Cost of equity using the CAPM for the firm

 

– Select a U.S. public company (Make sure to include the company name in the title page)
– Calculate the cost of equity using the CAPM for the firm
– Evaluate the results – how realistic do you believe the result to be?
– Pull the beta from at least 2 sources – discuss why they may be different

Sample Solution

Cost of Equity for Apple Inc. using CAPM

This analysis will calculate the Cost of Equity (Ke) for Apple Inc. (AAPL) using the Capital Asset Pricing Model (CAPM).

Data Acquisition:

  • Risk-Free Rate (Rf): As of June 16, 2024, the 10-year U.S. Treasury note yield is approximately 3.20% [Source: financial websites like Yahoo Finance or Google Finance].
  • Market Return (Rm): The historical average market return in the U.S. equity market is generally assumed to be around 8-10%. For this example, we will assume a Market Return (Rm) of 8.5%.
  • Beta (β): We will obtain the Beta from two sources and discuss the potential reasons for any discrepancies.

Beta Acquisition and Analysis:

Source 1: Yahoo Finance

  • Yahoo Finance lists Apple’s (AAPL) Beta as 1.12.

Source 2: https://www.marketwatch.com/investing/stock/beta?countrycode=hr

  • MarketWatch lists Apple’s (AAPL) Beta as 1.05.

Reasons for Beta Differences:

There can be several reasons for the slight difference in Beta between these two sources:

  • Calculation Methodology: Different financial websites might use slightly different methodologies to calculate Beta. Some might use a shorter or longer historical timeframe, or they might use different risk-free rate adjustments.
  • Data Source: The Beta calculation relies on historical stock return data and the chosen market index. Variations in the data sources used can lead to minor discrepancies.

CAPM Calculation:

Ke = Rf + β (Rm – Rf)

  • Ke = Cost of Equity
  • Rf = Risk-Free Rate = 3.20%
  • β = Beta (average of 1.12 and 1.05) = 1.085
  • Rm = Market Return = 8.5%

Scenario 1: Using Beta from Yahoo Finance (1.12)

  • Ke = 3.20% + 1.12 (8.5% – 3.20%)
  • Ke = 3.20% + 6.048%
  • Ke = 9.248%

Scenario 2: Using Beta from MarketWatch (1.05)

  • Ke = 3.20% + 1.05 (8.5% – 3.20%)
  • Ke = 3.20% + 5.72%
  • Ke = 8.92%

Evaluation of Results:

The calculated Cost of Equity for Apple using CAPM falls between 8.92% and 9.25%. Given Apple’s large size, market dominance, and relatively stable stock price compared to the overall market, a Cost of Equity in this range seems somewhat reasonable. However, it’s important to consider limitations of CAPM:

  • Market Assumptions: CAPM relies on the assumption of a perfectly efficient market, which may not be entirely true in reality.
  • Beta Stability: Beta is a historical measure and can fluctuate over time.
  • Company-Specific Factors: CAPM doesn’t account for all factors affecting a company’s risk, such as company-specific news or industry trends.

Conclusion:

The CAPM calculation provides a starting point for estimating Apple’s Cost of Equity. While the results appear somewhat realistic, it’s crucial to consider the limitations of the model and incorporate other financial analysis techniques for a more comprehensive assessment. Investors should also consider their own risk tolerance and investment goals when making investment decisions.

 

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