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Nike: Cost of Capital

Haoyuan Li
1. I disagree with Joanna Cohens WACC Calculations in some parts.
First, what I agree with her is that a single cost of capital should be
used. As WACC is the average of the costs of companys different
types of financing, it is used for Kimi ford to evaluate Nikes share
price. In addition, according to Joanna Cohens finding, Nikes
business segments are very similar except Cole Haan which only
makes up a tiny part of revenues-, therefore computing one cost of
capital is a proper way.
However, it is quite confusing that she estimated cost of debt by
taking interest expense for yr2001 and dividing it by the average of
debt balance of yr2000 and yr2001. Since WACC shows the return
that both kinds of stakeholders (lenders and equity owners) expect
to receive in the future, the cost of debt should be estimated to
demonstrate the future interest rate that the company should pay
for.
Additionally, according to MACC formula, it is more realistic to use
market value instead of book value to calculate total capital.
2. WACC=E/V* Re + D/V* Rd(1-Tc)
=9.811%*11427.44/ 12738.83+4.44%* 1311.39/ 12738.83
=9.26%
(Please find the breakdowns in spreadsheet Q2)
3. ((Please find the calculations in spreadsheet Q3)

CAPM:

cost of equity =9.811%


Advantage:
The CAPM calculates investors return by considering both the time
value of money and risk and makes sure investor get compensated
in both aspects. The model takes the systematic risk into
consideration which is often left out in other return models. The
model can be used in various situations since it assumes investors
hold diversified portfolios. Also the model is easy to use once you
get those indicators. It is not time-consuming and yields data
quickly. Compared to WACC, it provides more useful formula for
investors to make investment appraisal.

Disadvantage:
The CAPM has set many assumptions which are not quite realistic.
First it is hard to predict beta since the market is flowing all the
time. When predicting beta, the overall market for the
company/industry can be varied. Therefore, the beta may not reflect
very accurate risk for the asset.
Also, about risk-free rate, we usually use the yield on short term
government securities. However, the yield changes every day and it
may affect the reliability of the outcome. Thirdly, the return on
market is a historic data and the model is for predicting future
market returns- which is not quite representative.
Additionally, the model assumes that all shareholders have access
to the same information and agree about the risk and expected
return of all assets which is not in quite accordance with reality.

Dividend Discount Model


cost of equity =6.7%
Advantage:
This method is easy to understand and is common to use. Different
Companies in different industries can be compared by using this
method since it values shares price without considering the market
situations.
Whats more, under the dividend discount model, investors receive
a fixed return on investment. The earnings from such companies are
growing at the same rate hence the investors can be certain that
the company would meet its obligations.
Disadvantage:
The growth rate is assumed to be greater than the cost of capital
and remain constant, which is not happened all the time in reality.
In addition, it did not consider the effects of stock buybacks, effects
that can make a vast difference in regard to stock value being
returned to shareholders. Ignoring stock buybacks illustrates the
problem with the DDM of being, overall, too conservative in its
estimation of stock value.

Earnings Capitalization Ratio


cost of equity =5.13%
Advantage:

This method determines the value of a business by looking at the


current cash flow, the annual rate of return and the expected value
of the business, it is good for investors to see the future return of
the company and make investment decision.
Disadvantage:
Estimated earnings are used in this formula. However, companies
can be wrong about its predications on earnings and thus results in
a wrong cost of capital.
Bu using the capitalization of future earnings, the number can be
very different from the market valuation. Market valuation reflects
values of the asset based on what other similar companies are
selling. Thus it maybe more connected to the reality by using
market valuation.
The valuation may not be persuasive for newly-established
companies since they dont have too much data in the first couple
years.

4. With the assumption that the terminal growth rate is 3% and the
cost of capital calculated above 9.26%, we worked out the Equity
value per share of Nike is $57.12, which revealed Nike was
undervalued at its current share price of $42.09. I would
recommend Cohen to buy Nike Inc..
Not only because the Nikes share price is undervalued, but also
Nike announced that they are planning to make business segments
adjustments to develop athletic-shoe products and its apparel line.
This means Nike probably will generate more revenues by digging
deep into some markets which have been overlooked. Therefore, I
would recommend Kimi Ford and also NorthPoint Group to buy
shares from Nike.