Nike, Inc.

: Cost of Capital

Study Questions

1. What is the WACC and why is it important to estimate a firms cost of
capital? Do you agree with Joanna Cohens WACC calculation? Why or
why not?
2. If you do not agree with Cohens analysis, calculate your own WACC for
Nike and be prepared to justify your assumptions.
3. Calculate the costs of equity using CAPM, the dividend discount model,
and the earnings capitalization ratio. What are the advantages and
disadvantages of each method?
4. What should Kimi Ford recommend regarding an investment in Nike?

Discussion Questions

1. Why is it important to estimate a firms cost of capital? What does it
represent? Is the WACC set by investors or by managers?
This opening motivates the ensuing discussion with one of the most
important arguments in modern finance, that operating managers should
look to the capital markets for guidance (e.g., through WACC).
2. What was your estimate of WACC? What mistakes did Joanna Cohen
make in her analysis? Which method is best for calculating the cost of
equity?
The instructor can solicit estimates and then ask one student to go
through a calculation in detail. In the process, the instructor can highlight
the important and often inadequately understood components of WACC.
3. What should Kimi Ford recommend regarding an investment in Nike?

CALIFORNIA PIZZA KITCHEN

Study Questions

1. In what ways can Susan Collyns facilitate the success of CPK?
2. Using the scenarios in case Exhibit 9, what role does leverage play in
affecting the return on equity (ROE) for CPK? What about the cost of
capital? In assessing the effect of leverage on the cost of capital, you
may assume that a firms CAPM beta can be modeled in the following
manner:
L
=
U
[1 + (1 T)D/E], where
U
is the firms beta without
leverage, T is the corporate income tax rate, D is the market value of
debt, and E is the market value of equity.
3. Based on the analysis in case Exhibit 9, what is the anticipated CPK
share price under each scenario? How many shares will CPK be likely to
repurchase under each scenario? What role does the tax deductibility of
interest play in encouraging debt financing at CPK?
4. What capital structure policy would you recommend for CPK?

The four alternatives considered explicitly in the case are

1. Maintain existing financial policy with no debt;
2. Borrow $23 million (10% debt to total book capital);
3. Borrow $45 million (20% debt to total book capital);
4. Borrow $68 million (30% debt to total book capital).