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.
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 is it important to estimate a firm's cost of capital? What does it represent?
2. Calculate the costs of equity using CAPM and the dividend discount model. What are the advantages and disadvantages of each of these methods? Are they any other methods you could use?
3. What should Kimi Ford recommend regarding an investment in Nike? Is the price of Nike overpriced, underpriced, or fairly priced?
Corporate tax rate of 38%
20 year bond is 5.745
The arithmetic mean of 7.50% for Equity Risk Premium
Average Beta of 0.80
In our analysis, we examine why WACC is important in decision making and we show how WACC for Nike Inc. is calculated correctly. Also, we calculate the company's cost of equity using two different models: the Capital Asset Pricing Model (CAPM), and the Earnings Capitalization Model (EPS/ Price).
Computation of the Cost of Equity
The CAPM is a model for pricing an individual security (asset) or a portfolio. For individual security perspective, we made use of the security market line (SML) and its relation to expected return and systematic risk (beta) to show how the market must price individual securities in relation to their security risk class. The SML enables us to calculate the...