Valuation of Nike Inc. has been made by the portfolio manager of Mutual Fund Management Company by using the two approaches which are widely used. The approaches arediscounted cash flow method and sensitivity analysis. Discounted cash flow method shows that the company is following an inconsistent revenue growth rate of 7% which will be reduced to 6% within a 10-year forecasting period from 2001 to 2011.
The enterprise value calculated by the manager is around 11,415 million dollars.This value is used for calculating the equity value per share which is around 37.27 dollars per share and is lower than the current market price of company’s share i.e. $42.09. So, it shows that the company’s stock is overvalued and it provides the investors the indication of decline in the share price of company’s stock in near future.
Moreover, the discount rates were estimated by using the sensitivity analysis which resulted in an equity value of around 37.27 dollars at 12% discount. So, it was analyzed further to calculate cost of capital to get better results, and it seemed to be a higher rate which needs to be evaluated further to get the proper valuation through different fundamental models.
WACC is also known as cost of capital which is considered as the opportunity cost of getting return for any project. It consists of taking average of the debt financing returns and return of equity along with the return of preferred stock.It is the minimum return required to cover the investment. This rate will give the company an indication to get a rate which is enough to cover the return of creditors as well as investors for debt and equity financing.
WACC is important because it provides help in estimating the capital budget required for financing. It helps in better decision making with respect to the IRR as the decision can also be taken by comparing WACC and IRR. It also helps a company to maintain an acceptable capital structure. It should be maintained in a way so that company gets maximum returns out of it rather than paying more cost on debts and loose its credibility. Moreover, it is necessary to estimate the hybrid capital structure as it helps in forecasting the dividend, capital growth and cost on debts to minimize the risk. It is also important to evaluate the profitability and comparison with requirement of working capital.
I do not agree with the calculation of WACC done by Joanna as it is not showing a realistic value. She worked properly by using CAPM model to calculate the cost of equity which is around 10.46. However, it consists of few flaws which may result in the change of decision making for the investors. First of all, she started the calculation by taking into account the incorrect measures to calculate the weights for debt and equity financing. She needed to consider the current market price of debts and equity rather than considering the book value for valuation purpose. She miscalculated the value of equity and stock. She has also used another approach for calculating cost of debt by just dividing the interest amount with average cost of debt which resulted in a very low cost of debt. This resulted in a relatively higher WACC calculated by Ms. Joanna that has been altered and presented in the following tables………………..
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