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Determining the current cost of capital

The cost of capital is the weighted average of the required rates of return on equity and debt. The cost of equity is determined using the Capital Asset Pricing Model (CAPM).

This model uses the yield on long-term risk-free Bunds, increased by the risk premium attaching to investments in the equity market. The risk premium comprises a general market risk and a specific business risk.

The general risk premium, which reflects the general risk of a capital investment in the equity market and is oriented on the Morgan Stanley Capital International (MSCI) World Index, was raised from 5.0% to 5.5% due to the increased uncertainty currently to be seen in the capital market.

Since 2010, the specific business risk – price fluctuations in Volkswagen preferred shares – has been modeled when calculating the beta factor in comparison to the MSCI World Index.

The switch in benchmark index from the DAX to the MSCI World Index was necessary because Volkswagen shares experienced considerable price fluctuations in 2008 and 2009, and the share class in the DAX was changed to preferred shares in 2010. The MSCI World Index sets a standard that reflects a global capital market benchmark for investors.

The analysis period for the beta factor calculation spans five years with annual beta figures on a daily basis and an average subsequently being calculated. A beta factor of 1.09 was determined for 2011 (previous year: 0.99).

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COST OF CAPITAL AFTER TAX AUTOMOTIVE DIVISION

 

 

 

 

%

 

2011

 

2010

Risk-free rate

 

2.7

 

3.0

MSCI World Index market risk premium

 

5.5

 

5.0

Volkswagen-specific risk premium

 

0.5

 

–0.1

(Volkswagen beta factor)

 

(1.09)

 

(0.99)

Cost of equity after tax

 

8.7

 

7.9

Cost of debt

 

5.2

 

4.3

Tax

 

–1.5

 

–1.3

Cost of debt after tax

 

3.6

 

3.0

Proportion of equity

 

66.7

 

66.7

Proportion of debt

 

33.3

 

33.3

Cost of capital after tax

 

7.0

 

6.3

The cost of debt is based on the average yield for long-term debt. As borrowing costs are tax-deductible, the cost of debt is adjusted to account for the tax rate of 30%.

A weighting on the basis of a fixed ratio for the fair values of equity and debt gives an effective cost of capital for the Automotive Division of 7.0% (6.3%) for 2011.

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