Matatag-Curriculum and the 21st Century Skills Presentation.pptx
235948716 nike-case-study
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Nike Case Study
1. WACC is theweighted averagecost of capitaland it is the required rate of return or discount rate
average of thecosts of a company's sources of financing-debt and equity, each ofwhich is
weighted byits respective use in thegiven situation.
a. It is what thefirm needs to make collectivelyon allinvestments in order for them to be
considered goodinvestments
b. Bytaking a weighted average, we can see howmuch interest thecompany has to payfor
every marginaldollarit finances.
c. A firm's WACC is the overallrequired return on thefirm as a wholeand, as such, it is often
used internallyby companydirectors to determine theeconomic feasibilityofexpansionary
opportunitiesandmergers. Also, WACC is theappropriatediscount rate to use in stock
valuation
d. Since WACC is theminimum return required by capitalproviders,managers should invest
only in projectsthat generate returns in excess of WACC
e. The WACC is set bytheinvestors (or markets), not by managers. Therefore, we cannot
observe the true WACC, we can only estimate it
2. Calculations
a. Singleor multiple
i. I agree with the use ofthe single cost instead of multiplecosts of capital.Thereason
of estimating WACC is to value the cash flows for the entire firm, that is provided by
Kimi Ford. Plus, thebusiness segments of Nike basicallyhave about thesame risk;
thus, a single cost is sufficient for this analysis.
b. Cost of debt
i. The WACC is used for discounting cash flows in the future, thus allcomponents of
cost must reflect firm’s concurrent or future abilitiesin raising capital.
ii. Cohen mistakenly uses thehistoricaldatain estimating thecost ofdebt. She
divided theinterest expenses by theaverage balance of debt to get 4.3% of before
tax cost of debt. It maynot reflect Nike’s current or future cost of debt.
iii. The cost of debt,if its intention is to be forwarding looking,shouldbe estimated by
1. Yieldto maturityof bond
2. According to credit rating.
2. iv. The more appropriatecost ofdebt can be calculated byusing dataprovided in
Exhibit 4. We can calculatethecurrent yieldto maturityof theNike’s bond to
represent Nike’s current cost ofdebt.
PV= 95.60
N=40 (20 years paidsemi annually)
Pmt=-3.375
FV=-100
Comp I = 3.58% (semiannual) 7.16% (annual)
After tax cost of debt = 7.16%(1-38%) = 4.44%
c. Cost of equity
i. Cohen seems to use CAPM to estimate cost of equity. Her number comes from
following:
1. 10.5% = 5.74% +(5.9%)*0.80
a. Her risk free rate comes from 20-year T-bondrate
b. Cohen uses average betafrom 1996 to July 2001, 0.80.
c. Cohen uses a geometricmean of market risk premium 5.9%
ii. Risk free rate
1. It is no problemto use 20-year T-bond rate to represent risk-free rate. The
cost of equityand the WACC are used to discount cash flows of very long
run, thus rateof return a T-bondwith 20 years maturity,5.74%, is thelongest
rate that are available.
iii. Market risk premium
1. To use a geometricmean of market risk premium 5.9% is also correct. Using
arithmeticmean to represent true market risk premium, we have to have
independentlydistributed market risk premium. It is often found that
market risk premium are negativelyserial correlated.
iv. Beta
1. I don’t agree that Cohen uses average betafrom 1996 to July 2001, 0.80 to
be themeasure of systematic risk, because we need to find a betathat is
most representative to future beta. As such, most recent betawill most
relevant in thisrespect. So I suggest using themost recent betaestimate,
0.69.
v. Recalculated Cost of Equity
vi. 5.74% + (5.9%)*0.69 = 9.81%
d. Weightsof capitalcomponents
i. Cohen is wrong to use bookvalues as thebasis for debt and equity weights;the
market values shouldbe used in calculating weights.
ii. The reasoning of using market weights to estimate WACC is that it is how much it
will cause thefirm to raise capitaltoday. That cost is approximated bythemarket
value of capital,not bythebookvalue of capital.
iii. For market value ofequity, $42.09*273.3 m shares = 11,503 m.
iv. Due to the lackof information of themarket value of debt,bookvalue of debt,1,291
m, is used to calculateweights.
v. Thus, themarket value weight for equity is 11,503 / (11,503+1,291) = 89.9%; the
weight for debt is 10.1%.
3. Calculationof theWACC is as follow:
a. 4.44%*0.101 + 9.81%*0.899 = 9.27%
4. See above
5. To discount cash flows in Exhibit 2 with the calculated WACC 9.27%, thepresent value equals
$58.13 per share, which is more thancurrent market price of $42.09.
3. a. Some might thinkthisvalue is stillunderstated, due to that current growth rate used (6% to
7%) is much lower thanthat estimated bymanager (8% to 10%). So the recommendationis
to BUY!
4. Class Answer
1. WACC
What is WACC?
Required rate of return
Why is it important?
Used to:
Value a capitalproject
Perform valuations of thewholefirm (FCF)
Who sets WACC?
Set bytheinvestors of thefirm
Could argue that it is a combinationas themanagers determine theweighting of debt to
equity in thefirm and theinvestors only determine therequired rate of return on equity
2.
2.1 – Single or Multiple costsof capital
She argues that although therearemultiplebusinesses, theyare very similar in terms of theirrisk. Even
though theywere located in different places. Shealso used one ratebecause she was valuing thewhole
company.
2.2 – Calculationof WACC:
Capital Structure – Jo’s Assumptions
She used thebookvalue (straight from the balancesheet) as opposed to themarket value
Traditionalview: if you have a target structure, use that.If not, market values. Thereafter, market value.
Cost of Debt – Jo’s assumptions
She tooktotalinterest for theyear divided bythe company’saverage debt balance
Can actuallycalculatewhat the yieldis on theirsecurities
Her argument re borrowing in Japan at lower rate is not badbut not great either
She has use Nike’s effective tax rate (use thisbecause it is specific to the company)
Cost of Equity – Jo’s assumptions
She used theCAPM model – says it’s more superior. This modelis used 65% yet hugelycontroversial. 100s
of peoplesaying CAPM doesn’t work. But it does help us do a valuationwhich is never exact science
anyway.
She used a 20 year treasury bond as her risk free (most ofteb used). Could haveused the10 year too.She
used thegeometricaverage for theequity risk premium which is superior to thearithmeticmean. For
Beta,she tooktheaverage from 1996 to 2001 (present). She couldhave taken something likethecurrent
YTDbetaas it is forward looking which is what we require.
3. CAPM calculation
𝑅𝑓 = 5.74%
𝐾𝑒 = 5.74% + 0.69(5.9)… = 9.8%
𝑘𝑒 = 5.74% + 0.8(5.9%)… = 10.46%
𝑅𝑓 = 5.39%
𝑘𝑒 = 5.39 + 0.69(5.9)… = 9.46%
𝑘𝑒 = 5.39 + 0.8(5.9)… = 10.11%
This gives us a range of 9.46% to 10.46% using different risk free rates (10 year or 20 year) and different
betas (averagesince 96 or YTD)
None of them are incorrect – just have to justify
CAPM advantages and disadvantages
DDM – Calculation
She used thevalue line forecast for dividendgrowth of 5.5%. Last dividendwas 48c
𝐾𝑒 =
𝐷1
𝑃0
+ 𝑔 =
0.48 𝑥 1.055
42.09
+ 0.55 = 6.73%
This rate is too low to use
DDM – Advantages and disadvantages
Earnings capitalization method – calculation
5. 2.16 × 1.055 =
2.2788
42.09
= 5.41%
𝑉 =
𝐸1
𝑟 − 𝑔
Taking the diluted EPSfrom theAFS, growing it bythegrowth rate and then dividing bythecurrent share
price
Earnings capitalization method – advantages and disadvantages
4.
Capital Structure
Cost of debt
PV= 95.60
N=40 (20 years paidsemi annually)
Pmt=-3.375
FV=-100
Comp I = 3.58% (semiannual) 7.16% (annual) (market related yieldto maturity)
After tax cost of debt = 7.16%(1-38%) = 4.44%
Many peoplewouldtake theYTM and put it into a formula with thepar value ofthe notes.
Going to do theshortcut method and takethe amount on thebalance sheet
1296.6 ×
7.17%
6.75%
= 1377
The sum of current portionof long term debt (5.4), long term debt(435.9)and notes payable(855.3)x
(calculated cost of debt)/(couponrateof debt)
Value of Equity:271.5 (number ofshares outstanding)x 42.09 = 11427
Thus weightings– 10.75% (debt),89.25% (equity)
Cost of equity
WACC
5. Buy or sell?
