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Nike Cost of Capital Case Assignment - Financial Decision-Making | FIN 304, Study notes of Finance

nike cost of capital case assignment Material Type: Notes; Professor: Cooper; Class: Fin Decision-Making; Subject: Finance; University: La Salle University; Term: Fall 2010;

Typology: Study notes

2009/2010

Uploaded on 12/09/2010

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Sebastian Matouk Monday 15th November 2010
FIN-304: Case Study
Nike Inc. Cost of Capital
1) The weighted average cost of capital (WACC) is the rate (expressed as a percentage) that
a company is expected to pay to debt holders (cost of debt) and shareholders (cost of
equity). It is important in estimating a firm’s cost of capital because different securities
are expected to have different returns; WACC is calculated taking into account the
relative weights of each component of the capital structure – debt and equity, and is used
to see if the investment is worthwhile to undertake.
2) It is possible for a firm to have just one cost of capital. Most times however, a firm will
have multiple costs of capital for the numerous investments and projects they may have.
Different projects and investments typically have varying costs of capital, so only using
one can cause serous inaccuracies. For simplicities’ sake, I assumed that Nike uses one
cost of capital since its multiple business segments are not very different (shoes, apparel,
sports equipment etc.) and would experience similar risks and betas.
3) I do not agree with Joanna Cohen’s WACC calculation. She decided to use the book
value for both debt and equity. Even though the book value of debt is accepted as an
estimate of market value, book value of equity should not be used. To find the market
value of equity, multiply the stock price of Nike Inc. by the number of shares
outstanding:
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Sebastian Matouk Monday 15th^ November 2010 FIN-304: Case Study Nike Inc. Cost of Capital

  1. The weighted average cost of capital (WACC) is the rate (expressed as a percentage) that a company is expected to pay to debt holders (cost of debt) and shareholders (cost of equity). It is important in estimating a firm’s cost of capital because different securities are expected to have different returns; WACC is calculated taking into account the relative weights of each component of the capital structure – debt and equity, and is used to see if the investment is worthwhile to undertake.
  2. It is possible for a firm to have just one cost of capital. Most times however, a firm will have multiple costs of capital for the numerous investments and projects they may have. Different projects and investments typically have varying costs of capital, so only using one can cause serous inaccuracies. For simplicities’ sake, I assumed that Nike uses one cost of capital since its multiple business segments are not very different (shoes, apparel, sports equipment etc.) and would experience similar risks and betas.
  3. I do not agree with Joanna Cohen’s WACC calculation. She decided to use the book value for both debt and equity. Even though the book value of debt is accepted as an estimate of market value, book value of equity should not be used. To find the market value of equity, multiply the stock price of Nike Inc. by the number of shares outstanding:
  1. (b) Cost of equity E = Stock Price * Number of Outstanding Shares = $42.09 * 271. =$11,427. (a) Cost of debt Even though one could use the book value of debt as an estimate of the market value, Cohen should have found the actual market value by discounting the value of Nike’s long term debt at the coupon rate. D = Current long-term debt + notes payable + long-term debt (discounted) = $5.40 + $855.30 + $416. = $1,277. (c) Weighted average Using the market values of debt and equity: Weight (D) = D/ (D+E) = $1,277.42/ $12,704. = 10.05% Weight (E) = E/ (D+E) = $11,427.44/ $12,704. = 89.95%