Nike Inc. - Cost of Capital

In: Business and Management

Submitted By Natrix2003
Words 1377
Pages 6
What is he WACC and why is it so important to estimate a firms 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 a proper overall price, they must be multiplied with their respective single prices. What is crucial in the calculation process is that one must not omit the tax shield effect caused by debt. Which is, due to fiscal regulations, that all interest expenses which occur in the financing process are tax deductible and, hence, reduce the overall result. This circumstance is mathematically reflected by inserting the term (1-tc). Tc here stands for the corporate tax rate, which, as in the NIKE case, needs adjustment for any taxes imposed by particular states. So if a company faces 38% corporate tax rate the remaining part of 62% count as an expense. Again, as there is a direct relationship to the proportion of the debt and its cost, the higher the tax rate the higher the tax payments and the lower the actual expenses for debt, this term is linked by multiplication to its adjacent terms. The complete WACC formula is given by the following:
WACC = (1-tc) cd + ce
The resulting figure from WACC is a rate which is used to valuate companies by discounting their expected future free cash flows. Moreover it can be used to assess projects. The…...

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