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    Cost of Equity for Under Armour

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    The Cost of Equity for Under Armour

    Estimate the cost of equity or the rate of return Under Armour shareholders ââ?¬Å"require.ââ?¬Â? This is an important piece of information that every top manager must be able to estimate because it will be an important input in any effort to determine whether any particular course of action by the company will or will not add value to the shareholders.

    Use the Capital Asset Pricing Model (CAPM) in order to estimate the rate of return that Under Armour shareholders require on their investment as expressed in percentages or in a decimal format.

    The CAPM states the following equilibrium relationship between the (excess) rate of return that shareholders of a particular company "j" require (or actually in some sense 'deserve' if they fully diversify their investments) and the (excess) expected rate of return on the market portfolio:

    Rj - RF = Ã?²j [RM - RF]

    It follows that the rate of return that shareholders require or expect to earn on their investment in the shares of the company, or 'the cost of equity' is:

    Rj = RF + Ã?²j [RM - RF]

    Most companies obtain an estimate by using the ââ?¬Å"betaââ?¬Â? or systematic risk coefficient, on the annual rate of return on a risk-free investment, and on the expected rate of return on the ââ?¬Å"market portfolio.ââ?¬Â?

    What is Under Armour's present Yield to Maturity (YTM) on a US Government bond that matures in one year. That rate is the ââ?¬Å"risk-free rate.ââ?¬Â?

    Next, it is customary to assume that the difference between the expected rate of return on the ââ?¬Å"market portfolioââ?¬Â? and the risk-free rate of return is about 7.0%. This is the expression [RM - RF]. So, if for example, the risk-free rate of interest is, say, 3% per year, than the expected rate of return on the ââ?¬Å"market portfolio,ââ?¬Â? RM, is 10%. So, multiply the ââ?¬Å"betaââ?¬Â? of your SLP Company by 7.0%. That will be the equivalent of your company's Ã?²j [RM - RF]. Then add to that number the current yield to maturity on a US Government bond [see step (1) above]. You can also assume that RF = 3, RM =10 and [RM - RF]= 7.

    1) What is the cost of equity for Under Armour?

    2) Is this cost of equity higher or lower than expected? The average cost of capital for a firm in the S&P 500 is 10.2 percent. Would you think Under Armour firm should have a lower or a higher cost of capital than the average firm?

    3) Compare betas for some of the Nike and Puma. How do their betas compare to Under Armour?

    4) Explain how would you go about finding the cost of equity using the dividend growth model or the arbitrage pricing theory for Under Armour? explain how to go about doing these calculations and if any additional information is needed?

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    Solution Preview

    The Cost of Equity for Under Armour

    Estimate the cost of equity or the rate of return Under Armour shareholders ââ?¬Å"require.ââ?¬Â? This is an important piece of information that every top manager must be able to estimate because it will be an important input in any effort to determine whether any particular course of action by the company will or will not add value to the shareholders. Use the Capital Asset Pricing Model (CAPM) in order to estimate the rate of return that Under Armour shareholders require on their investment as expressed in percentages or in a decimal format.
    The CAPM states the following equilibrium relationship between the (excess) rate of return that shareholders of a particular company "j" require (or actually in some sense 'deserve' if they fully diversify their investments) and the (excess) expected rate of return on the market portfolio:
    Rj - RF = Ã?²j [RM - RF]
    It follows that the rate of return that shareholders require or expect to earn on their investment in the shares of the company, or 'the cost of equity' is:
    Rj = RF ...

    Solution Summary

    Cost of Equity for Under Armour

    $2.19

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