Cost Of Capital Analysis

949 Words2 Pages

Cost of capital refers to the cost of obtaining funds, that is, debt or equity to finance an investment project. The cost of capital is useful in assessing the applicability of a capital account because the cost of capital is the lowest return for the investor to fund the company. Different sources of capital have different capital costs. On the other hand, risk refers to the uncertainty that exists in making financial decisions. Because the forecast may be different from the actual result, for example, the stock price may change unfavorably. The risk can be divided into two categories: systemic risk and non-systemic risk. The risk is measured by variance analysis or beta. (Brigham & Ehrhardt, 2011).
Weighted Average Cost of Capital (WACC) …show more content…

Here uses Capital Asset Pricing Model (CAPM) to calculate the required rate of return. The formula is:
Cost of Equity = Risk-Free Rate of Return + Beta of Asset * (Expected Return of the Market - Risk-Free Rate of Return)
a) Here uses 10-Year Treasury Constant Maturity Rate as the risk-free rate. It is updated daily. The current risk-free rate is 2.78000000% (apple, 2017).
b) Beta is the sensitivity of the expected excess asset returns to the expected excess market returns. Apple Inc's beta is 1.08 (AAPL, 2017).
c) (Expected Return of the Market - Risk-Free Rate of Return) is also called market premium. Here requires market premium to be 6% (AAPL, 2017).

Cost of Equity = 2.78000000% + 1.08 * 6% = 9.26%
3. Cost of Debt:
Here uses last fiscal year end Interest Expense divided by the latest two-year average debt to get the simplified cost of debt.
As of Sep. 2017, Apple Inc's interest expense (positive number) was $2323 Million. Its total Book Value of Debt (D) is $101356 Mil (Gurufocus, …show more content…

The latest Two-year Average Tax Rate is 25.06% (Gurufocus, 2017).
Apple Inc.’s Weighted Average Cost Of Capital (WACC) for Today is calculated as:

WACC = E / (E + D) * Cost of Equity + D / (E + D) * Cost of Debt * (1 - Tax Rate)
= 0.8936 * 9.26% + 0.1064 * 2.2919% * (1 - 25.06%)
= 8.46%
A WACC of 8.46 % means that the average cost of capital when both equity and debt is used is 8.46%. This WACC can be used as a discounting factor for capital projects (Gurufocus, 2017).
The security market line is a graphical representation of the CAPM model that shows the expected return on security as a systemic, non-decentralized risk function. All properly priced assets will be located in the securities market. The y-axis intercept of the safe market line will represent a risk-free interest rate and the slope is a risk premium. Any security measures on this line are either overpriced or underpriced, and these are effective / reasonable pricing.
Summary and

More about Cost Of Capital Analysis

Open Document