Valuation Updated November 2026

Cost of equity (CAPM)

Cost of equity by CAPM = risk-free rate + beta x equity risk premium, for example 3% + 1.2 x 5.5% = 9.6%. It is the return shareholders require for the company's risk and the equity input to WACC. There is no tax adjustment, because dividends are not tax deductible.

Syntax

Re = Rf + beta x (Rm - Rf);  Rm - Rf = equity risk premium (ERP)

Part	What it is
`Rf`	Risk-free rate: the yield on a long-dated government bond in the currency of the cash flows, usually 10 or 20 years
`beta`	How much the stock moves with the market: from a regression, or a peer group beta unlevered and relevered to the company's debt to equity
`ERP`	Equity risk premium, the expected market return above the risk-free rate; a published estimate, commonly in the 4% to 6% range for the US

Examples

Rf 3%, beta 1.2, ERP 5.5%
=3% + 1.2 * 5.5%

Result: 9.6%

Rf 4%, beta 0.8, ERP 5%
=4% + 0.8 * 5%

Result: 8.0%

A beta below 1 gives a cost of equity below the market return of 9%.

Relever a peer beta: unlevered beta 0.9, D/E 0.5, tax 25%
=0.9 * (1 + (1 - 25%) * 0.5)
=4% + 1.2375 * 5%

Result: Levered beta 1.2375, cost of equity 10.19%

Unlever each peer with beta / (1 + (1 - t) x D/E), average, then relever with the target company's own D/E.

Common mistakes

Using a 3-month T-bill as the risk-free rate for cash flows ten years out: match the bond maturity to the forecast horizon.
Adding beta x total market return instead of beta x the premium: Re = Rf + beta x (Rm - Rf), otherwise Rf is counted twice.
Multiplying the cost of equity by (1 - tax rate): only the cost of debt gets the tax shield.
Using a raw regression beta for a thinly traded stock or a private company: unlever a set of liquid peers and relever to the target's capital structure.

Practice Cost of equity (CAPM)

These drills check your answer on live data, free, no account needed.

Discount factors and present valuesFill the discount factor for each year (row 6: 1 divided by (1 + rate) to the power of the year), the present value of each cash flow (row 7) and the total present value in B8.
NPV across discount ratesBuild a sensitivity row: the NPV of the cash flows in row 5 at each discount rate in row 7. Write B8 with NPV and fill right to F8.

Questions

Why is the cost of equity higher than the cost of debt?

Shareholders are paid last and have no fixed claim, so they demand a higher return than lenders. Interest is also tax deductible, which lowers the after-tax cost of debt further.

Is the cost of equity the discount rate in a DCF?

Only in an equity DCF that discounts levered free cash flow or dividends. A standard DCF discounts unlevered free cash flow at WACC, where the cost of equity is one of the two components.

What beta should a private company use?

Take the betas of listed peers, unlever each with its own debt to equity and tax rate, take the median, and relever at the private company's target leverage.

WACCWACC = E/V x cost of equity + D/V x cost of debt x (1 - tax rate). Cost of equity from CAPM, market value weights, an example giving 9.0% and common errors.
DCF model stepsThe six steps of a DCF: forecast unlevered free cash flow, set WACC, compute terminal value, discount it all, bridge to equity value and divide by shares.
Discount factorA discount factor converts a future cash flow into present value: DF = 1 / (1 + r)^t. Worked examples, the Excel formula with absolute references, mid-year.
Enterprise value to equity valueEquity value = enterprise value - debt + cash - preferred stock - minority interest. The EV to equity bridge step by step, with examples and per share value.