Which formula represents the cost of equity?

The cost of equity is commonly estimated using the Capital Asset Pricing Model (CAPM), which suggests that the expected return on equity is directly linked to its risk compared to the market. The formula for calculating the cost of equity under CAPM is expressed as:

Cost of Equity = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate)

In this context, Beta represents the sensitivity of the equity's returns to the overall market returns, while the Market Risk Premium is calculated as the expected market return minus the risk-free rate. Therefore, the answer you've identified highlights the important role of Beta alongside the Market Risk Premium in estimating the cost of equity, aligning with the principles of CAPM.

This method effectively provides an estimate of the return required by equity investors to compensate for the risks they take by investing in a company's equity compared to a risk-free investment. By using Beta and the Market Risk Premium, the formula takes into account not only the inherent risk of that particular stock but also the general conditions of the overall market.