Case 15 provides a WACC calculation that contains errors based on conceptual mistakes in the analysis. Read the case carefully and present your answers to the following questions:

1. What is the WACC and why is it important to estimate a firm's cost of capital? Is the WACC set by investors or by managers?

2. What was your estimate of cost of debt? What mistakes did Joanna Cohen make in her estimate? Provide justification for your estimate.

3. Do you agree with Cohen's assumption of risk free rate and beta in her estimate of the cost of equity ? Calculate the cost of equity using CAPM and the dividend growth model. What are the advantages and disadvantages of each method?

4. Cohen was using book values as the basis for debt and equity weights. Calculate the weight of debt and equity using market value basis. What basis should be used in your opinion? and Why?

5. What was your estimate of WACC? What should Kimi Ford recommend regarding an investment in Nike?

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Nike, Inc.: Cost of Capital On July 5, 2001, Kimi Ford, a portfolio manager at NorthPoint Group, a mutual-fund management firm, pored over analysts' write-ups of Nike, Inc., the athletic-shoe man- ufacturer. Nike's share price had declined significantly from the beginning of the year. Ford was considering buying some shares for the fund she managed, the NorthPoint Large-Cap Fund, which invested mostly in Fortune 500 companies, with an emphasis on value investing. Its top holdings included ExxonMobil, General Motors, McDonald's, 3M, and other large-cap. generally old-economy stocks. While the stock market had declined over the last 18 months, the NorthPoint Large-Cap Fund had performed extremely well. In 2000, the fund earned a return of 20.7%, even as the S&P 500 fell 10.1%. At the end of June 2001, the fund's year-to-date returns stood at 6.4% versus -7.3% for the S&P 500. Only a week earlier, on June 28, 2001, Nike had held an analysts' meeting to dis- close its fiscal-year 2001 results. The meeting, however, had another purpose: Nike management wanted to communicate a strategy for revitalizing the company. Since 1997, its revenues had plateaued at around $9 billion, while net income had fallen. from almost $800 million to $580 million (see Exhibit 1). Nike's market share in U.S. athletic shoes had fallen from 48%, in 1997, to 42% in 2000. In addition, recent supply-chain issues and the adverse effect of a strong dollar had negatively affected revenue. At the meeting, management revealed plans to address both top-line growth and operating performance. To boost revenue, the company would develop more athletic- shoe products in the midpriced segment--a segment that Nike had overlooked in recent years. Nike also planned to push its apparel line, which, under the recent leadership of 'Nike's fiscal year ended in May. Douglas Robson, "Just Do... Something: Nike's invalarity and Foot-Dragging Have It Running in Place," Business Work (2 July 2001). Sneakers in this segment sold for $70-$90 a pair. This case was prepared from publicly available information by Jessica Chan, under the supervision of Robert F. Bruner and with the assistance of Sean D. Carr. The financial support of the Batten Institute is gely acknowledged. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright © 2001 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to sales@ Abusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system, ed in a spreadsheet, or transmitted in any form or by any means-electronic, mechanical, photocopying, econding, or otherwise without the permission of the Darden School Foundation. Rev. 10/05. 235 Nike, Inc.: Cost of Capital On July 5, 2001, Kimi Ford, a portfolio manager at NorthPoint Group, a mutual-fund management firm, pored over analysts' write-ups of Nike, Inc., the athletic-shoe man- ufacturer. Nike's share price had declined significantly from the beginning of the year. Ford was considering buying some shares for the fund she managed, the NorthPoint Large-Cap Fund, which invested mostly in Fortune 500 companies, with an emphasis on value investing. Its top holdings included ExxonMobil, General Motors, McDonald's, 3M, and other large-cap. generally old-economy stocks. While the stock market had declined over the last 18 months, the NorthPoint Large-Cap Fund had performed extremely well. In 2000, the fund earned a return of 20.7%, even as the S&P 500 fell 10.1%. At the end of June 2001, the fund's year-to-date returns stood at 6.4% versus -7.3% for the S&P 500. Only a week earlier, on June 28, 2001, Nike had held an analysts' meeting to dis- close its fiscal-year 2001 results. The meeting, however, had another purpose: Nike management wanted to communicate a strategy for revitalizing the company. Since 1997, its revenues had plateaued at around $9 billion, while net income had fallen. from almost $800 million to $580 million (see Exhibit 1). Nike's market share in U.S. athletic shoes had fallen from 48%, in 1997, to 42% in 2000. In addition, recent supply-chain issues and the adverse effect of a strong dollar had negatively affected revenue. At the meeting, management revealed plans to address both top-line growth and operating performance. To boost revenue, the company would develop more athletic- shoe products in the midpriced segment--a segment that Nike had overlooked in recent years. Nike also planned to push its apparel line, which, under the recent leadership of 'Nike's fiscal year ended in May. Douglas Robson, "Just Do... Something: Nike's invalarity and Foot-Dragging Have It Running in Place," Business Work (2 July 2001). Sneakers in this segment sold for $70-$90 a pair. This case was prepared from publicly available information by Jessica Chan, under the supervision of Robert F. Bruner and with the assistance of Sean D. Carr. The financial support of the Batten Institute is gely acknowledged. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright © 2001 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to sales@ Abusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system, ed in a spreadsheet, or transmitted in any form or by any means-electronic, mechanical, photocopying, econding, or otherwise without the permission of the Darden School Foundation. Rev. 10/05. 235

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1 WACC or weighted average cost of capital is the average cost of capital for a company that uses several different forms of capital like debt equity ... View the full answer