Hi Kirk,
WACC we use for internal purpose mostly by management to decide on its capital structure. 3 source of long term fund for the company is Common shares, Pref . Shares and Debt(Bank loan or Bonds). The WACC of the company should be less than the Expected return of the investors then only the performance of the company can bring Value addition ( in terms of financial growth).
CAPM is used mostly by external users (Prospective investors) and current investors to calculate the expected return of a given investment in relation to the market.
ERi=Rf+βi(Rm−Rf)
Here we are considering more of external factors.
ERi=expected return of investment
Rf=risk-free rate
βi=beta of the investment (beta establishes a relation of the investment to its market)
(Rm−Rf)=market risk premiumCAPM is used in scenarios where a person want to invest in a share. he knows the Rf that is the interest rate of the safest investment. Beta is the relation of that share with the market. Rm is the return of the market. for particular risk how much return he should expect from that share. This view is addressed in CAPM.
Hope i have covered what you wanted.
------------------------------
Mohammed Nadeem
Accountant
Vi Sigma Apparel Group FZE
Abu Dhabi
United Arab Emirates
------------------------------
Original Message:
Sent: 05-28-2021 12:44 AM
From: Kirk Nebel
Subject: W.A.C.C vs. C.A.P.M. (CMA Part II)
I'm looking for a concise explanation for the difference between "Weighted Average Cost of Capital" (W.A.C.C.) and the "Capital Asset Pricing Model" (C.A.P.M.).
I am familiar with and know both of the formulas, however, I'm trying to find a way to do more than just memorize the formulas. I want to solidify the reason each would be used, and why one would be used instead of the other. As many of you know, there are many formulas in Part II of the CMA, so any tips would be very helpful. Thank you in advance for your help!
Best regards,
Kirk Nebel
------------------------------
Kirk Nebel
Accountant
Santa Clarita CA
United States
------------------------------