Nike Cost of Capital
1. What is the WACC and why is it important to estimate a firm’s cost of capital? Do you agree with Joanna Cohen’s WACC calculation? Why or why not?
WACC- The weighted average cost of capital is the rate (percentage) that a company has to pay to its creditors and shareholders to finance assets. It is the “cost” of their worth. Companies raise money from many different types of securities and loans and the various required returns are what make up the cost of capital. WACC is used to decide if an investment is worth it or not based on the weights of debt and equity.
Why WACC is important * To decide what projects to accept or reject. Rate of return should be equal to or greater than company cost of capital * Knowing cost of debt and cost of equity helps a company determine how they should be structured and whether more financing should come from equity or debt
I do not agree with Cohen’s calculation for WACC. While some of her calculations were good, I think that there were some that she could have used different numbers and rates to come up with more accurate numbers.
WACC=(E/(D+E)) Ke + (D/(D+E)) Kd (1-t) 2. If you do not agree with Cohen’s analysis, calculate your own WACC for Nike and be prepared to justify your assumptions
Cost of debt-based on yield to maturity
PMT= 100(.0675)=6.75
N= 20 (2)=40
FV= 100
PV= 95.6
I/Y= computed on calculator=7.0832(semiannually)
7.0832(2)=14.166% annually
COST OF EQUITY
Cost of equity using CAPM
Ke =Rf + Beta(Rf-Rm)=Rf+Beta(MRP)
Steps in determining Ke using the CAPM 1. Market risk premium
Geometric (5.9) or arithmetic mean (7.5)?
I used the geometric mean. I think that it is a better method of valuation for investment purposes because it takes into account the fact that the numbers used are not independent of one another from year to year and do have an effect.
2. Multiply market risk premium by the beta
Beta choice- I think that the average beta (.8) makes the most sense
WACC- The weighted average cost of capital is the rate (percentage) that a company has to pay to its creditors and shareholders to finance assets. It is the “cost” of their worth. Companies raise money from many different types of securities and loans and the various required returns are what make up the cost of capital. WACC is used to decide if an investment is worth it or not based on the weights of debt and equity.
Why WACC is important * To decide what projects to accept or reject. Rate of return should be equal to or greater than company cost of capital * Knowing cost of debt and cost of equity helps a company determine how they should be structured and whether more financing should come from equity or debt
I do not agree with Cohen’s calculation for WACC. While some of her calculations were good, I think that there were some that she could have used different numbers and rates to come up with more accurate numbers.
WACC=(E/(D+E)) Ke + (D/(D+E)) Kd (1-t) 2. If you do not agree with Cohen’s analysis, calculate your own WACC for Nike and be prepared to justify your assumptions
Cost of debt-based on yield to maturity
PMT= 100(.0675)=6.75
N= 20 (2)=40
FV= 100
PV= 95.6
I/Y= computed on calculator=7.0832(semiannually)
7.0832(2)=14.166% annually
COST OF EQUITY
Cost of equity using CAPM
Ke =Rf + Beta(Rf-Rm)=Rf+Beta(MRP)
Steps in determining Ke using the CAPM 1. Market risk premium
Geometric (5.9) or arithmetic mean (7.5)?
I used the geometric mean. I think that it is a better method of valuation for investment purposes because it takes into account the fact that the numbers used are not independent of one another from year to year and do have an effect.
2. Multiply market risk premium by the beta
Beta choice- I think that the average beta (.8) makes the most sense