Qinthara Silmi Faizal 29120391

Nadhia Sekarwardani 29120546

Dila Hadiputri 29120511
Faiz Fauzan 29120586

1. What is the WACC and why is it important to estimate a firm’s cost of capital? Do
you agree with Joanna Cohen’s WACC calculation? Why or why not?

WACC (weight average cost of capital) is the rate at which a company’s future cash
flows need to be discounted to arrive at a present value for the business. If the value
of a company equals the present value of its future cash flows, WACC is the rate we
use to discount those future cash flows to the present. WACC is important to estimate
a firm's cost of capital because an increase in WACC suggests that the company’s
valuation may be going down because it’s using more debt and equity financing to
operate. On the other side, a decrease in WACC shows the company is growing
earnings and relying less on outside funding.

In the Joanna’s calculation, she estimated the firm’s cost of debt based on its historical
data. This can cause the calculation to not reflecting Nike’s current or future cost of
debt. Based on its definition, the WACC is the required return on investment by the
firm in the future, so all components of the WACC must reflect the future interest rate.
Hence, we do not agree with Joanna Cohen's calculation.
2. If you do not agree with Cohen’s analysis, calculate your own WACC for Nike and be prepared to justify your assumptions.

I $58.70 Cost of Debt (ri) 11%

Nd $95.60 Cost of Preffered Stock (rp) 0.05
n 25 year Cost of common stock (rn) 9.28%
rd 17.32% WACC 11%
T 36%
Dp $0.48 Million
Cohen should have used market value for debt and equity weights rather than book
Np $9.26 Million value. This causes the market value to be able to estimate the WACC. This estimate
Risk free return 5.74% means how much WACC can cause an increase in capital at a certain time. Another
thing to consider is that many economic accounts are not included by Joanna, such as
Beta 0.6 the latest Beta, the average Beta should be used because WACC is used for the
MRP 5.90% future. And in Joanna's calculation, she used the tax rate incorrectly, she should have
used the 2001 one instead.
Wi 99.43%
Wp 0.06%
Ws 0.52%
Calculate the costs of equity using CAPM, the dividend discount model, and the earnings
capitalisation ratio. What are the advantages and disadvantages of each method?

Cost of equity :
is the rate of return of a company that pays out to equity investors

The cost of equity can be calculated using :

a. CAPM (Capital Asset Pricing Model)

This method required return should be equal to the risk-free rate plus the compensation for risk. The
compensation for risk will depend on the amount of systematic risk (the beta) and equity risk premium
(km-krf)

Known :
For calculating the cost of equity of a company using the CAPM method, we can use the data on exhibit 4

Nike historic betas (βj)

1996 0.98
1997 0.84
1998 0.84
1999 0.63
2000 0.83
2001 0.69 average = 0.802
(equity risk premium using the geometric mean)
 Period krf* βj km-krf kj
3-month 3.59% 0.802 5.90% 8.32%
6-month 3.59% 0.802 5.90% 8.32%
1-year 3.59% 0.802 5.90% 8.32%
5-year 4.88% 0.802 5.90% 9.61%
10-year 5.39% 0.802 5.90% 10.12%
20-year 5.74% 0.802 5.90% 10.47%

(equity risk premium using the arithmetic mean)

Period krf* βj km-krf kj
3-month 3.59% 0.802 7.50% 9.60%
6-month 3.59% 0.802 7.50% 9.60%
1-year 3.59% 0.802 7.50% 9.60%
5-year 4.88% 0.802 7.50% 10.89%
10-year 5.39% 0.802 7.50% 11.40%
20-year 5.74% 0.802 7.50% 11.75%

krf* : To calculate the real risk-free rate, subtract the inflation rate from the yield of the Treasury bond matching
your investment duration.

b. The Deviden Discount Model (DMD)

This method only applies to company that pay deviden. It aslo assume that the devidens will grow at a
constant rate. Value line forecast or historical deviden can be used to get the information about deviden
growth rate.
 *constant growth model
kcs : the DMD value
D1 : the next period's deviden based on a constant growth rate of g, D1 = D0 x (1+g)
P0 : the current stock price
g; the expected constant growth rate of devidens

For calculating the cost of equity of a company using the DMD method, we can use the data on exhibit 2 and 4

Deviden history and forecast

payment dates 31 Mar 30 Jun 30 sept 31 Dec Total
1997 0.1 0.1 0.1 0.1 0.4
1998 0.12 0.12 0.12 0.12 0.48
1999 0.12 0.12 0.12 0.12 0.48
2000 0.12 0.12 0.12 0.12 0.48
2001 0.12 0.12

Value line forecast of deviden growth from '98-'00 to '04-'06 5.50%

Current share price $42.09

The DMD method :

D1 0.5064
P0 $42.09
g 5.50%
kcs 6.70%

c. The Earnings Capitalization Ratio (ECM)

This method is notoriously poor in estimating equity costs for growing firms and reasonable for only no
growth firms known.
For calculating the cost of equity of a company using the ECM method, we can use the data on exhibit
1 and 2 .

E1 : $2.16
P0 : $42.09
kcs : 5.13%

What are the advantages and disadvantages of each method?

Method Advantage Disadvantage

CAPM (Capital Asset Pricing Model) -Consider the systematic risk - Difficult to find a risk free
-Mostly applied in practice security.

The Deviden Discount Model (DMD) -Flexible when estimating future -Subjective input resulted in a
dividend streams, provide useful over reliance on a valuation, and
value approximations. high sensitivity to small changes.

The Earnings Capitalization Ratio (ECM) -Calculates the return on -Growth of the company does not
investment that is expected by an take into consideration, so it is
investor only appropriate for no-growth
firms
4. What should Kimi Ford recommend regarding an investment in Nike?
to analyze that kimi ford should take regarding investment in nike or not, need to
consider the table of sensitivity of equity value that related to discount rate which
mentioned in exhibit 2. before that she halready measured cost of capital analyze by
doing quick sensitivity analysis. By using this quick analyze, she get get undervalue at
discount rate ~11.17% compared to market share price is $42.09 and she taught that
her assistant need to re-calculate it. The second calculation using WACC (weight
average cost of capital), the new number of discount rate is lower than previous
calculation which also means that there is an increase number of market share price.
If the market price higher it might be increase in total sales, leading to the increase of
profit and share price. By use this all information, it can be concluded that kimi ford
should buy nike's share.