NIKE INC. CASE 14
Philip Chen, Choco Huang, Ariel Chou, Matt Krieger
In this report we analyzed Cohen’s approach in calculating WACC. After observing how Cohen derived his figures we came up with our own WACC, terminal value, and EPS.
Cohen broke down his calculations into five parts 1) Single or Multiple Costs of Capital 2) Proportion of capital from debt and equity 3) Cost of Debt 4) Cost of Equity 5) WACC
In part one; we disagreed with Cohen where he decided to value the company as a whole instead of valuing each division separately. Since Nike is a multidivisional firm Cohen should of aggregated the values of the individual divisions and calculate a different cost of capital for each one. Since the exhibit 1
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The beta is the 0.69 YTD 06/30/2001 figure and our risk premium is the arithmetic mean. Both are found in exhibit 4. We used the arithmetic mean because it is a better indicator of the average returns in the past and 71% of financial analysts prefer arithmetic mean over geometric mean. Geometric mean is not preferred because (PLEASE ADD “WHY NOT” HERE. I REMEBER BOB DOING AN EXAMPLE IN CLASS WHERE GEOMETRIC MEAN IS A TRICK ON STUIPID INVESTORS). Here is our calculation of CAPM.
CAPM=5.39%+0.69(7.50%). CAPM= 10.6%
In Part 5 we can summarize our calculations for WACC. Table 1.2 shows our WACC. | Portion | Cost (K) | Contribution to WACC | Common Share | 30.57% | 10.60% | 3.24% | Debt | 69.43% | 9% | 6.25% | | | WACC | 9.49% |
Our WACC is higher than Cohen’s because of the portions allocated to debt and equity, and the use of market value to calculate cost of debt.
Since WACC has changed the terminal value will also change. The formula for terminal value= year 10 FCF*(1+L-T growth)/ (WACC-L-T growth). We used the L-T growth in exhibit 4, which is forecast of dividend growth at 5.50%. Therefore the new terminal value is 41,584. Since terminal value has changed the discounted present value of future cash flow will also change. The new discounted PV of FCF less debt is 21,224. The new EPS is $67.50 (21,224/271.5).
MAYBE ADD CONCLUSION PLEASE
Additional Calculation
Table 1.3 | R/E Yr.2000 | NI Yr. 2001 | R/E Yr.2001 | |
First, the projected cash flows range from $21.2 million in 2007 to $29.5 million in 2011 as shown in the data exhibit ‘DCF model.’ To generate these numbers Liedtke’s base case performance projections are used for the projected 2007 – 2011 net revenue numbers and the estimated depreciation and then his projections for Balance sheet accounts were used to determine the current net working capital and capital expenditure as in the exhibit ‘Financial statements.’ These projections were based by Liedtke under the following assumptions, women’s casual footwear would be wound down within one year and the historical corporate overhead-revenue ratio would conform to historical averages. These annual cash flows give us a PV (Cash flows) of $96.15 million over the next 5 years.
General speaking, WACC is the rate that a company’s shareholders expect to be paid on average to finance its assets, and it is the overall required return on the firm as a whole. Therefore, company directors often use WACC to determine whether a financial decision is feasible or not. In this case, I will choose 9.38% as discount rate. The reason why I choose 9.38% as discount rate is because the estimated Debt/Equity is 26% under the assumptions by CFO Sheila Dowling, which is most close to 25% of Debt/Equity from the projected WACC schedule. There might be some flaws existing by using WACC as discount rate. As we know, the cost of debt would be raised significantly as the leverage increased. The investment will definitely increase the firm’s current debt. So, the cost of debt would not keep at 7.75%.
Then we can use the following formula to calculate the WACC. The cost of debt is taken to be on an after tax basis to further to account for the depreciation tax shield.
WACC= (%of debt) (after-tax cost of debt) + (% of preferred stock)(Cost of preferred stock) + (% of common equity) (Cost of common equity)
Given these approximations, the CAPM model would total the risk-free rate and the market risk premium times beta to arrive at a cost of equity of 9.68%, which reflects the investors’ expected return from investing in shares of the company.
WACC = Cost of Debt X proportion of debt + Cost of Preferred Stock X Proportion of preferred stock + Cost of equity X proportion of equity
Weighted average cost of capital (WACC) is a calculation of a firm’s cost of capital which each type of capital is proportionately weighted. WACC is used as a discount rate for investment appraisal. Hence, calculating WACC of a firm is important.
For this reason, new, or marginal, costs are used in its calculation. WACC is calculated by multiplying the cost of each capital component by its proportional weight and then summing then together. The capital components included in this calculation are a firms after-tax costs of debt, preferred stock, and common stock.
1.a) To value Spyder Active Sports Inc., we decided to use the WACC method since we can easily value its cost of assets with the data immediately available to us in the case. We first unlevered the beta’s of 7 comparable companies and took the average to get a comparable unlevered beta for Spyder (Exhibit 1). Since we are assuming Spyder is entirely equity financed, its unlevered asset beta is equal to the beta of its assets. We now have a rough estimate of Spyder’s asset beta, we can
As an increasing in pedestrian activity in CBD retail sector that mentioned in the former section, with fashion and luxury market, Brisbane is of the attractive destinations for investment. The local and foreign retailers have set their sights on Brisbane’s inner-city areas of Edward Street and the Queen Street Mall precinct. Edward Street is emerging as a favoured luxury shopping destination with the arrival of international brands Burberry and Bvlgari. Forever 21 opened its first Australian store in the Queen Street Mall in October while Top Shop operated its largest Australian store in the precinct in late 2013 (Brisbane City Council, 2015).
We are providing below the assumptions and other calculations we used while computing the WACC and the cash flows.
Gillette has some decisions to make regarding the launch of its Sensor shaving system. They are wrestling with how aggressively to launch a new shaving system, which markets to focus on, and how much to commit to marketing this new product.
While calculating the Nike’s cost of capital using both the book value (Exhibit 1.1) and the market value (Exhibit 1.2), I could notice the mistake Cohen made finding the equity value. Cohen used the book value to reflect equity value. Although the book value is an accepted measure to estimate the debt value, the equity’s book value is an inaccurate measure of the value perceived by the shareholders. Since Nike is a publicly traded company, market value is the better method in reflecting Nike’s equity value.
Marriott uses WACC to measure the opportunity costs of capital of investments with similar risks. Each division of Marriott has a different cost of capital, based on debt capacity, debt cost, and equity cost. They use the estimate of cost of capital to determine the fraction of debt that should be floating rate debt. WACC is also used to determine the premium above government bond rates for their unsecured debt. This makes sense because the
Kimi Ford is a portfolio manager at NorthPoint Group, a mutual-fund management firm. She is evaluating Nike, Inc. (“Nike”) to potentially buy shares of their stock for the fund she manages, the NorthPoint Large-Cap Fund. This fund mostly invests in Fortune 500 companies, with an emphasis on value investing. This Fund has performed well over the last 18 months despite the decline in the stock market.