Nike,Inc.

: Cost of Capital
Adina Bustea’s analysis

To:Kimi Ford
From: Adina Bustea
Date:10-28-19
Subject: Nike’s cost of capital

The weighted average cost of capital (WACC) is one of the most useful tools in the
realm of finance. It relies upon many variables to be properly calculated and Cohen’s
assessment is dependent upon the proper category weights. The calculation utilizes all
sources of a company’s capital, this includes: bonds, common stock, preferred stock,
and any other long-term debt. This rate is what a company is expected to pay, on
average, to all its security holders to finance its assets. It should be noted that this rate
is dictated by the external market and not by management.

Single vs multiple cost of capital

In my opinion, I think using multiple cost of capital wouldn’t show relevant changes - the
percentages in revenue obtained by selling other brands (Cole Haan) or Non-Nike
brands is insignificant at 4.5 %. The risks related to footwear and apparel are similar,
thus , I consider there is no need to separate the cost of capital from single to multiple. I
adopted the same approach as Joanna.

Methodology for calculating the Cost of Capital

The WACC is important because it is a measure of how much it costs a company to raise
money to finance a future project. Through understanding the costs to finance new projects, the
management team can work to optimize resources and move the business forward. In the
analysis set up by Cohen, there are elements to the calculation that are both accurate and some
that are questionable regarding best practice. Starting out with the tax rate - she made the
correct choice by using the 38% tax rate - this covers the average values of the state tax

Cost of equity
Some problems arise when she generated the cost of debt and equity values.
Considering the WACC is a forecast analysis and investors set the trends in cost
through the required rate of return, Joanna shouldn’t have used historical betas - she
should have focused on future trends and not industry average and not past betas.
Instead of average betas I would use current beta (0.69). As Joanna, I would also use
the 20Y Current yield on U.S Treasuries as risk free rate and geometric mean as risk
premium. I opted for the same geometric mean as it is more accurate and it considers
compounding effect.
Rf: 5.74%
Beta: 0.69
Risk Premium: 5.90%
Cost of debt(bonds): 9.81%

Cost of debt
When calculating cost of debt, I would use more current data, not information from
balancing sheet as Johanna did. We know that the current coupon yield is 6.75 % and
the current price is 95.50. The period left up until maturity (from 2001 to 2021 ) is 20*2
=40, since interest is paid twice a year. With Face Value =100, we calculate the rate as
below:

PV -95.6
N 40
PMT 3.375
FV 100
rate: 3.58%
rate: 7.17%
after tax cost of debt: 7.17*(1-0.38)
after tax cost of debt: 4.4

In estimating the current equity value, Johanna shouldn’t have used the shareholder’s
equity from balance sheet as numbers have changed, she should have used the current
prices per share: 42.09 given in Exibit 2. Thus, shareholders equity is current
price/share * number of total shares=42.09*273.3=11,503 MM. This will cause the
percentages of debt and equity to be different than Joanna’s numbers: Now, we know
total capital = debt + equity=11503 + 855.3+453.9= 12794.2

The Percentage of equity is now 11503/12794.2=90% which leaves us with 10% of debt
proportion, thus, WACC = 90%*9.8% +10%*4.4% =9.3 %

The WACC is slightly higher that Joanna’s WACC. Given this result, if we consider the
discount rate of 11.17, the current cost per share is equal to book equity value. Book
values are historical data and it is recommended to use current data and forecasts.
Given the current beta of 0.69, we know the shares for Nike’s are less volatile than the
market, which means they are less risky. We also know that at a discount rate of 11.17
the stock is undervalued and that required rate of return or cost of capital is lower than
expected rate of return. These factors indicate it would be worth investing in Nike’s
stocks as there is potential for great profits.