...UV0010 NIKE, INC.: COST OF CAPITAL On July 5, 2001, Kimi Ford, a portfolio manager at NorthPoint Group, a mutual-fund management firm, pored over analysts’ write-ups of Nike, Inc., the athletic-shoe manufacturer. Nike’s share price had declined significantly from the beginning of the year. Ford was considering buying some shares for the fund she managed, the NorthPoint Large-Cap Fund, which invested mostly in Fortune 500 companies, with an emphasis on value investing. Its top holdings included ExxonMobil, General Motors, McDonald’s, 3M, and other large-cap, generally old-economy stocks. While the stock market had declined over the last 18 months, the NorthPoint Large-Cap Fund had performed extremely well. In 2000, the fund earned a return of 20.7%, even as the S&P 500 fell 10.1%. At the end of June 2001, the fund’s year-to-date returns stood at 6.4% versus −7.3% for the S&P 500. Only a week earlier, on June 28, 2001, Nike had held an analysts’ meeting to disclose its fiscal-year 2001 results.1 The meeting, however, had another purpose: Nike management wanted to communicate a strategy for revitalizing the company. Since 1997, its revenues had plateaued at around $9 billion, while net income had fallen from almost $800 million to $580 million (see Exhibit 1). Nike’s market share in U.S. athletic shoes had fallen from 48%, in 1997, to 42% in 2000.2 In addition, recent supply-chain issues and the adverse effect of a strong dollar had negatively affected revenue. At the meeting...
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...NIKE, INC. COST OF CAPITAL Context: Estimating Cost of Equity with different methods. Compute WACC Nike’s current price per share= $ 42.09 Question: Is it undervalued or overvalued to make buy /sell decision? Forecasts for Cash flows, Dividend growth, EPS estimates for NIKE are given. Interest rate #’s, Betas, Book values on debt and equity are given. Also historical performance #s are given. At 12% WACC Nike is overvalued and hence sell decision; At 11.17% correct valuation; WACC below 11.17% , undervaluation and hence buy decision. Exhibit 2 : The bottom table shows the sensitivity of share price to discount rate. The issue is which discount rate (WACC) to use to make the decision. Lower the discount rate, higher the estimate of stock price. How do you estimate WACC? Weights of Debt and Equity Cost of Debt and Cost of Equity Overall Assessment of the firm: Exhibit 1 Uneven growth rate in revenue, operating income and net income from negative to low positive. All profit margin #s are relatively stable. Market share has declined. Company’ plans: (1) New Products in shoes and Athletic Apparel; (2) Expense Control Revenue growth target= 8-10% Earnings growth target=15% Both are substantially higher than the recent performance. Methodologies for Valuing a Firm 1. Estimating Cash flows per share; Take a good look at Exhibit 2. Exhibit 2 has information for ten years. Question: Why is terminal value given at the end of year 10...
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...Case Study: Nike, Inc.: Cost of Capital BUSFIN 4214 Written By: Joe Nau Nau.33@osu.edu Section: 32347 Cost of Capital NorthPoint Group’s strategy consists of identifying and investing in undervalued public companies. Joanna Cohen, an assistant to a portfolio manager at NorthPoint, is asked to help evaluate whether Nike Inc. is undervalued. Analysis by the portfolio manager shows that when Nike’s cash flows are discounted at 12% their shares are overpriced, however, when discounted at rates below 11.17% the firm is undervalued. Cohen is tasked to further analyze Nike’s cost of capital to accurately estimate what rate their cash flows should be discounted back at. Joanna Cohen’s WACC Calculations Cohen decides to use a single cost of capital rather than multiple costs of capital. This is accurate as Nike operates primarily in the same business segments and each segment assumes similar risks. To find Nike’s Weighted Average Cost of Capital (WACC), she must first find the capital structure of the firm. Cohen incorrectly uses the book value of equity, rather than the market value. Additionally, she uses the book value of debt, however this is acceptable because the market values are not provided in the case. With Nike’s capital structure in hand, Cohen begins calculate the cost of capital for debt and equity. To calculate the cost of debt, Cohen uses historical interest expenses as a proxy, however this is not a forward looking estimation and using the materials provided...
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...Nike, Inc.: COST OF CAPITAL CASE ANALYSIS Importance of Cost of Capital The concept of cost of capital is used in finance decisions. Acceptance or rejection of an investment project depends on the cost that the company has to pay for financing it. Good financial management calls for selection of such projects, which are expected to earn returns, which are higher than the cost of capital. It is therefore, important for the finance manager to calculate the cost of capital, which the company has to pay and compare it with the rate of return, which the project is expected to earn. In capital expenditure decisions, finance managers go on accepting projects arranged in descending order of rate of return. The manager stops at the point where the cost of capital equals to the rate of return offered by the project. That is, the finance manager finds out the break-even point of the project. Accepting any project beyond the break-even point will cause financial loss for the company. The cost of capital is a guideline for determining the optimum capital structure of a company. Weighted Average Cost of Capital The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is the minimum return that a company must earn on an existing asset base to satisfy its creditors, owners, and other providers of capital. A company's assets are financed by either...
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...recording constant revenues in 1997 and net income fell from $800M to $580M. Therefore, the firm had to take action and make a more averaged priced athletic shoe while adding a push to the apparel line. After examining Nike’s financial statements we have come up with our conclusion. The weighted average cost of capital, WACC, is the rate of return required by investors. The WACC calculates the different risks associated with the individual components of the capital structure. The individual components within the WACC are preferred stock, common stock, and after-tax debt. The WACC is very important because it tells the investors if the return they are receiving is equal to the return they require depending on the risk associated with the investment. The WACC is the company’s overall rate of return and cost of capital. After much calculations, we believe Joanna Cohen’s analysis is incorrect. The reason being, when she calculated the WACC she used the book value instead of market values for the weights of debt and equity. When calculating the long term debt, Joanna should have discounted the debt that appears on the balance sheet. When calculating the risk free rate in her capital asset pricing model, Joanna used the 20 year U.S. treasury yield of 5.74% and a geometric mean of 5.90%. We chose to use the one-year U.S. treasury yield 3.59% and the arithmetic mean of 7.50%. As discussed in class, you should always try to use the current yield under a year. Cohen averaged all of the...
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...problem Nike has new investment endeavors revamp its recent drops in net income and market share. Wall Street analyst reactions to the endeavors are mixed, with some recommending Nike as a “Strong Buy” and others recommending a “Hold.” In case 13, Nike Inc.: Cost of Capital, I am acting as a portfolio manager to estimate Nike’s cost of capital to determine whether the stock is overvalued or undervalued. II. Alternative Solutions • Dividend Growth Model (DGM) see appendix for calculations • Capital Asset Pricing Model (CAPM) see appendix for calculations • Weighted Average Cost of Capital (WACC) see appendix for calculations III. Analysis of the Alternatives • Dividend Growth Model (DGM) The Dividend growth model is a simple and easy to understand model used to estimate a company’s cost of capital. The method works because RE the return that the stockholders require to the stock, so it can be interpreted as the firms cost of equity capital. In able to use this method I used Value Line’s Forecast of Dividend Growth from ’98-00 to ’04-’06 of 5.50% for Nike as my growth (g) ( see Exhibit 4). I was able to forgo the calculation of D1 because Nike had paid a constant dividend of .48 for the past 3 years (Exhibit 5). Although the method is simple in its approach, DGM does not account explicitly for risk. There is no adjustment for the riskiness of the investment. • Capital Asset Pricing Model (CAPM) The CAPM is widely used to determine a company’s cost of equity...
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...NIKE, INC.: COST OF CAPITAL The cost of capital represents the minimum return required by providers of finance for investing in an asset, it may be a project, a business or strategic unit or an entire company. It needs to represent the capital structure used to finance the investment and therefore likely to include cost of equity and debt. The cost of capital also represents a “hurdle rate” that a company’s projects must exceed in order to increase shareholders wealth and is used as a discount rate in net present value (NPV) investment appraisal techniques. Projects that generate a positive NPV at the cost of capital are accepted since they earn more than the investors required rate of return. Projects which generate a negative NPV are rejected as they earn less than their target rate of return. The cost of capital therefore plays a vital role in corporate finance, establishing a link between investment decisions and finance decisions i.e what companies should be spending their money on and how this should be funded. The weighted average cost of capital (WACC) represents the overall cost of capital for a firm, incorporating the cost of debt, equity and preference share capital, weighted according to the proportion of each source of finance within the business. In arriving at the WACC for a firm, the models used to calculate the cost of each source of finance assume that the required rate of return is a function of the shareholders’ expectations of future cash...
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...is it so important to estimate a firms cost of capital? The WACC (weighted average cost of capital) is a percentage figure resulting from a calculation method by which the adequate cost of capital of a firm is expressed. It considers the composition of a company’s funding, be it debt or equity. A corporation whose source of funding is equity by 100 percent will have a WACC equal to the cost of equity. By contrast, a levered company will have to reflect the cost of debt as well. The WACC takes their respective quantitative contributions to the entire amount of funding, serving hence as an allocation base, into account. As there is a direct relationship between the two portions, debt and equity, in order to calculate a proper overall price, they must be multiplied with their respective single prices. What is crucial in the calculation process is that one must not omit the tax shield effect caused by debt. Which is, due to fiscal regulations, that all interest expenses which occur in the financing process are tax deductible and, hence, reduce the overall result. This circumstance is mathematically reflected by inserting the term (1-tc). Tc here stands for the corporate tax rate, which, as in the NIKE case, needs adjustment for any taxes imposed by particular states. So if a company faces 38% corporate tax rate the remaining part of 62% count as an expense. Again, as there is a direct relationship to the proportion of the debt and its cost, the higher the tax rate the higher the...
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...1. What is the WACC and why is it important to estimate a firm’s cost of capital? Do you agree with Joanna Cohen’s WACC calculation? Why or why not? Answer: The cost of capital refers to the maximum rate of return a firm must earn on its investment so that the market value of company's equity shares will not drop. This is a consonance with the overall firm's objective of wealth maximization. WACC is a calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation. All else equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk. The WACC of a firm is a very important both to the stock market for stock valuation purposes and to the company's management for capital budgeting purposes. In an analysis of a potential investment by the company, investment projects that have an expected return that is greater than the company's WACC will generate additional free cash flow and will create positive net present value for stock owners. Thus, since the WACC is the minimum rate of return required by capital providers, the managers in the company should invest in the projects which generate returns in excess of WACC. We do not agree with Joanna Cohen’s calculation regarding the WACC from 3 aspects: 1) When Joanna Cohen...
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...Calculation of cost of debt by using IRR method : Formula : B0=I*t=1n11+rd t +M*11+2dn=I*PVIFA r d,n+M*PVIFrd,n B0=Value of the bond at time zero I= annual interest paid in dollars n=number of years to maturity m=par value in dollars rd=required return on bond B0=$956 Coupon Rate =13.5% I= coupon payment=13.5%*1000 = 135 Year to maturity =n=25 years Par value =1000 A trial –and – error technique: At the first consider rd=7.58%equal to method one and B0=$956 I= coupon payment=$135 1)The first try: 956=135*t=1251(1+7.58%)t +1000*(1(1+7.58%)25) 956= 135*(PVIFArd,n) +1000*(PVIFArd,n) From table A-4 and A -2 (Appendix A) r=7.58%, n=25 PVIFArd,n=11.164 1000*(1(1+7.58%)25)=1000*0.161=161 135*11.164=1507.1 956≠1507.1+22.3 2)Another try rd=0.10 956=135*t=1251(1+10%)t +1000*(1(1+10%)25) PVIFArd,,n=9.077 135*9.077=1225.4 1000(1(1+10%)25)=0.092 PVIFrd,n=0.092 ,1000*0.092=92 956 ≠ 1225.4 +92 3)An other try: rd:=12% PVIFArdn=7.843 PVIFrdn=0.059 135×7.843=1058.9 1000×0.059=59 956≠1058.9+59 4) An other try: rd=%14 PVIFArdn=6.873 PVIFrdn=0.038 135×6.873=927.9 1000×0.038=38 927.9+38=965.9 956≠965.9 5)An other try: rd=%14.2 PVIFArdn=6.791 PVIFrdn=0.036 135×6.791=916.8 1000×0.036=36 916.8+36=952.6 956≠952.8 6)An other try: rd=%14.15 PVIFArdn=6.810 PVIFrdn=0.037 135×6.81=919.3 1000×0.037=37 919.3+37 = 956.3 959=956.3 rd=%14.15= cost of debt=correct...
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...# C3 Nike, INC.: Cost of Capital Jul 31st, 2014 Case Approach As required in the instructions, the group will answer each of the questions regarding the case, along with its justifications. In addition, a spreadsheet will be attached with all the calculations regarding this case. Q1. What is the WACC and why is it important to estimate a firm’s cost of capital? Do you agree with Joanna Cohen’s WACC calculation? Why or why not? WACC is defined as the weighted average cost of capital, which is the minimum rate of return the project (or the firm) must generate in order to attend the suppliers of capital´s expectations. The implications behind WACC definition is straight simple. The cost of capital of any firm depends on the composition of the equity and debt in its funding. By composition, we mean the percentage and the costs related to each of its components, as it can be summarized in the formula below: WACC = [Cost of debt x D/D+E] + [Cost of equity x E/E+D] In this sense, to obtain a WACC of any firm (or project) we must have the cost of debt, the percentage of the debt in the firms’ funding following by the cost of equity and its percentage. Taking a look at Joanna Cohen´s WACC calculation, there are some important things missing in her analysis: * Capital Sources: Mrs. Cohen used the book values to calculate the total capital employed by Nike. However, the correct approach would be to obtain these values using their market values. * Cost of Debt:...
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...Ford, pored over analysts’ write-ups of Nike, Inc. NorthPoint Large Cap fund was deciding on whether it would be wise to purchase stock from Nike. The issue was that Nike has experienced sales growth decline, where not only was there a decline in profits, but a decrease in their market share as well. In attempt to recuperate from this situation, Nike then suppressed their concern for their company by creating more merchandise. Here, Nike would enhance their exposure in mid-price footwear and apparel lines where they would then commit to cut down various expenses that were occurring. The stock market was responding to various signals to the changes Nike was making therefore, Ford did a cash flow estimation while she asked for help. Ford asked her new assistant, Joanna Cohen to estimate Nike’s cost of capital because her forecast seemed to be incorrect. Ford’s forecast showed that Nike had a discount rate of 12% and was undervalued at it current share price of $42.09. On the other hand, Ford conducted a quick sensitivity analysis that revealed Nike was undervalued at discount rates below 11.17%. What is the weighted average cost of capital (WACC)? The weighted average cost of capital otherwise known as the “WACC” is the capital finding of a company, that which has been developed in two aspects, debt and equity. Lenders as well as equity holders expect to have a certain return on the funds/capital they have provided. The cost of capital is then the expected return to equity owners/shareholders...
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...NIKE INC. Cost of capital estimation | GROUP FINN- 400 | NIKE INC. Cost of capital estimation | GROUP FINN- 400 | Background: The case is built around the stock buy decision of Nike Incorporation by the North-Point Large Cap fund. The mutual fund manager, Kimi Ford is evaluating Nike’s financial performance. Nike’s revenues had stabilized at $9 Billion since 1997 and Net Income had fallen from $800 Million to about $580 Million. In sum, Nike was experiencing a decline in sales growth, profits as well as its market share in US. In a meeting in 2001, the management sought to increase its market exposure in the mid-priced footwear and apparel lines to revitalize growth and to cut down expenses to increase profits. These measures were expected to yield higher growth in revenues and consequently income of Nike Inc. The Issue: “The issue is the Buy or Not Buy decision of Nike Stock by the mutual fund manager.” The Issues requires the analysis of Market price per share of Nike Inc. and to value it according to the estimates of future growth. Analysts provide contradictory evidence on Buy Vs Sell of Nike Inc. Shares as well: Lehman Brothers: Buy UBS Warbug & CSFB: Not Buy The Decision Criteria: The decision to buy the stock of Nike is based upon the valuation of its share price. The current share price of Nike Inc. may be overpriced or underpriced. If it’s underpriced, the decision would be to buy the stock and if...
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...NIKE, INC.: COST OF CAPITAL Book value vs. Market value While calculating the Nike’s cost of capital using both the book value (Exhibit 1.1) and the market value (Exhibit 1.2), I could notice the mistake Cohen made finding the equity value. Cohen used the book value to reflect equity value. Although the book value is an accepted measure to estimate the debt value, the equity’s book value is an inaccurate measure of the value perceived by the shareholders. Since Nike is a publicly traded company, market value is the better method in reflecting Nike’s equity value. Cohen’s book value of equity is the total shareholder’s equity in the balance sheet, $3494.5. The market value of equity on the other hand, is $11427; computed using stock price X number of shares outstanding ($42.09*271.5 million shares), which is also commonly exercised computing market capitalization of a company in an industry. The book value of equity used by Cohen is very different from the market value of equity. Therefore the weight of debt and equity also differ greatly. Cohen found that Nike is financed by 27% on debt and 73% on equity, but using the market value to better reflect Nike’s debt and equity, I found that Nike is financed by 10.19% on debt and 89.81% on equity. The differences are bigger than it looks, as we are talking about millions of dollars being calculated inaccurately, so it is important for portfolio managers like Kimi Ford to carefully assess the assumptions that are needed to calculate...
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...JOHN MOLSON SCHOOL OF BUSINESS | CASE ANALYSIS: NIKE INC. – COST OF CAPITAL | FOR PROF. EDWARD WONG | | ARUN KUMAR DURAIRAJ – 27416008 NIDISH PC – 27254423 VIPUL PARTI – 27246307 | 12/3/2015 | | Evaluation of Cohen’s Report and Calculation of WACC We do not agree with Cohen’s report about the cost of capital because of the following reasons. * Capital Structure (% equity vs % debt): In calculating the capital structure of Nike Inc., Johanna Cohen has calculated the percentage of equity from the book value given in the balance sheet. However this is not a correct index of the current market value of the firm. Instead, she should use the most recent value given by the recent market price of the share. Market Value of Equity = Current outstanding shares*Current share price = 271.5 million * 42.09 = 11427.44 million Debt: Current Portion of LT Debt = $5.4 million Notes Payable = $855.3 million Long Term Debt = $435.9 million Total Debt = $1296.6 million Proportion of Debt = 1296.6/(1296.6+11427.44)...
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