What Is the Connection Between Cost of Capital and CAPM?

The cost of equity capital refers to the price paid by an enterprise to obtain funds by issuing ordinary shares. It is equal to the dividend yield plus the capital gains yield, which is the necessary return for shareholders.

Cost of equity capital

Measurement of the cost of equity capital:

In terms of separately measuring the cost of various types of capital (mainly the cost of equity capital), the currently widely used tools are: the capital asset pricing method (

Explanation of cost of equity capital

From the perspective of financial management, determining the cost rate of equity capital is also called the cost of equity capital, including the cost of ordinary shares and the cost of retained earnings. The cost of retained earnings can also be called internal equity cost, and the cost of common stock can also be called external equity cost.

Formula for calculating the cost of equity capital

(1) Capital Asset Pricing Model Method (CAPM)

Calculated using the capital asset pricing model (CAPM), the calculation formula is:

KE = RF + (RM-RF)

In the formula: RF-risk-free rate of return; -market risk coefficient of listed company's stock. Weighted average return of RM-listed company stock

The risk-free rate of return in the above parameters is generally based on the annual interest rate of the national debt for a certain period; the daily coefficient of the stock can be determined by referring to the average daily coefficient of the listed company's entire industry for several weeks (generally should be more than 100 weeks); the weighted average return of the listed company's stock The rate of return can be determined by referring to the average rate of return of all industries of listed companies.

In addition, according to the specific situation of the evaluation object, the calculation of value can also be calculated using the expected value method and the comparable adjustment method:

(2) Dividend growth model method

The calculation formula is K = D / P + G

K --- cost of equity funds

D-Expected annual dividend

P-ordinary stock price

G-Annual Dividend Growth Rate of Common Stocks

Relevant data can be found in the company's financial statements over the years and obtained through trend analysis and regression analysis.

If there are still financing costs when the common shares are issued, the financing costs need to be deducted in the calculation formula, and the calculation formula becomes:

K = D / P * (1-f) + G, where f is the financing expense ratio.

(3) In addition to the above two model methods, the cost of common stock funds can also be calculated by the method of post-tax debt cost plus risk premium.