Page 80 - DMGT409Basic Financial Management

Unit 4: Cost of Capital

Notes
Exhibit 5: Dr. Bhatt’s Analysis
Subject: Nike’s Cost of Capital
Based on the following assumptions, my estimate of Nike’s cost of capital is 8.4 percent :
Single or Multiple Costs of Capital

The first question I considered was whether to use single or multiple costs of capital
given that Nike has multiple business segments. Aside from footwear, which makes up
62 per cent of revenue. Nike also sells apparel (30 per cent of revenue) that complement
its footwear products. In addition, Nike sells sport balls, time-pieces, eyewear, skates, bats
and other equipment designed for sports activities. Equipment products account for 3.6
per cent of revenue. Finally, Nike also sells some non- Nike branded products such as Cole-
Haan dress and casual footwear, and ice stakes, skate blades, hockey sticks, hockey jerseys
and other products under the Bauer trademark, non-Nike brands account for 4.5 per cent
of the revenue.
I asked myself, whether Nike’s different business segments shad enough risks from each

other to warrant different costs of capital. Were their profiles really different? I concluded
that it was only the Cole-Haan line that was somewhat different : the rest were all sports-
related businesses. However, since Cole-Haan makes up only a tiny fraction of the revenues,
I did not think it necessary to compute a separate cost of capital. As for the apparel and
footwear lines, they are sold through the same marketing and distribution channels and
are often marketed in “collections” of similar design. I believe, they face the same risk
factors, as such, I decided to compute only one cost of capital of the whole company.
Methodology for Calculating the Cost of Capital; WACC
Since Nike is funded with both debt and equity, I used the Weighted Average Cost of
Capital (WACC) method. Based on the latest available balance sheet, debt as a proportion
of total capital makes up 27.0 per cent and equity accounts for 73.0 per cent:
Capital sources Book Values
Debt

Current portion of long-term debt $ 5.4
Notes payable 855.3
Long-term debt 435.9
$ 1.291.2 → 27.0% of total capital

$ 3.494.5 → 72.0% of total capital
Cost of Debt
My estimate of Nike’s cost of debt is 4.3 per cent. I arrived at this estimate by taking
total interest expense for the year 2001 and dividing it by the company’s average debt
balance. The rare is lower than Treasury yields but that is because Nike raised a portion
of its funding needs through Japanese yen notes, which carry rates between 2.0 per cent to
4.3 per cent.
After adjusting for tax, the cost of debt comes to 2.7 per cent. I used a tax rate of 38 per
cent, which I obtained by adding state taxes of 3 per cent to the U.S. statutory tax rate.
Historically, Nike’s state taxes have ranged from 2.5 per cent to 3.5 per cent.

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