Nike Case Essay

1074 words - 4 pages

NIKE, INC: COST OF CAPITALNorthPoint Group, a mutual management firm is weighting whether to buy Nike's stock or not. The firm has experienced sales growth, profits and market share decline. Nike is now committing to cut down expenses while increasing growth and operating performance.Kimi Ford has asked her assistant, Joanna Cohen, to estimate Nike's cost of capital. The cost of capital depends on the mode of financing used. In this case, the business is financed through equity and debt.To value the cash flows of the entire firm, I will be using single cost. Therefore, I will be estimating the weighted average cost of capital (WACC) based on the book values, and also, the market values presented in the case.Methodology for calculating cost of capital: WACC (based on book values)DebtFirst of all, I calculated the proportion of the debt and equity based on the available balance sheet. Nike's accounting based book values capital structure has a 27.06% of debt and a 72.94% of equity.Cost of DebtThe best way to calculate cost of debt is to use yield to maturity method, which the data provided in exhibit 4. Nike can borrow at an interest rate of 7.13% and its marginal federal-plus-state tax rate is 38%. It's after tax cost of debt will be 4.42%.Cost of EquityTo calculate cost of equity I will be using the capital asset pricing model (CAPM), the dividend yield plus growth rate the new common stock method.The rate of return that investors require on the firm's common stock by using CAPM would be 9.81%; with the dividend yield plus growth rate would be 6.79%; and by applying the new stock model the rate of return would be 6.00%.Capital CostThe WACC using these three different approaches would be 8.29% (CAPM), 6.15% (dividend yield plus growth rate) and 5.57% (new common stock).Methodology for calculating cost of capital: WACC (based on market values)DebtThe company is trading at a par, which means that the market value of debt equals the book value of debt. Nike's market values capital structure has 10.13% of debt and 89.87% of equity.Cost of DebtThe yield to maturity method will be used again. Therefore, Nike can borrow at an interest rate of 7.13% and its marginal federal-plus-state tax rate is 38%. It's after tax cost of debt will be 4.42%.Cost of EquityThe cost of common equity will be again 9.81% for CAPM; for the dividend yield plus growth rate would be 6.64%; and the new common stock would be 6.00%.Capital CostThe average cost of each whole dollar, or the WACC, would be 9.26% (CAPM); 6.41% (the dividend yield plus growth rate); 5.84%(new common stock).Based on Joanna's calculations, I agree with the use of the single cost of capital. The business segments of Nike have about the same risk; therefore, a single cost is sufficient for this analysis. Anyways, Joanna mistakenly used the historical data estimating the cost of debt, which does not reflect Nike's current or future cost of debt. This cost intents to be forward looking, so it should be...

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