(Luz’s answer for discussion question #1 should go here)
Based on her calculations, Joanna Cohen estimated that Nike’s cost of capital was approximately 8.4%. Ms. Cohen used a single Weighted Average Cost of Capital to calculate the firm’s cost of capital, and we agree that only a single cost of capital needs to be used due to the similarities between more than 95% of their revenues. However we believe that the cost of capital calculation is inaccurate based on some of the information that Cohen gives while explaining the figures used in the WACC formula. Capital Weights:
Ms. Cohen calculated the weight of debt to be 27% and equity to be 73% based on the book values found in Nike’s consolidated balance sheet from May 31, 2001 (see Exhibit 1). Total debt was found by adding together all interest-bearing debt on the balance sheet, which we agree is the most accurate way to estimate its weight. However, using book values for equity is not the most accurate way to measure the capital weights; instead we used market value based on the share price of Nike on July 5, 2001and number of shares outstanding, which resulted in the weights of debt and equity of 10.2% and 89.8% respectively (see Exhibit 2). Cost of Debt:
Cost of debt was calculated by Ms. Cohen by finding the historical interest rate of 2.7% and tax rate of 38%. We agree with her estimation of the tax rate of 38%, but calculated a cost of debt of 7.17% based on the market price of Nike bonds and finding their yield to maturity (see Exhibit 3). This cost of debt is more accurate for estimating the cost of capital for Nike, while Cohen’s estimation identifies a past cost of debt, ours reflects current and future figures better. Cost of Equity:
There are total three methods to evaluate Cost of equity, Dividend discount model (DDM Model), Capital assets pricing model (CAPM Model) and the Earnings Capitalization Model (EPS/ Price). The dividend discount model...
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