Nike, Inc.: Cost of Capital - QUESTIONS 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? The cost of capital is rate of return required by a capital provider in exchange foregoing an investment in another project, assets or business with similar risk.
Look at the results in Table 1. In general, what is the order of risk for the four risky asset classes? What happens to the reward-to-risk ratio for the different asset classes as the holding period increases? Is this pattern consistent with the change in the optimal allocations for Small Stocks as the holding period increases (shown in Table 2)? Explain.
In particular, is Midland’s choice of market risk premium appropriate, and if not, what recommendations would you make and why? 3. Should Midland use a single corporate hurdle rate (i.e. a firm-wide WACC) for evaluating investment opportunities in all of its divisions? Why or why not?
INTRODUCTION This essay will discuss the concept of real options and their application in the capital budgeting exercise. We will describe a real option and its valuation using commonly used pricing formulae. We will then try and estimate project uncertainty, also known as volatility. Once we’ve estimated volatility we will demonstrate obtaining this estimate using ASX listed company, the Coca Cola Amatil Group. REAL OPTIONS AND THEIR INCORPORATION WITHIN CAPITAL BUDGETING A real option is a form of derivative, similar to a forward contract, but with a couple of important differences.
Determine the major supporting points that will help in solving the above. I think the real issues here will be resolved by making the assumptions made when plugging in for these equations reasonable. Are Nike’s managers’ estimates of growth reasonable, or are their trends indicating decline more reasonable to use? In addition, what discount rate should be used? What are their costs associated with Equity vs Debt.
Key Questions Which of the two methods should Baz emphasize in the client meetings? Should he emphasize one over the other at all? If he didn’t how could he best explain the apparent difference in the results of the two methods? Analysis For more sophisticated analysis, first we decompose the ERP into common and model-specific variables. Common variables include current share price and riskless long-term real yield that are observed in the market.
This section would focus on the possible cons of adopting IFRS in the U.S. faced by the same group of people discussed above. The auditors will have to make changes to the reports from the previous years for the comparative purposes. The public companies would have to bear a heavy monetary cost of transition from the U.S. GAAP standards to IFRS. It may affect the prices of the stocks of these companies, which in turn would be faced by the investors. This can affect the growth of the company.
ABC is a method of evaluating the cost of providing products and services by activity. Under this method cost is evaluated by dividing a firm into operational sectors and conducting interviews or issuing survey to gather information needed to see how much it cost to provide a product or service. Once the information is gathered and evaluated it provides a substantiated accurate cost for producing a product. I do not agree with Chuck, and I feel that he should have inquired about the current job costing method. A comparison of the two methods would provide a course of action for examining the firm loss of market share problem.
1. Cost of Capital Pratt and Grabowski (2010) defined cost of capital is the expected rate of return required by the managers in order to seeking additional funds for a particular investment. It measures the total costs to finance an investment through a combination of debt and equity taking into account different financial risks. There are several reasons why estimating the cost of capital is vital for the management of the company. First of all, cost of capital forces managers to reconsider the capital structure in order to discover the better approach to raise finances.
Identify the needs of the stakeholders in this case study. The needs of the taxpayers would be that they would rely on income and financial support from having an investment in the business. In this case the taxpayers own 83% of RBS and 41% of Lloyds demanding for an increase in the value of their investment. Tax payers may withdraw their share of the company if the actual or projected financial return is no longer profitable for them. Identify the possible causes of conflict which may arise in this situation.