nike inc.
NorthPoint Large Cap Fund, a mutual fund management firm, deciding whether to buy Nike’s Stock
Nike’s net income has fallen from $800 million to $580 million since 1997. Also its profit and market share have declines significantly from 48% to 42% (Shoe products market share) from 1997 to 2000
To counter this down fall Nike has decided to develop more athletic shoe products in mid-priced segment and also to push their apparel line. It has also decided to cut down expenses
Analyst reactions are mixed – Lehman Brothers report a recommended “Strong Buy” whereas UBS Warburg and CSFB analysts expressed misgivings and recommended a “Hold”
Kimi Ford, a manager and NorthPoint Large Cap Fund has done a quick sensitivity analysis and asked her assistant, Joanna Cohen to estimate Nike’s cost of capital
Identification of Issues and their Possible Solutions
Introduction to WACC
WACC stands for Weighted Average Cost of Capital
The company cost of capital is defined as the expected return on a portfolio of all the company’s existing securities. It is also known as the opportunity cost of capital for investment in firm’s assets
Hence WACC is the minimum return required by the investors. So one should invest only in projects having higher return than WACC
Issues in calculating WACC
Single cost or Multiple cost
Nike has multiple business segments – use same cost of capital for all segments or use different rate for different segments
Footwear and Apparel, Nike’s two major business segments are sold through same merchandizing outlets and hence have a similar risk
Also our goal is value the cash flows of the entire firm; thus a single cost is apt for analysis
Cost of Debt
There are two methods to calculate Cost of Debt
As Cohen calculated using Interest on Debt divided by total Debt but it might not reflect Nike’s current or future cost of Debt
More appropriate method for forward looking cost of debt is using the YTM of company’s bonds
Cost of Equity
Nike’s net income has fallen from $800 million to $580 million since 1997. Also its profit and market share have declines significantly from 48% to 42% (Shoe products market share) from 1997 to 2000
To counter this down fall Nike has decided to develop more athletic shoe products in mid-priced segment and also to push their apparel line. It has also decided to cut down expenses
Analyst reactions are mixed – Lehman Brothers report a recommended “Strong Buy” whereas UBS Warburg and CSFB analysts expressed misgivings and recommended a “Hold”
Kimi Ford, a manager and NorthPoint Large Cap Fund has done a quick sensitivity analysis and asked her assistant, Joanna Cohen to estimate Nike’s cost of capital
Identification of Issues and their Possible Solutions
Introduction to WACC
WACC stands for Weighted Average Cost of Capital
The company cost of capital is defined as the expected return on a portfolio of all the company’s existing securities. It is also known as the opportunity cost of capital for investment in firm’s assets
Hence WACC is the minimum return required by the investors. So one should invest only in projects having higher return than WACC
Issues in calculating WACC
Single cost or Multiple cost
Nike has multiple business segments – use same cost of capital for all segments or use different rate for different segments
Footwear and Apparel, Nike’s two major business segments are sold through same merchandizing outlets and hence have a similar risk
Also our goal is value the cash flows of the entire firm; thus a single cost is apt for analysis
Cost of Debt
There are two methods to calculate Cost of Debt
As Cohen calculated using Interest on Debt divided by total Debt but it might not reflect Nike’s current or future cost of Debt
More appropriate method for forward looking cost of debt is using the YTM of company’s bonds
Cost of Equity