Date:

Group
no.
and
Cohor
t:

05/05/2015
CEO:
MGB September 2014, Group no 5 Team
Members:

Sanah Bijlani
Shreya
Bhattacharya
Shubhi Jain
Varun Bhattacharya
Vinit Kore

Key Points Discussed:

As a group, we discussed the case on hand and debated upon the calculations
projected by Cohen. Our comments on the assumptions made by Cohen for the
calculations are as follows:
Nike is a company that is majorly focused on foot wear, however, apparel, sports
accessories and a small portion of non-Nike branded products also forms part of
its sales. For the purpose of future cash flow calculations, she has used standard
projections for all segments and considered all separate segments to behave in
the same manner in the future. Hence, to use a single cost of capital as the
discounting factor is justified. However, we feel that separate projections of cash
flows could have been made for the segments to give a more accurate picture,
and then individual cost of capitals would be used for discounting. Assuming
risks associated with different product segments to be the same would not give a
true valuation at the time of discounting. This process would be more tedious
and would require more data for calculations.
Since the company uses equity and debt to finance the business, using WACC
was an appropriate method. However, the basis for calculation of the weights of
equity and debt relied on book value. Research suggests that book values of
equity for a listed company are far removed from their market values, and 10
fold differences between debt to equity ratios calculated from book and market
values are actually typical (Jacob & Shivdasani, 2012) hence making it
inappropriate to use the book value of equity and debt for the basis of our
calculations.
Market Value of Equity:
273.3 million outstanding shares * 42.09 Current Market price= 11503 Million
Market value of Debt: Lack of information , therefore assuming market value of
debt as book value= 1296.6 million
The percentage distribution is now Debt: 10.12% debt and remaining equity
instead of the 27%-73% breakup as calculated. This would raise the cost of
capital as the cost of debt is lower than cost of equity.
For the purpose of calculating the cost of debt, the historic figures for debt have
been used instead of projecting the funding that the company would raise
through different sources of debt in the future. Hence, using an average of 2000
and 2001 figures does not depict a true picture of the cost of debt and instead,
future projections should be used. The interest calculations are based on a single
year interest outflow of 2001, which would stand to change in the future. Debt is
not perpetual, and hence, the influence of the Japanese note interest rates on
lowering the historic cost of debt, is not certain in the future.

For the purpose of calculating the Cost of Equity, 3 models have been identified
that could have been used. Capital Asset Pricing Model, Dividend Discount Model
and Earnings Capitalization model. We agree with using the CAPM model because
the company doesn't lend itself for other models to be applied. Nike doesn't give
out a dividend, hence a discounted dividend method cannot be applied as it
assumes that the company pays a substantial dividend.
Earnings capitalization model calculates the cost of equity by dividing the future
earnings by Price per share. Capitalization of Earnings Method determines the
business value using a single measure of the expected business economic
benefit as the numerator. This is divided by the capitalization rate that
represents the risk associated with receiving this benefit in the future. In using
this valuation method, care must be given to the proper selection of the
economic benefit being capitalized and the appropriate capitalization rate.
Capitalized earnings method only gives the valuator a chance to get the
normalized earnings estimate correct. This leads to a greater estimation error.
For the purpose of calculating the return on equity through CAPM, expected rates
are taken. The current calculation is entirely dependent on past data and historic
beta values that might not help in eliminating systematic risk or may overestimate the volatility.
Hence, we feel that the assumptions made by Cohen to arrive at the figure of
8.4% as the discounting factor is relatively lowering the discounting rate.
Starting with using the single cost of capital, basing the cost of debt on historic
values and the debt-equity percentage composition are the major assumptions
that would result in the shares being estimated as highly undervalued upon
discounting.