Cost of Capital

M5007 - Financial Management

Prepared by Syndicate 1
Niluh Christin Shanti - 29121184
Rabin Sebayang - 29121168
Ardyanto Mulya - 29121255
Dimas Haribowo - 29121166
Andhitiawarman Nugraha - 29121154
Azkal Fata Herzasha - 29121019
NORTHPOINT GROUP
● A mutual fund management firm.
● Kimi Ford a portfolio manager at NorthPoint Group
● Ford was considering buying some shares for the fund
she managed, the NorthPoint Large-Cap Fund.
● NorthPoint Large-Cap Fund invested mostly in Fortune
500 companies.
● NorthPoint Large-Cap Fund had performed extremely
well in 2000.
NIKE, INC.
● The athletic shoe manufacturer.
● Nike’s share price had declined
significantly from the beginning of
2001.
● On June 28, 2001, Nike had held an
analysts’ meeting to disclose its
fiscal year 2001 results.
Another Purpose of
Nike Analysts’ Meeting to Communicate a Strategy
for Revitalizing the Company

● Since 1997 had plateaued at around $ 9 billion.

● Net income had fallen from almost $800 million to
$580 million.
● Nike’s market share in US athletic shoes had fallen
from 48 % in 1997 to 42 % in 2000.
● Recent supply chain issues and the adverse effect of
a strong dollar had negatively affected revenue.
 Long term revenue
growth targets of 8 % to
10 %.

Earning growth targets of

above 15 %.
1a

What is WACC and why it is important

to estimate a firm’s cost of capital?
The weighted average cost of capital (WACC) is the rate that a company is
expected to pay on average to all its security holders to finance its assets. It
represents a firm's average cost of capital from all sources, including common
stock, preferred stock, bonds, and other forms of debt.

It is important to estimate a firm’s cost of capital as a benchmark in deciding the

most effective to deploy a company’s capital. WACC is a common way to
determine required rate of return because it expresses, in a single number, the
return that both bondholders and shareholders demand in order to provide the
company with capital.

A firm’s WACC is likely to be higher if its stock is relatively volatile or if its debt is
seen as risky because investors will demand greater returns.
1b

Do you agree with Joanna Cohen’s WACC

calculation? Why or why not?
Agree on Joanna Cohen calculation with the use of the single cost
instead of multiple costs of capital. WACC is value cash flow of the entire
firm. The reason of estimating WACC is to value the cash flows for the
entire firm, that is provided by Kimi Ford. Business segments of Nike
have about the same risk therefore a single cost is sufficient for this
analysis
2
If you do not agree with Cohen’s analysis, calculate your
own WACC for Nike and be prepared to justify your
assumptions.
The thing to do in our WACC calculations is to calculate Nike's cost of debt. Nike's last debt issue
was rated A2 by Moody's or A by S&P, awarded October 25, 2000. With this rating, we can
determine the approximate cost of Nike's debt, we will use the 10-year Treasury rate as the base
rate and add the necessary spreads, given Nike's debt rating.
3

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?
3

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?

CAPM Dividend Discount Model Earning Capitalization Ratio

Advantages:
- Ease of use
- Consideration into
systematic risk
Disadvantages:
- Unrealistic real world
picture, ability to borrow
and lend at free risk rate
Advantages:
- Easy to understand, no
ambiguity
Disadvantages:
- Assumption of constant
growth rate in perpetuity
- Limited to companies that
pay dividends at rising rate
Advantages:
-
Disadvantages:
- Inaccurate, resulting less
than expected yields
- Earnings is compromised
during extraordinary
events
4

What should Kimi Ford recommend

regarding an investment in Nike?
Since non-Nike brands account for only 4.5% of Nike's total revenue and the only non-sports-related
business segment is their Cole Haan line, it is likely that all of the different business segments face
the same risk factors. Therefore, instead of calculating multiple costs of capital, we think that it would
be more appropriate to use one cost of capital for the entire firm.

The calculated WACC is 9.27% and the present value per share is $58.13 (15,782.295/271.5).
This shows that the present value is higher by 1.38 times than Nike’s current market
price of $42.09. The shares price of Nike is undervalued by $16.04 (58.13-42.09) as Nike is
presently trading in 2001. The current growth rate that is about 6 to 7% is much
lower than the one estimated which was 9.27%. This value is
considered majorly understated. Nike Changed their business technique by focusing in
mid-priced segment, which for a long time was less concentrated. This means that there is a
possibility for their sales total to increase that that will lead to an increase in revenues and
profit.
In addition to this Nike’s share prices and dividend will be increased in the
long term. Based on these records, we recommend
to the North Point Large-Cap Fund to buy Nike’s shares,
because the stock is currently undervalued and it has a major growth
potential that will be beneficial to the fund.

THANK YOU