•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. WACC CALCULATION:
Cost of Capital Calculations: Nike Inc
Cohen calculated a weighted average cost of capital (WACC) of 8.3 percent by using the capital asset pricing model (CAPM) for Nike Inc. I do not agree with her figure, and the reasons to that are as follows: Value of equity
The problem with Cohen’s calculations is that she used the book value for both debt and equity. While the book value of debt is accepted as an estimate of market value, book value of equity should not be used when calculating cost of capital. The market value of equity is found by multiplying the stock price of Nike Inc. by the number of shares outstanding. Market Value of Equity(E) Calculation:
E = Stock Price X Number of Shares Outstanding = $42.09 X 271.5 = $11,427.44 This figure is much different than the book value of equity that Joanna Cohen used ($3,494.50). Value of Debt
Market value of debt should be used in the calculation of the cost of debt contrary to a book value used by Cohen. She should have discounted the value of long-term debt that appears on the balance sheet. The market value of debt is found by adding the current portion of long-term debt, notes payable, and long- term debt discounted at Nike’s current coupon. Market Value of Debt D = Current LT + Notes Payable + LT Debt (discounted) = $5.40 + $855.30 + $416.72
Using these figures, we can now find the market value of Nike Inc., and the company’s capital structure. Weights
The weights of debt and equity are calculated using the market values of debt and equity as follows: Weight of Debt(WD)
WD = D/D+E = $1,277.42 / $12,704.86 = 10.05%
Weight of Equity (WE) D +E
WE = E/ D +E = $11,427.44 / $12,704.86 = 8 9. 9 5 %
Cost of Debt and Equity
The next issue at hand is finding the correct costs of debt and equity in order to find an accurate calculation of WACC. Cohen used the 20-year yield on U.S. Treasuries as the risk free rate, which was a correct figure given that Nike Inc. debt was valued over 25 years. Because there is no other given yield that is comparable to a 25-year valuation period, my risk free rate used in calculations is 5.74 percent. The geometric mean is a better estimate for longer life valuation while the arithmetic mean is better for a one-year estimated expected return. Therefore, I chose to use the geometric mean to coincide with the choice to use the 20-year yield on U.S. Treasuries, which is 5.9 percent. Next is to decide on a beta to use for Nike Inc. for use in the CAPM approach. The logical choice was to use the average (0.80) to account for the large fluctuations seen in Nike’s historic betas. From here, we calculate the cost of debt and equity. Cost of debt was calculated by finding the yield to maturity on 20-year Nike Inc. debt with a 6.75% coupon semi-annually. I assumed Nike Inc. to have a single cost of capital since its multiple business segments (shoes, apparel, sports equipment, etc.) are not very different and would experience similar risks and betas. Cost of Debt KD = YTM on 20 Year Nike Inc. Bond = 7.51%
The cost of equity was calculated as follows:
Cost of Equity(KE) =Rf + β(Rf - Rm) = Rf + Beta*(MRP) = 10.46% Rf = 5.74% 20 Yr Yield on US Treasuries, MRP = 5.90%Geometric Mean, Beta= 0.8 Average Nike Beta Weighted Average Cost of Capital (WACC) for Nike Inc.
CAPM was found to be more superior to other methods of calculating cost of...