NIKE INC : COST OF CAPITAL

KELOMPOK 2
H A D I S U N D OYO E KO Z U N I A N T O NU R ADI K U NCORO MUSTIKA AJI A C H M A D H A S PA N I D W I WO R O J AT I D U D Y H ATA R I R A H M AT TA U F I K

CASE BACKGROUND
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Kimi Ford, a portfolio manager at North Point Group, a mutual fund

manager firm. Northpoint thinking to buy Nikes stock Nikes stock decline in profits and market share in recent years Nike will increase in mid-price product that will cut down expenses Market responds the Nikes action Kimi Ford has done a case flow estimation for Nike, and asked her Assistance to estimate Nikes cost of capita.

COMPANY PROFILE
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North Point Group North Point Group, a mutual fund managerment firm Invested mostly in Fortune 500 companies, including Exxon Mobil, General Motors, McDonalds, 3M, etc. In 2000, the fund earned a return of 20,7% even the S&P 500 fell 10.1 % At the end of June 2001 gain 6,4% vs the S&P 500s -7.3% Nike Inc. The athletic-shoe manufacturer Revenue in 2001, $9 billion Net income fallen from $800 million to $580 million Market share dropped from 48% in 1997 to 42% in 2000

COMPANY PERFORMANCE
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Northpoint Constantly profitable Annual Sales Growth : 18% Gross sales projection : 90.9 million Rs in the FY ended December 31, 2001. Net Profit : 2.6 million (in 2000)

Q&A (1)
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Q: What is WACC and why is it important to estimate a firms cost of capital? A: WACC (Weight Average Cos t of Capital) 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 is set by the investors (or markets), not by managers. Therefore, we cannot observe the true WACC, we can only estimate it Since WACC is the minimum return required by capital providers, managers should invest only in projects that generate returns in excess of WACC

Q&A (2)
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Q: Do you agree with Joanna Cohens WACC calculation? Why or why not? A: We do not agree with Joanna Cohens WACC calculation. She uses the historical data in estimating the cost of debt. She divided the interest expenses by the average balance of debt to get 4.3% of before tax cost of debt. It may not reflect Nikes current or future cost of debt. She uses book values as the basis for debt and equity weights; the market values should be used in calculating weights. The reason of using market weights to estimate WACC is that it is how much it will cause the firm to raise capital today. That cost is approximated by the market value of capital, not by the book value of capital.

Q&A (3)
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Q: If you do not agree with Joannas analysis, calculate your own WACC for Nike and be ready to justify your assumptions A: Assumptions: For market value of equity, $42.09*273.3 mn shares = 11,503 mn. Due to the lack of information of the market value of debt, book value of debt, 1,291 mn, is used to calculate weights. Thus, the market value weight for equity is 11,503 / (11,503+1,291) = 89.9%; the weight for debt is 10.1%.

WACC = Wd*Kd(1-T) + WeKe = 4.44%*0.101 + 9.81%*0.899 = 9.27%

Q&A (4)
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Q: Calculate the costs of equity using CAPM, the Dividend Discount Model and the Earnings Capitalization Ratio. What are the advantages and disadvantages of each method? A: CAPM Cost of Equity 9,81% Dividend Discount Model 6,64%

Earnings Capitalization Ratio 9,88%

Q&A (4)
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Q: Calculate the costs of equity using CAPM, the Dividend Discount Model and the Earnings Capitalization Ratio. What are the advantages and disadvantages of each method? A:

Methode

Advantages

Disadvantages

CAPM

More accurate as it is calculated by adding financial, investment and operational risk.

Risks not included Risks not included

Difficult to determine cost of common stock equity because it use book value
Easier to adjust because of using market value Difficult to determine cost of common stock equity because it use book value

Dividen Discount Model Earnings Capitalization Ratio

Q&A (5)
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Q: What should Kimi Ford recommend regarding an investment in Nike? A: Kimi Ford should not recomended to buy Nikes stock because the stock is overvalue. What Kimi Ford can do is wait for a better buy period when this stock is trading closer to the proper value. She should keep a close eye on the company because Nike Inc. has growth potential that would be beneficial to the fund. Along with this fact, management has goals for the near future that could provide a great deal of profit for Nike Inc. Kimi Ford used a discount rate of 10.1 percent to find a share price of $36.14. This makes Nike Inc. share price overvalued by $5.95 as Nike is currently trading at $42.09. We already established that we found this discount rate to not reflect the true market value and solved for a discount rate that would be more accurate. We found the weighted average cost of capital by using CAPM, finding a discount rate of 9.8765 percent. This discount rate results in a share price of $36.49, meaning that Nike Inc. is overvalued by $5.60 per share.

THANK YOU
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THANK YOU