Kimi Ford, a portfolio manager at NorthPoint Group, a mutual-fund management firm, was considering buying share for the fund she managed, the NorthPoint Large-Cap Fund, with an emphasis on value investing.
Ford held an analysts’ meeting to disclose its fiscal-year 2001 results and most importantly, to communicate a strategy for revitalizing the company. Nike had maintained revenue of about 9 billion since 1997. However, its net income had fallen from almost $800 million to $580 million. Moreover, Nike’s market share in U.S. athletic shoes had fallen from 48% since 1997 to 42% in 2000.
In order to boost revenue, management decided to develop more ...view middle of the document...
She should have instead used liquidation value in calculating the value of equity. Using the liquidation value per share is definitely more realistic to be used than the book value as an estimate of the current market value.
The market value of equity (E) is calculated by multiplying Nike’s stock price by the number of shares outstanding.
E = Stock Price x Number of Shares Outstanding
By referring to Exhibit 2, it is found that the current shares outstanding are 271.5 and $42.09 the current price of share.
E= $42.09 * 271.5
It is evident that there is a tremendous gap between $11,427.44 and $3,393.5 derived by Cohen.
Cohen also uses the book value of debt presented on the balance sheet as an estimate to the current market value of debt. She calculates this by dividing the total interest expense by the company’s average debt balance; whereas I used the yield to maturity (YTM) of a twenty-year debt using the 6.75% coupon paid semi-annually.
When calculating the value of debt, one should discount the value of the long-term debt. This implies that the future value of long-term debt should be also considered.
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.
To calculate the Market Value of Debt: -
D= Current portion of LT Debt+Notes Payable+Discounted LT
From July 15th, 2000 until January15, 2001 = 6.75% coupon rate paid semi-annually. From January15, 2001 until May 31st, 2001 (4.5 months) =
6.75 % x 4.5 months/6 months = 5.06%
The Discounted Long-Term Debt is calculated as follows:-
435.9 – (435.9*5.06) = 413.72
Market Value of Debt (D) Calculation:
D = Current LT + Notes Payable + LT Debt (discounted)
= $5.40 + $855.30 + $413.72
The following step would be calculating the market value and along with the Nike’s capital structure.
COST OF DEBT
Nike is financing its operations by both equity and debt. In order to calculate WACC, we need to find the cost of both debt and equity.
I would use the same Yield to Maturity on U.S Treasuries used by Cohen as the risk free rate.
According to Exhibit 4, A 20-year Yield accounts for 5.74%. However, I wouldn’t calculate cost of debt by dividing interest expense by the company’s average debt.
It is also found that there are two Historical Equity Risk Premiums from 1926 till 1999.
Geometric mean gives a more realistic outlook on what you can expect in the future. Using both the geometric mean and the 20-year Yield would arrive at a more accurate result.
We are still left with the last component of CAPM approach. Exhibit 4 shows Nike Historic Betas from the period 1996 till 2001. However, it is evident that there are quite clear variations between the figures presented. Therefore, I would use the average of the Betas .80, which I believe is a better composition and reflection of to measure the real systematic risk.
I would agree with Cohen...