# Nike Case

1172 Words5 Pages
Nike Inc. Case 1. What is the WACC and why is it important to estimate a firm’s cost of capital? WACC is weighted average cost of capital, which is the expected rate of return on average from all the company’s existing debts and securities. It takes into account all different types of financing in the company’s capital structure. The reason it is important to estimate WACC is because it measures what it costs the firm to take on a project based on its current Debt and Equity mix. When the firm decides to take on a project it needs to discount the future cash flows of the project by the company’s WACC to determine whether or not to take the project on. High WACC generally indicates more risk since the company pays more for its…show more content…
- % Debt = D/D+E = 1296.6/ (1296.6+11410.6) = 1296.6/12707.2 =10.2% - % Equity = E/D+E = 11410.6/12707.2 = 89.8% Tax rate (Tc) = 38% - WACC = (1-Tc)*Rd*(D/D+E) + Re * (E/D+E) = (1-0.38)*7.2%*10.2% + 10.5%*89.8% = 0.46 + 9.4 = 9.9% 4. Calculate the costs of equity using the CAPM and the dividend discount model (DDM). What are the advantages and disadvantages of each model?
Cost of Equity using CAPM:
- Risk free rate (Rf) = Current yield on 20 year treasury bond = 5.74%
- Historical market risk premium (Rm-Rf) = 5.9%
- Beta (β) = average of Nike’s betas from 1996 to the present = 0.8
- Cost of equity (Re) = Rf + β*(Rm-Rf) = 5.74+0.8*5.9 = 10.5% Advantages of CAPM: Easy to calculate, takes systematic market risk into account, and ability to provide a precise estimate of cost of equity. Disadvantages of CAPM: Difficulty in beta estimation expected by the investors for the future, controversy regarding the choice of short term versus long term treasury rates, and estimation of market risk premium might be difficult. It is also a backward looking measurement using the history to map out what will happen in the future. Cost of Equity using DDM:
- Growth rate (g) = 5.5%
- Current dividend (D0) = 0.48
- Current stock price =