I'm reading a textbook on corporate finance and am hung up on cost of equity. I understand how it's calculated (free rate + market premium * beta). I just don't understand how it's used.
Let's work with an example: a company wants to build out a new factory and to raise the $1m to do so by offering equity. Now, my Shark Tank level understanding of equity sales is that the owner comes up with a value for his company (say, $10 million), so if they need $1 million, they would just sell a 10% equity stake.
So how does "cost of equity" figure into this? Is it an alternative approach? Or is it used in conjunction with the value of the company? Like, instead of the investor relying on the owner's subjective valuation they instead use the formula to calculate the company's cost of equity? Let's say they do that and the cost of the company's equity is found to be 15%. That's how much an investor has to make on their investment. So the investor contributes the $1 million but instead of just getting a straight 10% equity share, the investor gets a 11.5% equity share (($1m * 1.15)/$10m)?
Is that how it's used?
Submitted April 08, 2021 at 11:28PM by torchma https://ift.tt/3uAlHJF
