Case Study –Nike, Inc.: Cost of Capital Essay

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Case Study –Nike, Inc.: Cost of Capital
FIN202a-Spring 2011

1. Please define Weighted Average Cost of Capital (WACC). Write down the WACC formula, and discuss its components.

WACC (Weighted Average Cost of Capital) is a market weighted average, at target leverage, of the cost of after tax debt and equity.
It is a critical input for evaluating investment decision, and typically the discount rate for NPV calculation. And it serves as the benchmark for operating performance, relative to the opportunity cost of capital employed to create value.

Algebraically, it is given by

WACC = [E/(E + D)] *re + [D/(E + D )]*rd * (1-t)
Where WACC= Weighted Average Cost of Capital re = cost of equity rd = cost of debt
E = market
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is not this kind of companies. If we want to use the data of dividends, we need to consider the growth rate and future potential changes of dividend. In a word, we don’t think DDM is fit for Nike’s case.

4. Calculate cost of debt. Use market yields that are presented in Exhibit 4.
Present Value: $95.6
Future Value: $100
Matures: 40
Coupon Rate: 6.75%/2 = 3.375% (Semiannually)
3.375(1 + r)-1 + 3.375 (1 + r)-2 + 3.375 (1 + r)-3 + ...…+ 3.375 (1 + r)-40+100(1 + r)-40 = 95.6 r = 3.5813% (Semiannually)
YTM= Kd= 3.5813%*2= 7.16%

5. Finally calculate WACC. * Please choose either the CAPM estimate or the DDM estimate for cost of equity based on your answer to Question 3. * Risk-free rate: Choose a risk-free rate that is consistent with the life of the asset that is being valued. * Following our discussion in class, use the market values of equity and book values of debt when calculating debt and equity weights.

We use the CAPM to estimate.
Market Value of Equity= 11,427.4 M
Book Value of Debt = 1,296.6 M
Total Capital= 12,724.0 M Formula, WACC = [E/(E+D)] re + [D/(E + D)]rd (1-t) E = 89.89%, D = 10.19%, re = 10.46%, rd = 7.16%, tax rate = 38%
WACC =10.46%*89.89%/(89.89% + 10.19%)+ 7.16%*(1-0.38%)*10.19%/(89.89% + 10.19%) WACC = 9.846%

6. Does your estimate of WACC differ from Cohen’s estimate? Why? What are the mistakes that Ms. Cohen make

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