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This 3-page paper discusses analysis of Shell Oil's cost of capital report. Topics discussed include weighted average cost of capital and capital asset pricing model, then describes advantages and disadvantages to each method. Bibliograpy lists 2 sources.
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3 pages (~225 words per page)
File: D0_MTsheacc.rtf
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weighted average cost of capital and the capital asset pricing model. It first helps to understand what the definition of cost of capital is. Simply put, cost of capital involves
an opportunity cost of an investment, in other words, a rate of return a company would earn otherwise if it were to invest its money in another investment that had
the same risk value (Investorwords.com, 2003). For example, much of Shell Oil Companys investments during 2002 involved acquisitions of Enterprise Oil, Pennzoil-Quaker State, DEA and interests in Equilon and Motiva
(Shell Oil Company, 2003). The cost of capital analysis would examine whether a rate of return would be the same or better if Shell had decided to invest in another
asset with the same risk return - such as acquiring part of Texaco (as the company did during the late 1990s). Cost
of capital can be calculated in two ways: weighted average cost of capital (WACC) and Capital Asset Pricing Model (CAPM). With the WACC method, we calculate an average representing an
expected return on all of a companys securities, using each source of capital in the calculation (Investorwords.com, 2003). For example, Shells cash, cash equivalents and short-term securities were $1.6
billion by the end of 2002 (Shell Oil Company, 2003). The key to using the WACC in this case would be to analyze the expected rate of return on the
securities (which is a fancy word for "stocks") as well as other assets including fixed and long-term assets (which were $112.1 billion) and medium term note and commercial paper ($26
billion) (Shell Oil Company, 2003). Based on this method, anticipated rate of return would be measured by performance in previous years, than averaged together for the result. The advantage of
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