paying dividends, as it relies on $ DPS $, $ CSP $, and $ GRD $. For non-dividend stocks, use CAPM.

Q: How does CAPM account for risk?
A: CAPM uses $ \beta $ to measure a stock’s volatility relative to the market, adjusting the expected return based on systematic risk.