Essay About Present Value Of This Project And Market Share

Nike Apparel
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Nike Apparel
Executive Summary
пЃ® On a stand-alone basis, this project is a good project, albeit not a
great one.
• The average return on capital, even under the more conservative finite life
assumption, is 13.47%, which is higher than the cost of capital of 9.71%.
• The net present value of this project, using a cost of capital of 9.71%
• is $ 88 million, under the conservative assumption of a finite life of 12 years
• is $ 94 million, under the more realistic assumption of an infinite life
• On the two variables that are the most critical – market share and
operating margin – the firm has a reasonable margin for error on market
share and a narrower margin for error on operating margins.
пЃ® If we consider the potential project synergies (i.e. the gains to the
shoe division from having an apparel division), it will make this
project a more attractive one.
Cost of Capital: Nike Apparel
пЃ® Debt to Equity ratio for Nike
• Market Value of Equity = $ 64* 498.7 mil = $ 31,917 mil
606 million
• PV of Operating lease commitments = $1,229 million
• Market Value D/E Ratio = 5.75%; MV Debt/Capital Ratio = 5.44%
пЃ® Unlevered Beta for Apparel Business
• Average Beta of Apparel firms = 1.18
• Aggregate D/E Ratio of Apparel firms = 12.59% (The average is 22.25%)
• Unlevered Beta = 1.18/(1+ (1-.4) (.1259)) = 1.097
пЃ® Beta for Nike Apparel = 1.097 (1+ (1-.4)(.0575)) = 1.135
пЃ® Cost of capital calculation for apparel project
• Cost of Equity = 4.5% + 1.135 (4.91%) = 10.07%
• After-tax Cost of Debt = 5.75% (1-.4) = 3.45%
• Cost of Capital = 10.07% (.9456) + 3.45% (.0544) = 9.71%
Nike Apparel: Operating Income
– Deprecn $ – $ – $ 300 $ 240 $ 192 $ 154 $ 235 $ 200 $ 190 $ 180 $ 172 $ 98
Some Thoughts on Operating Income
пЃ® There are a number of allocation mechanisms that can be used to
compute operating income, and the return on capital is affected by
decisions on allocation.
пЃ® Your choices on depreciation have profound effects on return on
capital. Using a more accelerated depreciation method would raise
your return on capital substantially.
пЃ® Note that the operating income is computed after marginal taxes
(Why?) and does not include the tax savings due to interest expenses
(Why?)
Nike: Return on Capital
Year EBIT(1-t) Average BV ROC
1 $0 $1,500
2 $0 $2,311
3 -$102 $2,490 -4.11%
4 -$13 $2,260 -0.57%
5 $74 $2,087 3.57%
6 $162 $1,961 8.24%
7 $183 $2,077 8.79%
8 $281 $2,002 14.01%
9 $370 $1,924 19.22%
10 $400 $1,830 21.83%
11 $430 $1,739 24.72%
12 $501 $1,284 39.00%
Average= 13.47%
Nike Apparel: After-tax Cash Flows
+ Deprecn $ – $ – $ 300 $ 240 $ 192 $ 154 $ 235 $ 200 $ 190 $ 180 $ 172 $ 98
– Opp. Cost of Distn System $ 1,126 $ (1,243)
– Chg in WC $ – $ 121 $ 38 $ 41 $ 45 $ 49 $ 53 $ 58 $ 20 $ 21 $ 22 $ –
+ Salvage Value $ 1,470
After-tax Cashflow $ ( 1,000) $ ( 1,000) $ ( 621) $ 229 $ 259 $ 298 $ ( 780)$ 449 $ 511 $ 632 $ 656 $ 1,926 $ 2,177
Includes book
value of fixed
assets