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Nike, Inc.: Cost of Capital
On July 5, 2001, Kimi Ford, a portfolio manager at NorthPoint 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 NorthPoint 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-economy 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.1 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
shoes had fallen from 48%, in 1997, to 42% in 2000.2 In addition, recent supply-chain issues and the adverse
effect of a strong dollar had negatively affected revenue.
At the meeting, management revealed plans to address both top-line growth and operating performance.
To boost revenue, the company would develop more athletic-shoe products in the mid-priced segment3—a
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,4 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 earnings-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.
1 Nike’s fiscal year ended in May.
2 Douglas Robson, “Just Do…Something: Nike’s Insularity and Foot-Dragging Have It Running in Place,” BusinessWeek (2 July 2001).
3 Sneakers in this segment sold for $70 to $90 a pair.
4 Mindy Grossman joined Nike in September 2000. She was the former president 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 F. Bruner and with the assistance of Sean
D. Carr. The financial support of the Batten Institute is gratefully acknowledged. It was written as a basis for class discussion rather than to illustrate
effective or ineffective handling of an administrative situation. Copyright 2001 by the University of Virginia Darden School Foundation,
Charlottesville, VA. All rights reserved. To order copies, send an e-mail to sales@dardenbusinesspublishing.com. No part of this publication may be reproduced,
stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the
permission of the Darden School Foundation. Our goal is to publish materials of the highest quality, so please submit any errata to
editorial@dardenbusinesspublishing.com.
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Page 2 UV0010
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.
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Page 3 UV0010
Exhibit 1
Nike, Inc.: Cost of Capital
Consolidated Income Statements
Year Ended May 31 1995 1996 1997 1998 1999 2000 2001
(in millions of dollars except per-share data)
Revenues $ 4,760.8 $ 6,470.6 $ 9,186.5 $ 9,553.1 $ 8,776.9 $ 8,995.1 $ 9,488.8
Cost of goods sold 2,865.3 3,906.7 5,503.0 6,065.5 5,493.5 5,403.8 5,784.9
Gross profit 1,895.6 2,563.9 3,683.5 3,487.6 3,283.4 3,591.3 3,703.9
Selling and administrative 1,209.8 1,588.6 2,303.7 2,623.8 2,426.6 2,606.4 2,689.7
Operating income 685.8 975.3 1,379.8 863.8 856.8 984.9 1,014.2
Interest expense 24.2 39.5 52.3 60.0 44.1 45.0 58.7
Other expense, net 11.7 36.7 32.3 20.9 21.5 23.2 34.1
Restructuring charge, net – – – 129.9 45.1 (2.5) –
Income before income taxes 649.9 899.1 1,295.2 653.0 746.1 919.2 921.4
Income taxes 250.2 345.9 499.4 253.4 294.7 340.1 331.7
Net income $ 399.7 $ 553.2 $ 795.8 $ 399.6 $ 451.4 $ 579.1 $ 589.7
Diluted earnings per common share
Average shares outstanding (diluted)
$ 1.36 $ 1.88 $ 2.68 $ 1.35
$
294.0 293.6 297.0 296.0
1.57
287.5
$ 2.07
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
39.9
1
0.9
6.4
39.0
1
0.7
6.2
Effective tax rate (%)* 38.5 38.6 38.8 39.5 37.0 36.0
*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.
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Page 4 UV0010
Exhibit 2
Nike, Inc.: Cost of Capital
Discounted Cash Flow Analysis
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Assumptions:
Revenue growth (%) 7.0 6.5 6.5 6.5 6.0 6.0 6.0 6.0 6.0 6.0
COGS/sales (%) 60.0 60.0 59.5 59.5 59.0 59.0 58.5 58.5 58.0 58.0
SG&A/sales (%) 28.0 27.5 27.0 26.5 26.0 25.5 25.0 25.0 25.0 25.0
Tax rate (%) 38.0 38.0 38.0 38.0 38.0 38.0 38.0 38.0 38.0 38.0
Current assets/sales (%) 38.0 38.0 38.0 38.0 38.0 38.0 38.0 38.0 38.0 38.0
Current liabilities/sales (%) 11.5 11.5 11.5 11.5 11.5 11.5 11.5 11.5 11.5 11.5
Yearly depreciation and capex equal each other.
Cost of capital (%) 12.00
Terminal growth rate (%) 3.00
Discounted Cash Flow
(in millions of dollars except per-share data)
Operating income $ 1,218.4 $ 1,351.6 $ 1,554.6 $ 1,717.0 $ 1,950.0 $ 2,135.9 $ 2,410.2 $ 2,554.8 $ 2,790.1 $ 2,957.5
Taxes 463.0 513.6 590.8 652.5 741.0 811.7 915.9 970.8 1,060.2 1,123.9
NOPAT
Capex, net of depreciation
Change in NWC
Free cash flow
Terminal value
Total flows
Present value of flows
755.4
–
8.8
764.1
764.1
$ 682.3 $
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
– – – – – – – – –
(174.9) (186.3) (198.4) (195.0) (206.7) (219.1) (232.3) (246.2) (261.0)
663.1 777.6 866.2 1,014.0 1,117.6 1,275.2 1,351.7 1,483.7 1,572.7
17,998.3
663.1 777.6 866.2 1,014.0 1,117.6 1,275.2 1,351.7 1,483.7 19,57
1.0
528.6 $ 553.5 $ 550.5 $ 575.4 $ 566.2 $ 576.8 $ 545.9 $ 535.0 $ 6,30
1.2
Enterprise value
Less: current outstanding debt
Equity value
Current shares outstanding
Equity value per share
$
$
$
11,415.4
1,296.6
10,118.8
271.5
37.27 Current share price: $ 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.
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Page 5 UV0010
Exhibit 3
Nike, Inc.: Cost of Capital
Consolidated Balance Sheets
As of May 31,
(in millions of dollars) 2000 2001
Assets
Current assets:
Cash and equivalents $ 254.3 $ 304.0
Accounts receivable 1,569.4 1,621.4
Inventories 1,446.0 1,424.1
Deferred income taxes 111.5 113.3
Prepaid expenses 215.2 162.5
Total current assets 3,596.4 3,625.3
Property, plant and equipment, net 1,583.4 1,618.8
Identifiable intangible assets and goodwill, net 410.9 397.3
Deferred income taxes and other assets 266.2 178.2
Total assets $ 5,856.9 $ 5,819.6
Liabilities and shareholders’ equity
Current liabilities:
Current portion of long-term debt $ 50.1 $ 5.4
Notes payable 924.2 855.3
Accounts payable 543.8 432.
0
Accrued liabilities 621.9 472.1
Income taxes payable – 21.9
Total current liabilities 2,140.0 1,786.7
Long-term debt 470.3 435.9
Deferred income taxes and other liabilities 110.3 102.2
Redeemable preferred stock 0.3 0.3
Shareholders’ equity:
Common stock, par 2.8 2.8
Capital in excess of stated value 369.0 459.4
Unearned stock compensation (11.7) (9.9)
Accumulated other comprehensive income (111.1) (152.1)
Retained earnings 2,887.0 3,194.3
Total shareholders’ equity 3,136.0 3,494.5
Total liabilities and shareholders’ equity $ 5,856.9 $ 5,819.6
Source of data: Company filing with the Securities and Exchange Commission (SEC).
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Page 6 UV0010
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
3-month 3.59%
6-month 3.59%
1-year 3.59%
5-year 4.88%
10-year 5.39%
20-year 5.74%
Historical Equity Risk Premiums (1926-1999)
Geometric mean 5.90%
Arithmetic mean 7.50%
Current Yield on Publicly Traded Nike Debt*
Coupon 6.75% paid semi-annually
Issued 07/15/96
Maturity 07/15/21
Current Price $ 95.60
0.4
0.5
0.6
0.7
0.8
0.9
1.0
1.1
1.2
1.3
Ja
n
–
0
0
M
ar
-0
0
M
ay
-0
0
Ju
l-
0
0
S
ep
-0
0
N
o
v
-0
0
Ja
n
–
0
1
M
ar
-0
1
M
ay
-0
1
Ju
l-
0
1
Nike S&P 500
Nike Historic Betas
1996 0.98
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 0.10 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:
$ 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.
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Page 7 UV0010
Exhibit 5
Nike, Inc.: Cost of Capital
Joanna Cohen’s Analysis
TO: 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%:
I. Single or Multiple Costs of Capital?
The first question I considered was whether to 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%:
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Page 8 UV0010
Exhibit 5 (continued)
Capital Sources Book Values (in millions)
Debt
Current portion of long-term debt $ 5.4
Notes payable 855.3
Long-term debt 435.9
$ 1,296.6 27.0% of total capital
Equity $ 3,494.5 73.0% of total capital
III. 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.1 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 = Kd(1 − t) × D/(D + E) + Ke × E/(D + E)
= 2.7% × 27.0% + 10.5% × 73.0%
= 8.4%
1 Debt balances as of May 31, 2000 and 2001, were $1,444.6 million and $1,296.6 million, respectively.
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Nike, Inc.: Cost of Capital
Exhibit 1 Nike, Inc.: Cost of Capital
Exhibit 2 Nike, Inc.: Cost of Capital
Exhibit 3
Exhibit 4 Nike, Inc.: Cost of Capital
Exhibit 5 Nike, Inc.: Cost of Capital
Exhibit 5 (continued)
| Solution Excel File — Fill in Yellow Cells — Submit this Excel File with your Write Up | |||||||||||||||||||||||||||||||
| Cost of | Debt | <--- | show formula, not a hard-coded number | ||||||||||||||||||||||||||||
| Tax Rate | |||||||||||||||||||||||||||||||
| After-Tax Cost | |||||||||||||||||||||||||||||||
| Cost of | Equity | ||||||||||||||||||||||||||||||
| 1. CAPM: | exhibit 4 has options | 2. DDM: | |||||||||||||||||||||||||||||
| Risk Free Rate | Dividend Yield | ||||||||||||||||||||||||||||||
| Equity Risk Premium | Growth | ||||||||||||||||||||||||||||||
| Beta | |||||||||||||||||||||||||||||||
| Cost of Equity | 0.00% | ||||||||||||||||||||||||||||||
| 3. Earnings Cap | |||||||||||||||||||||||||||||||
| Component | Weights | WACC | |||||||||||||||||||||||||||||
| Total | 0.0% |
Individual Assignment – Nike Case Write-Up
Mergers & Acquisitions
The Nike Case Study is intended to serve as an introduction to the calculation of the Weighted-
Average Cost of Capital (WACC) of the firm.
The case provides a WACC calculation that contains errors based on conceptual
misunderstandings. Students will identify and explain the mistakes in the analysis. The case
assumes that students have been exposed to the WACC, CAPM, the dividend discount model,
and the earnings capitalization model.
Complete the Nike Case Study reading (found in the Readings and Course Materials folder).
Put yourself in the role of one of the stakeholders in the case and reflect on the information in
the document. Make sure to address the following items:
1. What is the WACC and why is it important to estimate a firm’s cost of capital? [2 to 3
sentences max.]
2. Calculate your own WACC for Nike. Note the following requirements:
a. Calculate the Cost of Debt based on the information provided in the case. [Fill in
the highlighted Excel cells; explain your calculation briefly]
b. When you are calculating the Cost of Equity, do it under three different
scenarios:
i. CAPM [Fill in Excel file]
ii. Dividend Discount Model [Fill in Excel file]
iii. Earnings Capitalization method [Fill in Excel file]
c. Summarize what the WACC would be in 3 different scenarios: using the Cost of
Debt and three different Cost of Equity percentages.
3. Highlight/note any differences versus Joanna Cohen’s calculation.
4. Which of your three WACC calculations (based on the 3 different Costs of Equity) do
you think makes the most sense and why?
You should have the following section in your final submission. They should look something like
this:
1. What is your WACC and Why is it Important?
Your answer…
2. WACC Calculations
A Summary of your findings. You will submit the Excel file separately.
3. Differences vs. Joanna Cohen
Your answer…
4. WACC Recommendation
Your answer….
Students will submit the filled out provided Excel file (answering the highlighted cells), and their
write-up by the due date. The write-up should be brief and organized to answer the questions
listed in section II. It should be 2 pages maximum, double-spaced, with Calibri (12 pt). This
assignment should also have a cover page with:
• Your name
• The course number/name
• Your instructor’s name
Rubric
This is an individual assignment and accounts for 5% of your overall grade. You will be
assessed according to the following rubric.
Superior
High
Quality
Average Below
Average
Poor
Formatting and Creativity – Student
correctly incorporates all formatting
requirements. Student identifies a role in
the case and analyzes the case from that
perspective; i.e. the student “owns” the
case.
10 – 9 pts 8 pts 7 pts 6 pts 5 – 0 pts
Part A – Student defines WACC and
effectively communicates its importance in
estimating a firm’s cost of capital.
5 pts 4 pts 3 pts 2 pts 1 pt
Part B – Calculates correct answer for part 1
and includes all supporting calculations;
calculates answers for part 2 and includes
all supporting calculations.
10 – 9 pts 8 pts 7 pts 6 pts 5 – 0 pts
Part C – Identify obvious errors and explain. 5 pts 4 pts 3 pts 2 pts 1 pt
Part D – Justifies selection of WACC
calculation and provides rational analysis
10 – 9 pts 8 pts 7 pts 6 pts 5 – 0 pts
Clarity and Mechanics – Writing is free of
grammatical and spelling errors.
Writing style communicates ideas clearly.
10 – 9 pts 8 pts 7 pts 6 pts 5 – 0 pts
