Revised Analysis of Nike and Its Investment Potential

[pic 1][pic 2][pic 3]

[pic 4][pic 5]

To: Kimi Ford

From: Team 313

RE: Revised analysis of Nike and its investment potential

Problem

Determine whether NorthPoint Group’s Large-Cap Fund should invest in Nike.  

Recommendation

Our conclusion, is you should invest in Nike as its current stock price is $42.09, and we have valued the stock price at a value of $58.13 (Appendix 3) meaning the stock price is undervalued. The value of its stock price is based on the following:

• We agree with Joanna’s use of a single cost of capital, as the bulk of Nike’s revenue comes from sports-related business
• Having looked at various models of cost of equity, we agree with Joanna that the CAPM model is the most appropriate
• We disagree with the cost of debt used and instead calculated it based on Nike’s bond yield
• To calculate the weights for WACC we should use market value of equity instead of the book value
• From our analysis our cost of capital is 9.27% (Appendix 2).

Analysis

Single or Multiple Cost of Capital

We do agree with Cohen’s decision to use a single WACC because the other divisions of Nike’s business are small relative to sports-related businesses. In addition, we do not have enough information to figure out separate growth rates of shoes and apparel, therefore a single rate is the best option in this analysis.

Cost of Debt

Cohen used a low cost of debt 4.30%, which is interest expense over average debt balance. However, we estimate a cost of debt of 7.16% (Appendix 5). Cost of debt should be based on current costs to raise debt. By using the Yield to Maturity (YTM) of the bonds issued by Nike we would get a more accurate cost of debt. Also, we assumed that the tax rate to be used for debt should be 38% as the U.S statutory tax rate was 35% and state tax varied yearly between 2.5% - 3.5%.

Costs of Equity

We calculated Nike’s cost of equity using the CAPM, the Dividend Discount Model, and the Earnings Capitalization Ratio.

Capital Asset Pricing Model (CAPM):

Nike’s cost of equity using CAPM is 9.81% (Appendix 1). The advantage of using CAPM is that it incorporates systematic risk, which is left out in other models. The CAPM is also good to use because we are an investment firm with a lot of different types of investments. This means our unsystematic risk is low and therefore we should account for systematic risk. The CAPM model also relates Nike’s valuation to the risk-free rate of the market which is helpful in investment decisions. However, because the beta fluctuates from 0.98 in 1996 to 0.69 YTD, it is hard to determine an appropriate proxy. We used the beta value of 0.69 because over time companies typically become more stable and less impacted by the market, so it is more accurate to use the most recent beta value. Since treasury bill yields change daily we used the 20-year treasury bill value of 5.74% for our risk-free rate to be conservative in our evaluation.