Nike,

Cost of Capital
 Case Overview

NorthPoint Large Cap Fund manager Kimi Nike has revealed that it would increase
Ford considering whether to buy Nike’s exposure in mid-price footwear and apparel
stock. lines. It also commits to cut down expenses.

Nike has experienced decline in sales
growth, profits and market share.
The market responded mixed signals to
Nike’s changes. Kimi Ford has done a cash
flow estimation, and ask her assistant,
Joanna Cohen to estimate the firms cost of
capital.
Cost of Capital :
Theoritical Review
Term used in the field of financial investment to refer to the cost of a
company’s funds (both debt and equity)

Cost of Debt :
The amount of interest being paid by a company on all of
the debts that it has incured.
Cost of Equity
The common stockholders’s required rate of return.
Weighted Average Cost of Capital (WACC)
Cost of acquiring debt and/or equity capital, computed on the basis of
interest rate, income tax rate, and return on equity goal. Expressed
usually as a percentage, it is used as a discount rate to deteermine
present value of specific investments
 Case Analysis
Let’s start the analysis with the set of slides

Case Analysis
 Single or Multiple Costs of Capital

We think, the use of single cost instead of multiple cost of capital that used
by Joanna is correct. Using single cost (in this case, we estimate WACC), will
help us to value the cash flows for the entire firm. Besides that, Nike’s
business segments basically have about the same risk, so a single cost is
sufficient for this analysis.
 Methodology for calculating the cost of capital : WACC
The proportion that made by Joanna is not correct. Based on the
available balance sheet, we re-calculate the proportion of the
debt and the equity below:

Debt Capital
Structure
Current portion of long-term debt $5,400,000
Notes Payable $855,300,000
Long-term Debt
$435,900,000

Total Current outstanding Debt $1,296,600,000 10.2%

Equity
Current Share outstanding 271,500,000
Current Share price $ 42.09
Total Equity $11,427,435,000 89.8%

Total Debt and Equity 100%

$12,724,035,000
 Cost Of Debt
To calculate the cost of debt, it is better use yield to maturity
method because it is generally use by almost people. We use the
data provided in Exhibit 4 and use current maturity to represent
Nike’s current cost of debt.

Settlement 05-Jul-01
Maturity 05-Jul-21
Coupon Interest Rate 6.75%
Par Value $ 100

Frequency for payment

2
interest (semi annual)

Current Price $ 95.6

Before tax Cost of Debt (rd) 7.17%

Tax 38.00%
After-tax Cost of Debt (ri) 4.45%
 Cost Of Equity
Here, we use 3 methods for estimating the cost of equity as a
comparison. We use all Dividend-Discount Model (DDM),
earnings-capitalization ratio or new common stock, and Capital-
Asset-Pricing Model (CAPM)

Dividend -discount Model New Common Stock (rn) D1/Nn + g

D1/Ns + g
(DDM) Current Price (Nn) 95.6
Dividend Growth (g) 5.50% Dividend (D1) 0.48
Current share price (July 5, $ Dividend Growth (g) 5.50%
2001) 42.09
New Common Stock (rn) 6.00%
Dividend (D1) 0.48
DDM 6.64%

Capital-asset-pricing Model
Rf + (Beta x (rm-Rf))
(CAPM)
Risk Free Rate (Rf) 5.74%
Beta 0.69
Risk Premium Rate (rm-Rf) 5.90%
CAPM (rs) 9.81%
 Putting it all together
Weight Cost Weighted Cost
WACC using YMT and DDM
(1) (2) (1 x 2)
Debt 1296.6 10.19% 4.42% 0.45%
Equity (DDM) 11,427.44 89.81% 6.64% 5.96%
Total 12724.04 100% 6.41%

Weighted
WACC using YMT and New Weight Cost
Cost
Common Stock
(1) (2) (1 x 2)
Debt 1296.6 10.19% 4.42% 0.45%
Equity (New Common Stock) 11,427.44 89.81% 6.00% 5.39%
Total 12724.04 100% 5.84%

Weight Cost Weighted Cost

WACC using YMT and CAPM
(1) (2) (1 x 2)
Debt 1296.6 10.19% 4.42% 0.45%
Equity (CAPM) 11,427.44 89.81% 9.81% 8.81%
Total 12724.04 100% 9.26%
 Conclusion
Because the WACC is 9.26% and the result from
the meeting said that the revenue growth targets
are 8%-10%, so we recommend to buy Nike
Stocks