Nike Apparel

Nike Apparel

Executive Summary

пЃ® 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 finite life

assumption, is 13.47%, which is higher than the cost of capital of 9.71%.

• The net present value of this project, using a cost of capital of 9.71%

• is $ 88 million, under the conservative assumption of a finite life of 12 years

• is $ 94 million, under the more realistic assumption of an infinite life

• On the two variables that are the most critical - market share and

operating margin - the firm has a reasonable margin for error on market

share and a narrower margin for error on operating margins.

пЃ® 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.

Cost of Capital: Nike Apparel

пЃ® Debt to Equity ratio for Nike

• Market Value of Equity = $ 64* 498.7 mil = $ 31,917 mil

• Market Value of Debt = $49.7 (PV of annuity, 4 yrs, 5.75%) + $541.2/1.05754 = $

606 million

• PV of Operating lease commitments = $1,229 million

• Market Value D/E Ratio = 5.75%; MV Debt/Capital Ratio = 5.44%

пЃ® Unlevered Beta for Apparel Business

• Average Beta of Apparel firms = 1.18

• Aggregate D/E Ratio of Apparel firms = 12.59% (The average is 22.25%)

• Unlevered Beta = 1.18/(1+ (1-.4) (.1259)) = 1.097

пЃ® Beta for Nike Apparel = 1.097 (1+ (1-.4)(.0575)) = 1.135

пЃ® Cost of capital calculation for apparel project

• Cost of Equity = 4.5% + 1.135 (4.91%) = 10.07%

• After-tax Cost of Debt = 5.75% (1-.4) = 3.45%

• Cost of Capital = 10.07% (.9456) + 3.45% (.0544) = 9.71%

Nike Apparel: Operating Income

Revenues $ - $ - $ 1,736 $ 2,279 $ 2,872 $ 3,518 $ 4,221 $ 4,986 $ 5,817 $ 6,108 $ 6,414 $ 6,734

- Oper. Exp. $ - $ - $ 1,372 $ 1,800 $ 2,269 $ 2,779 $ 3,335 $ 3,939 $ 4,596 $ 4,826 $ 5,067 $ 5,320

- Deprec'n $ - $ - $ 300 $ 240 $ 192 $ 154 $ 235 $ 200 $ 190 $ 180 $ 172 $ 98

- Allocated G&A $ - $ - $ 166 $ 187 $ 210 $ 235 $ 262 $ 291 $ 323 $ 339 $ 356 $ 374

- Advertising Exp. $ - $ - $ 69 $ 73 $ 77 $ 80 $ 84 $ 89 $ 93 $ 98 $ 103 $ 108

Operating Profit $ - $ - $ ( 171)$ ( 22)$ 124 $ 269 $ 304 $ 468 $ 616 $ 666 $ 716 $ 835

Taxes $ - $ - $ ( 68)$ ( 9)$ 50 $ 108 $ 122 $ 187 $ 247 $ 266 $ 287 $ 334

EBIT(1-t) $ - $ - $ ( 102)$ ( 13)$ 74 $ 162 $ 183 $ 281 $ 370 $ 400 $ 430 $ 500.81

Some Thoughts on Operating Income...

пЃ® 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.

пЃ® Your choices on depreciation have profound effects on return on

capital. Using a more accelerated depreciation method would raise

your return on capital substantially.

пЃ® Note that the operating income is computed after marginal taxes

(Why?) and does not include the tax savings due to interest expenses

(Why?)

Nike: Return on Capital

Year EBIT(1-t) Average BV ROC

1 $0 $1,500

2 $0 $2,311

3 -$102 $2,490 -4.11%

4 -$13 $2,260 -0.57%

5 $74 $2,087 3.57%

6 $162 $1,961 8.24%

7 $183 $2,077 8.79%

8 $281 $2,002 14.01%

9 $370 $1,924 19.22%

10 $400 $1,830 21.83%

11 $430 $1,739 24.72%

12 $501 $1,284 39.00%

Average= 13.47%

Nike Apparel: After-tax Cash Flows

EBIT(1-t) $ - $ - $ ( 102)$ ( 13)$ 74 $ 162 $ 183 $ 281 $ 370 $ 400 $ 430 $ 500.81

+ Deprec'n $ - $ - $ 300 $ 240 $ 192 $ 154 $ 235 $ 200 $ 190 $ 180 $ 172 $ 98

+ Fixed Allocated Exp (1-t) $ - $ - $ 69 $ 73 $ 77 $ 80 $ 84 $ 89 $ 93 $ 98 $ 103 $ 108

- Cap Ex $ 1,000 $ 1,000 $ 500 $ - $ - $ - $ - $ - $ - $ - $ - $ - $ -

- Opp. Cost of Dist'n System $ 1,126 $ (1,243)

- Chg in WC $ - $ 121 $ 38 $ 41 $ 45 $ 49 $ 53 $ 58 $ 20 $ 21 $ 22 $ -

+ Salvage Value $ 1,470

After-tax Cashflow $ ( 1,000) $ ( 1,000) $ ( 621) $ 229 $ 259 $ 298 $ ( 780)$ 449 $ 511 $ 632 $ 656 $ 1,926 $ 2,177

Includes book

value of fixed

assets