...Executive summary In this report we focus on Nike's Inc. Cost of Capital and its financialimportance for the company and future investors. The management of NikeInc. addresses issues both on top-line growth and operating performance. The company's cost of capital is a critical element in such decisions and it isimportant to estimate precisely the weighted average cost of capital (WACC). In our analysis, we examine why WACC is important in decision making andwe show how WACC for Nike Inc. is calculated correctly. Also, we calculatethe company's cost of equity using three different models: the Capital AssetPricing Model (CAPM), the Dividend Discount Model (DDM) and the EarningsCapitalization Model (EPS/ Price), we analyze their advantages anddisadvantages and finally we conclude whether or not an investment in Nikeis recommended. Our analysis suggests that Nike Inc.'s common stock should be added to theNorth Point Group's Mutual Fund Portfolio. I. The Weighted Average Cost of Capital and its Importance for Nike Inc. The Weighted Average Cost of Capital (WACC) is the average of the costs of a company's sources of financing-debt and equity, each of which is weightedby its respective use in the given situation. By taking a weighted average,we can see how much interest the company has to pay for every marginaldollar it finances. A firm's WACC is the overall required return on the firm asa whole and, as such, it is often used internally by company directors todetermine the economic...
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...WACC What does Weighted Average Cost Of Capital (WACC) mean? A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation. All else equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk. The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing: Where: Re = cost of equity Rd = cost of debt E = market value of the firm's equity D = market value of the firm's debt V = E + D E/V = percentage of financing that is equity D/V = percentage of financing that is debt Tc = corporate tax rate Businesses often discount cash flows at WACC to determine the Net Present Value (NPV) of a project, using the formula: NPV = Present Value (PV) of the Cash Flows discounted at WACC. Investopedia explains Weighted Average Cost Of Capital (WACC) Broadly speaking, a company’s assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it finances. A firm's WACC is the overall required return on the firm as a whole and, as such...
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...Midland Energy Resource Report for Cost of Capital October 16, 2014 Abstraction General Analysis of Midland Energy Resources Cost of Debt • • • • Consolidated Company Exploration & Production Refining and Marketing Petrochemicals Cost of Equity Equity market risk premium of 5% is reasonable. According to the Exhibit 6, the U.S. stock return minus Treasury bond yields for each period varies. Since each period has different standard error, it will be better to take the weighted average of the data, then EMRP is approximately 5.9% or lets say 6.0%. Comparing to the EMRP that Midland would use in the calculation of WACC which is 5%, the historical data reflects a higher EMRP. But from the market risk premium survey results, we see that finance professors, CFOs and fund managers advocate a lower rate on risk premium. Because these people have better understanding in the performance of the market and be more aware of how economics works, then the analysis from them should be taken into great consideration. Therefore, 6.0% from the past data balanced with some lower rates that suggested by bankers, auditors as well as Wall Street analysts, 5% should be appropriate. Weighted Average Cost of Capital WACC = λ(1 − t)KD + (1 − λ)KE The Effect of Leverage on the Cost of Equity and WACC Cost of Equity The relation between cost of equity and leverage can be shown as follows: βEquity = 1 βU (1 − λ) Asset Cost of Equity = Risk Free Rate + βEquity × (Risk Premium) We further illustrate...
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...“Calculate and make a recommendation on how Telus should employ their cost of capital." Introduction: In introducing this case the basic problem do be solved deals with determining the cost of capital within the organization of Telus. Barb Williams and Rick Thomas both managers from service firms, were attending a business seminar when given an assignment to calculate the cost of capital for Telus. They were given basic data including balance sheets, income statement, data on Telus common stock, market index, and average annual returns in North America capital markets. This information was given to them in order to calculate the cost of capital within the company and to make a recommendation on how to employ their cost of Capital. In order to determine the actual cost of capital, various steps need to be taken in finding out cost of debt, equity, preferred shares in order to determine the overall weighted average cost of capital (WACC) within the company. What is WACC? Weighted average cost of Capital is defined as a calculation of a firm’s cost of capital in which each category of capital is properly weighted. All capital resources are used in determining this cost which includes common stock, preferred stock, bonds and any other long term debt. Calculating overall WACC. Use of short and Long term debt When calculating the cost of debt for this case, it is necessary to take into account both the long and short term components of Telus’ financing via debt...
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...The Cost of Capital Teresa Cortez Keith Gemmell Brandon Papsidero Robin Reschke October 28, 2013 Table of Contents 1. Are the four components of Marriott’s financial strategy consistent with its growth objective? ...................................................................................................................... 1 2. How does Marriott use its estimate of its cost of capital? Does this make sense? ...... 3 3. What is the weighted average cost of capital for Marriott Corporation? ..................... 4 4. What type of investments would you value using Marriott’s WACC? ........................ 6 5. If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time? ......... 7 6. What is the cost of capital for the lodging and restaurant divisions of Marriott? ........ 8 7. What is the cost of capital for Marriott’s contract services division? How can you estimate its equity costs without publicly traded comparable companies? ................ 11 APPENDIX I – Math Utilized to Derive WACC for Marriott .......................................... 13 APPENDIX II – Math Utilized to Derive WACC for Divisions...
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...Financial Management Weighted Average Cost of Capital 1 Weighted Average Cost of Capital (WACC) • This lecture answers the following questions: - What is the “opportunity” cost of funds for a firm, and thus the firm’s discount rate used in NPV calculations? - What is a firm’s Asset Beta & how do we lever Asset Betas and unlever Equity Betas? - Link to previous lectures - No longer use a “given” discount rate. We will calculate the correct discount rate for our NPV calculations. WACC - 1 2 1.0 The Cost of Capital: Some Preliminaries • A. Required (rate of) Return versus Cost of Capital • Cost of capital - required return - appropriate discount rate all denote the same opportunity cost of using capital in one way as opposed to an alternative investment in the financial market having the same systematic risk. – required return: is from an investor's point of view – cost of capital: is the same return from the firm's point of view – appropriate discount rate: is the same return yet again to be used in a present value calculation WACC - 2 3 B. Required (rate of) Return • COMBINING BOTH INVESTORS’ AND FIRMS’ PERSPECTIVES: • A FIRMS COST OF CAPITAL OR DISCOUNT RATE IS GIVEN BY INVESTORS REQUIRED RATE OF RETURN. • RETURN TO INVESTMENT DECISION!! • NPV of a project is dependent on: • (1) EXPECTED CASH FLOWS • (2) RISK WACC - 3 4 3 Determinants of Required (Rate of) Return • What are investors’ concerned with? (and thus firms should also be concerned...
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...Chemical’s weighted average cost of capital (WACC). Note: round to the nearest whole number. Discuss the theory used by Clarkson to determine Cape Chemical’s optimum target capital structure (30% debt and 70% equity). Cape Chemical’s weighted average cost of capital (WACC) is 15%. Cape Chemical’s optimum target capital structure theory, used by Clarkson, is considered a systematic approach to funding business activities. Furthermore, the traditional capital structure theory aims to minimize WACC, while also maximizing the firm’s value. As a result, Clarkson chose the capital structure which would yield a lower WACC for Cape Chemical. This produced a lower cost of debt capital and a higher cost of equity capital. Moreover, the cost of debt is lower because it holds less risk since debt payments are more definitive than equity payments. With debt payments, Cape Chemical would only have to worry about principal and interest payments, whereas, the dividends and stock appreciation that comes with equity payments are less definitive and have more risk (Ross, 2015). Overall, capital budgeting is useful because it...
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...2016. Deliverable The Weighted Average Cost of Capital I choose Costco Corporation, which is an American based company that sells a variety of merchandise. The company is also a wholesale company and it supplies its products and services to various countries despite the United States of America. The company is traded on NASDAQ with ticker symbol COST. As at 2015, the company had revenue worth US $ 116.553 billion, operating income worth US $ 3.62 billion, total assets worth US $ 33.44 billion, total equity worth US $ 10.61 billion, and 117,000 employees. According to yahoo finance, Costco Corporation had short-term debt of $ 1,283,000, long-term debt of $ 4,864,000 giving a total debt of $ 6,147,000, and shareholder’s equity worth $ 10,617,000 as at 2015. It is also evident that the company had an interest expense of $ 124,000 as at that year. The market capitalization of the selected company is $ 65.32 billion with a beta of 0.84. In this report, I will consider a risk premium of 4 percent and a risk-free rate of 1.83 percent. Weighted Average Cost of Capital is the calculation of an organization’s cost of capital in relation to its weight. These sources of capital include preference shares, common stock, and debt whether short term or long term. It is used as a discounting rate to calculate the profitability of a project using a technique like Net Present Value approach. To calculate the Weighted Average Cost of Capital, we use the formula below: ...
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...arriott Corporation: The Cost of Capital (Abridged) Executive Summary: The case "Marriott Corporation: The Cost of Capital (Abridged)" focuses on an ideal opportunity to review the capital asset pricing model and the weighted average cost of capital through calculation of the cost of capital for Marriott as a whole. Dan Cohrs is faced with making recommendations for the hurdle rates at Marriott Corporation and its three divisions utilizing CAPM and WACC. This case illustrates how to calculate beta based on comparable companies and to lever betas to adjust for capital structure; the appropriate risk-less rate and market risk premium; the choice of time period to estimate expected returns and the difference between the geometric and the arithmetic average as a measure of expected returns. SYNOPSIS Marriott Corporation began in 1927, and over the next 60 years, the company grew into one of the leading lodging and food service companies in the US. In 1987, the Marriott's annual report stated, "We intend to remain a premier growth company. Our goal is to be the preferred employer and provider, and the most profitable company". Marriott's profits were $223 million on sales of $6.5 billion. In April 1988, vice president of project finance at the Marriott Corporation, Dan Cohrs, must prepare annual recommendations for the hurdle rates at each of the firm's three divisions, including restaurant, lodging, and contract services, as well as...
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...Naomi Stanford The look on Subway Finance and Investment Co. Subway Franchising The company I chose is Subway. I chose this because majority of my clients own subway franchises and I think it is a good company to determine the WACC and the return on equity. I a lot of my clients repeatedly open new subway locations and I ask myself, is the return on the franchise investment worth it? When I receive the accounting work for my subway locations from my client, I notice that the expenses that they pay out every month is the same across the board. I also notice the amount of cash that they acquire throughout the month to cover the expenses. It’s not a lot but apparently it is covering the expenses and also it is covering their home expenses. So it makes me stop and think, what is the weighted average cost of capital for opening a Subway franchise and how much return will they receive on the investment made in a subway franchise. History on Subway The first store was opened in August of 1965. A goal was set to have 32 stores open in 10 years by two men, Peter Buck and Fred Deluca. With an investment of $1000, these two men took owned and operated 16 submarine sandwich shops throughout Connecticut. They began franchising, launching the Subway brand into a period of remarkable growth which continues to this day. The brand of Subway grew very large to about 37, 000 locations around the world and becoming the people choice for seeking quick, nutritious meals that the whole family...
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...Corporation to Demonstrate the Optimal Capital Structure Trade-off Theory John C. Gardner, Carl B. McGowan Jr., and Susan E. Moeller1 ABSTRACT In this paper, we apply the trade-off theory of capital structure to Microsoft. We use data for bond ratings, bond risk premiums, and levered CAPM betas to compute the cost of equity and the weighted average cost of capital for Microsoft at different debt levels. This study shows the impact of increasing financial leverage on WACC. As financial leverage increases, the WACC decreases until the optimal debt ratio is reached, after which, the WACC begins to rise. At this debt ratio, the value of Microsoft will be maximized. Our results indicate the optimal debt ratio for Microsoft is 37.5 percent. Introduction One of the most difficult concepts for finance students to learn and for faculty to teach is how a firm determines its optimal capital structure. While most corporate finance textbooks stress the importance of maximizing the value of the firm by minimizing its opportunity cost of capital, how a firm can actually achieve the appropriate debt–to–capital ratio is often a mystery. Brigham and Ehrhardt (2008) in Financial Management: Theory and Practice outline a framework that can be used by financial practitioners to determine a firm’s optimal capital structure. Modigliani and Miller (1958 and 1963) provide the basis for the trade-off theory which is how firms can conceptually determine their optimal capital structure. What is lacking in these...
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...How to calculate the Weighted Average Cost of Capital (WACC) from financial statement By waccawacca, eHow Member User-Submitted Article A firm's WACC (Weighted Average Cost of Capital) reflects the average 'cost' for a firm to raise capital. The WACC is one of the most fundamental economic measures of a company, as all typical investment projects undertaken by the firm should earn a return AT LEAST as high as the firm's WACC. Otherwise, the firm is destroying value. This eHow will summarize the WACC formula, and then step you through how to find all of the 'component' variables you will need to plug in the formula. If you want to skip the algebra, the website at http://thatswacc.com will calculate the WACC for you. The formula for WACC is: WACC = rD (1- Tc )*( D / V )+ rE *( E /V) Instructions Things You'll Need: • • • The firm's stock ticker symbol (to find financial statements and the firm's Beta) The 'risk free' rate of return The historical returns of the stock market 1. Get the Firm's INCOME STATEMENT Data: From the income statement, copy down the following values: a) INTEREST EXPENSE b) INCOME BEFORE TAX c) INCOME TAX EXPENSE 2. Get the Firm's BALANCE SHEET Data: From the Balance Sheet, copy down the following values: a) SHORT/CURRENT LONG TERM DEBT b) LONG TERM DEBT 3. 3 Find the firm's stock market Beta and current market capitalization: Note: A firm's 'Beta' is a measure of correlation between the stock returns of the firm compared to the 'broader' market...
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...billion and $42.2 billion respectively. Among these three divisions, E&P was Midland’s most profitable business, R&M was Midland’s largest business, and Petrochemical was Midland’s smallest yet still substantial business. In 2007, Midland’s financial strategy will mainly focuses on four aspects: 1) Fund Overseas Growth; 2) Value-creating Investments; 3) Optimize Capital Structure; 4) Repurchase undervalued stocks. Fund Overseas Growth: Due to the exploited domestic resources in the domestic market, overseas investment will be the main sources for economic growth in Midland as a form of specialized financial and contractual arrangements similar to project financing, all of which are valued in dollars. Value-creating Investments: Discounted Cash Flow (DCF) methods, involving debt-free cash flows and a hurdle rate equal to or derived from the WACC for the project of division, are typically used to evaluate most prospective investment, yet for overseas projects are evaluated as streams of future equity cash flows and discounted as a rate based on the cost of equity. Optimize Capital Structure: Midland optimized its capital structure by carefully exploring the borrowing capacity inherent in its energy reserves and in long-lived productive assets such as refining facilities, and based on the annual operating cash flow and collateral value of its identifiable assets, each division has its own target debt ratio. Repurchase undervalued stocks: Possibilities to repurchase its own shares...
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...Midland, its capital planning model and Janet Mortensen's role in the case. Midland Energy Resource, Inc. has three major divisions: Exploration & Production (E&P), Refining and Market (R&M), and Petrochemicals. E&P division provides the most profit for Midland. R&M is the largest division in Midland by revenue. Petrochemicals is the smallest division in Midland. Midland’s financial strategy in 2007 consisted of four principals: funding significant overseas growth, investing in value-creating projects, optimizing corporate capital structure, and repurchasing undervalue shares. Janet Mortensen, senior analyst reporting to CFO, takes role of estimating Midland’s cost of capital for various analyses, both corporate and division level, throughout the company. Her main method is using Weighted Average Cost of Capital (WACC) formula to evaluate required Cost of Capital estimate. 2. Briefly explain the meaning of the following concepts: cost of capital, WACC, and CAPM. Cost of Capital: the minimum acceptable rate of return for new investments in the corporation. The opportunity cost of investing. WACC: Weighted Average Cost of Capital, a calculation of company’s cost of capital, which is seemed as composite cost of debt and equity. Every category of capital in WACC is proportionally weighted. CAPM: Capital Asset Pricing Model, a theory representing the financial market behavior. Used to estimate the cost of equity. 3. Address what you use “cost of capital”...
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...Nike, Inc.: COST OF CAPITAL CASE ANALYSIS Importance of Cost of Capital The concept of cost of capital is used in finance decisions. Acceptance or rejection of an investment project depends on the cost that the company has to pay for financing it. Good financial management calls for selection of such projects, which are expected to earn returns, which are higher than the cost of capital. It is therefore, important for the finance manager to calculate the cost of capital, which the company has to pay and compare it with the rate of return, which the project is expected to earn. In capital expenditure decisions, finance managers go on accepting projects arranged in descending order of rate of return. The manager stops at the point where the cost of capital equals to the rate of return offered by the project. That is, the finance manager finds out the break-even point of the project. Accepting any project beyond the break-even point will cause financial loss for the company. The cost of capital is a guideline for determining the optimum capital structure of a company. Weighted Average Cost of Capital The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is the minimum return that a company must earn on an existing asset base to satisfy its creditors, owners, and other providers of capital. A company's assets are financed by either...
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