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Cost of Equity Formula (Examples) | How to Calculate Cost of Equity? - YouTube
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that's given below welcome everyone and
today we have a fantastic topic cost of
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equity something which is used actually
over weighted average cost of capital or
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cost of equity those are used for
calculating for your valuation purposes
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so well here we begin we are doing this
topic from the box of Pandora called
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valuation and in that we have discounted
cash flows discounted cash flows gives
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rise to cost of equity so what we do
have in our session today first we will
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try to learn what exactly the formula is
all about there are few methods for
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calculating this formula so we'll try
and evaluate through different methods
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we'll take an example with the help of
evaluating those two methods post-facto
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what we'll try and do we will try and
understand with the help of the
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real-life example and in the end we'll
try learn how does the cost of equity
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formula calculator works well here we
begin with the cost of equity formula so
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cost of equity formula there are two
methods method number one for the
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company's work dividend-paying Companies so ke
is known as the cost of equity as a part
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of disclosing or you know if you want to
see what cost of equity looks like then
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its ke okay so ke is equal to your
dividend per share divided by market
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price per share divided per share by market
price per share is your dividend ratio
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the right plus your return so your
dividend ratio in terms of percentage
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plus your return is what is your cost of
equity method number two is
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expected it return that is basically a cost
of equity is equal to RF RF means your
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your free rate of return that is your
government bonds rate something which
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has Laura's Treasury ports government
bonds government securities plus beta
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beta is what it is a change of price due
to change in the index it is basically
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the sensitivity of the stock to the
market what exactly is the sensitivity
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of the stock how risky it is however
stress then so RF plus beta its RM risk
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of the market on Em it says it is
basically the risk of the market by this
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D risk of thee from the free rate of
return well here we begin on so what is
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cost of equity formula so cost of equity
that is is what V City the shareholders
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they expect for investing their equity
into the firm so the cost of the equity
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formula can be calculated through method
one as I just explained you that is the
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cost of equity formula for dividend
companies and method number two cost of
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equity formula using the chip a model
that is capital asset pricing model
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we'll discuss each of the methods in
detail let me start with method number
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one that is cost of equity ke for
dividend companies well so ke is equal
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to your dividend per share okay / market
price per share plus R so here
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DPS is your dividend per share
MPs is your market price per share and R
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is your growth rate of the dividend I am
so sorry that was not the return but as
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the growth rate of dividends so your
dividend percentage you are trying to
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grow with the help of growth rate so the
dividend growth model basically requires
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that a company pays dividend and it is B
the upcoming divided upcoming means the
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dividend that I will to cover the near
future so the logic behind this equation
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is that you know company's obligation to
pay dividend is the cost of paying its
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shareholders and therefore ke is the
cost of equity and this is limited model
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in the interpretation of the costs so
now let's do this with the help of an
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example let me try the value
let's try calculate for cost of equity
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in formula the first problem we assumed
companies paying regular debited suppose
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let's a company is named as XYZ and it
is regular paying dividend come in its
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stock price is trading closely around at
all let's say 20 it expects to pay
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dividend at 3.2 next year let's say and
following the dividend payment history
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what we need to calculate is the cost of
the equity let's say for year 1 2 3 4 5
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we have dividend 3 you increase it to
every time you know by 5% 3.05 3.11 3.16
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just a way of showing the revolt this is
out the dividend is increasing so how
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does the solution will go about so let's
first calculate the average growth what
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the average growth rate of the dividend
continuing the same formula as for the
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yield for the early growth so how do you
calculate that well it's quite simple
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the growth rate over here is calculated
at this will be not applicable meaning
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growth rate here right here cure 3.0 2 divided by B
2 3 minus 1 simple as that
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just make it a positive and do control D
and you have the answer what you want to
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do is probably this increase the
decimals so the growth rate for all the
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zeros
others okay so now take a simple average
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growth rate which will come down to is
equal to average of all of this that
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comes down to work with G 1 so this is
the input now so now the cost of the
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equity formula is going to be
a sample is that no very easy is equal
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to the what we call as the dividend per
share that is three point two divided by
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the market price per share 20 and +1.131% and well that
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comes down to 17% is what the cost of
equity is okay so this is how the old
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formula is calculated now this is the
example of Infosys you know if you see
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here the dividend history of the company
ignoring the interim and special
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dividend announcement affected it what
is the dividend type the post age and
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some details so as you can see the share
price of Infosys was 678 on BSE average
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dividend growth was 6.9 and
computed from thee about table weight in
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the last dividend 20 per shin now let's
calculate with the help of method number
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two method number two was er expected
return is equal to your RF plus beta
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bracket RM minus RF okay this is it well
let's begin on this so the capital asset
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pricing model CAPM however can be used
on a number of stock even if they are
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not paying dividend with that say the
logic we had UK Pam is rather any
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complicated which suggests the cost of
equity is based on the stock volatility
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okay
it is based on these stock volatility
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which is committed by beta remember that
as I told you beat out what Vida is all
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about right and the level of the risk
that is compared to the journal market
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that is equity market risk premium which
is nothing but your difference between r
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em minus small RM minus RF okay so in
the CAPM equation the risk of risk-free
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return is the rate of the return that is
paid to the risk-free investments like
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governments bonds Treasuries and beta is a
measure of basically a risk that can be
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calculated as a regression of the
company's market price so the higher the
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volatility II remember higher the
volatility it goes the higher the beta
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is going to be simple as that that
aggression and the relative risk
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compared to the general stock market so
the MA
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the returned EMR is the average market
rate which is generally been assumed to
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be 11 to 12% it's it's over the past
eight years in general a company with a
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high beta have a high degree of risk
that will pay you more equity let me
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take you an example so that you have a
idea of what we are talking about here X
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Y Z your RF let's say 3-8
four and four then we have your Vita
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Vita is one point one one zero point
nine eight and one point four and final
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is your market return seven seven and
seven we will take it as same so
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solution movie first we'll try and
calculate the equity risk premium which
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is differential between the market rate
overwritten okay so what we are trying
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to calculate is your RM and this time
you align this all in the middle so that
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it's visible view well so now our M is
going to be market rate of return is
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equal to market rate of return minus the
risk-free rate control R okay then we
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have the equity so basically sorry this
is this is basically the equity risk
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free
it's called e RM e RM right so then
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we'll calculate the cost of the equity
that is s for the CAPM method CAPM is RF
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plus beta e m minus RF that is your is
free rate plus be dung equity risk
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premium so continuing the same formula
cost of equity is going to be is equal
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to your risk-free rate plus your beta
into risk premium we already found risk
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premium right so this is going to be
your cost of equity I hope you have got
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it idea how things are being calculated
here well finally let me show you the
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cost of the equity formula calculator
how does exactly that works so the
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dividend per share let's say over here
I'll take 10 market price per share let
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me take as 20 grow
as 10-person 60 person comes through a
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cost of equity let's say your dividend
who is only one it comes down to 50 this
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10% so 10% and am growing dividend at
10% so well that's how you can make
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things for your flow well there are some
relevance and use of cost of equity well
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a form basically uses the cost of equity
to assess the relative attractiveness of
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its opportunity in the form of
investments and including both the
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external projects and the internal
acquisition so the companies will
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typically use the combination of debt
and equity financing with equity capital
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is proving to be more expensive second
investors of the need to invest in stock
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also uses the cost of equity okay to
find whether the company is earning a
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rate of return that is greater than that
and less than or equal to that rate
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third the equity analyst and research
analyst they buy or sell side analysts
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who are majorly invoice the involve in
financing of financing modeling and an
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issue research repos uses this kind of
constant with equity to arrive at t
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valuation of the companies they follow
then accordingly advise whether the
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stock is over or under value and then
take take the investment decision based
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on that there are many other methods
also used to compute the cost of equity
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which are running regulation analysis a
multi-factor model and survey method and
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so on and so forth okay so I hope you
guys have got a fantastic idea after
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studying this topic if you have learned
and enjoy watching this video please
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like comment of this video and subscribe
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updates thank you once again for joining
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