Nike, Inc.

:
Cost of Capital
Syndicate 4
Lutfi M. Basith 29318329 Nadya Eka Putri 29318318
Bara Yohantomo 29318424 Herdi Sularko 29318326
Lucky Wibisono 29318303 Fikri Pahlevi Sofyan 29318307
Indra Siregar 29318308 Aunurrahman Prio Aji 29318402
Deri Meidian 29318301 Hadi Putra 29318319
Overview

● Nike faced a decline in sales growth, profits and market share.

● Nike came up with a revitalizing strategy :
A. Increase the volume of mid-priced athletic shoe products.
B. Improved expense control to reduce cost.
● Due to mixed analyst reports, Kimi Ford (Portfolio Manager at NorthPoint
Group) developed her own discounted-cash-flow forecast, and requested her
assistant, Joanna Cohen to estimate Nike’s cost of capital.
Business Issue

● Kimi Ford was deciding whether to buy Nike’s stock or not because
Nike’s share price had declined significantly from the start of the year.
 WACC (Weighted Average Cost of Capital) 1 - 2
● Cost of capital is the weighted average of the required returns of the
securities that are used to finance the firm. Most firms raise capital with a
combination of debt, equity, and hybrid securities.
● WACC incorporates the required rates of return of the firm’s lenders and
investors and the particular mix of financing sources that the firm uses.
● WACC is used as a starting point for determining the discount rate for
investment projects the firm might undertake.
● WACC is the appropriate rate to use when evaluating performance,
specifically whether or not the firm has created value for its shareholders.
 WACC (Weighted Average Cost of Capital) 2 - 2

Formula WACC

WACC = [ KE x E / (D + E) ] + [ KD x (1-T) x D / (D + E) ]

Note: The WACC is set by the investors (or markets), not by managers.
Therefore, we cannot observe the true WACC, we can only estimate it.
 We don’t agree with Joanna’s WACC
Result of Joanna’s WACC
calculation due some comparisons as
below:
● Cost of Debt (Kd) = 4.3% & after tax of Kd = 2.7% 1. Target Debt for Joanna’s calculation
● Cost of Equity (Ke) = 10.5% just only include Current portion of
● D/(D+E) = 27.0% long term debt + Note payable +
● E/(D+E) = 73% LTD meanwhile our calculation is
total debt or liabilities
So the WACC = Kd(1-Tax)x(D/D+E)+Kex(E/(D+E)
2. She divided the interest expenses by
= 2.7% x 27% + 10.5% x 73%
the average balance of debt to get
= 8.4%
4.3% of before tax cost of debt. It
may not reflect Nike’s current or
future cost of debt while WACC is
used for discounting cash flows in
the future
Result of Ours WACC Calculation
Financial Analysis
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.

By following Joanna Cohen’s calculation, she estimated the firm’s cost of debt based on its historical
data. So, she used today’s figure that is total interest expense for the year of 2001 (around 58.7 millions),
and then divided it by the average debt balance of the year of 2000 and 2001, which eventually showed
4.3% as the predicted cost of debt . It may not reflect Nike’s current or future cost of debt. Hence, she
made a mistake for estimating the firm’s cost of debt when taking historical data for calculation, because
in terms of academic theory, the WACC is the required return on investments by the firm in the future, so
all components of the WACC, of which is the cost of debt that must reflect the future interest rate the
firm has obligations to pay upon its new borrowing.

Cohen should not use the book values as the basis for debt and equity weights, she should use the
market values instead. The reason of using market weights to estimate WACC is that it is how much it
will cause the firm to raise capital today.
Conclusion and Recommendation
Based on all the data, including the old , the recent and the future ones, it looks clear that Kimi Ford
should buy Nike’s shares because it is pretty safe and it has potentials. In details, Kimi Ford also should
consider before buy Nike’s shares depend on some of reasons.

First of all, the long-term shares considered as a wonderful investment, but Kimi should also be careful
because of the fast-changing industry, the changing of Nike, the changing of trend in footwear industry
and so on. Beside that, Kimi Ford should never forget to monitor its activities very closely.

If North-Point Large-Cap Fund want to invest in Nike’s shares in short-term, they should buy Nike’s
shares at the end of the year, while others not really pay attention to much in market and sell it in the
first month of the following year. In January, when people is a little overestimating, North-Point Large-
Cap Fund can sell to get their profit.