a). The cost of debt is determined as the interest expense/average debt balance and is taken to be 4.3%.

Assuming all Nikes cash flows are earned in USD (for simplicity/clarity),

- briefly explain if this is a sensible way to measure the cost of debt?

- What other (sensible) alternative is possible for measuring the cost of debt?

b). Explain (briefly) how the WACC is determined and why is it used here as a discount rate?

c). Explain (briefly) how the equity value per share obtained?

d). (Briefly) mention two key things you might do to try and improve the methodology used to estimate the fair value of Nikes equity.

You may use standard abbreviations (eg. CAPM. SIM, WACC, DDM etc)

II. 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% and equity accounts for 73.0% : III. Cost of Debt My estimate of Nike's cost of debt is 4.3%. 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 rate 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% and 4.3%. After adjusting for tax, the cost of debt comes out to 2.7%. I used a tax rate of 38%, which I obtained by adding state taxes of 3% to the U.S. statutory tax rate. Historically, Nike's state taxes have ranged from 2.5% to 3.5%. IV. Cost of Equity I estimated the cost of equity using the capital-asset-pricing model (CAPM). Other methods, such as the dividend-discount model (DDM) and the earnings-capitalization ratio, can be used to estimate the cost of equity. In my opinion, however, the CAPM is the superior method. My estimate of Nike's cost of equity is 10.5%. I used the current yield on 20 -year Treasury bonds as my risk-free rate, and the compound average premium of the market over Treasury bonds (5.9%) as my risk premium. For beta, I took the average of Nike's betas from 1996 to the present. Putting It All Together After entering all my assumptions into the WACC formula, my estimate of Nike's cost of capital is 8.4%. WACC=Kd(1t)D/(D+E)+KeE/(D+E)=2.7%27.0%+10.5%73.0%=8.4%