Cost of Capital Essay

1. WACC is used for discounting cash flows in the future, thus all the modules of represent must reflect firms future abilities in raising nifty. Cohen made the mistake of victimisation the historical data in estimating the greet of debt yet the share price has changed considerably over time. The securities industry value of equity should be used instead of book value. 2. Cohen augurs the damage of debt by taking add up interest expense for the year 2001 and dividing it by the companys average debt balance.This is an estimate of the true cost of debt, but is inaccurate and may not reflect Nikes current or future cost of debt. 3. Cohen obtained the corporate tax rate of 38% which is used to calculate the adjusted cost of debt by adding separate taxes of 3% to the U. S. statutory tax rate 35%. In WACC calculation, marginal tax rate should be used as a corporate tax rate for the future estimate. We can use revert to Maturity (YTM) on 20-year Nike Inc. Bond issued in1996 of 6. 75% Cost of Equity The 20-year old U. S.treasury used by Cohen for a short-term investment of NorthPoint for the short-term 3 months to 1 year yields is more suitable. Given the unhazardous rate (Rf) of 5. 74%, the market risk premium (Rm-Rf) of 5. 90% and beta value of 0. 80, we can calculate the cost of equity using the CAPM as follows Cost of equity = Rf + ? *(Rm-Rf) = 5. 75%+0. 80(5. 90%) = 10. 46% Weighted Average Cost of Capital (WACC) We calculate the WACC of Nike Inc. using the weights and costs of debt and equity using the avocation formula WACC = Wd Kd(1-T) + We Ke.= 10. 05% x 7. 5 %( 1-38%) + 10. 46% x 89. 95% = 0. 4682% + 9. 4083% = 9. 8765% The weighted average cost of capital for Nike Inc. is approximately 10% percent. Recommendation Given the stock price at WACC of approx. 10% ,stock price should be greater than $50. 92, which is higher than current stock price $42. 09. This shows that the current stock of Nike is undervalued and is discounted rate of 11. 17%. Cohens WACC of 8. 4% of the stock was undervalued compared to 10%. Therefore Kim Ford should invest in the Nike for her mutual fund.