Essay on Nike Inc. - Cost of Capital
The WACC (weighted average cost of capital) is a percentage figure resulting from a calculation method by which the adequate cost of capital of a firm is expressed. It considers the composition of a company’s funding, be it debt or equity. A corporation whose source of funding is equity by 100 percent will have a WACC equal to the cost of equity. By contrast, a levered company will have to reflect the cost of debt as well. The WACC takes their respective quantitative contributions to the entire amount of funding, serving hence as an allocation base, into account. As there is a direct relationship between the two portions, debt and equity, in order to calculate …show more content…
Considering the application of the discounted free cash flow model in order to find out whether Nike’s stock is undervalued, the calculation of the WACC is in general a necessity since it is used to discount the free cash flows. As NIKE is funded by both equity and debt and no information is given about a potential future change in the debt-to-value-ratio we can therefore use the WACC formula, which Joanna correctly applied. Nevertheless there are several misgivings to be expressed.
- Single or Multiple Costs of Capital?
In the authors’ opinion calculating the single overall costs of capital of NIKE is the accurate method. The reason is that in case you calculate multiple costs of capital one would have to derive different WACCs belonging to each sub division and subsidiary. At this place the problem arises that divisions and also many subsidiaries usually did not issue own stocks or bonds as they might not be listed at the stock exchange (e.g. Bauer was a limited company at that time). Therefore you can compute neither a beta, nor a bond’s yield to maturity in order to get out the equity and debt costs of capital. Another reason is that the WACC itself reflects an overall number that takes into account the overall equity and debt costs of capital of NIKE. This in turn means that it is useless to calculate several sub-WACCs to merge them together thereafter. Furthermore Joanna is right when she says that the risk of the footwear and