Case Study –Nike, Inc.: Cost of Capital
FIN202a-Spring 2011

1. Please define Weighted Average Cost of Capital (WACC). Write down the WACC formula, and discuss its components.

WACC (Weighted Average Cost of Capital) is a market weighted average, at target leverage, of the cost of after tax debt and equity. It is a critical input for evaluating investment decision, and typically the discount rate for NPV calculation. And it serves as the benchmark for operating performance, relative to the opportunity cost of capital employed to create value.

Algebraically, it is given by

WACC = [E/(E + D)] *re + [D/(E + D )]*rd * (1-t)
Where WACC= Weighted Average Cost of Capital
re = cost of equity
rd = cost of debt
E = market value of equity
D = Market value of debt
t = tax rate

2. Calculate cost of equity using the Capital Asset Pricing Model (CAPM). Given are the values:
Rf = 5.74%
β = 0.8
Rm – rf = 5.9%
Required to calculate the cost of equity re; using CAPM.
It follows that from our formula
Re = rf + β (Rm –rf)
= 5.74% + 0.8 (5.9%)
= 10.46%
Assumptions:
We decided to use the 20 year treasury risk free rate value of 5.74% because it is a conservative value for such a period of time; and having covered such a span of time compensates for volatility. The average beta (β) of Nike firm from 1996-date which is 0.80 appears to be the best for such an analysis, so we adopt it as well.

3. We have discussed in class the dividend discount model (DDM)as an alternative method to calculate cost of equity:

Re = (D1/P0) + g

Re = Cost of equity
D1 = Expected dividends
P0 = Current share price
g = Expected dividend growth rate

Calculate cost of equity using the dividend Discount Model (DDM). Compare your estimate using the dividend discount model to your estimate from the CAPM. Which estimate makes more sense to you?

Re=D1/P0 + g
=D0(1 + g)/P0 + g
= 0.48*(1 + 5.5%)/42.09 + 5.5%
= 6.7%

...NikeInc. Case Number 2
Nike Incorporated’s cost of capital is a vital element when addressing opportunities regarding top-line growth and operating performance. Weighted Average Costs of Capital (WACC) is an essential estimation that is needed in order to determine the amount of interest that will be paid for each additional dollar financed. This translates to be the minimum overall required rate of return that the firm will keep. We disagree with Johanna Cohen’s assessment of Nike due to two factors.
The first distinction we have made is in the way in which Cohen calculates the cost of debt. As she stated in her memo, Cohen calculates the cost of debt by taking the total interest expense for the year and dividing it by the company’s average debt balance; whereas we calculated the yield to maturity (YTM) of a twenty year debt using the 6.75% coupon paid semi-annually as seen on the third page in our calculations. The second distinction that was made is Cohen’s use of the book value of equity in determining its percentage of total capital. Cohen’s use of book values gives her an equity weight of 27% and debt weight of capital of 73%. We, instead, calculated the weights of equity based upon the market value of equity, which gave us an equity weight of 89.8% along with a debt weight of...

...Nike Valuation
At North Point Group we believe we have developed the formula for investing success. As you know better than anyone, our Large-cap fund has exceeded all possible expectations in recent years as it outperformed the S&P 500 by 30% with respect to returns in 2000 and has continued the trend into 2001; as of the end of June 2001 it has already produced returns of 6.4% while the S&P 500 has continued to struggle producing a return of -7.3%. We believe these results are made possible by our “workhorses” of the market as we like to call them. For those of you that don’t know these “workhorses” are our holdings in companies that have been there through the history of modern America. These companies are those such as 3M, General Motors, McDonalds, and ExxonMobil, which have gone through the many roller-coaster type rises and falls that defines our nation’s economy and has utilized these experiences to prosper and grow step for step with our nation.
We are here today to share and discuss our recent findings in our search for another candidate worthy of investment from our Large-Cap Fund. The company originally named “Blue Ribbon Sports,” now NikeInc. has caught our attention. Initially known for their athletic performance shoes, Nike has developed itself into a sporting good and apparel monster while maintaining their domination in the athletic shoe sector over the last fifty years. In 1997,...

...tasked with analyzing Nike and coming up with a valuation for Nike so that her company can decide whether it is a good investment or not. She found that at a discount rate of 12% the company is overvalued, while with a slight decrease in the discount rate, to 11.7% the company is undervalued. In order to value the company correctly an accurate cost of capital must be estimated.
Analysis
An analysis of cost ofcapital is based on company financials as well as market trends and forecasts. There should only be once cost of capital estimated for the company since so many of its segments share the same general risk and growth factors, aside from their non-Nike brand lines. However, they only comprise 4.5% of company revenues and are relatively insignificant.
One of the first errors regarding the analysis in the case is that the employee calculated equity as a portion of total capital based on the company book value of $3,494.5. It is more appropriate to value the equity based on current market value. The current market value of the firm as shown in the analysis is 11,427.44 (in millions). Therefore the weights of debt and equity are 11.27% & 88.73%, respectively.
The cost of debt was calculated incorrectly. The cost of debt should be based on the yield to maturity and on expected...

...Nike, Inc.: Cost of CapitalCase 15
Financial Administration
FINC 5713-180
Team 1
Fall 2013.
October 8, 2013.
Introduction
Kimi Ford a portfolio manager at NorthPoint Group which is a mutual-fund management firm, is considering to buy some shares from Nike, inc even if it’s share price had declined from the beginning of the year, for the Northpoint Large-cap fund she managed which invested mostly in Fortune 500 companies and it was doing well despite the decline in the stock market over the last 18 months. Kimi therefore surveyed the results of Nike’s fiscal-year 2001which had been revealed a week earlier.
Issues that caused a decline in market sales as revealed by the management of Nike
1. Revenues since 1997 had stopped growing but remained around $9.0 billion.
2. The net income had fallen from $800m to $580m a decline of $220 million.
3. Nike’s market share in the U.S. athletic shoe industry had fallen from 48 percent in 1997 to 42 percent in 2000 (6% decline)
4. The issue of Supply-chain and strong dollar exchange rate also affected the revenue negatively.
Nike’s Strategic plan to address the above issues
1. Increase revenues by developing more athletic-shoe products in the mid-priced range.
2. Push its apparel line which had performed tremendously well.
3. Exert more expense control on the cost...

...Nike, Inc. : Cost of Capital
1. Do you agree with Joanna Cohen’s WACC calculation?
No, there are several wrong assumptions made by Joanna Cohen in calculating Nike’s WACC:
* In estimating the cost of debt, Cohen taking total interest expense for the year 2001 and dividing it by the company’s average debt balance to get 4.3%. Cohen should use YTM of Nike’s bond to calculate the cost of debt.
* In estimating the cost of equity, Cohen uses average beta from 1996 to July 2001, 0.80. She should use a beta that is most representative to future beta which is the most recent beta, 0.69.
* Cohen uses Nike’s book value of equity $3,494.5. She should use market value of the stocks when calculating the cost of equity
2. Calculate your own WACC!
* Capital Structure
Assumption: Market value of stock
* Debt
Current portion of long term debt $ 5.4
Notes payable 855.3
Long-term debt 435.9
$ 1,296.6
* Equity (current price $42.09 x 271.5 million shares) $ 11,427.4
$ 12,724.0
* Cost of Debt
Assumption: YTM of Nike’s bond
Current price= $95.6
N=20x2=40 (semi-annually)
Payment= -6.75/2= -3.375
Future Value=$100
Semi-annual rate= 33.58% , annual rate= 7.16% =RATE(40,-3.375,95.6,-100)
Cost of debt= 7.16%x(1-38%)= 4.44%
*...

...evaluating Nike, Inc. (“Nike”) to potentially buy shares of their stock for the fund she manages, the NorthPoint Large-Cap Fund. This fund mostly invests in Fortune 500 companies, with an emphasis on value investing. This Fund has performed well over the last 18 months despite the decline in the stock market.
Ford has done a significant amount of research through analysts’ reports, which had mixed reviews. She found no clear guidance from the analysts and decided to develop her own discounted cash flow forecast to come to a conclusion. Her forecast showed that Nike was overvalued at its current share price causing a discount rate of 12%; however, a quick sensitivity analysis showed that Nike was undervalued at a discount rate below 11.17%.
Ford then asked her assistant, Joanna Cohen, to estimate Nike’s cost of capital, which, per Cohen’s analysis, came to 8.4%.
Background
The cost of capital is the minimum return that a company should make on an investment or the minimum return necessary for investors to cover their cost. Two main factors of the cost of capital are the cost of debt and the cost of equity.
The capital used for funding a business should earn returns for the investors who risk their capital. For an...

...Executive summary
In this report we focus on Nike's Inc. Cost of Capital and its financial importance for the company and future investors. The management of NikeInc. addresses issues both on top-line growth and operating performance. The company's cost of capital is a critical element in such decisions and it is important to estimate precisely the weighted average cost ofcapital (WACC).
In our analysis, we examine why WACC is important in decision making and we show how WACC for NikeInc. is calculated correctly. Also, we calculate the company's cost of equity using three different models: the Capital Asset Pricing Model (CAPM), the Dividend Discount Model (DDM) and the Earnings Capitalization Model (EPS/ Price), we analyze their advantages and disadvantages and finally we conclude whether or not an investment in Nike is recommended.
Our analysis suggests that NikeInc.'s common stock should be added to the North Point Group's Mutual Fund Portfolio.
I. The Weighted Average Cost of Capital and its Importance for NikeInc.
The Weighted Average Cost of Capital (WACC) is the average of the costs of a company's sources of financing-debt and equity, each...

...1. Weighted Average Cost of Capital (WACC) is used to determine the average cost of financing a company. Companies are funded using both debt and equity and both require varying rates of return. WACC allows you to put a “weight” on the different types of financing and their differing rates to get a total cost of capital.
Team 12 does not agree with Joanna Cohen’s WACC calculation because we feel she took some liberties in her numbers, the most notable being that of equity. Ms. Cohen used book equity, which was $3,494,500,000. Since Nike is a publicly traded company, the stock price should be multiplied by the number of shares outstanding in order to get the true equity of the firm. 271,500,000 multiplied by $42.09, would give you $11,427,435,000 in equity.
In Ms. Cohen’s calculation debt was 27% of total financing and equity was 73%. When using market value for equity those numbers change to 10.2% for debt and 89.8% for equity.
2. Using the following numbers and inputs, our WACC is 9.53%:
To calculate the cost of debt the yield of Nike’s publicly traded debt is utilized:
● N = 40 (semi-annual coupon, 2 x 20)
● PV = $95.60
● PMT = 3.375 (semi-annual coupon, half of 6.75)
● FV = 100 (Amount of debt in future)
Inserting the numbers above in our calculations result in 3.583724 for the I/YR which is multiplied by two to get an annual rate of...

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