Cost of Equity

Cost of Equity is the minimum rate of return a company must earn on its equity-financed portion of the investment project in order to leave unchanged the market price of such shares. There is no legal obligation to pay dividend on equity shares and rate of dividend to be paid to equity shareholders is also not determined. But the company has to pay dividend to its shareholders because it affects market value of shares. Normally, equity shareholders have following expectations from the company

  1. A certain amount of Earning per Year
  2. A certain amount of Dividend per year
  3. Increase in shareholding value

The following approaches could be used to calculate the cost of equity.

Points to remember while solving Numerical:

  1. Earnings Per share could be obtained by dividing the amount of profit from total number of shares.
  2. Floatation cost, discount, premium etc. must be adjusted to obtain the Net proceeds. This net proceed would be taken as market price per share. Such information is provided generally in case of new issue.
  3. Market Price per share could be calculated in three ways:
  4. Market Value
  5. Net Proceeds (could be obtained in the same way as done in Kd)
  6. In the absence of above information, Face Value would be taken as MPS.