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 ...view middle of the document...
75% coupon paid semi-annually (Exhibit 1.2) to find the yield to maturity. I took an assumption, concurring with Cohen, that Nike has a single cost of capital since its multiple business segments such as shoes, apparels, or sports equipment are not very different and share similar risks.
The cost of equity was found using the CAPM model, which I believe Cohen used correctly. Cohen and I both used the 20-year yield on U.S Treasuries as the risk free rate. As Nike’s debt was valued over 25 years and there is no other given yield that is comparable to a 25-year valuation period, I decided that Cohen’s choice of 5.74% as risk free rate was correct. As for market premium, I used the geometric mean. For investors, the arithmetic mean is rarely used because it does not include compounded interests and therefore is only used as an indication of returns in one-year or years in average. Geometric is more suited for longer life valuation and therefore the 5.9% is used to coincide with the risk free rate of the 20-year Treasuries. As for beta, I chose to use 0.8 because although the YTD beta (0.69) was a good reflection of current business practices of Nike, the goal of Nike was to look forward and regain its market share and increase its revenues. The average beta of 0.8 seemed well suited for this case because it reflects the historical business practices of Nike better than, say, YTD beta of 0.69.
WACC and Conclusion
Finally, we know that the WACC is the minimum return that a company must earn on an existing asset base to satisfy its creditors, owners, and other investors, or they will invest elsewhere. Cohen’s cost of capital was 8.4% using the book values, but using the market values and different cost of debt to calculate the cost of capital, I got 9.87% (Exhibit 1.2). It is relevant to know that Nike has to pay 9.87% of interest for every dollar it finances. With the discount rate of 9.87%, the Nike’s share price is $56.81, undervalued by $14.72 per share. Kimi Ford’s discount rate of 8.4% meant that the stock price is even more undervalued at $63.50 per share, undervalued by $21.41.
From the data found above, Kimi Ford should include Nike Inc. to the...