You were a portfolio manager in a mutual fund firm. On July 10^th in 2001, you were asked to evaluate Nike, Inc. Nikes stock price had declined recently, which may provide a good buying opportunity considering the investment focus at your firm is value investing.

In the last analysts meeting held a week ago, Nike posited that the firm would develop more athletic shoes in the mid-priced range to attract more customers. Further, they would exert more effort in controlling all costs. Their long-term targets for revenue growth is 8%-10% and for earnings growth is above 15%.

The analysts had estimated the free cash flows for Nike from year 2002 to 2011 (Spreadsheet1). Assuming the weighted-average cost of capital was12%, Nikes enterprise price value would be $11,415.4 million. Given that the current debt outstanding was $1,296.6 million, the estimated equity value of would be $10,118.8 million. Because the shares outstanding was 271.5 million, the equity value per share would be $37.27. The Nike stock price was $42.09 at the time, so Nike was overvalued and your firm should not investment in Nike stock.

However, your colleagues provided mixed opinions on Nikes weighted-average cost of capital. They also argue that Nike would be undervalued if the discount rate is below 11%. As the Nikes valuation is very sensitive to its cost of capital, the correct estimation is crucial in making right investment decision.

1. What is the weighted-average cost of capital (WACC)?