What is Cost of Equity Capital Formula?
Cost of equity (Ke)Cost Of Equity (Ke)Cost of equity is the percentage of returns payable by the company to its equity shareholders on their holdings. It is a parameter for the investors to decide whether an investment is rewarding or not; else, they may shift to other opportunities with higher returns.read more is what shareholders expect to invest their equity into the firm. Cost of Equity formula can be calculated through below two methods:
 Method 1 – Cost of Equity Formula for Dividend Companies
 Method 2 – Cost of Equity Formula using CAPM ModelCAPM ModelThe Capital Asset Pricing Model (CAPM) defines the expected return from a portfolio of various securities with varying degrees of risk. It also considers the volatility of a particular security in relation to the market.read more
We will discuss each of the methods in detail.
Method #1 – Cost of Equity Formula for Dividend Companies
Where,
 DPS = Dividend Per ShareDividend Per ShareDividends per share are calculated by dividing the total amount of dividends paid out by the company over a year by the total number of average shares held.read more
 MPS = Market Price per Share
 r = Growth rate of Dividends
The dividend growth model requires that a company pays dividends, and it is based on upcoming dividends. The logic behind the equation is that the company’s obligation to pay dividends is the cost of paying its shareholders and, therefore, the Ke, i.e., cost of equity. This is a limited model in its interpretation of costs.
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For eg:
Source: Cost of Equity Formula (wallstreetmojo.com)
Cost of Equity Calculations
You can consider the following example for a better understanding of the Cost of Equity Formula:
Example #1
Let’s try the calculation for Cost of Equity formula with a 1^{st} formula where we assume a company is paying regular dividends.
Suppose a company named XYZ is a regularly paying dividend company, and its stock price is currently trading at 20 and expects to pay a dividend of 3.20 next year has following dividend payment history. Calculate the cost of equity of the company.
Year  Dividend Per Share 

1  3.00 
2  3.02 
3  3.05 
4  3.11 
5  3.16 
Solution:
Let’s first calculate the average growth rate of dividends. Continuing the same formula as per below will yield yearly growth rates.
So the growth rate for all the years will be
Now take a simple average growth rate, which will come to 1.31%.
Now we have all the inputs i.e. DPS for next year = 3.20, MPS = 20 and r = 1.31%
Hence
 Cost of Equity Formula= (3.20/20) + 1.31%
 Cost of Equity Formula= 17.31%
 Hence, the cost of equity for the XYZ company will be 17.31%.
Example #2 – Infosys
Below is the dividend history of the company, ignoring interim and any special dividendSpecial DividendThe term "Special Dividend" refers to an amount distributed to shareholders in the name of a dividend that is in addition to the regular dividend. Companies do this in the event of an unexpected inflow of cash or assets.read more for the time being.
Announcement Date  Effective Date  Dividend Type  Dividend (%)  Remarks  Dividend Per Share 

12/04/2018  14/06/2018  Final  410  Rs. 20.5000 per share (410%) Final Dividend  20.50 
13/04/2017  01/06/2017  Final  295  Rs. 14.7500 per share (295%) Final Dividend  14.75 
15/04/2016  09/06/2016  Final  285  Rs. 14.2500 per share (285%) Final Dividend  14.25 
24/04/2015  15/06/2015  Final  590  Rs. 29.5000 per share (590%) Final Dividend (equivalent to Rs 14.75/ per share after 1.1 bonus issue)  29.50 
15/04/2014  29/05/2014  Final  860  Rs. 43.0000 per share (860%) Final Dividend  43.00 
12/04/2013  30/05/2013  Final  540  Rs. 27.0000 per share (540%) Final Dividend  27.00 
13/04/2012  24/05/2012  Final  640  Rs. 22.00 per share (440%) Final Dividend & Rs.10.00 per share (200%) Special Dividend  22.00 
The Share price of Infosys is 678.95 (BSE), and its average dividend growthDividend GrowthDividend Growth is defined as a significant rise in a company's dividend payout to its shareholders from one period of time to another in comparison to the dividend payout of the previous period of time (generally the growth is calculated on yearly basis).read more rate is 6.90%, computed from the above table, and it paid last dividend 20.50 per share.
Therefore,
 Cost of Equity Formula = {[20.50(1+6.90%)]/678.95} +6.90%
 Cost of Equity Formula = 10.13%
Method #2 – Cost of Equity Formula using CAPM Model
Below is the formula of the Cost of Equity using the Capital Asset Pricing ModelCapital Asset Pricing ModelThe Capital Asset Pricing Model (CAPM) defines the expected return from a portfolio of various securities with varying degrees of risk. It also considers the volatility of a particular security in relation to the market.read more.
Where,
 R(f) = RiskFree Rate of Return
 β = Beta of the stock
 E(m) = Market Rate of Return
 [E(m)R(f)] = equity risk premium
The capital asset pricing model (CAPM), however, can be used on n number of stock, even if they are not paying dividends. With that said, the logic behind CAPM is rather complicated, which suggests the cost of equity (Ke) is based on the stock’s volatility, which is computed by Beta and level of risk compared to the general market, i.e., the equity market risk premiumMarket Risk PremiumThe market risk premium is the supplementary return on the portfolio because of the additional risk involved in the portfolio; essentially, the market risk premium is the premium return investors should have to make sure to invest in stock instead of riskfree securities.read more which is nothing but a differential of Market Return and RiskFree Rate.
In the CAPM equation, the riskfree rate (Rf)The Riskfree Rate (Rf)A riskfree rate is the minimum rate of return expected on investment with zero risks by the investor. It is the government bonds of welldeveloped countries, either US treasury bonds or German government bonds. Although, it does not exist because every investment has a certain amount of risk.read more is the rate of return paid on riskfree investments like Government bonds or Treasuries. Beta, a measure of risk, can be calculated as a regression on the company’s market price. The higher the volatility goes, the higher the beta will come, and its relative risk compared to the general stock market. The market rate of return Em(r) is the average market rate, which has generally been assumed to be eleven to twelve % over the past eighty years. In general, a company with a high beta will have a high degree of risk and will pay more for equity.
Example #1
Below, inputs have been arrived for the three companies, calculate its cost of equity.
Particulars  X  Y  Z 

Risk Free Beta  3.00%  3.40%  4.00% 
Beta  1.11  0.98  1.4 
Market Return  7.00%  7.00%  7.00% 
Solution:
First, we will calculate the equity risk premiumThe Equity Risk PremiumEquity Risk Premium is the expectation of an investor other than the riskfree rate of return. This additional return is over and above the risk free return.read more, which is the difference between Market Return and RiskFree Return Rate, i.e. [E(m) – R(f)]
Then we will calculate cost of equity using CAPM i.e. Rf + β [E(m) – R(f)] i.e. Riskfree rate + Beta(Equity Risk Premium).
Continuing the same formula as per above for all the company, we will get the cost of equity.
So, the cost of equity for X, Y, and Z comes to 7.44%, 6.93%, and 8.20%, respectively.
Example #2 – TCS Cost of Equity using the CAPM Model
Let’s try the calculation of the cost of equity for TCS through CAPM Model.
For the time being, we will take 10year Govt Bond yield as RiskFree Rate as 7.46%
Source: https://countryeconomy.com
Secondly, we need to come up to Equity Risk Premium,
Source: http://pages.stern.nyu.edu/
For India, Equity Risk Premium is 7.27%.
Now we need Beta for TCS, which we have taken from Yahoo finance India.
Source: https://in.finance.yahoo.com/
So the cost of equity (Ke) for TCS will be
 Cost of Equity Formula = Rf + β [E(m) – R(f)]
 Cost of Equity Formula= 7.46% + 1.13 * (7.27%)
 Cost of Equity Formula= 15.68%
Cost of Equity Calculations
You can use the following Cost of Equity Formula Calculator.
Dividend per Share  
Market price per Share  
Growth Rate of Dividends  
Cost of Equity Formula =  
Cost of Equity Formula = = 
 

Relevance and Use
 A firm uses a cost of equity (Ke) to assess the relative attractiveness of its opportunities in the form of investments, including both external projects and internal acquisition. Companies will typically use a combination of debt and equity financing, with equity capital is proving to be more expensive.
 Investors willing to invest in stock also use a cost of equity to find whether the company is earning a rate of return greater than it, less than it, or equal to that rate.
 Equity Analyst, Research AnalystResearch AnalystResearch analyst is a profession where the main task includes research on specific fields, analyzing the facts and figures, interpreting the analysis, and finally presenting the same to a structured audience that can relate to marketing, finance, operations.read more, Buy or sell side Analyst, etc. who are majorly involve in financing modeling and issue research reports uses the cost of equity to arrive at the valuation of the companies they follow and then accordingly advise whether the stock is over or under value and then take an investment decision based on that.
 There are many other methods also used to compute the cost of equity, which are running a regression analysis, multifactor modelMultifactor ModelFactor Models are financial models that incorporate factors (macroeconomic, fundamental, and statistical) to determine the market equilibrium and calculate the required rate of return. They associate the return of a security to single or multiple risk factors in a linear model.read more, survey method, etc.
Cost of Equity Formula in Excel (with excel template)
Now let us take the case mentioned in the above Cost of Equity Formula Example #1 to illustrate the same in the excel template below.
Suppose a company named XYZ is a regularly paying dividend company. Its stock price is currently trading at 20 and expects to pay a dividend of 3.20 next year has the following dividend payment history.
In the belowgiven table is the data for the calculation of the cost of equity.
In the below given excel template, we have used the calculation of Cost of Equity Equation to find the Cost of Equity.
So the calculation of the Cost of equity will be
Cost of Equity Formula Video
Recommended Articles:
This article has been a guide to the Cost of Equity Formula. Here we learn the two methods to calculate the cost of equity 1) for dividendpaying companies 2) using CAPM Model along with practical examples and concepts. You may learn more about valuations from the following articles –