Case Study Nike

Case 14: Nike, Inc. (Cost of Capital)

INDIVIDUAL QUESTIONS

Learning Objectives:

1. An introduction to the calculation of WACC.

2. The case provides a WACC calculation that contains errors based on conceptual misunderstandings.

3. Identify and explain the mistakes in the analysis.

Case Questions:

1. What is the WACC and why is it important to estimate a firm’s cost of capital?

A company’s assets are financed by either debt or equity. Weighted Average Cost of Capital (WACC) is a calculation of a company’s cost of capital in which each category of capital is proportionately weighted. All capital sources are taken into consideration, including common stock, preferred stock, bonds and any other long-term debt. Assume there is no change, the WACC of a firm increases as the beta and rate of return on equity increases. An increase in WACC also indicates a decrease in valuation and a higher risk.

It is important to estimate a firm’s WACC when valuing and selecting investments. The firm’s WACC represents the minimum rate of return at which a company produces value for its investors. If the WACC is greater than the internal rate of return, investors should put their money elsewhere. Internally, a company uses WACC to evaluate potential investment opportunities.

2. Calculate your own WACC for Nike and be prepared to justify your assumptions. (Assume there are some problems with Cohen’s analysis)

Cost of Debt (Kd): 7.16%

N=20x2 (semi-annual), PV=-$95.60, PMT=6.75/2, FV=-$100,

I/Y=3.58

So, kd=3.58*2=7.16

Cost of Equity using CAPM:

Expected Return = r = rf + β(rm-rf)

rf = Risk Free Return

rm= Market Return

Average of Nike Historic Betas = 0.80

(In Exhibit 4 presents the historical Betas for Nike, Inc. The most current beta is 0.69, however, it is only representative of six months of activity. If there are any cyclic patterns within the Nike business or any unanticipated fluctuations in the market, it may not be a good idea to annualize this...