Cost of Equity Calculator
Calculate the cost of equity — the return shareholders require for investing in a company. This calculator shows two methods: the Capital Asset Pricing Model (CAPM) and the Dividend Growth Model (DGM), so you can compare both.
CAPM Inputs
Dividend Growth Model Inputs
What Is the Cost of Equity?
The cost of equity is the return shareholders require to hold a company's stock. Unlike debt, equity has no contractual interest payment — shareholders take on more risk, and they expect a higher return as compensation.
Cost of equity is the most expensive source of capital for a company, and it is a key input to WACC. There are two common methods to estimate it: the Capital Asset Pricing Model (CAPM) and the Dividend Growth Model (DGM).
Cost of Equity Formulas
Method 1 — CAPM:
Cost of Equity = Risk-Free Rate + Beta × (Market Return − Risk-Free Rate)
Method 2 — Dividend Growth Model (Gordon Growth):
Cost of Equity = (Expected Dividend ÷ Current Price) + Dividend Growth Rate
- CAPM — uses market risk (beta) and is the standard method used in most textbooks and financial models.
- DGM — uses dividend yield and growth; only works for dividend-paying companies, and the result is sensitive to the growth rate assumption.
Worked Example
CAPM method: risk-free rate 4%, market return 10%, beta 1.2
Market risk premium = 10% − 4% = 6%
Cost of equity = 4% + 1.2 × 6% = 11.20%
DGM method: stock price $50, dividend $2.50, growth 5%
Dividend yield = $2.50 ÷ $50 = 5%
Cost of equity = 5% + 5% = 10.00%
The two methods give different answers (11.20% vs 10.00%). This is normal — CAPM uses market risk; DGM uses dividend characteristics. Analysts often average the two or use CAPM when beta is reliable and DGM when the company has a long dividend history.
CAPM vs DGM: When to Use Each
- Use CAPM — for public companies with observable beta, and for any company in a well-defined market. It is the standard method in finance textbooks and valuation models.
- Use DGM — for companies with a long, stable dividend history. It is unreliable for non-dividend payers, companies in rapid transition, or when the growth rate exceeds the cost of equity.
- Use both — compare the results. If they are close, confidence is high. If they are far apart, investigate why — beta may be unstable, the dividend may be unsustainable, or the growth assumption may be aggressive.
Frequently Asked Questions
What is a good cost of equity?
It depends on risk. Large stable companies typically have 7–10% cost of equity; smaller riskier companies 12–18%. Software and biotech often have 15–20% because of high risk. In low-interest-rate environments, the whole range shifts down. Cost of equity is always higher than cost of debt for the same company because equity is riskier.
Why does cost of equity matter?
Cost of equity is what shareholders require to invest. If a company cannot generate returns above its cost of equity, it is destroying shareholder value. Cost of equity is a key component of WACC, which is the discount rate for DCF valuation. It is also the threshold for evaluating whether share buybacks or new projects are worthwhile.
Why is CAPM usually preferred over DGM?
CAPM applies to any publicly traded company with observable beta — even non-dividend payers. DGM requires a long, stable dividend history, which many modern companies do not have. CAPM also has a stronger theoretical foundation. The main weakness of CAPM is beta instability — beta changes over time and depends on the market proxy used.
What happens if dividend growth rate exceeds cost of equity?
The DGM formula breaks down mathematically — it produces a negative or infinite cost of equity. This is a sign that the growth assumption is unrealistic. No company can grow dividends faster than its cost of equity forever. If DGM produces a nonsensical result, use CAPM instead.
Can cost of equity be negative?
No. Cost of equity is a required return and cannot be negative. In CAPM, even a negative beta would only reduce the cost of equity down to the risk-free rate (never below). If a calculation gives a negative number, there is a data error — check the inputs.
How is cost of equity used in WACC?
In WACC, cost of equity is weighted by the equity proportion of total capital: WACC = (E ÷ V) × Re + (D ÷ V) × Rd × (1 − T). Cost of equity contributes more to WACC than cost of debt for most companies because equity is usually the larger funding source and has a higher rate. A 1% increase in cost of equity typically raises WACC by 0.5–0.8%.