Nike, Inc. Cost of Capital Executive Summary

The weighted average cost of capital (WACC) is the rate (expressed as a percentage) that a company is expected to pay to its security holders to finance its assets. Stated differently, it is the minimum return that a company must earn on an existing asset base to satisfy its creditors, owners, and other providers of capital. Because WACC is the minimum return required by providers of capital, individuals should invest only in projects that generate returns in excess of WACC. As such, WACC is used to determine if the investment in question is worthwhile to undertake.

Joanna Cohen calculated a WACC of 8.4% for Nike, Inc. and this figure is not correct. Cohen used the book value for both debt and equity in her calculations which is incorrect. The book value of equity should not be used when calculating cost of capital; the market value of equity should be used instead. In order to calculate the market value of equity, multiply the stock price of Nike, Inc. (which is the current share price) by the number of shares outstanding. The calculation is: 42.09*271.5 = 11,427.44. In her calculation of the market value of debt, Cohen should have discounted the value of long term debt. The calculation for the value of debt is: 5.4 + 855.30 + 416.72 = 1,277.42. The value of 416.72 was found by discounting the Long-term Debt by 4.4%. The value of 4.4% is the after tax cost of debt. In order to obtain this value, I solved for the annual YTM (yield to maturity) of Nike debt and then multiplied that value by one minus the tax rate (which is 35% U.S. statutory tax plus 3% average state tax). The equation for the annual yield to maturity is: (6.75/x)*[(1-1/(1+x)20)] + 100/(1+x)20 = 95.6. Solving for ‘x’ results in a value of approximately 7.17%. This value is the Nike current YTM and represents Nike’s current cost of debt.

In order to calculate the correct WACC, we must first find the correct weightings of debt and equity. Using the current values of debt and equity, the weightings of debt and equity used in the WACC equation are: WD = 1,277.42/12,704.86 = 10.05% and WE = 11,427.44/12,704.86 = 89.95%. Next, the cost of debt and equity must be found. The cost of debt has already been calculated and is 7.17%, which is the YTM on a 20 year Nike Bond. The cost of equity can be calculated either by using Capital Asset Pricing Model (CAPM) or