What does the cost of equity without CAPM include in its calculation?

• A. Net income divided by total equity
• B. Dividends per share divided by share price plus growth rate
• C. Return on assets divided by liabilities
• D. Cost of debt plus equity returns

Answer: (B)

The cost of equity can be determined through various methods, one of which is the Dividend Discount Model (DDM), which aligns with the choice that was selected. In this model, the cost of equity is calculated using dividends paid to shareholders relative to the current share price, adjusted for any growth rate expected in those dividends. Specifically, this method looks at dividends per share divided by share price, accounting for the growth rate of those dividends.

This approach effectively captures not only the immediate returns that investors expect from their dividends but also incorporates the anticipated increases in those dividends over time, reflecting a more comprehensive view of equity holders' returns. It emphasizes the potential income generation from owning a share as well as future performance expectations, making it a suitable method for estimating the cost of equity without relying on CAPM.

The alternate options do not provide a correct framework for calculating the cost of equity. For instance, net income divided by total equity is more indicative of return on equity (ROE) rather than a direct measure of cost of equity. Similarly, return on assets divided by liabilities does not directly pertain to equity costs, focusing instead on overall asset efficiency. Lastly, combining the cost of debt with equity returns does not specify how equity costs are derived and can be