Capital Asset Pricing Model and Nike Sample Essay

Joanna began her computation of Nike’s WACC by happening the necessary weights of debt and equity to be used. To get down. Joanna found Nike’s debt by uniting the book values of current long-run debt. notes collectible. and long-run debt. which were all found on Nike’s balance sheet. The values were $ 5. 4 million. $ 855. 3 million. and $ 435. 9 million severally. This computation gave Nike a entire debt of $ 1. 296. 9 million. To happen Nike’s equity. Joanna used the book value of entire shareholders’ equity which was besides found on the balance sheet. The value was $ 3. 494. 5 million. Therefore. Joanna found Nike’s debt plus equity to be $ 4. 791. 4 million. Dividing the values for debt and equity each by $ 4. 791. 4 million gave Joanna the weights to be used in the WACC expression. Debt was weighted as 27 % and equity as 73 % .

Joanna so proceeded to cipher Nike’s costs of debt and equity. She found Nike’s cost of debt by spliting entire involvement disbursal. which was found on the income statement. by her old computation for debt. Nike’s entire involvement disbursal was $ 58. 7 million. so their cost of debt was found to be 4. 3 % . Joanna used a revenue enhancement rate of 38 % in her computations. doing Nike’s cost of debt after revenue enhancement to be 2. 7 % . Joanna decided to utilize the CAPM theoretical account in her computation of Nike’s cost of equity. She used the riskless rate of 5. 74 % on a 20-year Treasury bond. the geometric mean for market hazard premium from 1929 to 1999 which was 5. 9 % . and Nike’s mean beta from 1996 to 2001. which was 0. 80 to do her computations. Using these values. she obtained a cost of equity of 10. 5 % . Joanna so took the weights and costs of debt and equity that she found and calculated Nike’s WACC to be 8. 4 % .

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Joanna made several mistakes in her computation of Nike’s WACC. To get down. she used book values when happening Nike’s debt and equity instead than market values. If markets are efficient. market values will be present value of hard currency flows. Book values. on the other manus. stand for historical cost. Therefore. market values appear to be a superior footing for developing weights ( Seitz. Ellison 556 ) .

For untraded bonds or for long-run debt non in the signifier of marketable securities. the market value can be estimated by happening the present value of staying chief and involvement payments. discounted at the output to adulthood ( Seitz. Ellison 557 ) .

The market value of common stock is the value of the common stockholders’ entire claims. which equals the figure of portions outstanding. multiplied by the market monetary value per portion ( Seitz. Ellison 557 ) .

Using the values given sing Nike’s publically traded debt. the analysis found the output to adulthood to be 7. 13 % . The values used in this computation were: a present value of $ 416. 7 million. a voucher rate of 6. 75 % semi-annually. a clip period of 25 old ages. and a future value of $ 435. 9 million. By dismissing long-run debt of $ 435. 9 million by the output to adulthood. a value of $ 406. 9 million was obtained. Uniting this value with the current long-run debt and notes collectible gave a entire debt for Nike of $ 1. 267. 6 million. as compared to Joanna’s computation of $ 1. 296. 6 million. Nike had 271. 5 million portions outstanding and was selling at a portion monetary value of $ 42. 09. Therefore. utilizing the proper computation for market value of equity. the analysis found Nike’s equity to be $ 11. 427. 4 million. whereas Joanna found a sum of $ 3. 494. 5 million. Using these values of Nike’s debt and equity. debt plus equity was found to be $ 12. 695 million. By spliting the proper values for debt and equity by this value. the analysis found the weights for debt and equity to be 10 % and 90 % severally.

Joanna’s usage of entire involvement disbursal divided by debt as a step of Nike’s cost of debt is wrong.

Interest disbursal and floatation costs are tax-deductible disbursals in that they cut down nonexempt income. Therefore. the after revenue enhancement cost of bing debt ( kd ) is about: kd = YTM ( 1 revenue enhancement rate ) where YTM is the output to adulthood ( effectual involvement rate ) on bing debt ( Seitz. Ellison 548 ) .

By utilizing the right expression for after revenue enhancement cost of debt. the analysis found Nike’s cost of debt to be 4. 4 % . Joanna’s computation was 2. 7 % .
Although the dividend growing theoretical account and the net incomes output theoretical account were besides
available to Joanna for her usage in ciphering Nike’s cost of equity. the analysis concluded that her determination to utilize the CAPM theoretical account was sound due to the CAPM’s ability to be used in about all state of affairss.

Cost of debt

The dividend growing theoretical account analysis began with an ascertained monetary value and last year’s dividend. so the lone point hard to gauge is the dividend growing rate. If dividends have grown steadily in the past and there is ground to believe that form will go on. the historical growing rate can be used as g. Unfortunately. historical dividend growing is rarely that steady ( Seitz. Ellison 551 ) .

A job with the net incomes output theoretical account is that it is based on accounting income instead than hard currency flow. Furthermore. it is based on net incomes per portion for a past period while the stock monetary value reflects investors’ outlooks of future public presentation ( Seitz. Ellison 552 ) .

The mean-variance capital plus pricing theoretical account attack differs from the cost of equity attacks antecedently discussed in that it focuses on market returns for investings of similar hazard instead than investor response to a peculiar security. Therefore. it can be used when net incomes and dividends are unstable and when the stock is non publically traded so there is no market monetary value ( Seitz. Ellison 552 ) .

The analysis besides found that Joanna’s determination to utilize the geometric mean of market hazard premium. 5. 9 % . instead than the arithmetic mean was right every bit good due to the geometric mean’s inclusion of growing. which is a existent universe happening. doing geometric mean a better representation of existent public presentation.

In finance. the geometric mean is associated with rates of return and represents the expected long-term growing rate of money. given repeated investings with the same chance distribution of returns ( Seitz. Ellison 353 ) .

Joanna used the rate on a 20-year Treasury bond of 5. 74 % for her computations. This was found by the analysis to be acceptable as Nike’s publically traded long-run debt matures in a similar sum of clip. 25 old ages. Joanna’s usage of the mean beta for Nike. 0. 80. was incorrect. Nike’s beta had fluctuated throughout the old ages used in happening the norm and was really volatile. runing from 0. 63 to 0. 98. A better step to utilize would hold been the most recent beta of 0. 69. By utilizing the CAPM theoretical account and the same measurings for riskless rate and market hazard premium that Joanna used in her computations. and by utilizing the recent beta of 0. 69 instead than the norm of 0. 80. Nike’s cost of equity was found by the analysis is be 9. 8 % . Joanna’s computation was 10. 5 % . Using the new computations for Nike’s weights and costs of debt and equity the analysis found Nike’s WACC to be 9. 3 % as compared to Joanna’s determination of 8. 4 % .

Kimi Ford’s discounted hard currency flow statement used a price reduction rate of 12 % and found an equity value per portion of $ 37. 27. doing Nike overvalued at its current monetary value of $ 42. 09. By replacing the price reduction rate of 12 % with the WACC of 9. 27 % . the analysis found an equity value per portion of $ 55. 66. This means that at a portion monetary value of $ 42. 09 and a price reduction rate of 9. 3 % . the analysis found Nike to be undervalued.


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