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Cost of equity capital is acknowledged as the rate of return that is necessary to satisfy commitments made to the common shareholders of a corporation. Generally, it is expected to be equal to the rate of return that is expected on equity-supplied capital. The basic formula for calculating the cost of equity capital involves a few simple figures that are easily extracted from the financial data relevant to the period cited.
In order to determine the cost of equity capital, it is necessary to know three specific figures. First, the current market value associated with the shares must be determined. Second, the dividend growth rate as it relates to the period under consideration must be calculated. Last, the number of dividends per share should be identified. Once these three pieces of information are in hand, it is possible quickly calculate the current figure.
The basic formula begins with dividing the dividends per share by the current market value. The resulting number is added to the dividend growth rate. After adding the two figures, the cost of equity capital as it relates to the shares is revealed, and can be reported to the shareholders.
Companies tend to use this basic formula on an ongoing basis, taking into account any new data that may have come to light since the previous financial period. Monitoring the cost of equity capital is one of the tools that is used to make sure that the shareholders are protected, and also that the best interests of the company are served. Because the formula is so simple, the harder part of the process is to gather the needed data. However, once the figures are in hand, it takes no time to determine the current cost of equity capital.
Investors who are able to access the three basis figures needed to calculate this number can also make use of this simple formula as well. The data needed is often included in financial reports to investors, or can be obtained by speaking with financial analysts. As a quick and easy way to check on the status of the shares, the cost of equity capital does in an indirect way help to ensure the investor that the shares are being managed properly and the investment remains sound.
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