Cost of New Equity Calculator

Formula

The formula to calculate the Cost of New Equity (rₑ) is:

\[ r_e = \left( \frac{D_1}{P_0} \right) + g \]

Where:

$ r_e $ is the Cost of New Equity
$ D_1 $ is the next year's dividends per share ($)
$ P_0 $ is the current market price of the stock ($)
$ g $ is the growth rate of dividends

Cost of New Equity Definition

The cost of new equity refers to the return that a company must offer to attract new investors to purchase its stock. It is a critical component in the calculation of a company’s weighted average cost of capital (WACC) and is used to evaluate the feasibility of new projects and investments. The cost of new equity takes into account the dividends expected to be paid in the future and the growth rate of those dividends, providing a comprehensive measure of the return required by equity investors.

Example Calculation

Let's consider an example:

Next Year's Dividends per Share (D₁): $2
Current Market Price of the Stock (P₀): $50
Growth Rate of Dividends (g): 5%

Using the formula to calculate the Cost of New Equity:

\[ r_e = \left( \frac{2}{50} \right) + 0.05 = 0.09 \, \text{or} \, 9\% \]

This demonstrates that with a D₁ of $2, a P₀ of $50, and a growth rate of 5%, the cost of new equity would be 9%.