What Does Cost of Equity Mean?
In general terms, the cost of equity is the compensation that the market demands in exchange for owning and bearing the risk of ownership in the equity of a company. From a company’s perspective, an equity holder's expected rate of return is a cost of equity.
Divestopedia Explains Cost of Equity
The most accepted method for calculating the cost of equity is the capital asset pricing model. It explicitly accounts for an investment’s riskiness. However, it implicitly relies on empirical data of past performance on public companies. Determining an accurate cost of equity is integral to calculating the firm's cost of capital and, ultimately, its value.
This is a difficult and arduous calculation that is rarely performed by owners of private mid-market businesses. In general, expected cost of equity for businesses at various sizes and stages of the business life cycle are as follows:
- Blue chip public companies: 8–15%
- Well-established large companies: 16–24%
- Mid-market businesses: 25–34%
- Main Street businesses: 35–45%
- Start-ups: 45%+