How do you calculate the cost of equity?

The cost of equity is the return shareholders require for owning the stock. There's no contract that states it, the way there is for debt, so I have to estimate it. The standard way is CAPM. The formula is the risk-free rate plus beta times the equity risk premium. I'll assume a risk-free rate of 4%, a beta of 1.2 and an equity risk premium of 5%. Beta times the premium is 6%, and adding the risk-free rate gives a cost of equity of 10%. The risk-free rate comes from government bond yields. I'd use the ten-year bond in the same currency as the cash flows. Beta measures how much the stock moves with the market. I can get it from a regression of the stock's returns against an index, or from comparable companies. The equity risk premium is the extra return investors want for holding stocks instead of government bonds. It's estimated from long-run history or implied from current market prices. So a company that moves more with the market has a higher cost of equity.

The cost of equity is the return shareholders require for owning the stock. There's no contract that states it, the way there is for debt, so I have to estimate it. The standard way is CAPM. The formula is the risk-free rate plus beta times the equity risk premium. I'll assume a risk-free rate of 4%, a beta of 1.2 and an equity risk premium of 5%. Beta times the premium is 6%, and adding the risk-free rate gives a cost of equity of 10%. The risk-free rate comes from government bond yields. I'd use the ten-year bond in the same currency as the cash flows. Beta measures how much the stock moves with the market. I can get it from a regression of the stock's returns against an index, or from comparable companies. I'd trust the peers more, because one company's regression is noisy. The equity risk premium is the extra return investors want for holding stocks instead of government bonds. It's estimated from long-run history or implied from current market prices. Nobody can observe it directly, so it's the input I'd hold least firmly. So a company that moves more with the market has a higher cost of equity. The logic is that investors only get paid for risk they can't diversify away. One company's bad news washes out in a portfolio, but its exposure to the whole market doesn't, and beta measures that exposure. Two checks. The answer has to sit above the company's cost of debt, because shareholders get paid after lenders. And I'd show a range. With a beta of 1.0 it's 9%, and with 1.5 it's 11.5%, so half a point of beta moves it by 2.5 points. For a small or private company, many practitioners add a size premium on top of CAPM. That's a convention, not part of the formula, so I'd say so if I used one.