WHAT DO SHAREHOLDERS DEMAND, AND WHY?
Cost of equity is the return a shareholder needs before they will hold this share rather than a government bond. It is not a rate anybody quotes you — there is no invoice for it — so it has to be built. Every method below is defensible and they will not agree; that disagreement is the useful part. Pick one, know why, and cross-check it against another.
The risk-free rate
The 10-year Government of India bond yield, published daily by RBI and on the CCIL and NSE sites. Ten-year specifically, because equity is a long-dated claim and the discount rate has to match its life.
Never a US Treasury yield for an Indian company. The cash flows are in rupees, so the rate must be in rupees — the gap between the two is the inflation difference, and borrowing it silently understates the discount rate.
The equity risk premium
The extra annual return investors demand for holding shares instead of that bond. Damodaran publishes a country ERP for India free every January; it has sat around 7–8.5%. It should be stable year to year — if you find yourself changing it to make a valuation work, you are no longer valuing.
Beta
How hard this share swings against the index. Measure it rather than guess it — the beta calculator works it out from real NSE data.
CAPM assumes a large, liquid, well-followed company
For a mid-cap or small-cap that assumption breaks: the share is thinner, the research coverage is lighter, and an investor demands more for that. The build-up keeps CAPM and adds the premiums it leaves out.
Ke = Rf + β×ERP + size premium + company-specific premium
What the extra premiums are worth
Damodaran and Duff & Phelps publish size premiums by market capitalisation — broadly 0–1% for large caps, 1–3% for mid, 3–5% for small. A company-specific premium covers single-customer concentration, a founder-dependent business, a pending regulatory case. Both are judgements; write down the reason beside the number.
Equity is riskier than the company's own debt — by roughly a fixed amount
A lender is paid before a shareholder, so a shareholder must demand more than the company's own borrowing rate. The gap is usually taken as 3–5%.
Ke = the company's pre-tax cost of debt + risk premium
Use it as a cross-check, not as the answer
It needs no beta and no ERP, which makes it a genuinely independent second opinion. If it lands far from your CAPM number, one of the two inputs is wrong — usually the beta. Work out the cost of debt properly first.
Ask the market what it is already demanding
Gordon's formula rearranged: if the price is right and the dividend grows steadily, then Ke = next year's dividend ÷ price + growth. No beta, no ERP — just what people are paying today.
It only works on a real, steady dividend payer
On a company that pays little or nothing, the first term collapses and the answer becomes the growth rate alone, which is nonsense. And it assumes today's price is fair — so it tells you the market's required return, not whether the market is right.