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Nike Case Analysis

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Case Background

Kimi Ford was considering whether to buy some Nike’s shares for the fund she manages, the NorthPoint Large-Cap Fund. She read all the analyst reports about the meeting discussing the decline Nike Inc. Is experiencing at the beginning of the year but it gave her no clear guidance. She decided instead to develop her own discounted-cash-flow forecast and requested her new assistant, Joanna Cohen, to estimate Nike’s cost of capital.

The goal of this case analysis is to identify if mistakes had been made by Ms. Cohen in the estimation of Nike’s cost of capital.

Case analysis

  1. Single or Multiple Cost of Capital?

Since Nike has multiple business segments (footwear contributing 62% to total revenue and other business segments, apparel contributing 30% of revenue, equipment products account for 3.6% of revenue and non-Nike branded products account for 4.5% of Nike’s revenue) and all of these segments were all sports-related business except Cole-Haan, there is no reason to compute multiple costs of capital. Although the non-Nike branded products of Cole-Haan line have some differences with other segments, it does not pose significant risks that will warrant different cost of capital since Cole-Haan makes up only a tiny percentage of Nike’s total revenues.

  1. Computation for the cost of debt

The cost of debt is the cost of debt financing to a company when it issues a bond or take out a bank loan. Two approaches may be used to get the cost of debt, the Yield-to-Maturity (YTM) or Debt-rating approach. Using the YTM approach, the cost of debt of Nike is

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Cost of Debt (before-tax) is equal to 7.12% annually

Cost of Debt (after-tax) = 7.12(1 - 0.38)

= 4.41%

It must be noted that the estimation of Joanna Cohen for the cost of debt is incorrect because she used historical data which may lead to non-reflection of Nike’s current or future cost of debt.

  1. The cost of equity is the required rate of return on the firm’s common stock. This can be estimated using one of the following:

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Earnings Capitalization Model

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Dividend Discount Model is used if dividends are expected to grow at a constant rate. Since Nike Inc. didn’t declare any dividend after June 30, this model could not be used. The Earnings Capitalization Model values the company based upon its earnings. It refers to the return on investment that is expected by an investor. But this does not consider the growth of the company, so this could not be used. Therefore, we agree with Ms. Cohen to use Capital Asset Pricing Model.

  1. Methodology for Calculating the Cost of Capital

In the computation for Cost of Capital, our group agrees with Joanna Cohen to use the Weighted Average Cost of Capital (WACC) method wherein WACC is calculated taking into account the relative weights of debt and equity components. However, in connection with the basis of computation of the weight of each component, Ms. Cohen should have used the market values of debt and equity instead of using their respective book values because market values reflect how much it costs Nike, Inc. to raise capital today. Also, debt components should include only notes payable and long-term debts, or those debts that bear interest.        



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