We believe that many of the assumptions that she made were incorrect and somewhat altered the outcome of the WACC calculation. The first piece that we disagreed with was with Joanna’s estimation of the equity of the company. Joanna simply used the Total Shareholders Equity figure off the balance sheet of Exhibit #2. We feel that she undervalues the equity of the company by using this figure. In our calculation, we multiplied the shares outstanding by the current market price of the stock.
This is a good assumption when debt represents a fairly small fraction of the firm’s value. Questions: 1. How can the Capital Asset Pricing Model be used to estimate the cost of capital for a project (as opposed to a financial asset)? In particular, how can we apply the CAPM to estimate the cost of capital when we do not even know how the investment in the project will be financed (debt vs. equity)? (Here you think in terms of the risk of the project, or project beta, or asset beta).
3. a. What is the best estimate of Ace’s cost of debt? b. Should flotation costs be included in the component cost of debt calculation? Explain.
We calculated cost of equity using the CAPM method, where re = rf + B(EMRP) The case stated that the BBB+ rated bonds have an interest rate of 5.5%, or 125 bps over the current yield on 10 year US treasury bonds. Given that this is the only information in the case about any rate of return on treasuries, we used 5.5% - 1.25% = 4.25% for the risk free rate. The equity market risk premium is given as 5% To calculate beta, we took the equity betas given for comparable companies in exhibit 7 and unlevered them using their respective net debt to equity ratios and a tax rate of 40%. We took the average of those un-levered betas and re-levered them under the assumption of zero debt financing (essentially just leaving them unlevered as debt/equity is 0/1). Note - we excluded Agile Connections from our comparable set as it had negative net income and thus do not reflect the risk profile and operations of our company.
My evaluation of Nike’s share price is based on Joanna Cohen’s analysis. In the following paragraphs I am going to point out the mistakes that Joanna has made and also give my suggestions in the WACC calculation First of all, for as much as over 95% of Nike’s revenue comes from sports-related business, I do agree with Joanna’s assumption of single costs of capital. Although cost of capital of non-Nike branded product may different from its main sport business, it has a minor effect on the cost of capital of the company as a whole. However, I found that she has made a few mistakes in calculating debt and equity weights and cost of debt. Debt and Equity Weights The first mistake in Joanna’s calculation is that the weights of Nike’s debt and equity should be based on the market value rather than book value mixes of Nike’s debt and equity.
Assume that (i) if the trial proceeds it is expected to last less than a month and result in two possible outcomes in terms of the price per share established in court: the $273,000 claimed by the plaintiffs, or the $55,400 being defended by Herbert Kohler; (ii) Kohler estimates the probabilities of these outcomes at 30% and 70%, respectively. 5. How would your answer to question 4 change if you also assume that (i) the inheritance tax owed on Frederic Kohler’s estate was 50.2% of its holdings in Kohler Co. (equivalent to 489 shares of the 975 he owned); (ii) the taxes paid by the estate amounted to $27 million (489 shares at $55,400 each); (iii) were the settlement or the trial to result in a revised share price in excess of $55,400, the IRS would likely demand a similar valuation for its claim on Frederic’s estate; and (iv) Herbert Kohler estimates the probability of the IRS’s demand at 100% if he proceeds to trial, and 50% if he
This determines the point in which a profit begins to be turned. c. What deficiencies does payback have as a capital budgeting decision method? d. Does payback provide any useful information regarding capital budgeting decisions? e.
Theoretically, the weights should be based on market values, but if a firm’s book value weights are reasonably close to its market value weights, book value weights can be used as a proxy for market value weights. Consequently, target market value weights should be used in the WACC equation. 12- In general, failing to adjust for differences in risk would lead the firm to accept too many risky projects and reject too many safe ones. Over time, the firm would become more risky, its WACC would increase, and its shareholder value would suffer. The cost of capital for average-risk projects would be the firm’s cost of capital, 10%.
The total of the above vales gives us the total capital of the company $309.132 million + $2,975 million = $3,284. 132 million Wdebt = debt/ (debt + equity) = $309,132 million/$3,284. 132 million= 0.094 (9.4%) Wequity= equity/ (debt + equity) = $2,975 million/$3,284. 132 million= 0.906 (90.6%) QUESTION 2: What is WB’s before-tax cost of long-term debt? Firm has only two long term debt, which are specifically the two bonds issued.
Alternatively, Amram could issue a 20-year bond that is convertible into common equity, may be called, and has a sinking fund. Which of the following most accurately describes the coupon rate that Amram would have to pay on the second bond, the convertible, callable bond with the sinking fund, to have it sell initially at par? a. The coupon rate should be exactly equal to 6%. b.