Compass Record Case Study

  This report will tend to analyze the financial importance of computing Nike’s cost of capitalfor the company itself and future investors. We examine why WACC is important in decisionmaking and we will show how WACC for Nike, Inc. is calculated correctly. Also, we calculatethe company’s cost of capital using three different models: the Capital Asset Pricing Model(CAPM), the Dividend Discount Model (DDM) and the Earnings Capitalization Model (EPS/Price), we analyze their advantages and disadvantages and finally we conclude whether ornot an investment in Nike is recommended.

I. The Weighted Average Cost of Capital and its Importance for Nike Inc.

 The Weighted Average Cost of Capital (WACC) is the average of the costs of a company'ssources of financing-debt and equity, each of which is weighted by its respective use in thegiven situation. By taking a weighted average, we can see how much interest the companyhas to pay for every marginal dollar it finances. A firm's WACC is the overall required returnon the firm as a whole and, as such, it is often used internally by company directors todetermine the economic feasibility of expansionary opportunities and mergers. Also, WACCis the appropriate discount rate to use in stock valuation.

II. Calculation of Nike's WACC

We reexamine the calculation made by Joanna Cohen’s and noted the followingdisagreements with her calculations in Exhibit 5:- Calculation of the cost of debt by taking the total interest expense for the year 2001dividing it by the company's average debt balance, which is not appropriate for the WACCestimation- Use of the Book Value of equity rather than the market value which is suggested as it givesmore precise results- Calculation of the cost of equity using long time period of 20-year current yields on U.S. Treasuries for risk free rate and using the geometric mean of historical risk premiums- Shares outstanding used are 271.5 shares, it does not match the diluted share count onthe income...