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Dykstra: Determining the Cost of Equity

In last week's example, we determined that Halliburton's (HAL - Get Report) total capital (debt plus equity) came to $18.8 billion at the end of 2008. Total capital was 13.8% long-term debt and 86.2% equity.

Now, let's determine the cost of equity. To get that, we'll use a formula called the capital asset pricing model. The math for the CAPM formula is fairly simple. Here's how you can get a working CAPM: Look up the current 3-month T-bill rate (0.0019 on Monday), known as the risk-free rate. Next, look up Halliburton's beta on TheStreet.com. You'll find it here.

Beta measures a stock's risk and return compared to the overall market, with 1.0 being the market's risk and return. Halliburton's beta of 1.43 indicates it carries higher risk than the market.

We multiply its beta by a standard 6.7% -- the market's historical excess return rate. Then we add that to the risk-free rate of 0.0019, which gives us 0.0977, or 9.8%.

Here's the CAPM formula in plain English, with the market's historical excess return rate already plugged in: beta times 0.067 plus the 3-month T-bill rate = cost of equity.

A stock's beta can vary according to the methodology used by the data source, so these calculations are not hard and fast numbers. Still, they are useful guides.

Next time, we'll combine the weighted cost of equity with the weighted cost of debt for Halliburton's total cost of capital. Then we will compare that to the company's historical return on capital.

At the time of publication, Dykstra had no positions in stocks mentioned.

Nicknamed 'Nails' for his tough style of play, Lenny is a former Major League Baseball player for the 1986 World Champions, New York Mets and the 1993 National League Champions, Philadelphia Phillies. A three time All-Star as a ballplayer, Lenny now serves as president for several privately held businesses in Southern California. He is the founder of The Players Club; it has been his desire to give back to the sport that gave him early successes in life by teaching athletes how to invest and protect their incomes. He currently manages his own portfolio and writes an investment strategy column for TheStreet.com, and is featured regularly on CNBC and other cable news shows. Lenny was selected as OverTime Magazine's 2006-2007 "Entrepreneur of the Year."

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