Question

Our discussion topic concerns the calculation of stock values using the Capital Asset Pricing Model (CAPM). Explain the CAPM model.Choose the firms J&j and Pepsi Co and discuss whether the betas are what you would expect. Be sure to explain why or why not. Calculate the returns based on the CAPM model. Be sure to state your assumptions.

The Weighted Average Cost of Capital (WACC) for a firm can be calculated or found through research. Select two firms in the same industry. The industry may be that in which you currently work or it may be an industry in which you are interested. Calculate or find the WACC for the two firms. How do the WACCs compare? Are the WACCs what you would expect? What causes the differences between the two firms' WACCs?

just google and respond best abilities please, thanks*

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Answer 1

“The capital asset pricing model (CAPM) is a model that describes the relationship between systematic risk and expected return for assets.”

It is widely used for pricing the securities and generating the expected return with the given risk.

The formula for calculating the expected return of an asset given its risk is -

Ra = Rrf + [Ba x (Rm – Rrf)]

Where:

Ra = Expected return on a security
Rrf = Risk-free rate
Ba = Beta of the security
Rm = Expected return on market

Note: Risk Premium = (Rm – Rrf)

As per the information from google analytics, Pepsico shows a beta of 0.10 whereas Jhonson & Jhonson shows a beta of 0.70 which signifies that J&J is more volatile to the market than pepsico.

"“Beta expresses the fundamental tradeoff between minimizing risk and maximizing return. Let's give an illustration: Say a company has a beta of 2; this means it is two times as volatile as the overall market. If we expect the market to provide a return of 10% on an investment, then we would expect the company to return 20%. On the other hand, if the market were to decline and provide a return of -6%, investors in that company could expect a return of -12% (a loss of 12%). If a stock had a beta of 0.5, we would expect it to be half as volatile as the market; a market return of 10% would mean a 5% gain for the company. “"

So in the given comparison J&J has more chances of more return and at the same time is at more risk.

"Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is proportionately weighted."

All sources of capital, including common stock, preferred stock, bonds and any other long-term debt, are included in a WACC calculation. A firm’s WACC increases as the beta and rate of return on equity increase, as an increase in WACC denotes a decrease in valuation and an increase in risk.

To calculate WACC, multiply the cost of each capital component by its proportional weight and take the sum of the results. The method for calculating WACC can be expressed in the following formula:

Where:
Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V = E + D = total market value of the firm’s financing (equity and debt)
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate

Let us consider ACC ltd and Ambuja Cements companies of India inorder to have a comparison of WACC and to know the significance of WACC

As per the info analytics by google ACC Limited has WACC of 10.06% and Return on Investment (ROI) of 17.95% where as Ambuja Cements has WACC of 11.47% and ROI of 21.37%

“Investors use WACC as a tool to decide whether to invest. The WACC represents the minimum rate of return at which a company produces value for its investors. Let's say a company produces a return of 20% and has a WACC of 11%. That means that for every dollar the company invests into capital, the company is creating nine cents of value. By contrast, if the company's return is less than WACC, the company is shedding value, which indicates that investors should put their money elsewhere.”

So for ACC Ltd , as per the above mentioned figures, the company is creating the value of 7.89% where as ambuja cements is creating the worth of 9.9% So when compared in the industry ambuja cements yield more return thsn ACC where investors would be more willing to invest their money in.

"The capital funding of a company is made up of two components: debt and equity. Lenders and equity holders each expect a certain return on the funds or capital they have provided. The cost of capital is the expected return to equity owners (or shareholders) and to debtholders, so WACC tells us the return that both stakeholders - equity owners and lenders - can expect. WACC, in other words, represents the investor's opportunity cost of taking on the risk of putting money into a company."