1. What is Cost of Common Equity?

The cost of common equity represents the return required by common shareholders for their investment in a company. It's a key component in calculating a company's weighted average cost of capital (WACC) and is used in capital budgeting decisions.

2. How Does the Calculator Work?

The calculator uses the Dividend Growth Model (Gordon Growth Model):

Where:

• \( D1 \) — Expected dividend in the next period (USD)
• \( P0 \) — Current stock price (USD)
• \( g \) — Constant growth rate of dividends (decimal)

Explanation: The formula calculates the cost of equity by adding the dividend yield (D1/P0) to the expected growth rate of dividends.

3. Importance of Cost of Common Equity

Details: Understanding a company's cost of equity is crucial for making investment decisions, evaluating projects, and determining the company's overall cost of capital. It helps investors assess whether expected returns justify the risk.

4. Using the Calculator

Tips: Enter the expected dividend in USD, current stock price in USD, and growth rate as a decimal (e.g., 0.05 for 5%). All values must be positive.

5. Frequently Asked Questions (FAQ)

Q1: What if a company doesn't pay dividends?
A: For non-dividend paying companies, alternative methods like the Capital Asset Pricing Model (CAPM) should be used.

Q2: How do I estimate the growth rate (g)?
A: The growth rate can be estimated using historical dividend growth or analysts' earnings growth forecasts.

Q3: What are typical values for cost of common equity?
A: Typically ranges from 8% to 16% (0.08 to 0.16 in decimal form) for most companies, depending on risk.

Q4: What are limitations of this model?
A: Assumes constant dividend growth forever and that the growth rate is less than the cost of equity.

Q5: How does this differ from cost of preferred equity?
A: Preferred equity cost is simpler (dividend/price) as preferred dividends are typically fixed.