Cost of Equity

Cost of equity (자기자본비용) is the required rate of return demanded by shareholders. Contrary to the cost of debt, the cost of equity is not directly observable and therefore must usually be estimated.

Dividend Growth Model

The cost of equity can be obtained from the dividend growth model when dividends are expected to grow at a constant rate.

$R_E=\frac{D_1}{P_0}+g$

Here, $R_E$ is the cost of equity, $D_1$ is the dividend expected next period, $P_0$ is the current stock price, and $g$ is the constant growth rate of dividends.

Capital Asset Pricing Model

The capital asset pricing model (CAPM) estimates the cost of equity as the risk-free rate plus a market risk premium adjusted by beta.

$R_E=r_f+\beta \times (E\left[R_M\right]-r_f)$

Here, $r_f$ is the risk-free rate, $\beta$ is the firm's beta, and $E\left[R_M\right]$ is the expected return on the market portfolio.