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Nike, INC : Cost of Capital

ANTHONY 291 17 005


SOFIA PUJIASTI 291 17 053
AFRISKA YUNI ANGGRAINI 291 17 238 SYNDICATE 10
ARFAN NUR AKBAR 291 17 246
Background
Kimi Ford, a portfolio manager at NorthPoint Group, going to evaluate
the financial of Nike to decide should they bought Nike’s shares or not.
A week prior to the evaluation, Nike held an analysis meeting to
disclose its fiscal-year 2001 results. Another purpose of the meeting
was to revitalize the company’s strategy after the declining of their
revenue.
Background – cont.
Kimi believes it is necessary to develop her own discounted-cash flow
forecast in order to have proper investment. According to her
calculation, Nike’s 12% of discount rate was overvalued at its current
share price of $42.09. Kimi asked her new assistant Cohen to gather
more data and calculate cost-of capital in order to assured the
decision of the Group.
Problem Identification
Do you agree with Joanna Cohen’s
WACC estimations? Why or why not?

Issues
• Single cost or Multiple Cost?
• Cost of debt
• Cost of equity
• Weights of capital components
WACC (Weighted Joanna Cohen’s
Average Cost of Capital) Analysis
Total Equity (E) 3.494,50
Total Debt (D) 1.296,60
Total Capital (E + D) 4.791,10
Tax Rate (t) 38%
Weight of Equity 72,94%
Weight of Debt 27,06%
Cost of Debt (Kd) 4,30%
Cost of Equity (Ke) 10,50%
After tax cost of debt 2,70%
WACC 8,38%
Multiple or Single Cost
of Capital
Based on the understanding about single and multiple cost of capital, we
agree that the single cost of capital is the best way to value the cash flows
for the entire firm . The reason are as following :
• Nike has multiple segment that contributor to revenue like sport balls,
apparel, skates, bats, etc. we can see clearly that apparel, equipment
products gained over a half of footwear, but this is not enough evidence
to consider them as a cost of capital distinct from footwear.
Multiple or Single Cost
of Capital
• The first deficiency is the risk rate. Except the non-Nike branded
products such as Cole Hann have some differences, but they only
contributed a tiny part of Nike’s revenue. There are not significantly
different between the risk rate that every Nike’s segments stand
because all of these segments are related to sport business.
• The second deficiency is about business activities such as marketing,
distribution channel. With the management of Nike, all of these
segments are set in the same state. They have the same marketing
project, distribution channel, customer service, qualify guarantee, etc.
They are displayed in stores with the same design.
• For these deficiencies, it is company to claim that computing all of the
segments as only one cost of capital for whole company, is the true way.
Weight of Debt & Equity
Cost of capital based on market value not book value

Market value of equity – current share price x average shares outsanding


= ($42.09 x 273,3) million = $11.503 million

Thus, Market value weight for equity is


= 11.503 million / (11.503 million + 1.291 million) = 89,9%

The weight for equity = 89,9%


The weight for debt is (100-89,9)% = 10,1%
Cost of Debt
The current yield to maturity of the Nike’s bond to represent Nike’s current cost of
debt.
Current Bond Price = 95,6
r = 7,16%
Face value = 100
Cost of debt (after tax) is
Annual coupon rate = 0,0675
Coupon = 100 x 0,03375 = 3,375 7,16% x (1-0,38) = 4,4%
n = 2x(25-5) = 40 years (paid semiannually)
Bond issue in 07/15/96, its maturity is 07/15/21, Now is year 2001.
𝑟 −40
1− 1+2 100
95,6 = 3,375 + 𝑟
𝑟/2 (1+ )40
2
Cost of Equity - CAPM
KE = KRF + (KM – KRF) x Beta

Exhibit 4
• Geometric mean = 5.90%, arithmetic mean = 7.50%)
• Given from 1996 is Average beta = 0.98, beta in 2001 is 0.69.
• U.S Treasury 20-year Krf = 5,74%.

(Km – KRF ) = Risk Premium = 5.9%


Beta = 0.69

KE = 5,74% + 5,9% x 0,69 = 9,811%


Weighted-Average Cost of
Capital (WACC)
The cost of capital is the rate of return required by a capital provider in
exchange for foregoing an investment in another project or business
with similar risk. Thus, it is also known as an opportunity cost.

Since WACC is the minimum return required by capital providers,


managers should invest only in projects that generate returns in excess
of WACC.

The WACC is set by the investors (or markets), not by managers.


Therefore, we cannot observe the true WACC, we can only estimate it.
Weighted-Average Cost of
Capital (WACC)
WACC = Kd (1-t) x D / (D+E) + Ke x E /(D+E)

D : Debt V : D+E = Total Capital Ke : Cost of Equity


E : Equity Kd : Cost of Debt t : Tax Rate

WACC = Kd (1-t) x D / (D+E) + Ke x E /(D+E)


WACC = 10,1% x 4,44% + 89,9% x 9,81%
= 0,45% + 8,82%
= 9,27%
Nike Inc : Cost of Capital - Discounted Cash Flow Analysis
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Assumptions :
Revenue Growth (%) 7.00 6.50 6.50 6.50 6.00 6.00 6.00 6.00 6.00 6.00
COGS/Sales (%) 60.00 60.00 59.50 59.50 59.00 59.00 58.50 58.50 58.00 58.00
SG&A/Sales (%) 28.00 27.50 27.00 26.50 26.00 25.50 25.00 25.00 25.00 25.00
Tax Rate (%) 38.00 38.00 38.00 38.00 38.00 38.00 38.00 38.00 38.00 38.00
Current Assets/Sales (%) 38.00 38.00 38.00 38.00 38.00 38.00 38.00 38.00 38.00 38.00
Current Liabilities/Sales (%) 11.50 11.50 11.50 11.50 11.50 11.50 11.50 11.50 11.50 11.50

Cost of Capital (%) 9.27


Terminal Growh Rate (%) 3.00

Revenue 9,488.80 10,153.02 10,812.96 11,515.80 12,264.33 13,000.19 13,780.20 14,607.02 15,483.44 16,412.44 17,397.19
Current Asset 3,625.30 3,858.15 4,108.93 4,376.01 4,660.45 4,940.07 5,236.48 5,550.67 5,883.71 6,236.73 6,610.93
Current Liabilities 926.00 1,167.60 1,243.49 1,324.32 1,410.40 1,495.02 1,584.72 1,679.81 1,780.60 1,887.43 2,000.68
NWC 2,699.30 2,690.55 2,865.43 3,051.69 3,250.05 3,445.05 3,651.75 3,870.86 4,103.11 4,349.30 4,610.26

Discounted Cash Flow (in millions of dollars except per-share data)


Operating Income 1,218.4 1,351.6 1,554.6 1,717.0 1,950.0 2,135.9 2,410.2 2,554.8 2,790.1 2,957.5
Taxes 463.0 513.6 590.8 652.5 741.0 811.7 915.9 970.8 1,060.2 1,123.9
NOPAT 755.4 838.0 963.9 1,064.5 1,209.0 1,324.3 1,494.3 1,584.0 1,729.9 1,833.7
Capex, net of depreciation - - - - - - - - - -
Change in NWC 8.8 (174.9) (186.3) (198.4) (195.0) (206.7) (219.1) (232.3) (246.2) (261.0)
Free cash flow 764.1 663.1 777.6 866.2 1,014.0 1,117.6 1,275.2 1,351.7 1,483.7 1,572.7
Terminal value 25,835.5
Total flows 764.1 663.1 777.6 866.2 1,014.0 1,117.6 1,275.2 1,351.7 1,483.7 27,408.2
Present value of flows $699.31 $555.38 $596.02 $607.58 $650.94 $656.55 $685.60 $665.08 $668.09 $11,294.62

Enterprise Value 17,079.2


Less: current outstanding debt 1,296.6
Equity value 15,782.57
Current shares outstanding 271.5
Equity value per share $ 58.13 Current share price $ 42.09
Analysis – Market Value
To discount cash flows in the Discounted Cash Flow Analysis with the
calculated WACC 9.27%, the present value equals $58.13 per share, which
is more than current market price of $42.09.

So Nike shares price is undervalued. Moreover, Nike also changed their


business strategy by more concentrate in mid-priced segment, which is
Nike less concentrate for a long time before.

Using this data, we found that North Point Large-Cap Fund should buy
Nike Inc..
Analysis – Technical Analysis
thanks!
Any questions?

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