NIKE INC. CASE 14
Philip Chen, Choco Huang, Ariel Chou, Matt Krieger
In this report we analyzed Cohen’s approach in calculating WACC. After observing how Cohen derived his figures we came up with our own WACC, terminal value, and EPS.
Cohen broke down his calculations into five parts 1) Single or Multiple Costs of Capital 2) Proportion of capital from debt and equity 3) Cost of Debt 4) Cost of Equity 5) WACC
In part one; we disagreed with Cohen where he decided to value the company as a whole instead of valuing each division separately. Since Nike is a multidivisional firm Cohen should of aggregated the values of the individual divisions and calculate a different cost of capital for each one. Since the exhibit 1 and 3 provide a consolidated income statement and balance sheet it is difficult to segregate the divisions. Therefore when we did our own calculations we used Cohen’s assumption of a single cost of capital.
In part two Cohen allocated the weight of debt and equity based on book value. This method is incorrect because the allocation should be based on market value. The table below is our calculation of capital allocation.
Table 1.1 | Price: Exhibit 4 | shares outstanding | Total | % of Capital | Debt | 95.60 | 271.50 | 25,955.40 | 69.43% | | | | | | | Price: Exhibit 2 | shares outstanding | Total | % of Capital | Equity | 42.09 | 271.50 | 11,427.44 | 30.57% | | | | 37,382.84 | 100.00% |

Part 3 is the cost of debt. Cohen’s estimate of cost of debt is subjective because he did not include tax implications. We used the formula: cost of debt=Interest rate (1-tax rate)/Price of debt. The interest rate is the 6.75% paid semi-annually multiplied by two and tax rate we used the 2001 rate of 36%. The price of debt is the same as table 1.1. Therefore cost of debt= 9% ((13.5(1-0.36)/95.6)).
Part 4 is the cost of equity. Cohen used CAPM, which is common practice for financial analysts. We agreed with Cohen but instead of using a 20-year U.S. Treasury rate we used the 10-year rate because the forecast on exhibit 2 is 10 years. The beta is the 0.69 YTD 06/30/2001 figure and our risk premium is the arithmetic mean. Both are found in exhibit 4. We used the arithmetic mean because it is a better indicator of the average returns in the past and 71% of financial analysts prefer arithmetic mean over geometric mean. Geometric mean is not preferred because (PLEASE ADD “WHY NOT” HERE. I REMEBER BOB DOING AN EXAMPLE IN CLASS WHERE GEOMETRIC MEAN IS A TRICK ON STUIPID INVESTORS). Here is our calculation of CAPM.
CAPM=5.39%+0.69(7.50%). CAPM= 10.6%
In Part 5 we can summarize our calculations for WACC. Table 1.2 shows our WACC. | Portion | Cost (K) | Contribution to WACC | Common Share | 30.57% | 10.60% | 3.24% | Debt | 69.43% | 9% | 6.25% | | | WACC | 9.49% |
Our WACC is higher than Cohen’s because of the portions allocated to debt and equity, and the use of market value to calculate cost of debt.
Since WACC has changed the terminal value will also change. The formula for terminal value= year 10 FCF*(1+L-T growth)/ (WACC-L-T growth). We used the L-T growth in exhibit 4, which is forecast of dividend growth at 5.50%. Therefore the new terminal value is 41,584. Since terminal value has changed the discounted present value of future cash flow will also change. The new discounted PV of FCF less debt is 21,224. The new EPS is $67.50 (21,224/271.5).
MAYBE ADD CONCLUSION PLEASE
Additional Calculation
Table 1.3 | R/E Yr.2000 | NI Yr. 2001 | R/E Yr.2001 | | 2887 | 589.7 | 3194.3 | Dividend Paid out | | | 282.4 | Shares outstanding | | | 271.5 | DPS | | | 1.04 |

Estimation
Value of Equity = D1/k-g * # shares outstanding + debt
K=9.49%, g=5.50%, D1= 1.04
Value of equity =8,374.61