Hello, I'm working on my case project related to WACC. I would like to make sure that I'm using the right numbers in order to calculate the weighted average cost of capital. So for example, what is the right way to calculate the cost of debt and equity. I would really appreciate your help. Thanks

CHAPTER 10 The Cost of Capital 341 CASE STUDY FOR CLASS DISCUSSION - I NIKE, INC. -COST OF CAPITAL On July Kimi-ford, a portfolio manager at North Point Group. a mutual-fund-management firm, pored over analysts' write-ups of Nite. Inc., the athletk-shoe manufacturer. Nike's share price had declined significantly from the start of the year. Ford was considering buying some shares for the fund she managed. the North Point Large-Cap Fund, which invested mostly In fortune 500 companies, with an emphasis on value Investing. Its top holdings incladed Exxon Mobile. General Motors, McDonald's, 3M, and other large-cap. It had performed extremely well. In 2000, the fund earned a return of 20.7 per cent even as the S&P 500 fell 10,1 per cent. The fund's car- to-date returns at the end of June 2001 stood at 6.4 versus the 5 &P - 7.3 per cent. Only a week ago, on june 28.200 1. Nike held an anchor" meeting to disclose is fiscal-year 2001 results. The meeting, however had another purpose : Nike management wanted to communicate a strategy for revitalizing the company Since 1997 Nike's revenues had plateaued at around $9 billion, while net income had fallen from almost $ 800 milion to $380 million (see Exhibit . Nike's markets in the U.S. had fallen from 4 5 per cerit in 1 997 in 42 percent in 2000. In addition, recent supply chain Issues and the adverse effect of a strong dollar had negatively affected revenue. At the meeting, the management revealed plans to address both- line growth and operating performance. To bood revenue, the company would develop more athletic shoe products in the mid-priced segment - a segment that had been overlooked in the recent ycars. Nike also planned to push its apparel line, which, under the recent leadership of industry veteran Mindy Grossman had performed extremely well. On the cost side, Nike would exert more effort on expense control, finally the company's executives reiterated their long-term revenue growth targets of 8-10 per cent and earnings growth targets of above 1 percent. The Analysts reactions were mised. Some thought, the financial targets too aggressive : other saw significant growth opportunities In apparel and in Nike's International businesses. Ford read all the analysts reports that she could find about the June 25 meeting, but the reports gave her no clear guidance : a Lehman Brothers report recommended a "Strong Buy", while UBS analysts expressed misgiving about the company and recommended a " Hold". Ford deckled instead to develop her own discounted-cash flow forecast to come to a clearer conclusion, Her forecast showed that, at discount rate of 12 per cent, Nike was overvalued at its current share price of $42.09 (see Exhibit Z). She had, however, done a quick sensitivity andleads that revealed Nike was valued at discount rates below | 1.2 per cent. As she was about to go into a meeting. she asked her new assistant. kurra Cohen. to estimate Nike's cost of capital. Cohen Immediately gathered all the data she though she might need (Exhibitss 1, 2.3 and 47 began to work on her analysis. At the end of the day she submitted her cost-of-capital estimale and a memo (Exhibit 5) explaining her assumption to Ford. Lahlba I: Consolidated Income Stalements car ended May 3 On millions exospla per share datal 3030 2001 2002 1003 2004 2005 2006 1 760 2 6 470.6 9 516.5 8,776.9 9,484.4 Cou of goods sold 7 565 3 $4235 Gross profit 1.395 6 2.563.5 3,4876 1.591.J 3.703.9 Selling ned admininthe 1,209 8 588.6 2 301 7 2.6218 2.426.6 2.606 4 2.630.7 685 3 975,3 13798 853 8 456.8 9845 1,014.2 Interal Caponec 14.7 10.0 44.1 Other p : 5 Met 11.7 367 12.3 20.9 23.2 Feinkain's chace red .-. 125.2 45.1 2.5 Income boloore Income taxcl 1.295 20 1530 2461 lecome Lives 250.2 345.9 4984 253.4 HO.I JOLT Net Income 197.7 $53.2 755.8 395.6 4514 5794 589.7 Dusted cardlag per Andun Shares 1.4 1.9 17 1.4 1.6 2.1 2.2 Average shares outstanding Idiluted 297.0 296.0 287.5 279.8 273.J 15.9 2.0 40 2.5 5.5 Operating Income 42 2 415 37.4 No kicoma Gross margin 10.1 56.5 174 Operating nurgo 15.1 D'S 107 Nri margin 8.7 6.1 5.2 10.5 370 1510342 Financial Management Exhibit 2: Discounted - Cast - flow Analyst 2007 2008 2007 2010 2011 2012 2013 2014 2015 2015 Assumption Revenue growth {%) 70 6.5 6.0 60 600 59.5 59.5 590 58.5 SH.O 5&A/ Saks 090) 28.0 17.5 27.0 26.3 260 25.3 250 25.0 250 Tax rate (39 360 38.0 180 38.0 150 38.0 J80 36.0 Current Assets / sales (8) 38 0 380 36.0 35.0 38.0 38.0 38.0 Current lubiltkey sales 09 1.5 I1.5 II.5 115 01.5 11.5 113 11.5 Yearly depreciations Equals capex. Cost of Capital $39 12.0 Terminal powth rate (9 Discounted cash flow Opeating income 1,2184 1.331.6 1554.6 17170 1950.0 2135 9 2410.2 2554.8 2790. 1 2957.5 1530 513.6 5203 741.0 811.7 915.9 970.8 |1060.2 11219 NOPAT 735 4 838.0 963.9 10345 1209.0 13243 1494.3 15840 1729.9 Capex.net of dared icon Change In NWC 1749 186.3 195.0 206.7 219.1 232.3 246,2 261,0 Free cash Cow 764,1 563, 1 776.6 366 2 | 10140 1176 6 ) 12753 1851 7 14837 1572.7 Terminal values 17998.7 Total flows 764.1 553,1 776.6 866.2 |10140| 1176.6 ) 1275.2 1351.7 1453,7 19571.5 Present value of flows 687.3 528.6 553.5 550.5 5754 1 566.2 3768 545.9 Enterprise value 11415.7 Less : current outstanding dept. 1296.6 Equity value 1 0149.1 Current shares outstanding 271.5 Easily value per share $37.27 Current share price $42 09 Exhibit 3: Sendthiry of couty value of discount rate Discount rate Equity value B.OOM 575 80 8.5 67.59 0.00 81.25 9.50 10,00 50.172 10.50 40.81 11 00 43.22 11.17 42.09 11.50 40.07 12.00 37.27CHAPTER 10 The Cost of Capital 343 Exhibit 4: Consolidated Balance Sheets (in millions) May 31 2005 2009 Assets Current assets Cash and equivalents 5254.3 $304.0 Accounts receivable 1 859.4 1.521 4 Inventories 14460 1,424.0 Deterred income toes 1115 113 3 Prepaid expenses 216 2 162 5 Total Current assets 3,566. 4 3.825.3 Properly, plant and equipment, net ,583. 4 1.618 3 Identifiable. intangible essots and goodwill, nat 410.9 397.3 Deferred income taxes and other assets 266,2 178 2 Total assets $5, 850.8 $5,815.6 Lisbilicies and shareholder's equity Current abilities Current portion of lang-ten dalt $50,1 $54 Notco payable 824.2 Accounts payable 543.8 Accrued labatless 821.9 472.1 Income taxes payable 21.5 Total current Nabiities 2.140.0 1.786.7 Long-term debt 470.3 135.9 Deferred income fuges and other labitties 110.2 102 2 Redeemable protoned stock 0.3 03 Share holder equity Common stock, par 2.8 2.8 Capital in excess of slated value 369.0 459. 4 Unearned stock comper 117 Accumulated other comprehensive income 111.1 Retained earnings 2887.0 3194.3 Total share holder equity 3134. 3494 15 Total liabilities and shareholder's equity $5,050.9 15,810.8 Exhibit 5: Dr. Shatt'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 mulipic costs of capital given that Nike has multiple business segments. Aside from lootwear. which makes up 62 per cent of revenue. Nike also sells apparel (30 per cent of revenue) that complement is footwear products. In addition, Nike sell sport bells, time-pieces, eyewear, skates. bats and other equipment designed for sports activities. Equipment products account lor 3.6 per cent of revenue. Finally, Nike also sells some non- Nilo branded products such as Cole- Haan drew and casual footwear and ice stakes, skate blades, hockey sticks. hockey jerseys and other products under the Bauer trademark. non-Nike brands account for 4.3 per cent of the revenue344 Financial Management 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 compulc a separate cast of capital. As for the apparel and footwear lines, they are sold through the same marketing and distribution channels and are often marketed in "collectionis " of similar design. I believe, they face the same risk factors, as such, I decided to compule only one cost of capital of the whuk compare Methodology for Calculating the Cost of Capital; WACC Since Nike is funded with both debt and enquiry. I used the Weighted Average Cost of Capital (WACC) method. Based on the latest zealbible balance sheet, debt is a proportion of total capital makes up 27.0 per cent and couity accounts for 73.0 per cent: Capital sources Book Values Debt Current portion of long-term debt $54 Notes payable Long-term debut 435.9 $1,291.2 ->27.0%of total capital 53,494.5 - 72.0% of total capital Cost of Debt Myeximale of Nike's cost of debt is 4 3 per cent. I arrived at this estimate by taking total interest expense for the year 200 1 and dhiding H 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 lapanese yen notes, which carry rates between 2.0 per cent to 4.3 per ccat. After adjusting for lax, 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 I per cent to the U.S. statutory tax rate. Historically Nike's stale taxes have ranged from 2.5 per cent to 3 5 per cent_ Cost of Eqully I estimated the cost of equity using the Capital Asset Pricing Model [CAPM). Other methods such as the Didend Discount Madel IDDM) and the Eamings cap tallestion Ratio can be used to estimate the cod of costly However In my opinion, the CAPM is the superior method. My estimate of Nie's cost of equity is 10.5 per cent I used the curren yield on 20 year Treasury bonds as my risk-free rate, and the compound merage premium of the market over Treasury bonds [5 2 per cent) as my riss premium. For beta, I took the average of Nike's beta from 1996 to the present. Putting it all Together Alter inputting all my assumptions into the WACC formula, my estimate of Nike's cost of capital is 8.4 per cent WACC -KID-0 *D/D + E) + K - EAD +0) -2.7% -27.0% + 20.5% *73.0% -8.4%