What is cost of equity?

Cost of equity is the return shareholders expect for investing in a company. It's used in valuation and capital budgeting decisions. Calculated using CAPM: Cost of Equity = Risk-Free Rate + Beta × (Market Return - Risk-Free Rate). Higher risk companies have higher costs of equity. Companies must generate returns exceeding their cost of equity to create value.

What is Beta in the CAPM formula?

Beta measures a stock's volatility relative to the overall market. Beta of 1.0 means the stock moves with the market. Beta > 1.0 indicates higher volatility (riskier, technology stocks often have beta of 1.2-1.5). Beta < 1.0 means less volatile (utilities, consumer staples often 0.5-0.8). Higher beta increases cost of equity as investors demand higher returns for higher risk.

What should I use as the risk-free rate?

The risk-free rate is typically the yield on 10-year U.S. Treasury bonds (currently around 4-5%). Use current yields, not historical averages. For international companies, use equivalent government bonds from that country. The risk-free rate changes over time with economic conditions and central bank policy.

What's a typical market risk premium?

Market risk premium (Market Return - Risk-Free Rate) historically averages 6-8% in the U.S. Some analysts use 7% as standard. This represents the extra return investors expect for taking market risk versus holding risk-free bonds. In volatile times, investors might demand higher premiums; in stable times, lower premiums. Historical equity returns average 10-11%, with risk-free rates around 3-4%.