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Cost of Equity The cost of equity is the rate of return that shareholders expect to earn from their investment in a company. It is a key component in calculating the cost of capital and is used to determine the expected return on equity investments. Formula: The cost of equity can be calculated using the following formula: Ke = Rf + β(Rm - Rf) Where: Ke = cost of equity Rf = risk-free rate (e.g. the return on a government bond) β = beta of the company (a measure of its systematic risk) Rm = expected market return (the average return of the overall stock market) Example: Suppose the risk-free rate is 6%, the expected market return is 12%, and the beta of the company is 1.2. Then, the cost of equity would be: Ke = 6% + 1.2(12% - 6%) = 6% + 1.2(6%) = 6% + 7.2% = 13.2% This means that investors expect to earn a return of at least 13.2% from their investment in the company. Importance: The cost of equity is important because it: Helps companies determine the expected return on equity invest...