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Since the closing rate of Malaysia Government 10-year Bond which is risk free ratetotal 3.86% based on Appendix 3.134, and beta of Maxis is 0.63 refer to Appendix 3.235.Therefore, all the relevant data is complete collected in order to demonstrate SecurityMarket Line (SML). 34 “Malaysian Government Securities (MGS)-Conventional,” Bank Negara Malaysia, accessed March 28, 2016, 35 “Maxis Bhd (MXSC.KL),” Reuters, accessed March 29th, 2016, 11
According to the graph demonstrated above, point A is represented the risk-free ratereturn which is based on Malaysia Government 10-year Bond. As it is risk free, therefore thebeta is 0. Calculation of CAPM has been made refer to Appendix Point B is represented CAPMhas a return rate of -0.2098% and beta of 0.63%. In addition, point C (1, -2.5985) isrepresented the market return. Last but not least, Point D is the stock return of Maxis whichcarried the return rate of 2.1898% and beta of 0.63. Since point D which is stock return ofMaxis is above the security market line (SML), therefore the stock price for Maxis isundervalued. 3.0 Cost of CapitalCost of capital refers to the funds used to finance a company. It can be solely financedthrough equity or debt, or a combination of equity and debt. The overall cost of capitalderived from the combination is commonly known as weighted average cost of capital(WACC). Moreover, the purpose of calculating cost of capital during capital budgeting processis to determine which project the company should proceed and invest.363.1 Cost of EquityThere are two methods for Maxis to calculate the cost of equity. The first method isCapital Asset Pricing Method (CAPM). CAPM is used to illustrate the relationship betweenexpected return and risk, and perform as a standard for the pricing of uncertain securities.37CAPM is suitable for every industry as long as we can calculate the beta. However, themarket risk premium and beta are usually computed from historical data which may notalways be reliable.38The formula of CAPM is RE=Rf+β(RM−Rf)where Rfdenotesrisk-free rate, RMis market return, and βis beta. In this case, we refer to 10 year36 “Cost of Capital”, Investopedia, assessed 28thMarch, 2016, 37 “Capital Asset Pricing Model”, The Free Dictionary, assessed 28thMarch, 2016, -dictionary.thefreedictionary.com/capital+asset+pricing+model38 Elson Goh, “Cost of Capital” (lecture, Curtin University of Technology, March 28, 2016).12
Malaysian government bond for risk-free rate which is 3.86% (Appendix 3.1).39RMiscalculated in risk-return analysis which is -2.6% as shown above. Beta is a measure ofsystematic risk or volatility which is computed based on regression analysis. If the security’sprice is less volatile than the market, the beta will be less than 1; if the security’s price ismore volatile than the market, the beta will be greater than 1. If a company beta is 1 thatmeans the security’s price will shift along with the market. For instance, the beta of Maxis is0.63 (Appendix 3.2),40means the security’s price is hypothetically 37% less volatile than themarket. Therefore, the cost of equity is -0.2098% (Appendix 3.3).