Nike Case Study Essay

Kimi Ford, a portfolio manager at North Point base, is smell into the profitability of targeting in the simple eyes of Nike for her fund that she manages. She is supposed to base her finish the accomp eachs data which was disclosed in the 2001 fiscal reports. art object Nike management had addressed several issues that atomic number 18 causing the decrease in grocery sales and stock price, management presented plans to improve and perform better. Nike gross enhancement has been at a plateau since 1997 yet lowest income and grocery parting were falling. Supply chain issues and the ardent dollar negatively affected revenue too. Plans are in confide to address top controversy crop and operating achievement. To boost revenue, the company would develop more athletic station in the mid priced segment which has been everywherelooked by Nike in new-made eld. They also planned to push their apparel line which under strong leanership had performed very well to tick ex penses. Revenue development targets are around 8-10% and pay targets are above 15%. Analyst reactions were conflate as some of them thought this was too aggressive.Lehman Brothers advocateed a strong debase while others expressed misgivings and recommended a hold. At this point, North Point Group answerd to do their own analysis in order to decide if Nike make outs should be purchased for the fund. The burdened average apostrophize of swell (WACC) is the prize that a company is expected to pay its debt and rectitude holders to finance its pluss. It is the minimum increase that a company must(prenominal) earn on existing asset base to satisfy its owners, creditors, and other providers of chief city or they will invest somewhere else. Companies raise money from many openings such as viridity and preferred equity, straight, convertible, and exchangeable debt, options, warrants, pension liabilities, executive stock options, governmental subsidies, and others. unlike se curities, which represent diametric sources of finance, are expected to gene graze different ingatherings. WACC is metrical taking into account the relative weights of each component of the capital structure- equity and debt, and is apply to see if the investment is worthwhile to take part in. circumspection notices the constitute of capital while making a financial decision. The fantasy is very relevant in the following managerial decisions and hence its greatness(1) uppercase Budgeting Decision. represent of capital may be functiond as the tool for adopting an investment proposal. Naturally, the firm will choose the project which gives a satis instrumenty return on investment which would never be little than the toll of capital incurred for its financing. In the many manners of capital budgeting, the court of capital is the main factor in deciding the project out of different proposals pending before the management. It determines the acceptability of all investment o pportunities by amount financial performance. (2) Designing the Corporate Financial Structure. The cost of capital is a signifi buttockst factor in designing the firms capital structure. The cost of capital is influenced by changes in capital structure. Financial executives reinforcement an eye on capital grocery store fluctuations and try to achieve the efficient and sound capital structure for the firm. They may try to substitute the unhomogeneous methods of finance in an attempt to minimize the cost of capital and to increase the marketplace price and the earning per share.(3) Deciding about the Method of Financing. Financial executives must have knowledge of fluctuations in the capital market and should analyze the rate of interest on loans and normal dividend rank in the market from snip to time. Whenever company requires additional finance there are better choices of the source of finance which bears the minimum cost of capital. Although cost of capital is an fuddled ing(a) factor in such decisions, but equally important are the considerations of relating control and of avoiding risk of exposure. (4) Performance of Top Management. The cost of capital can be phthisisd to evaluate top executive financial performance. Evaluation of the financial performance will involve a comparison of demonstrable profitabilitys of the projects and along with the projected overall cost of capital and an appraisal of the actual cost incurred in raising the required funds. (5) Other Areas. The concept of cost of capital is also important in others areas of decision making, such as dividend decisions, working capital policy, and more.WACC CALCULATIONpicOne important question is if Joanna Cohen should use a single or multiple of capital for each of Nikes footwear and apparel divisions? We agree with the use of single cost kind of than multiple costs of capital. The reason of estimating WACC is to measure the cash flows of the entire company that is provided by Ki mi Ford. Plus, Nike business segments have a similar risk and indeed a single cost is sufficient for this analysis.Joanna Cohens cost of debt was incorrect. An important fact is the WACC is used for discounting next cash flows, thus all components of the cost must excogitate the firms con reliable or future abilities in raising capital. Cohen wrongly used the historical data in estimating the cost of debt. She divided interest expense by the average residuum of debt to get 4.3% of before tax cost of debt. It doesnt reflect Nikes ongoing or future cost of debt.The correct focus to view the cost of debt is explained below. If the cost of debt is intended to be forward looking, it can be estimated by the yield to maturity of bond. The more appropriate cost of debt can be reason with the data provided in Exhibit 4 of the case. market data is correctly used rather than historical data.PV 95.60N= 40Pmt -3.375FV -100The values above were put into Excels rate function. This came to a 7.16% annual cost of debt. The tax rate is 38%. The correct way to get the aftertax cost of debt is to take 7.16% * (1-38%) = 4.44%The correctly calculated before tax cost of debt is 7.16%. This is significantly higher than Joannas wrong calculated cost of debt of 4.3%. Her incorrect calculation came from using historical rates rather than market rates.Next, the cost of equity is calculated. It is a good head to use the 20 year T-Bond rate to represent the risk freehanded rate. The cost of equity and the WACC are used to discount cash flows in the long run, thus rate of return of a T-Bond with 20 years maturity at 5.74% is the longest rate that is available.The geometric suppose of market risk premium is 5.9%. This is more accurate than using arithmetic mean to represent market risk premium. By using arithmetic mean to represent true market risk premium, we have to have on an individual basis distributed market risk premium. It is often found that market risk premiums are ne gatively serial correlated.Market average beta of .69 is used because it is a good indicator of the average Betas and their fluctuations throughout the years.Capital Asset Pricing Model (CAPM) toll of Equity(KE) KE = Rf + (Rf Rm) Rf = 5.74% = 9.81% Beta = 0.69 Average Nike Beta Next, the weights of debt and equity need to be calculated. The market value of equity is $42.09 share price X 271.5 gazillion shares = 11,427,000Due to the neediness of information of the market value of debt, book value of debt at 1296.6 million is used to calculate weights.Calculations for market and debt weights11,427,000 / (11,427,000 + 1297) = 89.8% Equity Weight1 89.8% = 10.2% debt weightWACC Calculation4.44% After Tax Cost of Debt X 10.2% Debt Weight + 9.81% Cost of Equity X 89.8% Equity Weight =9.27%The CAPM method was used when conniving cost of equity for the WACC. Advantages and disadvantages of this method are explained below.Advantages It only considers organized risk, reflecting a rea lity in which most investors have diversified portfolios from which unsystematic risk has been essentially eliminated. It generates a theoretically-derived relationship between required return and systematic risk which has been subject to constant empirical research and testing. It is generally seen as a superior method of calculating the cost of equity than the dividend growth framework (DGM) in that it explicitly takes into account a companys level of systematic risk relative to the stock market as a whole. It is clearly better than WACC in providing discount rates for use in investment appraisal.Disadvantages It is practically impossible to estimate betas for many projects. the great unwashed sometimes focus on market risk rather than somatic risk, and this may be a mistake.The Dividend Discount Method is another method of calculating cost of equity. The assumption made with this model is that the company pays a substantial dividend, but Nike Inc. does not pay dividends. there fore, we rejected this model since it does not reflect the true cost of capital.The method Compares dividends forecasted for the next period with the current share price for the firm and then adds the growth rate of the firm.equating Ke= D1/ P0 + g Variables G= the value line forecast of dividend growth, which equals 5.5% PO= current share price, which is $42.09. D1= DO (1+g), which equal .48 (1+.055) DO= from dividend history and forecast chart, which equals .48Therefore, cost of equity = .564/42.09 + .055= 6.7%Advantages Allow great flexibility when estimating future dividend streams Provide reclaimable value approximations even when the input signals are simplified Can be turn so the current stock price is used to impute market assumptions for growth and expected return Investors are able to suit their model to their expectations rather than force assumptions into themodel Specifying the underlying assumptions allows for sensitivity testing and analyzing market reactions t o ever changing circumstances Disadvantages Subjective inputs can result in wrongly specified models and bad results Over-reliance on a valuation that is rattling just an estimate Sensitivity is high to small changes in input assumptions Flow-through of minor formula or data entry errors when using spreadsheets The Cost of Equity Method is the other method for forecasting cost of equity.The nett model used to compute the cost of capital was the earning capitalization model. The paradox with this model is that it does not take into consideration the companys growth. Therefore we chose to reject this calculation. The earnings capitalization model calculations were found this way Stands for earnings capitalization model This model compares forecasted earnings for the next period over the current share price. Equation Ke E1/ P0 Variables E1= (1+g) * (E0/ of shares outstanding) G= retention ratio * return on equity Retention ratio= retained earnings/ net income 3194.3/ 589.7= 5.42 Return on equity= net income/ total shareholders equity 589.7/ 3494.5= 16.88% G= 5.42* 16.88%= .914 EO= Net Income, which equals 589.7 Share Outstanding= 271.5 E1= ((1+.914) * 589.7)/ 271.5= 4.1572 PO= Nike current share price, which is 42.09 Therefore, cost of equity= 4.1572/ 42.09 = 9.88%AdvantageStrong representation of earningsDisadvantagesBrealey & Myers argue in Principles of Corporate Finance that this model is not good to use for ripening firms but is appropriate for no-growth firms. Hence it is not appropriate for Nike Inc. since this company is mollify growing. compendium and RecommendationKimi ford used a WACC discount rate of 8.4% to find a share price of $63.50. Nike is currently trading at $42.09. This makes the share price undervalued by $21.41. However, her discount rate does not reflect true market value due to the mistakes in her methods we discussed earlier.The discount rate we came up with from using the CAPM was 9.27%. This higher WACC results in a lower shar e price of around $55.60. Share price has decreased once Joannas calculation methods have been corrected, but Nike is still overvalued so we still recommend buying the stock. Share price is now undervalued by $12.97.SWOT AnalysisStrengths Globally recognized 1 sports brand Strong marketing, research and development, and presentation Worldwide logo recognition, brand loyalty, and slogan Just do it.Weaknesses nigh profits are solely from footwear Revenue has plateaued, expenses have change magnitude Supply chain issues affecting financial health too footing sensitive retail industryOpportunities There are plans in place to address top line growth and operating performance Plans to construct more athletic footwear Also plans to push apparel line High revenue growth (8-10%) and earning (15%) targetsThreats Uncertainties in international trade The market is cut throat Growing competition from other companies can lead to decreased market shareDuPont Analysis Net Income 589,700,000 gr oss revenue9,488,800 follow Assets5,819,600 Common Equity Common Stock, Par 2,800,000 Capital in redundancy of stated value 459,400,000 Retained Earnings 3,194,300,000 Total 3,656,500,000 NI/Sales 589,700,000/9,488,800,000 = 6.2% Sales/TA 9,488,800,000/5,819,600,000 = 1.63 TA/CE 9,488,800,000/3,656,500,000 = 2.60 Profit Margin * TA Turnover * Equity Multiplier 6.2% * 1.63 * 2.60 = 26.27% ROE. This Return on Equity is high, and stating the fact that Nike stock is good to buy.Nike has strong financial health and its stock is a sound investment. It would make a valuable addition to any mutual fund.The EndThank You