Case Study Report of Nike

Case Study – Nike, Inc.: Cost of Capital

Report

Importance of WACC

WACC is the weight average cost of capital, weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is proportionately weighted. Weighted average capital costs can be used to determine the required yield of an average risk investment project. What’s more, the WACC can be used as the minimum return required by investors.

Adjustment for the WACC Calculation

Cost of Debt Estimation

Cost of debt calculation by Cohen in this case is not appropriate regarding that he used average historical ratio as the estimator of cost of debt, which can’t represent the debt ratio in the future. It is much better to use the current market ratio as cost of debt. Referring to exhibit 4, we calculate YTM to estimate the cost of debt:

FV:100,

PV:95.6

COUPON RATE:6.75%

PERIOD:25 YEARS

In this way, the YTM is 7.1296%, which can be used as cost of debt. After-tax yield is 4.4144%.

(Assume that the tax rate is 38% according to exhibit 1)

Cost of Equity Using CAPM

For risk free rate, 20-year Treasury bond is acceptable because Nike is a big company and could have a long life. Thus, the risk-free rate should refer to a long duration rate.

For beta, Cohen assumes the beta is the same as historic beta, we choose to use YTD 6/30/01 beta 0.69 due to the fact that the newest beta can reflect the company’s current situation.

As for the risk premium, geometric mean is better as the discount rate would compound every year. Geometric mean can reflect the compound better than arithmetic mean.

Rf:5.74%; risk premium: 5.9%; beta :0.69;

The cost of equity: 5.74%+5.9%*0.69=9.81%

Weight of WACC

Cohen uses book value to calculate the weight of WACC, however the weight should be calculated by market value because market value can better reflect the market actual situation, which refer more to preferred stock, common stock and bond.

He used the book value to calculate the weight, for the debt part the book value is close to market value. But for equity part, they are not very approximate to each other so we recalculate the weight occupied by debt and equity using the data in EXHIBIT 2 -- the debt is 1296.6 and the equity is 42.09*271.5. After calculation, the corresponding weight is 10.1% and 89.9%.

Adjusted WACC=7.1296%*(1-38%)*10.1%+9.81%*89.9%=9.27%

Cost of Equity Using DDM

From exhibit 4, the dividend growth rate by value line forecast is 5.5%.

Current share price: $42.09

Dividend: $0.48

According to the DDM: Ke= (0.48/42.09) +5.5%=6.64%

Cost of Equity Using Earnings Capitalization Ratio

From the estimation information, the EPS on 2002 is 2.32.

According to the earning capitalization ratio: Ke=2.32/42.09=5.51%

Cost of Equity Estimation

CAPM, DDM and earning capitalization ratio method are used above, by different method different ratio is calculated.