Cost Of Equity

AAA

DEFINITION of 'Cost Of Equity'

In financial theory, the return that stockholders require for a company. The traditional formula for cost of equity (COE) is the dividend capitalization model:
 


Cost Of Equity

A firm's cost of equity represents the compensation that the market demands in exchange for owning the asset and bearing the risk of ownership.

INVESTOPEDIA EXPLAINS 'Cost Of Equity'

Let's look at a very simple example: let's say you require a rate of return of 10% on an investment in TSJ Sports. The stock is currently trading at $10 and will pay a dividend of $0.30. Through a combination of dividends and share appreciation you require a $1.00 return on your $10.00 investment. Therefore the stock will have to appreciate by $0.70, which, combined with the $0.30 from dividends, gives you your 10% cost of equity.

The capital asset pricing model (CAPM) is another method used to determine cost of equity.

RELATED TERMS
  1. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders ...
  2. Cost Of Capital

    The required return necessary to make a capital budgeting project, ...
  3. Optimal Capital Structure

    The best debt-to-equity ratio for a firm that maximizes its value. ...
  4. Cost Of Debt

    The effective rate that a company pays on its current debt. This ...
  5. Capital Structure

    A mix of a company's long-term debt, specific short-term debt, ...
  6. Required Rate Of Return - RRR

    The minimum annual percentage earned by an investment that will ...
RELATED FAQS
  1. What is the difference between residual income and operational income?

    Residual income is usually calculated in the context of personal finances, as opposed to operating income, which is calculated ... Read Full Answer >>
  2. Why might two companies calculate capital employed differently?

    The primary reason there are different ways of calculating a company's capital employed is because there are different definitions ... Read Full Answer >>
  3. What is the difference between the cost of capital and the discount rate?

    The cost of capital refers to the actual cost of financing business activity through either debt or equity capital. The discount ... Read Full Answer >>
  4. Why does zero-based budgeting require ongoing evaluation and management?

    Zero-based budgeting must have ongoing evaluation and management due to the fact a zero-based budget requires management ... Read Full Answer >>
  5. How does the market share of a few companies affect the Herfindahl-Hirschman Index ...

    In economics and commercial law, the Herfindahl-Hirschman Index (HHI) is a widely used measure that indicates the amount ... Read Full Answer >>
  6. What does the rule of 70 indicate about a country's future economic growth?

    The rule of 70 could be used to indicate the approximate number of years that it would take a company's economic growth to ... Read Full Answer >>
Related Articles
  1. Fundamental Analysis

    Discounted Cash Flow Analysis

    Find out how analysts determine the fair value of a company with this step-by-step tutorial and learn how to evaluate an investment's attractiveness for yourself.
  2. Investing Basics

    Capital Budgeting

    Learn the process through which businesses determine whether projects are worth pursuing.
  3. Markets

    Digging Into The Dividend Discount Model

    The DDM is one of the most foundational of financial theories, but it's only as good as its assumptions.
  4. Fundamental Analysis

    Taking Shots At CAPM

    Find out why many investors think the capital asset pricing model is full of holes.
  5. Economics

    How Return On Equity Can Help You Find Profitable Stocks

    It pays to invest in companies that generate profits more efficiently than their rivals. This is where ROE comes in.
  6. Investing Basics

    DCF Valuation: The Stock Market Sanity Check

    Calculate whether the market is paying too much for a particular stock.
  7. Personal Finance

    An Introduction To Capital Budgeting

    We look at three widely used valuation methods and figure out how companies justify spending.
  8. Bonds & Fixed Income

    Investors Need A Good WACC

    Weighted average cost of capital may be hard to calculate, but it's a solid way to measure investment quality.
  9. Fundamental Analysis

    Taking Stock Of Discounted Cash Flow

    Learn how and why investors are using cash flow-based analysis to make judgments about company performance.
  10. Bonds & Fixed Income

    Equity Valuation In Good Times And Bad

    Learn how to filter out the noise of the market place in order to find a solid way of determing a company's value.

You May Also Like

Hot Definitions
  1. Net Worth

    The amount by which assets exceed liabilities. Net worth is a concept applicable to individuals and businesses as a key measure ...
  2. Stop-Loss Order

    An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit ...
  3. Covered Call

    An options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset ...
  4. Butterfly Spread

    A neutral option strategy combining bull and bear spreads. Butterfly spreads use four option contracts with the same expiration ...
  5. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
  6. Moving Average - MA

    A widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random ...
Trading Center