Use of CAPM Equation
In calculating the WACC, Joanna solely utilized the CAPM method. To do so, she used book values of both equity and debt and 20 year treasury yields for risk free rate. To calculate the risk of Nike, she calculated an average beta based on historical data from 1996 – 2001.
We recommend utilizing the CAPM method, however, with different variables compared to what was used in the case. Market values of debt and equity should be utilized as they are more accurate reflections of what an asset worth at the current time, rather than what it was valued at the time of purchase. As this is a stock and we do not anticipate an extended holding period, we used the 1 year Treasury yield of 3.59% compared to 5.74%. We chose to use the most recent beta of .83 compared to using a historical average as the recent beta reflects current volatility of the firm compared to the market as a whole.
Calculating WACC
According to a survey of corporations, 81% responded as estimating their cost of equity through the CAPM method.1 It is not recommended to use the Earnings Capitalization Method for calculating equity as Nike has many growth opportunities before it. When using the ECM, you assume zero growth in the firm and we assume Nike will be utilizing a portion of their earnings to reinvest in the firm. We shy away from the Dividend Discount Model due to an uncertainty with a constant growth rate for Nike.
