Nike Inc Cost of Capital Essay

2985 Words Feb 22nd, 2010 12 Pages
Introduction

Kimi Ford is a portfolio manager at NorthPoint Group, a mutual-fund management firm. She is evaluating Nike, Inc. (“Nike”) to potentially buy shares of their stock for the fund she manages, the NorthPoint Large-Cap Fund. This fund mostly invests in Fortune 500 companies, with an emphasis on value investing. This Fund has performed well over the last 18 months despite the decline in the stock market.
Ford has done a significant amount of research through analysts’ reports, which had mixed reviews. She found no clear guidance from the analysts and decided to develop her own discounted cash flow forecast to come to a conclusion. Her forecast showed that Nike was overvalued at its current share price causing a
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A standard means of expressing a company’s cost of capital is the weighted average of the cost of individual sources of capital employed.

WACC = (Wdebt(1-t)Kdebt)+(WpreferredKpreferred)+(WequityKequity) where

K=component cost of capital
W=weight of each component as percent of total capital
t = marginal corporate tax rate

There are several observations to consider when estimating a company’s WACC for example, all capital costs as well as the weights should be current and not historical. Also the cost of debt should be after corporate tax and not before. As we will see in the survey findings, this equation, combined with these observations can be helpful; however, there are still some difficult choices that would have to be made and the most troublesome component being the cost of equity capital.
The survey findings first show multiple similarities. The discounted cash flow is the dominant investment-evaluation technique and the WACC is the dominant discount rate used in the discounted cash flow analysis. Weights are based on market not book value mixes of debt and equity. The after-tax cost of debt is predominantly based on marginal pretax costs, and marginal or statutory tax rates. The CAPM is the dominant model for estimating the cost of equity, which in and of itself seems to be a bit…

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