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In Financial management Cost of equity represents return required by investors calculated using either capital asset pricing model or dividend valuation model and therefore included in Cost of capital formula. Unlike shareholder return formula calculated as (Share price at end - share price at beginning + Dividends)/ Share price at beginning.
Cost of capital for Equity always calculated by CAPM, or Capital asset pricing model approach
Cost of equity = (Market risk premium) x ( Equity beta) + Risk-less rate
Consider a situation where the following holds for one company's stock:
Market risk premium: 4.0%Equity beta for this stock: 0.60Risk free rate: 5.0%
Cost of equity = (4.0%) x (0.60) + 5.0% =7.4%
In the CAPM, beta is a measure of the stock's historical price changes compared to price changes for the market as a whole. A beta of0 indicates the stock tends to rise or fall independently from the market. A negative beta means the stock tends to rise when the market falls and the stock tends to fall while the market rises. A positive beta means the stock tends to rise and fall with the market.
Shareholder's return can not be included in calculation of cost of capital reason being share holder are nothing but owners of the company and can not be considered as cost to company. They will always be getting profit which will be calculated after deducting all other finance cost in the form of dividend.
But there are circumstances where shareholders return will be considered which calculating cost of capital which is called as cost of equity in case for comparison of investment to other investment with similar risk but that is always calculated by investor not by the company.
Hope this clarifies, please do let me know if you need more / detailed explanation.
Thanks,
Vishnu
This occur because in capital market price of shares fluctuates globally
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