Question

Expected returns: What the investor expects.
Required Return: What the investor requires.
Cost of Capital: What firm needs to “pay” investors.

In equilibrium, these three should be the same. Why?

When (under what conditions) are they equal? Under what conditions are they not equal?

Answer 1

The cost of equity is the return a company requires to decide if an investment meets capital return requirements. It is often used as a capital budgeting threshold for required rate of return. A firm's cost of equity represents the compensation the market demands in exchange for owning the asset and bearing the risk of ownership. The traditional formulas for cost of equity (COE) are the dividend capitalizationmodel and the capital asset pricing model.