Please read and answer the case study. the case study should include an executive summary and introduction.

On July 5, 2001, Kimi Ford, a portfolio manager at North Point Group, a mutual fund management firm, pored over analysts' write-ups of Nike, Inc., the athletic-shoe manufacturer. Nike's share price had declined significantly from the beginning of the year. Ford was considering buying some shares for the fund she managed, the North Point 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 large-cap, generally old-cconomy stocks. Although the stock market had declined over the last 18 months, the NorthPoint Large-Cap Fund had performed extremely well. In 2000, the fund earned a return of 20.7%, even as the S&P 500 fell 10.1%. At the end of June 2001, the fund's year-to-date returns stood at 6.4% versus -7.3% for the S&P 500, Only a week earlier, on June 28, 2001, Nike had held an analysts' meeting to disclose its fiscal year 2001 results. The meeting, however, had another purpose: Nike management wanted to communicate a strategy for revitalizing the company. Since 1997, its revenues had 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 had fallen from 48%, in 1997, to 42% in 2000.2 In addition, recent supply chain issues and the adverse cffect of a strong dollar had negatively affected revenue. At the mecting, management revealed plans to address both top-line grow and operating performance. To boost revenue, the company would develop more athletic-shoe products in the mid-priced segmenta segment that Nike had overlooked in recent years. Nike also planned to push its apparel line, which, under the recent leadership of industry veteran Mindy Grossman,' had performed extremely well. On the cost side, Nike would exert more effort on expense control. Finally, company executives reiterated their long-term revenue growth targets of 8% to 10% and carings-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 international businesses. Ford read all the analysts' reports that she could find about the June 28 meeting, but the reports gave her no clear guidance a Lehman Brothers report recommended a strong buy, while UBS Warburg and CSFB analysts expressed misgivings about the company and recommended a hold. Ford decided instead to develop her own discounted cash flow forecast to come to a clearer conclusion Nike's fiscal year coded in May. 2 Douglas Robson, "Just Do Something Nike's Insulanty and Foot Deco Have It Running in Place," BusineWeek (2 July 2001). Sneakers in this segment sold for 570 to $90 a pait Mindy Grossman joined Nike in September 200. She was the former pectilent and chief executive of Jones Apparel Group's Polo Jeans division. This case was prepared from publicly available information by Jessica Chan, under the supervision of Robert E. Bruner and with the assistance of Scan D. Car. The financial support of the Batten Institute is gratefully acknowledged. It was written as a basis for class discussion rather than to illustrate cffective or ineffective handling of an administrative situation Copynght 2001 by the University of Virginia Darden School Foundation, Page 2 UVA-F-1353 Her forecast showed that, at a discount rate of 12%, Nike was overvalued at its current share price of $42.09 (Exhibit 2). She had done a quick sensitivity analysis, however, which revealed Nike was undervalued at 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 (Exhibit 1 through Exhibit 4) and began to work on her analysis. At the end of the day, Cohen submitted her cost-of-capital estimate and a memo (Exhibit 5) explaining her assumptions to Ford. Exhibit 1 Nike, Inc.: Cost of Capital Consolidated Income Statements Year Ended May 31 1995 (in millions of dollars except per-share data) 1996 1997 1998 1999 2000 2001 Revenues Cost of goods sold Gross profit Selling and administrative Operating income Interest expense Other expense, net Restructuring charge, net Income before income taxes Income taxes Net income $4,760.8 $ 6,470.6 $9,186.5 $9,553.1 $8,776.9 $ 8,995.1 $ 9,488.8 2,865.3 3,906.7 5,503.0 6,065.5 5,493.5 5,403.8 5,784.9 1,895.6 2,563.9 3,683.5 3,487.6 3,283.4 3,591.3 3,703.9 1,209.8 1,588.6 2,303.7 2,623.8 2.426.6 2,606.4 2,689.7 685.8 975.3 1,379.8 863.8 856.8 984.9 1,014.2 24.2 39.5 52.3 60.0 45.0 58.7 11.7 36.7 32.3 20.9 21.5 23.2 34.1 129.9 45.1 (2.5) 649.9 899.1 1,295.2 653.0 746.1 919.2 921.4 250.2 345.9 499.4 253.4 294.7 340.1 331.7 $399.7 $ 553.2 $ 795.8 $ 399.6 $ 451.4 $ 579.1 $ 589.7 44.1 $ Diluted earnings per common share Average shares outstanding (diluted) 1.36 $ 1.88 $ 293.6 2.68 $ 297.0 294.0 1.35 $ 296.0 2.07 $ 1.57 $ 287.5 279.8 2.16 273.3 Growth (%) Revenue Operating income Net income 35.9 42.2 38.4 42.0 41.5 43.9 4.0 (37.4) (49.8) (8.1) (0.8) 13.0 2.5 15.0 28.3 5.5 3.0 1.8 Margins (%) Gross margin Operating margin Net margin 39.6 15.1 8.5 40.1 15.0 8.7 36.5 9.0 4.2. 37.4 9.8 5.1 399 10.9 6.4 39.0 10.7 6.2 39.5 370 36.0 Effective tax rate (%)* 38.5 38.6 38.8 *The U.S. statutory tax rate was 35%. The state tax varied yearly from 2.5% to 3.5%. Sources of data: Company filing with the Securities and Exchange Commission (SEC), UBS Warburg. Exhibit 2 Nike, Inc.: Cost of Capital Discounted Cash Flow Analysis 2003 2004 2005 2006 2007 2008 2009 2010 2011 2002 Assumptions: Revenue growth (%) 7.0 COGS/sales (%) 60.0 SG&A/sales (%) 28.0 Tax rate (%) 38,0 Current assets/sales (%) 38.0 Current liabilities/sales (%) Yearly depreciation and capex equal each other. Cost of capital (%) 12.00 Terminal growth rate (%) 3.00 6.5 60.0 27.5 38.0 38.0 11.5 6.5 59.5 27.0 38,0 6,5 59.5 26,5 38,0 38.0 11.5 6.0 59.0 26.0 38.0 38.0 11.5 6.0 59.0 25.5 38.0 38.0 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 58.0 25.0 38.0 38.0 115 38.0 6.0 58.0 25.0 38.0 38.0 11.5 11.5 11.5 11.5 Discounted Cash Flow (in millions of dollars except per-share data) Operating income $ 1,218.4 $ 1.351.6 S 1,554.6 S 1,717,0 $ 1,950,0 $ 2,135.9 $ 2,410.2 S 2,554.8 $ 2,790.1 $ 2,957.5 Taxes 463.0 513.6 590.8 652.5 741.0 8117 915.9 970.8 1.060.2 1.123.9 NOPAT 755.4 838.0 963.9 1,064.5 1,209.0 1,324,3 1,494.3 1,584.0 1,729.9 1,833.7 Capex, net of depreciation Change in NWC 8.8 (1749) (186,3) (198.4) (1950) (206.7) (219.1) (2323) (246.2) (261.0) Free cash flow 764.1 663.1 777.6 866.2 1,014.0 1,117.6 1,275.2 1,351.7 1,483.7 1,572.7 Terminal value 17.998.3 Total flows 764.1 663.1 777.6 866.2 1,014.0 1,117.6 1,275.2 1,351.7 1.483.7 19,57L0 Present value of flows S 682.3 $528.6 $ 553.5 S 550.5 S 575.4 S 566.2 S 576.8 S 545.9 $ 535.0 S 6.301.2 Enterprise value $ 11,415.4 Less: current outstanding debt 1.296.6 Equity value $ 10,118.8 Current shares outstanding 271.5 Equity value per share S 37.27 Current share price: s 42.09 Sensitivity of equity value to discount rate: Discount rate Equity value 8.00% $ 75.80 8.50% 67.85 9.00% 61.25 9.50% 55.68 10.00% 50.92 10.50% 46.81 11.00% 43.22 11.17% 42.09 11.50% 40.07 12.00% 37.27 Source: Case writer's analysis Exhibit 3 Nike, Inc.: Cost of Capital Consolidated Balance Sheets As of May 31, 2000 2001 (in millions of dollars) Assets Current assets: Cash and equivalents Accounts receivable Inventories Deferred income taxes Prepaid expenses Total current assets $ 254.3 1,569.4 1,446.0 111.5 215.2 3,596.4 $ 304.0 1,621.4 1,424.1 113.3 162.5 3,625.3 Property, plant and equipment, net Identifiable intangible assets and goodwill, net Deferred income taxes and other assets Total assets 1,583.4 410.9 266.2 $ 5,856.9 1,618.8 397.3 178.2 $ 5,819.6 $ Liabilities and shareholders' equity Current liabilities: Current portion of long-term debt Notes payable Accounts payable Accrued liabilities Income taxes payable Total current liabilities 50.1 924.2 543.8 621.9 $ 5.4 855.3 432.0 472.1 21.9 1,786.7 2,140.0 Long-term debt Deferred income taxes and other liabilities Redeemable preferred stock 470.3 110.3 0.3 435.9 102.2 0.3 Shareholders' equity: Common stock, par Capital in excess of stated value Unearned stock compensation Accumulated other comprehensive income Retained earnings Total shareholders' equity Total liabilities and shareholders' equity 2.8 369.0 (11.7) (111.1) 2,887.0 3,136.0 $ 5,856.2 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 Exchange Commission (SEC). Page 6 UVA-F-1353 Exhibit 4 Nike, Inc.: Cost of Capital Capital Market and Financial Information on or around July 5, 2001 Current Yields on U.S. Treasuries Nike Share Price Performance Relative to S&P 500: January 2000 to July 5, 2001 1.3 3-month 6-month 1-year 5-year 10-year 20-year 3.59% 3.59% 3.59% 4.88% 5.39% 5.74% 1.2 1. 0.9 0.8 Historical Equity Risk Premiums (1926-1999) Geometric mean 5.90% Arithmetic mean 7.50% Wypotheek 0.7 0.6 0.5 10-me 0.98 Current Yield on Publicly Traded Nike Debt Coupon 6.75% paid semi-annually 0.4 Issued 07/15/96 8 Maturity 07/15/21 Current Price $ 95.60 Nike ---- S&P 500 Nike Historic Betas 1996 1997 0.84 Nike share price on July 5, 2001: $ 42.09 1998 0.84 1999 0.63 Dividend History and Forecasts 2000 0.83 Paymt Dates 31-Mar 30-Jun 30-Sep 31-Dec Total YTD 6/30/01 0.69 1997 0.10 0.10 0.10 0.40 1998 0.12 0.12 0.12 0.12 0.48 Average 0.80 1999 0.12 0.12 0.12 0.12 0.48 2000 0.12 0.12 0.12 0.12 0.48 2001 0.12 0.12 Consensus EPS estimates: FY 2002 FY 2003 Value Line Forecast of Dividend Growth from 98-00 to 04-06: S 2.32 $ 2.67 5.50% Data have been modified for teaching purposes. Sources of data: Bloomberg Financial Services, Ibbotson Associates Yearbook 1999, Value Line Investment Survey, IBES. 0.10 Exhibit 5 Nike, Inc.: Cost of Capital Joanna Cohen's Analysis : : Kimi Ford FROM: Joanna Cohen DATE: July 6, 2001 SUBJECT: Nike's cost of capital Based on the following assumptions, my estimate of Nike's cost of capital is 8.4% 1. Single or Multiple Costs of Capital? The first question I considered was whether use single or multiple costs of capital, given that Nike has multiple business segments. Aside from footwear, which makes up 62% of its revenue, Nike also sells apparel (30% of revenue) that complements its footwear products. In addition, Nike sells sport balls, timepieces, eyewear, skates, bats, and other equipment designed for sports activities. Equipment products account for 3.6% of its revenue. Finally, Nike also sells some 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 accounted for 4.5% of revenue. I asked myself whether Nike's business segments had different enough risks from each other to warrant different costs of capital. Were their profiles really different? I concluded that it was only the Cole Haan line that was somewhat different; the rest were all sports-related businesses. Since Cole Haan makes up only a tiny fraction of revenues, however, I did not think that it was necessary to compute a separate cost of capital. As for the apparel and footwear lines, they are sold through the same marketing and distribution channels and are often marketed in other collections of similar designs. Since I believe they face the same risk factors, I decided 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 used the weighted average cost of capital (WACC) method. Based on the latest available balance sheet, debt as a proportion of total capital makes up 27.0% and equity accounts for 73.0%: UVA-F-1353 Exhibit 5 (continued) Book Values (in millions) Capital Sources Debt Current portion of long-term debt Notes payable Long-term debt $ 5.4 855.3 435.9 $ 1,296,6 $ 3,494.5 Equity 27.0% of total capital 73.0% of total capital 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 it by the company's average debt balance. The rate is lower than Treasury yields, but that is because Nike raised a portion of its funding needs through Japanese yen notes, which carry rates between 2.0% and 4.3%. After adjusting for tax, the cost of debt comes out to 2.7%. I used a tax rate of 38%, which I obtained by adding state taxes of 3% to the U.S. statutory tax rate. Historically, Nike's state taxes have ranged from 2.5% to 3.5%. IV. Cost of Equity I estimated the cost of equity using the capital-asset-pricing model (CAPM). Other methods, such as the dividend-discount model (DDM) and the earnings-capitalization ratio, can be used to estimate the cost of equity. In my opinion, however, the CAPM is the superior method. My estimate of Nike's cost of equity is 10.5%. I used the current yield on 20-year Treasury bonds as my risk-free rate, and the compound average premium of the market over Treasury bonds (5.9%) as my risk premium. For beta, I took the average of Nike's betas from 1996 to the present. Putting It All Together After entering all my assumptions into the WACC formula, my estimate of Nike's cost of capital is 8.4%. WACC = K.(1 t) * D/D + E) + K. XE/D + E) = 2.7% X 27.0% + 10.5% X 73.0% = 8.4% Debt balances as of May 31, 2 and 2 wire 510 WILMINGTON UNIVERSITY COURSE TITLE: Advanced Financial Analysis COURSE NUMBER: MBA 7294 STUDENT NAME: Maximum Points Week #2 Case Study - Nike Case Study Analysis Papers grading rubric Grading Criteria Define WACC and discuss how WACC is calculated. a. How is it calculated? b. How can organizations utilize WACC within capital budgeting and investment decisions? 2.5 pts 2.5 pts Discuss how to use WACC within a capital budgeting decision or investment decision? 7.5 pts Does this approach maximize shareholder value? 7.5 pts Develop the WACC for Nike Corporation 15 a. What risk-free rate and risk premium did you use to calculate the cost of equity? 15 b. How did you measure Nike's cost of debt? 10 pts c. Did you use arithmetic or geometric averages to measure rates of return? Why? 5 pts Calculate the impact of an error in Nike Corporation's WACC; if estimated WACC was 10%; and actual WACC was 12% & if estimated WACC was 10%; and actual WACC was 8%? 10 10 Calculate the value of Nike Shares 10 Proper spelling, punctuation, and APA Formatting 5 Total 100 On July 5, 2001, Kimi Ford, a portfolio manager at North Point Group, a mutual fund management firm, pored over analysts' write-ups of Nike, Inc., the athletic-shoe manufacturer. Nike's share price had declined significantly from the beginning of the year. Ford was considering buying some shares for the fund she managed, the North Point 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 large-cap, generally old-cconomy stocks. Although the stock market had declined over the last 18 months, the NorthPoint Large-Cap Fund had performed extremely well. In 2000, the fund earned a return of 20.7%, even as the S&P 500 fell 10.1%. At the end of June 2001, the fund's year-to-date returns stood at 6.4% versus -7.3% for the S&P 500, Only a week earlier, on June 28, 2001, Nike had held an analysts' meeting to disclose its fiscal year 2001 results. The meeting, however, had another purpose: Nike management wanted to communicate a strategy for revitalizing the company. Since 1997, its revenues had 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 had fallen from 48%, in 1997, to 42% in 2000.2 In addition, recent supply chain issues and the adverse cffect of a strong dollar had negatively affected revenue. At the mecting, management revealed plans to address both top-line grow and operating performance. To boost revenue, the company would develop more athletic-shoe products in the mid-priced segmenta segment that Nike had overlooked in recent years. Nike also planned to push its apparel line, which, under the recent leadership of industry veteran Mindy Grossman,' had performed extremely well. On the cost side, Nike would exert more effort on expense control. Finally, company executives reiterated their long-term revenue growth targets of 8% to 10% and carings-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 international businesses. Ford read all the analysts' reports that she could find about the June 28 meeting, but the reports gave her no clear guidance a Lehman Brothers report recommended a strong buy, while UBS Warburg and CSFB analysts expressed misgivings about the company and recommended a hold. Ford decided instead to develop her own discounted cash flow forecast to come to a clearer conclusion Nike's fiscal year coded in May. 2 Douglas Robson, "Just Do Something Nike's Insulanty and Foot Deco Have It Running in Place," BusineWeek (2 July 2001). Sneakers in this segment sold for 570 to $90 a pait Mindy Grossman joined Nike in September 200. She was the former pectilent and chief executive of Jones Apparel Group's Polo Jeans division. This case was prepared from publicly available information by Jessica Chan, under the supervision of Robert E. Bruner and with the assistance of Scan D. Car. The financial support of the Batten Institute is gratefully acknowledged. It was written as a basis for class discussion rather than to illustrate cffective or ineffective handling of an administrative situation Copynght 2001 by the University of Virginia Darden School Foundation, Page 2 UVA-F-1353 Her forecast showed that, at a discount rate of 12%, Nike was overvalued at its current share price of $42.09 (Exhibit 2). She had done a quick sensitivity analysis, however, which revealed Nike was undervalued at 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 (Exhibit 1 through Exhibit 4) and began to work on her analysis. At the end of the day, Cohen submitted her cost-of-capital estimate and a memo (Exhibit 5) explaining her assumptions to Ford. Exhibit 1 Nike, Inc.: Cost of Capital Consolidated Income Statements Year Ended May 31 1995 (in millions of dollars except per-share data) 1996 1997 1998 1999 2000 2001 Revenues Cost of goods sold Gross profit Selling and administrative Operating income Interest expense Other expense, net Restructuring charge, net Income before income taxes Income taxes Net income $4,760.8 $ 6,470.6 $9,186.5 $9,553.1 $8,776.9 $ 8,995.1 $ 9,488.8 2,865.3 3,906.7 5,503.0 6,065.5 5,493.5 5,403.8 5,784.9 1,895.6 2,563.9 3,683.5 3,487.6 3,283.4 3,591.3 3,703.9 1,209.8 1,588.6 2,303.7 2,623.8 2.426.6 2,606.4 2,689.7 685.8 975.3 1,379.8 863.8 856.8 984.9 1,014.2 24.2 39.5 52.3 60.0 45.0 58.7 11.7 36.7 32.3 20.9 21.5 23.2 34.1 129.9 45.1 (2.5) 649.9 899.1 1,295.2 653.0 746.1 919.2 921.4 250.2 345.9 499.4 253.4 294.7 340.1 331.7 $399.7 $ 553.2 $ 795.8 $ 399.6 $ 451.4 $ 579.1 $ 589.7 44.1 $ Diluted earnings per common share Average shares outstanding (diluted) 1.36 $ 1.88 $ 293.6 2.68 $ 297.0 294.0 1.35 $ 296.0 2.07 $ 1.57 $ 287.5 279.8 2.16 273.3 Growth (%) Revenue Operating income Net income 35.9 42.2 38.4 42.0 41.5 43.9 4.0 (37.4) (49.8) (8.1) (0.8) 13.0 2.5 15.0 28.3 5.5 3.0 1.8 Margins (%) Gross margin Operating margin Net margin 39.6 15.1 8.5 40.1 15.0 8.7 36.5 9.0 4.2. 37.4 9.8 5.1 399 10.9 6.4 39.0 10.7 6.2 39.5 370 36.0 Effective tax rate (%)* 38.5 38.6 38.8 *The U.S. statutory tax rate was 35%. The state tax varied yearly from 2.5% to 3.5%. Sources of data: Company filing with the Securities and Exchange Commission (SEC), UBS Warburg. Exhibit 2 Nike, Inc.: Cost of Capital Discounted Cash Flow Analysis 2003 2004 2005 2006 2007 2008 2009 2010 2011 2002 Assumptions: Revenue growth (%) 7.0 COGS/sales (%) 60.0 SG&A/sales (%) 28.0 Tax rate (%) 38,0 Current assets/sales (%) 38.0 Current liabilities/sales (%) Yearly depreciation and capex equal each other. Cost of capital (%) 12.00 Terminal growth rate (%) 3.00 6.5 60.0 27.5 38.0 38.0 11.5 6.5 59.5 27.0 38,0 6,5 59.5 26,5 38,0 38.0 11.5 6.0 59.0 26.0 38.0 38.0 11.5 6.0 59.0 25.5 38.0 38.0 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 58.0 25.0 38.0 38.0 115 38.0 6.0 58.0 25.0 38.0 38.0 11.5 11.5 11.5 11.5 Discounted Cash Flow (in millions of dollars except per-share data) Operating income $ 1,218.4 $ 1.351.6 S 1,554.6 S 1,717,0 $ 1,950,0 $ 2,135.9 $ 2,410.2 S 2,554.8 $ 2,790.1 $ 2,957.5 Taxes 463.0 513.6 590.8 652.5 741.0 8117 915.9 970.8 1.060.2 1.123.9 NOPAT 755.4 838.0 963.9 1,064.5 1,209.0 1,324,3 1,494.3 1,584.0 1,729.9 1,833.7 Capex, net of depreciation Change in NWC 8.8 (1749) (186,3) (198.4) (1950) (206.7) (219.1) (2323) (246.2) (261.0) Free cash flow 764.1 663.1 777.6 866.2 1,014.0 1,117.6 1,275.2 1,351.7 1,483.7 1,572.7 Terminal value 17.998.3 Total flows 764.1 663.1 777.6 866.2 1,014.0 1,117.6 1,275.2 1,351.7 1.483.7 19,57L0 Present value of flows S 682.3 $528.6 $ 553.5 S 550.5 S 575.4 S 566.2 S 576.8 S 545.9 $ 535.0 S 6.301.2 Enterprise value $ 11,415.4 Less: current outstanding debt 1.296.6 Equity value $ 10,118.8 Current shares outstanding 271.5 Equity value per share S 37.27 Current share price: s 42.09 Sensitivity of equity value to discount rate: Discount rate Equity value 8.00% $ 75.80 8.50% 67.85 9.00% 61.25 9.50% 55.68 10.00% 50.92 10.50% 46.81 11.00% 43.22 11.17% 42.09 11.50% 40.07 12.00% 37.27 Source: Case writer's analysis Exhibit 3 Nike, Inc.: Cost of Capital Consolidated Balance Sheets As of May 31, 2000 2001 (in millions of dollars) Assets Current assets: Cash and equivalents Accounts receivable Inventories Deferred income taxes Prepaid expenses Total current assets $ 254.3 1,569.4 1,446.0 111.5 215.2 3,596.4 $ 304.0 1,621.4 1,424.1 113.3 162.5 3,625.3 Property, plant and equipment, net Identifiable intangible assets and goodwill, net Deferred income taxes and other assets Total assets 1,583.4 410.9 266.2 $ 5,856.9 1,618.8 397.3 178.2 $ 5,819.6 $ Liabilities and shareholders' equity Current liabilities: Current portion of long-term debt Notes payable Accounts payable Accrued liabilities Income taxes payable Total current liabilities 50.1 924.2 543.8 621.9 $ 5.4 855.3 432.0 472.1 21.9 1,786.7 2,140.0 Long-term debt Deferred income taxes and other liabilities Redeemable preferred stock 470.3 110.3 0.3 435.9 102.2 0.3 Shareholders' equity: Common stock, par Capital in excess of stated value Unearned stock compensation Accumulated other comprehensive income Retained earnings Total shareholders' equity Total liabilities and shareholders' equity 2.8 369.0 (11.7) (111.1) 2,887.0 3,136.0 $ 5,856.2 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 Exchange Commission (SEC). Page 6 UVA-F-1353 Exhibit 4 Nike, Inc.: Cost of Capital Capital Market and Financial Information on or around July 5, 2001 Current Yields on U.S. Treasuries Nike Share Price Performance Relative to S&P 500: January 2000 to July 5, 2001 1.3 3-month 6-month 1-year 5-year 10-year 20-year 3.59% 3.59% 3.59% 4.88% 5.39% 5.74% 1.2 1. 0.9 0.8 Historical Equity Risk Premiums (1926-1999) Geometric mean 5.90% Arithmetic mean 7.50% Wypotheek 0.7 0.6 0.5 10-me 0.98 Current Yield on Publicly Traded Nike Debt Coupon 6.75% paid semi-annually 0.4 Issued 07/15/96 8 Maturity 07/15/21 Current Price $ 95.60 Nike ---- S&P 500 Nike Historic Betas 1996 1997 0.84 Nike share price on July 5, 2001: $ 42.09 1998 0.84 1999 0.63 Dividend History and Forecasts 2000 0.83 Paymt Dates 31-Mar 30-Jun 30-Sep 31-Dec Total YTD 6/30/01 0.69 1997 0.10 0.10 0.10 0.40 1998 0.12 0.12 0.12 0.12 0.48 Average 0.80 1999 0.12 0.12 0.12 0.12 0.48 2000 0.12 0.12 0.12 0.12 0.48 2001 0.12 0.12 Consensus EPS estimates: FY 2002 FY 2003 Value Line Forecast of Dividend Growth from 98-00 to 04-06: S 2.32 $ 2.67 5.50% Data have been modified for teaching purposes. Sources of data: Bloomberg Financial Services, Ibbotson Associates Yearbook 1999, Value Line Investment Survey, IBES. 0.10 Exhibit 5 Nike, Inc.: Cost of Capital Joanna Cohen's Analysis : : Kimi Ford FROM: Joanna Cohen DATE: July 6, 2001 SUBJECT: Nike's cost of capital Based on the following assumptions, my estimate of Nike's cost of capital is 8.4% 1. Single or Multiple Costs of Capital? The first question I considered was whether use single or multiple costs of capital, given that Nike has multiple business segments. Aside from footwear, which makes up 62% of its revenue, Nike also sells apparel (30% of revenue) that complements its footwear products. In addition, Nike sells sport balls, timepieces, eyewear, skates, bats, and other equipment designed for sports activities. Equipment products account for 3.6% of its revenue. Finally, Nike also sells some 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 accounted for 4.5% of revenue. I asked myself whether Nike's business segments had different enough risks from each other to warrant different costs of capital. Were their profiles really different? I concluded that it was only the Cole Haan line that was somewhat different; the rest were all sports-related businesses. Since Cole Haan makes up only a tiny fraction of revenues, however, I did not think that it was necessary to compute a separate cost of capital. As for the apparel and footwear lines, they are sold through the same marketing and distribution channels and are often marketed in other collections of similar designs. Since I believe they face the same risk factors, I decided 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 used the weighted average cost of capital (WACC) method. Based on the latest available balance sheet, debt as a proportion of total capital makes up 27.0% and equity accounts for 73.0%: UVA-F-1353 Exhibit 5 (continued) Book Values (in millions) Capital Sources Debt Current portion of long-term debt Notes payable Long-term debt $ 5.4 855.3 435.9 $ 1,296,6 $ 3,494.5 Equity 27.0% of total capital 73.0% of total capital 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 it by the company's average debt balance. The rate is lower than Treasury yields, but that is because Nike raised a portion of its funding needs through Japanese yen notes, which carry rates between 2.0% and 4.3%. After adjusting for tax, the cost of debt comes out to 2.7%. I used a tax rate of 38%, which I obtained by adding state taxes of 3% to the U.S. statutory tax rate. Historically, Nike's state taxes have ranged from 2.5% to 3.5%. IV. Cost of Equity I estimated the cost of equity using the capital-asset-pricing model (CAPM). Other methods, such as the dividend-discount model (DDM) and the earnings-capitalization ratio, can be used to estimate the cost of equity. In my opinion, however, the CAPM is the superior method. My estimate of Nike's cost of equity is 10.5%. I used the current yield on 20-year Treasury bonds as my risk-free rate, and the compound average premium of the market over Treasury bonds (5.9%) as my risk premium. For beta, I took the average of Nike's betas from 1996 to the present. Putting It All Together After entering all my assumptions into the WACC formula, my estimate of Nike's cost of capital is 8.4%. WACC = K.(1 t) * D/D + E) + K. XE/D + E) = 2.7% X 27.0% + 10.5% X 73.0% = 8.4% Debt balances as of May 31, 2 and 2 wire 510 WILMINGTON UNIVERSITY COURSE TITLE: Advanced Financial Analysis COURSE NUMBER: MBA 7294 STUDENT NAME: Maximum Points Week #2 Case Study - Nike Case Study Analysis Papers grading rubric Grading Criteria Define WACC and discuss how WACC is calculated. a. How is it calculated? b. How can organizations utilize WACC within capital budgeting and investment decisions? 2.5 pts 2.5 pts Discuss how to use WACC within a capital budgeting decision or investment decision? 7.5 pts Does this approach maximize shareholder value? 7.5 pts Develop the WACC for Nike Corporation 15 a. What risk-free rate and risk premium did you use to calculate the cost of equity? 15 b. How did you measure Nike's cost of debt? 10 pts c. Did you use arithmetic or geometric averages to measure rates of return? Why? 5 pts Calculate the impact of an error in Nike Corporation's WACC; if estimated WACC was 10%; and actual WACC was 12% & if estimated WACC was 10%; and actual WACC was 8%? 10 10 Calculate the value of Nike Shares 10 Proper spelling, punctuation, and APA Formatting 5 Total 100