Define cost of Equity. If risk perceptions change what happens to cost of equity? How equity cost of capital for foreign project is arrived at?

Cost of Equity:

The cost of equity represents the return that a company's shareholders expect to receive on their investment. It is the required rate of return for investors who provide the company with equity financing, which means they become part-owners of the business. Unlike debt financing, where interest payments are contractual and fixed, the cost of equity is more subjective and depends on various factors, including the company's risk profile, market conditions, and investor expectations.

The cost of equity is essential for businesses and investors as it helps determine the company's overall cost of capital. This cost is used in evaluating potential projects, making investment decisions, and setting the hurdle rate for projects to ensure they generate enough return to compensate for the cost of capital and create value for shareholders.

The most commonly used methods to calculate the cost of equity are the Dividend Discount Model (DDM) and the Capital Asset Pricing Model (CAPM).

1. Dividend Discount Model (DDM): The DDM estimates the cost of equity based on the present value of expected future dividends. It assumes that the value of a company's stock is equal to the sum of all future dividends discounted back to the present value using the cost of equity.

The formula for the DDM is as follows:

Cost of Equity (Ke) = Dividends per Share (DPS) / Current Stock Price + Growth Rate of Dividends (g)

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