The Cost of Capital for Papa John's

The Cost of Capital for Papa John’s

An important measure required for decisions on quantifying public and private funded projects is the appropriate cost of capital. The components of capital asset pricing are critical to the financial analysis of a company. The Capital Asset Pricing Model (abbreviated as CAPM) is an economic analysis model used to determine the market price for risk. More specifically CAPM provides assumptions needed to determine the appropriate measure of risk a single asset has. The information gleaned from CAPM reveals equilibrium rates of return on all risky assets in relation to with the market and their portfolio. By using this method, an understanding as to why expected returns become variable and change over time.

CAPM states that the expected return of any capital asset is proportional to its systematic risk measured by the beta. (Iqbal and Brooks, 2007). Taking into consideration varying assumptions; the CAPM is becomes an expression of a linear function. This function represents the free rate, beta and the expected risk premium.

The model provides the amount of expected return based on the discount rate.

Data

When managing and evaluating returns for a period by using the closing prices for a day, a week, a month, or a quarter. While the option to calculate them at different lengths of time exists the shorter the holding period, the more likely the data is to present random variances. Conversely, the greater the number of years of data used, the more likely it is that the subject company’s risk position has changed.

Methodology of CAPM

The benchmark for a well-diversified stock portfolio is the market portfolio, which is a portfolio containing all stock. Therefore, the relevant risk of an individual stock, which is called its beta coefficient, is defined under CAPM as the amount of risk that the stock contributes to the market portfolio. (Bringham & Ehrhardt, 2005).

The purpose of using financial analysis CAPM is to provide the correct relationship that exists between beta coefficients, non-systematic risk, and returns. The general practice when doing this is to view the data in relation to 30-day Treasury bill rates and long-term Treasury bond rates. Using the treasury bill and bond data offers a bench-line estimate of the risk-free rate. (Bringham & Ehrhardt, 2005)

Beta

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