Definition
Cost of equity is the return equity investors require for the risk of owning the business. It is a key input to WACC and discount rate selection.
Formula
CAPM (common) = risk-free rate + beta * equity risk premium
Example
If risk-free rate is 4%, beta is 1.2, and equity risk premium is 5%, cost of equity ~ 4% + 1.2*5% = 10%.
How to use it
- Often estimated using CAPM as a starting point, then adjusted with judgment for company-specific risk.
- Higher risk implies higher cost of equity and lower present value in a DCF.
Common mistakes
- Using a single-point estimate without sensitivity analysis.
- Mixing short-term market moves into long-term discount assumptions without context.
Why this matters
This term matters because cash timing and risk are usually the difference between a plan that works on paper and a plan that survives. Use consistent definitions so decisions are comparable over time.
Practical checklist
- Write a 1-line definition for "Cost of Equity" that your team will use consistently.
- Keep the time window consistent (weekly/monthly/quarterly) when comparing trends.
- Segment results (channel/plan/cohort) before drawing big conclusions from blended averages.
- Use a calculator that references this term (e.g., WACC Calculator) to sanity-check assumptions.
- Read the related guide (e.g., WACC explained: how to estimate a discount rate for DCF) for context and common pitfalls.
Where to use this on MetricKit
Calculators
- WACC Calculator: Calculate WACC (Weighted Average Cost of Capital) from capital structure, cost of equity, cost of debt, and tax rate.
Guides
- WACC explained: how to estimate a discount rate for DCF: A practical guide to WACC: what it is, how to compute it, and how to use it (carefully) as a DCF discount rate.
- DCF valuation: forecast cash flows, discount rate, and terminal value: A practical guide to DCF valuation and WACC discount rate choices: how to forecast FCF, choose a discount rate, and avoid terminal value traps.