# Nike's Cost of Debt and Equity

**Topics:**Financial ratios, Financial ratio, Dividend yield

**Pages:**8 (2023 words)

**Published:**November 7, 2012

Table of Contents

Cost of Capital2

Value of Equity2

Cost of Equity2

CAPM Model2

Dividend Growth Model3

Value of Debt3

Cost of Debt4

WACC (Weighted Average Cost of Capital)4

Comparison to Joanna Cohen’s Analysis4

Financial Statement Analysis5

Nike Inc.5

Financial Ratios6

Leverage Ratios6

Efficiency Ratios6

Liquidity Ratios7

Profitability Ratios7

Valuation Ratios7

Conclusion8

Appendix A – Ratio Calculation9

Leverage Ratios9

Efficiency Ratios9

Liquidity Ratios9

Profitability Ratios10

Valuation Ratios10

Cost of Capital

Value of Equity

Cohen's calculation considered the book values to calculate the proportion of equity for calculating the value of WACC which should only be done if the target or market values are not available. In order to determine a more realistic cost of equity, it is recommended to use the market value. The current market share price of Nike as of 2001 is $42.09 and there are 271.5 total shares outstanding. Therefore the market value of equity is:

Current share price * Average shares outstanding: (42.09 * 271.5) = $11,427.44 million This figure is much higher than the book value of $3,494.5 million that Cohen used to calculate the value of equity. Cost of Equity

There are two approaches that can be used to calculate the cost of equity: the Dividend Growth Model or the CAPM model. CAPM Model

The formula to calculate CAPM considers three important variables, the Risk Free Rate (RF), the Market Risk Premium (RM - RF) and the company Beta (β). 1. Risk Free Rate: RF = 5.74 (Current yield on 20-year U.S. treasuries) The maturity period for Nike’s current publicly traded debt is 25 years. The closest available information on current risk free yields is for 20-year bonds. 2. Market Risk Premium: (RM – RF) = 5.9% (Geometric mean) Here the geometric mean is used instead of the arithmetic mean as it is better long-term measure of the market risk premium. 3. Company Beta: β = 0.80 (Average)

The formula to calculate CAPM is: Ke = RF + β (RM – RF)

Therefore Ke = 5.74 + 5.9 (0.80) = 10.46%

Dividend Growth Model

The DDM growth model considers the expected dividend growth rate (g), the current annual dividend (d) and the current price of common shares (P0). 1. Dividend Growth Rate: g = 5.5%

2. Current Annual Dividend: d = $0.48

3. Current Share Price: P0 =$ 42.09

The formula for the DDM is: Ke = d (1+g)P0+g

Therefore Ke= 0.48 (1+0.055)$42.09+0.055 = 6.7%

In theory the value derived by DDM should equal the value derived by CAPM. As this is not the case the CAPM model will be used to determine the cost of equity. The CAPM method is preferred in this instance because of the consistently low dividend yield that did not reflect the change in Nike’s earnings during the period of time between 1998 and 2001. Value of Debt

When calculating the value of the debt it is important to separate debt from other types of liabilities in order to get the closest to market value of the actual debt of the company. When interest rates have been relatively stable, the book values debt can be used. In the case of Nike, it is calculated by adding the values of: 1. Current portion of long term debt: $5.4

2. Notes payable : 855.3

3. Long Term Debt : 435.9

Therefore the current value of Nike’s debt is $1,296.6 million. Cost of Debt

When calculating the cost of debt (Kd) the following are considered: the current yield on publicly traded Nike debt and the corporate tax rate (T) and the federal tax rate of 35% plus an average state tax rate of 3% for a total tax rate of 38%: Here the following inputs are used to calculate the cost of debt: 1. PMT = 6.75/2 (as 6.75% is a semi-annual rate) = $3.375 2. Face Value = $100

3. Present Value = $95.60

4. Years (N) = 25*2 (for semi-annual payments) = 50

This gives a yield to maturity (YTM) of 3.56%, multiplied by two for an annual YTM of 7.1296%. To take...

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