27 October 2014
Nike, Inc. Cost of Capital Executive Summary
In this case, we were asked to compare Kimi Ford’s new assistant, Joanna Cohen’s calculation of Nike Inc.’s WACC to our calculation and find where Ms. Cohen made her errors. This case was very tough, mainly deriving the weights of debt and equity in the WACC formula. To start, Cohen used a single cost of capital, which we agree with. We understand that Nike is such a large company and it would be impractical to calculate different costs of capital for each business segment. Since the majority of Nike’s cash flows are in the footwear and apparel lines, the smaller segments would not make a significant difference. We disagreed with Cohen’s methodology in calculating her WACC. Cohen used the book values as the basis for debt and equity weights. From class, we understand that market values are most appropriate in calculating these weights, due to the fact that we are interested in finding out how much it is expected to cost a company to raise the capital TODAY. This cost we speak of is approximated by the market value of the company’s capital, instead of the book value. The market value of equity is calculated by multiplying the company’s current stock price by its number of outstanding share. The book value of equity does not take into account the company’s growth potential. The market value of debt is typically difficult to calculate, but it has to do with the amount of debt, and it can include all debt or just long-term or short-term, depending on whom is doing the calculations. We also disagreed with Cohen’s calculation of the cost of debt. She calculated the cost of debt using historical information. Since the WACC represents the return that capital providers require today, using historical information is inappropriate. Instead, we used market yields to guage the cost of debt. We understand that the yield to maturity is the proper cost of debt input. As far as...
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