What are the different methods used for estimating the cost of equity in capital budgeting?

What are the different methods used for estimating the cost of equity in capital budgeting?

There are several methods used for estimating the cost of equity in capital budgeting. Some of the commonly used methods include:

1. Dividend Discount Model (DDM): This method estimates the cost of equity by discounting the expected future dividends of a company to their present value.

2. Capital Asset Pricing Model (CAPM): CAPM estimates the cost of equity by considering the risk-free rate of return, the market risk premium, and the beta of the company's stock.

3. Bond Yield Plus Risk Premium: This method estimates the cost of equity by adding a risk premium to the yield of a company's long-term debt.

4. Earnings Capitalization Model: This method estimates the cost of equity by dividing the expected earnings of a company by the required rate of return.

5. Build-Up Method: This method estimates the cost of equity by adding various components such as the risk-free rate, equity risk premium, size premium, and specific company risk premium.

It is important to note that each method has its own assumptions and limitations, and the choice of method may vary depending on the specific circumstances and preferences of the analyst or company.