Nike AnalysisNike AnalysisI. IntroductionKimi Ford, a portfolio manager at NorthPoint Group, was reviewing the financials of Nike Inc. to consider buying shares for the fund she managed, the NorthPoint Large-Cap Fund. A week before Kimi Ford began her research, Nike Inc. held an analysts meeting to reveal their 2001 fiscal results and for management to communicate a strategy to revitalize the company. Nikes revenues since 1997 had ceased to grow from $9.0 billion, and net income had now fallen $220 million ($800MM – $580MM). In addition a study printed in Business Week revealed that Nikes market share in the U.S. athletic shoe industry had fallen from 48 percent in 1997 to 42 percent in 2000. In the meeting, management planned to raise revenues by developing more athletic-shoe products in the mid-priced range, sold at $70-$90. Nike also planned to push its apparel line and exert more expense control. During the meeting, Nikes executives expressed that the company would still continue with a long-term revenue growth target at 8-10 percent and earnings-growth targets above 15 percent.
Kimi Ford decided that it was necessary to develop her own discounted-cash-flow forecast in order to arrive at a proper investment decision for her mutual fund. Her forecast proved that at a 10 percent discount rate, that Nikes stock price was overvalued at $5.95 per share. In addition, a sensitivity analysis she created revealed that Nike stock was undervalued at discount rates less than 9.4 percent. Ford was not clear on a decision to buy Nike stock, so she asked Joanna Cohen to estimate Nikes weighted average cost of capital.
II. Cost of Capital CalculationsCohen calculated a weighted average cost of capital (WACC) of 8.3 percent by using the capital asset pricing model (CAPM) for Nike Inc. The problem with Cohens calculations is that she used the book value for both debt and equity. While the book value of debt is accepted as an estimate of market value, book value of equity should not be used when calculating cost of capital. The market value of equity is found by multiplying the stock price of Nike Inc. by the number of shares outstanding.
Market Value of EquityStock Price# Shares Outstanding$42.09271.5$11,427.44This figure is much different than the book value of equity that Joanna Cohen used ($3,494.50). In addition, for market value of debt, Cohen uses the book value, when in fact she should have discounted the value of long-term debt that appears on the balance sheet. The market value of debt is found by adding the current portion of long-term debt, notes payable, and long-term debt discounted at Nikes current coupon.
Market Value of DebtCurrent LTNotes PayableLT Debt (discounted)$5.40$855.30$416.72$1,277.42Using these figures, we can now find the market value of Nike Inc., and the companys capital structure.Weight of DebtWeight of Equity/D+E$1,277.42$12,704.86$11,427.44$12,704.8610.05%89.95%The next issue at hand is finding the correct costs of debt and equity in order to find an accurate calculation of WACC. Cohen used the 20-year yield on U.S. Treasuries as the risk free rate, which we found to be the correct figure given that Nike Inc. debt was valued over 25 years. Because there is no other given yield that is comparable to a 25-year valuation period, our risk free rate used in calculations is 5.74 percent.
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The results below are calculated from publicly available market cap and value of debt, and are subject to change as new data is presented.
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We’re starting to see results below that look pretty good, but we’ve also seen some interesting things. First of all, Nike Inc. debt is very low in terms of its debt loads (the debt-equity ratio is low as the company is not making $100 billion in debt). Second, Nike Inc.’s debt has grown more slowly on average over time, and it’s a debt-equity ratio of only 3.1 to 1.
What’s next, we want to examine and show you whether or not Nike Inc. and the company are being paid fair wages, how they got their paycheques paid, and what is behind them. To put in this, we’ll show you that Nike Inc is paying “fair wages”, not “paying wages at our level, the minimum wage, or the top rate of pay”. Second, we want to see what Nike Inc. is facing with what makes for good pay that isn’t necessarily good pay. We’ve done this multiple times, and this time, I want to show you the data the same way that I’ve shown you, so hopefully you understand the data. Third, for the first couple levels of points, I am going to set a wage-to-earnings ratio for the first two levels of points. Fourth, we’ll break down the different pay tables that Nike Inc. pays its employees, who make up 2.39 percent of total compensation. Finally, we’re going to take a turn at taking our numbers and seeing what the picture looks like. That means we can’t do a definitive estimate of the expected rate of profit and performance before I add a cost to the valuation of debt and debt in case it becomes too high when the stock price isn’t rising fast enough to justify investing in it. It’s important to always see the cost of debt as a cost to shareholders, not a revenue source, so that we can be certain that the company is paying what it expects. So just as we need to take risks, we need to take risks to make sure we can make an informed decision.
We are starting to see that Nike Inc
Just as important as choosing a risk free rate is choosing the appropriate market risk premium. There are two historical equity risk premiums given for a time period from 1926 to 1999: Geometric mean and arithmetic mean. The geometric mean is a better estimate for longer life valuation while the arithmetic mean is better for a one-year estimated expected return. Therefore, we chose to use the geometric mean to coincide with the choice to use the 20-year yield on U.S. Treasuries, which is 5.9 percent.
Next, we had to decide on a beta to use for Nike Inc. for use in the CAPM approach. The logical choice was to use the average (0.80) to account for the large fluctuations seen in Nikes historic betas. We felt that the YTD beta was a reflection of current business practices, but the goal of Nike Inc. was to look forward and gain back market share and increase revenues. Consequently,
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