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CoECore·13 min·11 checks

Cost of equity and beta

What shareholders require, and why it depends on someone else’s debt.

  • Finance
  • Financial analysis
  • Investing course
  • Financial markets
  • Economics
  • Certification

Debt has a price you can read off a loan agreement. Equity does not (no one sends shareholders an invoice) so it has to be inferred. The capital asset pricing model does this by arguing that investors are compensated only for risk they cannot diversify away, measured by beta. The awkward part, and the part interviews test, is that a company's observed beta reflects its own leverage. To use a peer's beta you must first strip out their capital structure and then apply your own. Skipping that step is why two analysts can produce costs of equity two hundred basis points apart from the same peer set.

Take the courseFree. One attempt per check, saved as you answer.

What this course covers

  1. 01Pick the risk-free rate
  2. 02Collect peer betas
  3. 03Unlever each peer
  4. 04Take the median and relever to your target
  5. 05Assemble the cost of equity

What you will be able to do

  • Building WACC for a DCF on a listed company or a private company with listed peers
  • Discounting free cash flow to equity directly
  • Setting a divisional hurdle rate using the betas of pure-play peers
  • Testing whether a target return is consistent with the risk being taken

Where it does not apply

  • Very early-stage companies, where CAPM understates risk badly: venture investors use target returns instead
  • Companies with no meaningful listed comparable, where the unlevering step has nothing to draw on
  • Markets where the risk-free asset is not genuinely risk-free; a sovereign spread adjustment is needed
  • As a precise number: a cost of equity is an estimate with a wide confidence interval, not a measurement

Predict it first

Not marked

The peer group is rebuilt and the regression comes back with a higher beta. The risk-free rate and the equity risk premium are unchanged.

ChangeBeta: 1.10 → 1.60

What happens to the value per share?
Commit to an answer before the model runs.

How this prepares you for the assessment

This is one of 17 courses, and none of them is required for the Verified Valuation Assessment. The credential is earned on two timed drills, graded by the same engine that checks this course, and the drill score decides what it says you are capable of, from Foundation through to Distinction.

  • Distinction90%+Works independently across all three core methods.
  • Merit75%+Builds the core models with limited supervision.
  • Pass60%+Understands the mechanics; works through a model with guidance.
  • FoundationcompletedKnows the vocabulary and the shape of each model.