2. Calculate your own WACC for NIKE and be prepared to justify your assumptions.
WACC = Rd (1-T) x (D/V) + Re x (E/V)
Rd = cost of debtRe = cost of equityE = market value of the firm’s equity
D = market value of the firm’s debtV = E + D = total market value of the firm’s financing (equity and debt)E/V = percentage of financing that is equityD/V = percentage of financing that is debtTc = corporate tax rateCAPM : Re = rf + ? (rm – rf)
Case study data factors,
Tax Rate = 36%
Beta, ? = 0.69
Market Risk Rate = 7.50%
Risk Free Rate = 3.59%
Debt, D = 435.9
Equity, E = 42.09 x 271,500,000 = 11,427.4
Value, V = 435.9 + 11,427.4 = 11863.3
Solving for D/V, E/V,
D/V = 435.9/11863.3
E/V = 11427.4/11863.3
Solving for Rd and Re and Tax Rate,
Cost of Debt
Current bond price, P = 95.60
Annual coupon rate, C = (6.75/2) = 3.375
Face value, F = 100
n = 40
*Bond issued in 07/15/96, its maturity is 07/15/21 =; 25-year bond (or the bond was issued 5years ago, because now is year 2001). As result, we have n=2×(25-5)=40 (paid semiannually).
= 3.56% (semiannually)
= 7.13% (annual)
= Rd (1-T)
= 0.0713 (1-0.36)
Cost of Equity (via CAPM method)
rf = 3.59%
? = 0.69
rm = 7.50%
Re = rf + ?(rm – rf)
= 3.59% + (0.69)( 7.5% – 3.59%)
= 3.59% + (0.69)(3.91%)
= 3.59% + 2.698
Re = 6.29%
WACC = Rd (1-T) x (D/V) + re x (E/V)
= 4.56% x 3.67% + 6.29% x 96.33%
= 0.167352 + 6.059157
WACC = 6.23%
Justification of assumptions:
We believe that the firm should only use long-term debt on WACC without include current portion of long-term debt and notes payable.
We believe that Ms. Cohen should have used a tax rate of 36% which is the most recent tax rate paid by Nike in 2001 because it will be more accurately and reflects the current tax environment and thus is more likely to represent the actual tax rates the firm encounter.
We believe that Ms. Cohen should use the most current year-to-date beta of 0.69 rather than used the average of Nike’s historical betas which comes to 0.8. We believe that when we use the current year-to-date beta, it will be more accuracy of the estimated cost of equity and the subsequent WACC.
We believe that using the current yield on 20-year Treasuries for the risk free rate 5.74% is incorrect due to the fact that the CAPM is a short-term model that calls for a short-term interest rate such as the current yield on short-term Treasuries (12 months or less). Ms. Cohen should use the short term 3.59% as the risk free rate.
We believe that Ms.Cohen should calculate the equity used the current market value which is multiplying the current stock price by the current number of shares outstanding, Equity = 42.09 x 271,500,000 = 11,427.4.