In finance, the cost of equity is the return a firm theoretically pays to its shareholders to compensate for the risk they take by investing their capital. Companies need external capital to operate and grow, and the cost of equity helps determine the rate of return required to satisfy equity investors.

This rate represents the shareholders' expectations for the minimum return they should earn, considering the risks involved and the opportunity cost of investing elsewhere. For example, if an individual like Alex invests in a new start-up, he expects a return that compensates for the risk of investing, as his capital could have been used in other ventures. The cost of equity is the minimum return that would make Alex's investment worthwhile.

Companies calculate the cost of equity using models like the Capital Asset Pricing Model (CAPM), which takes into account the risk-free rate, the stock's volatility (beta) relative to the market, and the expected market return above the risk-free rate.

Understanding the cost of equity helps businesses evaluate the financial viability of projects, ensuring they generate enough returns to satisfy investors and promote long-term growth.

From Chapter 8:

article

Now Playing

8.3 : Cost of Equity

Cost of Capital

57 Views

article

8.1 : Concept of Cost of Capital

Cost of Capital

168 Views

article

8.2 : Required Return vs. Cost of Capital

Cost of Capital

64 Views

article

8.4 : Calculating Cost of Equity

Cost of Capital

70 Views

article

8.5 : Cost of Preferred Stock

Cost of Capital

43 Views

article

8.6 : Cost of Debt

Cost of Capital

68 Views

article

8.7 : Calculating Cost of Debt

Cost of Capital

62 Views

article

8.8 : Weighted Average Cost of Capital

Cost of Capital

103 Views

article

8.9 : Calculating Weighted Average Cost of Capital

Cost of Capital

159 Views

article

8.10 : Capital Structure Weights

Cost of Capital

49 Views

JoVE Logo

Privacy

Terms of Use

Policies

Research

Education

ABOUT JoVE

Copyright © 2025 MyJoVE Corporation. All rights reserved