Case: Nike Inc: Cost of Capital

Autor: Laurentiu Matei • February 25, 2019 • Case Study • 526 Words (3 Pages) • 525 Views

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Assignment 4

Case: Nike inc: Cost of Capital

1. What is the WACC and why is it important to estimate a firm’s cost of capital? Do you agree with Joanna Cohen’s WACC calculation? Why or why not?

The WACC according to Joanna is 8.4%. This is an important metric as it measures the burden a company has to taken on in order to borrow more money. The larger the burden the harder a company has to work in order to turn a profit. The hard a company has to work to turn a profit the less sustainable it is. Therefore it is a metric that measures the opportunity cost of using capital for one investment over the other. Therefore this is an important metric for investors as they must consider it for the viability of long term investment.

I disagree with Joanna’s calculation. The cost of debt is incorrect as you must consider an apples to apples case. The market yield on the same amount of debt must be compared. Furthermore the pre tax cost of debt should be calculated from the debt that is already by the firm. For instance.

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With these two piece of information we can piece together a more accurate picture of WACC

WACC = 7.17% x 27% + 10.5% x 73%

= 8.86%

2. If you do not agree with Cohen’s analysis, calculate your own WACC for Nike and be prepared to justify your assumptions.

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3. Calculate the costs of equity using CAPM, the dividend discount model, and the earnings capitalization ratio. What are the advantages and disadvantages of each method?

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CAPM
Advantages	Disadvantages
Takes systematic risk into consideration with a Beta being baked into cost of equity.	Beta is not so easily calculated or estimated as different investments have different criterion and risk.
The higher the Beta, the more potential for risk	CAPM tends to give a more accurate picture short term than long term.
Assists in diversifying unsystematic risk away	If a market is consistently changing CAPM model does not handle that well.

DDM
Advantages	Disadvantages
Market info used for variables are easily obtainable	Doesn’t consider risks
Valuation of shares are based on the forecast of what is to be paid to investors	Primarly relies on growth rate when calculating returns
Good way to determine the companys present value when in comes to shares.	Only useful for companies who pay out dividends.

4. What should Kimi Ford recommend regarding an investment in Nike?

Ford should firstly reconsider the numbers given by Joanna. Then once the correct WACC is provided she must compare to the Sensitivity chart:

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Since Nikes current share price is $42.09 then if a discount rate were to be below 11.17% then the share is undervalued. However if it were to be above then it would be over valued. Since the correct WACC was calculated to be 9.26% the share would seem to be undervalued. Therefore according to the Equity chart above and inline with our WACC the share should be valued between $55.68 and $61.25 per share. Furthermore, Ford should add Nike to the Portfolio based on the analysis discussed above.

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