Cost of Capital Essay

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1. WACC is used for dismissing hard currency flows in the hereafter. therefore all the faculties of cost must reflect firm’s hereafter abilities in raising capital. Cohen made the error of utilizing the historical information in gauging the cost of debt yet the portion monetary value has changed well over clip. The market value of equity should be used alternatively of book value. 2. Cohen calculates the cost of debt by taking entire involvement disbursal for the twelvemonth 2001 and spliting it by the company’s mean debt balance.

This is an estimation of the true cost of debt. but is inaccurate and may non reflect Nike’s current or future cost of debt. 3. Cohen obtained the corporate revenue enhancement rate of 38 % which is used to cipher the adjusted cost of debt by adding province revenue enhancements of 3 % to the U. S. statutory revenue enhancement rate 35 % . In WACC computation. fringy revenue enhancement rate should be used as a corporate revenue enhancement rate for the future estimation. We can utilize Output to Maturity ( YTM ) on 20-year Nike Inc. Bond issued in1996 of 6. 75 % Cost of Equity The 20-year old U. S.

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exchequer used by Cohen for a short-run investing of NorthPoint for the short-run 3 months to 1 twelvemonth outputs is more suited. Given the riskless rate ( Rf ) of 5. 74 % . the market hazard premium ( Rm-Rf ) of 5. 90 % and beta value of 0. 80. we can cipher the cost of equity utilizing the CAPM as follows: Cost of equity = Rf + ? * ( Rm-Rf ) = 5. 75 % +0. 80 ( 5. 90 % ) = 10. 46 % Leaden Average Cost of Capital ( WACC ) We calculate the WACC of Nike Inc. utilizing the weights and costs of debt and equity utilizing the undermentioned expression WACC = Wd Kd ( 1-T ) + We Ke.

= 10. 05 % ten 7. 5 % ( 1-38 % ) + 10. 46 % ten 89. 95 % = 0. 4682 % + 9. 4083 % = 9. 8765 % The leaden mean cost of capital for Nike Inc. is about 10 % per centum. Recommendation Given the stock monetary value at WACC of approx. 10 % . stock monetary value should be greater than $ 50. 92. which is higher than current stock monetary value $ 42. 09. This shows that the current stock of Nike is undervalued and is discounted rate of 11. 17 % . Cohen’s WACC of 8. 4 % of the stock was undervalued compared to 10 % . Therefore Kim Ford should put in the Nike for her common fund.

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