NIKE, INC.: COST OF CAPITAL
Book value vs. Market value 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. Cohen’s book value of equity is the total shareholder’s equity in the balance sheet, $3494.5. The market value of equity on the other hand, is $11427; computed using
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to the NorthPoint Large-Cap Fund because the stock is undervalued. I recommend a buy decision, which concurs with Lehman Brothers report, as Nike has a growth potential that would be beneficial to the fund if it s included in the portfolio.
EXHIBIT 1.1
WACC using Book Values (Cohen’s calculation)
Debt value = Current portion of long-term debt + Notes Payable + Long-term debt $5.4 + 855.3 + 435.9 = $1296.6
Equity value = $3494.5 (Total shareholder’s equity or Assets-Liabilities)
Debt weight = D/(D+E) = 1296.6/3484.5 = 27% of weight on debt
Equity weight = E/(D+E) or (1-0.27) = 73.3% of weight on equity
Cost of debt: Total interest expense / average debt balance 58.7/(1444.6+1296.6/2) = 0.0428 = 4.3% Using the tax rate of 35% plus state taxes of 3%, cost of debt becomes 4.3%*(1-0.38) = 0.266 = 2.7%
Cost of equity: Cohen used the current yield on 20-year Treasury bonds as risk-free rate (5.74%) then compounded average premium of the market over Treasury bonds (5.9%) for risk premium. As for beta, Cohen used the average of Nike’s beta from 1996 to 2001 (0.8).
Using the CAPM = Kf + b(Km-Kf)
Where Kf= risk free rate, Km = market rate, B = beta, (Km-kf) = risk premium
CAPM = 5.74% + 0.8(5.9) = 10.46%
WACC = Kd(1-T) x D/(D+E) + Ke x E/(D+E) = 2.7% 27% + 10.46%*73% = 8.4%
EXHIBIT 1.2
WACC using Market Values
Debt value = Current portion of long-term debt + Notes Payable + Long-term
The cost of equity is the theoretical return that equity investors expect or receive from the company for investing their funds in the company. The risk free rate that is the Government Treasury bill rate is 3.1%, the market risk premium is 7% and the beta has been calculated as
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%
The most obvious reason for the difference between the market value of equity and the book value of equity is the inability to record certain intangible assets such as brand value, customer loyalty, and perhaps most importantly, human capital. These intangible assets are likely to provide tremendous earnings growth in the future which determines the company’s market value. Notice also that the company’s choice of conservative accounting policies has the effect of depressing the company’s book value of equity.
Another problematic issue is that the accounting rate of return can not be used to compute the cost of equity because normally accounting rate of return is in book value rather than market value. The value of the stock will fluctuate greatly from year to year while the book value does not indicate any risk or future cash flows at all, so it is crucial to calculate the cost of equity by using market value.
Market value per share = Book value per share = $12,000 / 750 shares = $16 per share
Cost of Equity = Risk free rate + (Market return – risk free rate) X beta
The Equity beta for the whole company and for the commercial division is calculated in the appendix.
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
However during the last reported years the company kept a stable reserve of cash and increased its short term investments especially in the last year from 5.16 to 8.78 of total assets. While Nike had decreased gross receivable over the years and from 23.1 in FY 08 to 22.6 in FY 09 of total assets, it considerably increased its provisions for doubtful accounts. This might be a precautionary measure on part of the company in the face of the financial crisis the occurred in the last reported year, which eventually resulted in decreasing the company’s net receivables from 22.4 to 21.7 of total assets in FY 09. Nike’s inventory has been slightly fluctuating over the reported years. The clear decrease in the company’s inventory in FY 09 cannot be explained by more sales as sales grew by only 2% as seen from the income statement. Therefore, the less inventory in the last year might be caused by the Company’s slowing down of its manufacturing process for fear of not being to sell its finished goods due to the
clear assessment of the financial health of the company: NIKE International. Just knowing that this company chose a symbol that references the winged goddess of victory seems to have been a premonition for the designer of the ‘swoosh’ as well as the founder, Phil Knight, of NIKE. (Hinker,)
Nike’s total revenue has steadily increased over the years. In 2013, Nike’s cash and equivalents totaled of $3.3 billion. This was 25.5% higher than cash and equivalents in 2012. Cash and cash equivalent is one of the big asset account in the company’s assets. Cash increased by 18.5% in 2012, and in 2013 it increased by 44%. Nike has an up and down in short-term investments account. In 2012, the short-term investments decreased by 44.3% but in 2013 it went up almost double by 82.5%. In 2011, investments made up 17.2%, in 2012 investments made up 9.3%, and in 2013 investments made up 15% of the company’s total assets.
Interest rate #’s, Betas, Book values on debt and equity are given. Also historical performance #s are given.
At this time, Nike presents an interesting investment opportunity. With the consistent longevity of dividend increases coupled with the attractive ROE ratio in comparison to competitors, Nike appears to be a great investment but that may not be the whole story. With an intrinsic value calculated from the discounted cash flow model of $87.84, Nike stock currently seems overpriced. While Nike has a strong history of consistent revenues and profits, which it is poised to continue in the future, and is a global power in its industry, Nike’s recent acquisition of Converse is driving up stock price. In the eyes of Graham this would be an unattractive investment. However, if the gap between stock price and intrinsic vale were to close, I believe this company to be a solid long-term investment in the eyes of Buffett.
The Oregon-based company, Nike Inc., is one of the biggest brands across the world. Nike is dominating the segment of athletic footwear, clothing and accessories through a strong market base. According to Yahoo Finance ( 2016), Nike has a market capitalisation of $85.14 billion whereas its competitors such as Adidas (32.63) puma ( 3.68) ralph lauren (8.01) JC Penny ( 2.62). Such a huge market capitalisation has led Nike to have P/E ratio of 25.56 which is lower than the industry (textile – footwear apparel and accessories) of 19.4. This suggests that investors expects the company to grow. Nike has achieved this by clo