How do you quantify the cost of equity?
The dividend is a tangible cost that makes up a small portion of the cost of equity and the cost of debt can be directly quantified by the interest paid on debt. But how do you quantify the cost of equity?
You don’t because it is an implicit cost. That’s why we have certain models (CAPM, Fama-French, Build-Up and risk premia approaches, etc.) to estimate the cost of equity based on different factors. In the end it is whatever investors demand for holding equity in a given business. The riskier, the higher.
For Dividend Paying Companies, you can use Dividend Capitalization Model:
Re = (D1 / P0) + g
For Non-Dividend Paying Companies, Models like CAPM can be used:
E® = Rf + β** ***** [E(Rm) – Rf]**