Equity Spread (ES)

The equity spread calculates the equity value creation of capital.

It is computed by multiplying the beginning equity capital by the difference between return on equity and cost of capital.

The higher the equity spread, the better. A high equity spread means that there is a big difference between the returns received from investing in equity and the cost of investing in such.

Equity Spread (ES) Formula

The formula in computing for the equity spread is:

ES = Beginning stockholders' equity x (re - ke)

re = Return on equity = Income / Average Equity
ke = Cost of equity

Example: Computation of Equity Spread

The stockholders' equity of ABC Company had a beginning balance of $1,200,000 and ending balance of $2,000,000. It generated operating income of $400,000. The cost of equity is 10%. Compute for the equity spread.

1. Computation of return on equity

Return on equity =
Average equity
($1.2M + $2M) ÷ 2
Return on equity = 25%

2. Computation of equity spread

ES = Beginning stockholders' equity x (re - ke)
ES = $1,200,000 x (25% - 10%)
ES = $180,000

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