The cost of equity is a return percentage a company must offer investors to spark investment in the company. This is an important measure, because an investor will only invest if he believes he will receive his desired rate of return. Managers also use this measure to calculate weighted-average cost of captial (WACC). WACC calculates the average cost the company needs to pay to raise capital through equity and debt.
Find the current market value per share of stock. This is the amount the stock is currently being bought for on the open market. Estimate a projected dividend amount the company will pay next year. The project dividend amount is an estimate investors will make based on previous dividends. For example, if a company always pays $1 per share of dividends each year, an investor would project dividends to be $1 a share for next year. Determine the dividend growth rate for the company. As this calculation can become complicated, the dividend growth rate is normally disclosed by the company or calculated on investment sites. For example, a company projects to pay $1.50 in dividends next year. The current market price per share is $20. The dividend growth rate of the company is 4 percent.
Divide the projected dividends for next year by the current market price per share. In the above example, $1.50 divided by $20 equals 0.075, or 7.5 percent.
Add the dividend growth rate to the number calculated in Step 2 to calculate cost of equity. In the above example, 4 percent plus 7.5 percent equals 11.5 percent.
- Investopedia: Cost of Equity Definition
- Myron J. Gordon. "The Investment, Financing, and Valuation of the Corporation." R.D. Irwin, 1962.
- Walmart. "Dividend History." Accessed August 3, 2020.
Carter McBride started writing in 2007 with CMBA's IP section. He has written for Bureau of National Affairs, Inc and various websites. He received a CALI Award for The Actual Impact of MasterCard's Initial Public Offering in 2008. McBride is an attorney with a Juris Doctor from Case Western Reserve University and a Master of Science in accounting from the University of Connecticut.