Nike, Inc.

Case Analysis

The purpose of this case analysis is to dissect an analysis of Nike, Inc. mainly through the
concept of weighted average cost of capital (WACC) and relevant concepts. First, we will
discuss the importance of WACC, then will analyze Joanna Cohen’s WACC calculation and
compare it with our own. Next, we will explore the cost of equity. We do this in hopes of finding
the most accurate and best recommendation for Kimi Ford to invest in Nike, Inc.

The cost of each source of capital is known as the weighted average cost of capital or WACC.
Typically, capital is made up of the debt that lenders choose to invest in a firm or the equity that
shareholders choose to invest in a company, each of which is proportionally weighted separately.
Determining the weighted average cost of capital (WACC) is crucial since any use of the
invested capital would result in an opportunity cost for the investors since the money can be used
for other investments. By computing the Weighted Average Cost of Capital (WACC), lenders or
shareholders can make an educated guess as to what kind of return they can expect if they choose
to invest in this business.

We do not agree with Cohen's calculation of WACC because, In Cohen's calculations and
assumptions, we realized that she calculated the Equity figure by including all of the
shareholders' equity to arrive at a figure of $3,494,500,000 which is incorrect. After all, when
calculating the equity she should have used the current market value which is calculated by
multiplying the current stock price by the current number of shares outstanding. Book value is
the price paid for an asset that will never change as long as you own that asset. In calculating the
capital structure of Nike Inc., Johanna Cohen has calculated the percentage of equity from the
book value given in the balance sheet. However, this is not a correct index of the current market
value of the firm. Instead, she should use the most recent value given by the recent market price
of the share. The market value of Equity = Current outstanding shares*Current share price =
271.5 million
* 42.09 = 11427.44 million. We recommend the market value because using the market weights
to estimate WACC helps to show how much it causes the firm to raise capital today.
Additionally, Cohen should have discounted the value of long-term debt that appears on the
balance sheet to find the market value of debt even if the book value of debt is accepted.

Exhibit 4 states that the bond was issued on 07/15/96 and matured on 07/15/21, therefore our n=
2*(25-5) = 40( paid semiannually). When we incorporate these into our
Excel Rate formula, the r(discount rate) will be 3.58%*2 (semi-annual). Therefore our most
accurate after-tax cost of debt will be 7.16%(1-38%) = 4.44%.
In calculating the weight of the capital structure, it is advisable to include all of its components
like common stock, debt, and preferred stock, however, Cohen did not include the effect of
preferred stock in her calculations although it may have not significantly affected the weight.
Another aspect of Cohens' calculation we disagree with is the use of the 0.80 beta which is the
average of Nike's historical betas. We recommend that using the most recent year's beta of 0.69
in 2001 is most representative of future data rather than the average of the 1996 to 2001 beta.
Using the average beta from the historical record of 0.80 does not represent the future systematic
risk.

With the information provided in the case study, we can calculate Nike's cost of capital and
WACC for the year 2001, keeping in mind that we do not have specific details about the cost of
debt for that particular year.

First, we calculate the cost of equity using the CAPM:

Risk-Free Rate (rf)

Looking at the Capital market and financial information on or around July 5, we notice that the
20-Year Treasury Bond Yield was 5.74% in 2001. We use this value in calculating the cost of
equity using CAPM

Market Risk Premium (RP)

The analysis in the Capital market and financial information on or around July 5, gives geometric
mean historical equity risk premium covering the period from 1926 to 1999 as 5.9%. Even
though this covers multiple periods, we will tentatively use it therefore RP=5.9%

Beta Coefficient (β)

Reviewing Capital market and financial information shows several historical betas. Since we are
given a half-year beta for the period of interest, i,e year 2001, we adopt the average of 0.81 in
our calculations. Finally, substituting in the formulae, we get 11.4% as the cost of equity

Re=rf+β*RP=5.74%+(0.81*5.9%) =9.81%
Assuming we knew the cost of debt (denoted as Rd) and applied a representative tax rate (T) of
38% from the consolidated income statement, we could attempt to produce WACC.

Assuming Nike's cost of debt in 2001 aligns with contemporary economic conditions, the post-
tax cost of debt will be =7.17%* (1−0.38) =4.44%

Weighted Average Cost of Capital (WACC) assumes the following formulae: WACC=(E/V*Re)
+((D/V*Rd) *(1-T) therefore, substituting with the values calculated above we

WACC= (0.8981*9.811%) + (0.1019*4.44%) =9.264%

Now we are going to calculate the cost of equity using CAPM and DDM, while also talking
about its advantages and disadvantages. In this case, Joanna Cohen said the cost of equity is
10.5%, but it looks like she made a mistake when using the Capital Asset Pricing Model
(CAPM) and the Dividend Discount Model (DDM).

Risk-free rate: 5.74% Beta:

When we checked using CAPM, we got the cost of equity as 9.81%. Then, using DDM, we
found it's 6.7%. So, there seems to be a mistake in Joanna Cohen's 10.5% cost of equity. The
correct numbers are 9.81% and 6.7%, suggesting a possible error in her calculations.

Advantages of CAPM:

Simplicity - CAPM is simple and easy to understand, making it accessible to a wide range of
users by financial analysts. For example, in the case of Nike, CAPM helped estimate the cost of
equity by considering factors like the risk-free rate, market risk premium, and beta.
Widely Accepted - CAPM is widely used in the financial industry and is a common tool for
estimating the cost of equity. Many financial analysts and institutions relied on CAPM in their
valuation processes.
Disadvantages of CAPM:

Assumptions - CAPM relies on assumptions like a risk-free rate and a linear relationship
between systematic risk and expected return, which may not always be true.

Market Conditions - CAPM assumes market efficiency & uniform investor expectations, which
may not be realistic in all situations.

Advantages of Dividend Discount Model (DDM):

Focus on Dividends - DDM directly considers dividends, making it suitable for valuing
stocks that regularly pay dividends. For example, in the case of Nike, if the company pays
consistent dividends, DDM can capture the direct cash returns to shareholders.
Incorporation of Growth - DDM allows for the inclusion of dividend growth,
accommodating companies with changing dividend patterns. For example, if Nike is expected to
increase its dividend payouts over time, DDM can reflect this growth in its valuation.
Consistency - Dividends tend to stay consistent over long periods, which makes it easier
to arrive at a discount rate. This consistency eliminates risk, and dividends are generally
discounted at a lower rate compared to other metrics used in valuation Stability and Risk
Aversion: The DDM is preferred by risk-averse investors due to the stability and risk aversion it
offers. This is valuable to investors who prefer stability over the possibility of quick gains

Disadvantages of Dividend Discount Model (DDM):

Dependency on Dividends - DDM may not be suitable for companies that do not pay
dividends, limiting its applicability. For example, if Nike does not regularly pay dividends or if
the dividends are sporadic, DDM might not provide an accurate valuation.
Sensitivity to Growth Rate - The valuation output is sensitive to the assumed dividend
growth rate, which can be challenging to predict accurately.
Too Conservative- The DDM is considered too conservative as it does not take into account
stock buybacks, which can also impact the value of a stock. Additionally, it ignores the effects of
stock buybacks, which can make a significant difference in terms of stock value being returned
to shareholders
Inapplicable to Non-Dividend Stocks- The DDM cannot be used to value non-
dividend stocks or growth stocks that pay relatively small dividends, limiting its utility for a
broader range of investment opportunities
Nike's Weighted Average Cost of Capital (WACC) is an important financial metric used to
assess the average rate of return that a company is expected to pay on all its securities. According
to Ford, Nike was been undervalued at a discount rate of 11.17%. However, her 12% discount
rate on finding the Equity value per share of 5037.27 also made Nike overvalued since it was
operating on a current share price of $42.09 per share. Based on our calculations, we found out
that the wrong discount rate was been used and we arrived that Nike's WACC is approximately
9.26%, a key input in the company's investment and capital budgeting decisions, as it represents
the average cost of financing its assets. A lower WACC suggests lower risk and can make
potential investments more attractive. Then, we use the WAAC value to find the present value
per share which is $58.13 We can see that the market price for Nike, Inc. is undervalued as the
present value is higher than the current market price. Next, the growth rate of Nike is lower (6 to
7%) than our calculation of 9.26%. Hence, the growth rate is undercalculated. So, Nike will most
likely see an increase in sales that will increase revenue and profits. Hence, it is a good decision
for Kimi Ford to recommend buying Nike’s shares, as the stock is undervalued and has great
growth potential. Additionally, based on past performance, Nike goes over the current market
returns which shows promise that Nike, Inc. will have great potential.