Essay on Nike, Inc.: Cost of Capital
Nike has new investment endeavors revamp its recent drops in net income and market share. Wall Street analyst reactions to the endeavors are mixed, with some recommending Nike as a “Strong Buy” and others recommending a “Hold.” In case 13, Nike Inc.: Cost of Capital, I am acting as a portfolio manager to estimate Nike’s cost of capital to determine whether the stock is overvalued or undervalued.
II. Alternative Solutions
• Dividend Growth Model (DGM) see appendix for calculations
• Capital Asset Pricing Model (CAPM) see appendix for calculations
• Weighted Average Cost of Capital (WACC) see appendix for calculations
III. Analysis of the Alternatives
• Dividend Growth Model (DGM)
The Dividend growth …show more content…
In calculating my market risk premium I took the average of both the Geometric mean and the Arithmetic mean of the Historical Equity Risk Premiums (1926-1999) (Exhibit 4). The arithmetic mean is noted as the best estimator of expected return, while the geometric mean accurately portrays historical investment experience and has been noted to give a better estimate of expected returns over long periods of time. In estimating the cost of equity with risk adjustment, I used the current Beta Coefficient (.69) instead of the average. In much of corporate finance and valuation, our interest is in the beta looking forward and not the beta looking back. A regression beta, even if well estimated, reflects the firm as it existed over the period of the regression. If the firm has changed, some can argue that the beta looking forward will be different from the historical beta, which is why I used the most current.
Although CAPM accounts for risk, it requires estimates. The Beat coefficient (β) and market risk premium are estimated. If estimates are poorly made, the resulting cost of equity will be inaccurate.
• Weighted Average Cost of Capital (WACC)
The weighted average cost of capital accounts for both a company’s debt and equity positions. In analyzing the