Business valuation is linked to risk, and that risk is reflected in the cost of equity. The cost of equity is the return shareholders require. This article expores the costs of equity for 2025.
Each year the “Dean of Valuation”, Professor Damodaran, publishes market data to assist in assessing risk and valuing businesses. This article takes some of the Professor’s current data to estimate the return (costs of equity) that an owner of an Australian private businesses may require.
Undiversified costs of equity
Owners of private businesses are often assumed to be unable to diversify away some or all of the firm specific risk. Consequently, these investors expect a higher rate of return compared to diversified investors.
The figure below shows the estimated Australian costs of equity for owners of private businesses unable to diversify away any firm specific risk [1].
The costs of equity are estimated using Professor Damodaran’s industry global Total Betas and his Australian equity risk premium as at 5 January 2025.[2]
Across the total market the implied cost of equity remained relatively consistent at 23%, compared to 22% at 5 January 2024. In the observed sectors, the cost of equity ranged between 20% and 34%.[3]
As shown in the figure, the implied cost of equity increased in certain industry sectors, notably: education, entertainment, information services and software (systems & applications) where the estimated cost of equity increased to 28%, 32%, 26% and 34% respectively. These increases were due to increased Total Betas.
Total Beta trend
The undiversified equity returns are estimated using Professor Damodaran’s global Total Betas.
According to the Professor’s data, the Total Betas “reflect a firm’s total exposure to risk rather that just the market risk component” and “might provide better estimates of costs of equity for undiversified owners of private businesses”.[4]
According to the Professor’s data, Total Beta for the total market increased to 4.41, compared to 3.76 in the previous year.
The figure below summarises Total Beta by sector for the 2024 and 2025 years. Significant increases in Total Beta occurred in the education, entertainment, information services and software (systems & applications) sectors.
Market correlation coefficient trend
The market correlation coefficient explains the strength and direction between the returns of an individual company and the returns of the market. Total Beta can be calculated by dividing beta by the correlation coefficient.
The increase in the Total Betas is principally explained by a reduction in the correlation coefficients. The correlation coefficient for the total market decreased to 18.0% from 20.9% in the previous year.
The figure below shows the historical correlation coefficient, per Professor Damodaran’s data.
The figure shows that the correlation coefficient averaged approximately 20% between 2013 and 2019, peaked during the COVID years and then subsequently declined back to pre-COVID levels.
Diversified v undiversified returns
As the professor states, in the real world an investor in a private business lies somewhere between being fully diversified and completely undiversified. [5]
The figure below shows the 2025 cost of equity for undiversified owners compared to fully diversified investors. Fully diversified investors are assumed to be able to diversify away all firm specific risk.
The costs of equity for the fully diversified investors are based on the Professor’s global industry betas.
The figure shows that the cost of equity for a fully diversified investor for the total market was 8% compared to 23% for an undiversified investor,a difference of 15%.
Equity Risk Premium and risk-free rate
The 2025 cost of equity calculations use the Professor’s equity risk premium for Australia. The equity risk premium decreased to 4.33%, from 4.60% the year before. This reduction in the equity risk premium effectively offset some of the increases in Total Beta.
Risk free rates of 4.19% and 4.31% are used at 5 January 2024 and 5 January 2025 respectively. The risk-free rates are based on the Australian Government ten-year bond yields for December 2023 and 2024.
2025 Cost of equity and valuation summary
Total Betas have increased in the Professors current data, indicating that the 2025 costs of equity for private businesses may have increased leading to lower business valuations. However, the increase in Total Betas has been offset by a reduced equity risk premium.
Industry sectors that experienced a significant increase in the undiversified cost of equity include the entertainment, information services and software (systems & applications) sectors.
For the observed sectors, the 2025 cost of equity ranged between 20% and 34% for completely undiversified investors, compared to between 7% and 10% for fully diversified investors. Investors in private businesses are likely to require a return somewhere in between!
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About the Author
Simon is the found of Lotus Amity Business Valuation and specialises in wrestling with and attempting to pacify often complex valuation problems. He is a Business Valuation Specialist with Chartered Accountants Australia and New Zealand (CA ANZ). He chairs the CA ANZ Business Valuation group for Queensland, is a member of the CA ANZ Trans-Tasman Business Valuation Committee and likes running long distances.
References and disclaimer
[1] Unlevered costs of equity assume no debt in the business. To arrive at the cost of equity for the subject business the cost of equity needs to be relevered for the amount of debt.
[2] Global Total Betas are used as, according to the Professor, a larger data reduces statistical errors. Cost of equity = risk free rate + equity risk premium (ERP) X Total Beta. https://people.stern.nyu.edu/adamodar/New_Home_Page/datacurrent.html
[3] The figure is for illustration and only includes a sample of twelve industry sectors from ninety-four sectors in the total market. No adjustment is made to reflect a lack of liquidity in privately held businesses.
[4] The Professor has in the past seemingly sought to distance himself from the term Total Beta, but he still provides the annual Total Beta metrics.
The information presented in this article is for general informational purposes only and should not be interpreted as financial advice whatsoever and is not intended as a substitute for professional advice. While we strive to provide accurate data, numbers and statistics may vary depending on the source and methodology used. Always consult with a qualified professional before making any decisions on estimating inputs in relation to valuing businesses.
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