Final answer:
To estimate Apple's Weighted Average Cost of Capital (WACC), we must estimate the company's cost of equity through CAPM, cost of debt, and leverage. We then calculate the WACC by appropriately weighting each component using the firm's capital structure.
Step-by-step explanation:
Estimating Apple's Cost of Capital (WACC)
To estimate Apple's Weighted Average Cost of Capital (WACC), we need to calculate the cost of equity, cost of debt, and the company's leverage ratio.
1. Cost of Equity
Cost of equity can be estimated using the Capital Asset Pricing Model (CAPM), which includes three components: the risk-free rate, beta, and the market risk premium. The formula for CAPM is:
Re = Rf + β(E(Rm) - Rf)
where Re is the cost of equity, Rf is the risk-free rate, β (beta) is the stock's volatility relative to the market, and E(Rm) is the expected market return.
2. Cost of Debt
The cost of debt (Rd) can be calculated based on the yield to maturity on the company's existing debt or the interest rate on new debt if applicable.
3. Leverage
The firm's leverage is found by dividing total debt by total equity.
Based on publicly available financial data for Apple, you would compute these elements as follows:
- Estimate Apple's Beta: Research financial databases or services to find Apple's beta.
- Estimate Apple's Market Risk Premium: This is typically the historical premium of the returns on the stock market over the risk-free rate.
- Estimate appropriate Risk-Free Rate: Often derived from the yield on government bonds such as U.S. Treasury securities.
- Cost Debt: This is the after-tax yield to maturity on Apple's long-term debt.
- Leverage: This is calculated based on Apple's balance sheet, taking the ratio of debt to equity.
Once each component has been estimated, WACC can be computed by weighting the cost of equity and cost of debt by their respective proportions in the firm's capital structure.