Case 14 Nike: Cost of Capital Essay

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Nike, Inc.: Cost of Capital
Case 14

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September 28, 2011

This case highlights Kimi Ford, a portfolio manager with NorthPoint Group, a mutual-fund management firm. She managed the NorthPoint Large-Cap Fund, and in July of 2001, was looking at the possibility of taking a position in Nike for her fund. Nike stock had declined significantly over the previous year, and it appeared to be a sound value play. Nike had held an analysts’ meeting one week earlier to release the company’s fiscal results for 2001. Apparently Nike had an ulterior motive; the management wanted this opportunity not only to release their fiscal
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In order to be more confident in her forecast, she asked her assistant to estimate Nike’s cost of capital.
Nike’s Estimated Cost of Capital
Ms. Ford’s assistant estimated Nike’s cost of capital to be 8.4%. This is based on four main assumptions. First, a single cost of capital for all of Nike’s various business segments will be sufficient, rather than using a business segment specific cost of capital. Seeing as footwear made up 62% of revenues, and that all the significant segments were sport related, the assistant felt that the risk factors were similar for all of the business segments. Next, since Nike was funded through both debt and equity, the WACC was used to calculate the cost of capital. Third, the cost of debt was estimated to be 4.3%. This was calculated by taking the interest expense for the entire year of 2001 and dividing it by Nike’s average debt balance. Tax adjusted, the cost of debt is 2.7%; this uses a tax rate of 38% based on a state tax of 3% and the U.S. statutory tax rate. Lastly, the CAPM was used to estimate the cost of equity. Using the current yield of the 20-year Treasury bond as the risk-free rate, the compound average premium of the market over Treasury bonds as the risk premium, and the average of Nike’s betas from 1996 to 2000 as the beta, Nike’s cost of equity was estimated to be 10.5%.
Validity of the Assumptions
Single Cost of Capital
The first assumption is that
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