Bond Yield Plus Risk Premium Method

Bond yield plus risk premium method is used to calculate cost of common equity for a firm. This is not an exact rate but an estimate of the cost. For more accurate calculations of cost of common equity use capital asset pricing model or discounted cash flows. Bond yield plus risk premium equals the cost of debt, in this case the bond yield plus the risk premium.

Determine the bond yield. This is the effective interest on a company's long-term debt.

Determine the risk premium. The risk premium is the amount over the risk-free rate an investment makes. The risk premium is a general estimate usually ranging between 5 percent to 7 percent.

 

Add bond yield and risk premium to determine the cost of common equity.