Cost of capital denotes the opportunity cost of using capital for a particular investment as oppose to the alternative investment which has similar systematic risk. It is extremely important since it is used in evaluating whether a project is feasible or not in the net present value (NPV) analysis, or in assessing the value of an asset.
WACC (weighted average cost of capital) is the proportional average of each category of capital inside a firm (common shares, preferred shares, bonds and any other longterm debt). WACC is also called required return. The term required return tends to reflect an investor’s point of view, while cost of capital is the same return only from the firm’s point of view. WACC is the rate of return required by the capital provider in exchange for giving up the opportunity of investment in another project or business with similar risk. Therefore, WACC is set by investors, not by managers. It cannot be observed it can only be estimated. I do not entirely agree with Joanna Cohen’s WACC calculation. I believe she made the following mistakes: 1. She is wrong to use book values in debt and equity weights calculations. WACC is market driven. It is the expected rate of return that the market requires to commit capital to an investment. Therefore, the base against which the WACC is measured is market value, not book value. 2. In calculations of the cost of debt she used historical data. She divided the interest expense by the average debt balance. The purpose of WACC is to reflect company’s current and future ability to raise capital. Data used in the case will not reflect future perspectives. Cost of debt should be estimated by yield to maturity of bond. 3. In calculations of the cost of equity the average of betas from 1996 to present is being used. This method of beta estimation seems to be too retrospective. Theory calls for a forwardlooking beta. However since it is unobservable over...
...Nike, Inc.: Cost of Capital
Case14
A Case Brief Submitted to
Submitted by
In Partial Fulfillment of the Requirements for
Date Submitted
September 28, 2011
Summary
This case highlights Kimi Ford, a portfolio manager with NorthPoint Group, a mutualfund management firm. She managed the NorthPoint LargeCap Fund, and in July of 2001, was looking at the possibility of taking a position inNike for her fund. Nike stock had declined significantly over the previous year, and it appeared to be a sound value play. Nike had held an analysts’ meeting one week earlier to release the company’s fiscal results for 2001. Apparently Nike had an ulterior motive; the management wanted this opportunity not only to release their fiscal results, but to convey a strategy to revitalize the company as well. Revenues had been relatively flat since 1997, and net income had decreased over that time (EXHIBIT 1). They had lost 6% of the market share, realized some supplychain problems, and were suffering negative effects as a result of the strengthening U.S. dollar.
At the analysts’ meeting Nike unveiled plans to remedy both the revenue growth, or lack of, and the operating performance. The company planned to grow revenues through the development of more midpriced athletic shoe products, and by putting more emphasis on their apparel...
...the company has to pay for every dollar it finances. Basically, the WACC is the minimum required return that the company must earn to satisfy its creditors, owners, and other providers of capital, or they will invest in another company that has higher returns. In this case, I will first address the issues with Cohen’s calculation, and then analyze an new WACC to decide whether we should invest in Nike Inc.
Many issues should be addressed regarding Joanna Cohen’s WACC calculation. First, to calculate the debt cost of capital, Cohen divided the total interest expense by the company’s average debt balance. This is an issue because she did not take into account the current yield on publicly traded Nike debt. Another issue that should be addressed is the calculation of the equity cost of capital. Using CAPM, Cohen took a 20 year Treasury bond as her risk free, the average Beta for the last 6 years, and a geometric mean for market premium. Also, Cohen calculated the book value of equity and debt instead of using market values.
In my analysis, I will argue about choosing different numbers than Cohen to get a more accurate WACC. For the calculation of debt cost of capital, I used the current yield on publicly traded Nike debt to get a market value for the debt and not the book. Having the 6.75% coupon rate paid semiannually, 20 years to maturity, and the current price of $95.60, the debt cost of capital would be estimated...
...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 interestbearing 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 ofNike 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 (DDM) is a simple model to evaluating equity. It is good for investor to...
...Corporate Finance
Nike, INC: Cost of capital
1. What is the WACC and why is it important to estimate a firm’s cost of capital? Do you agree with Joanna Cohen’s WACC calculation? Why or why not?
Definition of WACC (Weighted Average Cost of Capital):
WACC is basically the average of the cost of finance (debt and equity). Since a company’s assets can be financed by debt or equity, WACC can show the averages of the costs involved in the sources of financing. These costs are then weighted by the users of the information as required in a specific situation. This shows how much both debt holders expect to pay in interest and how much return the shareholder can expect to receive, for each dollar of financing (Investopedia, ND).
The calculation of the cost of capital is one of the important elements that decide the enterprise value. The value of the enterprise can significantly change when the percentage of cost of capital changes in the business model, with the cost of capital representing the expected return for shareholders.
We disagree with Joanna’s WACC calculation for following reasons: The calculations of WACC and DCF can be effected as they are subjective by her human judgment. Even though there are no right answers to make these decisions, our team disagrees with some of the assumptions Joanna Cohen made.
i. ‘Ratio of debt financing’ and ‘Ratio of equity financing’
It has to be applied the market value because...
...NIKE, INC.: COST OF CAPITAL
Professor Meiberger
By Sebastian Gomez
Team 5
Cohort: Front
The portfolio manager for NorthPoint Group, Kimi Ford was deciding if she should pitch in and draw Nike within NorthPoint LargeCap Fund. Nike, which did not have the strongest fiscal year results in 2001, was implementing new strategies to heighten its revenue and income. Kimi Ford, after having carefully read reports by analyst, and their input within this publicly traded company decided to emphasize its attention in the cost of capital and the financial stability of the company. Before one invests in a company, it is important for the investor to be aware of the company’s cost of capital, and to know what is the firm weighted average cost of capital (WACC).
Within this report I emphasize the importance of WACC and why it is an important financial mechanism that all investors should utilize before investing in a company. I calculated Nike’s weighted average cost of capital into two separate parts to truly understand the pros and the cons within this firm. Having deeply analyzed the company’s cost of capital into different segments, I will make a recommendation if it is a wise decision for NorthPoint Group to include Nike within its outperforming portfolio.
A company finances its assets either by debt or equity. The Weighted Average Cost of Capital (WACC) is a financial estimate that equally evaluates the...
...Nike Valuation
At North Point Group we believe we have developed the formula for investing success. As you know better than anyone, our Largecap 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 rollercoaster 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 LargeCap Fund. The company originally named “Blue Ribbon Sports,” now Nike Inc. 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, Nike reached...
...Introduction
Nike’s leadership has been meeting to address issues and provide suggestions to boost revenue. The targets provided by management included longterm revenue growth of 810% and earnings growth above 15%. Kimi Ford, a portfolio manager at NorthPoint Group has been 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 of capital 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 nonNike 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...
...
NIKE, INC.: COST OF CAPITAL 





Introduction
Our report aims to help Kimi Ford make a decision on her investment of Nike. We choose WACC as our method to estimate the cost of capital, which can be used as a discount rate to verify whether Nike is correctly valued in current market.
We have mainly four steps to calculate WACC: I. Identify the type of cost of capital; II. Figure out the weights of debt and equity; III. Calculate the cost of debt and equity respectively; IV. Get WACC.
After our analysis, we conclude that Nike is undervalued at its current share price and recommend buying this stock.
I. Single or multiple costs of capital
We decide to apply single cost of capital, because all segments of Nike are in sportsrelated industry and have similar risk premiums.
II Methodology for calculating the cost of capital
While we agree that the WACC is appropriate for calculating cost of capital, we think it is better to apply market value of cost and debt than book value. Book value is certainly accessible and not volatile, but cost of capital under book value is much conservative and cannot reflect the real economic trend. The market value of equity is $11,427.44, which is a multiple of current share price ($42.09) and current shares outstanding (271.5) .To calculate MV of debt, we assume that all longterm debt are publicly traded and get their present value...
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