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Nike, Inc. Essay

1285 words - 5 pages

Part of Nike's strategy to revitalize the company was aimed at addressing their revenues which had been fixed for four years and their net income which had fallen to almost $220M. Additionally, Nike had been losing overall market share and the strong dollar had adversely affected revenue. To address those issues, management was planning to; (1) raise revenue by developing increased levels of athletic-shoe products in the mid-priced segment. (2) Push its well performing apparel line, and (3), control expenses.Kimi Ford, a portfolio manager at a mutual fund management firm, was considering adding Nike's shares to the portfolio she managed. To come to a decision she asked Joanna Cohen, her assistant, to develop a discounted cash flow forecast. Her analysis had a few flaws that will be pointed out in this paper through a new analysis.Cohen's first mistake was to use Nike's book value of equity in her calculation of the WACC; $3,494.50. Though the book value is an accepted estimate of the debt value, the equity's book value is an inaccurate measure of the value perceived by the shareholders, therefore an irrelevant source when finding the equity value. Moreover, Nike is a public traded firm, therefore its equity value can be best reflected by its market value.Market Value of Equity = Market price of the share * Number of Shares Outstanding= $42.09* 271.5 = $11,427.44Book Value of debt = Current portion of long term debt + Notes payable= $855.3 + $435.9 = $1,291.2E / (D+E) = $11,427.44 / ($11,427.44 + $1,291.2) = 0.89847 which is 90% of total capitalD / (D+E) = $1,291.2 / ($11,427.44 + $1,291.2) = 0.1015 which is 10% of total capitalD + E = $12,718.635 millionThere is an enormous difference between the book value of equity and its market value. Therefore, the portion of equity to debt (E/D+E) is much higher now as 89.8% compared to Cohen's estimate of 73% of total capital.Cost of debtBy calculating the weighted average of the interest on Commercial paper outstanding, notes payable to banks and interest-bearing accounts payable, I calculated the cost of debt to be 4.5%, which is similar to Cohen's estimate. Consequently, the cost of debt to Nike is 2.8 percent [(1-38%)*4.5%]. I used a 38% tax rate, which I obtained by calculating the historical average which coincides with the rate obtained by taking the U.S. statutory tax rate and adding the historical average of the tax variation.Cost of equityThere are several methods to estimate the cost of capital; Cohen did it using the Capital Asset Pricing Model (CAPM), which states that Ke = Kf + b(Km-Kf)Kf: Risk free rate. Derived from the current yield on the 20-year U.S. Treasury Bond; 5.74%.b: Company's risk that cannot be diversified away. Nike's six year historic average: 0.80Km-Kf: The market's risk premium; the historical equity risk premium used is 5.9%, which is the geometric mean return.CAPM= 5.74 +.8(5.9) = 10.46When a firm like Nike uses both equity and debt to finance itself, the cost of capital...

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