1. What is the Cost of Equity?

The cost of equity represents the return a company must offer investors to compensate for the risk of investing in its stock. It's a key component in determining a company's weighted average cost of capital (WACC).

2. How Does the CAPM Work?

The calculator uses the Capital Asset Pricing Model (CAPM):

Where:

• \( \text{Risk-Free Rate} \) — Typically the yield on government bonds (%)
• \( \beta \) — Measure of stock volatility compared to the market (unitless)
• \( \text{Market Return} \) — Expected return of the market portfolio (%)

Explanation: The model quantifies the relationship between systematic risk and expected return for assets, particularly stocks.

3. Importance of Cost of Equity

Details: Accurate cost of equity calculation is crucial for investment decisions, corporate finance, and valuation models like discounted cash flow analysis.

4. Using the Calculator

Tips: Enter the risk-free rate (usually 10-year government bond yield), the stock's beta (available from financial websites), and the expected market return (historical average is often used).

5. Frequently Asked Questions (FAQ)

Q1: What's a typical risk-free rate?
A: Often the 10-year government bond yield of the country where the company operates (e.g., ~3-4% for US Treasury bonds).

Q2: How is beta determined?
A: Beta is calculated by regressing the stock's returns against market returns. A beta of 1 means the stock moves with the market.

Q3: What market return should I use?
A: Historical average market returns are often used (typically 7-10% for US markets long-term).

Q4: Are there limitations to CAPM?
A: Yes, it assumes markets are efficient and investors hold diversified portfolios. Alternative models like Fama-French exist.

Q5: How often should cost of equity be recalculated?
A: It should be updated regularly as market conditions, interest rates, and company risk profiles change.