Cost of Equity
the cost of equity is the rate of return an investor requires from a stock before exploring other opportunities. companies have to reward shareholders for the risk that other investments will pay a higher return. typically, the cost of equity is higher when the overall stock market is strong, or when the company is seen as volatile. the rate of return that investors seek may come from two possible sources. in some cases, they receive dividends, which provide an immediate reward for their ownership. or the stock could experience appreciation, enabling them to profit when they sell shares. cost of equity equals dividend payout divided by share price plus rate of appreciation. ? is considering an investment in bubbly fresh beverage company, a financially stable business, whose stock is trading at $10 per share. due to a robust economy, ? is looking for relatively low risk stocks that provide a return of at least 15% with an estimated annual dividend of $1 per share or 10% of the purchase price. the stock will need to appreciate by 5% a year in order to meet his cost of equity criteria. of course, the challenge is that an investor can never predict the exact return of a stock ahead of time. the best they can do is provide ? educated guess based on past financial performance over all economic trends and other factors.
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