Case Study of Nike Company
| NIKE, INC.: COST OF CAPITAL | | | | |
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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 sports-related 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 long-term debt are publicly traded and get their present value $416.73. Then MV of debt ($1,277.42) is the sum of current debt, notes payable and PV of long term debt1.
III Cost of Debt
We estimate the Nike’s pre-tax cost of debt 7.2% and after-tax cost of debt 4.46%.
First of all, we try to use YTM of Nike’s long-term debt as its cost of debt. In 2001, Nike has a 25-years publicly traded debt, which still has 20 years to maturity, so we calculate the YTM of this debt as 7.17%2.
Another way to calculate the cost of debt is to use its rating and a typical default spread, since Nike is a rated company. Its rating in 2001 is A13
|
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 sports-related 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 long-term debt are publicly traded and get their present value $416.73. Then MV of debt ($1,277.42) is the sum of current debt, notes payable and PV of long term debt1.
III Cost of Debt
We estimate the Nike’s pre-tax cost of debt 7.2% and after-tax cost of debt 4.46%.
First of all, we try to use YTM of Nike’s long-term debt as its cost of debt. In 2001, Nike has a 25-years publicly traded debt, which still has 20 years to maturity, so we calculate the YTM of this debt as 7.17%2.
Another way to calculate the cost of debt is to use its rating and a typical default spread, since Nike is a rated company. Its rating in 2001 is A13