MBA 505

Financial Management

Nike, Inc.: Cost of Capital

Ini case Financial yang ketiga, yang pendek banget! Tapi presentasinya tetep aja ampe jam 7..capek
deh..

Nike, Inc. : Cost of Capital

Background
NorthPoint Large-Cap Fund adalah salah satu perusahaan manajemen pendanaan yang berada
dibawah NorthPoint Group yang mengalokasikan dananya untuk berinvestasi di perusahaan-
perusahaan besar. NorthPoint Large-Cap Fund sudah banyak menginvestasikan dananya dalam
perusahaan-perusahaan Fortune 500, yang menekankan pada nilai investasi. Top holdingsnya
mencakup ExxonMobil, General Motors, McDonald’s, 3M, dan modal besar yang lainnya.
Walaupun bursa saham telah menurun sejak 18 bulan terakhir, NorthPoint Large-Cap telah
menunjukkan performanya yang cukup bagus. Pada tahun 2000, dana-dana tersebut
menghasilkan return sebesar 20.7% walaupun S&P 500 turun 7.3%.
Kimi Ford, Portfolio manajer dari NorthPoint Large-Cap sedang memutuskan untuk berinvestasi
dalam salah satu perusahaan besar di Amerika Serikat, yaitu Nike, Inc., sebuah perusahaan yang
memproduksi sepatu olahraga, tapi dia belum membuat kepastian mengenai keputusan ini,
ditambah dengan harga saham Nike, Inc. yang telah menurun secara signifikan sejak awal tahun.
Nike Inc, sebuah perusahaan manufaktur yang berdiri sejak tahun 1964 di Portland.
Awalnya perusahaan ini telah memproduksi sepatu atletis, yang kemudian berkembang sehingga
pada akhirnya memproduksi berbagai macam produk olahraga. Produk-produk yang diproduksi
oleh Nike secara umum dibagi 2 yaitu produk dengan merek Nike serta merek non-Nike. Khusus
produk bermerek Nike adalah sepatu, aparel sebagai pelengkap produk sepatu, bola olahraga,
perelatan waktu, kacamata, skates, bats. Produk bermerek Non-Nike yang diproduksi adalah
Cole-Haan line dress dan casual footwear, ice skates, skate blades, hockey sticks, hockey jerseys,
dan produk-produk lain di bawah Bauer trademark.
Nike adalah market leader untuk sepatu atletis. Pangsa pasarnya sampai tahun 2000
adalah 42%. Dengan pendapatan yang stabil yaitu sekitar 9 milliar tiap tahunnya.
Tetapi ternyata ada masalah pada bidang keuangan dari Nike. Inc,. Menurut financial
statementnya, Net income Nike menurun dari hampir $800 juta pada tahun 1997, menjadi $589,7
juta di tahun 2001. Selain itu, sekalipun tetap menjadi market leader, namun market sharenya di
sepatu atletik di US sebesar 42% pada tahun 2000 ternyata turun dari 48% sebelumnya.
Nike telah mengadakan meeting dengan analis-analis untuk memperlihatkan hasil fiscal
year 2001-nya. Nike menargetkan revenue growth sebesar 8-10% dan earnings-growth diatas
15%. Melihat optimisme dari Nike, ternyata para analis memiliki respon yang berbeda-beda. Hal
inilah yang membingungkan Kimi Ford apakah akan melakukan investasi di Nike atau tidak.
Lehman Brothers menyarankan Kimi Ford untuk melakukan investasi di Nike karena
menurutnya Nike memiliki kesempatan berkembang di apparel line dan di bisnis internasional.
Di lain pihak, UBS Warburg dasn analis CSFB sama sekali tidak mendukung investasi di Nike,
dengan alasan target mereka terlalu agresif.
SWOT Analysis
Strengths
 Nke, Inc. pemimpin pasar di produk sepatu olahraga.

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Financial Management

 Pendapatan yang cukup stabil dari tahun 1997.

 Citra merek yang sudah kuat di pasar dunia.
Weakness
 Pangsa pasar untuk sepatu atletik di Amerika menurun dari 48% di tahun 1997 menjadi
42% di tahun 2000.
 Harga saham yang terus menurun dari awal tahun 2001.
Opportunity
 Mengembangkan produk sepatu di segmen harga menengah yang sedang bertumbuh.
 Mendorong pendapatan melalui segmen produk apparel.
Threats
 Harga saham yang terus menurun akan terus berkelanjutan.
Statement of the problem
 Keputusan apakah yang akan dikeluarkan oleh Kimi Ford dalam investasi NorthPoint Large
Cap Fund di Nike, Inc.?
Alternative Course of Actions
 Membuat keputusan untuk investasi di Nike, Inc. dengan menggunakan perhitungan
Weighted Average Cost of Capital yang dibuat oleh Joanna Cohen.
 Menahan investasi yang akan dilakukan pada Nike, Inc.dengan mempertimbangkan keadaan
perusahaan yang sedang menurun.
Recommendation
 Kami merekomendasikan alternatif pertama, dimana Kimi Ford harus mengeluarkan
investasi untuk Nike, Inc.

CASE STUDY
NIKE INC.: COST OF CAPITAL

1. What is WACC and why is it so important to estimate a firm’s cost?

The weighted average cost of capital (WACC) is the rate at which the firm is able to raise
investment for future or ongoing projects. The WACC is an average cost because it is a weighted
average of the firm's component costs of capital. This includes the cost of debt to debt holders
and cost of equity (including preferred stock and common stocks) to share holders. WACC is
calculated considering the relative weights of each component of the capital structure- debt and
equity, and is used to see if the investment is worth taking.

Following are the reasons to why it is important to estimate a firm’s cost:-

a. Capital Budgeting Decision: It is important to estimate a firm’s cost of capital to decide

Capital Budgeting Decision. Cost of capital is used to decide whether an investment proposal
should be undertaken or not. A wrong estimation of WACC would lead to selection of a
wrong investment or rejecting a good investment proposal.

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b. Method of financing decision: The WACC can be observed constantly to see the market
changes in interest rate on load and dividend rates on stocks to make a better choice of the
source of financing when the firm needs financing. The idea here is to minimize the cost of
capital based on market changes.

c. Firms Performance: This can also be used as a measure to evaluate the performance of the
firm based on comparing the returns that it is getting from a selected project and the cost it is
incurring in raising the finance for this project.

2. Do you agree with the Joanna Cohen’s WACC calculation? Why or why not?
Joanna’s calculated weighted average cost of capital (WACC) as 8.4% using CAPM model
and I do not agree with her WACC calculations and the reasons to that are mentioned below:-

a. Joanna’s calculation uses the book value for both debt and equity. The book value of debt is
as an estimate of market value and the book value of equity should not be used when
calculating cost of capital. The market value of equity should be calculated by multiplying
the stock price of Nike Inc. by the number of shares outstanding.
b. Also, the market value of debt should be used in the calculation of the cost of debt instead of
the book value used by Joanna. She should have discounted the value of long-term debt that
appears on the balance sheet ($ 435.9) at Nike’s current coupon.
c. Hence, this led to incorrect weights for the cost of equity and cost of debt.

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3. If you don’t agree with Joanna’s analysis calculate your own WACC for Nike.

Market Value of Equity = Share Price x No. of shares

= $42.09 x 271.5
= $11427.435
Market Value of Debt = Current LT + Notes Payable + LT Debt (discounted)
= $5.40 + $855.30 + $408.337
= $1,269.037
Total Financing = $11427.435+ $1,269.037
= $12696.472
Weight of Equity, we = $11427.435 / $12696.472
= 90.00%
Weight of Debt, wd = $1,269.037 / $12696.472
= 10.00%

Note: Geometric mean is used to coincide with the choice to use the 20-year yield on U.S.
Treasuries

Market Risk Free Rate = 5.74% (i.e. 20-year yield on U.S. Treasuries)
Beta (β) = 0.80 (Avg. Beta based on historic betas)
Equity Risk Premium = 5.9% (Geometric Mean for Historical Equity Risk
Premium)
Cost of Equity, rs = rRF + (RPM) β
= 5.74 +(5.9) * 0.8
= 10.46%

Current Price of the Bond = $956

Par Value of the Bond = $1000
Coupon Rate = 6.75% (Semi-Annual Bond)
Time of Maturity = 20 Years
Cost of debt, rd = 3.584 x 2
= 7.167%

WACC = we x rs + wd x rd x (1 –t)
= 90% x 10.46% + 10% x 7.167% x (1 – 0.38)
= 0.44% + 9.41%
= 9.85%

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4. Calculate cost of equity using Capital Asset Pricing Model (CAPM), Dividend Discount
Model (DDM), and Earnings Capitalization Model (ECM). What are the advantages and
the disadvantages of each model?

Cost of Equity using CAPM:-

Market Risk Free Rate = 5.74% (i.e. 20-year yield on U.S. Treasuries)
Beta (β) = 0.80 (Avg. Beta based on historic betas)
Equity Risk Premium = 5.9% (Geometric Mean for Historical Equity Risk Premium)
Cost of Equity, rS = rRF + (RPM) β
= 5.74 +(5.9) * 0.8
= 10.46%

Advantages:
a. It uses only systematic risk, reflecting a reality in which most investors have diversified
portfolios from which unsystematic risk has been essentially eliminated.
b. It generates a theoretically-derived relationship between required return and systematic risk
which has been subject to frequent empirical research and testing.
c. It is clearly superior to the WACC in providing discount rates for use in investment appraisal

Disadvantages:
a. It is difficult to estimate betas for many projects.
b. People sometimes focus on market risk and exclude corporate risk, and this may be a mistake

Cost of Equity using DDM:-

Growth, g = 5.5%
Dividend Payment, D0 = $0.48
Share Price, P0 = $42.09
Cost of Equity, rS = (D0(1 + g)/P0) + g
= 6.7%

Advantages:
a. Allow significant flexibility when estimating future dividend streams.
b. Provide useful value approximations even when the inputs are overly simplified
c. Can be reversed so the current stock price can be used to impute market assumptions for
growth and expected return
d. Investors are able to suit their model to their expectations rather than force-fit assumptions
into the model

Disadvantages:
a. Subjective inputs can result in mis-specified models and bad results
b. Over-reliance on a valuation that is at heart an estimate
c. High sensitivity to small changes in input assumptions

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Cost of Equity using ECM:-

Earnings per share, E = $2.32

Share Price, P0 = $42.09
Cost of Equity, rS = E/P0
= 5.52%

Advantages:
a. Very simple to calculate.

Disadvantages:
b. Does not take into consideration the growth of the company.

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

As per Kimi Ford’s forecast, at the current share price of $42.09 Nike is over-valued at a
discount rate of 12% and under-valued at discount rate below 11.2%.

The weighted average cost of capital (WACC) by using CAPM was found out to be 9.85%. This
discount rate is less than the 11.2% which implies that the Nike share is under-valued at $42.09.

Hence, based on this forecast, Nike Inc. should be added to the North Point Large-Cap Fund at
this time because the stock is undervalued. Therefore, at this point in time we recommend a buy
decision for Nike Inc.

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