Cost of Equity Calculator (CAPM)
Last updated: 27 June 2026
Reviewed by Gavin Meiring, Lead research and primary author · Doctoral Candidate (Corporate Governance) · Research and drafting assisted by AI
- The CAPM was developed independently in the early 1960s by Jack Treynor, William Sharpe, John Lintner and Jan Mossin — with Sharpe sharing the 1990 Nobel Prize in Economics for the work.
- CAPM's core idea — that an asset's expected return depends on its beta, or sensitivity to the overall market — grew directly out of Harry Markowitz's modern portfolio theory of 1952.
- The 'risk-free rate' in the model is usually a government bond yield, because governments are assumed never to default on their own currency.
Cost of Equity Calculator
A cost of equity calculator estimates the return required by equity investors to compensate them for the risk of holding a company's shares. It is used by corporate finance teams setting hurdle rates for new projects, analysts building discounted cash flow models, and anyone calculating the weighted average cost of capital (WACC).
How to Use the Cost of Equity Calculator
- Enter the risk-free rate (typically the yield on a 10-year government bond).
- Enter the equity risk premium (the expected excess return of equities over the risk-free rate, typically 4 to 6% for developed markets).
- Enter the stock's beta (measure of systematic risk relative to the market).
- Click calculate to see the cost of equity using the Capital Asset Pricing Model (CAPM).
- Optionally, use the Dividend Discount Model (DDM) inputs: current dividend, expected growth rate, and current share price.
The Formula
Capital Asset Pricing Model (CAPM):
Cost of Equity (Ke) = Risk-Free Rate + Beta x Equity Risk Premium
Where Equity Risk Premium = Expected Market Return - Risk-Free Rate.
Dividend Discount Model (DDM / Gordon Growth Model):
Cost of Equity (Ke) = (Next Year's Expected Dividend / Current Share Price) + Dividend Growth Rate
The CAPM is more widely used, particularly for companies that do not pay dividends or where dividend policy is irregular. The DDM is most appropriate for stable, dividend-paying companies with predictable growth.
Real-World Example
Using CAPM for a UK retailer:
- Risk-free rate: 4.5% (approximate 10-year gilt yield)
- Equity risk premium: 5.0%
- Stock beta: 0.85 (less volatile than the market)
Cost of equity: 4.5% + 0.85 x 5.0% = 4.5% + 4.25% = 8.75%
This means equity investors in this company require a return of at least 8.75% per year to justify the risk of holding these shares, given the current interest rate environment and the company's moderate systematic risk.
Using DDM for the same company (if it pays dividends):
- Current share price: £5.00
- Next year's expected dividend: £0.22
- Expected long-term dividend growth rate: 3.5%
Cost of equity: (£0.22 / £5.00) + 0.035 = 4.4% + 3.5% = 7.9%
Cost of Equity in WACC Calculations
The cost of equity is one input into the Weighted Average Cost of Capital, which blends the cost of equity and cost of debt in proportion to the company's capital structure:
WACC = (Equity / (Equity + Debt)) x Ke + (Debt / (Equity + Debt)) x Kd x (1 - Tax Rate)
Where Ke is the cost of equity, Kd is the cost of debt, and (1 - Tax Rate) reflects the tax deductibility of interest payments (the interest tax shield). WACC is used as the discount rate in DCF valuations. A company whose projects earn returns above its WACC is creating value for shareholders; below WACC, it is destroying value. The cost of equity is generally higher than the cost of debt because equity holders bear more risk (they are paid after debt holders in any liquidation) and their return is not tax-deductible.
Frequently Asked Questions
Why is the cost of equity higher than the cost of debt? Debt holders have a legal claim on a company's assets that ranks ahead of equity holders. In a bankruptcy, debt holders are paid first; equity holders receive what remains, which may be nothing. This priority makes debt less risky, so lenders accept a lower return. Equity holders, facing greater risk, require a higher return. Additionally, interest paid on debt is tax-deductible (reducing its effective cost), while dividends paid to equity holders are not, further widening the effective cost difference.
What equity risk premium should I use? The equity risk premium (ERP) is the additional return investors expect from equities over the risk-free rate. Historical ERP estimates for UK and US markets typically range from 4 to 6% per year over the long run. Damodaran (New York University) publishes updated implied ERP estimates regularly, which are widely used in practice. Using a current implied ERP is often more accurate than a long historical average, particularly when interest rates have changed significantly.
How does gearing affect the cost of equity? Adding debt to a company's capital structure increases the financial risk borne by equity holders (because debt holders must be paid before equity holders in any outcome). This increased risk raises the required return on equity, increasing the cost of equity. The Modigliani-Miller framework formalises this: the equity beta of a levered firm equals the asset beta adjusted upward for gearing. When comparing companies with different capital structures, analysts often "unlever" beta to remove the effect of debt before comparison.
Can a company have a negative cost of equity? In theory, no: investors always require positive compensation for risk. However, certain discount rates derived from models can appear negative in extreme low-rate environments if the risk-free rate is below zero and beta is very low. In practice, a negative cost of equity is a modelling artefact indicating a floor should be applied. Analysts typically set a minimum cost of equity (for example, the long-run average risk-free rate or 5%) when model inputs suggest an unrealistically low figure.
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Three companies in one table
The single-example calculation above shows the mechanics. The table below shows the range a real comparison produces when the same formula is applied to firms with different risk profiles. Every figure is worked from the formula printed above, so each row can be reproduced on a calculator.
| Company | Risk-free rate | Equity risk premium | Beta | Cost of equity | What moves the answer |
|---|---|---|---|---|---|
| A UK retailer | 4.5% | 5.0% | 0.85 | 8.75% | The beta below one pulls the result under the market return |
| B US software company | 4.2% | 5.5% | 1.20 | 10.80% | The beta above one pushes the result past the market return |
| C European utility | 4.8% | 4.6% | 0.55 | 7.33% | Low beta and a lower premium compound each other |
The arithmetic for each row is the same shape. Row B is 4.2 plus 1.20 times 5.5, which is 4.2 plus 6.60, giving 10.80 percent. Row C is 4.8 plus 0.55 times 4.6, which is 4.8 plus 2.53, giving 7.33 percent. The spread between the highest and lowest row is 3.47 percentage points.
Note what drives that spread. The risk-free rates in the three rows differ by only 0.6 points between B and C, and the premiums differ by under a point. The beta column does the heavy lifting, and the effect is multiplied rather than added: a beta of 1.20 against a premium of 5.5 percent contributes 6.60 points on its own, more than the risk-free rate contributes in any row.
Relevering beta for a geared company
Betas published by data providers are usually the equity beta of a levered firm, which mixes business risk with the financial risk added by debt. To compare a geared company against an ungeared one, or to re-estimate the cost of equity for a company that is about to change its borrowing, the financial risk has to be stripped out and put back.
The Hamada relationship does that in one step. The levered beta is the ungeared beta multiplied by one plus, in brackets, one minus the tax rate, times the debt-to-equity ratio.
Take an ungeared beta of 0.70, a debt-to-equity ratio of 0.65 and a corporate tax rate of 25 percent. One minus the tax rate is 0.75, and 0.75 times 0.65 is 0.4875, so the bracket is 1.4875. The levered beta is 0.70 times 1.4875, which is 1.04125.
Applied to the same inputs as row A, the cost of equity becomes 4.5 plus 1.04125 times 5.0. That is 4.5 plus 5.20625, so 9.71 percent. The ungeared version of the same business has a cost of equity of 4.5 plus 0.70 times 5.0, which is 8.00 percent. Borrowing at a debt-to-equity ratio of 0.65 adds 1.71 percentage points to what shareholders require.
The direction of that effect is the point. Adding debt does not change the assets, but it does change the order in which claims are paid, and the equity claim now sits behind a bigger fixed obligation.
Checking CAPM against the dividend model
The two models on this page answer the same question from different sides, and comparing them is a cheap way to find a broken input.
The dividend model row above prices the same retailer at 7.90 percent using a current share price of 5.00 pounds, a next-year dividend of 0.22 pounds and growth of 3.5 percent. The CAPM row prices it at 8.75 percent. The gap is 0.85 percentage points.
Read that gap as an implied growth rate. If CAPM is right at 8.75 percent and the dividend yield is 4.40 percent, then the market is pricing perpetual growth of 8.75 minus 4.40, which is 4.35 percent. If the dividend model is right at 7.90 percent, the CAPM inputs are expecting a return roughly nine tenths of a point higher than the cash flows justify.
Neither model wins by default. A gap of under a point is normal and reflects the fact that the equity risk premium is an estimate while the dividend and share price are observed. A gap of three or four points usually means one of the inputs is stale, most often a share price that has moved or a growth assumption that has been carried over from a different company.
The cost of equity inside WACC
The weighted average cost of capital blends the equity rate with the after-tax cost of debt in proportion to the capital structure. With 600 million of equity at 8.75 percent, 400 million of debt at 5.5 percent and a 25 percent tax rate, the weights are 60 percent and 40 percent.
The equity leg is 0.60 times 8.75, which is 5.25 percent. The debt leg is 0.40 times 5.5 times 0.75, which is 0.40 times 4.125, giving 1.65 percent. The weighted average is 5.25 plus 1.65, which is 6.90 percent.
The equity leg carries about 76 percent of the total weight in the blend even though equity supplies only 60 percent of the funding, because the equity rate is higher. A project that earns 7.5 percent on capital clears this hurdle; one that earns 6.5 percent does not, even though 6.5 percent sounds close to a pass. Use the same currency and the same nominal basis for the rate and the cash flows it discounts.
Sensitivity of the answer to beta and the premium
Two of the three inputs move together in practice, because a higher risk-free rate tends to come with a different pricing of risk. Holding the risk-free rate at 4.5 percent isolates the interaction between beta and the equity risk premium. Each cell is the risk-free rate plus beta times the premium.
| Beta | Premium 4.5% | Premium 5.0% | Premium 5.5% |
|---|---|---|---|
| 0.6 | 7.20% | 7.50% | 7.80% |
| 0.8 | 8.10% | 8.50% | 8.90% |
| 1.0 | 9.00% | 9.50% | 10.00% |
| 1.2 | 9.90% | 10.50% | 11.10% |
The tightest corner of the table is 7.20 percent and the widest is 11.10 percent, a spread of 3.90 percentage points across inputs that all sit inside normal published ranges. Moving the premium from 4.5 to 5.5 adds 0.6 points at a beta of 0.6 and 1.2 points at a beta of 1.2, so a high-beta company is twice as exposed to the same error in the premium. That is the reason the premium deserves more scrutiny than the beta on any page of inputs, and the reason a cost of equity quoted to two decimals should be treated as an estimate rather than a measurement.
What the model assumes
Four assumptions sit under every number on this page.
- Investors hold diversified portfolios. The model prices only the risk that cannot be removed by diversification, which is what beta measures. Company-specific events are assumed to cancel out across a portfolio.
- The risk-free rate is genuinely risk-free in the currency of the cash flows. A long-dated government bond in the same currency is the usual proxy. Pairing a sterling discount rate with dollar cash flows produces an answer with no meaning.
- The equity risk premium is an expectation, not an observation. Historical averages for developed markets sit in the 4 to 6 percent range over long periods. A forward-looking implied premium, estimated from index prices and expected cash flows, will differ from the historical average, and the difference is largest after a sustained move in interest rates.
- The dividend model grows at a constant rate forever. That requires the growth rate to be below the discount rate, and it fails for any company whose payout is irregular or whose growth is about to change stage.
Two further conventions keep the result usable. Rates are nominal and should be matched with nominal cash flows, so a real discount rate belongs with real cash flows and never with nominal ones. Output is quoted to two decimal places, because the inputs are estimates and any figure beyond the second decimal is noise dressed as precision.
Sources for the model and the inputs
The capital asset pricing model was set out by William F. Sharpe in Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk, Journal of Finance, volume 19, number 3, 1964, pages 425 to 442, with a parallel derivation by John Lintner the following year. The result that gearing raises the required return on equity follows from Franco Modigliani and Merton Miller, The Cost of Capital, Corporation Finance and the Theory of Investment, American Economic Review, volume 48, number 3, 1958, pages 261 to 297. The practical form of the relevering step used above comes from Robert Hamada, The Effect of the Firm's Capital Structure on the Systematic Risk of Common Stocks, Journal of Finance, volume 27, number 2, 1972, pages 435 to 452.
For the equity risk premium, Aswath Damodaran at New York University publishes implied estimates for a range of markets and updates them regularly. Those series are the usual reference when a current premium is preferred to a long historical average.