Nike Executive Summary
Kimi Ford manages a large mutual fund for NorthPoint Group. Her company is trying to decide whether or not to invest in Nike’s stock, which has been declining in price in the past year. Kimi has asked her assistant, Joanna Cohen, to estimate Nike’s weight average cost of capital (WACC) to help make this decision (Case 13, pg. 58). We looked at Joanna’s estimates and discovered a few problems that she made when estimating her cost of capital.
We found Joanna’s estimates to be wrong because of a few reasons. The first mistake she made was using the average beta instead of the most recent beta provided. She was using average of Nike’s beta from 1996 to the present, which was .80 (Case 13, pg. 59). We used the beta of .69, which was the most recent beta provided to us. The second mistake we found was that she used the book value of debt instead of the market value of debt. The book value was $441.30 and the market value was $421.88 so she overstated debt by $19.42 (Exhibit 6).
To find Nike’s cost of debt, we used three different methods: the Capital Asset Pricing Model (CAPM) (Exhibit 7), the Dividend Discount Model (DDM) (Exhibit 5), and the Earnings Capitalization Model (ECM) (Exhibit 8). We decided that the CAPM gave us the most accurate estimate of Nike’s cost of debt, and we used that in arriving at our before-tax cost of debt of 7.173% and our final after-tax cost of debt of 4.447% (Exhibit 6). To find our WACC, we used the market value of equity and debt to determine our weights of equity and debt. Our weight of equity is 89.947% and our weight of debt is 10.053%. Using the above numbers, we calculated a WACC of 7.338% (Exhibit 9).
After discounting Nike’s cash flows using the WACC value we calculated, we believe that Nike is undervalued by $2.51 per share of stock. Also, Nike’s terminal value of cash flows is greater than the equity value of the firm. (Exhibit 3). We think that they should invest because the price of...
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