Nike’s leadership has been meeting to address issues and provide suggestions to boost revenue. The targets provided by management included long-term revenue growth of 8-10% and earnings growth above 15%. Kimi Ford, a portfolio manager at NorthPoint Group has been tasked with analyzing Nike and coming up with a valuation for Nike so that her company can decide whether it is a good investment or not. She found that at a discount rate of 12% the company is overvalued, while with a slight decrease in the discount rate, to 11.7% the company is undervalued. In order to value the company correctly an accurate cost of capital must be estimated.
An analysis of cost of capital is based on company financials as well as market trends and forecasts. There should only be once cost of capital estimated for the company since so many of its segments share the same general risk and growth factors, aside from their non-Nike brand lines. However, they only comprise 4.5% of company revenues and are relatively insignificant.
One of the first errors regarding the analysis in the case is that the employee calculated equity as a portion of total capital based on the company book value of $3,494.5. It is more appropriate to value the equity based on current market value. The current market value of the firm as shown in the analysis is 11,427.44 (in millions). Therefore the weights of debt and equity are 11.27% & 88.73%, respectively.
The cost of debt was calculated incorrectly. The cost of debt should be based on the yield to maturity and on expected values rather than historical data. The yield to maturity on Nike’s publicly traded debt is 7.17% as opposed to her 4.3%. After tax the cost of debt is now 4.44%.
The cost of equity was also calculated incorrectly using the CAPM equation. Instead of using an average of the historical betas I used the current beta as of 6/30/2001, the time of the analysis. I also used the geometric mean as the...