Question

For a typical U.S. (exchange-listed) corporation, approximately what is the cost of equity capital? Explain your reasoning. What firm characteristics (other than leverage) are associated with higher than average costs of equity capital?

Answer 1

Cost of capital of US Corporation Varies between 7 % to 10%. lets begin with the example of few big companies in US Market.

Facebook - 9.5%

Alphabet - 7.63%

Baidu - 9.8%

Apple - 7.61%

Netflix -10.27%

So, typically if we take all major companies it will vary from 7 to 10%. Lets try to understand the major characteristics behind the higher average cost of equity.

See first of all apart from leverage that is use of debt in the firm there are various other important factors which impact the cost of equity.

1) The returns that the investors are expecting from the risk free investments in the market if the returns from risk free investments are high than the cost of equity will go up or vice versa.

2) The degree to which the company's equity returns vary with the returns of overall Market.

3)The risk which is associated with the Business as well as the financials.

4) Investors expectation as they are taking higher risk so they will expect higher returns. In other words we can say Market Risk Premium.

5) Cost of equity of a firm is also depends on the financing needs of the company. If the fund requirements are high than the cost of equity will be higher.

6) Sometimes Dividend policy of the companies also defines the cost of equity if the company decides to retain the profits instead of distributing dividends it means they are adding capital at the cost of equity.