IBM's Cost of Capital

Suggested Solution

a. The cost of equity from the CAPM is:
4.40%+1.09(12%-4.40%) = 12.68%

b. The after-tax cost of debt is: Rate(1-Taxrate) = 5.36%(1-.36) = 3.43%
The market value of equity is price*shares = 130*0.943 billion = $122.59 billion.
The debt, short- as well as long-term, is worth $61.7 billion. The sum of these is $184.29 billion.

The weighted-average cost of capital is thus
12.68%(122.59/184.29+3.43%(61.7/184.29 = 9.59%  

IBM
12-96 12-97 12-96 as % of assets 12-97 as % of assets
Assets ($ mil)
Cash 8,137.0 7,553.0 10.03 9.27 Inventories 5,870.0 5,139.0 7.24 6.31 Other 26,688.0 27,726.0 32.89 34.02
Current assets 40,695.0 40,418.0 50.16 49.59 Non-current assets 40,437.0 41,081.0 49.84 50.41
Total assets 81,132.0 81,499.0 100.00 100.00
Liabilities & Shareholders’ Equity ($ mil)
Current liabilities 34,000.0 33,507.0 41.91 41.11 Long-term debt 25,504.0 28,176.0 31.44 34.57 Other liabilities 15,632.0 14,480.0 19.27 17.77
Total liabilities 75,136.0 76,163.0 92.61 93.45 Shareholders’ equity 21,628.0 19,816.0 26.66 24.31
Total liab. & equity 96,764.0 95,979.0 119.27 117.77
Balance Sheet Ratios
Current ratio 1.2 1.2 Debt/equity ratio 1.2 1.4