Nike

Background

Kimi Ford, a portfolio manager of mutual- fund management firm, NorthPoint Group, was considering buying some shares for the NorthPoint Large-Cap Fund, which invested mostly in Fortune 500 companies, with an emphasis on value investing. The NorthPoint Large-Cap Fund has performed well despite the decline of the stock market, earning a return of 20.7% and 6.4% versus that of S&P 500 falling at 10.1% and standing at -7.3%, in 2000 and at the end of 2001, respectively.

Nike held an analyst meeting to discuss its fiscal year 2001 results and communicate a strategy for revitalizing the company from its revenues of USD 9B since 1997 and a falling income from USD 800M to USD 580M. The Nike management revealed plans to address top-line growth and operating performance, which includes developing athletic shoe products in mid-priced segment to boost revenues and pushing its apparel line while exerting effort in cost control.

This results in mixed analyst reactions. Kimi Ford read analysts’ reports and gave no clear guidance. She decided to develop her own discounted cash flow forecast resulting to the following:

• At a discount rate of 12%, Nike was overvalued at its current share price of USD 42.09

• Through a quick sensitivity analysis, Nike was undervalued at discount rates below 11.17%

Her assistant, Joanna Cohen, estimated Nike’s cost of capital at around 8.4%.

Identification of the Problem

The case will determine the following:

1. Is the computed cost of capital correct? If no, what is the correct cost of capital?

2. Should an investment in Nike be added in the NorthPoint Large-Cap Fund?

Analysis

The Weighted Average Cost of Capital (WACC) represents the average cost of sources of capital of a company. In this case, Nike’s WACC is the average of the company’s cost of debt and cost of equity.

Cohen’s computation of Nike’s WACC resulted to a value of 8.4%. We do not agree with this computation, and we will compute our own WACC in the following...