Cost of Equity: In finance, the cost of equity refers to the return a company theoretically pays to its equity investors (shareholders( in lieu of the risk they undertake by investing their company (capital).
The most common formula used to calculate cost of equity is the CAPM method:
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As per CAPM formula, Cost of Equity = (Risk-Free Rate of Return) + (Beta * (Market Rate of Return – Risk-Free Rate of Return)).
Management / MBA question on this topic:
Q) Alpha Limited has a debt equity ratio of 3:2. The pre-tax cost of debt is 12%. Effective tax rate for the company is 30%. The equity beta of Alpha is 1.5. Market risk premium is 8% and the risk-free rate is 7%.
a) Discuss and Compute the cost of equity of Alpha Limited
b) Discuss WACC and determine the WACC based on after tax cost of debt and cost of equity?
Q. The risk free Rate of return is 6 %, Return on market is 11% and the Beta of Michelllo Private limited is 1.1. Estimate the cost of Equity and also mention the steps to calculate the opportunity cost of capital as per the CAPM Model.
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