FINANCIAL MANAGEMENT DISCUSION BOARD

Apple's WACC

The calculation of a firm’s cost of capital for each category of capital that is proportionately weighted is done by the weighted average cost of capital. The following are also included in calculating the WACC: common stock, any other long-term debt, preferred stock, and bonds. The WACC can be increased as the beta and the rate of return on equity continues to increase. For a company to have an increase in WACC, it implies that there is a decrease in valuation and an increase in the risk. The WACC can also be used as a hurdle rate against companies and investors can gauge ROIC performance. To calculate WACC, the following formula can be used:

WACC= E/V * Re + D/V * Rd * (1-Tc)

Weight Calculation

            The company’s assets are financed by their equity and debt, so in order to determine this information; we must calculate the weight of equity and the weight of debt. The market value of equity is also known as the market cap as well. For Apple, their market capitalization is $1501993.770 million. “As of Mar. 2020, Apple’s latest two-year average Short-Term Debt & Capital Lease Obligation was $18494 Mil and its latest two-year average Long-Term Debt & Capital Lease Obligation was $92771 Mil. The total Book Value of Debt (D) is $1111265 Mil” (Apple WACC).

Weight of Equity= E/(E+D)= 1501933.770/ (1501933.770 + 111265) = 0.931

Weight of Debt= D/(E+D)= 111265/ (1501933.770 + 111265) = .069

Cost of Equity

“The cost of equity is the return a company requires to decide if an investment meets capital return requirements” (Kenton, 2020). 

Cost of equity= .660% + 1.09 * 6%= 7.2%

This is calculated by risk-free rate of return + beta of asset * (expected return of the market –risk free rate of return).

Cost of Debt

Apple’s interest expense as of Sept 2019 was $3576 mil and its total book value $111265 mil.

Cost of debt= 3576/111265= 3.21%

The next step would be to calculate the average tax rate minus 1. So one would take the WACC formula and multiply it by the 1-average tax rate and the formula for this is:

WACC = E/(E/D) * Cost of equity + D/(E+D) * Cost of debt * (1-tax rate) 

The latest tax rate for Apple over the last two years averages to 17.14%.

WACC= .931 * 7.2% + 3.21% * (1-17.14%)

WACC= 6.89% 

For any company, it cost to raise capital. Any firm that is able to generate a higher ROIC% than it costs the company to raise the capital that is necessary for the investment is earning excess returns. With Apple’s WACC being 6.89% and their ROIC 22.56%, it implies that Apple is able to generate higher returns on their investment than it cost the company to raise capital that is needed to invest. As Apple continue to generate positive excess returns on new investments in the future, they will see their value increase as the growth continues to increase.

 2 Corinthians 9:10AMP says, “Now He who provides seed for the sower and bread for the food will provide and multiply your seed for sowing [that is, your resources] and increase the harvest of your righteousness [which shows itself in active goodness, kindness, and love].

 

References: 

Kenton, W. (2020, January 29). Cost of Equity. https://www.investopedia.com/terms/c/costofequity.asp.

Apple WACC %. Apple WACC % | AAPL - GuruFocus.com. https://www.gurufocus.com/term/wacc/AAPL/WACC/Apple inc.

 

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Caterpillar Inc. WACC

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WACC stands for "Weighted Average Cost of Capital." According to Pablo Fernandez, PhD, “The WACC is just the rate at which the Free Cash Flows must be discounted to obtain the same result as in the valuation using Equity Cash Flows discounted at the required return to equity. The WACC is neither a cost nor a required return: it is a weighted average of a cost and a required return.” The text provides the formula for WACC to be WACC = (ke * We) + (kp * Wp) + (kd/(pt) [1 – t] * Wd) where: 

· WACC = Weighted average cost of capital 

· ke = Cost of common equity capital 

· We = Percentage of common equity in the capital structure, at market value 

· kp = Cost of preferred equity 

· Wp = Percentage of preferred equity in the capital structure, at market value 

· kd/(pt) = Cost of debt (pre-tax) 

· t = Tax rate 

· Wd = Percentage of debt in the capital structure, at market value  

(Bruner, Eades, Schill, 2018). WACC can also be calculated using different formulas to reach a similar result since, as Fernandez defined, WACC is not a cost nor a required return. To calculate the WACC for Caterpillar Inc., there will be a few different numbers calculated first, then those numbers will be applied to the formula: WACC=E/(E + D)*Cost of Equity+D/(E + D)*Cost of Debt*(1 - Tax Rate) where “E” is the market value of equity and “D” is the book value of debt. This formula is similar to the formula used in the text but combines different values into fewer pieces of the equation.  

Referencing Caterpillar Incorporated’s 10-k, the company’s “E” would be $64656.440 million. To find the book value of debt, one would add the two-year average Short-Term Debt & Capital Lease Obligation and the two-year average Long-Term Debt & Capital Lease Obligation together, meaning $11464.5 + $25640.5 = $37105. As of March 2020, the cost of equity for Caterpillar Inc. Is 6.54%, using the capital asset pricing model. Looking back at historical financial statements, Caterpillar’s interest expense in December. 2019 was $421 million (positive), and it was previously established that “D” is $37105 million (“CAT WACC %”, 2020). Therefore, cost of debt is interest expense/debt, equaling 1.1346%. The final piece of the initial equation to calculate is the average tax rate for the company. To stay consistent with the previous calculations, a two-year average will be calculated. For CAT, the two-year average tax rate is 22.03%. When going back to the original equation of WACC=E/(E + D)*Cost of Equity+D/(E + D)*Cost of Debt*(1 - Tax Rate), one can fill in the calculated number for each corresponding letter or value. WACC= 0.6354*6.54%+0.3646*1.1346*(1-22.03%). Therefore, Caterpillar Incorporated’s WACC is 4.48%. The WACC can also change very quickly based on the company’s performance, the industry overall, and which method is used to calculate it. Because of these varying effects, it is very important to know why WACC is being calculated the specified way, not just what the WACC is.  

 

References 

Bruner, R. F., Eades, K., and Schill, M. (2018). Case Studies in Finance (8th Edition). New York, NY: McGraw-Hill Education. 

Caterpillar Incorporated. (2020-2019). Form 10-K 2018-2016 Retrieved from SEC EDGAR Website  https://www.sec.gov/cgi-bin/viewer?action=view&cik=18230&accession_number=0000018230-20-000056&xbrl_type=v#  

Caterpillar WACC %. (2020, March). Retrieved from https://www.gurufocus.com/term/wacc/NYSE:CAT/WACC-/Caterpillar#:~:text=As of today, Caterpillar's weighted, It is earning excess returns. 

Fernández, P. (2010). WACC: Definition, Misconceptions, and Errors. Business Valuation Review, 29(4), 138–144. doi: 10.5791/0897-1781-29.4.138 

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Discussion Board 685: LIBOR

Definition

The finance in practice box for Chapter 23 discusses how LIBOR is set and its relationship to the treasury bill rates.  LIBOR stands for the London Interbank Offered Rate and EUIBOR stands for the Euro Interbank Offered Rate.  They are “two key benchmark interest rates used in a plethora of financial contracts” (Eisl et al, 2017).  Global-rates defines LIBOR as an indicative average interest rate at which a selection of banks (the panel banks) are prepared to lend one another unsecured funds on the London money market.”  Interestingly, LIBOR is calculated for 7 different maturities and in 5 different currencies: dollars, euros, the Japanese yen, the pound sterling, and the Swiss Franc (Brealey et al, 2020).  LIBOR rates are published and managed by the ICE Benchmark Administration, which makes selections on panel banks with the assistance of Foreign Exchange and Money Markets Committee (FX&MMC) (Brealey, 2020 and LIBOR).  They base their selection off of banks market volume, reputation, and knowledge of currency concerns.  LIBOR rates are not calculated based on actual

Significance

            LIBOR rates is viewed as the “most important benchmark in the world for short-term interest rates” (LIBOR).  The biggest factor is using it as a base rate for setting interest rates in loans, savings, and mortgages.  Because they are used as a base rate for other products, is the reason why they are monitored by such a big organization and with many panel banks worldwide (LIBOR). Eisl, Jankowitsch, and Subrahmanyam discussed the impact on the integrity of these rates, the potential for manipulation, and the effect it has causing potentially global chaos in the markets.  They found “such alternative rate fixings, particularly methodologies that eliminate outliers based on the time-series information, and larger sample sizes, could significantly reduce the effect of manipulation” (2013).

Biblical Integration

“You shall not charge interest on loans to your brother, interest on money, interest on food, interest on anything that is lent for interest” (Deuteronomy 23:19, ESV).

 

References

Brealey, R. A., Myers, S. C., & Allen, F. (2020). Principles of Corporate Finance. New York, NY: McGraw-Hill Education.

Eisl, A., Jankowitsch, R., & Subrahmanyam, M. G. (2017). The manipulation potential of Libor and Euribor. European Financial Management, 23(4), 604-647.

Eisl, A., Jankowitsch, R., & Subrahmanyam, M. G. (2013). Are interest rate fixings fixed? an analysis of libor and euribor. An Analysis of Libor and Euribor (January 15, 2013).

LIBOR (n.d.). LIBOR, information about the London Interbank Offered Rate. Global-rates.com. Retrieved from https://www.global-rates.com/interest-rates/libor/libor-information.aspx

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DB # 685 Fear Index

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           The Volatility Index also know as VIX Index, on a global basis, it recognized to be the most valuable measures of volatility that is widely report the financial media and followed closely by a variety of market participations as a daily market indicator. This shows an expectation of 30-day forward-looking volatility for the market. “Derived from the price inputs of the S&P 500 index options, it provides a measure of the market risk and investors’ sentiments” (Kuepper, 2020). VIX values are used to help assist investors, research analysts, and portfolio managers to measure the market risk before making an investment decision. Other indicator, unlike the CBOE Volatility Index, measures a different type of volatility, which makes this index uniquely different. Other indicators measure the level of price fluctuations, while VIX measures the future.

            Volatility is a statistical measure for financial instruments like stocks, to the degree of variation in their trading price observed over a certain period of time. As the price swings continue to become more dramatic, the higher the level of volatility that occurs and vice versa. “A rising VIX indicates that traders expect the S&P 500 Index to become more volatile. The higher the VIX, the higher the fear, which, according to market contrarians, is considered a buy signal” (COE Market Volatility Index (VIX)).  To be able to measure volatility, it can be done by two methods. The first one is based upon performing statistical calculations over a specific time period on the historical prices. The second method involves inferring (deduce or conclude) the value as implied by the option prices.

            This method after research seems to be a benefit for those looking to making an investment in a stock. It helps them make a sound decision by doing their part on researching. Proverbs 3:13 NIV, “Blessed are those who find wisdom, those who gain understanding.”

References:

Kuepper, J. (2020, March 13). CBOE Volatility Index (VIX) Definition. https://www.investopedia.com/terms/v/vix.asp .

What Is VIX? - CBOE Market Volatility Index. Fidelity. https://www.fidelity.com/learning-center/trading-investing/technical-analysis/technical-indicator-guide/cboe-vix .

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