“Best Practices” in Estimating the Cost of Capital: Survey and Synthesis

Nama Kelompok:Matthew Victoria 37408003Venny Dwiyanti 37408010Inge Talia 37408018Gentry DSG 37408039

Pengertian cost of capital

Cost of capital sisi investor

sisi perusahaan

Sisi investor = opportunity cost dari dana yang ditanamkan investor pada suatu perusahaan.

Sisi perusahaan = biaya yang dikeluarkan oleh perusahaan untuk memperoleh sumber dana yang dibutuhkan

• Perhitungan cost of capital sangat penting karena:

1. Membantu perusahaan untuk melakukan bench mark pada perusahaan lain yang cukup baik

2. Membantu membuat keputusan karena cost of capital telah diestimasi

I. Weighted Average Cost of Capital (WACC)

• Untuk menghitung cost of capital kita menggunakan WACC

• WACC adalah rata-rata tertimbang dari seluruh komponen modal

• Komponen modal yg sering dipakai adalah: saham biasa, saham preferen, utang, laba ditahan

• Seluruh komponen modal ( capital components) mempunyai satu kesamaan, yaitu investor yang menyediakan dana berharap untuk mendapatkan return dari investasi mereka

Weighted Average Cost of Capital (WACC)

WACC = wd.kd (1-T)+wps.kps+ws.( ks atau ke)

kd = biaya hutang

kps = biaya saham preferen

ks = biaya laba ditahan

ke = biaya saham biasa baru

T = pajak

Hal-hal yang diperhatikan dalam perhitungan WACC

1. Capital cost yang ada menunjukkan kondisi pasar saat ini bukan historical.

2. Bobot yang ada harus dari bobot pasar

3. Cost of debt harus dikurangi pajak Penggunaan hutang sebagai modal, menurunkan penghasilan yg dikenai pajak karena bunga yg harus dibayar. Karena itu penggunaan hutang dapat mengurangi pajak yang dibayar (tax deductible)

II. Sample Selection

Sample yang digunakan adalah perusahaan

Cara yang dilakukan dari sample ini adalah

1.Memberikan surat tentang penelitian

2. Lalu melakukan telepon.

Selain perusahaan,sampel yang lain adalah

Penasehat keuangan dan text book

III. Survey Findings• Discounted cash flow (DCF) is the dominant investment-

evaluation technique• WACC is the dominant discount rate used in DCF

analyses• Weights are based on market, not book, value mixes of

debt and equity• The after tax cost of debt is predominantly based on

marginal pretax costs and marginal or statutory tax rates• The capital asset pricing model (CAPM) is the dominant

model for estimating the cost of equity

Capital Asset Pricing Model (CAPM)

K = Rf + β (Rm – Rf)

Rf = Interest rate available on a risk free bond

Rm = Return required to attract investors to hold the broad market portfolio of risky assets

β = The relative risk of the particular asset

Risk free rate of return• Choice of a risk free rate can have a material

effect on the cost of equity and WACC• Long term bond yields more closely reflect default

free holding period returns available on long lived investments and thus more closely mirror the types of investments made by companies

Risk free rate of return

• Our survey results reveal a strong preference on the part of practitioners for long term bond yields.

• Many corporations said they matched the term of risk free rate to the tenor of the investment.

• Of both corporations and financial advisers, 70% use treasury bond yield and only 4% of the corporations use the treasury bill yield.

Beta Estimates• Finance theory calls for a forward-looking beta, one

reflecting investor’s uncertainty about the future cash flows to equity.

where:

Rit = Return on stock I in time period

Rmt = Return on the market portfolio in period t

αi = Regression constant for stock I

βi = Beta for stock i

Rit = αi + βi (Rmt)

Beta Estimates

Bloomberg Value Line Standard and Poor’s

Number of observationsTime interval

Market index proxySample mean betaSample median beta

102

Weekly over 2 yearsS&P 5001.031.00

260

Weekly over 5 yearsNYSE composite1.241.20

60

Monthly over 5 yearsS&P 5001.181.21

Compromises underlying beta estimates and their effect on estimated betasOf sample companies

Over half of the corporations in our sample rely on published sources for their betaestimates. Among financial advisers, 40% rely on published sources, 20% calculated their own, and another 40% use what might be called “fundamental” beta estimates

Equity Market Risk Premium

• Finance theory says the equity market risk premium should equal the excess return expected by investors on the market portfolio relative to riskless assets.

• Where respondents chiefly differed was in their use of arithmetic versus geometric average historical equity returns.

• Arithmetic mean return is the simple average of past returns.• The geometric mean return is the internal rate of return

between a single outlay and one or more future receipts.

Equity Market Risk Premium

• Of the texts and trade books survey, 71% support use of the arithmetic mean return as the best surrogate for the equity market risk premium.

• Ernhardt (1994) recommends use the geometric mean return. Copeland, Koller, and Murrin (1990): “We believe that the geometric average represents a better estimate of investor’s expected returns over long period of time”

IV. The Impact of Various Assumptions For Using CAPM

The resulting ranges of estimated WACCs for two firms under various combinations of beta, risk free rate, and risk premium :

The range from minimum to maximum is large for both firms, and the economic impact is potentially stunning.

V. Risk Adjustment To WACC

• Financial Theory : A firm’s overall WACC is a suitable benchmark for a firm’s average risk investments.

• The fact : • Earlier studies ( summarized in Gitman And Mercio (

1982 )) reported that between a half of firms surveyed did not adjust for risk differences among capital project

• When asked about risk adjustment, these firms responded as follows : • “We make these adjustment in cash flow

rather than in discount rates”• “Risk factor may be different for realization of

synergies, but we make adjustment to cash flow rather than the discount rates”

• Why do practitioners risk-adjust discount rates in one case and work with cash-flow adjustment in another ?• Our interpretation is that risk-adjusted discount rates are more

likely used when the analyst can establish relatively objective financial market benchmark for what rate adjustment should be

• Sometimes when the analyst is lack of good market analog, the analyst is forced to rely more on internal focus

• The conclusion : Practical implementation of risk adjusted discount rates thus appear to depend on the ability to find traded financial assets that are comparable in risk to the cash flow being valued and then to have financial data on these traded asset.

VI. Conclusions• The survey revealed broad acceptance of the WACC as the basis

for setting discount rates.• In summary, we believe that the following elements represent “best

current practice” in the estimation of WACC :• Weight should be based on market-value mixes of debt and

equity• The after-tax cost of debt should be estimated from marginal

pretax costs, combined with marginal tax rates• CAPM is currently the preferred model for estimating the cost of

equity• Betas are drawn substantially from published sources

• Risk-free rate should match the tenor of the cash flow being valued

• Choice of an equity market risk premium is the subject of considerable controversy both as to its value and method of estimation

• Monitoring for changes in WACC should be keyed to major changes in financial market conditions, but should be done at least annually

• WACC should be risk adjusted to reflect substantive differences among different business in a corporation

Nike Inc.Cost of capital

Background

• Pada bulan Juli 2001 , Kimi Ford seorang manajer portofolio dari North Point Group berencana untuk membeli saham Nike yang merupakan manufaktur sepatu olahraga .

• Harga Saham Nike sedang turun secara signifikan sejak awal tahun dan Kimi berencana untuk menambah jumlah saham dalam pengelolaanya yaitu NorthPoint Large-Cap Fund , yang telah berinvestasi di 500 perusahaan besar seperti ExxonMobil,GM,Mcdonald,dsb .

• Performa NorthPoint Large-Cap Sangat bagus di tahun 2000 yaitu mendapat return 20,7% saat return S&P 500 turun 10.1%.

Pada tanggal 28 juni 2001 , Nike mengadakan meeting untuk membahas kinerjanya di tahun 2001 yang dirasa kurang maksimal yaitu :

• Sejak tahun 1997 revenue nike tetap berkutat di kisaran $9 Billion .

• Net income yang menurun dari $800 million di tahun 1997 menjadi $580 million di tahun 2001 .

• Market Share Nike yang menurun dari 48% di tahun 1997 menjadi 42% di tahun 2000.

Rencana kebijakan Manajemen yang diambil oleh Nike yaitu :

• Untuk meningkatkan Revenue Nike berencana mengembangkan sepatu olahraga di midpriced segment (segmen tengah).

• Nike berencana untuk mendorong produk Pakaian (apparel) karena dirasa mampu bersaing di pasar.

• Nike akan mengusahakan cost control yang lebih efisien dari tahun ke tahun.

• Nike merencanakan Long Term Revenue Target sebesar 8-10% dan Earning Growth target Sebesar 15%

Reaksi Analis terhadap kebijakan tersebut berbeda-beda :• Lehman Brothers pada saat itu merekomendasikan “Strong

Buy”.• CSFB dan UBS Warburg merekomendasikan “Hold”.

Kimi kemudian menghitung DCF forecast dan menemukan kesimpulan bahwa dengan Discount Rate 12% maka harga saham Nike pada saat itu ($42.09) adalah Overvalued dan jika Discount Rate dibawah 11.2% maka harganya Undervalued.

Maka dari itu kimi meminta Joanna Cohen untuk mengestimasi Cost of Capital dari Nike .

Consolidated Income Statement

Income Statement 1995 1996 1997 1998 1999 2000 2001

Revenues 4,760.8 6,470.6 9,186.5 9,553.1 8,776.9 8,995.1 9,488.8

COGS 2,865.3 3,906.7 5,503.0 6,065.5 5,493.5 5,403.8 5,784.9

Gross Profit 1,895.5 2,563.9 3,683.5 3,487.6 3,283.4 3,591.3 3,703.9

Selling and Admin 1,209.8 1,588.6 2,303.7 2,623.8 2,426.6 2,606.4 2,689.7

Operating Income 685.7 975.3 1,379.8 863.8 856.8 984.9 1,014.2

Interest Expense 24.2 39.5 52.3 60.0 44.1 45.0 58.7

Other Exp. 11.7 36.7 32.3 20.9 21.5 23.2 34.1

Restructuring Charge,net - - - 129.9 45.1 (2.5) -

Income before Taxes 649.8 899.1 1,295.2 653.0 746.1 919.2 921.4

Income Taxes 250.2 345.9 499.4 253.4 294.7 340.1 331.7

Net Income 399.6 553.2 795.8 399.6 451.4 579.1 589.7

Growth & Margins

Growth(%) 1996 1997 1998 1999 2000 2001

Revenue 35.9

42.0

4.0

(8.1)

2.5

5.5

Operating Income 42.2

41.5

(37.4)

(0.8)

15.0

3.0

Net Income 38.4

43.9

(49.8)

13.0

28.3

1.8

Margin(%) 1996 1997 1998 1999 2000 2001

Gross Margin 39.6

40.1

36.5

37.4

39.9

39.0

Operating Margin 15.1

15.0

9.0

9.8

10.9

10.7

Net Margin 8.5

8.7

4.2

5.1

6.4

6.2

Tax Rate (Statutory+State)

38.5

38.6

38.8

39.5

37.0

36.0

Assumptions & DCF AnalysisAssumptions (%) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Rev. Grwoth 7.0 6.5 6.5 6.5 6.0 6.0 6.0 6.0 6.0 6.0

COGS/Sales 60.0 60.0 59.5 59.5 59.0 59.0 58.5 58.5 58.0 58.0

S&A/Sales 28.0 27.5 27.0 26.5 26.0 25.5 25.0 25.0 25.0 25.0

Tax Rate 38.0 38.0 38.0 38.0 38.0 38.0 38.0 38.0 38.0 38.0

CA/Sales 38.0 38.0 38.0 38.0 38.0 38.0 38.0 38.0 38.0 38.0

CL/Sales 11.5 11.5 11.5 11.5 11.5 11.5 11.5 11.5 11.5 11.5

Discounted Cash Flow

Operating Income 1,218.4 1,351.6 1,554.6 1,717.0 1,950.0 2,135.9 2,410.2 2,554.8 2,790.1 2,957.5

Taxes 463.0 513.6 590.8 652.5 741.0 811.7 915.9 970.8 1,060.2 1,123.9

NOPAT 755.40 838.00 963.80 1,064.50 1,209.00 1,324.20 1,494.30 1,584.00 1,729.90 1,833.60

CAPEX,net of dep - - - - - - - - - -

Change In NWC 8.8 (174.9) (186.3) (198.4) (195.0) (206.7) (219.1) (232.3) (246.2) (261.0)

FCF 764.20 663.10 777.50 866.10 1,014.00 1,117.50 1,275.20 1,351.70 1,483.70 1,572.60

Terminal Value (3%) 17,998.7

Total Flows 764.20 663.10 777.50 866.10 1,014.00 1,117.50 1,275.20 1,351.70 1,483.70 19,571.30

PV of Flows (12%) 682.32 528.62 553.41 550.42 575.37 566.16 576.84 545.93 535.04 6,301.43

Enterprise Value 11,415.54 Sensitivity

Current Outstanding Debt 1296.6 Discount Rate Equity Value

Equity Value 10,118.94 8% $ 75.80

Current Shares Outstanding 271.5 8.50% $ 67.85

Equity Value PerShare $ 37.27 9% $ 61.25

Current Share Price $ 42.09 9.50% $ 55.68

10% $ 50.92

10.50% $ 46.81

11% $ 43.22

11.17% $ 42.09

11.50% $ 40.07

12% $ 37.27

Consolidated Balance SheetBalance Sheet , May 31 2000 2001 Balance Sheet , May 31 2000 2001Assets Liabilities & Equity Current Assets : Curent Liabilities : Cash 254.3 304.0 Current Long-term Debt 50.1 5.4 Acc Recievable 1,569.4 1,621.4 Notes Payable 924.2 855.3 Inventories 1,446.0 1,424.1 Acc Payable 543.8 432.0 Deffered Income Taxes 111.5 113.3 Accrued Liabilities 621.9 472.0 Prepaid Exp 215.2 162.5 Income Tax Payable - 21.9 Total Current Asset 3,596.4 3,625.3 Total Current Liabilities 2,140.0 1,786.6 Property,Plant,Equipment 1,583.4 1,618.8 Long Term Debt 470.3 435.9 Intangible Asset&Goodwill 410.9 397.3 Deffered Income Taxes 110.3 102.2 Deffered Income Taxes 266.2 178.2 Redeemable Pref Stock 0.3 0.3 Total Assets 5,856.9 5,819.6 Total Liabilities 2,720.9 2,325.0

Equity : Common Stock 2.8 2.8 Capital in Exces of stated Value 369.0 459.4 Unearned Compensation (11.7) (9.9)Accumulated Other Income (111.1) (152.1)Retained Earnings 2,887.0 3,194.3 Total Equity 3,136.0 3,494.5 Total Liabilites And Equity 5,856.9 5,819.5

Financial Information

Current Yield on US Treasuries

Historical Equity Risk Premium (1926-2000)

3 Month 3.59% Gemotric Mean 5.90%

6 Month 3.59% Arithamtic Mean 7.50%

1 Year 3.59%

5 Year 4.88%Current Yield on Nike Debt

10 Year 5.39% Coupon 6.75%Semi Annual

20 Year 5.74% Issued7/15/19

96

Maturity7/15/20

21Nike Average Historic Betas Current Price $ 95.6

1996-2000 0.8

Joanna Cohen’s Analysis

• A. Single atau Multiple Cost of Capital ?Cohen menggunakan Single Cost of Capital karena dia berasumsi meskipun Nike memproduksi beraneka ragam produk seperti Sepatu, Pakaian , Bola , Kacamata , Aksesoris , dan Perlengkapan Olahraga lainya tetapi sebagian besar adalah Bisnis dalam bidang Olahraga dan produksi yang diluar olahraga hanya menyumbang revenue yang kecil . Dan Juga distribusi dan Marketingnya tetap berada pada satu Channel.

• B. Methodology Perhitungan Weight Capital Sources Book Values

Debt Current Long-Term Debt 5.4

Notes Payable 855.3 Long Term Debt 435.9

Total Debt 1296.6 27%Equity 3494.5 73%

Total Capital 4791.1

• C. Cost of DebtCohen menggunakan Cost of Debt dengan perhitungan interest expense / average debt balance sehingga menghasilkan Cost of Debt sebesar 4.3%

• D. Cost of Equity

• E. WACC

WACC = Kd (1-t) * Wd + Ke * We

= 4.3 * (1-38%) * 27% + 10.5% * 73%

= 8.4%

CAPM = RF + B *RPM

= 5.74% + 0.8 * 5.9%

= 10.5%

55.02

41.99

56.24 53.65

44.47

53.49

68.46

75.75

90.6986.6 86.79

81

99.03

58.2964.24

59.61

51 51.78

66.07 67.55

81.1

Nike Share Price

Price

Group’s Analysis 2010 2010 2009 2008 2007 2006

Total Revenue 19,014.00 19,176.10 18,627.00 16,325.90 14,954.90Cost of Revenue, Total 10,213.60 10,571.70 10,239.60 9,165.40 8,367.90Gross Profit 8,800.40 8,604.40 8,387.40 7,160.50 6,587.00 Selling/General/Administrative Expenses, Total 6,326.40 6,149.60 5,953.70 5,028.70 4,477.80Research & Development 0 0 0 0 0Depreciation/Amortization 0 0 0 0 0Interest Expense (Income), Net Operating 0 0 0 0 0Unusual Expense (Income) 0 596.3 0 0 0Other Operating Expenses, Total -12.8 -48.3 46.6 48.8 54.9Operating Income 2,516.90 1,956.50 2,502.90 2,199.90 2,141.60 Interest Income (Expense), Net Non-Operating 0 0 0 0 0Gain (Loss) on Sale of Assets 0 0 0 0 0Other, Net 0 0 0 0 0Income Before Tax 2,516.90 1,956.50 2,502.90 2,199.90 2,141.60 Income Tax - Total 610.2 469.8 619.5 708.4 749.6Income After Tax 1,906.70 1,486.70 1,883.40 1,491.50 1,392.00 Minority Interest 0 0 0 0 0Equity In Affiliates 0 0 0 0 0U.S. GAAP Adjustment 0 0 0 0 0Net Income Before Extra. Items 1,906.70 1,486.70 1,883.40 1,491.50 1,392.00 Total Extraordinary Items 0 0 0 0 0Net Income 1,906.70 1,486.70 1,883.40 1,491.50 1,392.00

Assets2010 2009 2008 2007 2006

Cash and Short Term Investments 5,145.90 3,455.10 2,776.10 2,847.00 2,303.00Cash & Equivalents 3,079.10 2,291.10 2,133.90 1,856.70 954.2Short Term Investments 2,066.80 1,164.00 642.2 990.3 1,348.80

Total Receivables, Net 2,649.80 2,883.90 2,795.30 2,494.70 2,382.90

Accounts Receivable - Trade, Net 2,649.80 2,883.90 2,795.30 2,494.70 2,382.90

Accounts Receivable - Trade, Gross 2,766.50 2,994.70 2,873.70 2,566.20 2,450.50

Provision for Doubtful Accounts -116.7 -110.8 -78.4 -71.5 -67.6Total Inventory 2,040.80 2,357.00 2,438.40 2,121.90 2,076.70Prepaid Expenses 873.9 765.6 602.3 393.2 380.1Other Current Assets, Total 248.8 272.4 227.2 219.7 203.3Total Current Assets 10,959.20 9,734.00 8,839.30 8,076.50 7,346.00

Property/Plant/Equipment, Total - Net 1,931.90 1,957.70 1,891.10 1,678.30 1,657.70Goodwill, Net 187.6 193.5 448.8 130.8 130.8Intangibles, Net 467 467.4 743.1 409.9 405.5Long Term Investments 0 0 0 0 0

Note Receivable - Long Term 0 0 0 0 0

Other Long Term Assets, Total 873.6 897 520.4 392.8 329.6Other Assets, Total 0 0 0 0 0Total Assets 14,419.30 13,249.60 12,442.70 10,688.30 9,869.60

Liabilities and Shareholders' Equity 2010 2009 2008 2007 2006

Accounts Payable 1,254.50 1,031.90 1,287.60 1,040.30 952.2Payable/Accrued 0 0 0 0 0Accrued Expenses 1,610.10 1,593.60 1,089.30 876.9 968.8

Notes Payable/Short Term Debt 138.6 342.9 177.7 100.8 43.4

Current Port. of LT Debt/Capital Leases 7.4 32 6.3 30.5 255.3

Other Current Liabilities, Total 353.6 276.6 760.6 535.5 392.7

Total Current Liabilities 3,364.20 3,277.00 3,321.50 2,584.00 2,612.40 Total Long Term Debt 445.8 437.2 441.1 409.9 410.7Long Term Debt 445.8 437.2 441.1 409.9 410.7Deferred Income Tax 855.3 842 854.5 668.7 561

Minority Interest 0 0 0 0 0Other Liabilities, Total 0 0 0 0 0Total Liabilities 4,665.30 4,556.20 4,617.10 3,662.60 3,584.10

Redeemable Preferred Stock 0.3 0.3 0.3 0.3 0.3

Preferred Stock - Non Redeemable, Net 0 0 0 0 0Common Stock 2.8 2.8 2.8 2.8 2.8Additional Paid-In Capital 3,440.60 2,871.40 2,497.80 1,960.00 1,447.30

Retained Earnings (Accumulated Deficit) 6,095.50 5,451.40 5,073.30 4,885.20 4,713.40Other Equity, Total 214.8 367.5 251.4 177.4 121.7Total Equity 9,754.00 8,693.40 7,825.60 7,025.70 6,285.50

Total Liabilities & Shareholders’ Equity 14,419.30 13,249.60 12,442.70 10,688.30 9,869.60

Cost of Capital

• A. Methodology Perhitungan Weight

• B. Cost of DebtYTM Valuation

Bond Price 95.6 , n=40 , coup = 6.75%/2

YTM = 3.58*2 = 7.16%

Capital Sources BVDebt : Current Long-term Debt 7.40Notes Payable 138.6Long Term Debt 445.8 591.80 5.7%Equity 9,754.00 94.3%Total Capital 10,345.80

• C. Cost of Equity

• D. WACC/Cost of Capital

CAPM = RF + B *RPM

= 4.12% + 0.96 * (7.5%-4.12%)

= 7.3648%

WACC = Kd (1-t) * Wd + Ke * We

= 7.16% * (1-38%) * 5.7% + 7.36% * 94.3%

= 7.19%

Nike’s Stock Value

2010 2009 2008 2007 2006Operating Income 2,516.90 1,956.50 2,502.90 2,199.90 2,141.60Taxes (38%) 956.422 743.47 951.102 835.962 813.808NOPAT 1,560.48 1,213.03 1,551.80 1,363.94 1,327.79CAPEX -49.2 443.2 340.4 83.8 Change in NWC 1138 939.2 25.3 758.9 FCF 471.68 -169.37 1,186.10 521.24 Enterprise Value (6%) 43101.61Debt 591.8Equity Value 42509.81Shares Outstanding 484Stock Value $87.83019 Current Price $81.1Enterprise Value (6.25%) 55072.29Debt 591.8Equity Value 54480.49Shares Outstanding 484Stock Value $112.563