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case study nike

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INTRODUCTION
Background:
Kimi Ford, a portfolio manager of a large mutual fund management firm, is looking into the viability of
investing in the stocks of Nike for the fund that she manages. Ford should base her decision on data on
the company which were disclosed in the 2001 fiscal reports. While Nike management addressed several
issues that are causing the decrease in market sales and prices of stocks, management presented its plans
to improve and perform better. Third party sources also gave their opinions on whether the stock was a
sound investment.
The weighted average cost of capital (WACC) is the rate (expressed as a percentage, like interest) that a
company is expected to pay to debt holders (cost of debt) and shareholders (cost of equity) to finance its
assets. It is the minimum return that a company must earn on existing asset base to satisfy its creditors,
owners, and other providers of capital. Companies raise money from a number of sources: common
equity, preferred equity, straight debt, convertible debt, exchangeable debt, warrants, and options, pension
liabilities, executive stock options, governmental subsidies, and so on. Different securities are expected to
generate different returns. WACC is calculated taking into account the relative weights of each component
of the capital structure- debt and equity, and is used to see if the investment is worthwhile to undertake.
Management always takes notice of the cost of capital while taking a financial decision. The concept is
quite relevant in the following managerial decisions and hence its importance:
(1) Capital Budgeting Decision. Cost of capital may be used as the measuring road for adopting an
investment proposal. The firm, naturally, will choose the project which gives a satisfactory return on
investment which would in no case be less than the cost of capital incurred for its financing. In various
methods of capital budgeting, cost of capital is the key factor in deciding the project out of various
proposals pending before the management. It measures the financial performance and determines the
acceptability of all investment opportunities.
(2) Designing the Corporate Financial Structure. The cost of capital is significant in designing the
firm's capital structure. The cost of capital is influenced by the chances in capital structure. A capable
financial executive always keeps an eye on capital market fluctuations and tries to achieve the sound and
economical capital structure for the firm. He may try to substitute the various methods of finance in an
attempt to minimize the cost of capital so as to increase the market price and the earning per share.
(3) Deciding about the Method of Financing. A capable financial executive must have knowledge of the
fluctuations in the capital market and should analyze the rate of interest on loans and normal dividend
rates in the market from time to time. Whenever company requires additional finance, he may aver a
better choice of the source of finance which bears the minimum cost of capital. Although cost of capital is
an important factor in such decisions, but equally important are the considerations of relating control and
of avoiding risk.
(4) Performance of Top Management. The cost of capital can be used to evaluate the financial
performance of the top executives. Evaluation of the financial performance will involve a comparison of
actual profitability’s of the projects and taken with the projected overall cost of capital and an appraisal of
the actual cost incurred in raising the required funds.
(5) Other Areas. The concept of cost of capital is also important in many others areas of decision
making, such as dividend decisions, working capital policy etc.

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WACC CALCULATION:
II. Cost of Capital Calculations: Nike Inc
Cohen calculated a weighted average cost of capital (WACC) of 8.3 percent by using the capital asset
pricing model (CAPM) for Nike Inc. And we do not agree with her figure, and the reasons to that are
postulated as follows:
I. Value of equity
The problem with Cohen’s calculaons is that she used the book value for both debt and equity. While
the book value of debt is accepted as an esmate of market value, book value of equity should not be
used when calculang cost of capital. The market value of equity is found by mulplying the stock price
of Nike Inc. by the number of shares outstanding.
Market Value of Equity(E) Calculation:
E
= Stock Price X Number of Shares Outstanding
= $42.09 X 271.5
= $11,427.44
This figure is much different than the book value of equity that Joanna Cohen used ($3,494.50).

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INTRODUCTION Background: Kimi Ford, a portfolio manager of a large mutual fund management firm, is looking into the viability of investing in the stocks of Nike for the fund that she manages. Ford should base her decision on data on the company which were disclosed in the 2001 fiscal reports. While Nike management addressed several issues that are causing the decrease in market sales and prices of stocks, management presented its plans to improve and perform better. Third party sources also gave their opinions on whether the stock was a sound investment. The weighted average cost of capital (WACC) is the rate (expressed as a percentage, like interest) that a company is expected to pay to debt holders (cost of debt) and shareholders (cost of equity) to finance its assets. It is the minimum return that a company must earn on existing asset base to satisfy its creditors, owners, and other providers of capital. Companies raise money from a number of sources: common equity, preferred equity, straight debt, convertible debt, exchangeable debt, warrants, and options, pension liabilities, executive stock options, governmental subsidies, and so on. Different securities are expected to generate different returns. WACC is calculated taking into account the relative weights of each component of the capital structure- debt and equity, and is used to see if the investment is worthwhile to undertake. Management always takes notice of the cost of capital while taking a financial decision. ...
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