Cost of Equity Capital Approaches

Question No.3. (b) Explain different approaches to the computation of cost of equity capital.

Solution: The following are the approaches to computation of cost of equity capital:

1. E / P Ratio Method: Cost of equity capital is measured by earning price ratio. Symbolically:

2. E / P Ratio + Growth Rate Method: This method considers growth in earnings. A period of 3 years is usually being taken into account for growth. The formula will be as follows:

Where (1 + b) 3 = Growth factor where b is the growth rate as a percentage and estimated for a period of three years.

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