ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

Nike, Inc.: Cost of Capital

Updated on July 30, 2018
lee custodio profile image

Lee is a Masters in Management graduate who has been working as a freelance writer and researcher since 2009.

Nike, Inc.
Nike, Inc.

Executive Summary

This paper will present the financial importance of the Cost of Capital for Nike and its future investors. Nike Inc. tries a new strategy to revitalize the company by focusing on top-line growth and operating performance. As such, the cost of capital is a critical factor in decision-making and in estimating the weighted average cost of capital (WACC). Our analysis will include how WACC is calculated using the Capital Asset Pricing Model (CAPM) to find out if NorthPoint Group should include Nike, Inc. in its portfolio. A firm’s WACC shows the required return on the firm and is used by the firm’s decision makers to determine which expansionary opportunities and or mergers to take. Investors also use WACC as the discount rate in stock valuation. The result of our analysis suggests that it is a sound financial decision to include Nike Inc. to NorthPoint Group’s mutual fund portfolio.

I. Single Cost of Capital

It is sufficient to use the single cost instead of multiple costs of capital to compute WACC to be able to value the cash flows of the firm. Additionally, Nike Inc.’s business segments relatively have the same risk. Thus, based on our assumption, a single cost of capital is more appropriate

II. Capital Structure

The weights of the costs, Wd and We, are very important in calculating WACC because these show the company's capital structure. In calculating the weights, Joanna Cohen, Ford’s assistant, used the book values of debt and equity. But using the market values provide more accurate results. As book and market values of debt and equity tends to differ a lot, I used market values of debt and equity to get a closer estimation of the capital structure.

III. Cost of Debt

Cohen miscalculated the cost of debt by using the historical data. She divided the interest expenses by the average balance of debt to get 4.3 percent of before tax cost of debt. This may not reflect Nike’s current or future cost of debt because the cost of debt should be forward-looking.

First, I reexamine the cost of debt (Kd), which in this case is the yield to maturity (YTM) on the bonds. The YTM is a good estimate for the cost of debt if a company had issued debt in the past and the bonds are publicly traded just as in Nike's case. My calculations for Nike's yield to maturity based on the given data showed that Kd is 7.16 percent.

IV. Cost of Equity

For the risk-free rate, Krf, I used the current yield on 10-year US treasury bonds (5.39) instead of the 20-year because the 10-year bond matches the tenor of cash flows for the Nike's investment project [as seen on Exhibit 2], which is 10 years. Secondly, it is relatively less exposed to unexpected changes in inflation and liquidity premium when compared to the 20-year bond.

For the market risk premium, Km –Krf, I used the arithmetic mean of 7.5 percent of historic risk premiums to estimate the current risk premium on the assumption that the future will resemble the historical behavior. Given that this is a viable assumption, the annual arithmetic average is the theoretically correct predictor for the next year's risk premium. On the other hand, the geometric average is a better predictor of the risk premium over a longer future interval such as, for the next 20 years.

For Beta, I used the most recent beta estimate, 0.69. I did not use 0.80 to be the measure of systematic risk because I need to find a beta that is most representative of future beta. As such, I believe that the most relevant beta in this respect is 0.69.

I used the Capital Asset Pricing Model (CAPM) in estimating the cost of equity, which is 10.57 percent.


V. Weighted Average Cost of Capital (WACC)

Using the above values, the WACC is computed as follows:

VI. Computing for the Enterprise Value

With WACC at 9.95 percent, I recomputed the enterprise value and equity value per share of Nike. My computation showed that at 9.95 percent, the value of equity and equity value per share is $19,135.53 and $65.71 respectively. [See Annex A for details of computation.]

VII. Conclusion

Kimi Ford should recommend to the NorthPoint Group Board that acquiring Nike Inc. shares is a SOUND INVESTMENT. To discount cash flows in Exhibit 2 with the calculated WACC of 9.95 percent, the present value of Nike is $65.71 per share, which is more than its current market price of $42.09. I believe that this value is still understated because the current growth rate used—6 to 7 percent is much lower than that estimated by Ford—8 to 10 percent. To conclude, since the data shows that Nike Inc.’s common stock is undervalued NorthPoint Group should add Nike Inc. to its Large Cap Fund.

Annex A: Discounted-Cash-Flow Analysis

Comments

    0 of 8192 characters used
    Post Comment

    No comments yet.

    working

    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, hubpages.com uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at: https://hubpages.com/privacy-policy#gdpr

    Show Details
    Necessary
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
    CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the googleapis.com or gstatic.com domains, for performance and efficiency reasons. (Privacy Policy)
    Features
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Marketing
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Statistics
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)