Nike, Inc.

Topics: Stock market, Stock, Weighted average cost of capital Pages: 5 (1540 words) Published: November 22, 2012
Edward C. La VictoriaNovember 18, 2011

Case: Nike, Inc.: Cost of Capital

I. Point of View
- Kimi Ford, portfolio manager at NorthPoint Group, a mutual-fund management firm.

II. Problem
Should Kimi Ford proceed to buy shares from Nike, Inc.? Or not?

III. Objective
This case analysis aims to increase the earnings of NorthPoint Group which, at the end of June 2001 stood at 6.4%.

IV. Areas of Consideration
1. On July 5,2001, Kimi Ford pore over analysts’ write-ups of Nike, Inc.. 2. Nike’s share price had declined significantly from the beginning of the year. But Ford was considering buying some share for the fund she managed. 3. While the stock market had declined over the last 18 months, the NorthPoint Large-Cap Fund had performed extremely well. In 2000, the fund earned a return of 20.7%, even as the S&P 500 fell 10.1%. At the end of June 2011, the fund’s year to date returns stood at 6.4% versus -7.3% for the S&P 500. 4. On June 28, 2001, Nike held an analysts’ meeting to disclose its fiscal-year 2001 results and to communicate a strategy for revitalizing the company. 5. Since 1997, Nike’s revenue had plateaued at around $9 billion, while net income had fallen from almost $800 million to $500 million. Nike;s market share in US athletic shoes had fallen from 48%, in 1997, to 42% in 2000. 6. At the meeting, management revealed plans to address both top-line growth and operating performance. To boost revenue, the company would develop shoe products in midpriced segment. Nike also planned to push its apparel line with the leadership of Mindy Grossman. 7. On the cost side, Nike would exert more effort on expense control. 8. Company executives reiterated their long-term revenue-growth targets of 8% to 10% and earning-growth targets of above 15%. 9. There were mixed reactions among the analysts. Some thought the financial targets were too aggressive; others saw significant opportunities in apparel and in Nike’s international businesses. 10. Kimi’s own forecast shows that at 12% discount rate, Nike was overvalued at $42.09. However, it was undervalued as 11.17% discount rate. 11. Joanna Cohen, the assistant of Kimi, calculated that Nike’s cost of capital is 8.4%. This is based on the tables provided by Kimi.

V. Alternative Courses of Action
Before going to the recommendations, let us first take a look at Joanna Cohen’s calculations of WACC. Cohen used the capital asset pricing model (CAPM) and her WACC is at 8.4%. The problem with Cohen’s calculations is that she used the book value for both debt and equity. While the book value of debt is accepted as an estimate of market value, book value of equity should not be used when calculating cost of capital. The market value of equity is found by multiplying the stock price of Nike Inc. by the number of shares outstanding. |Market Value of Equity | | |E = |Stock Price |# Shares Outstanding | | |$42.09 |271.5 | |E = |$11,427.44 | |

This figure is much different than the book value of equity that Joanna Cohen used ($3,494.50). In addition, for market value of debt, Cohen uses the book value, when in fact she should have discounted the value of long-term debt that appears on the balance sheet. The market value of debt is found by adding the current portion of long-term debt, notes payable, and long-term debt discounted at Nike’s current coupon.

|Market Value of Debt | | | |D = |Current LT |Notes Payable |LT Debt (discounted) | | |$5.40 |$855.30 |$416.72 | |D = |$1,277.42...
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