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?
WACC is the weighted average cost of capital. It can be calculated as:
WACC = (Weight of funding source 1) x (Cost of funding source 1) + … + (Weight of funding source n) x (Cost of funding source n)
Usually this will be simply:
WACC = (Percentage of debt) x (Cost of debt) + (Percentage of equity) x (Cost of equity)
It is important to estimate a firm’s cost of capital for the appraisal of new projects; a project should only be undertaken if the return from it is greater than that of the capital required to fund it unless there are other compelling (strategic) reasons.
A firm should also be aware of it’s own cost of capital and try to minimise this.
We do not agree with Joann’s WACC calculation:
▪ Her funding source weightings are wrong
▪ There is an argument that all debt (including accounts payable etc) or net debt and a blended return on this should be used
▪ The debt figure will only ever be an estimate as the balance sheet is one day in the year
▪ Her analysis assumes Nike debt is trading at par – it is not
▪ Equity should be based on market value, not book value
▪ Hence total will be based on market cap., not balance sheet
▪ Her debt cost is wrong
▪ She should use the current or projected cost rather than a historic one
▪ i.e. use a Bloomberg terminal (other terminals are available) to research yields on debt of the same credit rating as Nike
▪ It is unlikely Nike has a cost of debt lower than T bills
▪ Raising debt in a foreign currency (Jap Yen) either carries an associated hedging cost or exposes the borrower to FX risk, hence the coupon rate on the notes is not the actual cost of the debt
▪ Her assumed tax rate is probably wrong, if a firm is paying
WACC is the weighted average cost of capital. It can be calculated as:
WACC = (Weight of funding source 1) x (Cost of funding source 1) + … + (Weight of funding source n) x (Cost of funding source n)
Usually this will be simply:
WACC = (Percentage of debt) x (Cost of debt) + (Percentage of equity) x (Cost of equity)
It is important to estimate a firm’s cost of capital for the appraisal of new projects; a project should only be undertaken if the return from it is greater than that of the capital required to fund it unless there are other compelling (strategic) reasons.
A firm should also be aware of it’s own cost of capital and try to minimise this.
We do not agree with Joann’s WACC calculation:
▪ Her funding source weightings are wrong
▪ There is an argument that all debt (including accounts payable etc) or net debt and a blended return on this should be used
▪ The debt figure will only ever be an estimate as the balance sheet is one day in the year
▪ Her analysis assumes Nike debt is trading at par – it is not
▪ Equity should be based on market value, not book value
▪ Hence total will be based on market cap., not balance sheet
▪ Her debt cost is wrong
▪ She should use the current or projected cost rather than a historic one
▪ i.e. use a Bloomberg terminal (other terminals are available) to research yields on debt of the same credit rating as Nike
▪ It is unlikely Nike has a cost of debt lower than T bills
▪ Raising debt in a foreign currency (Jap Yen) either carries an associated hedging cost or exposes the borrower to FX risk, hence the coupon rate on the notes is not the actual cost of the debt
▪ Her assumed tax rate is probably wrong, if a firm is paying
Bibliography: BREALEY, R.A. and MYERS, S.C. (2000) Principles of Corporate Finance. Sixth Edition. London: McGraw Hill BRIGHAM, E.F. and HOUSTON, J.F. (2009) Fundamentals of Financial Management. Twelfth Edition. Mason: Cengage