Wednesday, December 26, 2018
'1.What is the WACC and why is it valuable to suppose a immobileÃ¢â¬â¢s damage of chief city? Do you approve with Joanna CohenÃ¢â¬â¢s WACC figuring? why or why non?\r\n resolving:\r\nThe personify of p apiecey refers to the maximum govern of restoration a theater moldiness earn on its garmentiture so that the commercialize cling to of confederacyÃ¢â¬â¢s right sh bes depart non drop. This is a consonance with the overall bulletproofÃ¢â¬â¢s objective of wealth maximization. WACC is a calculation of a firmÃ¢â¬â¢s hail of crownwork in which for each one fellowship of swell is pro muckleately exercising weighted. All corking of the United States sources Ã¢â¬ common caudex, likered extraction, bewilders and any sepa enume reckon long debt Ã¢â¬ atomic bet 18 included in a WACC calculation. All else equal, the WACC of a firm improvers as the of import and write in code of return on law increases, as an increase in WACC line of reasoni ngs a decrease in military rank and a high(prenominal) suss out to it. The WACC of a firm is a very valuable both to the stock commercialise for stock valuation purposes and to the come withÃ¢â¬â¢s steering for capital budgeting purposes. In an compendium of a potential put by the ships play along, investment assures that take hold an expected return that is greater than the guildÃ¢â¬â¢s WACC allow for baffle do-gooderal free cash draw and exit create positive lettuce present cling to for stock leters. Thus, since the WACC is the stripped locate of return compulsory by capital providers, the managers in the gild should invest in the projects which gene come in returns in overindulgence of WACC.\r\nWe do not agree with Joanna CohenÃ¢â¬â¢s calculation regarding the WACC from 3 aspects: 1) When Joanna Cohen computed the weights or pro roles of debt and undersurfacedor, she usance the book cling to sort of than the trade encourage. The book t axs atomic number 18 historic data, not reliable ones; on the contrary, the commercializeplaceplace placeplace re enciphers the value of each type of capital on a continuous basis, therefore, commercialize values atomic number 18 much(prenominal) take into account. 2) The edges of debt should not be cipher by Ã¢â¬Å"pickings tot up hobby depreciate for the yr 2001 and dividing it by the go withÃ¢â¬â¢s total debt balance. These historical data would not mull over NikeÃ¢â¬â¢s received or approaching greet of debt. 3) She mistakenly utilize the honest of import from year 1996 to 2001. The total genus Beta could not fabricate the future systemic assay, and we should find the about young Beta as Beta estimate in this situation.\r\n2.If you do not agree with CohenÃ¢â¬â¢s analysis, foreshadow your own WACC for Nike and be prep ard to justify your assumptions.\r\nAnswer:\r\n1)Weights of law and debt:\r\n commercialise value of equity = string up assign damage x menstruation shares outstanding = $42.09 x 271.5m = $11,427.44m\r\nDue to the deprivation information of market value of debt, we could call the book value for calculation: Market value of debt = Current mint of long debt + Notes settleable + gigantic- experimental condition debt = $5.4m + $855.3m + $435.9m = $1,296.6m We = $11,427.44m/($11,427.44m +$1,296.6m) = 89.81%\r\nWd = $1,296.6m/($11,427.44m +$1,296.6m) = 10.19%\r\n2) bell of Debt:\r\nWe screw get the authoritative yield to due date of the NikeÃ¢â¬â¢s bond to represent NikeÃ¢â¬â¢s current equal of debt. Po=$95.6 N=20Ã2=40 PAR=$ hundred PMT=$100Ã6.75%/2=3.375\r\nBy utilise monetary calculator: r=3.58%(semiannual)\r\nSo Rd=3.58% x 2 = 7.16%\r\n3) apostrophize of lawfulness:\r\n exp block upiture 20-year T-bond deem to represent luck of infection-free locate, as the range of return of a T-bond with 20 days maturity is the longest rate which is available right forthwith. So Rf=5.74% practise up a geometric cogitate of market risk gift 5.9% as Market endangerment bountifulness As we mentioned in Q1, the most recent important will most relevant in this respect, so we will commit B=0.69 Re=Rf+B(Market Risk Premium)\r\n=0.0574 + 0.69Ã0.059 = 9.81%\r\n4)WACC:\r\nUse levy rate = US statutory measure rate + state tax\r\n= 35% + 3% = 38%\r\nWACC=Wd x Rd x (1-T) + We x Re\r\n= 10.19% x 7.16% x (1- 38%) + 89.81% x 9.81% = 9.26%\r\n3.Calculate the be of equity smashment CAPM, and the dividend tax deduction baby-sit.\r\nWhat are the advantages and disadvantages of each role clay sculpture?\r\nAnswer:\r\n1) approach of candor using CAPM:\r\nMarket Risk part with ramble (Rf)= 5.74% (20-year yield on US Treasuries) Beta (B) = .69 (most recent important use as most relevant beta to compute NikeÃ¢â¬â¢s valuation) Market Risk Premium = 5.9% (Geometric Mean utilize as Historic uprightness Risk Premium) constitute of paleness using CAPM = Re = Rf + B(M arket Risk Premium) Re = 9.81% = 5.74% + .69(5.9%)\r\nAdvantages:\r\n-CAPM includes taxonomic risk by incorporating Beta in the toll of candour formula. victimization the stockÃ¢â¬â¢s Beta to calculate equity will provide a return rate base on how barbaric the stock is perceived by investors. The high the risk, the higher(prenominal) the Beta will be and will result in a higher required rate of return on the investment. Systematic risk canÃ¢â¬â¢t be diversify away, epoch irregular risk can be modify away by maintaining a diversified portfolio. -CAPM proves to be a meliorate model than other(a)s much(prenominal) as the Dividend sack forge, because the valuation behind CAPM is based on risk and rates of return turn the Dividend snub Model relies heavily on dividends and a outgrowth rate.\r\nDisadvantages:\r\n-When using CAPM, it can be difficult determining the estimate of Beta. unalike investments whitethorn involve diametric risks and the Beta apply in cyp her CAPM should reflect the appropriate amount of risk relating to the particular(prenominal) investment. -The risk free rates apply in calculating CAPM are continually changing as with the values of the investments in the market which behave up the market risk premium. The unending changes in the market can have negative impacts on the valuation of CAPM. -Another disadvantage in using the CAPM in investment appraisal is that investment appraisal is premised on a long metre horizon, whereas CAPM drives a single-period time horizon, i.e. a holding period of one year. speckle CAPM variables can be off-key constant in successive future periods, market reality often shows that this is not the case.\r\n2) constitute of truth using the Dividend snub Model:\r\n festering (g) = 5.5%\r\nDividend (D0) = $.48\r\nShare Price (P0) = $42.09\r\n court of Equity using Dividend Discount Model = Re = (D0 x (1+g)/P0) +g Re = 6.7% = (.48 x (1+5.5%)/42.09+5.5%\r\nAdvantages:\r\n-Using the Divi dend Discount Model is very swooning to calculate because the formula is not complicated. in that respect are no real technical or difficult calculations involved with using this rule. -The inputs that are apply in the calculations of this model are market information and can be easily predominateed. -The Dividend give the sack model attempts to put a valuation on shares, based on forecasts of the sums to be remunerative out to investors. This should, in theory, provide a very solid basis to gear up the shareÃ¢â¬â¢s align value in present terms.\r\nDisadvantages:\r\n-The Dividend Discount Model relies heavily on the growth rate to calculate the rate of return. If growth slows or becomes temporarily negative, it can result in calculations which whitethorn not truly represent future expected returns. -This model is reason using dividends and canÃ¢â¬â¢t be use in instances where a company is not paying dividends. This is also a disadvantage for any investment without a r easonably constant growing dividend stream. -The Dividend Discount Model is very sensitive to nipper changes in input figures. If the growth rate changes by 1 % the price of equity will also change by that rate. -The Dividend Discount Model does not explicitly consider the risks which the company faces.\r\n4.What should Kimi crossover cheer regarding an investment in Nike?\r\nAnswer:\r\nIn come out for Kimi hybridization to make a determination regarding an investment in Nike, she must compare an accurately reckon WACC to the sensibility of equity value to discount rate chart shown in Exhibit #2. The sensibility chart in Exhibit #2 states that at a discount rate of 11.17%, NikeÃ¢â¬â¢s current share determine is fairly valued at $42.09. If a discount rate were to be careful down the stairs 11.17% then the Nike shares would be under-valued in the current market, but if their discount rate were higher than the 11.17% Nike share price would be considered over-valued when compared to the current share price. When we calculated NikeÃ¢â¬â¢s discount rate, we determined that their appropriate WACC should be 9.26%. Since this WACC of 9.26% is below 11.17%, we believe that NikeÃ¢â¬â¢s shares are currently under-valued in the market. We believe that NikeÃ¢â¬â¢s equity value based on the WACC of 9.26% should fall some(prenominal)where between $55.68 and $61.25. Kiki Ford should recommend plying Nike shares to the NorthPoint Large-Cap Fund based on our analysis.\r\n03/03/2011\r\nCASE OVERVIEW\r\nKimi Ford is a portfolio manager at a liberal mutual- stock certificate focussing firm called, NorthPoint assembly. Ford is considering the addition of Nike Inc. to the Large-Cap Fund at NorthPoint Group. NikeÃ¢â¬â¢s share price has notably declined since the outgrowth of the year. Her decision whether or not to add Nike to the portfolio should be made by facial expression at the 2001 fiscal year end 10-K report.\r\nIn 1997 NikeÃ¢â¬â¢s receipts enha ncements plateaued around $9 billion while lowest income had travel from around $800 million to $580 million. Also, from 1997-2000 NikeÃ¢â¬â¢s market share in U.S. athletic station fell from 48% to 42%. Supply-chain issues and the inauspicious effect of a strong long horse had negatively stirred revenue in recent years. At the June 28, 2001 analyst confluence Nike planned to add both top-line growth and operating performance. One goal was to develop much mispriced ($70-$90) athletic shoes and the other to push its apparel line. At this contact a target long-run revenue growth rate between 8%-10% was given and an earnings-growth target above 15%.\r\nAfter reviewing all the analystsÃ¢â¬â¢ reports somewhat the June twenty-eighth meeting Ford still did not have a clear realise of how to value Nike. Ford then performed her own sensitivity analysis which revealed Nike was undervalued at discount rates below 11.17%.\r\nWHAT IS THE WACC?\r\nA firm derives its assets by either rhytidectomy debt or equity or both. There are exists associated with raising capital and WACC is an comely figure used to indicate the greet of financing a companyÃ¢â¬â¢s asset base. More formally, the weighted average approach of capital (WACC) is the rate that a company is expected to pay to debt holders and shareholders to pay its assets. Companies cabbage money from a number of sources so the WACC is the minimum return that a company must earn on existing asset base to fill up its creditors, owners, and other providers of capital.\r\nWACC is calculated taking into discover the relative weights of each component of the capital expression which esteems it is the proportional average of each category of capital at bottom a firm. This rate, also called the discount rate, is used in evaluating whether a project is feasible or not in the net present value (NPV) analysis, or in assessing the value of an asset.\r\nWACC = [Wdebt * Kdebt * (1-t)] + [Wequity * Kequity] + [ W preferable * Kpreferred]\r\nK = component damage of capital\r\nW = weight of each component as percent of total capital\r\nt = marginal incarnate tax rate\r\nwhy IS IT definitive TO ESTIMATE A FIRMÃ¢â¬â¢S monetary value OF CAPITAL?\r\nThe make up of capital is an important issue from the perspective of oversight while taking a financial decision. We can list some base issues related to the importance of WACC and its interpretation by firms:\r\n* The importance of the WACC is in its relation to the military rank of\r\nprojects. For a project to be feasible, not just profi circuit card, it must generate a return higher than the exist of raising debt (Kd) and the represent of raising equity (Ke). WACC is affected not only by Re and Rd, but it also varies with capital structure. Since Rd is commonly disappoint than Re, then the higher the debt level, the trim back the WACC. This partly explains why firms usually prefer issuing debt first before they raise more equity. As part of their risk commission processes, some companies add a risk factor to the WACC in order to include a risk jar in their project evaluation.\r\n* The cost of capital is also important for the wariness while taking a decision about capital budgeting. Naturally, the project which gives a higher (satisfactory) return on investment compared to the cost of capital incurred for its financing would be elect by the management. speak to of capital is the keystone factor in deciding which project to undertake out of different opportunities.\r\n* The cost of capital is significant in conception the firmÃ¢â¬â¢s capital structure. It will direct the management about adopting the most appropriate and economical capital structure for the firm which means the management may try to substitute the various modes of finance to minimize the cost of capital so as to increase the market price and the earning per share.\r\n* The cost of capital is also an important factor for taking a decis ion about the soundest method of financing for the company whenever the company requires additional finance. The management may try to catch the source of finance which bears the minimum cost of capital.\r\n* The cost of capital can be used to appraise the financial performance of the top management by comparing actual gainfulnessÃ¢â¬â¢s of the projects and the projected overall cost of capital and an appraisal of the actual cost incurred in raising the required funds.\r\nDO WE AGREE WITH JOANNA COHENÃ¢â¬â¢S WACC advisement? WHY OR WHY NOT?\r\nWe do not completely agree with Joanna CohenÃ¢â¬â¢s calculation of WACC. There are some(prenominal) jobs in her calculation;\r\n* In CohenÃ¢â¬â¢s calculation, she used the book value for the weights of each capital structure component (debt and equity). take hold value of equity should not be used when calculating cost of capital. instead she should have calculated the market value of equity. Also, she should have discounted the value of long-term debt that appears on the balance sheet to find the market value of debt (even if the book value of debt is evaluate as an estimate of market value).\r\n* Also, she should have considered the preferred stock while calculating the weights of the components of capital structure (the redeemable preferred stock is relatively small in NikeÃ¢â¬â¢s capital structure so it doesnÃ¢â¬â¢t affect the weights).\r\n* Another problem with her calculation is about the cost of debt. Cohen used a cost of debt which is even dismay than exchequer yield. In common sense, a company, even it might be a large AAA firm, should be untamed than US government. Cost of debt should be calculated by finding the yield to maturity on 20-year Nike Inc. debt with current voucher rate paid semi-annually instead of by taking total interest expense for 2001 and dividing it by the companyÃ¢â¬â¢s average debt balance.\r\n employ SINGLE OR MULTIPLE cost OF CAPITAL IS APPROPRIATE FOR NIKE INC.?\ r\nEven Nike Inc. has ternary business segments such as footwear, apparel, sports equipment and some non-Nike-branded products (which accounts for relatively small fraction of revenues), we assumed Nike Inc. to have a single cost of capital since its multiple business segments are not very different and would be intimate similar risks and betas.\r\nWHICH EQUITY RISK gift SHOULD BE USED TO DETERMINE THE COST OF CAPITAL?\r\nFor the cost of capital, the geometric mean is a better alternative to the arithmetic mean. Furthermore, the geometric mean is a more conservative measure to use compared to the arithmetic mean. The average market risk premium has fluctuated by large amounts in pitiful time periods from 1926-1999. 1926-1929 truism high market risk premiums; however, the 1930s and 1970s saw very low market risk premiums. Therefore, we use the geometric mean since it is a better measurement compared to arithmetic mean when the measurable period is longer and contains more flu ctuations.\r\nVALUE OF EQUITY, VALUE OF DEBT AND WEIGHTINGS OF EACH parting\r\n| Value(in millions $)| Weight|\r\nCurrent Portion of grand term Debt| 5.40| 0.04%|\r\nNotes Payable| 855.30| 6.73%|\r\nLong-Term Debt| 416.72| 3.28%|\r\n broad(a) Debt| 1,277.42| 10.05%|\r\nEquity| 11,427.44| 89.95%|\r\n hedge 1. The weight of debt and equity in total capital of Nike\r\n numeration OF THE COST OF EQUITY UNDER distinct METHODS AND ADVANTAGES AND DISADVANTAGES OF EACH METHOD\r\n1. Capital plus Pricing Model (CAPM)\r\n downstairs CAPM we can find the cost of equity as;\r\nKe = Rf + Betai * Equity Risk Premium\r\nThe first issue is to find an appropriate risk-free rate. We think the 20-year yields on treasures would be the one because NIKE is assumed to be operated for such long time, according to the revitalizing schema proposed by the management and the long-term debt issued.\r\n following is to determine the beta. The historic betas has been generally decreasing, and we assume it is the market condition and management`s purpose that make NIKE to be a defensive company. Furthermore, we find that the competitors such as K-Swiss and Lacrosse also have beta little than one. So rather than the average, we use the YTD beta into calculation. On the other hand, since the beta has been set in motion to be on average surrounding(prenominal) to the mean value of 1, which is the beta of an average-systematic-risk security, we calculate the adjusted beta, giving two-third weight to the YTD beta and one-third weight to 1.\r\nRegarding the risk premium, we use the geometric mean since it is a better measurement compared to arithmetic mean when the measured period is longer and contains more fluctuations.\r\n combining the above information, we calculate the cost of equity as follows:\r\nUsing YTD Beta => 5.74% + 0.69*5.9% = 9.81%\r\nUsing familiarised Beta => 5.74% + [(2/3)*0.69 + (1/3)*1)]*5.9% = 10.42%\r\nAdvantages:\r\n* It provides an economically grounded and re latively objective procedure * It concentrates on the systematic risk that investors can`t avoid, rather than unsystematic risk that can be avoided through diversification * It is suitable for company that doesn`t pay dividend\r\n* It is widely used.\r\nDisadvantages:\r\n* The assumptions may not be realistic. For ex antiophthalmic factorle, investors may not be all risk antipathetic and rational that holds efficient portfolio * Investors may mention more than just market risk.\r\n2. Dividend Discount Model (DDM)\r\nnether DDM we can find the cost of equity as;\r\nKe = (D1/P0) + g\r\nKe = (0.48*1.055/42.09) + 5.5% = 6.70%\r\nHere we assume NIKE will pay dividend at constant growth rate of 5.5% which forecasted by Value Line, so we use the Gordon growth model to derive required rate of return.\r\nAdvantages:\r\n* It is simple and widely used\r\n* Can be used to deduct implied required rate of return\r\n* It is encouraging to perform a sensitivity analysis on the inputs\r\nDisadva ntages:\r\n* It is not suitable for company that doesn`t pay consistent dividends or the dividends are not tied to favourableness * It is suitable for only matured company\r\n3. Earnings Capitalization Ratio (ECM)\r\nUnder ECM we can find the cost of equity as;\r\nKe = E1/P0\r\nKe = 2.32/42.09 = 5.51%\r\nAdvantage:\r\n* simplex\r\nDisadvantages:\r\n* It assumes the earnings would be the same in the future, which may not be true * It doesn`t take the growth of company into consideration.\r\nCost of Equity| | |\r\nCAPM| | |\r\n| Risk-free prize| 5.74%|\r\n| Equity Risk Premium| 5.90%|\r\n| Year-to-Date Beta| 0.69|\r\n| familiarized Beta| 0.79|\r\n| Cost of Equity with YTD Beta| 9.81%|\r\n| Cost of Equity with Adjusted Beta| 10.42%|\r\n| | |\r\nDDM| | |\r\n| Current Dividend| 0.48|\r\n| Growth drift| 5.50%|\r\n| Current melodic line Price| 42.09|\r\n| Forecasted Dividend| 0.5064|\r\n| Cost of Equity| 6.70%|\r\n| | |\r\nECM| | |\r\n| Consensus Earnings numerate| 2.32|\r\n| Curren t Stock Price| 42.09|\r\n| Cost of Equity| 5.51%|\r\n| | |\r\nBuild-up method acting| | |\r\n| Risk-free Rate| 5.74%|\r\n| Equity Risk Premium| 5.90%|\r\n| Cost of Equity| 11.64%|\r\n plank 2. Cost of Equity under different methods\r\nWHICH RATE AS RISK FREE RATE IS surmount FOR NOTES PAYABLE AND LONG-TERM DEBT?\r\nFor long term debt, the 20-year yield on U.S. Treasuries is best as the risk free rate. Considering the long time horizon of Nike, a 20-year bond is property. And also, it is alike(p) to the current 25-year bond which Nike issued 5 years ago. Although NikeÃ¢â¬â¢s current bond is 25 years, we could consider it as a 20-year bond issued this year, and use the current price to calculate the 20-year bond YTM.\r\nAnd for abruptlyly term debt, because the note payable was a major portion in the debt structure, the 1-year treasuries would be preferred as risk free rate.\r\nCOST OF DEBT CALCULATION FOR NIKE\r\nWe could not agree with CohenÃ¢â¬â¢s analysis. Because Cohen us ed a cost of debt\r\nwhich is even lower than treasury yield. In common sense, a company, even it might be a large AAA firm, should be risky than US government.\r\nFirst, CohenÃ¢â¬â¢s emphasis that be year, the effective cost of debt of Nike was less than treasury yield due to its Japanese languish notes. However, the rates of debt based on money change are unstable and non-repeatable. We could apt consider that NikeÃ¢â¬â¢s last yearÃ¢â¬â¢s low cost of debt is a kind of arbitrage by chance.\r\nSecond, to calculate the cost of debt, market value of debt should be used rather than the book value used by Cohen. The market value of debt is compounded by the current portion of long-term debt, notes payable, and long- term debt discounted at NikeÃ¢â¬â¢s current coupon.\r\nTherefore, we would like to recalculate the cost of debt. Cost of debt was calculated by using the current liquidated 20-year bond of Nike, Inc. with a 6.75% coupon semi-annually. Then we obtain a cost of lon g term debt before tax as 7.17%, and cost of short term debt before tax as 5.02%.\r\nAs shown above in Table 1, short term debt took a significant portion in NikeÃ¢â¬â¢s debt structure; therefore, we use a weighted cost of debt to comply both long term and short term debt effects as in following equation:\r\nHere is the weight of short-term debt, while is the weight of long-term debt. And both cost of short-term and long-term debt are after tax.\r\nCost of Debt| | |\r\nLong Term Debt| | |\r\n| Coupon Rate| 6.75%|\r\n| cartridge clip to Maturity| 40|\r\n| Current Stock Price| $95.60|\r\n| Cost of Debt| 7.17%|\r\n| After tax income Cost of Debt| 4.44%|\r\nShort Term Debt| | |\r\n| 20-year pass| 5.74%|\r\n| 1-year Yield| 3.59%|\r\n| Risk Premium| 1.43%|\r\n| levy Rate| 38.00%|\r\n| Cost of Debt| 5.02%|\r\n| After levy Cost of Debt| 3.11%|\r\nFinal Weighted Cost of Debt After Tax| 0.36%|\r\nTable 2. Cost of debt\r\nWHAT IS OUR WACC CALCULATION FOR NIKE?\r\nUnder different methods , we would obtain different cost of equity, then, definitely different WACCs which range from 5.31% to 10.83%. However, no matter which method we use, the stock price of Nike is undervalued currently.\r\nWACC| | |\r\n| Under CAPM with Adjusted Beta| 9.73%|\r\n| Under CAPM with YTD Beta| 9.18%|\r\n| Under DDM| 6.39%|\r\n| Under ECM| 5.31%|\r\n| Under Build-up Method| 10.83%|\r\nTable 4. Weighted Average Cost of Capital\r\nAs shown in Table 5, the actual implied discount rate by current price is 11.17%, which is significantly beyond the range of WACCs we calculated and presented in Table 4. Therefore, in our analysis, NikeÃ¢â¬â¢s price would be considered as undervalued.\r\nDiscount Rate| Equity Value|\r\n8.00 %| $ 75.80|\r\n8.50 %| 67.85|\r\n9.00 %| 61.25|\r\n9.50 %| 55.68|\r\n10.00 %| 54.92|\r\n10.50 %| 46.81|\r\n11.00 %| 43.22|\r\n11.17 %| 42.09|\r\n11.50 %| 40.07|\r\n12.00 %| 37.27|\r\nTable 5. Sensitivity exam on WACCs\r\nRECOMMENDATION\r\nThis graph shows the estimated value provided under different WACCs, and NIKE is currently barter at 42.09 with corresponding 11.17% WACC. So if the calculated WACC is below 11.17%, the estimated value would be higher than the current price and NIKE is undervalued; if the calculated WACC is beyond 11.17%, the estimated value would be lower than the current price and NIKE is overvalued.\r\nAfter adjusting the possible mistakes that Joanna made, the table shows the calculated WACC under each method:\r\nMethod| WACC|\r\nCAPM (Adjusted Beta)| 9.73%|\r\nCAPM (YTD Beta)| 9.18%|\r\nDDM| 6.39%|\r\nECM| 5.31%|\r\nBuild-up| 10.83%|\r\nWe can see none of them is above 11.17%, indicating NIKE is currently undervalued and Ford should add NIKE to the NorthPoint Large-Cap Fund. However, it is important to confirm monitoring the revitalizing scheme that the management offered, since the future market condition may have huge impact on this strategy and hence, predicted future economic income.\r\nNorthPoint Group is a mutual fund man agement firm who has the preference on investing in Fortune 500 companies, such as EXXONMobil, GM, McDonaldÃ¢â¬â¢s 3M and other large-cap. If we look back to a decade ago, the fund had performed extremely well compared to the market in general (we refer S&P500 to represent the market).\r\nKimi Ford was the portfolio manager in NorthPoint Group, who was concerned about whether or not to add Nike, Inc. shares into her fund. Since net income and market share had been fallen from 1997, a new strategy was proclaimed by the Nike management squad during the meeting held in June, 2001:\r\nFirst, highly priced products are no longer their only target, now they would develop the midpriced segment so that more customers will be able to pay it.\r\nSecond, another way to boost the revenue is to focus on its apparel line, which they raise out to be profitable. Finally, Nike needs to stamp down its costs by exerting more safari on expense control. Company executives were approbatory ab out the long-term revenue, expecting an 8%~ 10% growths and earnings growth above 15%.\r\nAnalysts had different opinion about the company prospects; Lehman Brothers suggested a strong buy while UBS and CSFB recommended a hold. Meanwhile, Ford wanted to make her own forecast so she true a discount cash flow to determine that, at a discount rate of 12%, Nike was overvalued at its current price $42.09 and undervalued if the discount rate was below 11.17%. She asked her assistant, Joanna Cohen, to calculate the companyÃ¢â¬â¢s cost of capital precisely.\r\nOn the report, Joanna Cohen used WACC to calculate the cost of capital, where she adopted book values to obtain a proportion of 27% of debt and 73% of equity. For cost of debt, she took total interest expense divided by average debt balance which resulted lower than treasury yields. For cost of equity, she used 20-year Treasury bond as risk-free rate and 5.9% as market premium. Moreover, she divided each division by revenue, decidi ng to use one overall WACC. At the end, she came to a conclusion that the cost of capital for Nike, Inc was 8.4%.\r\n'