Nike Inc.: Cost of Capital

Essay by lolu2000University, Master'sA+, October 2006

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Executive summary

In this report we focus on Nike's Inc. Cost of Capital and its financial importance for the company and future investors. The management of Nike Inc. addresses issues both on top-line growth and operating performance. The company's cost of capital is a critical element in such decisions and it is important to estimate precisely the weighted average cost of capital (WACC).

In our analysis, we examine why WACC is important in decision making and we show how WACC for Nike Inc. is calculated correctly. Also, we calculate the company's cost of equity using three different models: the Capital Asset Pricing Model (CAPM), the Dividend Discount Model (DDM) and the Earnings Capitalization Model (EPS/ Price), we analyze their advantages and disadvantages and finally we conclude whether or not an investment in Nike is recommended.

Our analysis suggests that Nike Inc.'s common stock should be added to the North Point Group's Mutual Fund Portfolio.

I. The Weighted Average Cost of Capital and its Importance for Nike Inc.

The Weighted Average Cost of Capital (WACC) is the average of the costs of a company's sources of financing-debt and equity, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every marginal dollar it finances. A firm's WACC is the overall required return on the firm as a whole and, as such, it is often used internally by company directors to determine the economic feasibility of expansionary opportunities and mergers. Also, WACC is the appropriate discount rate to use in stock valuation.

II. Calculation of Nike's WACC

The calculating methodology for Nike's Inc. WACC seems to be inconsistent with the principles1 that should be followed when estimating this measure. These are...