Nike Case Essay
Jordan Hirsch AF 495 October 18, 2012 Nike Executive Summary Executive summary In this report I will focus on Nike’s Inc. Cost of Capital and its financial importance for the company and future investors. The management of Nike Inc. addresses issues both on top-line growth and operating performance. The company’s cost of capital is a critical element in such decisions and it is important to estimate precisely the weighted average cost of capital (WACC). In my analysis, I will examine why WACC is important in decision-making and I will show how WACC for Nike Inc. s calculated correctly. Also, I will calculate the company’s cost of equity using three different models: the Capital Asset Pricing Model (CAPM), the Dividend Discount Model (DDM) and the Earnings Capitalization Model (EPS/ Price), I can analyze their advantages and disadvantages and finally conclude whether or not an investment in Nike is recommended. My analysis suggests that Nike Inc. ‘s common stock should be added to the North Point Group’s Mutual Fund Portfolio Calculations Debt Current Long term$5. 4 Notes Payable$855. 30 Long Term (discounted)$416. 2 $1,277. 42= 10. 05% weight Equity$11,427. 44= 89. 95% weight Cost of Debt YTM on 20 year Nike Inc. Bond = 7. 51% Cost of Equity (CAPM) Rf + B(Rf- Rm) *Rf= 5. 74% (20 year yield in US T-bill) *Beta= . 8 = 10. 46% WACC Wd*Kd(1-T) + WeKe = 10. 05%*7. 51% (1-38%) + 89. 95*10. 46% = 9. 8767% DDM = (Do(1+g)/Po) + g = (. 48(1+. 055)/$42. 09) + . 055 = 6. 70% Earnings Capitalization Ratio = E1/Po = 232/42. 09 = 5. 51% I don not agree with Joanna Cohen’s WACC calculation. Her amount of debt was correct. I also calculated the same $1,296. 6 as she did.
However, her equity was off. Cohen used the book value for both debt and equity, while this is ok for calculating debt, the calculation for equity should be done differently. I calculated equity by multiplying the current stock price of Nike Inc. by the number of shares outstanding. For WACC, Cohen’s numbers were off as well. First of, the weight of equity was off. Taking the total interest expenses for the year and diving it by the company’s average debt balance calculated Cohen’s cost of debt. I, however, I used the Nike YTM on a 20 year bond.
For cost of equity I used a risk free rate of 5. 74%, the 20-year yield on US T-bill, and my beta was . 8, which was an average Nike beta. Finally, I was able to calculate the WACC for Nike and came up with 9. 8767%. However, I was also able to calculate the DDM and ECR too. My DDM came out to be 6. 7%. There are many advantages to using DDM. First, it allows significant flexibility when estimating future dividend streams. Also, by specifying the underlying assumptions, sensitivity testing and market analysis can be easier.
However, there are some disadvantages as well. First, it is just an estimate, when making investments one must look at other numbers to support the DDM, since it is highly sensitive to small changes in the market. The ECR is helpful as well. It is useful when computing the cost of capital. However, the major disadvantage I that it does not take into consideration of company growth. Overall, I feel that Nike is a good investment for NorthPoint Group. Nike is undervalued and has strong growth opportunities. I would buy!