Essay About Average Cost Of Capital And Minimum Return

Nike Management Case Study
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INTRODUCTION
Background:
Kimi Ford, a portfolio manager of a large mutual fund management firm, is looking into the viability of
investing in the stocks of Nike for the fund that she manages. Ford should base her decision on data on
the company which were disclosed in the 2001 fiscal reports. While Nike management addressed several
issues that are causing the decrease in market sales and prices of stocks, management presented its plans
to improve and perform better. Third party sources also gave their opinions on whether the stock was a
sound investment.
The weighted average cost of capital (WACC) is the rate (expressed as a percentage, like interest) that a
company is expected to pay to debt holders (cost of debt) and shareholders (cost of equity) to finance its
assets. It is the minimum return that a company must earn on existing asset base to satisfy its creditors,
owners, and other providers of capital. Companies raise money from a number of sources: common
equity, preferred equity, straight debt, convertible debt, exchangeable debt, warrants, and options, pension
liabilities, executive stock options, governmental subsidies, and so on. Different securities are expected to
generate different returns. WACC is calculated taking into account the relative weights of each
component of the capital structure- debt and equity, and is used to see if the investment is worthwhile to
undertake.
Management always takes notice of the cost of capital while taking a financial decision. The concept is
quite relevant in the following managerial decisions and hence its importance:
(1) Capital Budgeting Decision. Cost of capital may be used as the measuring road for adopting an
investment proposal. The firm, naturally, will choose the project which gives a satisfactory return on
investment which would in no case be less than the cost of capital incurred for its financing. In various
methods of capital budgeting, cost of capital is the key factor in deciding the project out of various
proposals pending before the management. It measures the financial performance and determines the
acceptability