Nike, Inc.: COST OF CAPITAL
Importance of Cost of Capital
The concept of cost of capital is used in finance decisions.
Acceptance or rejection of an investment project depends on the cost that the company has to pay for financing it.
Good financial management calls for selection of such projects, which are expected to earn returns, which are higher than the cost of capital. It is therefore, important for the finance manager to calculate the cost of capital, which the company has to pay and compare it with the rate of return, which the project is expected to earn.
In capital expenditure decisions, finance managers go on accepting projects arranged in ...view middle of the document...
It is the appropriate discount rate to use for cash flows with risk that is similar to that of the overall firm.
It's important for a company to know its weighted average cost of capital as a way to gauge the expense of funding future projects.
Cost of Debt is the effective rate that a company pays on its current debt.
Cost of Equity is the return that stockholders require for a company.
Using Market Value for WACC
Market value weights are more practical because it reflects the expectations of the investors and market value closely reflects how a company has to raise new capital.
Analyzing Joanna Cohen’s WACC calculation I faced with some issues:
1. Should Joanna use single or multiple costs of capital?
The business segments of Nike basically have the same risk, thus, a single cost is sufficient for this analysis.
2. Should Joanna use book or market values for both debt and equity to calculate the Cost of Capital?
Book values reflect the cost of capital already spent. Market value estimates the cost of capital to be raised in the near future. Using the market value would be more appropriate because new projects are generally funded with newly – raised equity.
Market value of Equity = Stock price x Shares Outstanding
42.09 x 271.7
Market value of Equity is $11,435.85.
This figure is much different than the book value of equity $3,494.5 that Joanna used.
Market value of Debt = Current portion of long-term debt + Notes Payable + Long-term debt (discounted). The amount of $435.9 of long-term debt should be discounted at the coupon rate. Since it is paid semi-annually, and its payments are done on the 15th of every month, 6.75% must be modified for the next 4.5 months from January 15, 2001 until May 31, 2001, the date of the balance sheet.
So 6.75% x (4.5/6months) = 5%