814 words - 4 pages

Nike Inc.: Cost of Capital

We reviewed Joanna’s memo estimating Nike Inc.’s cost of capital and wanted to

express our thoughts on the methods, assumptions, and conclusions utilized in her analysis.

While we agree with some of the fundamental assumptions & methods, we have concerns

about several others. We agree with using a single cost of capital, as the mix of product lines &

business units don’t represent a material enough variance in risk profile to warrant the

utilization of multiple costs of capital. While there is some risk in expanding the apparel line

and increasing focus on mid-priced shoes, we don’t believe these are substantial. As Joanna

stated, there are some ...view middle of the document...

A better proxy

would be to calculate the current yield to maturity which is 7.1% and adjust for the effective tax

rate, which gives us an approximate 4.4% cost of debt. Using market values instead of book

values, it’s apparent that market equity and debt weights of 89.9% and 10.1% are dramatically

different from Joanna’s calculated weights of 73% and 27%. WACC is an estimate of cost of

capital that is determined by the market, not management or book values.

While we’re fine with Joanna’s use of CAPM to calculate cost of equity and even her use

of the Geometric mean risk premium due to the longer time horizon, we disagree with Joanna’s

use of the 20-year U.S. Treasury Bond yield for the risk free rate. While CAPM normally calls for

short-term rates, we’d be open to using the 20-year Treasury Bond rate if the time horizon of

our analysis was over a 20-year period. However, if we use long-term Treasuries as our risk

free rate, we should restate our risk premium to reflect the average difference between equity

returns and returns on long-term Treasuries. Due to our analysis being over a 10-year period,

we feel that the 10-year Treasury Bond yield with an adjusted risk premium, or another method

of deriving the risk free rate (such as risk premiums of bonds over short term treasuries) would

be better suited for our...

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