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Week Five Financial Exercises

Apple Inc.

The weighted average cost of capital refers to the rate to which a company is expected to pay on average to all its security holders to finance its assets (Damodaran, 2016).

WACC=E/ (E + D)*Cost of Equity +D/ (E + D)*Cost of Debt*(1 - Tax Rate)

Weights

The market value E= $856747.095 million

Current long term debt= $ 15039 million

Average long term debt + capital lease obligation = $ 86317 million

Total book value of debt D = $ 101356 million

Weight of equity =(E/(E+D)

856747.095/ (856747+101356) = 0.8942

Weight of debt = D/(E+D)

101356/ (856747+101356) = 0.1058

Cost of equity

Cost of equity= Risk free rate of return + Beta of asset *(Expected return of the market – Risk free rate of return)

Apple Inc.’s beta is 1.08

Market Risk Premium is 5%

Risk free rate 3.5%

ri= rf + βi * (RMkt-rf)

= 5% + 1.08*3.5 = 8.78%

Cost of debt

Interest expense (+ positive Number) = $ 2323 million

Cost of debt therefore = 2323/101356= 2.2919%

Corporate Tax rate = 40%

WACC of Apple Inc.

WACC=E/ (E + D)*Cost of Equity +D/ (E + D)*Cost of Debt*(1 - Tax Rate)

=0.8942*8.78% + 0.1058*2.2919% * 0.6

= 7.851076 + 0.145489812

= 7.997

= 8%

WACC of Apple Inc. as at the year 2017 was at 8%.

Conclusion

The weighted average cost of capital or also known as the WACC is the average rate of return a company expects to compensate all its different investor. The weights are the fraction of each financing source in the company’s target capital structure. In simpler terms, the weighted average cost of capital represents the minimum rate of return at which a company produces value for its investors. What is the typical WACC of company’s? The typical average cost of capital is a high weighted average which means the firm’s operations may be at a higher risk. The importance of understanding a WACC because for companies to make their investment decisions and evaluate projects with similar and dissimilar risks. Based on the calculations above we can, therefore, conclude that Apple Inc. pays 8% on every dollar that it finances that is 8 cents for every dollar invested (Lynch et al. 2015). From the calculation, we understand that on every dollar the company spends on an investment, it must make eight plus cents the cost of the investment for the investments to become feasible and keep the company in operations. From the calculations, the value we obtained is close to the real WACC of the company. The confidence in the value of the WACC obtained, therefore, is not 100%. There were limiting factors that affected the accuracy of the WACC. Some of the factors include the assumptions that the corporate tax was 40%, a percentage value that is not similar to the real corporate tax from the Apple Inc. contributing errors in the final results. Also, the Market risk premium, as well as the risk-free rate, were provided, and therefore the real figures were not used but substituted instead. The substitution slightly affected the results as they were as a result of assumptions. The WACC of Apple Inc. being 8% means that an investor can comfortably invest in the company without any fear that the investment may end up in vain. Each dollar invested attracts 8 cents as returns making the company worth investing in capital. If Apple Inc. company had a return that was less than the WACC it wouldn’t be a good investment for the investor.

References

Damodaran, A. (2016). Damodaran on valuation: security analysis for investment and corporate finance (Vol. 324). John Wiley & Sons.

Lynch, P., Allen, R. G., & Graham, B. (2015). Choosing Your Investments. Cocktail Investing: Distilling Everyday Noise into Clear Investment Signals for Better Returns, 223.