Cost of Equity for Nike Using Both the CAPM

2021-05-28 16:37:38
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Vanderbilt University
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Capital Asset Pricing Model refer to the financial model aided to evaluate the expected returns on assets as well as the systematic risk attached to the returns CITATION Che16 \l 1033 (Chen, 2016). Nike cost of Equity is calculated as follows based on the CAPM model;

Calculate the costs of equity using CAPM, the dividend discount model, and the earnings capitalization ratio. What are the advantages and disadvantages of each method?

Formula utilized in calculation of CAPM

Re = R + Credit Risk Rate (1-t)

D = refer to the companys Long Term Debt

E = Current Stock Price multiplied by the Number of Outstanding Shares

rm = refer to the Market Risk Rate

rf = refer to the Risk Free Rate

CAPM Re = rf + b (rm rf)

Figures provided in the case study

36% = Tax Rate

7.50% = Market Risk Rate

3.59% = Risk Free Rate

0.69= Beta, b

435.9= Debt, D

Equity and value calculation based on Nikes case

Equity, E = 42.09 x 271,500,000 = 11,427.4

Value, V = 435.9 + 11,427.4 = 11863.3

Cost of Equity based CAPM Model is arrived at as follows

CAPM Formula Re = rf + b (rm rf)

= 3.59 % + 0.69 (7.5% - 3.59%)

= 3.59 % +0.69 (3.91)

= 3.59 % + 2.697%

Re = 6.2879%

Cost of Equity based on Dividend Discount Model:

Figures provided in the case study

P0 = $42.09

Div1 = 0.48

g = 5.50%

DDM Formula: r = Div1/P0 + g

= 0.48/42.09 + .055

= 0.0114 + 0.055

= 0.0664 X 100

Re = 6.64%

Question 2 WACC

Calculation of WACC

Solving for Rd since Re and Tax Rate are provided

Tax Rate = 36%

Re = 6.2879%

Cost of Debt

N = 40

PMT = (6.75/2) = 3.38

PV = -95.6

FV = 100

I/Y = 3.584 x 2 = 7.1674%

Rd = 2 x I/Y = 7.17%

Formula WACC = rd(1-T) x (D/V) + re x (E/V)

=7.1674% (1 36%) x (435.9/11,863.3) + 6.288% x (11,427.4/11,863.3)

= 7.1674% (64%) x (.0367) + 6.288% x (.9633)

= 0.0017 + .06057

= 0.06227 x 100

WACC = 6.23%

Weighted Average Cost of Capital (WACC) is a merged financial measure of the companys overall capital cost which is is encompasses various components that includes the required rate of return for every capital such as preferred stock, common stock and debt CITATION Gar16 \l 1033 (Garcia, 2016). The WACC gives the minimum return rate that the company expects to earn for every capital investments. Thus estimating the cost of Nikes capital provide the management accounting the company benchmark of analyzing capital budgeting decisions CITATION Fra16 \l 1033 (Frank, 2016).

References

BIBLIOGRAPHY Chen, J. M. (2016). The Practical Implications of a Spatially Bifurcated Four-Moment Capital Asset Pricing Model. In Postmodern Portfolio Theory. Palgrave Macmillan US.

Frank, M. Z. (2016). Investment and the weighted average cost of capital. Journal of Financial Economics, 119(2), 300-315.

Garcia, C. S. (2016). The weighted average cost of capital over the lifecycle of the firm: is the overinvestment problem of mature firms intensified by a higher WACC?

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