기업분석#(NIKE-나이키)

Statement Problem

 

To estimate Nike`s cost of capital, Joanna Cohen calculated the weighted average cost of capital (WACC) of 8.4%. However, she made error to estimate the WACC so the WACC (8.4%) is measured incorrectly.

 

Analysis of Problem

 Joanna Cohen calculated a weighted average cost of capital (WACC) of 8.40 percent by using the capital asset pricing model (CAPM) for Nike Inc. she used various variation to get the WACC. However, her estimation about the WACC was made by some error. First of all, the problem with Cohen’s calculations is that she used the book value of equity. To calculation cost of capital, Cohen should have used a market value not a book value because book value doesn`t represent current value of equity. The market value of equity is calculated by multiplying the stock price by the number of shares outstanding. The stock price is $42.09 and current shares outstanding are $271.50. Market value of equity is $11,427.44.

 

 This figure is much different than the book value of equity that Cohen used ($3,494.50). The market value of debt is also calculated by adding the current portion of long-term debt and notes payable and long term debt. However, the book value of debt is accepted as an estimate of market value because the book value contains current portion of long term debt so the value of debt is $1296.60. The equity portion of total capital is found by equity divided by debt plus equity so, $11,427.44 / ($1296.60+$11,427.44) is 89.80%. In the end, the weight of debt portion becomes 10.20% ($1296.60 / $1296.60+$11,427,44).

 

 Second problem is that Joanna Cohen estimated the cost of debt of 4.30%. She used total interest expense for the year 2001, and then divided it by the average debt balance. However, it doesn`t reflect Nike`s current or future cost of debt because cost of debt has to be calculated as using yield to maturity method. The WACC is the required return on investments by the firm in the future. The cost of debt must reflect the future interest rate. To calculate a cost of debt, the current yield is used on publicly traded Nike debit in Exhibit4. The coupon rate of the Nike is 6.75% semi-annually. Its maturity is 07/15/2021 so 20 years are remaining from the maturity because the financial information is based on around July 5, 2001. To calculate the cost of debt, a financial calculator is needed. The current price (PV) is $95.60 in Exhibit4 and the future value (FV) is $100. PMT is calculated by 6.75 divided by 2 because it is semi-annually. PMT is 3.375. N is 40.00 because the value of years has to be calculated by multiply the value of years by 2 in semi-annually. So the value of interest rate in semi-annually is 3.58%. In the end, annual interest rate is 7.16%. Because the tax rate is 38.00%, the cost of debt is 4.44% (7.16% *(1-0.38)= 4.44%).

 

  In calculating cost of equity, Joanna Cohen estimated that the cost of equity is 10.5% using CAPM. She used the average of Nike`s beta from 1996 to 2001. However, it is more proper to use recent beta estimation to represent future risk so the value of beta has to be used the recent value so Cohen should have used the value (0.69) of beta in 2001 not average value of beta (0.80). There are various methods to get cost of equity such as dividend-discount model (DDM), capital-asset-pricing-model (CAPM) etc. First of all, Through the DDM method ((D0*(1+g)/P0) + g), the cost of equity is estimated at 6.70% ((0.48*(1.055)/42.09) + 5.5%= 6.70%). Through the figures such as weight of debt and equity, cost of debt and equity, the WACC can be calculated. The WACC is cost of debt*(1-tax rate)*weight of debt +cost of equity*weight of equity (4.44%*10.20% +6.70%*89.80%=6.47%). 

 Through the WACC, we can calculate a terminal value that is Cash Flow2011*(1+growth rate)/ WACC-growth rate ($1572.7*(1.03)/6.47%-3.00%=$48,255.15). Through the terminal value, the enterprise value can be calculated using financial calculator. The value of enterprise is $32,393.37 so the equity value per share is $114.54. However, DDM method can`t be used for calculating the cost of equity in this case because the method only is available when the dividend was paid for share holders after June 30, 2001in Exhibit4. Therefore, The DDM method can`t correctly reflect the cost of capital so we need to CAPM method.  

 

 

 To use CAPM method, we need to value of beta, market risk premium and risk free rate. The method is risk free rate + beta * market risk premium. Beta is 0.69 in 2001. Risk market premium use geometric mean (5.90%) instead of arithmetic mean (7.50%) because arithmetic use usually the period under one year whereas geometric mean use better for long term period. Risk free rate is used at 5.74% of 20-year yields on U.S treasuries because using 20-year yields on U.S Treasuries get correct value of equity. So, the cost of equity is 9.811% (5.74%+0.69*5.90%=9.27%). Through the cost of equity, the WACC is calculated at 9.26% (4.44%*10.20%+ 9.811%*89.80%= 9.26%). Through the WACC, the value of terminal is estimated at $25,876.69 ($1527.70*(1.03)/9.26%-3%=$25,876.69). Through the terminal value, the enterprise value can be calculated using financial calculator. The value of enterprise is $17,109.09 and the equity per share is $58.241. Current Nike`s share price is $42.09. The present value of Nike is $58.241 much higher than current market share price of $42.09. Nike share price is undervalued.

 

Recommendation

 

 Kimi Ford should buy Nike`s shares because the current market share price is undervalued in comparison to the equity value. The current share price is $42.09. To gain equity value per share, we need to calculate a weighted average cost of capital (WACC). The WACC is estimated at 9.26%. At sensitivity equity value of discount rate, discount rate between 9.00% and 9.50% leads to equity value between $55.68 and $61.25. Specifically, through the WACC, terminal value is estimated at $25,876.69. Through the terminal value, equity value is obtained at $58.241. In comparison to current market share of $42.09, equity value of $58.241 is much higher so the market share price is undervalued.