Nike Cost of Capital 2001

Nike, INC.: Cost of Capital 2001

02/09/2015

Group 8

Caleb Allen

Zigang Chen

Ettore Fantin-Yusta

Jordan Fatoki

Nathan Guinto

Aaron Yeung

Problem Definition

        On July 5, 2001, Kimi Ford, a portfolio manager at NorthPoint Group, began considering the possibility of purchasing Nike shares for the NorthPoint Large-Cap Fund. One week earlier, the Nike analysts’ meeting disclosed that since 1997, revenues have plateaued for Nike while net income had fallen dramatically. The new management plan was to address both top-line growth and operating performance by ‘aggressively’ improving the mid-priced segment, revenue growth and earnings growth. There are a couple issues that need to be addressed, however, before Kimi can make a decision regarding the share purchase:

1. What is the WACC for Nike?
2. Are the Nike shares correctly valued at $42.09 per share?
3. Are Joanna Cohen’s calculations correct and viable for use?
4. Is this a good investment for NorthPoint Group?

Calculating Nike’s Cost of Capital

        Estimating the company’s cost of capital  is crucial for analyzing and decision-making of firm. The effects of capital structure can impact firm value, share price and then the cost of funding for the company. Moreover, calculating the company’s cost of capital can help investors diversify their portfolio, reduce investment risk and maximize profits.

        Cost of capital here is represented by WACC (Weighted Average Cost of Capital). To calculate WACC, we need both the cost of debt and the cost of equity. The cost of equity can be calculated by using Dividend Discount Model or the Capital Asset Pricing Model (CAPM).

        Dividend Discount Model: KE = D1/Po + G, 

        CAPM: KE = Risk Free Rate + Beta x Market Risk Premium

        Using the DDM, KE is calculated to be 6.7%^[1](Exhibit 4), however this does not reflect the cost of capital for Nike, because we do not know the certainty of dividend payments after June 30, 2001, and we have to depend solely on dividends for our calculation. Using the CAPM, we calculated 9.81%^[2] (Exhibit 4) for the cost of equity. We believe CAPM provides a more accurate cost of equity due to the utilization of more market data and variables. Our calculation of cost of equity differs from that of Joanna Cohen because she used the average historic beta of 0.8 instead of the most recent and forward-looking beta of 0.69.