Nike Inc Cost of Capital Case Study

Topics: Capital asset pricing model, Weighted average cost of capital, Mathematics Pages: 3 (917 words) Published: November 13, 2012
Nike Inc. 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 10.2% as we also illustrate in our calculation page. The difference in weights for the equity and debt in the capital structure changes the WACC calculation along with the different value for the cost of debt. The CAPM model is a valuable tool used in the estimation of cost of equity but as with many models, there are advantages and disadvantages. The advantages to this model are inherent to its portfolio management principles. The CAPM only considers systematic risk which can be realized in diversified portfolios. A disadvantage of the CAPM can be the difficulting of finding the equity risk premium and the timely beta of the equity. We believe this is a safe method to...
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