Nike Wacc free essay sample

The definition of WACC Weighted average cost of capital(WACC), is a weighted-computational method of analyzing the cost of capital based on the whole capital structure of a firm. The result of WACC is the rate a firm use to monitor the application of the current assets because it represents the return the firm MUST get. For example this rate could be used as the discount rate of evaluating an investment, and maintaining the price of firm’s stock. . 2 Analysis of Johanna Cohen’s calculation We analyzed the process of Johanna Cohen’s calculation, and found some flaws we believe caused computational mistakes. i. When using the WACC method, the book value of bond is available as the market value since bonds are not quite active in the market, but the book value of equity isn’t. Instead of Johanna’s using equity’s book value, we should multiply the current price of Nike’s stock price by the numbers of shares outstanding. We will write a custom essay sample on Nike Wacc or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page ii. When calculating the YTM of the firm’s bond, Johanna only used the interest expense of the year divided by the average debt balance, which fully ignored the discounted cash flow of the cost of debt. 2. If you do not agree with Cohen’s analysis, calculate your own WACC for Nike and be prepared to justify your assumptions. Combining the analysis above, we now give our own WACC calculation as following. What are the advantages and disadvantages of each method? 3. 1 Calculating the costs of equity by CAPM, and its advantages amp; disadvantages i. Calculation: According to 2. 4, we have already got the result of CAPM, which is 10. 46%. ii. Advantages First, because CAPM is a theory based on the whole market, it obviously includes the effects between the market as the integrity and each individual stock. Second, with the counterbalance among each stock in the entire market, CAPM only needs the consideration of systematic risk, which much simplifies the calculation. Third, CAPM also bypasses the specific values of future cash flow because the equation is actually the relation between systematic risk and return rate, which is also another simplification of calculating. Fourth, merely depending on the systematic risk, CAPM could offer the investors a reliable discounting rate to assess the value of a certain investment. iii. Disadvantages: First, involving the counterbalance among the entire market, CAPM acquiesces an effective, active and healthy market environment. Second, comparing the consideration of market risk, CAPM may omit the subtle risk differences among each single firm. Third, the crucial systematic risk, the beta coefficient, is obviously hard to calculate. 3. 2 Calculating the costs of equity by DDM, and its advantages amp; disadvantages i. Calculation (based on EXIHIBIT 4):: Based on the dividend discount model, P0 = D0 * (1+g) / (k – g), then we get the return rate (the cost of equity) k = D0 * (1+g) / P0 + g = 0. 48 * (1 + 0. 055) / 42. 09 + 0. 055 = 6. 7% ii. Advantages First, DDM fully considers the time value of consistent cash flow of an investment. Second, it is pretty easy to get the necessary historical data. Third DDM is flexible enough for the adjustment of any future situation. Fourth, once the growth pattern is confirmed, it is very straightforward to get the discount rate of assessing an investment. iii. Disadvantages First, without enough consideration of risk cost, DDM may underestimate the equity cost. Second, all of the data is based on historical record, so the result is not reliable considering of the future situations. Third, with the predetermined growth rate, it is obviously practical for the stock investors to estimate the possible profit, but may mislead the stock issuing firm from a better budgeting decision to a comparatively unsubstantial investment. 3. 3 Calculating the costs of equity by the earnings capitalization ratio, and its advantages amp; disadvantages i. Calculation (based on EXIHIBIT 1amp;4) According to the earnings capitalization model, we have cost of equity = E1 / P0 = 2. 16 / 42. 09 = 5. 13% ii. Advantages First, it’s very easy to calculate and understand. Second, it’s easy to get the necessary accounting data iii. Disadvantages Without any consideration of the risk and the growth of the firm, it doesn’t reflect the true value of an investment or the cost of the budgeting at all. 4. What should Kimi Ford recommend regarding an investment in Nike? According to EXIHIBIT 2, the market’s forecasting sensitivity of equity value of Nike is 11. 17%. But based on our own analysis by WACC, we believe the discount rate of Nike is around 9. 85%. That means the market underestimated the value of Nike. So we recommend the Northpoint to purchase the stock of Nike.