Question 1: How, if at all, would you change Cohen’s equity cost of capital calculation? Why? In this case, Cohen calculated the equity cost of capital by using CAPM: rE = rf +βi ( E[rmkt]-rf ) 10.5% = 5.74% + 0.80 * (5.9%) * Risk free rate: The rf should be kept consistent with the time horizon of the investment. Since Cohen did her estimate in 2001 and Nike’s bond will expire in 2021, it is reasonable to use the 20-year T-bond rate, 5.74% as the risk free rate. * Risk premium: Arithmetic mean is often used for one-year period valuation, while geometric mean is better for long-term period estimated expected returns.
Assumption #1 - The yield of the Publicly traded Nike debt holds for the entire debt position. Assumption #2- We can use the price of the currently traded Nike bond to determine the market value of debt, by multiplying the current price by the book value of debt. I. Single cost of capital is appropriate because of the non-divergent business segments that possess similar risk profiles. II.
Joanna used the current yields on the 20-year U.S. Treasury bond as her risk-free rate. According to Exhibit 4, the risk-free rate was 5.74%. We thought that this figure was too aggressive. Since the risk-free rate is a theoretical interest rate at which an investment may earn interest without incurring any risk. In practice, the risk-free rate is often a short-term Treasury rate.
We should perceive the opportunity cost as the return investors will expect to earn somewhere else when accepting similar risk. * Tax rate of 38% is chose as an average within the range 37.5% - 38.5%. Implicit assumptions in the WACC method * Firm will continuously rebalance its debt to keep a constant leverage ratio. Theoretically when calculating the weight in WACC, we should consider
1+5*BEY5yr=exp5r, where BEY5yr is the annualized Treasury Bill’s bond equivalent yield and r is the continuous compounded interest rate we want to derive, which is 5.2627%. Secondly, since historical volatility could not perfectly reflect the scenarios in the future, we use options prices that could reflect the investors’ expected volatility (due to the efficient market hypothesis). Moreover, as the volatility derived from long-term call options are more precise than that derived from short-term, we would use the 3 long
2. If you do not agree with Cohen’s analysis, calculate your own WACC for Nike and be prepared to justify your assumptions. * * I calculated the cost of debt differently by calculating the yield to maturity then taking the tax out of that. * For cost of equity I agreed with how she calculated it with using the geometric mean instead of the arithmetic mean, the risk free rate using the 20 year treasury rate, and an average beta * The weights of equity and debt I calculated differently. For equity I took the number of shares outstanding times the stock price to get 11503.2 million.
Therefore, we assume she would be interested in quality stocks with are fairly priced. This report reviews and examines the analysis by Ford and Cohen. In our analysis, we re-perform the weighted average cost of capital (WACC) analysis and recalculate the cost of capital for Nike. The Dividend Discount Model and the Earnings Capitalization Model are also adopted to compute the cost of equity, apart from the CAPM method. With our new estimate of the cost of capital, Nike’s stock has been re-evaluated in the Discounted Cash Flow valuation.
INTRODUCTION This essay will discuss the concept of real options and their application in the capital budgeting exercise. We will describe a real option and its valuation using commonly used pricing formulae. We will then try and estimate project uncertainty, also known as volatility. Once we’ve estimated volatility we will demonstrate obtaining this estimate using ASX listed company, the Coca Cola Amatil Group. REAL OPTIONS AND THEIR INCORPORATION WITHIN CAPITAL BUDGETING A real option is a form of derivative, similar to a forward contract, but with a couple of important differences.
In Mr. Buffett`s opinion, intrinsic value is the present value of the future expected performance. It`s estimated calculating the discounted cash flow of a business during its remaining life. It`s important because the DCF is the only logical way to evaluate the attractiveness of a business or an investment. Other alternatives to intrinsic value fall short in determining whether an investor is indeed buying something which is really worth and is therefore truly operating on the most basic principle which is aggregating value. The $2.55 billion gain in Berkshire`s market value of equity and the 6.28% jump on Scottish Power`s stock means that the acquisition was a win-win situation, creating value for both companies.
Market Value of Business Asset 41,058 Cash 2,564 US Government Securities 20,024 Value of Financial Investment 22,588 Total Asset Value 63,646 2. Terminal Value Terminal value based on book value of invested capital is not valid assumption because this is a backward looking method of assessing terminal value. It does not take into account future value creation of the firm. Instead, we used the FCF method where we assumed that FCF grows at a constant rate “g” after the forecast period. This method is superior to the book value method since it is forward looking.