CASE STUDY AND EXCEL !
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NikeCaseStudypowerpoint.pptxNike Case Study
By; Nour Abdulaziz,
Maryam Barifah,
Shrouq Al-Jaaidi
Balquis Mekhlafi
Introduction
A north point portfolio manager named kimi ford is trying to decide whether to buy Nike's stock or not.
Nike the previous year had a very negative year which lead to;
Severe decline in sales growth
Decline in profits
Decline in market share.
A meeting was held to look at different strategies where nike can boost revenues;
Additional exposure in mid-price footwear and apparel line
Trying to control expenses even more
Ford created her own Discounted cash flow forecast to get a clearer conclusion
Joanna Cohen her assistant helped in estimating the cost of capital
What is WACC and why is it important to estimate a firm’s cost of capital?
WACC stands for Weighted Average Cost of Capital.
It measure the cost individual sources of Capital invested in a company.
It is an important tool as it aids investors to make a decision to invest in a certain company or not.
What does it represent?
WACC represents the minimum rate of return by which a company can produce value to its investors.
Example: if a company produces 25% of Return and has a WACC of 10%, it is able to produce a value of 15 cents per dollar invested in capital.
WACC is set by investors and not managers. It is usually estimated.
Do you agree with Joanna Cohen’s WACC calculation? Why or why not?
No we don’t agree with Cohen’s Weighted Average Cost of Capital for these reasons:
Weights of debt and equity are calculated using book value not market value.
Book value is the price paid for an asset that will never change as long as you own that asset.
Market value is based on current data
The reason behind this decision is it shows how much it will cost the firm to raise the capital today.
Cont.
therefore Cohen’s cost of debt calculation which was done by taking the total interest expense for 2001 and dividing it by the company’s average debt balance is wrong.
She should have instead calculated the yield to maturity on a 20-year debt basis with a coupon rate that is paid semiannually.
Another error that was done was using the average beta (from 1996-2001), which is 0.80,
this number doesn’t represent the future systematic risk, so it is better to use the most recent beta (0.69)
calculate your own WACC for Nike and justify your assumptions?
Cont.
Cont.
Calculate the costs of equity using CAPM, the dividend discount model, and the earnings capitalization ratio. What are the advantages and disadvantages of each method?
Cost of Equity RE :-
Using Dividend Discount Model (DDM)
RE = D1/P0 + g D1 = D0 (1+g)
D0 = 0.48; g = 5.5%
D1 = 0.48 x (1+ 0.055)= 0.5064
P0 = 42.09
RE= D1/P0 + g = 0.5064/42.09 + 5.5%= 6.70%
Based on the above calculations, we can see that after June 30, 2001 the company did not pay any dividends to its shareholders, so this model (DDM) is not useful since it doesn’t reflect the intrinsic cost of capital.
Cont.
Advantages of this model;
There is a flexibility in forecasting the future dividends.
It assists in the approximations, no matter the impact of the inputs.
Helps in sensitivity analysis and analysis of markets variations to changing situations
Method is very simple.
Disadvantages of this model;
The model is not suitable to use in many cases since it will result in inaccurate answers.
High sensitivity to minor variations in the inputs of the models and assumptions
The model assumes that the company pays substantial dividends that will grow at a constant rate.
It carries no consideration for systematic risk.
b. Using Earning Capitalization Model
ECM= E1 / P0 = 2.16 / 42.09 = 5.13%
E1: forecasted earnings, current diluted earnings per share
P0: stock price today.
This model is not recommended due to that that it ignores the potential growth of the firm.
Cont.
Advantages of this model;
It helps in predicting the earnings
It carries consideration for the forecasted earnings and the current price of the stock.
Disadvantages of this model;
t ignores the growth of the company
This model is not appropriate for the firms with no growth
The estimates may not be accurate
It has errors in the current capitalization rate.
c. Using Capital Asset Pricing Model(CAPM) to calculate RE:
RE = RRF + (RM – RRF) x Beta
→RE =5.74% + 5.9% x 0.69 = 9.811%
The model is the recommended way to calculate the cost of equity for Nike Inc., as it is very simple to apply, an addition to that it includes the most important variables for instance Beta (systematic risk), risk free rate and also market return.
Cont.
Advantages of this model;
Simple
Applied in practice
Adjusts for risk
Can be used by companies that do not have steady dividend growth
Disadvantages of this model;
Unrealistic assumptions specially in estimations of risk free rate
Sometimes it fails in explaining the behaviors of the investors and the used beta will not be successful in capturing the risk of investment
Difficult to validity
Predicts future based on past (there is change in economic conditions)
It is important to consider the market value, book values ratios, as it is highly relevant to return.
What should Kimi Ford recommend regarding an investment in Nike?
the CALCULATED WACC = 9.27%
present VALUE = $58.13 (15,782.295/271.5)
This shows that the present value is higher by 1.38 times than Nike’s current market price of $42.09.
The shares price of Nike is undervalued by $16.04 (58.13-42.09)
current GOWTH RATE IS 6 TO 7% LOWER THAN THE WACC OF 9.27%
cont.
Nike Changed their business technique by focusing in mid-priced segment, which for a long time was less concentrated.
This means that there is a possibility for their sales total to increase that that will lead to an increase in revenues and profit.
In addition to this Nike’s share prices and dividend will be increased in the long-term.
recommendation
we recommend to the North Point Large-Cap Fund to buy Nike’s shares, because the stock is currently undervalued and it has a major growth potential
the goals that were set by the management of Nike Inc. could be a great source of profit
the past performance of Nike Inc. shares against the market index, technical analysis supports the buy decision.
The past performance shows that Nike can out preform the current market returns
now that it has gone down,
it is left with the hope for an increase based on the plans being set up.
Conclusion
before buying Nike Inc. shares, Kimi Ford must decide whether she wants the shares for long or short term. If it is for the long-term, then the decision to invest is a good one and if it is for the short-term she should be cautious about the fast changing industry the changes that Nike is doing and also changes in the footwear trends. However, based on historical, recent and future data the decision that Kimi should consider that is to buy Nike’s shares for the reason that it is quite safe, currently undervalued and has great potential.
