Saturday, 29 April 2017

Cost of Equity and Investors' Required Rates of Return

You should think about the cost of equity as the minimum expected rate of return that a company must offer investors to purchase its shares in the primary market and to maintain its share price in the secondary market.

If the required rate of return is not maintained, the price of the security in the secondary market will adjust to reflect the minimum rate of return required by investors.

If investors require a higher return than the company's cost of equity, they will sell the company's shares and invest elsewhere, which would bring down the company's stock price.

This decline in the stock price will lead to an increase in the expected return on equity and bring it in line with the (higher) required rate of return.

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