1. What is the WACC and why is it important to estimate a firms cost of capital? Do you agree with Joanna Cohens WACC calculation? Why or why not?

2. If you do not agree with Cohens analysis, calculate your own WACC for Nike and be prepared to justify your assumptions.

3. 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? What should Kimi Ford recommend regarding an investment in Nike?

CASE 15 Nike, Inc.: Cost of Capital 10.1% On July 5, 2001, Kiri Ford, a portfolio manager at NorthPoint Group, a mulual-Tund management fim, pored over analysts' write-ups of Nike. Inc.. the athletic-shoe man- ulacturer. Nike's share price had declined signilicantly from the beginning of the year, Ford was considering buying some shares for the fund she managed, the NorthPoint Large-Cap Fund, which invested mostly in Fortune 500 companies, with an emphasis on value investing. Its top holdings included ExxonMobil, General Motors. McDonald's. 3M. and other larye-cap, generally oll-ecovny sexks. While the stock market had declined over the last 18 months, the Northloint Large-Cap Fund had performed extremely well. In 2000, the fundamed a relum of 20.7%, even as the S&P 500 fell Att t the end of June 2001, the fund's year-to-date returns stood at 1.4% versus -7.3% for the S&P 500. Only a week earlier, on June 28, 2(X)1. Nike had held an analysts' meeting to dis- close ils fiscal-yeur 2001 results.' The meeting. However, had another purpose: Niku management wanted communicate a strategy for revitalizing the company. Since 1997, ils revenues bud plateaued at around $9 billion, while net income had fallen from almost $800 million to $580 million (see Exhibit 1). Nike's market share in U.S. athletic shocs bad fallen from 48% in 1997. to 42% in 2000. In addition, recent supply-chain issues and the adverse effect of a strong dollar had negatively allected revenue A1 the meeting, management revealed plans 10 address Inch Lop-line growth and opcrating performance. To boost revenue, the company would develop more athletic- shue products in the midpriced segmenta segment that Nike had overlooked i years. Nike also planned to push its apparel linc, which, under the recent leadership of l'ecent Nike's Liscal year ended i. Muy. *Douglas Robson. "Just Do... Something: Nike's insularity and Foot-Dragging Have Ir Running in Place." Businessleek, (2 July 2001). S-Leakers in this wyrun sol for S7 90 air. This case was prepared frora publicly available information by Jessica Chan, under the supervision of Robert E. Bruner and with the assistance of Scan D. Carr. The financial support of the Barten Institute is gratefully ackouwledged. It was write as a basis for class etiscussion zilber thui lu illu situle effective ur inelective bandling of an imioistulive situativo. Copyrigtu 2001 by lee Loiversity of Virginiu Dacien Schwol foundation, Charlottesville, VA. All riglus resevw. To order copies, send an e-mail to suk: durden businesspublishing.com. Nu purt of this publication may be reproduced, wond in a retrieval system. used in o spreadster, or trased in any form or by care consectronic mechanical, potocopying recording, or olierisewithout live permission of die Durdon School locomotion ker 100s. 235 11 Three Estimating the cost of capital industry veteran Mindy Grossman, had performed extremely well. On the cost side, Nike would cxert mon cflott on expense control. Finally, voinpany executivos fciler- ated their long-term revenue-growth targets of 8 to 10% and earnings-growth targets of above 15% Analysts' reactions were mixed. Some thought the financial targets were too aggressive, others saw significant growth opportunities in apparel and in Nike's inter- national businesses. Kimi Ford read all the analysts' reports that she could find about the Junc 28 meeling, but the reports gave her no clear guidance: a Lehman Brothers report rec- ommended strong buy, while UBS Wwwburg and CSFB analysts expressed misgiv- ings about the company and recommenced a hold. Ford decided instead to develop her own discounted cash flow forecast to come to a clarer conclusion. ller forecast showed that, at a discount rale of 12%, Nike was overvalued at its curent share price of 542.09 (Exhibit 2). However, she had done a quick sensitivity analysis that revealed Nike was undervised al discount rates below 11.17%. Because she was about to go into a meeting, she asked her new assistant, Joanna Cohen, to estimate Nike's cost of capital. Cohen immediately gathered all the data she thought she might need (Exhibits 1 through 4) and began to work on her analysis. At the end of the day, Cohen submit ted her cost-of-capital estimate and a memo (Exhibit 5) explaining her assumptions to l'ord. Mickly Gussrun colored Nike in September 2000. She was the former president and chicl executive of Jones Apparel Group's lulu Jesus division Case Is Nine, Tc. Cost of Capital 237 EXHIBIT 1 | Consolidated Income Statoments Year Ended May 31 (in millions of dollars except per-share data) 1995 1996 1997 1998 1999 2000 2001 59,553.1 6.065.5 58,776.9 5,493.5 54,760.8 2.865.3 1,895.6 1,209.8 685.8 24.2 11.7 $6.170.6 $9.186.5 3,906.7 5.503.0 2,563.9 3,683.5 1,588.6 2.303.7 975.3 1,379.8 39.5 52.3 36.7 32.3 $8.995.1 5.4038 3.591.3 2,606.4 3,487.6 2.623.8 863.8 60.0 20.9 129.9 653.0 259.4 S 399.6 3.283.4 2.126.6 855.8 44.1 21.5 45.1 746.1 294.7 $ 451.4 59,488.8 5,784.9 3,703.9 2,689.7 1,014.2 58.7 34.1 984.9 45.0 23.2 (2.5) 919.2 340.1 $ 579.1 649.9 899.1 2502 345.9 S 399.7 $ 553.2 1,295.2 499.4 S 795.8 921.4 331.7 S 589.7 Revenues Coat of goods sold Gross profit Selling and administrative Operating Income Interest exponsa Other expense, net Restructuring charge, net Income before income taxes Income taxes Net income Dilutoo carnings per comman share Average shares outstanding (diluted) Growth (%) Povonuc Operating income Net income Margins (%) G'oss margin Oporating margin Nel margin Effeclive lax rate (9) $1.36 $1.88 $2.68 $1.35 $1.57 $2.07 $2.16 2940 293.6 2970 296.0 287.5 279.8 273.3 35.9 422 38.4 42.0 41.5 43.9 4.0 (374) (49.8) (8.1) (0.8) 13.0 2.5 15.0 28.3 5.5 30 1.8 39.6 15.1 9.5 40.1 15.0 38.5 9.0 4.2 37.4 9.3 5.1 39.9 10.9 6.4 39.0 10.7 6.2 38.5 38.6 38.8 39.5 37.0 36.0 The U.S. Statutory lax rate was 25%. Tre state tax varied yearly fror 2.5% to 3.5% Sources of data: Company filing with the Securities and Exchange Commission (SEC), UBS Warburs. 238 Pun Three Llinating the Cost of Cup EXHIBIT 2 | Discounted Cash Flow Analysis 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Assumptions: Aevenue growth We COSS'salos 1 SG&A'sales (%) Tax rate (?) Current assets/salos (%) Gureri liabilities ales ) Yearly depreciullor und Capo qualcach other Cost of capital Terminal value growth rale ) 7.0 600 28.0 38.0 38.0 115 6.5 60.0 27.5 38.0 38.0 11.5 0.5 595 27.0 380 38.0 11.5 6.5 595 26.5 38.0 38.0 - 1.5 6.0 50.0 26.0 38.0 38.0 - 1.5 5.0 59.0 25.5 39.0 35.0 6.0 58.5 25.0 38.0 38.0 11.5 6.0 58.5 25.0 38.0 38.0 11.5 6.0 580 250 38.0 38.0 11.5 58.0 25.0 38.0 38.0 11.5 12.00 3.00 Discounted Cash Flow lin rrillions of dollars except por share cata) Operating income $ 1218,4 51,366 $1,5546 $1,7170 $ 9500 $2.135.9 $2,410.2 S2,564.8 12.790.- 12.9575 Taxes 463.0 5.3.6 590.8 6525 721.0 811.7 915.9 970.8 1,0602 1.123.9 NCIPAT 755.4 3.0 963.9 1,064.5 1.209.0 1.224.3 1.494.2 ..564.0 1,729.9 1.A2.7 Capex.net of cecreciation Change in NWC B.& 1174.9) 1186.8) (1984) (195.0) (205.7! (205.7! 219.1) (232.9) (246.2) (261.0) Free cash flow 761.1 063.1 777.6 8662 1.014.0 1,014.0 1.117.6 1,275.2 1,361.7 1,183.7 1.572.7 Terminal value 17.998.3 Total flows 764.1 663.1 777.6 8662 1,014.0 1.117.6 1.275.2 1,361.7 1,483.7 19.571.0 Presort value of fions $ 6823 $528.6 $ 553.5 $ 550,5 $ 575.4 $ 566.2 $ 576.8 $ 545.9 $ 535.0 16.301.2 Enterprise value $11.4151 Lese: current outstanding debt $ 1.295.6 Equity value $10.118.8 Curre-t shares Outstanding 27-5 Equity value per share S 37.27 Current share price 5 42.09 Sensitivity of equity value to discount rate: Discount rate Equity value 8.00% & 75.00 8.50% 67.86 9.00% 6.25 9.00 9.50% 65.68 10.00 -50..92 10.50 -15.81 11.00 43.72 11.17% 42.09 11.50 40.07 12.DDY 37.27 Source: Caso writor's analysis Ca 15 Nikr, The Case of Capital 2.39 EXHIBIT 3 | Consolidated Balance Sheels As of May 31, (in millions of dollars) 2000 2001 $ 251.3 1,569.4 1.446.0 111.5 215.2 3,596.4 1,583.4 410.9 266.2 $ 5,856.9 $ 301.0 1,821,4 1,424.1 113.3 162.5 3,625.3 1,818.8 397.3 178.2 $ 5,819.6 $ Assets Current assels: Cash and equivalents Accounts receivable Inventorios Dolerrec income laxos Prepaid expenses Total current assets Properly. plant and equipment, nel Identifiable inlangible assels and goodwill, nel Deferred income taxes and other assets Total assets Llabilities and shareholders' equity Current liabilities: Current porlion of long-term cebi Notos payable Accounts payable Accrued liabilities Income taxes payable Total current liabilities Long-lo'm dobt Dolor ed income laxes and other liabilities Redeemable preferred stock Shareholde s'equity: Common stock, par Capital in excess ol slalod value Unea'nod slock componsalion Accumulaled other comprehensive income Retained carnings Total shareholders' equity Total liabilities and shareholders' equity 50.1 924.2 543.8 621.9 5.4 355.3 432.0 472.1 21.9 1.786.7 2,140.0 470.3 110.3 0.3 435.9 102.2 0.3 2.8 369.0 (11.7) (111.11 2.887.0 3,136.0 $ 5,856.9 2.8 459.4 (9.9) (152.1) 3,194.3 3,494 5 $ 5.819.6 Source of data: Company filing with the Securities and Exc-ange Commission (SEO) EXHIBIT 4 | Capital Market and Financial Information On or Around July 5, 2001 Nike Share Price Perlormance Relative lo S&P500: January 2000 to July 5 2001 Current Yields on U.S. Treasuries 3-month 3.59% 6-month 3.59% 1 -year 3.599 5-year 4.83% 10-year 5.3994 20-year 5.74% N. sar 533 mm Historical Equity Risk Premiums (1926-1999) Geometric mean 5.90% Arithmctic mcan 7.50% 0.9 Current Yield on Publicly Traded Nike Debt Coupon 6.75%: paio semi-annually Issues 07/15/98 Malurity 07/15/21 Current Price $95.60 0.7 Nike Historic Betas 1996 1997 1998 1999 2000 YTD 6/30/01 0.4 0.98 0.84 0.81 1.63 0.83 0.69 100 Bap.co Now-co Jan-1 Mar 01 Amy-01 Julci Nike share price on July 5, 2001: $ 42.09 Dividend History and Forecasts Payment Dates 31-Ma 80-Jur Average 0.80 30-9 Consensus EPS estimates: FY 2002 FY 2003 $2.32 S2.67 1997 1998 1999 2000 2001 0.10 0.12 0.12 0.12 0.12 0.10 0.12 0.12 0.12 0.12 0.10 0.12 0.12 0.12 81-De 0.10 0.12 0.12 0.12 0.40 0.48 0.48 0.48 Value Line Forecast of Dividend Growth from '98-'00 to '04-'06: 5.50% Data have been mod tied for teaching purposes. Sources of data: Boo Tiberg Financial Services, bbotson Associates Yearbook 1999. Value Line Investment Survey. BES. Case IS Nise. The Color Capital 7:41 EXHIBIT 5 Joanna Cohen's Analysis TO FROM: DATE SUBJECT: Kimi Ford Joanna Cohen July 6, 2001 Nike's cost of capital Based on the following assumplions, my eslimale or Nike's cost of capital is 8.4% 1. Single or Multiple Costs of Capital? The first question thall considered was whether to use single or multiple cosis ol capital, given thal Nike has mulliple business segments. Aside from foolwear, which makes up 82% of ils revenue, Nike also sells apparel (30% of revenuc) that complements its footwea' products. In addition, Niko sells sport balls, timepieces. cyc- wear, skates. bats, and othecquipment designed for sports activities. Equipment products account for 3.6% of its revenue. Finally, Niko also sells somo non-Nike-branded products such as Cole Haan dress and casual footwear, and ice skates, skate blades, hockey sticks, hockey jerseys, and other products under the Bauer trademark. Non-Nike brands accounteo for 4.5% of revenue I asked myself whether Nike's business segments had different enough risks from each other to warrant cifferent costs of capital. Were their profiles really cifferent? I concluded that it was only the Cole Haan line that was somewhat different the rest were all sporls-related businesses. Since Cole Haan makes up only a tiny fraction of ovenuos, however, I oic not think that it was necessary to compulo a sopa ale cost of capital. As fo' the apparel and foolwoar lines. They are solo through the same marketing and distribution channels and are often ma keteo in other collections of similar designs. Since I believe they face the same risk factors, I decideo to compute only one cost of capital for the whole company. II. Methodology for Calculating the Cost of Capital: WACC Since Nike is funded with both debt and equity, I usco the WACC methoo (weighted average cost of capital). Based on the latest available balance sheet, debt as a propo tion of total capital makes up 27.0% and equity accounts for 73.0%s: Capilal Sources Book Valuos (in millions) Debt Current portion of long-term debt $ 5.4 Notes payable 855.3 Long-term nabt 435.9 $1,296.6 27.0% of total capital Equity $3,494.5 73.0% of total capital III. Cost of Debt My estimate of Nike's cost of debt is 4.3%. I arrived at this estimate by taking total interest expense for the year 2001 and dividing il by the company's average debl balance. The ralo is lower than Treasury yields, but thalis because Nike raised a po tion of its funding needs through Japanese yen notes, which carry ales between 2.0% and 4.3%. After acusting for tax, the cost of debt comes out to 2.7%. I used a tax rale af 38%, which I obtained by adding state taxes of 3%: to the U.S. statutory tax rate. Historically Nike's alate taxes have ranged from 2.5% lO 3.5%. 'Debt balances as of May 31, 2000 and 2001, wcro S1,444.6 million and $1,2966 million, rescxcctively 242 Pia Tbzee Labmwling the cost of Cuplu EXHIBIT 5 | (continued) IV. Cost of Equity Teslimaled the cost of equily using the capilal-assel-pricing model (CAPM). Olher melhods, such as the divicenc-discounl model (DDM) and the earnings-capilalization ralio, can be used lo estimale the cost of equily. In my opinion, hovicver, the CAPM is the superior methoo. My estimate of Nike's coat of equity is 10.5%. I used the current yield on 20-yea Treasury hands as my riak-free rate, and the compound average p'emium of the market over Treasury bonds (5.9%) as my risk pre- mium. For beta, I took the average of Nike's hear from 1996 to the present. Putting It All Together Inputting all my assumptions into the WACC formula, my estimate of Nike's cost of capital is 8.4%. WACC = K 1 - L) X DXD - E) + K: XE/D 2.79 X 27.0% - 10.5% x 73.0% CASE 15 Nike, Inc.: Cost of Capital 10.1% On July 5, 2001, Kiri Ford, a portfolio manager at NorthPoint Group, a mulual-Tund management fim, pored over analysts' write-ups of Nike. Inc.. the athletic-shoe man- ulacturer. Nike's share price had declined signilicantly from the beginning of the year, Ford was considering buying some shares for the fund she managed, the NorthPoint Large-Cap Fund, which invested mostly in Fortune 500 companies, with an emphasis on value investing. Its top holdings included ExxonMobil, General Motors. McDonald's. 3M. and other larye-cap, generally oll-ecovny sexks. While the stock market had declined over the last 18 months, the Northloint Large-Cap Fund had performed extremely well. In 2000, the fundamed a relum of 20.7%, even as the S&P 500 fell Att t the end of June 2001, the fund's year-to-date returns stood at 1.4% versus -7.3% for the S&P 500. Only a week earlier, on June 28, 2(X)1. Nike had held an analysts' meeting to dis- close ils fiscal-yeur 2001 results.' The meeting. However, had another purpose: Niku management wanted communicate a strategy for revitalizing the company. Since 1997, ils revenues bud plateaued at around $9 billion, while net income had fallen from almost $800 million to $580 million (see Exhibit 1). Nike's market share in U.S. athletic shocs bad fallen from 48% in 1997. to 42% in 2000. In addition, recent supply-chain issues and the adverse effect of a strong dollar had negatively allected revenue A1 the meeting, management revealed plans 10 address Inch Lop-line growth and opcrating performance. To boost revenue, the company would develop more athletic- shue products in the midpriced segmenta segment that Nike had overlooked i years. Nike also planned to push its apparel linc, which, under the recent leadership of l'ecent Nike's Liscal year ended i. Muy. *Douglas Robson. "Just Do... Something: Nike's insularity and Foot-Dragging Have Ir Running in Place." Businessleek, (2 July 2001). S-Leakers in this wyrun sol for S7 90 air. This case was prepared frora publicly available information by Jessica Chan, under the supervision of Robert E. Bruner and with the assistance of Scan D. Carr. The financial support of the Barten Institute is gratefully ackouwledged. It was write as a basis for class etiscussion zilber thui lu illu situle effective ur inelective bandling of an imioistulive situativo. Copyrigtu 2001 by lee Loiversity of Virginiu Dacien Schwol foundation, Charlottesville, VA. All riglus resevw. To order copies, send an e-mail to suk: durden businesspublishing.com. Nu purt of this publication may be reproduced, wond in a retrieval system. used in o spreadster, or trased in any form or by care consectronic mechanical, potocopying recording, or olierisewithout live permission of die Durdon School locomotion ker 100s. 235 11 Three Estimating the cost of capital industry veteran Mindy Grossman, had performed extremely well. On the cost side, Nike would cxert mon cflott on expense control. Finally, voinpany executivos fciler- ated their long-term revenue-growth targets of 8 to 10% and earnings-growth targets of above 15% Analysts' reactions were mixed. Some thought the financial targets were too aggressive, others saw significant growth opportunities in apparel and in Nike's inter- national businesses. Kimi Ford read all the analysts' reports that she could find about the Junc 28 meeling, but the reports gave her no clear guidance: a Lehman Brothers report rec- ommended strong buy, while UBS Wwwburg and CSFB analysts expressed misgiv- ings about the company and recommenced a hold. Ford decided instead to develop her own discounted cash flow forecast to come to a clarer conclusion. ller forecast showed that, at a discount rale of 12%, Nike was overvalued at its curent share price of 542.09 (Exhibit 2). However, she had done a quick sensitivity analysis that revealed Nike was undervised al discount rates below 11.17%. Because she was about to go into a meeting, she asked her new assistant, Joanna Cohen, to estimate Nike's cost of capital. Cohen immediately gathered all the data she thought she might need (Exhibits 1 through 4) and began to work on her analysis. At the end of the day, Cohen submit ted her cost-of-capital estimate and a memo (Exhibit 5) explaining her assumptions to l'ord. Mickly Gussrun colored Nike in September 2000. She was the former president and chicl executive of Jones Apparel Group's lulu Jesus division Case Is Nine, Tc. Cost of Capital 237 EXHIBIT 1 | Consolidated Income Statoments Year Ended May 31 (in millions of dollars except per-share data) 1995 1996 1997 1998 1999 2000 2001 59,553.1 6.065.5 58,776.9 5,493.5 54,760.8 2.865.3 1,895.6 1,209.8 685.8 24.2 11.7 $6.170.6 $9.186.5 3,906.7 5.503.0 2,563.9 3,683.5 1,588.6 2.303.7 975.3 1,379.8 39.5 52.3 36.7 32.3 $8.995.1 5.4038 3.591.3 2,606.4 3,487.6 2.623.8 863.8 60.0 20.9 129.9 653.0 259.4 S 399.6 3.283.4 2.126.6 855.8 44.1 21.5 45.1 746.1 294.7 $ 451.4 59,488.8 5,784.9 3,703.9 2,689.7 1,014.2 58.7 34.1 984.9 45.0 23.2 (2.5) 919.2 340.1 $ 579.1 649.9 899.1 2502 345.9 S 399.7 $ 553.2 1,295.2 499.4 S 795.8 921.4 331.7 S 589.7 Revenues Coat of goods sold Gross profit Selling and administrative Operating Income Interest exponsa Other expense, net Restructuring charge, net Income before income taxes Income taxes Net income Dilutoo carnings per comman share Average shares outstanding (diluted) Growth (%) Povonuc Operating income Net income Margins (%) G'oss margin Oporating margin Nel margin Effeclive lax rate (9) $1.36 $1.88 $2.68 $1.35 $1.57 $2.07 $2.16 2940 293.6 2970 296.0 287.5 279.8 273.3 35.9 422 38.4 42.0 41.5 43.9 4.0 (374) (49.8) (8.1) (0.8) 13.0 2.5 15.0 28.3 5.5 30 1.8 39.6 15.1 9.5 40.1 15.0 38.5 9.0 4.2 37.4 9.3 5.1 39.9 10.9 6.4 39.0 10.7 6.2 38.5 38.6 38.8 39.5 37.0 36.0 The U.S. Statutory lax rate was 25%. Tre state tax varied yearly fror 2.5% to 3.5% Sources of data: Company filing with the Securities and Exchange Commission (SEC), UBS Warburs. 238 Pun Three Llinating the Cost of Cup EXHIBIT 2 | Discounted Cash Flow Analysis 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Assumptions: Aevenue growth We COSS'salos 1 SG&A'sales (%) Tax rate (?) Current assets/salos (%) Gureri liabilities ales ) Yearly depreciullor und Capo qualcach other Cost of capital Terminal value growth rale ) 7.0 600 28.0 38.0 38.0 115 6.5 60.0 27.5 38.0 38.0 11.5 0.5 595 27.0 380 38.0 11.5 6.5 595 26.5 38.0 38.0 - 1.5 6.0 50.0 26.0 38.0 38.0 - 1.5 5.0 59.0 25.5 39.0 35.0 6.0 58.5 25.0 38.0 38.0 11.5 6.0 58.5 25.0 38.0 38.0 11.5 6.0 580 250 38.0 38.0 11.5 58.0 25.0 38.0 38.0 11.5 12.00 3.00 Discounted Cash Flow lin rrillions of dollars except por share cata) Operating income $ 1218,4 51,366 $1,5546 $1,7170 $ 9500 $2.135.9 $2,410.2 S2,564.8 12.790.- 12.9575 Taxes 463.0 5.3.6 590.8 6525 721.0 811.7 915.9 970.8 1,0602 1.123.9 NCIPAT 755.4 3.0 963.9 1,064.5 1.209.0 1.224.3 1.494.2 ..564.0 1,729.9 1.A2.7 Capex.net of cecreciation Change in NWC B.& 1174.9) 1186.8) (1984) (195.0) (205.7! (205.7! 219.1) (232.9) (246.2) (261.0) Free cash flow 761.1 063.1 777.6 8662 1.014.0 1,014.0 1.117.6 1,275.2 1,361.7 1,183.7 1.572.7 Terminal value 17.998.3 Total flows 764.1 663.1 777.6 8662 1,014.0 1.117.6 1.275.2 1,361.7 1,483.7 19.571.0 Presort value of fions $ 6823 $528.6 $ 553.5 $ 550,5 $ 575.4 $ 566.2 $ 576.8 $ 545.9 $ 535.0 16.301.2 Enterprise value $11.4151 Lese: current outstanding debt $ 1.295.6 Equity value $10.118.8 Curre-t shares Outstanding 27-5 Equity value per share S 37.27 Current share price 5 42.09 Sensitivity of equity value to discount rate: Discount rate Equity value 8.00% & 75.00 8.50% 67.86 9.00% 6.25 9.00 9.50% 65.68 10.00 -50..92 10.50 -15.81 11.00 43.72 11.17% 42.09 11.50 40.07 12.DDY 37.27 Source: Caso writor's analysis Ca 15 Nikr, The Case of Capital 2.39 EXHIBIT 3 | Consolidated Balance Sheels As of May 31, (in millions of dollars) 2000 2001 $ 251.3 1,569.4 1.446.0 111.5 215.2 3,596.4 1,583.4 410.9 266.2 $ 5,856.9 $ 301.0 1,821,4 1,424.1 113.3 162.5 3,625.3 1,818.8 397.3 178.2 $ 5,819.6 $ Assets Current assels: Cash and equivalents Accounts receivable Inventorios Dolerrec income laxos Prepaid expenses Total current assets Properly. plant and equipment, nel Identifiable inlangible assels and goodwill, nel Deferred income taxes and other assets Total assets Llabilities and shareholders' equity Current liabilities: Current porlion of long-term cebi Notos payable Accounts payable Accrued liabilities Income taxes payable Total current liabilities Long-lo'm dobt Dolor ed income laxes and other liabilities Redeemable preferred stock Shareholde s'equity: Common stock, par Capital in excess ol slalod value Unea'nod slock componsalion Accumulaled other comprehensive income Retained carnings Total shareholders' equity Total liabilities and shareholders' equity 50.1 924.2 543.8 621.9 5.4 355.3 432.0 472.1 21.9 1.786.7 2,140.0 470.3 110.3 0.3 435.9 102.2 0.3 2.8 369.0 (11.7) (111.11 2.887.0 3,136.0 $ 5,856.9 2.8 459.4 (9.9) (152.1) 3,194.3 3,494 5 $ 5.819.6 Source of data: Company filing with the Securities and Exc-ange Commission (SEO) EXHIBIT 4 | Capital Market and Financial Information On or Around July 5, 2001 Nike Share Price Perlormance Relative lo S&P500: January 2000 to July 5 2001 Current Yields on U.S. Treasuries 3-month 3.59% 6-month 3.59% 1 -year 3.599 5-year 4.83% 10-year 5.3994 20-year 5.74% N. sar 533 mm Historical Equity Risk Premiums (1926-1999) Geometric mean 5.90% Arithmctic mcan 7.50% 0.9 Current Yield on Publicly Traded Nike Debt Coupon 6.75%: paio semi-annually Issues 07/15/98 Malurity 07/15/21 Current Price $95.60 0.7 Nike Historic Betas 1996 1997 1998 1999 2000 YTD 6/30/01 0.4 0.98 0.84 0.81 1.63 0.83 0.69 100 Bap.co Now-co Jan-1 Mar 01 Amy-01 Julci Nike share price on July 5, 2001: $ 42.09 Dividend History and Forecasts Payment Dates 31-Ma 80-Jur Average 0.80 30-9 Consensus EPS estimates: FY 2002 FY 2003 $2.32 S2.67 1997 1998 1999 2000 2001 0.10 0.12 0.12 0.12 0.12 0.10 0.12 0.12 0.12 0.12 0.10 0.12 0.12 0.12 81-De 0.10 0.12 0.12 0.12 0.40 0.48 0.48 0.48 Value Line Forecast of Dividend Growth from '98-'00 to '04-'06: 5.50% Data have been mod tied for teaching purposes. Sources of data: Boo Tiberg Financial Services, bbotson Associates Yearbook 1999. Value Line Investment Survey. BES. Case IS Nise. The Color Capital 7:41 EXHIBIT 5 Joanna Cohen's Analysis TO FROM: DATE SUBJECT: Kimi Ford Joanna Cohen July 6, 2001 Nike's cost of capital Based on the following assumplions, my eslimale or Nike's cost of capital is 8.4% 1. Single or Multiple Costs of Capital? The first question thall considered was whether to use single or multiple cosis ol capital, given thal Nike has mulliple business segments. Aside from foolwear, which makes up 82% of ils revenue, Nike also sells apparel (30% of revenuc) that complements its footwea' products. In addition, Niko sells sport balls, timepieces. cyc- wear, skates. bats, and othecquipment designed for sports activities. Equipment products account for 3.6% of its revenue. Finally, Niko also sells somo non-Nike-branded products such as Cole Haan dress and casual footwear, and ice skates, skate blades, hockey sticks, hockey jerseys, and other products under the Bauer trademark. Non-Nike brands accounteo for 4.5% of revenue I asked myself whether Nike's business segments had different enough risks from each other to warrant cifferent costs of capital. Were their profiles really cifferent? I concluded that it was only the Cole Haan line that was somewhat different the rest were all sporls-related businesses. Since Cole Haan makes up only a tiny fraction of ovenuos, however, I oic not think that it was necessary to compulo a sopa ale cost of capital. As fo' the apparel and foolwoar lines. They are solo through the same marketing and distribution channels and are often ma keteo in other collections of similar designs. Since I believe they face the same risk factors, I decideo to compute only one cost of capital for the whole company. II. Methodology for Calculating the Cost of Capital: WACC Since Nike is funded with both debt and equity, I usco the WACC methoo (weighted average cost of capital). Based on the latest available balance sheet, debt as a propo tion of total capital makes up 27.0% and equity accounts for 73.0%s: Capilal Sources Book Valuos (in millions) Debt Current portion of long-term debt $ 5.4 Notes payable 855.3 Long-term nabt 435.9 $1,296.6 27.0% of total capital Equity $3,494.5 73.0% of total capital III. Cost of Debt My estimate of Nike's cost of debt is 4.3%. I arrived at this estimate by taking total interest expense for the year 2001 and dividing il by the company's average debl balance. The ralo is lower than Treasury yields, but thalis because Nike raised a po tion of its funding needs through Japanese yen notes, which carry ales between 2.0% and 4.3%. After acusting for tax, the cost of debt comes out to 2.7%. I used a tax rale af 38%, which I obtained by adding state taxes of 3%: to the U.S. statutory tax rate. Historically Nike's alate taxes have ranged from 2.5% lO 3.5%. 'Debt balances as of May 31, 2000 and 2001, wcro S1,444.6 million and $1,2966 million, rescxcctively 242 Pia Tbzee Labmwling the cost of Cuplu EXHIBIT 5 | (continued) IV. Cost of Equity Teslimaled the cost of equily using the capilal-assel-pricing model (CAPM). Olher melhods, such as the divicenc-discounl model (DDM) and the earnings-capilalization ralio, can be used lo estimale the cost of equily. In my opinion, hovicver, the CAPM is the superior methoo. My estimate of Nike's coat of equity is 10.5%. I used the current yield on 20-yea Treasury hands as my riak-free rate, and the compound average p'emium of the market over Treasury bonds (5.9%) as my risk pre- mium. For beta, I took the average of Nike's hear from 1996 to the present. Putting It All Together Inputting all my assumptions into the WACC formula, my estimate of Nike's cost of capital is 8.4%. WACC = K 1 - L) X DXD - E) + K: XE/D 2.79 X 27.0% - 10.5% x 73.0%