Book value vs. Market value
While calculating the Nike’s cost of capital using both the book value (Exhibit 1.1) and the market value (Exhibit 1.2), I could notice the mistake Cohen made finding the equity value. Cohen used the book value to reflect equity value. Although the book value is an accepted measure to estimate the debt value, the equity’s book value is an inaccurate measure of the value perceived by the shareholders. Since Nike is a publicly traded company, market value is the better method in reflecting Nike’s equity value.
Cohen’s book value of equity is the total shareholder’s equity in the balance sheet, $3494.5. The market value of equity on the other hand, is $11427; computed using stock price X number of shares outstanding ($42.09*271.5 million shares), which is also commonly exercised computing market capitalization of a company in an industry. The book value of equity used by Cohen is very different from the market value of equity. Therefore the weight of debt and equity also differ greatly. Cohen found that Nike is financed by 27% on debt and 73% on equity, but using the market value to better reflect Nike’s debt and equity, I found that Nike is financed by 10.19% on debt and 89.81% on equity. The differences are bigger than it looks, as we are talking about millions of dollars being calculated inaccurately, so it is important for portfolio managers like Kimi Ford to carefully assess the assumptions that are needed to calculate the cost of capital of Nike.
Cost of Debt and Equity
Cohen’s calculation for finding the cost of debt for Nike was “total interest expense divided by average debt balance”. I believe this isn’t a good enough calculation because the investors want to know the cost of debt on new debt, not on already outstanding debt. So to calculate a better cost of debt, I used the 20-year Nike Inc. debt with 6.75% coupon paid semi-annually (Exhibit 1.2) to find the yield to maturity. I took an...