Case Analysis of Nike, Inc.: Cost of Capital Apparently, the issue of Nike’s case is to control and check the calculation cost of capital done by Joanna Cohen who is the assistant of a portfolio manager at NorthPoint Group. But I am willing to tell you that it can be a complex case in which we can doubt about sensitivity analysis done by Kimi Ford (portfolio manager) because her assumptions such as Revenue Growth Rate, COGS / Sales, S &A / Sales, Current Assets / Sales, and Current Liability / Sales have been adopted from previous income statements and balance sheets from 1995 to 2001. Perhaps, we can take new assumptions. Generally, the case issue is to examine if the share price of Nike is undervalue or overvalue and the common …show more content…
debt with a 6.75% coupon semi-annually. I assumed Nike Inc. to have a single cost of capital since its multiple business segments (shoes, apparel, sports equipment, etc.) are not very different and would experience similar risks and betas. Before-Tax Cost of Debt I used three (3) methods as follows: -Method (1): Using Cost Quotations Based on Coupon Interest Rate and Yield to Maturity (YTM) Cost of Debt = 14.14% -Method (2): Based on calculating the IRR Cost of Debt = 14.15% -Method (3): Approximating the Cost Based on the Value Bond and Coupon Rate Cost of Debt = 14% All of the calculations have been included in my spreadsheet. As we can see, all three methods present us approximately the same amount of the cost of debt. I have chosen 14.15% for the cost of debt. It is important to find the relationship between the required return and the coupon interest rate. When the required return is greater than the coupon interest rate, the bond value will be less than its par value. We choose cost of debt as 14.15% because it is rational (coupon value annually is 13.50%). When current value of bond is less than par, required return will be more than coupon rate. Weight Average of Cost of Debt: As I mentioned, there are two types of debt and consequently we have two types of Cost of Debt. I calculated the weight average for Cost of debt as follows: Total debt type 1 = $5.40 + $855.30 + 0.3 = $861 Total debt type 2 =
For Nike's business model to continually flourish and stay profitable, the senior management team and strategic planners must continually monitor short, intermediate and long-term economic factors that will affect their operations. Nike's business model is heavily dependent on supply chains, as the majority of their products are manufactured in Asian nations, either in their own manufacturing centers or contract manufacturing partners. Sales forecasts for next-generation shoes, apparel and sporting equipment must be accurate to ensure the supply chain estimates and forecasts can meet product demand. The influence of economic factors on sales and marketing planning and strategy development is among the most immediate and significant for any enterprise operating in global markets (Cerullo, Avila, 1975). Strategic planners at Nike, working in conjunction with product development and product launch teams, must understand the price elasticity of demand for a given new product or an entirely new division before launching it. Economic data gives Nike senior management and strategic planners the insight necessary to determine which new products to launch or not, when, and in which specific regions of the world. Economic variables will in short tell Nike's senior management how to navigate risk and capitalize on opportunities as quickly as possible.
9. What is the Cost of Debt, before and after taxes? Using the interest rate for the largest debt…cannot use the weighted interest rate for the debt since it includes capital lease obligations with no stated rate and could not find in the notes to the financials. 5.4% After tax cost is .054 x (1-.36) = 3.5%
I used WACC as the discount factor, we expect the rate of return to be higher than it, the same at least. The WACC reflects the average risk and overall capital structure of the entire firm [2]. It’s the required return and it presents how much the company pays for the capital it finances. In this case, the cost of equity is 10.33%, the cost of debt is 6.50%. I calculated WACC using those numbers and got a result of 8.49%.
a. What risk-free rate and risk premium did you use to calculate the cost of equity?
The three components of the cost of capital are debt, preferred stock, and common stock.
Risk free rate + Equity Beta * (Expected return on market - Risk free rate)
Risk Free Rate: The six-month and 30-year treasury rates given imply a fairly flat yield curve. Due to the relatively short forecast period and the short-term risk characteristics of this industry, the model uses the six-month rate as the risk free rate in calculating the cost of equity.
Moving forward, we must calculate the cost of debt. The cost of debt is the rate that a company pays on its current liability. This can be calculated before or after tax. For the purpose of this paper, the cost of debt will be determined by the type of long term rating the company has. According to Moody’s (n.d.), Molson Coors’ is Baa2 (as shown in the chart below) as of April 26, 2012.
➢ How was cost of debt measured of each division? Should the cost of debt differ across three divisions? Why?
* We assume the cost of capital to be a stated annual rate to facilitate calculations;
Should you use book or market value weights? If you want market value of debt use (BV/100) * Price
Over the last 5 years, Nike’s beta has fluctuated between 0.63-0.98. To account for these fluctuations, the historical average beta (0.8) was chosen for use in the analysis. While the YTD beta might reflect Nike’s current business practice, the aim of the firm is to revive their company by gaining back market share and increasing revenues. For this reason it was felt that the use of an average beta would be more appropriate as it better reflects Nike’s historical business practices.
The cost of debt (kd) rate of 13% was used after we assessed the key industrial financial ratios and compared them with that of Wrigley’s (See Appendix 2) to conclude that it was in the range between the BB rate of
Her forecast showed that, at a discount rate of 12%, Nike was overvalued at its current share price of $42.09 (Exhibit 2). However, she had done a quick sensitivity analysis that revealed Nike was undervalued at discount rates below 11.17%. Because she was