Explain the various approaches to calculate cost of equity with help o

Question

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

08 Oct 2024

Answer :

Word Count : 600

The cost of equity is the return that a firm must provide to its equity investors to compensate them for the risk they undertake by investing in the company. There are several approaches to calculate the cost of equity, each with its advantages and limitations. The three primary methods are the Dividend Discount Model (DDM), the Capital Asset Pricing Model (CAPM), and the Earnings Capitalization Ratio.

The Dividend Discount Model (DDM) calculates the cost of equity based on the present value of expected future dividends. According to DDM, the cost of equity can be expressed as:

\[
\text{Cost of Equity} = \frac{D_1}{P_0} + g
\]

where:
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