Aswath Damodaran
Aswath Damodaran!
1!
Executive Summary !
On a stand-alone basis, this project is a good project, albeit not a great one.
The average return on capital, even under the more conservative nite life assumption, is 13.25%, which is higher than the cost of capital of 8.20%.
The net present value of this project, using a cost of capital of 8.20%
is $ 399 million, under the conservative assumption of a nite life of 10 years
is $ 1099 million, under the more realistic assumption of an innite life
On the two variables that are the most critical - market share and operating margin - the rm has a reasonable margin for error on market share and a narrower margin for error on operating margins.
If we consider the potential project synergies (i.e. the gains to the shoe division from having an apparel division), it will make this project a more attractive one.
Aswath Damodaran!
2!
Earnings
Book Value Accounting return Cash ows Discount rate
Book values versus market values: While the book values of debt and equity are accessible on the balance sheet, the cost of capital is computed based upon markets.
Nikes current beta and cost of capital: Since the project is in a new business, the current beta (levered or unlevered) for Nike is not relevant and neither is a blended beta of any sort.
Effective versus Marginal tax rates: The after-tax cost of debt is a function of the marginal tax rate, not the effective tax rate.
Aswath Damodaran!
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5!
Aswath Damodaran!
Regression Beta Debt to Equity Ratio Unlevered Beta Cash/Firm Value Unlevered beta corrected for cash
The simple average beta is skewed by outliers in the D/E ratio. I will use the median beta value, but I could have gone with the aggregate (weighted average), since it reects larger rms in the sample.
Aswath Damodaran!
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Aswath Damodaran!
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Aswath Damodaran!
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0 1 2 3 4 5 6 7 8 9 10 $ 75,000 $ 78,750 $ 82,688 $ 86,822 $ 91,163 $ 95,721 $ 100,507 $ 105,533 $ 110,809 $ 116,350 $ 122,167 $ 0% 0% 0% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 5.00%
$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 1,736 1,372 300 166 79 (180) (72) (108) $ $ $ $ $ $ $ $ 2,279 1,800 240 187 82 (30) (12) (18) $ $ $ $ $ $ $ $ 2,872 2,269 192 210 85 116 46 69 $ $ $ $ $ $ $ $ 3,518 2,779 154 235 89 261 105 157 $ $ $ $ $ $ $ $ 4,221 3,335 235 262 92 297 119 178 $ $ $ $ $ $ $ $ 4,986 3,939 200 291 96 460 184 276 $ $ $ $ $ $ $ $ 5,817 4,596 190 323 100 610 244 366 $ $ $ $ $ $ $ $ 6,108 4,826 180 339 104 660 264 396 $ $ $ $ $ $ $ $
11 128,275 $ 5.00%
6,414 5,067 172 356 108 711 284 427 $ $ $ $ $ $ $ $
12 134,689 5.00%
6,734 5,320 98 374 112 830 332 498.22
In years 3 and 4, the project will lose money but Nike will offset these losses against other prots to save taxes.
Aswath Damodaran!
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There are a number of allocation mechanisms that can be used to compute operating income, and the return on capital is affected by decisions on allocation. For instance, I allocated the entire investment in the distribution system expansion to this project. If I had chosen to allocate 50%, the return on capital would have been much higher.
Your choices on depreciation have profound effects on return on capital. Using a more accelerated depreciation method would raise your return on capital substantially.
Note that the operating income is computed after marginal taxes (Why?) and does not include the tax savings due to interest expenses (Why?)
Aswath Damodaran!
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Aswath Damodaran!
11!
Aswath Damodaran!
12!
1
1,000 $ $ $ $ $
1,000
2 500
121
5 $ 69 $ 192 $ 77 $ $ 45
7 $ 178 $ 235 $ 84 $ $ 53
8 $ 276 $ 200 $ 89 $ $ 58
9 $ 366 $ 190 $ 93 $ $ 20
10 $ 396 $ 180 $ 98 $ $ 21
$ 253
$ 293
(784) $ 445
$ 507
$ 628
$ 653
Includes book value of xed assets and working capital at the end of year 12
Aswath Damodaran! 13!
The effect on the NPV is the difference in present values between investing in year 6 versus year 11:
PV of investing early = 1126/1.082^6 1243/1.082^11 = - $179 million
The depreciation tax benets reduce this cost a little.
Aswath Damodaran!
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Aswath Damodaran!
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Aswath Damodaran!
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1
1,000 $ $ $ $ $
1,000
2 500
121
5 $ 3 $ 302 $ 77 $ 308
$ 45 29
6
$ $ $ $ $ $ 67 304 80 310 1,126 49
7 $ 69 $ 417 $ 84 $ 426
$ 53 92
(82) $ (29) $
$ (1,034) $
$ 174
$ 305
$ 338
11 12 $ 300 $ 371 $ 384 $ 311 $ 103 $ 108 $ 391 $ 317 $ (1,243) $ 22 $ 9 $ 7,613 $ 1,616 $ 8,076
Aswath Damodaran!
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To make this project have innite life, with a growth rate of the ination rate, I have to preserve existing assets. I have assumed that the replacement of depleted assets will occur at a cost 2% over the depletion rate. Thus, to replace the assets that are depleted in year 1 (captured in the depreciation of $ 300 million), I assume that capital maintenance has to be $ 306 million.
This additional capital maintenance will increase book value and depreciation in subsequent periods.
None of the assets are salvaged in this case, since the project continues forever.
If I had assumed a shorter extension after 10 years, there would have been lower capital maintenance expenditures all the way through. The net present value does not change much.
Aswath Damodaran!
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Aswath Damodaran!
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Aswath Damodaran!
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Aswath Damodaran!
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$1,500
Breakeven = 17%
$1,000 Breakeven = 19% $500 Breakeven = 22% $0 Breakeven = 26 % -$500 7% 6% 5% 4% 21% 22% 23% 3% 24% 25%
20%
EBITDA Margin
Aswath Damodaran!
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Aswath Damodaran!
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