Nike Inc Cost of Capital

1. WACC is the average cost of financing a company’s assets, either through debt or equity. A firm's WACC is the overall required return on the firm as a whole. It is the appropriate discount rate to use for cash flows with risk that is similar to that of the overall firm.

2. She should use only one WACC for the entire company, not different, as per each business unit.

3. We look at the future debt at the company, not at the historical one. Debt in the past is not relevant. We look at Nike’s bonds. Currently, Nike’s bonds trade for $95.60 with a semiannual 6.75% coupon and mature in almost exactly 20 years. This yields an annual rate of 7.17%, as opposed to 4.3%. We can still use a 38% federal + state tax rate, and thus our final cost of debt is 4.45%.

Same goes for equity: we use the market value of that (current share price multiplied by the number of shares outstanding) to calculate equity.

4. Using the CAPM is a good choice, but using the current yield on 20-year Treasury bonds is not. Because the cost of capital will be used to discount relatively long-term cash flows, it is appropriate to use a relatively long-term risk-free rate, but we should use a more common type of bond to for valuation purposes, such as the yield on a 10-year Treasury bond. Indeed, a survey of highly regarded companies shows two-thirds of them use the rate on 10-year Treasury bonds, and the 5.39% 10-year Treasury is appropriate here.

The arithmetic average often is used as an estimate of next year’s risk premium; this is most appropriate if investor risk aversion had actually been constant during the sample period. On the other hand, the geometric average would be most appropriate to estimate the longer-term risk premium, say, for the next 20 years. Thus we will keep the geometric average of 5.90% that she used.

For beta, we can run a regression, with NKE returns on the Y axis and S&P returns on the X axis. This will yield a slope coefficient of .915, which is the beta for...