Nike, Inc. Case - Cost of Capital Analysis

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Introduction This case investigates the calculation of the weighted-average cost of capital (WACC) for Nike. The case provides a WACC calculation that contains errors based on conceptual misunderstandings, and we will use the correct method to come up with the correct WACC calculation which will allow us to properly compute the future estimated value of Nike stock. With this stock estimate, we can help guide NorthPoint as to whether Nike stock is a good buy. WACC and Its Importance The WACC is a calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation. A well-estimated WACC can benefit a company in various ways, such as estimating a company’s cost of capital, capital budget decision, designing the corporate financial structure, method of financing, evaluation of top managers’ performance, etc. Errors in WACC Calculation and Corrections During our discussion on Cohen’s analysis, we found that problems arose in her calculations regarding the use of historical data on calculation of cost of debt, value of beta used to compute cost of capital, and value of equity. We examined each error and made the following corrections. (a) Cohen mistakenly used the historical data in estimating the cost of debt. She divided the interest expenses by the average balance of debt to get 4.3% before tax cost of debt. The WACC is used for discounting cash flows in the future, thus all components of cost must reflect firm’s concurrent or future abilities in raising capital. The historical data may not reflect Nike’s current or future cost of debt. The appropriate cost of debt can be calculated by using data provided in Exhibit 4 in the case to be forward looking. We can calculate the current yield to

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