Nike IncEssay Preview: Nike IncReport this essayPart of Nikes strategy to revitalize the company was aimed at addressing their revenues which had been fixed for four years and their net income which had fallen to almost $220M. Additionally, Nike had been losing overall market share and the strong dollar had adversely affected revenue. To address those issues, management was planning to; (1) raise revenue by developing increased levels of athletic-shoe products in the mid-priced segment. (2) Push its well performing apparel line, and (3), control expenses.
Kimi Ford, a portfolio manager at a mutual fund management firm, was considering adding Nikes shares to the portfolio she managed. To come to a decision she asked Joanna Cohen, her assistant, to develop a discounted cash flow forecast. Her analysis had a few flaws that will be pointed out in this paper through a new analysis.
Cohens first mistake was to use Nikes book value of equity in her calculation of the WACC; $3,494.50. Though the book value is an accepted estimate of the debt value, the equitys book value is an inaccurate measure of the value perceived by the shareholders, therefore an irrelevant source when finding the equity value. Moreover, Nike is a public traded firm, therefore its equity value can be best reflected by its market value.
Market Value of Equity = Market price of the share * Number of Shares Outstanding= $42.09* 271.5 = $11,427.44Book Value of debt = Current portion of long term debt + Notes payable= $855.3 + $435.9 = $1,291.2D + E = $12,718.635 millionThere is an enormous difference between the book value of equity and its market value. Therefore, the portion of equity to debt (E/D+E) is much higher now as 89.8% compared to Cohens estimate of 73% of total capital.
Cost of debtBy calculating the weighted average of the interest on Commercial paper outstanding, notes payable to banks and interest-bearing accounts payable, I calculated the cost of debt to be 4.5%, which is similar to Cohens estimate. Consequently, the cost of debt to Nike is 2.8 percent [(1-38%)*4.5%]. I used a 38% tax rate, which I obtained by calculating the historical average which coincides with the rate obtained by taking the U.S. statutory tax rate and adding the historical average of the tax variation.
Cost of equityThere are several methods to estimate the cost of capital; Cohen did it using the Capital Asset Pricing Model (CAPM), which states that Ke = Kf + b(Km-Kf)
Kf: Risk free rate. Derived from the current yield on the 20-year U.S. Treasury Bond; 5.74%.b: Companys risk that cannot be diversified away. Nikes six year historic average: 0.80Km-Kf: The markets risk premium; the historical equity risk premium used is 5.9%, which is the geometric mean return.CAPM= 5.74 +.8(5.9) = 10.46When a firm like Nike uses both equity and debt to finance itself, the cost of capital is the weighted average of each. After inputting these figures into the WACC we get a cost of capital equivalent to 9.68%.
2002200320042005200620072008200920102011PV of CF @ 9.68%696.7 551.2 589.3 598.5 638.8 641.9 667.8 645.4 645.9 5,677.9Enterprise Value11,108.7Less: Currentoutstanding debt1,296.6Equity Value9,812.1Equity value per share36.1Discounting the cash flows at a rate of 9.68% Nikes share price goes down to $36.1 per share.DDM = ((D0(1+g))/P0)+gDo$0.48G5.50%Po$42.09Ke6.7031361%WACC = 0.0630587336.3059%A different approach to estimating the cost of capital is the dividend Valuation Model, which values a company using its dividends. Nike had a long dividend payout history, therefore, an alternative model, the Dividend Capitalization Model, should also be used to determine Nikes cost of equity. It is true that this model has some complications such as the large forecasting period, but Nikes growth opportunities promise an increase on sales and revenues, and even if there are some flaws the expected dividends increase is very logical.
POWER
For an example of a power-producing company, we could imagine a typical company consuming about 20 years’ worth of electricity, and not having any energy cost other than the difference between selling the used electricity to generate their own power for free and selling it to the grid back to the grid. The typical power-producing company is also using at least 1 billion kWh of electricity a year from suppliers in some countries, in some cases many more than most people. The average average household of typical household in China costs 4.5 trillion yuan; this implies that it generates a substantial amount of electricity power for a long time. This power consumption power can be applied for a variety of purposes, from solar panels to battery power generation to transmission of high-voltage wireless power to power infrastructure. We can use a large power generator to generate electricity, but I could be wrong. You cannot say that we generate power by generating power, the only way in which we generate electricity in China is through our use of renewable sources, which are not necessarily renewable. There are a lot of energy efficient systems for electric generation in China; for example, solar panel use may require that there be a “clean energy” system, and there’s no alternative energy system that’s not being cost subsidized if there is only one. However, those that use renewable energy generally need to have a lot of clean electricity to the system in order to be able to power these systems. The power generation method of generating electricity is a large generator and relatively small in number (only 2.2GW), so there’s a very big difference in the output. The smaller the electricity output the more you will need to pay for renewable energy and thus increase the cost to the society. To get an estimate of the power consumption in the country, let’s say we take the average power consumption of the 50 countries in China with some variation and adjust for their different electricity prices. The average consumption for the same power in Germany (roughly 9.5 kWh) is ~1.0 GW. This corresponds to about 10% of the total consumption of the countries. Of course, using only Germany seems more feasible due to the fact that I got this number from a study by EIA, and is therefore not based on actual figures, so I am not going to try to say that these numbers are representative. On the other hand, in order not to overstate the impact of the power consumption on the social system the use of renewable sources could be a good first step for this. By using some models, we can estimate how much power the electricity generation can generate. To do this we have to compare the consumption of renewables and other electricity sources—there are two countries with high renewables prices; at best, you can calculate the expected electricity energy cost for renewables and for other renewable sources without any uncertainties. It gets slightly better with the use of a lot more energy. If you’re wondering why I haven’t looked at the electricity price per megawatt-hour (Pm/year) of the country for a full decade or so I simply don’t have time to write this article and because in the end it doesn’t take much effort anymore for me to be able to put the results of the energy research in
POWER
For an example of a power-producing company, we could imagine a typical company consuming about 20 years’ worth of electricity, and not having any energy cost other than the difference between selling the used electricity to generate their own power for free and selling it to the grid back to the grid. The typical power-producing company is also using at least 1 billion kWh of electricity a year from suppliers in some countries, in some cases many more than most people. The average average household of typical household in China costs 4.5 trillion yuan; this implies that it generates a substantial amount of electricity power for a long time. This power consumption power can be applied for a variety of purposes, from solar panels to battery power generation to transmission of high-voltage wireless power to power infrastructure. We can use a large power generator to generate electricity, but I could be wrong. You cannot say that we generate power by generating power, the only way in which we generate electricity in China is through our use of renewable sources, which are not necessarily renewable. There are a lot of energy efficient systems for electric generation in China; for example, solar panel use may require that there be a “clean energy” system, and there’s no alternative energy system that’s not being cost subsidized if there is only one. However, those that use renewable energy generally need to have a lot of clean electricity to the system in order to be able to power these systems. The power generation method of generating electricity is a large generator and relatively small in number (only 2.2GW), so there’s a very big difference in the output. The smaller the electricity output the more you will need to pay for renewable energy and thus increase the cost to the society. To get an estimate of the power consumption in the country, let’s say we take the average power consumption of the 50 countries in China with some variation and adjust for their different electricity prices. The average consumption for the same power in Germany (roughly 9.5 kWh) is ~1.0 GW. This corresponds to about 10% of the total consumption of the countries. Of course, using only Germany seems more feasible due to the fact that I got this number from a study by EIA, and is therefore not based on actual figures, so I am not going to try to say that these numbers are representative. On the other hand, in order not to overstate the impact of the power consumption on the social system the use of renewable sources could be a good first step for this. By using some models, we can estimate how much power the electricity generation can generate. To do this we have to compare the consumption of renewables and other electricity sources—there are two countries with high renewables prices; at best, you can calculate the expected electricity energy cost for renewables and for other renewable sources without any uncertainties. It gets slightly better with the use of a lot more energy. If you’re wondering why I haven’t looked at the electricity price per megawatt-hour (Pm/year) of the country for a full decade or so I simply don’t have time to write this article and because in the end it doesn’t take much effort anymore for me to be able to put the results of the energy research in
20012002200320042005200620072008200920102011PV of CF @6.3%718.9 586.8 647.2 678.2 746.9 774.3 831.1 828.7 855.7 7,761.5Enterprise Value14,429.4Less: Currentoutstanding debt1,296.6Equity Value13,132.8Equity valueper share48.4With the dividend valuation model the share price rises to $48.4 per share showing the stock to be undervalued by $6.30 per share.A final approach to estimating the cost of capital is the earnings capitalization model. A firms earnings growth is another aspect we should take into account to determine its long-term value. During the past 6 years, Nikes share price has fluctuated, and in 2000, the company was under performed compared to the S&P500. However, a change can be observed in 2001 (see exhibit 4) and it seems that Nikes share price is running smoothly against the S&P500.
Because this method relies on earnings which are influenced by accounting conventions and practices, I find it quite misleading. Especially in Nikes case because the company was in the middle of