NIKE INC : COST

Presented by ANJUNA SUGUNESH

OF

CAPITAL

CASE BACKGROUND..

Kimi Ford, a portfolio manager at North point Group, a mutual Fund management firm is in a dilemma that whether to buy the Stocks of Nike, Inc., or not.

Recently Nike disclosed the fact that their Net Income and market share has come down.

Also communicated about new strategies and measures in order to improve this current situation.

Now Kim has to take decisions based on the last fiscal

year results and other analyst reports.

COST OF CAPITAL

Central concept in financial management. A companys cost of capital is the weighted average of various sources of finance used by it, viz; equity, preference , and debt.

Rate of return expected by capital providers. Reflects the business risk of the existing assets and the capital structure currently employed.

Provides Benchmark. Its the average cost of various capital components employed by it.

Also used for evaluating investment projects, determining the capital structure etc.

WACC

Weighted Average Cost of Capital is a market weighted average, at target leverage, of the cost of after tax debt and equity. Act as a critical input for evaluating investment decision, and typically the discount rate for NPV calculation. Benchmark for operating performance, relative to the opportunity cost of capital employed to create value. The WACC is set by the investors or markets, not by managers. Therefore, we cannot observe the true WACC, we can only estimate it.

SINGLE HURDLE RATE

I agree with the use of the single cost instead of multiple

costs of capital.

Because WACC is calculated to determine the value of capital of the entire firm.

Another reason for preferring single hurdle cost is that the other segments of Nike has also got a same level of

risk.

So I think there is no point in calculating the cost of capital of each business segments of Nike.

WACC ESTIMATION

Some mistakes in the calculation of cost of capital. Historical Price was used for calculating the cost of Debt. Even though Market value is more volatile, they are superior to book value.

Because the value of the firm must earn competitive returns for shareholders and debt holders on the current value of their investments.

Instead of considering the Post tax cost of Debt she had taken a pre tax amount.

COST OF DEBT BY COHEN:

She used historical value to calculate cost of Debt in WACC. According to her; Kd= (Total Interest or Expense for 2001/Average Debt balance.) Cost of capital=4.3 percent. After adjusting tax Kd=2.7 percent.

COST OF DEBT
Calculation of cost of Debt using YTM, FV=100, 2001-2020 =20, semi annully:20*2= 40 n= 40. As semi annually, 6.75/2=3.375 Coupon= 3.375 PV=95.60 YTM= 3.58% (Semiannually) annually= 7.16%. Post tax cost= Pretax(1-tax rate) Post tax rate=7.16%(1- 38%)= 4.44%

COST OF EQUITY BY COHEN..

CAPM was used to calculate cost of equity.

She considered risk free rate as the coupon of T- bonds

with 20 yrs of maturity

Rf =5.9% , Current yield on US Treasuries,20 yrs=5.74% GM was used .

Average of historic beta from 1996 to 2000 was taken.

Average of Nike historic beta=0.80(Exhibit 4) 10.5% = 5.74% +(5.9%)*0.80.

COST OF EQUITY

Instead of using Average of historic beta , she could have used the recent beta value because we need a value which represents the near future beta.

Its given in the Exhibit that 0.69 for the year 2001. So being the risk free rate and current yield on US treasuries same,

Ke= 5.74% +(5.9%)*0.69 New Ke=9.81%

COST OF EQUITY USING E/P APPROACH

Cost of Equity= E1/P0. E1= (Current Earnings per share)*(1+ growth rate of earnings per share). Current EPS=2.32 Growth rate= 0.03 Po=42.09 Here, Cost of Equity =5.51%.

COST OF EQUITY USING DIVIDEND DISCOUNT MODEL

Ke= (D1/Po )+g

D1=D0(1+g)=o.506
Po=42.09 g=0.055 Do=0.48 Ke (DDM)=6.70%

There is a slight discrepancy between these two

models. i.e, there is constant growth in DDM but its not there in E/p approach.

INVEST OR NOT?
Market Value Of Equity

Market share

42.09(Given)

Average Share

273.3(Exhibit 1)

(MS*AS)

11503.197

Market Value of Debt

Current proportion of Long Term Debt Notes Payable

5.4

855.3

Long term Debt

435.9

Debt

1296.6

CALCULATION OF WACC

Proportion of Equity:89.87015 Proportion of Debt:10.12985 Ke=9.81

Kd=4.44
WACC=9.81*.899+4.44*.101=9.27

DECISION TO BUY OR NOT:

The discount cash flows in Exhibit 2 with WACC 9.27%,

The present value equals $58.13 per share,

58.13= Average of 61.25 and 55.68

It is more than current market price of $42.09. So its better to buy the Nike stocks.