Question

Importance of Cost of Capital: Why is cost of capital important to NIKE Inc. and what does it measure?

o Meaning of Calculations: How does NIKE Inc.calculate various costs, and what do these calculations mean to business?

Answer 1

Cost of capital is basically the minimum rate of return which is required/expected by the shareholders/investors of the company. By knowing the minimum rate of return, it becomes easier for the company to evaluate whether to undertake various projects by comparing the rate of return with cost of capital.

Hence cost of capital becomes very important for a company like NIKE Inc. Nike can use it to determine whether to launch a new set of product series such as Nike Air by comparing the projected returns of such product over a period of next 5 years with the cost of capital. Cost of capital becomes very important for managerial decision making for various fields such as decisions on capital budgeting, designing the capital structure of the company or evaluating the performance of top management.

A company like NIKE Inc. calculates various costs based on the data recorded in the underlying the ERP used by it which is ultimately converted into financial statements consisting of various components such as Balance sheet, Income statement etc. Cost is generally expressly shown in the income statement divided into various heads such as cost of goods sold, administrative and selling expenses etc.

Calculating these costs is very important for the business. Cost cutting, reduction and controlling costs is essential for the future growth and success of the company. For this it is very important for the company to measure its current costs and take steps for keeping it in control in the future. The company can only calculate its profits and financial performance by calculating the costs first. Costs are also used in numerous financial ratios to evaluate the performance and profitability of the company.