Calcution of Cost of Capital

Expected Return

The expected return can be calculated using the CAPM model. Expected return means what investors are expecting from investing in the shares of a company (Reed, 2020). It can be calculated using the following formula:

CAPM             = Rf + Beta * (Rm – Rf)

Where,

Rf = Risk-free return on government securities (Australian government 10-year bond yield)

Beta  = systematic risk to the security

Rm = Market rate of return on this security or average of returns

Santos Limited

Rf = 3.65% (as per Bloomberg record for 10-year Australian Government Bond)

The beta of Santos Limited = 1.986

Rm = 2.32% (as per workings in Santos Limited excel file)

CAPM             = 3.65% + 1.986*(2.32%-3.65%)

= 4.306%

SOUTH32 Limited

Rf                    = 3.65% (as per Bloomberg record for 10-year Australian Government Bond)

The Beta of SOUTH32 Limited = 1.133

Rm                  = 1.144%

CAPM             = 3.65% + 1.133*(1.144%-3.65%)

= 0.811%