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Nike Cost of Capital Case

Autor:   •  January 8, 2017  •  Case Study  •  1,399 Words (6 Pages)  •  445 Views

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Nike Inc:  Cost of Capital Case Questions

Professor Christopher Hennessy

  1. How did Cohen estimate the cost of debt capital?

Cohen has estimated the cost of debt capital by taking the total interest expense as a percentage of average debt balance.

 

  1. Interest expense for the year 2001 is 58.7. Nike raised a portion of its funding need through Japanese yen notes which rate is lower than Treasury yields.

  1. The average of Debt balances as of May31, 2000 and 2001 is 1370.6 = (1444.6+1296.6)/2.

Nike’s cost of debt before adjusting for tax = 58.7/1370.6= 4.3%.

  1. Adding state taxes of 3% (historically 2.5% to 3.5%) to the statutory tax rate of 35%.

Cost of debt after adjusting for tax = 4.3% x [1-38%]= 2.7%

  1. What is the current yield the market demands on Nike debt (See Exhibit 4)?

Based on the information of Exhibit 4 we can calculate the yield to maturity of the bond by comparing the sum of discounted cash flows against the current market price and derive the annualized internal rate of return. This IRR will be a yield on market currently requires on the bond. We need to remember that the coupon is paid semi-annually and make sure we are using correct market conventions (basis etc.).

Bond has approximately 20 years to maturity and the first coupon is going to be paid very soon 15 July 2001 so the DF associated with this cash flow would be close to 1.

The equation can be simplified as

95.6=3.375/(1+R)^0+3.375/(1+R)^0.5+3.375/(1+R)^1+…+(3.375+100)/(1+R)20 

The solution as calculated in Excel using solver:

Today

05/07/2001

Maturity

15/07/2021

Years to Maturity

20.04109589

Price Today

95.6

Coupon

6.75

Semi-annual coupon

3.375

R (annualized) Found with solver.  Sum of discounted flows = Price today

0.0762

Sum of discounted flows

95.6000

The current yield the market demands (20years) on Nike debt(R)= 7.62%

  1. What is the appropriate cost of debt capital to use in the Weighted-Average Cost of Capital, noting that the WACC will be used to discount future cash flows?

The current and long-term debt balances as of May31,2001 are respectively 860.7 and 435.9. The proportions of the current and long-term debt are 66.4% and 33.6%.

Long term credit spread between Nike and US Treasuries is 1.88%(=Nike’s 20year rate :7.62% - US 20year Treasury:5.74%) based on Q2.

Assuming constant credit spread for Nikes debt (assuming CDS credit curve is flat) we can calculate the short term cost of debt as 5.47%(= 6month US Treasury:3.59% + Spread:1.88%)

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