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Nike,Inc.:CostofCapitalCaseBackground:NorthPointLargeCapFundweighingwhethertobuyNike’sstock.Nikehasexperiencedsalesgrowthdecline,declinesinprofitsandmarketshare.Nikehasrevealthatitwouldincreaseexposureinmid-pricefootwearandapparellines.Italsocommitstocutdownexpenses.ThemarketrespondedmixedsignalstoNike’schanges.KimiFordhasdoneacashflowestimation,andaskherassistant,JoannaCohentoestimatecostofcapital.WhatisWACC?andwhyisitimportanttoestimateafirm’scostofcapital?WhatisWACC?andwhyisitimportanttoestimateafirm’scostofcapital?DoyouagreewithJoannaCohen’sWACCestimations?Whyorwhynot?SinglecostorMultipleCost?CostofdebtThecostofdebt,ifitisintenttobeforwardinglooking,shouldbeestimatedby1.yieldtomaturityofbond,or2.accordingtocreditrating.ThemoreappropriatecostofdebtcanbecalculatedbyusingdataprovidedinExhibit4.WecancalculatethecurrentyieldtomaturityoftheNike’sbondtorepresentNike’scurrentcostofdebt.PV=95.60N=40Pmt=-3.375FV=-100CompI=3.58%(semiannual)7.16%(annual)Aftertaxcostofdebt=7.16%(1-38%)=4.44%CostofequityCommentsoncostofequity–Therisk-freerateTouseageometricmeanofmarketriskpremium5.9%isalsocorrect.Usingarithmeticmeantorepresenttruemarketriskpremium,wehavetohaveindependentlydistributedmarketriskpremium.Itisoftenfoundthatmarketriskpremiumarenegativelyserialcorrelated.Idon’tagreethatCohenusesaveragebetafrom1996toJuly2001,0.80tobethemeasureofsystematicrisk,becauseweneedtofindabetathatismostrepresentativetofuturebeta.Assuch,mostrecentbetawillmostrelevantinthisrespect.SoIsuggestusingthemostrecentbetaestimate,0.69.CostofequityWeightsofcapitalcomponentsFormarketvalueofequity,$42.09*273.3mnshares=11,503mn.Duetothelackofinformationofthemarketvalueofdebt,bookvalueofdebt,1,291mn,isusedtocalculateweights.Thus,themarketvalueweightforequityis11,503/(11,503+1,291)=89.9%;theweightfordebtis10.1%.TheWACCWhatshouldKimiFordrecommendregardinganinvestmentinNike?Stocksplit:03-Apr-07[2:1]
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