CMA Study Group

W.A.C.C vs. C.A.P.M. (CMA Part II)

  • 1.  W.A.C.C vs. C.A.P.M. (CMA Part II)

    Posted 18 days ago
    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

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    Kirk Nebel
    Accountant
    Santa Clarita CA
    United States
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  • 2.  RE: W.A.C.C vs. C.A.P.M. (CMA Part II)

    Posted 18 days ago
    Hi Kirk,

    WACC is the weighted average cost of financing the Assets of the firm with Liabilities and Equity.

    CAPM helps establishing what the Cost of Capital/Equity is. Solving the Risk Premium. Assuming you know the beta and the expected return of the stock.

    Hope it helps.

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    David Nieto-Heurtebis
    Palma De Mallorca
    Spain
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  • 3.  RE: W.A.C.C vs. C.A.P.M. (CMA Part II)

    Posted 16 days ago
    Hello Kirk,

    WACC = Cost of Debt + Cost of Equity

    CAPM is used just to calculate of cost of equity, which is more complex among the two.

    Cost of debt is a deductible expense, hence cost of debt is always lower than the cost of Equity but only up to a certain point. Borrow till the point return on investment is greater than the cost of debt ( taken to make the investment).

    Let me know if this helps.

    Thanks,
    Kiran

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    Kiran Kulkarni
    Director/Manager
    BENGALURU
    India
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  • 4.  RE: W.A.C.C vs. C.A.P.M. (CMA Part II)

    Posted 15 days ago
    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.

    E
    Ri=Rf+βi(RmRf)

    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)
    (RmRf)=market risk premium


    CAPM 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.

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    Mohammed Nadeem
    Accountant
    Vi Sigma Apparel Group FZE
    Abu Dhabi
    United Arab Emirates
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