Nike Case Analysis
Nike ANALYSIS The Weight Average Cost of Capital (WACC) is the firm’s cost of capital. We can think of WACC as an average representing the expected return on all of the companies’ securities. It is an extremely important number for both corporations and usually financials advisors.
Corporations use this number as a minimum for evaluating their capital projects or investments. So if for example the WACC of a firm is 10% and the return on investing in a project is 4. 5%, then the company would not invest in that particular project.
The company in this particular scenario would at least have to get a return of 10% or more to invest in a project. I agree with Johanna Cohen’s estimates as she did the calculations right because I went over them.
She also used the cost of debt after -tax as corporations usually do. I calculated the Cost of Equity using the CAPM by calculating it to be 5. 870%. I choose my market risk as 6%, because most corporations 37% had used a market risk rate of 5-6%. I choose the upper limit just to be conservative and not take the lower one in case it has been too optimistic.
I also choose the higher market risk rate of 6% since the S;P was down 7. 3% overall for the year. I choose the average beta of Nike over the last six years which was 0. 80%. The risk free rate in all my textbooks usually use is a risk free rate of T-bills but corporations use 10-year treasuries 33% of the time, and also choose 10-30 year treasuries 33% of the time.
By looking at the above number I thought using a 10 yeartreasury which currently had a yield of 5. 39% was the best option available. K(cost of Equity)=RF+Beta(RM-RF) 5. 870-5. 39+0.
8(6-5. 9) Therefore the cost of equity is 5. 870% For the dividend discount model the rate of growth is zero. Although (exhibit4) states that the value line forecast of dividend growth from 98-00 to ’04-’06 is 5. 50% the total dividend paid in 1997 was 0.
40 cents, but from 1998 to 2000 the dividend has been constant at 0. 48 cents. The first quarter and second quarter for the current year has given out dividends of 12 cents per quarter which will be in pace for a total of 48 cents for the year. Therefore the growth for dividends in my opinion is zero.
With a market risk of 6% the value of the Nike stock is $8 which is very undervalued when its current price is 42. 09.
Dividend discount Model dividend per share value of stock= ———————————- discount rate – dividend growth rate The earnings capitalization ratio also sometimes called the “price Earnings ratio” is commonly used in the financial world. The rice earnings ratio is quite simple. I did not take an average of the earnings per share of the historical date, because I believe they are irrelevantas they might have had a different stock price.
I used (exhibit 4) for costwhich were $2. 32 for 2002 and $2.
67 for 2003. The current earnings per share is$2. 16. I gave each number different consideration. The current year I gave 60% consideration with 30% and 20% respectively.
I then came up with a 2. 5260 average earnings per share. But I did two calculations one with the current earnings per share, as I see it a bit useless to calculate the current stock price by future earnings per share. 42. 09 19. 49= ———— 2.
16 Therefore, the current P/E ratio is 19. 49, which is quite high.
With the average price per earnings share: 42. 09 16. 67= ————– 2.
5260 Therefore using the average forecast we get a P/E ratio of 16. 67. I believe tat the dividend discount model was not very useful as it put the value of Nike stock at $8. A company might have value in its market cap. Certain companies might invest instead of giving dividends to their customers and I believe that the DDM is not very good at valuing a company. The cost of equity using CAPM is much better than the DDM as it shows us the cost of equity in relationships between the risk and expected return.
It gives the company an idea of what investors need to be compensated for their time value of money and the risk they are taking by investing in Nike. The price earnings ratio is the one I liked the most. It shows the measure of the price paid for a share of Nike stock relative to the net income earned by the company. I would recommend that the Nike stock should be expressed as a hold because its net income is quite small compared to the revenue it earns. Nike’s cost of goods sold is extremely high, even when they make most of their products overseas in third world countries.
Their revenue growth has also drastically slowed down only from five years ago when they had a growth rate of 35. 9% in 1995 and 42% in 1996. The past four years Nike had an average growth rate of revenue at 0. 975%, which is less than 1%. For a company the size of Nike and the previous large growth it had, something might have been wrong.
Their net income,has also as a percentage gone down. The Nike stock should be considered a hold for investors who already own the share.