Slightly wonkish blog post on equity returns ahead....

When valuing a privately held business, it is important to properly calculate the business’s total cost of capital in order to correctly capitalize or discount its cashflow. The basic premise of business valuation is that a business is worth the present value of its future cashflow, therefore discounting the future cashflow of the business at the appropriate discount rate is crucial.

What is the cost of capital for a business?

The weighted average cost of capital is the discount rate most often used to discount the future cashflow of a business. It reflects the time value of money and risk associated with the business’s future stream of unlevered cashflow (cashflow that accrues to equity holders and debt holders).

A business's capital structure is composed of its debt and its equity. Determining the company's total cost of capital basically entails taking its cost of debt (which is usually an interest rate) and its cost of equity (to be discussed below) and then taking the weighted average of the two based on the company's optimal capital structure (this is called the weighted average cost of capital, the WACC). Without getting too wonky (too late), it's very important to properly calculate this because the WACC is used to present value or capitalize the future cashlfows of the business, which is the key step in a business valuation.
So.... if your WACC is wrong then your business valuation conclusion can't be right. This post will look at the equity risk premium, which is a component of the total cost of equity which, in turn, is used to calculate the total cost of capital for a business.
Let's back up one step - what is the cost of equity??

The cost of equity is simply the return that equity investors expect to make on their investment in a business.