Also called CAPM, Capital asset pricing model
Cost of equity
The return shareholders demand for owning this particular company. Known as CAPM, the capital asset pricing model.
Updated 2026-09-03
How it is calculated
Cost of equity = risk-free rate + beta × equity risk premium
The cost of equity is the return a shareholder should demand for owning this particular company rather than something safe. It is not a cost the company pays in cash. It is the hurdle the business has to clear to be worth owning at all, and it is the larger half of the wacc for almost every company Angie values.
cost of equity = risk-free rate + beta × equity risk premium
The capital asset pricing model, CAPM. See risk-free rate, beta and equity risk premium.
Reading the formula
Start with what a government bond pays, because that is the return available for taking essentially no risk. Then add compensation for the extra risk of owning equities at all, which is the equity risk premium. Then scale that compensation by how risky this specific stock is relative to the market, which is beta. A company that swings twice as hard as the index earns twice the premium, so it has to clear a higher hurdle.
Same risk-free rate of 4.78 percent and the same 5 percent equity risk premium in all three. The entire difference is beta.
What CAPM assumes, and where it breaks
CAPM assumes risk means volatility relative to the market, and that the only risk worth paying for is the part you cannot diversify away. Both assumptions are contested. A stable business with a wobbly share price is not obviously riskier to a long-term owner than a fragile business with a quiet one. Beta is measured from past prices, and past prices are not a promise about future risk.
Angie uses it anyway because it is transparent, reproducible without judgement, and defensible as a standard. What it does do is refuse to accept the extremes: beta is bounded between 0.30 and 1.6, and Angie uses a fixed forward equity risk premium of 5 percent rather than whatever the last five years happened to return.
See also
- WACC — Cost of equity and cost of debt blended by how much of each the company uses. This is the rate every future dollar is discounted at, and it is the single most leveraged input in the model.
- Beta — How much the stock moves relative to the S&P 500. A beta of 1.0 moves with the market, higher is more volatile, and higher volatility raises the discount rate.
- Risk-free rate — The 10-year Treasury yield, standing in for the return available with essentially no risk. Every other rate in the model is built on top of it.
- Equity risk premium — The extra return investors demand for holding stocks instead of Treasuries. Beta scales it up or down for one particular company.
Educational content, not investment advice. Angie explains how a valuation is built so you can judge it yourself. What you do with that is your call.
