Nike
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? Why is it important to estimate a firm’s cost of capital? What does it represent?
WACC = wd (1-T) rd + we re
wd = debt portion of value of corporation
T = tax rate
rd = cost of debt (rate)
we = equity portion of value of corporation
re = cost of internal equity (rate)
The weighted average cost of capital (WACC) is used in finance to measure a firm's cost of capital. This is used by many firms as a discount rate for financed projects, as the cost of financing. WACC is the return a firm must earn on existing assets to keep its stock price constant and satisfy its creditors and owners.
Corporations raise money from two main sources: equity and debt. Thus the capital structure of a firm comprises three main components: preferred equity, common equity and debt (typically bonds and notes). The WACC takes into account the relative weights of each component of the capital structure and presents the expected cost of new capital for a firm.
There are some changes that I would make to Joanna Cohen’s WACC calculation. They are the following:
wd = debt portion of value of corporation
Joanna used $1,296 million, this is from the book value.
I am using $1,244 million, which under best practices is the market value.
T = tax rate
Joanna used 38%, she obtained this from taking the 35% statutory rate and 3% from the state local tax.
I am using 36%, which is the effective tax rate in 2001.
rd = cost of debt (rate)
Joanna used 4.35% which is derived from the 20-year treasury bond.
I am using 7.1%, which is based on long-term debt.
we = equity portion of value of corporation
Joanna used $3,495, this is from the book value....
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