Explain the various approaches to calculate cost of equity w

Question

Explain the various approaches to calculate cost of equity with help of examples.

18 Mar 2025

Answer :

Word Count : 621

The cost of equity represents the return required by shareholders for investing in a company. It is a crucial component in financial management as it helps in evaluating investment opportunities, capital structure decisions, and valuation of firms. Various approaches are used to calculate the cost of equity, each with its assumptions and applicability. The primary methods include the Dividend Discount Model (DDM), the Capital Asset Pricing Model (CAPM), the Earnings Capitalization Approach, and the Bond Yield Plus Risk Premium Approach.

### 1. Dividend Discount Model (DDM)
The Dividend Discount Model (also called Gordon Growth Model) calculates the cost of equity based on the assumption that a company's dividends will grow at a constant rate. The formula is:

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