briefly described,,,,

1. PRESENTATION ABOUT
COST OF EQUITY

2. What is cost of equity?
• Cost of equity (also known as cost of common
stock) is the minimum rate of return which a
company must generate in order to convince
investors to invest in the company's common
stock at its current market price. It is alternatively
referred to as required rate of return.
• Cost of equity is an important input in common
stock valuation under different models.

3. formula
Cost of equity under the capital asset pricing model:
• Cost of Equity = Risk Free Rate + Beta Coefficient ×
Market Risk Premium
• Cost of Equity = Risk Free Rate + Beta Coefficient ×
(Market Rate of Return − Risk Free Rate)

4. Risk free rate is the rate of return on short-term
treasury bonds. Beta coefficient is a statistic
that measures the systematic risk of a
company's common stock while the market rate
of return is the rate of return on the market.
Return on some relevant benchmark index such
as S & P 500 is a good estimate for market rate
of return.

5. Cost of equity under the dividend discount
model:
Cost of Equity =
Dividend in Next Period_______
Current Market Price + Growth Rate

6. Dividends in next period equals dividends in current period
multiplied by (1 + growth rate). Growth is the expected rate
of growth in the company's dividends. It is estimated by
the following formula:
Growth Rate = (1 × Payout Ratio) × Return on Equity
Dividend discount model for estimation of cost of equity is
useful only when the stock is dividend-paying. In reality, we
have a lot of stocks that do not pay dividends. In such
situations, the capital asset pricing model and some other
more advanced models are used.

7. Example: Cost of Equity Under the Capital
Asset Pricing Model
The yield on 5 year US treasury bonds as at 30 December
2012 is 0.72% (this data can be obtained from Bloomberg,
Morningstar, etc.). From Yahoo Finance, we find that
Caterpillar Inc.'s share price as at 30 December 2012 is
$86.81 per share while it has a beta coefficient of 1.86.
Trailing twelve months (TTM) return on S & P 500 is 11. 52%.
Estimate the cost of equity.

8. Solution: Under the capital asset pricing model, the rate of
return on short-term treasury bonds is the proxy used for
risk free rate. We have an estimate for beta coefficient and
market rate for return, so we can find the cost of equity:
Cost of Equity = Risk Free Rate + Beta Coefficient × (Market
Rate of Return − Risk Free Rate)
Cost of Equity = 0.72% + 1.86 × (11.52% − 0.72%) = 20.81%

9. Example: Cost of Equity Under the Dividend
Discount Model
Caterpillar Inc.'s share price as at 30 December 2012 is
$86.81 per share. Its last five year's average total
dividends, return on equity and payout ratios are
$1.6, 34.75% and 47.08%.
Before using the dividend discount model for estimating
cost of equity, we need to make sure we have the required
inputs which include the growth rate, dividends in next
period and current market price.
We have the current market price ($86.81) and we need
to estimate the growth rate and dividends in next period.

10. Growth Rate = (1 − 47.08%) × 34.75% = 18.39%
Dividends in Next Period = Dividends in Current Period × (1 + Growth
Rate) = $1.6 × (1+18.39%) = $1.89
We have the required inputs which we can just punch into the
following equation to get an estimate for return on equity:
Cost of Equity = Dividend in Next Period+ Growth Rate
Current Market Price
Cost of Equity = $1.89 ÷ $86.81 + 18.39% = 20.57%
Our estimates for cost for equity under both models are pretty close
which adds credibility to our estimate. Financial analysts frequently
use more than one models to estimate any statistic in order to obtain
a range of possible values.

11. Cost Of Capital - Cost Of Equity
• The cost of equity is the return that stockholders require
for their investment in a company. The traditional
formula for cost of equity (COE) is the dividend
capitalization model:

12. Completed and submitted by,,,
SAHIL MUKHIA
MBA+PGPBM
2013-15 BATCH
“BENGAL INSTITUTE OF BUSINESS STUDIES”