Article at a glance:

The real cost of equity

As central as it is to every decision at the heart of corporate finance, there has never been a consensus on how to estimate the cost of equity and the equity risk premium. Conflicting approaches to calculating risk have led to varying estimates of the equity risk premium from 0 percent to 8 percent—although most practitioners use a narrower range of 3.5 percent to 6 percent. With expected returns from long-term government bonds currently about 5 percent in the US and UK capital markets, the narrower range implies a cost of equity for the typical company of between 8.5 and 11.0 percent. This can change the estimated value of a company by more than 40 percent and have profound implications for financial decision making.