What model is commonly used to estimate the cost of equity?

The Capital Asset Pricing Model (CAPM) is a widely used method for estimating the cost of equity. This model quantifies the relationship between the expected return on an investment and its systematic risk, measured by beta. In essence, CAPM asserts that the expected return of an asset is equal to the risk-free rate plus a risk premium, which is based on the asset's beta and the market risk premium.

Using the CAPM allows investors and analysts to gauge the return required by equity investors given the inherent risks associated with a particular stock or equity investment relative to the overall market. This makes it particularly valuable for evaluating investments in uncertain environments and for determining if an investment meets or exceeds the minimum return hurdle rate.

While the other models listed offer insights into equity valuation, they do not specifically focus on estimating the cost of equity in the same systematic way that CAPM does. For example, the Dividend Discount Model primarily values stocks based on expected dividends, and the Discounted Cash Flow Model is more about valuing the entire business based on projected cash flows rather than just the equity component. The Market Value Added Model assesses company performance based on the difference between market value and capital invested but does not directly calculate the cost of equity. Therefore, CAPM stands