NIKE CASE STUDY QUESTIONS
NIKE CASE STUDY
1. Why is it important to estimate a firm’s cost of capital? What does it represent? Is the WACC set by investors or by managers?
Weighted average cost of capital or WACC represents the overall cost of capital in the company. It takes into considerations cost of debt and cost of equity. As company’s value can grow by increasing its assets that could be financed either be debt or equity and cost of capital shows how much it costs to do that. Cost of capital is a very important component in financial management decision-making as it shows the rate of return investors require when they invest in the company. Cost of capital is widely used in capital budgeting as projects with IRR lower than WACC should be abandoned otherwise company will destroy its own value. Cost of capital helps evaluate the performance of key people in the company as stock price and value of the company grows if the right projects were undertaken. WACC helps decide on methods of financing as it puts pressure on top managers to reduce the cost of capital. Using cost of capital, investor can decide if company’s stock is undervalued, overvalued or priced correctly and make very important decisions as the result as to buy, sell or hold shares of a particular company. WACC is set by the investors or markets, but not by managers. As market is the place where supply means demand, investor requires particular return for a certain risk and that is why WACC can only be estimated. WACC calculations are very sensitive to the small changes in assumptions of its formula.
2. What is your estimate of Nike’s WACC? What mistakes to Joanna Cohen make in her analysis? Which method is best for calculating the cost of equity?
I think that Joanna Cohen makes several mistakes while calculating Nike’s WACC. First mistake is her calculation of debt which should be measured according to the market value, not the book value. Joanna calculated debt using the book values of current portion of long-term debt,
1. Why is it important to estimate a firm’s cost of capital? What does it represent? Is the WACC set by investors or by managers?
Weighted average cost of capital or WACC represents the overall cost of capital in the company. It takes into considerations cost of debt and cost of equity. As company’s value can grow by increasing its assets that could be financed either be debt or equity and cost of capital shows how much it costs to do that. Cost of capital is a very important component in financial management decision-making as it shows the rate of return investors require when they invest in the company. Cost of capital is widely used in capital budgeting as projects with IRR lower than WACC should be abandoned otherwise company will destroy its own value. Cost of capital helps evaluate the performance of key people in the company as stock price and value of the company grows if the right projects were undertaken. WACC helps decide on methods of financing as it puts pressure on top managers to reduce the cost of capital. Using cost of capital, investor can decide if company’s stock is undervalued, overvalued or priced correctly and make very important decisions as the result as to buy, sell or hold shares of a particular company. WACC is set by the investors or markets, but not by managers. As market is the place where supply means demand, investor requires particular return for a certain risk and that is why WACC can only be estimated. WACC calculations are very sensitive to the small changes in assumptions of its formula.
2. What is your estimate of Nike’s WACC? What mistakes to Joanna Cohen make in her analysis? Which method is best for calculating the cost of equity?
I think that Joanna Cohen makes several mistakes while calculating Nike’s WACC. First mistake is her calculation of debt which should be measured according to the market value, not the book value. Joanna calculated debt using the book values of current portion of long-term debt,