What Is the Cost of Equity?

The cost of equity is the rate of return that ordinary shareholders require to compensate them for the risk of investing in a company. It is one of the two building blocks of the weighted average cost of capital (WACC) and a core FM and AFM concept.

How is the cost of equity calculated?

ACCA exams use two main models:

• The Capital Asset Pricing Model (CAPM): cost of equity = risk-free rate + beta × (market return − risk-free rate). This links required return to systematic risk through the beta factor.
• The dividend growth model (Gordon's growth model): cost of equity = (next dividend ÷ current share price) + growth rate.

CAPM is usually preferred in the exam because it captures risk explicitly, but you must be able to use whichever the question data points to.

Why does it matter?

The cost of equity feeds directly into WACC, which is often the discount rate in an NPV appraisal. It also underpins share valuation. Because equity is riskier than debt, the cost of equity is always higher than the cost of debt for the same company.

In the exam, the marks are in choosing the right model, laying out the formula and following your own figures through. Marking a full FM cost-of-capital answer against the official ACCA scheme with The 50% Club shows you which method and own-figure marks you actually earned, even when a number is wrong.