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FINANCIAL MANAGEMENT

MM5007
Case Study
Nike, Inc.: Cost of Capital

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29113385

Faris Hizrian

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Ghea Widya Pratiwi

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Maulana Angga Utama

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Silvia Regina

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Yuthika Fauziyyah

Master of Business Administration


School of Business and Management
Institut Teknologi Bandung
Bandung
2014

1. INTRODUCTION
Kimi Ford who is a portfolio manager at NorthPoint Group, a mutual-fund
management firm which invested mostly in Fortune 500 companies with an emphasis on
value investing, considering to buying some shares of Nike for the fund she managed.
Since the beginning of 2001, Nikes share price had decline significantly. While the stock
market had decline over 18 months, NorthPoint Large-Cap Fund had performed
extremely well and earned a return of 20.7% even as the S&P 500 fell 10.1%.
On June 2001 Nike held an analysts meeting to disclose its fiscal year 2001 result
that is to communicate a strategy for revitalizing the company. Since 1997, its revenues
had plateaued at around $9 billion, while net income had fallen from 48% in 1997 to 42%
in 2000, in addition recent supply-chain issues and the adverse effect of a strong dollar
had negatively affected revenue.
At the meeting, management revealed plans to address both top-line growth and
operating performance. To boost revenue, the company would develop more athletic-shoe
products in the midprice segment, push its apparel line. On the cost side, Nike would
exert more effort on expense control. Finally, company executives reiterated their longterm revenue-growth targets of 8% to 10% and earnings-growth targets of above 15%.
The report from Lehman Brothers recommended a strong buy, while UBS Warburg and
CSFB analyst expressed misgivings about the company and recommended a hold. Ford
decided instead to develop her own discounted cash flow forecast to come to a clearer
conclusion.
Her forecast showed that, at a discount rate of 12%, Nike was overvalued at its
current share price of S42.09. However, she had done a quick sensitivity analysis that
revealed Nike was undervalued at discount rates below 11.17%. The purpose of this case
is to discussing Nikes cost of capital.

2. ANALYSIS
Cost of Debt

Cost of Equity
CAPM formula used in finding cost of equity is: KE=Krf + (Km-Krf).

RF
Rm
b
CAPM

Joanna Cohen
5,74%
5,90%
0,80
10,5%

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5,74%
5,90%
0,69
9,8%

Cost of Capital

Kd(1-t) or CoD
D/(D+E)
1-tax
Ke or CoE
E/(D+E)
WACC

Joanna Cohen
2,7%
27%
10,5%
73%
8,4%

Syndicate 6
7,17%
10,19%
61,94%
9,81%
89,81%
9,26%

Total Equity

= Outstanding Shares x Current Shares Prices


= 271,5 x $42,09
= $11.427,44

Debt balance

= $1.296,60
Total Equity
100
(Total Equity+ Debt Balance)
= ($11.427,44 / ($11.427,44 + $1.296,60)) x 100%
= 89,81%

Weighted for Equity =

Weighted for Debt

= 1 - weighted for Equity


= 1 - 89,81%
= 10,2%

WACC

= (Cost of Debt ( 1tax ))+Cost of Equity


= 9,26%

Joanna Cohen
Cost of Debt (CoD)
Joanna estimate Nike CoD using:
CoD=

total interest expense


(1tax)
compan y ' s average debt

The result show that Nike CoD is 2.7%

Cost of Equity (CoE)

Joanna estimate Nike CoE using:


CAPM =R F+ x (r m R F)
The result show that Nike CoD is 10.5%

Cost of Capital (CoC)


Joanna estimating the CoC using:

WACC=Cost of Debt (1tax)+Cost of Equity

The result show that Nike CoC is 8.4%

Syndicate 6
Cost of Debt (CoD)
We calculate cost of debt by finding the yield to maturity (YTM) on Nike Inc. debt
with a 6.75% coupon semi-annually, with term 20 year, current price $ 95.60, and the
result is 7.17%. Joanna Cohen calculation didnt consider the current condition as the
cost of debt calculation. This calculation is not valid because we dont have enough
information about the debt balance in detail.

Cost of Equity (CoE)


To calculate the CoE, we are using CAPM approach too. We defined current yield on
20-year treasury bonds as the risk-free rate (RF), geometric mean of premium market
over treasury bonds as the risk premium (rm-RF), and the beta is using the newest Nike
historic beta. The different between Joanna Cohen CAPM and our CAPM is the beta,
because we want to estimate expected return in the future. So our CAPM is 9.8%.

Cost of Capital (CoC)


We are calculate the CoC by using WACC too, but the first step is to find out the
proportion between Total Equity and Debt balance, and then calculate WACC with
the result from CoD and CoE. The result of CoC is 9.26%.

3. CONCLUSION & RECOMMENDATION

From the sensitivity of equity value to discount rate, Nike is categorized as


undervalue because the present value was bigger than current market price.
The current market price of $42.09 at the discount rate was 11.17%
Nike WACC is 9.26%, the present value is between $55.68 $61.25 was bigger than
current market price that is $42.09, when the discount rate is between 9.00% 9.50%
We conclude that NorthPoint should consider cost of capital to decide the
investment of buying Nikes stocks. So, we recommended that Nike shares should be
added to the portfolio of North Point Group because Nike shares was undervalued (priced
below fair price), and Nike has growth potential. So, there is the possibility that the value
of Nikes equity value will grow up in the future than our recommendation is to buy the
Nikes stock.