What does the term "cost of equity" represent?

The term "cost of equity" refers specifically to the return a firm must provide to its equity investors as compensation for the risk associated with owning its stock. Equity investors expect a return on their investment that reflects the level of risk they assume, which can be influenced by various factors, including market conditions, company performance, and overall economic conditions.

When calculating the cost of equity, firms often use models such as the Capital Asset Pricing Model (CAPM), which incorporates the risk-free rate, the expected market return, and the stock's beta to estimate the required return for equity investors. This calculation helps firms understand what returns they need to generate from their investments to satisfy their shareholders and attract new investors.

In this context, the other options do not accurately reflect the concept of cost of equity. Total profits after expenses relate to a firm’s operational efficiency but do not account for investor expectations. The interest rate paid on borrowed funds pertains to debt financing rather than equity. Lastly, the dividend yield is a specific measure of the income component of a stock but doesn't encompass the overall return necessary to satisfy equity investors. Thus, the definition provided in the first option captures the essence of what the cost of equity entails in financial analysis.