Explanation:
The cost of equity represents the minimum rate of return that investors require to invest in a company's equity. This is the correct interpretation because:
Definition of Cost of Equity: The cost of equity is the return a company must offer to its equity investors to compensate them for the risk of investing in the company.
Why not option A: A company's intrinsic value is determined by discounting future cash flows at the cost of equity, but the cost of equity itself is not a proxy for intrinsic value. Intrinsic value is an output, while cost of equity is an input in valuation models.
Why not option B: Accounting return on equity (ROE) is a historical measure of profitability calculated as net income divided by shareholders' equity. It reflects past performance, while cost of equity is a forward-looking measure of required return based on risk.
Correct interpretation: The cost of equity serves as a proxy for the minimum required rate of return because it represents the opportunity cost of capital for equity investors - what they could earn by investing in alternative investments with similar risk.
Key Concept: Cost of equity = Risk-free rate + Equity risk premium × Beta
This formula shows that cost of equity compensates investors for:
Therefore, option C is the correct answer as it accurately describes the cost of equity as the minimum required rate of return for equity investors.
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