Nike Case

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?

The weighted average cost of capital (WACC) is the minimum return that a company must earn on an existing asset base to satisfy its creditors, owners, and other providers of capital, or they will invest elsewhere. Companies raise money from a number of sources:

• common equity;

• preferred equity;

• Debt.

The cost of capital will be different for each source of capital and class of securities a company has, reflecting the different risks. The WACC is the weighted average of the costs of each of the different types of capital. The weights are proportion of the company's capital that comes from each source.

Importance of cost of capital:

• Capital Budgeting Decisions

• Capital Structure Decisions

• Prospective Rate for Investment for Investors.

We do not agree with Cohen’s´ calculations except the tax rate. The following are our assumptions vs. her.

• We have taken the market value of equity and debt whereas Cohen takes the book value.

• We discounted the long term debt to calculate the total debt value. It is discounted by the average of the Bonds yield.

• We take the current data rather then the historical data which Cohen has used.

• The beta value is 0.69 which is the year to date 2001 value rather than the historical average which Cohen used was 0.80.

• The CAPM was used to calculate Ke.

If you do not agree with Cohen’s analysis, calculate your own WACC for Nike and justify your assumptions.

WACC= Kd(1-t)*(D/D+E)+Ke*(E/D+E)

Where,

Kd= Cost of Debt, T= Tax Rate, D=Total Debt, E=Total Equity, Ke=Cost of Equity

Based on our Assumptions we have recalculated every element of the inputs to determine the Weighted Average Cost of Capital.

Cost of Debt (Kd)

In the data given Cohen makes a mistake by calculating the cost of debt by using the historic data. Here we have to find the Kd by using...