1174 Words5 Pages

NIKE, INC.: COST OF CAPITAL

Book value vs. Market value While calculating the Nike’s cost of capital using both the book value (Exhibit 1.1) and the market value (Exhibit 1.2), I could notice the mistake Cohen made finding the equity value. Cohen used the book value to reflect equity value. Although the book value is an accepted measure to estimate the debt value, the equity’s book value is an inaccurate measure of the value perceived by the shareholders. Since Nike is a publicly traded company, market value is the better method in reflecting Nike’s equity value. Cohen’s book value of equity is the total shareholder’s equity in the balance sheet, $3494.5. The market value of equity on the other hand, is $11427; computed using*…show more content…*

to the NorthPoint Large-Cap Fund because the stock is undervalued. I recommend a buy decision, which concurs with Lehman Brothers report, as Nike has a growth potential that would be beneficial to the fund if it s included in the portfolio.

EXHIBIT 1.1

WACC using Book Values (Cohen’s calculation)

Debt value = Current portion of long-term debt + Notes Payable + Long-term debt $5.4 + 855.3 + 435.9 = $1296.6

Equity value = $3494.5 (Total shareholder’s equity or Assets-Liabilities)

Debt weight = D/(D+E) = 1296.6/3484.5 = 27% of weight on debt

Equity weight = E/(D+E) or (1-0.27) = 73.3% of weight on equity

Cost of debt: Total interest expense / average debt balance 58.7/(1444.6+1296.6/2) = 0.0428 = 4.3% Using the tax rate of 35% plus state taxes of 3%, cost of debt becomes 4.3%*(1-0.38) = 0.266 = 2.7%

Cost of equity: Cohen used the current yield on 20-year Treasury bonds as risk-free rate (5.74%) then compounded average premium of the market over Treasury bonds (5.9%) for risk premium. As for beta, Cohen used the average of Nike’s beta from 1996 to 2001 (0.8).

Using the CAPM = Kf + b(Km-Kf)

Where Kf= risk free rate, Km = market rate, B = beta, (Km-kf) = risk premium

CAPM = 5.74% + 0.8(5.9) = 10.46%

WACC = Kd(1-T) x D/(D+E) + Ke x E/(D+E) = 2.7% 27% + 10.46%*73% = 8.4%

EXHIBIT 1.2

WACC using Market Values

Debt value = Current portion of long-term debt + Notes Payable + Long-term

Book value vs. Market value While calculating the Nike’s cost of capital using both the book value (Exhibit 1.1) and the market value (Exhibit 1.2), I could notice the mistake Cohen made finding the equity value. Cohen used the book value to reflect equity value. Although the book value is an accepted measure to estimate the debt value, the equity’s book value is an inaccurate measure of the value perceived by the shareholders. Since Nike is a publicly traded company, market value is the better method in reflecting Nike’s equity value. Cohen’s book value of equity is the total shareholder’s equity in the balance sheet, $3494.5. The market value of equity on the other hand, is $11427; computed using

to the NorthPoint Large-Cap Fund because the stock is undervalued. I recommend a buy decision, which concurs with Lehman Brothers report, as Nike has a growth potential that would be beneficial to the fund if it s included in the portfolio.

EXHIBIT 1.1

WACC using Book Values (Cohen’s calculation)

Debt value = Current portion of long-term debt + Notes Payable + Long-term debt $5.4 + 855.3 + 435.9 = $1296.6

Equity value = $3494.5 (Total shareholder’s equity or Assets-Liabilities)

Debt weight = D/(D+E) = 1296.6/3484.5 = 27% of weight on debt

Equity weight = E/(D+E) or (1-0.27) = 73.3% of weight on equity

Cost of debt: Total interest expense / average debt balance 58.7/(1444.6+1296.6/2) = 0.0428 = 4.3% Using the tax rate of 35% plus state taxes of 3%, cost of debt becomes 4.3%*(1-0.38) = 0.266 = 2.7%

Cost of equity: Cohen used the current yield on 20-year Treasury bonds as risk-free rate (5.74%) then compounded average premium of the market over Treasury bonds (5.9%) for risk premium. As for beta, Cohen used the average of Nike’s beta from 1996 to 2001 (0.8).

Using the CAPM = Kf + b(Km-Kf)

Where Kf= risk free rate, Km = market rate, B = beta, (Km-kf) = risk premium

CAPM = 5.74% + 0.8(5.9) = 10.46%

WACC = Kd(1-T) x D/(D+E) + Ke x E/(D+E) = 2.7% 27% + 10.46%*73% = 8.4%

EXHIBIT 1.2

WACC using Market Values

Debt value = Current portion of long-term debt + Notes Payable + Long-term

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