Calculate the cost of common equity, dividend growth rate, market price, or annual dividends by entering any three share inputs.
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Cost of Common Equity Formula
The calculator uses the dividend growth model, also called the Gordon growth model. The main formula is:
- re = cost of common equity as a decimal
- D1 = expected annual dividends per share
- P0 = current market price per share
- g = dividend growth rate as a decimal
Because the calculator displays cost of common equity as a percent, it converts the decimal result by multiplying by 100:
The same relationship can be rearranged to solve for any missing input:
- Cost of common equity: enter dividends, market price, and growth rate to estimate the required return on common stock.
- Expected dividends: enter market price, growth rate, and cost of equity to solve for the dividend per share implied by those assumptions.
- Market price: enter dividends, growth rate, and cost of equity to estimate the stock price supported by the dividend growth model.
- Growth rate: enter dividends, market price, and cost of equity to solve for the implied dividend growth rate.
Common Input Formats and Result Interpretation
Use decimals for the growth rate field and percentages for the cost of common equity field.
| Value | Enter as | Meaning |
|---|---|---|
| 5% dividend growth | 0.05 | Dividends are expected to grow 5% per year. |
| 8% cost of equity | 8 | Investors require an 8% annual return. |
| $2.50 dividend | 2.50 | Expected annual dividend per share. |
| Result | General interpretation |
|---|---|
| Lower cost of equity | The stock may be viewed as less risky or supported by a higher current price relative to dividends. |
| Higher cost of equity | Investors require a higher return, often because of higher perceived risk or a lower price relative to dividends. |
| Growth rate near or above cost of equity | The model becomes very sensitive or invalid for solving price, because the denominator re – g becomes too small or negative. |
Example Problems
Example 1: Calculate cost of common equity
You have an expected annual dividend of $3.00 per share, a current market price of $50.00, and a dividend growth rate of 4%.
The cost of common equity is 10%.
Example 2: Calculate market price
You have an expected annual dividend of $2.40 per share, a cost of common equity of 9%, and a dividend growth rate of 3%.
The implied market price is $40.00 per share.
FAQ
What does cost of common equity mean?
Cost of common equity is the return common shareholders require for investing in a company’s stock. In the dividend growth model, it equals the dividend yield plus the expected dividend growth rate.
Why does the growth rate need to be entered as a decimal?
The formula adds the growth rate directly to the dividend yield, so 5% must be entered as 0.05. The cost of equity field is different because the calculator labels it as a percentage, so 10% should be entered as 10.
When should you not use this formula?
This formula is not a good fit for companies that do not pay dividends, have unstable dividends, or have a dividend growth rate that is not expected to continue. It is also unreliable when the growth rate is equal to or greater than the cost of equity.
