Nike Cost of Capital

CASE 14 NIKE, INC.: COST OF CAPITAL

On July 2001, Nike Inc.’s share price had declined significantly from the beginning of the year. Kimi Ford, portfolio manager at North Point Group, a mutual- fund management wanted to buy some shares for the fund. Kimi Ford read all the analyst’s reports about Nike Inc., but the reports gave her no clear guidance. Some analysts recommended a strong buy, and others recommended a hold (Bruner, 2010).

Reading all the reports, Ford decided to develop her own discounted cash flow forecast. According to her forecast, at 12% discount rate, Nike was overvalued at its current share price of $42.09. However, her sensitivity analysis showed that Nike was undervalued at discount rates below 11.17% (Bruner, 2010).

In this case analysis, I will try to estimate Nike’s Cost of Capital using different approaches.

The Weighted-Average Cost of Capital (WACC)

In order to find WACC, first we should calculate the Nike’s Cost of Equity.

COST OF EQUITY

According to the Nike’s Consolidated Income Statement in 2001 Nike has 273.3 average shares outstanding (diluted). Equity value per share is $37.27 and Current Share Price is $42.09 (at 11.17% discount rate).

Total Equity on a Book Value basis is about 273.3 x 37.27= $ 10185.891

Total Equity on a Market Value basis is about 273.3 x 42.09= $ 11503.197

Using the CAPM to estimate the cost of equity, we need the following information

Historical Equity Risk Premiums(1926-1999)

Geometric Mean 5.90%

Arithmetic Mean 7.50%

Exhibit 4, Case Studies in Finance (Bruner, p214)

Current Yields on US Treasuries

3-month 3.59%

6-month 3.59%

1-year 3.59%

5-year 4.88%

10-year 5.39%

20-year 5.74%

Exhibit 4, Case Studies in Finance (Bruner, p214)

Nike Historic Betas

1996 0.98

1997 0.84

1998 0.84

1999 0.63

2000 0.83

6/30/2001 0.69

Exhibit 4, Case Studies in Finance (Bruner, p214)

My assumption using CAPM model

Market Risk Premium = 7.50%

The reason I used 7.50% as my Market...