Professional Documents
Culture Documents
: Cost of Cupital
On July 5, 2001, Kimi Ford, a porrfolio 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. While 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 20.7Vo, even as the S&P 500 fell
IO.lVo. At the end of June 2001, the fund's year-to-date returns stood at 6.4Vo versus
-74%o 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.l 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 failen
from almost $800 million to $580 million (see Exhibit L). Nike's market share in
U.S. athletic shoes had fallen from 48Vo, \n 1991, to 427o in2OOO.2In addition, recent
supply-chain issues and the adverse effect of a strong dollar had negatively affected
revenue.
management revealed plans to address both top-line growth and
operating performance. To boost revenue, the company would develop more athleticshoe products in the midpriced segment3-a segment that Nike had overlooked in recent
years. Nike also planned to push its apparel line, which, under the recent leadership of
At the meeting,
Robson, "Just Do . . . Something: Nike's insularity and Foot-Dragging Have It Running in P1ace,"
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 O 2001 by the University ofVirginia Darden
School Foundation. Charlottesville, VA. A11 rights reserved. Tb order copies, send an e-mail ro saies@
dardenbusinesspublishing.com. No part of this publicafion may be reproduced, stored in a retrieval syslem,
used in a spreadsheet, or transmitted in any form or by any means-electronic, mechanical, photocopying,
recording, or otherwise-without rhe permission of the Darden School Foundation. Rev. 10/05.
40
Part
Cost of Capital
industry veteran Mindy Gr-ossman,4 had performed exkemely well. On the cost side,
Nike would exeft more effort on expense control. Finalty, company executives reiterated their long-lerm revenue-growttr targets of 9Vo to \l%o and eamings-growth targets
of
above LSVo.
Analysts' reactions were mixed. Some thought the financial targets were too
aggressivq others saw significant growth opportuoities in apparel and in Nike's international businesses.
Kimi Ford read all the analysts' report$ that she could find about the June 28
meeting, but the reports gave her no clear guidance: a khman 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.
Her forecast showed that, at a discount rate of t2Vo, Nike was overvalued at its
crurent share price of $42.09 (Exhibit 2). However, she had dore a quick sensitivity
analysis that revealed Nike was undervalued at discounr rates below ll.Ll 7o . Because
she was about to go into a meoting, she asked her new assistant, Joanna Cohen, to
estimate Nike's cost of capital.
Cohen immediately $ithered all the data she thought she might need (Exhibits 1
through 4) and began to work on her analysis. At the end of the day, Cohen submitted her cost-of-capital estimate and a memo (Elhibit 5) explaining her assumptions
to Ford.
'
oMindy
'j
Grossman joined Nike in September 2000. She was the former president and chief executive
of
Case
rl
14
ztr
gf dollarsrexcept
data)
. r":
lgg5i
.,,
:'
1999
Flevenues
Gross profit
Selling and administrative
ft,Operating income
I Interest expense
Other expense, net
Restructuring charge, net
,N"t in"om"
'Diluted earnings per
;. common share
Average shares
outstanding (diluted)
'ir
(%)
Revenue
rncome
llAet income
:,Mergins (%)
iGross margin
Operating margin
margrn
Effective tax raie (%).
2001
2000
$9,488.8
11.7
,U. ,r.
,?z:.3
856.8
44.1
21.5
45.1
746.1
294.7
984.9
45.0
1'014-2
23.2
(2.5)
919.2
649.9 899.1 1,255.2 653.0
340.1
250.2 345.9 499.4 253.4
$ 399.7 $ 553.2 $ 795.8 $ 399.6 $ 451.4 $ S29,1 $
58.7
34.1
921-4
3?1.7
589.7
$1.s6
$1.88
$2.68
$1.35
$1.57
$2.07
$2.16
294.0
293.6
297.O
296.0
287.5
275.8
273.3
(8.1)
(0.8)
13.0
2.5
15.0
zo.J
5.5
3.0
36.5
9.0
4.2
37.4
9.8
5.1
39.9
10.9
6.4
39.0
10.7
6.2
38.8
39.5
37.0
36.0
35.9
42.2
38.4
42.0
41.5
43.9
39.6
40.1
15.0
8.7
38.6
'15.1
8.5
38.5
4.O
(37.4)
(49.8)
U.S. statutory tax rate was 35%. The state tax varied yearly from 2.5"klo 3.5"k.
of data: Company liling with the Securities and Exchange Commission (SEC), UBS Warburg.
1.8
2t2
Part
EXHIBIT
Three
2 |
2003
2AO4
2005
2007
2006
2008
2009 2010
2011
Assumptions:
Bevenue growth (%)
COGS/sales ('/d
7.0
b.5
6.5
60.0
60.0
59.5
27.0
26.5
38.0
38.0
38.0
38.0
38.0
38.0
38.0
38.0
1.5
11.5
11.5
I 1.5
SG&A"/sates (%)
6.0
59.0
26.0
38.0
38.0
1 r.5
qoE
6.0
59.0
25.5
38.0
38.0
11.5
6.0
58.5
25.0
38.0
38.0
11.5
6.0
58.5
25.0
38.0
38.0
11_5
6.0
58.0
25.0
38.0
38.0
11.5
6.0
58.0
25.0
38.0
38.0
11.5
12.00
3.00
Taxes
NOPAT
$ 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
463.0 513.6 590.8 652.5 741.0 811.7 915.9 970.8 1,060.2 1,123.9
755.4 838.0 963.3 1 ,064.5 1,209.0 ,324.3 1 ,494.3 1 ,584.0 1,729.9 1,833.7
1
Change in NWC
Free cash flow
(1e5.0)
1
.014.0
,014.0
1 ,572.7
17,998.3
Terminal value
/o+. I
Total flows
ooJ.
777
$ 682.3 $ 528.6
Enterprise value
$1
1,296.6
.6
866.2
553.5$550.5$57s.4
,415.4
$10,1 18.8
Current shares
outstanding
Equity value per share
zt t-3
3?El
current share
rate
8.00%
8.50%
9.00%
Discount
9.50%
10.00%
10.50%
11.00%
11.177o
11.50y"
12.00%
Equity value
$ 75.80
67.85
61.25
55.68
50.92
46.81
43.22
42.09
40.07
37.27
il:11,1:rrr
t.-r
price:
4mtl
(261.0)
19,571.0
$ 53s.0 $6,301.2
Case
EXHIBIT
3 |
14
2000
254.3
1,569.4
1,446.0
111.5
215-2
304.0
1,621 .4
1,424.1
113.3
162.5
3,596.4
3,625.3
1,583.4
410.9
Total assets
zoo.z,
$ 5^8563
,618.8
397.3
178_2
$ 5,819.6
Longterm debt
Deferred income taxes and other liabilities
Redeemable preferred stock
Shareholders' equity:
Common stock, par
Capital in excess of stated value
Unearned stock compensation
Accumulated other comprehensive income
Retained earnings
Total shareholders' equity
924.2
543.8
5.4
855.3
432.0
621 .9
472.1
2,140.O
1,786.7
470"3
1 10.3
0.3
435.9
102.2
0.3
2.8
369.0
(11.7)
2.8
459.4
(e.e)
(152.1)
3,194.3
50.1
21.9
(1 1
1.1)
2,887.0
3,136.0
3,494.5
$ s,856.9
$ 5,819.6
Source of data: Company filing with the Securities and Exchange Commission (SEC).
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Case
TO:
FROM:
DATE:
SUBJECT:
14
215
Kimi Ford
Joanna Cohen
JulY 6, 2001
is 8.4"/""
Based on the tollowing assumptions, my estimate of Nike's cost of capital
l.
Debt
$1
Equity
s.a
855.3
435.9
,296.6 )
2O0O and 2001 , were $1 ,444.6 million and $1 ,296.6 million, respectively
216
Part
EXHfBE
lV. Cost
Three Estimathg
5 |
(continued)
of Equity
Putting it AllTogether
lnputting all my assumptions into the WACC formula, my estimate of Nike's cost of capital is 8.4"/o.
WACC
:
=
:
G(l
2.77" x 27.Ao/o
8.4%
.,li.
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+$ri
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