Capital is widely
Cost of capital is widely used in capital budgeting as projects with IR lower than WAC should be abandoned otherwise company will destroy its own value. Cost of capital helps evaluate the performance of key people in the company as stock price and value of the company grows if the right projects were undertaken. WAC helps decide on methods of financing as it puts pressure on top managers to reduce the cost of capital. Using cost of capital, Investor can decide If company’s stock Is undervalued, overvalued or priced correctly and make very
Important decisions as the result as to buy, sell or hold shares of a particular company. WAC Is set by the Investors or markets, but not by managers. As market Is the place where supply means demand, investor requires particular return for a certain risk and that is why WAC can only be estimated.
WAC calculations are very sensitive to the small changes in assumptions of its formula. 2. What is your estimate of Nine’s WAC? What mistakes to Joanna Cohen make in her analysis? Which method is best for calculating the cost of equity? I think that Joanna Cohen makes several stakes while calculating Nine’s WAC.
First mistake is her calculation of debt which should be measured according to the market value, not the book value. Joanna calculated debt using the book values of current portion of long-term debt, notes payable and long-term debt.
In order to calculate WAC correctly only long-term debt In the amount of 435,900,000 should be used. Nikkei, Like any big public company, grows using the long-term debt and In a long term It does not get much affected by the short-term borrowings. Assistant of Kim Ford incorrectly calculates the amount of equity as well.
She used the book value of 3,494. 5 million in her assumptions.
In my case, I calculated the total shareholders’ equity using the current market value estimates. I calculated it by multiplying the current stock price of $42. 09 by the number of current shares outstanding which is 271. 5 million. My equity value came up to 11,427,435,000.
Ms. Cohen also used incorrect beta of 0. 8 in her calculation. The most current beta should be used as it always changes. Instead of the most recent beta, she used average of all betas. In my calculations I used YET 6/30/01 beta of 0.
Joanna Cohen also incorrectly applied the 20-year bond rate of 5. 74% In her CAMP calculations. Corporate finance book highlights the proper way of using the short-term rate. Book states that one-year Treasury bill rate Is used the most frequently and I took I-year yield on U.
S. Treasuries In the amount of 3. 59% for my calculations. Joanna also decided to use the average of the effective tax rate in the amount AT 38%. I Delves Tanat ten latest under AT snow a De uses In ten calculations.
I used 36% in my calculations and believe they reflect the most current tax situation in the company.
The best method for calculating the cost of equity is considered to be CAMP method. This method was originally developed by Harry Margarita in 1952 and decade later was introduced by several economists including William Sharpe. The formula of CAMP calculations is: Cost of equity formula- = RFC Expected return on a security = risk-free rate + beta of the security x difference between expected return on market and risk-free rate. As I explained above the numbers for CAMP calculations are following: RFC = 3.
59% 0. 69 ARM = 7. 50% which is the arithmetic mean of historical equity (1926-1999).