Nike Capital Case

NIKE, INC.: COST OF CAPITAL

Teaching Note

This case is intended to serve as an introduction to the calculation of the weighted-average cost of capital (WACC) of the firm. The case provides a WACC calculation that contains errors based on conceptual misunderstandings. The task of the student is to identify and explain the mistakes in the analysis. The case assumes that students have been exposed to the WACC, CAPM, the dividend discount model, and the earnings capitalization model.

Suggested Advance Study Questions

1. What is the WACC and why is it important to estimate a firm's cost of capital? Do you agree with Joanna Cohen's WACC calculation? Why or why not?

2. If you do not agree with Cohen's analysis, calculate your own WACC for Nike and be prepared to justify your assumptions.

3. Calculate the costs of equity using CAPM, the dividend discount model, and the earnings capitalization ratio. What are the advantages and disadvantages of each method?

4. What should Kimi Ford recommend regarding an investment in Nike?

Student preparation of this case is enhanced by supporting textbook readings. Suggested supporting readings from the Darden Case Collection include: "The Weighted-Average Cost of Capital," (UVA-F-1185) and "The Dividend Discount Model," (UVA-F-1234). No spreadsheet file accompanies this case.

Discussion Questions

1. Why is it important to estimate a firm's cost of capital? What does it represent? Is the WACC set by investors or by managers?

This opening motivates the ensuing discussion with one of the most important arguments in modern finance, that operating managers should look to the capital markets for guidance (e.g., through WACC).

2. What was your estimate of WACC? What mistakes did Joanna Cohen make in her analysis? Which method is best for calculating the cost of equity?

The instructor can solicit estimates and then ask one student to go through a calculation in detail. In the process, the instructor can highlight the important and often inadequately understood components of WACC.

3. What should Kimi Ford recommend regarding an investment in Nike?

This question brings the class discussion back to a decision orientation, necessary because some students may get so wrapped up in the WACC calculation that they forget its practical significance.

The instructor can close with comments on the calculation of WACC, and on the ensuing fortunes of Nike, Inc. The firm's Web site, www.nikebiz.com, is a useful source of