Cost of capital
The cost of capital is important because it assists in making investment decisions and offers a benchmark of measuring the value of a proposed investment. It designs the market fluctuations and assists in achieving the capital structure of a company in addition to evaluating its financial performance.
Apple uses this technique to determine its capital structure by evaluating the optimal combination of financing that will give sufficient funding and to minimize the cost of capital. Apple has a higher return on investment when compared to the costs the company makes to get the capital required for that investment. In short, it is getting excess returns in investment. Such an analysis is achieved by applying the cost of capital technique and it helps the management to focus on increased growth and value through making investments in projects that generate positive excess returns.
Cost of capital measures the cost of equity and debt weighted based on the company’s forecasted or current capital structure. Apples uses cost of capital to calculate the average amount required to pay all its security holders to finance its assets. The cost of debt amounts to the interest rate paid by the company on its present debt while the cost of equity is the estimated return rate of the company’s shareholders.
In calculating the cost of capital, the Weighted Average Cost of Capital (WACC) is considered. All categories of a company’s’ capital are weighted proportionately to get a blended rate after considering all kinds of debt and equity from the balance sheet. To calculate the cost of debt Apple multiplies the interest costs connected to the debt by the inverse of the percentage tax rate, and the result is divided by the amount of unsettled debt. Apple approximates the cost of equity using the capital asset pricing model.