UK Accounting Glossary
The cost of equity is the minimum rate of return that a business or organization must offer investors or owners to offset their wait for a return on investment and for assuming some level of risk. There are conflicting approaches to estimating the cost of equity and cost of equity percentages. The traditional formula for calculating the cost of equity is the dividend capitalization model (dividend per share/price per share + growth rate of dividends). With the dividend capitalization model, the cost of equity can be calculated for a given industry based on the current rate of return. A higher cost of equity usually signifies a higher risk industry that commands a higher return for the increased risk. Cost of equity can also be determined by the capital asset pricing model (CAPM). Calculating the cost of equity using CAPM is often more difficult than using the dividend capitalization model for determining the cost of equity. The cost of equity does not show up on a company’s income statement, however, the cost of equity is never free.
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This glossary post was last updated: 4th February 2020.