Financial Glossary
Cost of Equity
Cost of equity is the rate of return that equity investors expect in exchange for the risk of holding a company's shares. It is commonly estimated using the capital asset pricing model, which combines a risk-free rate, the company's relative risk (beta), and an expected market return. Unlike interest on debt, the cost of equity is not an explicit cash payment but an implied required return.
Problem & Application
When a business calculates its weighted average cost of capital, the cost of equity is the component that captures shareholder expectations and is usually higher than the cost of debt. Founders and investors use it to set hurdle rates for new projects and to anchor valuation in a discounted cash flow analysis. Estimating it well matters because an understated cost of equity can make weak investments look attractive.
In Short
Cost of equity quantifies what owners expect to earn for bearing equity risk, and it is an essential building block for WACC and valuation work.