Case: Nike
The review of Weighted Average Cost of Capital
I. Capital structure
According to the 10-K of Nike, the short-term debt is mainly comprised by notes payable and commercial paper. And because the interest rates for U.S. operation and Non U.S. operation are quite different, we decided to count the interest rates for these two parts separately. The U.S. operation short-term debt in 2001 is $710 million dollars while the Non U.S. operation short-term debt is $145.3 million dollars. On the other, the long-term debt for 2001 is $435.9 million dollars. As for the equity, the shares outstanding in 2001 are 273.3 million shares and the current market price of Nike is $42.1, so the total equity value is $11,503.2 million dollars. Thus, the weight of debt should be 10.09% and the weight of equity should be 89.91%.
II. Cost of debt
In order to make sure the WACC is correct, our group scrutinized its calculation. For cost of debt calculation, we downloaded Nike’s 10-K for 2001. We find out that the interest rate of notes payable and commercial papers is different for U.S. operation and Non-U.S. operation. So in the calculation, we differentiate the long-term debt and short-term debt. In this case, Cohen simply uses the interest expense divided by the company’s average debt balance and it fails to reflect the difference of interest rates. Unlike her calculation, we differentiated the long-term and short-term debt. Also, for short-term debt, we used the interest rate for U.S. operation and Non U.S. operation separately. The yield-to-maturity for long-term debt in this case is 7.17% (Table.1) and interest rate for short-term debt for U.S. operation is 4.07% and for Non U.S. operation is 6.5%. After adjusting for tax, the cost of long-term debt is 4.44%, the cost of short-term debt for U.S. operation is 2.52% and for Non U.S. operation is 4.03%. After weighting, the total after-tax cost of debt is 3.34% (Table.2).
III. Cost of equity
As for the calculation of cost of equity, we have the same opinion with Cohen that CAPM is the superior method to get a more unbiased result. We first set the risk-free rate as 10-year treasury bond rate of 5.39%. Then we ran a three-year regression to find out the beta because we think three year is long enough to objectively reflect the correlation between stock and market while it also shows a more recent trend on their correlation. We regressed on and we got a coefficient of 0.65. The return we used for Nike is the daily return from June 1st 1998 to May 31st 2001. In order to match the daily data, we divided the risk-free rate, 10-year Treasury Bond Rate, by 365 days to get the daily rate. [pic 1][pic 2]