Cost of Equity Calculation Example

Let's put the CAPM and Build-Up Method side-by-side using a real company—Tesla—to illustrate how different inputs affect your output.

Recap of the CAPM Formula

$\text{Cost of Equity} = R_f + \beta \times (R_m - R_f)$

Where:

• $R_f$ = 4.31% (risk-free rate);
• $\beta$ = 2.58 (Tesla's beta);
• $R_m$ = 9% (market return).

With these values:

$\text{Cost of Equity} = 4.31\% + 2.58 \times (9\% - 4.31\%) \approx 16.14\%$

The high beta reflects Tesla's volatility, which significantly amplifies the equity cost—something investors demand as compensation for risk.

Build-Up Method in Parallel

Let's assume for comparison:

• Risk-free rate: 4.31%;
• Equity Risk Premium: 5%;
• Size Premium: 1%;
• Industry Risk Premium: 2%;
• Company-Specific Premium: 1.5%.

$\text{Cost of Equity} = 4.31\% + 5\% + 1\% + 2\% + 1.5\% = 13.81\%$

Even though both methods are valid, they yield different results. The Build-Up Method often produces more conservative estimates for private firms or startups where beta isn't well-defined.

• CAPM is dynamic and market-based, suitable for public companies with reliable data;
• Build-Up is additive and more controllable, ideal for private or high-uncertainty contexts;
• The cost of equity is not a fixed number—it reflects your assumptions and context.