Cost of equity

Cost of equity is the return shareholders require for bearing the risk of a firm's shares, commonly estimated with the CAPM. It is the equity component of the weighted average cost of capital.

ByHoang TruongUpdated June 30, 2026

FrameworkCAPM

What it is

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Cost of equity breaks into two parts: the risk-free rate and a risk premium. With a risk-free rate of 3%, a beta of 1.2, and a market risk premium of 6%, the risk premium equals 1.2 × 6% = 7.2%. Added together, 3% + 7.2% gives a cost of equity of 10.2%, the CAPM estimate of what shareholders require.

The formula

LaTeX

R_e = r_f + \beta(r_m - r_f)

Variables

$R_{e}$: Cost of equity (decimal)
$r_{f}$: Risk-free rate (decimal)
$β$: Equity beta (ratio)
$r_{m}$: Expected market return (decimal)

CAPM estimate of the return shareholders require.

LaTeX

R_e = \frac{D_1}{P_0} + g

Variables

$D_{1}$: Expected dividend in the next period (€)
$P_{0}$: Current share price (€)
$g$: Constant dividend growth rate (decimal)

Gordon growth model alternative; requires stable, perpetual dividend growth.

Check yourself

PracticeCORE

Estimate the cost of equity for a firm whose shares have a beta of 0.9. The risk-free rate is 3% and the market risk premium is 7%.

Select an answer to check your understanding.