Calculating Wacc
1. Cohen calculated Nike’s weighted average cost of capital (WACC) to be 8.3%. I find error in this calculation as a result of the following points of disagreement: a) Weighting of Capital Structure: Use of book values of capital rather than the market values b) Cost of Debt Calculation: Incorrect method for calculating debt c) Tax Rate: Use of a tax rate derived from the summation of state and statutory taxes instead of the firm's marginal tax rate
2. Revised Calculation of WACC:
WACC reflects the weighted average cost of the various sources of invested capital: WACC = Kd (1 – t) Wd + Ke We + Kp Wp
Where:
Kd (Wd), Ke (We) and Kp (Wp) are the costs (weights) associated, respectively, with the firm’s interest bearing debt, common equity and preferred stock.
Classification of redeemable preference shares as either debt or equity varies between different regions based upon the different standards they adopt. Given Nike is a U.S. firm, American standards will be followed. Thus, redeemable preference shares have been assumed debt components. WACC is therefore simplified to: WACC = Kd (1 - t) Wd + Ke We a) Cost of Debt (Kd):
To calculate Nike's Kd, Cohen simply divides total interest expense for the year by the average debt balance. Concern over this method lies in the possibility that the interest expense line, incorporates expenses not directly related to the company’s debt. A more appropriate measure for the cost of debt should include the current market yield on Nike's publicly traded debt.
In recalculating WACC, YTM on Nike's current bonds is used as a proxy to estimate Kd. This method is justified via the satisfaction of two conditions: a) the firm has issued debt in the past and b) the bonds issued were publicly traded. Having met these criteria, it is assumed that the rate paid by Nike on its current bonds, is an accurate measure of the firm's current credit risk as represented in the market. Thus, (refer to Appendix 2a. for
2. Revised Calculation of WACC:
WACC reflects the weighted average cost of the various sources of invested capital: WACC = Kd (1 – t) Wd + Ke We + Kp Wp
Where:
Kd (Wd), Ke (We) and Kp (Wp) are the costs (weights) associated, respectively, with the firm’s interest bearing debt, common equity and preferred stock.
Classification of redeemable preference shares as either debt or equity varies between different regions based upon the different standards they adopt. Given Nike is a U.S. firm, American standards will be followed. Thus, redeemable preference shares have been assumed debt components. WACC is therefore simplified to: WACC = Kd (1 - t) Wd + Ke We a) Cost of Debt (Kd):
To calculate Nike's Kd, Cohen simply divides total interest expense for the year by the average debt balance. Concern over this method lies in the possibility that the interest expense line, incorporates expenses not directly related to the company’s debt. A more appropriate measure for the cost of debt should include the current market yield on Nike's publicly traded debt.
In recalculating WACC, YTM on Nike's current bonds is used as a proxy to estimate Kd. This method is justified via the satisfaction of two conditions: a) the firm has issued debt in the past and b) the bonds issued were publicly traded. Having met these criteria, it is assumed that the rate paid by Nike on its current bonds, is an accurate measure of the firm's current credit risk as represented in the market. Thus, (refer to Appendix 2a. for