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Q:

# How is the cost of common equity calculated?

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Investopedia calculates the cost of common equity using the traditional model by dividing next year's estimated dividends per share by the market value of common stock and then adding the growth rate of dividends. Using the capital asset pricing model, cost of equity is determined by subtracting the stock's risk-free rate from the market rate, multiplying the result by the stock's beta coefficient and adding the risk-free rate.

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Corporations and stockholders both use the traditional model for calculating the cost of common equity. Investors use the capital asset pricing model to calculate the cost of common equity because it allows for adjustment based on the company's potential risk factors, reports Investopedia. The beta coefficient indicates how the company's stock moves in relation to the market as a whole. A lower beta indicates that the stock is more stable, while a higher beta indicates that the value is exaggerating the market's movements.

According to Investopedia, the cost of common equity is the return expected by stockholders for investments made in the company, or purchase of common stocks. Common equity is considered a cost because, in the event the company does not meet the stockholders' expectations of return on investments, the stockholder is able to sell shares. If stockholders begin selling shares, it drives the price of the company's stock down, which costs the company money. Simply put, the cost of equity for a company is the cost of maintaining stock at a level that is attractive to shareholders.

## Related Questions

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A home equity line of credit, or HELOC, is a loan taken out that uses a person's home equity as collateral. Contrary to a traditional loan where funds are disbursed all at once, a HELOC has a draw period during which funds can be accessed as needed, up to a set limit. In addition to only having to pay for the funds that have been used, HELOCs often allow borrowers to pay interest only initially, according to MyFICO.

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To get a home equity loan, consult with financial advisers, consider various options, ensure that you understand the terms and know your rights. Finally, apply for a loan.

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A home equity loan works as a second mortgage. It gives a homeowner a line of credit based on the amount of equity in his home, according to About.com. Equity is defined as a home's value minus what is owed on the mortgage. For example, if a home is worth \$250,000, and the home owner has \$150,000 left on his mortgage, then he has \$100,000 in equity in his home.