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Business Analysis

992 words - 4 pages

The Weighted Average Cost of Capital is the average of the costs of a company's sources of financing-debt and equity, each of which is weighted by its respective use in the given situation. By taking a weighted average, it shows how much interest the company has to pay for every marginal dollar it finances. A firm's WACC is the overall required return on the firm as a whole and, it is often used internally by company directors to determine the economic feasibility of expansionary opportunities and mergers. Also, WACC is the appropriate discount rate to use in stock valuation.
No, I don’t agree with Cohen’s WACC calculation. The cost of debt was determined incorrectly. To determine the cost ...view middle of the document...

My calculations for Nike's yield to maturity based on the given data showed that Kd= 7.16%

Calculation: (Values inserted in financial calculator)

PV: -95.6
FV: 100
n: 40
Pmt: 6.75/2= 3.375 (as it pays semiannually) → i* = 3.5813 semiannually, so, I/Y=(i*) * 2 →
i: 7.1627% = YTM= Kd= 7.16%

The second variable that should be noted is T or the tax rate. In her calculations, Joanna Cohen added the 3% state taxes to the 35% statutory tax where in WACC calculation the marginal rate should be used. The marginal tax rate generally refers to the "federal income tax that is levied onto the additional dollar earned" and usually is about 40%.
For the weights of the costs, Joanna Cohen used the book values of debt and equity where the market values are suggested as they provide more accurate results. For debt, the book value gives a close estimation for the current value, whereas the same doesn't hold for the value of equity. Thus, debt is equal to $1,296.6m (current portion of L-T debt + notes payable + L-T debt). In finding the weights, the previous explanation shows that equity is 88.65% whereas debt is 11.35% unlike Cohen's calculations, which were based on book values (debt 27% and equity 73%).

To calculate the cost of equity (Ke), I used the Capital Asset Pricing Model:
Ke=Krf+ β(Km-Krf)c2,

Ke is the cost of equity, β is beta ,Km is the required return of the market, Krf is the risk free rate and (Km - Krf) is the market risk premium.

-For the Krf (risk free rate), we used the current yield on 10yr bond (5.39) U.S. treasuries.
-For the market risk premium, I used the arithmetic mean (7.5%) of historic...

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