The cost of equity is ________.

Question

BlackTom AI · Accepted Answer

Cost of equity represents the rate of return investors require to compensate them for the risk of owning a company's equity.

1. Relevant knowledge points and concepts
- Cost of equity is the expected return investors demand for investing in a firm's common stock. It reflects opportunity cost and risk (business and financial). 
- Common estimation methods: CAPM (Capital Asset Pricing Model) and the Gordon Growth / Dividend Discount Model (DDM).
- CAPM formula: Re = Rf + β(Rm − Rf). DDM (for a growing dividend): Re = (D1 / P0) + g.
- Distinctions: cost of debt is interest paid on borrowed funds; WACC is a weighted average of cost of equity and cost of debt; asset turnover is an efficiency ratio (sales / assets).

2. Step-by-step reasoning
- By definition, equity investors expect compensation for their capital and risk. That expectation, expressed as a percentage return, is the cost of equity.
- Using CAPM, you compute the required return from market inputs (risk-free rate, market premium) and the stock’s beta. Using DDM, you use expected dividends and growth. Both yield the required investor return.

3. Example calculation (CAPM) — intermediate steps shown
- Suppose Rf = 2%, expected market return Rm = 8%, β = 1.2.
- Market risk premium = Rm − Rf = 8% − 2% = 6%.
- Re = Rf + β(Rm − Rf) = 2% + 1.2 × 6% = 2% + 7.2% = 9.2%.
- This 9.2% is the rate investors require — the cost of equity.

4. Why the correct answer is correct
- The phrase “the rate of return required by investors to incentivize them to invest in a company” exactly captures the economic and financial meaning of cost of equity: a required investor return compensating for risk.

5. Why other options are incorrect
- “Equal to the amount of asset turnover”: asset turnover is a sales/assets efficiency ratio, not a required return. 
- “The weighted average cost of capital”: WACC combines cost of equity and cost of debt; it is not solely the cost of equity. 
- “The interest associated with debt”: that describes cost of debt, not cost of equity.

6. Conclusion
The correct answer is: “the rate of return required by investors to incentivize them to invest in a company,” which matches the provided answer.

The cost of equity is ________.单项选择题

类似问题

Use CAPM to find the cost of equity capital, if US Treasury rate is 2.6%, Stock Market risk is 11.6% and stock's Beta is 1.3.

If the risk-free rate is 3%, market risk is 11%, and the company's Beta is = 1.2, what is the cost of equity?

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