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 A mutual-fund

management firm  It invests money mostly in Fortune 500 companies  Its top holdings include Exxon mobile, General Motors, McDonald, 3M and other large-cap

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 The

athletic-shoe manufacturer  Founded by Philip Knight in 1964  Headquarter Washington Country, Oregon, USA  Clothing and Sports equipment making industry  Revenue US$ 19.014 billion (FY 2010)  Total Employee 34,400 (May 2010)
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North Point Large Cap Fund weighing whether to buy Nike’s stock. Nike has experienced sales growth decline, declines in profits and market share. Nike has revealed that it would increase exposure in mid-price footwear and apparel lines. It also commits to cut down expenses. The market responded mixed signals to Nike’s changes. Kimi Ford has done a cash flow estimation, and ask her assistant, Joanna Cohen to estimate cost of capital.
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 If

Nike’s discount rate is 12%, its stock price is overvalued  If discount rate is below 11.17%, its stock price is undervalued  Ford needs to calculate the cost of capital to determine whether the investment in Nike should be made or ignored

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Cohen calculated a Weighted Average Cost of Capital(WACC) of 8.3 percent by using the capital asset pricing model(CAPM), but we do not agree with Cohen’s figure and the reason to that are as follows:

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Weights of Capital Components

Cohen is wrong to use book values as the basis for debt and equity weights; the market values should be used in calculating weights. The reasoning of using market weights to estimate WACC is that it is how much it will cause the firm to raise capital today. That cost is approximated by the market value of capital, not by the book value of capital.

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1.Value of equity E=Stock Price*Number of Shares=42.09*271.5=$11427.44 (Cohen:$3494.5) 2.Value of Debt Due to the lack of information of the market value of debt, book value of debt, 1,296.6m, is used to calculate weights. 3. Weighting  WD=D/D+E=1296.6/12724.04=10.19%  WE=E/D+E=11427.44/12724.04=89.81%

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4.Cost of Debt and Equity i. Risk Free rate=20-year yield on U.S Treasuries=5.74% ii. Market risk premium=Geometric mean=5.9% iii. β (historical data) =0.8 iv. Cost of Debt=YTM on 20 year Nike Inc. Bond=7.17% v. Cost of Equity=RE = RF + (RM – RF)β=10.46%

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WACC=Wd*Rd(1-T)+WeRe=10.19%*7.17%(1-38%)+89.81%*10.46%=9.85%

Why we get rid of the other two methods:  Dividend Discount Model-no substantial dividend  Earning Capitalization Model-Ignore the growth of company

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As per the calculations done in the excel sheet and the table given the stock price at WACC =9.85% or we can say close to 10% so the stock price should be greater than $50.92 , which is higher than current stock price $42.09. These calculations clearly shows that the current stock of Nike is undervalued and is discounted rate of 11.17%. The recommendation is to invest in the Nike, as the stock is undervalued for the calculated cost of capital, WACC=9.85%.

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