Capital Asset Pricing Model and Nike

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Joanna began her calculation of Nike’s WACC by finding the necessary weights of debt and equity to be used. To begin, Joanna found Nike’s debt by combining the book values of current long-term debt, notes payable, and long-term debt, which were all found on Nike’s balance sheet. The values were $5.4 million, $855.3 million, and $435.9 million respectively. This calculation gave Nike a total debt of $1,296.9 million. To find Nike’s equity, Joanna used the book value of total shareholders’ equity which was also found on the balance sheet. The value was $3,494.5 million. Therefore, Joanna found Nike’s debt plus equity to be $4,791.4 million. Dividing the values for debt and equity each by $4,791.4 million gave Joanna the weights to be used in the WACC formula. Debt was weighted as 27% and equity as 73%.

Joanna then proceeded to calculate Nike’s costs of debt and equity. She found Nike’s cost of debt by dividing total interest expense, which was found on the income statement, by her previous calculation for debt. Nike’s total interest expense was $58.7 million, so their cost of debt was found to be 4.3%. Joanna used a tax rate of 38% in her calculations, making Nike’s cost of debt after tax to be 2.7%. Joanna decided to use the CAPM model in her calculation of Nike’s cost of equity. She used the risk-free rate of 5.74% on a 20-year Treasury bond, the geometric mean for market risk premium from 1929 to 1999 which was 5.9%, and Nike’s average beta from 1996 to 2001, which was 0.80 to make her calculations. Using these values, she obtained a cost of equity of 10.5%. Joanna then took the weights and costs of debt and equity that she found and calculated Nike’s WACC to be 8.4%.

Joanna made several errors in her calculation of Nike’s WACC. To begin, she used book values when finding Nike’s debt and equity rather than market values. If markets are efficient, market values will equal present value of cash flows. Book values, on the other hand, represent...
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