Nike Case Study

838 WordsJul 25, 20144 Pages
Case Study: Nike 1. What is the WACC and 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 weighted average cost of capital is the maximum rate of return a firm must earn on its investment so that the market value of company's shares will not drop. This is consistent with the firm's overall objective of maximizing wealth. WACC is a calculation of a firm's cost of capital; each category of capital is equally weighted. All capital sources; common stock, preferred stock, bonds and any other long-term debt, are included in a WACC calculation. Everything being equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC means a decrease in valuation and a higher risk. A firms WACC is a very important both to the stock market for stock valuation purposes and to the company's management for capital budgeting purposes. In an analysis of a potential investment by the company, investment projects that have an expected return that is greater than the company's WACC will generate additional free cash flow and create positive NPV for stockholders. Since the WACC is the minimum rate of return required, the managers in the company should invest in the projects that generate returns in excess of the WACC. WACC is set by the investors (or markets), not by managers. Therefore, we cannot know the true WACC, we can only estimate it. 2. Do you agree with Joanna Cohen’s WACC calculation? Why or why not? If you do not agree with Cohen’s analysis, calculate your own WACC for Nike and be prepared to justify your assumptions (compare yours with Cohen’s) • For the costs of equity, calculate using CAPM, the dividend discount model, and the earnings capitalization ratio. What are the advantages and disadvantages of each method? I do not agree with Cohen’s

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