Cost of Capital
Kimi Ford, a portfolio manager of North Point Group 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. I. Objective
The objective of this report is to give recommendation for Kimi Ford whether North Point Group should invest on Nike or not. The recommendation is based of Nike’s Cost of Capital.
* Cost of Debt
Joanna mistakenly used the historical data in estimating the cost of debt. She divided the interest expenses by the average balance of debt to get 4.3% of before tax cost of debt. We believed the cost of debt should be estimated by yield to maturity of bond. We can calculate it by using data provided in exhibit 4. Calculation
Data input:PV = 95.60
FV = 100
n = 40
Pmt = 6.752 (as it pays semi annually)
By using spreadsheet we got before tax cost of debt = 3.58% (semiannual) or 7.16% (annual). Using 38% of tax rate we can calculate after tax cost of debt: After tax cost of debt= Before tax cost of debt x ( 1 – T)
= 7.16% (1 – 38%)
* Cost of Equity
We agree with Joanna’s decision to use CAPM to estimate the cost of equity because we considered CAPM approach has strong theoretical foundation. We used the current yield on 20-year Treasury bonds = 5.74% as risk free rate, the compound average premium of the market over treasury bonds = 5.9% as risk premium, and average of Nike Historic Beta = 0.8 as Beta. Calculation:
Cost of equity = 5.74% + 5.9% x 0.8...