Nike Inc Case

1. Johanna Cohen's calculations for Nike's cost of capital (WACC) are incorrect. Therefore, a new cost of capital of 9.87% was computed by making the following changes:

a. To calculate the weights of debt and equity, the book value of debt and the market value of equity were used.

b. The cost of debt should be calculated as the yield to maturity on

c. The cost of equity was calculated using CAPM.

d. CAPM used

 The current yield on the 20 years U.S. Treasuries [5.74%]

 The average of the historical betas [0.80]

 The geometric mean for the risk premium [5.90%]

e. Japanese yen was not included in the calculation

2. With a discount rate of 9.87%, Nike's stock has an equity value of $52.16 and is currently undervalued by $10.07.

3. Kimi Ford should invest in Nike for the NorthPoint Large-Cap Fund.

Quantitative Analysis

Joanna Cohen's Cost of Capital Calculations

Book value vs. Market value

In order to calculate debt and equity proportion of total capital, Cohen used the book value for both measures. While it is acceptable to measure the debt proportion using its book value, the market value of a publicly traded company such as Nike is a better measure of its equity value. Since we decided to use the market value of equity, the resulting weights for both debt and equity will be different. This change in assumption means that Nike is financed by 10.19% debt and 89.81% equity.

Cost of Debt

Cost of Debt was calculated by Cohen as total interest expense divided by average debt balance. We believe this is not an accurate way to account for cost of debt since it is based on the coupon rate of a firm's existing debt. Instead, it should depend on the interest that would be paid by the Company if it were to issue new debt at that time.

 For 20yr Nike Inc. Debt (Exhibit 4):

N = 40 PV = 9 PMT = 3.375 FV = 100 YTM = 3.5837% x 2 = 7.17 %

Cost of Equity

 CAPM = Rf + β[Rm – Rf]

 Discuss why the current yield on the 20 years U.S. Treasuries [5.74%], the average of the historical betas [0.80] and the geometric mean for the risk premium [5.90%] were used. (Look at the essays)

WACC Calculations

WACC = Kd(1-T) x D/V+