Case TRX - IPO

Topics: Weighted average cost of capital, Stock, Net present value Pages: 7 (1383 words) Published: March 25, 2014


Financial Engineering
Case Study Written Report

NIKE INC., COST OF CAPITAL
CASE REPORT

Submitted to: Mr. Mieczyslaw Grudzinski
Report date: 27 February 2014
BBA Finance & Accounting
Semester 6, Academic year 2013-2014

Group Member:
Tra My Nguyen 24458
Anna Kulishova 24444
Kaihao Zhang 25545
Zakariae Mokhliss 27727

NIKE INC., COST OF CAPITAL
CASE REPORT

INTRODUCTION

Our group was assigned to produce a report on the Nike Inc.: Cost of Capital case study as a component of Financial Engineering assignments. This case study presented a situation where Ms Kimi Ford, a portfolio manager at North Point Group, was considering buying some shares of Nike Inc. for the fund that she was managing. The reason was, after a quick sensitivity analysis of the discounted cash flow forecast, that she learned that Nike was undervalued at discount rates below 11.17%, which would make it beneficial to acquire its shares. In order to make a decision whether to buy Nike’s shares, she needed the estimation of Nike’s cost of capital. Her assistant, Ms Joanna Cohen, performed an estimation of the cost of capital by the end of the day with a result of 8.4%. Our task was to verify whether her estimation was correct and suggest our own proposal of changes.

CASE ANALYSIS

What our group agrees on with Ms Cohen’s approach is the choice of WACC – Weighted Average Cost of Capital. WACC is one of the most widely used estimation of a firm’s cost of capital, with each and every source of capital proportionally weighted. A firm is generally financed by debt and equity, therefore, the equation to calculate WACC is as follows:

Where:
- book value of the firm’s debt
- book value of the firm’s equity
- value of the firm’s financing
- cost of debt
- cost of equity
- Corporate tax

In terms of investment decision, WACC reflects the minimum rate of return required for the investment to break even. WACC is very often used by investors when deciding whether to invest or not. It is essential to estimate the firm’s cost of capital as it shows the feasibililty as well as profitability of the firm. WACC is also used to estimate the firm’s Net Present Value by discounting the Cash Flows by WACC, and then summing the discounted cash flows.

ISSUES ARRISING FROM THE CASE STUDY

When reviewing the assumptions and estimations by Ms Joanna Cohen, our group found a number of errors. These errors are likely to result from mistaken assumptions as well as mistaken application of wrong figures. We agree with Ms Cohen that there should only be one cost of capital for the whole company since majority of Nike’s revenue comes from sports-related businesses, except for Cole Han brand revenue that is actually not very significant in size. Before showing our final result of WACC, we would like to present the adjustments we made to the components of the WACC equation: proportions between Debt and Equity

cost of debt
corporate tax rate
cost of equity

1. PROPORTIONS BETWEEN DEBT AND EQUITY:

What Ms Cohen did was:

Our group took the same amount of equity, as stated in the Nike’s balance sheet, $ 3,494.5. However, we do not agree with the computation of debt. What we did was:

Debt

Current portion of long term debt
+ Notes payable
+ Long term debt
+ Preffered stock

$ 5.4
$ 855.3
$ 432.9
$ 0.3
$ 1,296.9
Equity

$ 3,494.5

Therefore, the proportions would be as follows:

Debt = 27.06 %
Equity = 100% - 27.06% = 72.93%

The difference in numbers is not significant due to the small size of Preffered Stock. However, Ms Cohen did not mention omitting this figure.

2. COST OF DEBT:

Due to mistatement of Debt, there would be a slight difference in the cost of debt:

, comparing to the 4.3% by Ms Cohen.

3. CORPORATE TAX RATE:

Ms Cohen took 38% as the corporate tax rate that would be used to adjust cost of debt. Our group thought this is not correct...
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