Case 15

1. Why is it important to determine the cost of capital for a firm?

Cost of capital is the cost of money the firm uses for financing. So it is beneficial to know how much a company is spending and how that will affect other aspects, and it’s important to have an overall rate of return on your assets that is higher than the cost of capital, that way value is not ruined. Also, if a firm doesn’t earn cost of capital then they’re destroying shareholders wealth and vice versa.

2. Is it investors or managers who determine the cost of capital?

Cost of capital is determined and calculated by investors when figuring out whether or not to invest in a firm, and finding out the overall cost of money to firm. Generally, a manager will listen in and give his or her opinion and leave the decision up to a board of investors who ultimately determine what to do.

3. What is the WACC for Nike?

Debt after taxes = YTM * (1- TR) .0675 * (1 - .38) = 4.185

I used 6.75% because that is the current yield to maturity on Nike debt and multiplying it by 1 minus the tax rate of 38% taking into account that the state varied about 2%

Equity = Rf + B(Rm – Rf) .0574 + 1 (.059) = 11.64

I used 5.74 because it is the current yield on U.S. treasuries (20 year) plus beta which we can assume to be 1 (Beta is usually closer to one so for it to be .69 as estimated is on the low side), times the geometric mean of 5.9%

Market Value Debt = 1,786.70 / 5,281.20 = .3383

Equity = 3,494.50 / 5,281.20 = .6617

I used the 2001 values given on the balance sheet for debt and equity, added them and then divided each by the sum

WACC = .3383 * 4.185 + .6617 * 11.64 = 9.118%

From that point I plugged in the numbers for debt and equity into the WACC formula then found the percent to be 9.118

4. What mistakes did Joanna Cohen make in her analysis?

A mistake that Joanna Cohen made when doing her analysis was taking historical data for calculations when the WACC is the...