What is WACC and why it is important to estimate a firm's cost of capital? Do you agree with Joanna Cohan's WACC calculation? What is WACC and why it is important? Do you agree with Joanna Cohan's WACC calculation?
WACC (Weighted average cost of capital) is the minimum return that a company must earn on existing asset base on satisfy its creditors, owners and other providers of capital
WACC is important to estimate a firm's cost of capital because:
The cost of capital is the rate of return required by a capital provider in exchange for foregoing an investment in another project or business with similar risk. Thus, it is also known as an opportunity cost
WACC is the minimum return required by capital providers, so that managers should invest only in projects that generate returns in excess of WACC
WACC is set by the investors, not by managers.
We cannot observe the true WACC, we can only estimate it.
We do not agree with Joanna Cohan's WACC calculation because she used much information irrelevant to apply in the WACC. And we introduce our method for Nike's WACC in the following part.
Calculate WACC for Nike.
The formula below is used to calculate the Weighted Average Cost of Capital (WACC):
WACC = Debt/(Debt + Equity) x after Tax Cost of Debt + Equity/(Debt + Equity) x Cost of Equity
We are going to find each component of the WACC formula.
Determining the proportion of each source of capital:
We use market value for weighting Nike's equity.
Market value of equity = current share price x share outstanding (data in Exhibit 2)
= $42.09 x 271.5 million shares = 11,427.44 million $