Should I add a country risk premium?

Only if the market return you entered does not already reflect that country. Adding a premium on top of a market return built from the same country double counts the same risk.

Why is the cost of debt reduced by the tax rate?

Because interest is deductible against taxable profit while dividends are not. The company bears only the after-tax cost of its interest.

Businessvaluation

Cost of Equity (CAPM) Calculator

Cost of equity by the capital asset pricing model, extended to a WACC where a capital structure is given. Every input is an estimate, and the output inherits all of that uncertainty, so the page shows how far the answer moves when beta does.

Also called: cost of equity calculator, capital asset pricing model.

Cost of equity

14.2%

14.2% cost of equity: a 7% risk free rate plus a beta of 1.2 on a 6% equity risk premium, with no extra premiums applied. Enter a debt share and a cost of debt to extend this into a weighted average cost of capital. A one point change in the equity risk premium moves this by about 1.2 points. Given that the premium itself is an estimate with a spread of several points, treat the answer as a range rather than the two decimal places it is printed with.

Equity risk premium

What beta adds

7.2%

CAPM before the extra premiums

14.2%

Weighted average cost of capital

After tax cost of debt

Cost of equity at a beta of 1

13%

Extra premiums

, with no extra premiums applied

On the WACC

Enter a debt share and a cost of debt to extend this into a weighted average cost of capital.

On sensitivity

A one point change in the equity risk premium moves this by about 1.2 points. Given that the premium itself is an estimate with a spread of several points, treat the answer as a range rather than the two decimal places it is printed with.

How this is calculated

An estimate, not an offer or a guarantee. Projected returns assume the rate you entered holds for the whole term, which no market does.

Method and background

How this is calculated

CAPM says the return demanded of an asset is the risk free rate plus its share of the market premium, where beta measures that share. The arithmetic is trivial and the inputs are not: the equity risk premium is unobservable and reasonable estimates span several points, beta depends on the window it was estimated over, and country and size premiums are conventions that different practitioners apply differently or fold into the market premium instead. Double counting is the usual error, adding a country premium to a market premium that was already built from that country. The WACC then weights this cost of equity against the after-tax cost of debt, which is lower because interest is deductible while dividends are not.

the risk free rate plus the market premium scaled by beta, with country and size premiums added where the market premium does not already contain them

k_e: Cost of equity
R_m - R_f: Equity risk premium

Worked examples

Each of these is asserted on every build. If a change to the engine ever moved one of these answers, the build would fail before the page could print it.

a beta of 1.2 on a 6 point premium

Risk free rate: 7%
Beta: 1.2
Expected market return: 13%
Country risk premium: 0%
Size premium: 0%
Share of capital that is debt: 0%
Cost of debt: 0%
Corporate tax rate: 25%

Cost of equity14.2%

7 + 1.2 x 6

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with a capital structure

Risk free rate: 7%
Beta: 1.2
Expected market return: 13%
Country risk premium: 1.5%
Size premium: 1%
Share of capital that is debt: 40%
Cost of debt: 10%
Corporate tax rate: 25%

Cost of equity16.7%

0.6 x 16.7 + 0.4 x 7.5

Open this example

Method and limits

What it assumes

Country and size premiums are additive and not already contained in the market return entered.

What it deliberately does not model

CAPM is a single-factor model with weak empirical support for the beta and return relationship.
The equity risk premium is an estimate, and a one point change in it moves the answer by roughly beta points.
A discount rate this sensitive should be presented as a range, not a point estimate.

Formula version 1.0.0 · definition 1.0.0 · United States · Report a problem with this calculator

Frequently asked questions

Should I add a country risk premium?: Only if the market return you entered does not already reflect that country. Adding a premium on top of a market return built from the same country double counts the same risk.
Why is the cost of debt reduced by the tax rate?: Because interest is deductible against taxable profit while dividends are not. The company bears only the after-tax cost of its interest.