Nike, Inc.: Cost of Capital

Executive Summary

Cohen miscalculated WACC:

• Used book values instead of market values when determining the weights
• Miscalculated the cost of debt by using the average of historical debt, which may not reflect Nike’s future cost of debt
• When determining cost of equity, Cohen used the average of historical betas, while she should have used more recent information

With the newly calculated WACC, Kimi Ford should suggest NorthPoint to buy shares of Nike because:

• Nike is undervalued

• Ford calculated that Nike is undervalued when the discount rate is below 11.17%, and we calculated the rate to be 9.27%, which is below 11.17%
• The PV = $58.13 per share when the WACC = 9.27%, and the current market price is $42.08
• Revenue growth was estimated to be between 6% and 7% in the DCF Analysis (Exhibit 2) in the case, while company executives expect long-term revenue to grow between 8% and 10%

• Nike is expected to grow

• Plans to push apparel line
• Developing more athletic shoe products in the mid-priced segment to increase market share and boost revenue
• Executives expect revenue to grow between 8% and 10% and earnings-growth targets of above 15%

• Nike’s shares have large potential as they are currently undervalued and are likely to further increase in value as Nike expands its business

1. Single Cost of Capital – Agree

• Similar Risks – WACC values the cash flows for the entire firm.  The breakdown of Nike’s revenue can be seen in Exhibit 1.  Besides the Cole Hahn dresses that fall under the Bauer trademark that make a small percentage of Nike’s revenue, all of the products are in the sports business market.  Therefore, there are not significant differences in the risk rates of Nike’s different segments.
• Business Activities – The products are sold through the same marketing and distribution channels.  They have the same quality guarantee and are often in collections of similar design.

Due to these factors, it makes sense to use the single cost of capital as the WACC

Methodology for Calculating WACC – Disagree

When calculating weights, Cohen should have used the market values instead of the book values.  She should have used market values because they reflect the true economic claim of each type of financing, and they estimate the value of how much it will cost the firm to raise capital today.  If investors were to invest in Nike, they would demand the market-required rate of return, not the book value of capital.  The weights should also reflect targeted capital structure, not historical.

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