North Point Group - Kimi Ford Case Study

EXECUTIVE SUMMARY

Kimi Ford is a portfolio manager of North Point Group and was analyzing Nike performance. Kimi was planning to buy some share for the mutual fund management firm she worked in. Nike held a meeting on June 28,2001 and stating that they would revitalized the company and push their apparel line and targeting mid-price segment. And that had divided experts opinion into investing more and holding the decision to buy.

Nike’s share is worth $58.19 while the current share price is $42.09. Regardless the struggling Nike was experiencing , by using WACC calculation we have managed to conclude that Nike’s share was undervalued. And suggest Kimi Ford acting as the portfolio manager of North Point Group to buy more share from Nike.

CASE OVERVIEW

Kimi Ford as a portfolio manager at NorthPoint Group, a mutual fund management firm, was considering buying some shares for the firm from Nike. However Nike’s market share has fallen from 48% to 42% in 1997. On June 28 , 2001, Nike had held an analysts’ meeting in which the management revealed a plan to revitalize the company by developing more athletic shoe products in the mid-priced segment and to push its apparel line. The company executives targeted 8% to 10% of revenue growth and earning growth targets above 15%. Some analysts said that the targets were too aggressive, but the others saw the significant growth opportunities in the firm.

Ford has done a quick analysis and revealed that Nike’s share price was undervalued at discount rates below 11.17%. By calculating the the Nike’s cost of capital, it will help Ford to decide whether she should buy Nike’s share or not.

KEY ISSUES

Joanna Cohen calculation in WACC should be reviewed again to give the right recommendation to Kimi Ford regarding an investment at Nike.

ANALYSIS

The cost of capital is the rate of return that the bondholders and the owners require as compensation for the contribution of capital. The most common way to estimate the rate of return is to calculate the marginal cost of each of the various sources of capital and then calculate the weighted average of that cost, and it is called Weighted Average Cost of Capital (WACC). WACC is calculated by the investors, not the managers. WACC will help them to make the investment decision. We used the long term assumption to calculate the WACC.

WACC = Wd Rd (1 - t) + We Re

Wd : proportion of debt that the company uses when it raises new funds Rd : before-tax marginal cost of debt

t : company’s marginal tax rate

We : proportion of equity that the company uses when it raises new funds

Re : marginal cost of equity

To get the WACC, we should find the value of cost of debt and cost of equity.

Cost of Debt

A firm’s cost of debt is the effective interest rate a company pays on its debt obligations. The alternative approaches to calculate the cost of debt are : Yield-to-maturity approach and debt-rating approach. Joanna’s approach is yield-to-maturity, but she made a mistake by calculating the cost of debt based on historical data, instead of market value.

According to the case, Nike’s bond issued on 1996 with maturity 25 years, but only 20 years left since the calculation that Joanne did was at 2001. Interest was paid 6.75% twice a year.

Po = $ 95.6

FV =$100

PMT = 67.5% of 100 : 2 = $ 33.75 N =20x2

Cost of debt before tax :

To get i, we use financial calculator online and the result is 7,17%

Cost of debt after tax :

To calculate the cost of debt after tax, we use the average of tax rate based on Exhibit 2 in the case,

which is 38%.

𝑅𝑖 = 7.17%𝑥(1 − 38%)=4.45%

𝑅𝑖 = 𝑅𝑑 𝑥 (1 − 𝑇)

Cost of Equity

A firm’s cost equity represents the compensation the market demands in exchange for owning the asset and bearing the risk of ownership.

There are several method to calculate the cost of equity :

a) CAPM (Capital Asset Pricing Model)

To quantify the relationship between risk and return, especially measure how much additional return an investor should expect from taking a little extra risk, we use CAPM model. This model give an understanding the basic risk-return tradeoffs involved in all types financial decisions. The equation is:

Rf = 5.74%, use Current Yields 20-year

= 0.69, use the recent beta June 30th 2001

Rm- Rf = 5.9%, use geometric mean because this value for long term so it is more stable From the calculation, the result is 9.81%.

Advantages using this model :

Disadvantages using this model : a.

b) DDM ( Dividend Discount Model)

The other method to calculate Cost of Equity other than CAPM we can use DDM. By assuming price reflects the intrinsic value of a share we can calculate cost of Equity using equation:

RE = D1/ P0 + g

D1 = 0.48 x (1 + 5.5%)0.5064 (dividend of the next period) P0 = $42.09 (current stock price)

a. The model takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk)

b. CAPM still remains popular due to its simplicity and utility in a variety of situations.

CAPM using historical data as the inputs to solve for a future return of asset i. However, the history may not be sufficient to use for predicting the future and modern CAPM approaches

have used betas that rely on future risk estimates.

b. The model assumes that all active and potential shareholders have access to the same