Kimi Ford, a portfolio manager of NorthPoint Large Cap fund is considering purchasing Nike’s stock. Nike’s report revealed a decline in sales growth, profits and market share. However, Nike had a strategy to revitalize the company. The strategy would address both top-line and operating performances by pushing its apparel lines and cutting down expenses. Analyst responded with mix signal to Nike new plan. Ford has done the discounted cash flow forecast, and Joanna Cohen estimated the cost of capital.
What is Weighted Average Cost of Capital and its Importance?
The weighted average cost of capital (WACC) is the rate that a company is expected to pay to debt holders and shareholders to finance its assets. It is …show more content…
Another error with Cohen’s calculation on the cost of equity. She used the book value for both debt and equity. Although the book value of debt can be used as an estimate of market value, the book value of equity should never be used when calculating the cost of capital.
To calculate the value of equity using market value:
Market Value of Equity
Equity (E): Stock Price x Number of Shares Outstanding E = $42.09 x 271.5 ( in millions) E = $11,427.44
III. Weights of Debt and Equity.
The market values of both debt and equity are used to calculate the weight of debt and equity.
Weight of Debt (Wd) = D / D+E
Weight of Equity (We) = E / E+D
Cost of Debt and Equity. * We agreed with Cohen using the 20-year Treasury bond as her risk-free rate. Since the longest rate available is the 20-year Treasury bond, our risk free rate used is 5.74%. * Since we’re using 20 year T-bonds, geometric mean of 5.9% would be the correct when estimate longer life valuation. * We don’t agree that Cohen should use the average beta of 0.8 to be the measure of systematic risk because Nike’s current goal is revitalized the company by focusing on increasing future revenue and gaining back market shares. As such, we suggest using the most recent beta, .89.
Calculating Cost of Debt (Kd):
Cost of Debt (Kd):
CPT I/Y: 3.57% x