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Diandra Kusumawardhani Nike: Cost of Capital Case Write Up Nike, one the biggest athletic manufacturer, showed some

trouble in 2001. At the beginning of the year, Nikes share price has dropped significantly. Nikes revenues stagnated at $9 billion since 1997 and net income fell from 48% in 1997 to 42% in 2000. Net income also fell from $800 million and market share fell from 48% in 1997 to 42% in 2000. Revenue were also affected by supply chain issues and the appreciating dollar. In June 28, 2001, Nike held a meeting for its analysts which held another purpose, which is to communicate strategies to revitalize the company. The plan was to address top line growth and operating performance. Plan to boost revenue would be done by developing more shoes in the midprice range and to push its apparel line. As far as the cost side, Nike plans to exert more control on expenses. Company executives also revealed their long-term revenue-growth targets of 8% to 10% and earnings-growth targets above 15%. Kimi Ford, an analyst in Northpoint group, wrote that at a discount rate of 12%, Nike was overvalued at its current share price of $42.09, however, a sensitivity analysis showed that if discount rates fall below 11.09%, Nike will become undervalued. An estimate of Nikes cost of capital is needed. Nikes Calculation for Cost of Capital Joanna Cohen, Kimi Fords assistant calculated the Cost of Capital to be 8.4% using the Weighted Average Cost of Capital method, in which she used the book value for debt and equity. Instead of book value for equity, it shouldve been market value, by multiplying stock price by number of shares outstanding. The market value of equity of $11,427.44 differs by a mile from Cohens book value of equity (taken from Total Shareholders Equity in Exhibit 3) amounting to $3,494.5. The market value of debt can be calculated by adding the current portion of long-term debt, notes payable, and long term debt discounted at Nikes current coupon rate, which comes out to $1,277.42. By adding these numbers together and calculating their weight, it is found that the Weight of Debt is 10.05% and the Weight of Equity is 89.95%. The agreeable thing in Cohens report was its use of the CAPM method to calculate the Cost of Equity, which comes out to 10.46% (which is equal to Cohens estimate of 10.5%). Cost of Debt, agreeing with Cohens report, is 4.3% as a before tax cost of debt. After tax cost of debt is 2.7%.

Nikes Market Value of Equity (Refer to Exhibit 2 in the Case) Stock Price = $42.09 Number of Shares Outstanding = 271.5 (in millions) Market value of Equity = $11,427.44 (in millions) Nikes Market Value of Debt Current Long Term Debt = $5.40 (in millions) Notes Payable = $855.30 (in millions) Discounted Long Term Debt = $416.72 (in millions) Market Value of Debt = $1,277.42 (in millions) Nikes Cost of Equity By using the CAPM method, Cost of Equity =Rf + (Rf Rm) Rf = Risk free rate = 20 Year Yield on US Treasuries = 5.74% (Refer to Exhibit 4) Rf Rm is the Market Risk Premium, calculated by the geometric mean in Exhibit 4 = 5.90% = 0.8 is the Nike Average Beta (Refer to Exhibit 4) Cost of Equity =5.74% + 0.8(5.90%) = 10.46% Nikes Cost of Capital WACC = Weight of Debt*Cost of Debt (1-Tax Rate) + Weight of Equity*Cost of Equity = 10.05% * 4.3% (1-0.38) + 89.95% * 10.46% = 0.2679% + 9.4087% = 9.676633% or 9.68% The result differs from Cohens report because the changes made in the value of debt and equity. Instead of using book value, we used market value, which differed by a lot. In the end result, Cohens report had a WACC of 8.4%, which is 15.24% lower than the one we just calculated. The financial performance affecting the companys cost of capital can range from its share price to how much debt it decides to take on will also be a great factor. The fact that the value of the company changes with a small change in WACC is not a problem because the more debt it takes will be relative to its equity so if the relative weight to each other does not change much, then the WACC will not significantly change either.

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