The paper "Joanna Cohen’ s WAAC Calculation" is an outstanding example of a finance and accounting assignment. The weighted average of capital or WACC was found as 8.3% by Cohen. The method used was the capital asset pricing model or CAPM. There is disagreement on the method used by Cohen. The reason for that book value was used for both debt and equity. There is no harm in accepting the book value of debt as an estimate of market value. There is the harm in accepting the book value of equity when calculating the cost of capital.
The fact the company proposed for the study was a public company and the market capitalization would have been the ideal choice for calculating the equity than relying on the book value of equity. There will be disagreement on the cost of debt calculated. The interest expense is divided by the average balance of the interest-bearing debt and it has been found as an approximation of the true value of debt. The point is that interest expense may have included expenses that are not directly linked with the debt of the company. 2) Calculating our own estimate of WACC?
Justify your assumptions? Calculate the cost of equity using various methods? The first step is to find the market value of equity. It has to be found out by multiplying the stock price of Nike with the shares that are outstanding. Assume the stock price to be42.09 $ at the time of valuation and the shares outstanding to be 271.5. Multiplying both the values will give a value of 11427.435 which can be represented as $ 11,427.44. The figure that has been got will be much different than the figure got by Cohen.
Cohen got the figure as $ 3,494.50. The next step is to find the market value of debt. This has to be found out using the formula below The current value of long term debt + Notes Payable + Long Term debt discounted The Current value of long term debt =5.40 $ The Notes Payable=855.30$ The long term debt discounted=416.72$ The net figure by adding all these together will be 1277.42$. From the figure that has been calculated, the next step will be to find out the Market Value of the Company and the capital structure of the company. The weight of debt can be found as by using this formula The market value of the debt/(The market value of debt + The market value of equity) The market value of debt =1277.42$. The market value of equity=$ 11,427.44.
The figure is calculated as $ 1277.42/$12,704.86 and that is 10.05%. The weight of Equity will be calculated as follows The market value of the equity/(The market value of debt + The market value of equity) $ 11,427.44/$12,704.86 and that is 89.95%.
The correct cost of equity and debt should be calculated and the correct calculation of WACC. The debt of Nike Inc has been valued over 25 years and the risk-free calculation that has to be used is fixed at 5.74% which is assumed to be correct. The market risk premium has to be calculated. Geometric mean and arithmetic mean can be used as calculating medium and the assumption is that geometric mean is the ideal choice as the period calculated is a long period. The use of beta that has to be used in the CAPM approach has to be found.
The company has been found to have large fluctuations in the betas and based on that average figure of 0.80 was used. The average beta was found to be much better in this case by considering the fact it suits the historical business practices of the company better. If we had used YTD beta what we had done would be to reflect only on the current business practices without looking forward. The calculation of the cost of debt and equity was calculated and that was found to be the yield on maturity which was calculated on a 20-year debt and that was fixed at the value of 6.75 % coupon semi-annually.
The assumption behind this is that the company is following a single cost of capital though the company is following different business segments and the other assumption is that all divisions will be facing the same risks and betas.
“Dividend Discount Model”. viewed on May 10,2009, http://www.scribd.com/doc/5276747/ch13-Dividend-Discount-Models
“What are the advantages and disadvantages of the three methods used to estimate the cost of existing equity”,viewed on May 10,2009, http://www.blackwellpublishing.com/baker/chapters/Baker_Chapter10_Concept_Checks_07_26_05.doc.