Case Analysis of Nike, Inc.: Cost of Capital

Apparently, the issue of Nike’s case is to control and check the calculation cost of capital done by Joanna Cohen who is the assistant of a portfolio manager at NorthPoint Group. But I am willing to tell you that it can be a complex case in which we can doubt about sensitivity analysis done by Kimi Ford (portfolio manager) because her assumptions such as Revenue Growth Rate, COGS / Sales, S &A / Sales, Current Assets / Sales, and Current Liability / Sales have been adopted from previous income statements and balance sheets from 1995 to 2001. Perhaps, we can take new assumptions. Generally, the case issue is to examine if the share price of Nike is undervalue or overvalue and the common stock of Nike Inc should be added to the North Point Group’s Mutual Fund Portfolio or not.

Now, let me approve Kimi Ford’s analysis and tell you only the mistakes of Joanna Cohen.

What is the cost of capital?

The cost of capital is the rate of return that a firm must earn on the projects in which it invests to maintain the market value of its stock. Cohen calculated a weighted average cost of capital (WACC) of 8.4 percent by using the Capital Asset Pricing Model (CAPM) for Nike Inc. I do not agree with Joanna Cohen because of below mentioned:

-In the field of Equity’s Cost:

Ø She should use current yields on US Treasuries 3 to 12 months at 3.59% because the yield curve is upward sloping.  Upward sloping yield curve means that North Point Group should rely to short-term financing instead of long term financing.  In fact, by short term financing, the manager can use cheaper cost of equity. It means that North Point Group should sell the purchased shares of Nike during the period of one year.

Ø In the case of value of equity, Cohen’s should use liquidation value in calculating value of equity.  Liquidation value per share is more realistic than book value because it is based on the current market value of the firm’s assets by using of balance sheet data. 

Market Value of Equity (E) Calculation:

E = Stock Price  x  Number of Shares Outstanding

= $42.09 X 271.5

= $11,427.44

This figure is should be used for market value of equity (E) rather than Joanna Cohen figure ($3,494.50).

-In the field of Debt’s Cost:

Ø In calculating value of debt, Cohen should have discounted the value of long-term debt that appears on the balance sheet. It means she should also consider the future value of total long term debt base on coupon rate.

To calculate total value of debt, the steps are as follows:

Market Value of Debt (D) Calculation:

I considered the total amount of Debt for all items which are included by a interest rate as follows:

-Current portion of long -term debt
-Notes payable
-Long - term debt
-Redeemable preferred stock

D = Current LT + Notes Payable + LT Debt (discounted) 

 = $5.40 + $855.30 + $435.9 + 0.3 

 = $1296.9

Using these figures, we can now find the market value of Nike Inc., and the company’s capital structure.

The Calculation of Weighs:

The weights of debt and equity are calculated using the market values of debt and equity as follows:

Weight of Debt (WD)


D + E = 1296.9 + 11,427.44 = 12724.34

WD = D/ D+E

WD = $ 1296.9 /$12724.34

= 10.2%

Weight of Equity (WE)

WE = E/ D +E

WE = 11,427.44/ 12724.34

     =89.8%

 Cost of Debt

There are two types of interest rate for Nike, Inc. as follows:


1) For Notes payable, Current portion of long - term debt and Redeemable preferred stock, all these debts should be cleared during the period of maximum 12 months. Therefore, I calculated the interest rate in accordance with Exhibit 1(Income Statement) for 2001 year as follows:


Interest rate = Interest payment / Operating income
Cost of Debt = Interest rate = (58.7 / 1014.2) * 100 = 5.78%
You can see this interest rate is approximately equal to 20 year yields on U.S Treasuries  
(Exhibit 4).


2) For Long - term debt, Nike, Inc. had issued the Bonds in which the Cost of debt was calculated by finding the yield to maturity on 20-year Nike Inc. debt with a 6.75% coupon semi-annually. I assumed Nike Inc. to have a single cost of capital since its multiple business segments (shoes, apparel, sports equipment, etc.) are not very different and would experience similar risks and betas.

Before-Tax Cost of Debt

I used three (3) methods as follows:

-Method (1):  Using Cost Quotations Based on Coupon Interest Rate and Yield to Maturity (YTM)

Cost of Debt = 14.14%

-Method (2): Based on calculating the IRR

Cost of Debt = 14.15%

-Method (3): Approximating the Cost Based on the Value Bond and Coupon Rate

Cost of Debt = 14%

All of the calculations have been included in my spreadsheet.

 

 

Note:  “All spreadsheets and calculation notes are available. The people, who are interested in having my spreadsheets of this case analysis as a template for further practice, do not hesitate to ask me by sending an email to: soleimani_gh@hotmail.com or call me on my cellphone: +989109250225. Please be informed these spreadsheets are not free of charge.”

 

 

As we can see, all three methods present us approximately the same amount of the cost of debt. I have chosen 14.15% for the cost of debt. 

It is important to find the relationship between the required return and the coupon interest rate. When the required return is greater than the coupon interest rate, the bond value will be less than its par value. We choose cost of debt as 14.15% because it is rational (coupon value annually is 13.50%).  When current value of bond is less than par, required return will be more than coupon rate.


Weight Average of Cost of Debt:


As I mentioned, there are two types of debt and consequently we have two types of Cost of Debt. I calculated the weight average for Cost of debt as follows:


Total debt type 1 = $5.40 + $855.30 + 0.3 = $861 
Total debt type 2 = $435.9 
Total debt = $1296.9


W (type 1) = (861 / 1296.9) * 100 = 66.4% , Cost of Debt (type 1) = 5.78%
W (type 2) = (435.9 / 1296.9) * 100 = 33.6% , Cost of debt (type 2) = 14.15%


Weight Average of Cost of Debt = (66.4% * 5.78) + (33.6% * 14.15) = 


3.84 + 4.75 = 8.59%


Therefore, the Cost of Debt is equal 8.6%

After-Tax Cost of Debt

Cost of financing must be stated on an after-tax basis.  Because interest on debt is tax deductible, it reduces the firm’s taxable income.

r_i =r_d x (1 –T)

  =8.6% x (1 – 38%)

  =5.33%

Cost of Equity

I have calculated the cost of equity by using of two methods as follows:

Ø Capital Asset Pricing Model (CAPM)

Ø Constant-Growth Valuation (Gordon) Model
 

 To be continued…….

Case Analysis of Compass Records: A good strategy Implementation (Con)

Now, let me write all “Treats” and “Weaknesses” in accordance with the case to analyze SWOT matrix (W – T) as follows:

Treats

T1: “The $32 – billion music recording industry was dominated by a handful of large, multinational corporations, which accounted for 86 percent of the market for global recorded music”

T2: “The global market for recorded music had stagnated ever since”

T3: “According to the Recording Industry Association of America (RIAA), the industry had registered no growth in any single year since 1995.”

T4: “By 2003, the recorded music sector had shrunk to 1993 levels ($32 billion), and annual dollar sales were estimated to have declined at a compound annual growth rate of 5 percent.”

T5: “And yet something like 98 percent of all records sell fewer than 5,000 copies, so if your benchmark is a million, or even 100,000, you’re obviously overlooking a lot of good music that sells well enough to deserve being out there.”

Weaknesses

W1: “Within the context of the global music business, Compass Records was tiny (very low market share).”

W2: “Brown estimated that 40 percent of Compass Records’ albums sold 5,000 units or more.”

Regarding to W –T analysis, we can mix all above mentioned to find out a new strategy as follows:

(T1, T2, T3, T4, T5, W1, W2)

New Strategy: Compass Record should focus on target sales of 5,000 copies and follow up the variety of albums. In fact, the new strategy is to increase the number of albums and target sales of 5,000 copies instead of going up the sales for an individual album.

This strategy can be translated to a combination strategy included all Intensive strategy in which we have Product development + Market penetration + Market development. It is clear, this is Corporate Level Strategy (C.L.S) of company as the strategy in action. For Business Level Strategy (B.L.S), Compass Records can gain competitive advantage from Focus strategy – Type 4 or 5 (Michael Porter’s Five Generic strategies) in which strategies such as Market penetration and Market development offer substantial focusing advantages. But we have also added Product development and we do not usually use market penetration and market development accompanied by product development strategy to be exchanged to focus strategy (type 4 or 5).

What is going on?

Here, I can say to you: “Sometimes small firms are supported by large multinational corporations, even though all of them are the competitors.”

This is just like to an Umbrella. In the field of structural engineering, it is the similar to Hanging Bridges or refers to my article of “

"The Supporter Systems (sleepers) in the Nature for Tunneling" on below link:

http://emfps.blogspot.com/2011_01_02_archive.html

 in the field of geotechnical engineering.

How can we expand this strategy to other goods?

Let me focus again on the characters of this market:

-Sales unit benchmark for 86 percent of market is 1000,000 or 100,000

-The growth rate of revenues has been declined and stagnated

-The same raw materials with the variety of finished goods

-Consumer price is approximately the same for all different products

The good strategy:

Regarding to above factors of market, major multinational corporations allow the small firms as well as utilize from scare resources such as land, labor, capital and entrepreneurship to produce the finished goods in which scare resources are the same the recorded albums.

Only you should find out the target sales of goods in market for instance, in this case, it is 5,000 copies from each album.

When the cost of goods sold has a significant increase (high PPI), we should care about the least sales units as target sales and look at the benchmark of major competitors in which two important factors are dominated:

1) The variety of goods with the same raw materials

2) The same price of different products


 

Note:  “All spreadsheets are available. The people, who are interested in having my spreadsheets  of this case analysis as a template for further practice, do not hesitate to ask me by sending an email to: soleimani_gh@hotmail.com or call me on my cellphone: +98 9109250225. Please be informed these spreadsheets are not free of charge.”

Case Analysis of Compass Records: A good strategy Implementation

When we are willing to analysis the case of Compass Records, we encounter the huge data.

There are some cases which present us so many data and assumptions but sometimes we do not need to use all data to analyze them. But in the case of Compass Records, we have to care about all data and utilize them to analysis this case.

In my opinion, the most crucial approach of this case is to design and plan a true income statement in accordance with all data for both financial strategies (to license artist’s music for a limited period of time or to produce and own the artist’s master recording outright). As the matter of fact, the designing of these income statements are the similar basic and detail engineering of a project in the field of Engineering science (the engineers who have the designing experiences, can understand the concept of my opinion). 

After preparing of these income statements, we should forecast them for next 4 and 5 years in accordance with the case’s assumptions. Then we will calculate cash in and cash out flows to obtain net cash flows. Finally, we should calculate Payback, IRR and NPV for each strategy by using of net cash flows. 

How can we design the income statements by using of data?

At the first, we should write all assumptions and data as follows:

-Sale units

-Average unit price

-Sales

-Variable costs

-Fixed costs

-Dividends

Then, we should insert all above data into an income statement framework.

Here are my results of case analysis:

Scenario (A):  The record label licensed

-Payback = 3.73 year

-IRR = 15%

-NPV = $3942.1

Scenario (B): To produce and own a master recording

-Payback = 2.45 year

-IRR = 22%

-NPV = $45808.8

Therefore, scenario (B) will be ok.

Note (1):  “All spreadsheets are available. The people, who are interested in having my spreadsheets of this case analysis as a template for further practice, do not hesitate to ask me by sending an email to: soleimani_gh@hotmail.com or call me on my cellphone: +98 9109250225.. Please be informed these spreadsheets are not free of charge.”

Note (2): As you can see through my spreadsheet, I did not consider 1500 units which will be sold by Roscommon by herself. Why? There were two reasons as follows:

- I should make a new template of spreadsheet for 1500 units while the impact of the result was negligible. If we use from same template of excel, the unit price for 8500 units will be equal to $9.93  whereas we have the unit price for 1500 units  just equal to $ 6.85. It means that  we will lose our net profit for both status ( A &B) by selling of 1500 units. Therefore,the direction of  the case analysis result for 10,000 units will be the same to 8500 units. 

-Since Compass will sell only 5000 units throughout the USA, it is not logical and accurate in accordance with the Marketing Management issues in which the additional sales approximately equal to third of 5000. It means that there is the probabilities which are assigned to the people are purchasing the albums form Compass or Roscommon, will be the same people.

Why did I choose this case?

Because I found a good strategy implementation in this case as follows:

As you can see, the case of Compass Records stated:

“The trouble with those huge corporations is that they have to have enough sales volume on a release……”

Usually we do not use from W – T section of SWOT analysis as the new strategies in action.

In the next my article, I will illustrate this strategy implementation and I will tell you how we can expand it as a new strategy for other goods and services so.

Case Analysis of Euroland Foods S.A. plus a new implement strategy

Nowadays, we can see the huge disasters around the world that some of them are natural disasters such as earthquake, tsunami and so on and others are artificial ones for instance, financial crisis, energy crisis, revolution and so on.

 When we are faced the problem or the case the following should be our reaction:

1) If the case or the problem is related to our life directly, we should assume that it is a case of another person and we are a consultant to solve her/his problem.

2) If the case is related to other people, we should consider that it is our problem directly and proceed to solve this case.

When we receive a case or problem, we should mush pit into the pool and only utilize from references and other people experiences focused on case. It means that we do not need read all of pages of book to analysis the case. At the first, we should consider that we are the leader of the world and we are able to solve each problem. Therefore, we do not need to be a skilled person on a special field such as finance, Economic, Physics, Mathematics or engineering and so on. I think that It is actual concept of MBA course.

In the case of Euroland Foods, we face to the constriction of capital spending (initial investment) equal Euro 120 million for 11 projects. How can we cope with this investment?

Which projects should be chosen?

My analysis is based on two categories as follows:

1) Quantitative Analysis (Internal Analysis)

I used from Capital Budgeting Techniques below cited:

-Sensitivity Analysis

I consider IRR as independent variable, NPV at minimum ROR and Equivalent Annuity as functions (just like Polynomials function in Math) for each 10 projects because project 6 (Effluent – water treatment at four plants) definitely should be done.

According to this analysis I found the location of abruptions and ranked projects by higher IRR.

- Profitability Index

It can be calculated by using of WACC (10.6%) and free cash flows.

 - Reinvestment Rate Comparisons for projects at WACC and IRR

It has been done by using of Conflicting Ranking concept and ranked by higher IRR and NPV

- Annualized Net Present Value (ANPV) Approach

It has been ranked in accordance with ANPV.

- Double Discounting Technique

According to this technique, FCF of all of projects have been discounted and changed to the least years of FCF. Then, all projects are ranked by IRR and NPV.

All above techniques have approved the projects as follows:

-Project 2. A new Plant (Dijon, France)

This project (2) will be compulsory, if we choose project (7)

-Project 7. Southward Market Expansions

-Project 11. Strategic Acquisition

-Project 6. Effluent – water treatment

But since there is not enough initial investment, we have to take a decision between two options as follows:

Option (1):

-Expanded Plant (Nuremberg, Germany)

-Eastward Expansion

- Strategic Acquisition

-Effluent – water treatment

Total initial investment = Euro 111 million

Total Rank = 108 Score

Option (2):

- Development and introduction of new artificially sweetened yogurt

- Networked, computer-based inventory- control system

- Strategic Acquisition

- Effluent – water treatment

Total initial investment = Euro 115.5 million

Total Rank = 118 Score

Therefore, option 2 has been approved

2) Qualitative Analysis (External Analysis)

It is included a PEST analysis in which the approach is a qualitative analysis as follows:

In this case, I eliminate project (11) even though financial indexes show us a better profit. The reason is to allocate huge initial investment to this project.

In fact, we can distribute total investment to the projects which have intangible benefits. On the other hand, by distribution of investment, we will run many projects instead of one project (11). In the result, the least profit is to decrease unemployment rate, customer satisfaction, environment sustainability, the development of technology and so on.

As a matter of fact, by using a Balance Scorecard framework, we can measure the performance of projects better than using from financial indexes alone.

Here are my choices:

Project1. Replacement and expansion of the truck fleet

-A 15 percent increase in cubic meters of goods hauled on each trip

-The new tractors would also be more fuel and maintenance – efficient

-The increase in the number of trucks would permit more flexible scheduling and more efficient routing and would cut delivery times (possibly inventories)

-To support geographical expansion over the long term

Project5. Plant automation and conveyer systems

-Systems reduce the chance of injury by employees (more than EUR 15000 per year cost saving)

-To be improved throughout speed

Project9. Development and introduction of new artificially sweetened yogurt

-Significant cost saving to food and leverage

-Growing demand for low-calorie products

-Protecting of present market share

-To prevent of brand suffering

Project10. Networked, computer-based inventory- control system

-Shorter delays in ordering and order processing

-Better control of inventory

-Reduction of spoilage

-Faster recognition of changes in demand at the customer level

Total initial investment is equal to EUR109.5 (million).

Now, let me leave financial case analysis and have a debate about a new strategy in food industry.

When you do a strategic analysis for so many big companies in the field of food industry, you will perceive that horizontal integration, market penetration, market development and product development will be the best strategies in action in accordance with QSPM in which all these strategies are led to cost leadership as a Generic strategy (Porter Five Generic).

Here, I am willing to find a new idea (strategy) as an implement strategy for product development.

When the people look at the package of food in store markets or shopping malls, they do not really care about food quality mentioned as energy per 100 gram or weight and so on.

Most people consider the brand, price and promotion. But if food companies present the actual value of food to the people, they will gain good competitive advantages.

When we look at the SWOT matrix especially S-T analysis, we can see that there is a big Treat in external analysis which is significant increase of crude oil price and energy price. On the other hand, so many food companies have the appropriate growth of revenues as Strength.

What can be a good strategy for these Treat and Strength?

I think it will be the nomination and definition of Value for food. In fact, if the analysis of energy on food packages is changed to the value, the people will definitely consider it as an approach to buy goods.

I mean that food companies should bear in mind quantitative factor just like to qualitative factor. What is quantitative factor? It is weight of pack.

Therefore, to obtain the value of a good, we have:

P: price   

E: energy

W: weight

Now, we should define the value as a function of above variables.

Value = f (P, E, W)

Now, the question is: How can we find the rational relationship among value and variables?

The answer is: It depends on the type of food industry. Here, I have brought you some examples as follows:

In the case of Snacks and Biscuit, we have P/ E and E/W in which E/W is very important because customers usually care about the compaction and distribution of energy on the weight. It means that they will be able to store energy with increase of weight.

Therefore, one of the best formulations can be as follows:

Value = (W . E) / P

In contrast, the approach for Chocolate industry is difference, maybe the similar to below formula:

Value = E / (W . P)

Sometimes we have to find an index by drawing the diagram of P/ E and E / W.

Besides, it is possible that food companies consider Partial Fractions as follows:

V = f (E)   and   V = g (E)

f (E) / g (E) = P(E) + F1(E) + F2 (E) +…..Fk (E)

Where:    

P (E): Polynomial

F1 (E) …..Fk (E): Partial fraction decomposition

Furthermore, some companies maybe consider below formula for value:

V = (P / E) / (P / E)I  * (E / W) / ( E / W)I

Where:

 (P / E)I  and  ( E / W)I are average whole of industry

 Of course, to implement this strategy, all food companies need to help of third party to standardize the value of food such as FDA, FSIS, Codex Alimentarius Commission and Food Standards Agency (UK).

Nowadays, we can see three items of Price, Weight and Energy per 100gr on all food’s packs. I think that the Value as the fourth item can be a new strategy for all food companies. In the matter of fact, customers need to see the value ranking of foods on packages by using of the colors or numbers.

To be continued ....

 

 

Note:  “All spreadsheets are available. The people, who are interested in having my spreadsheets (two Excel files included six sheets) of this case analysis as a template for further practice, do not hesitate to ask me by sending an email to: soleimani_gh@hotmail.com or call me on my cellphone: +98 9109250225.  Please be informed these spreadsheets are not free of charge.”

Where money goes? Where power comes from? (part 2)

 Before anything, let me return back to the second example of philosophic points in which we have:

“The change depends on the direction” and Math used it as follows:

“If a function of w=f(x,y,z,t) wants to move far from a point (p), the change of amounts for this function depends on its direction”

As you know, one of the most crucial things in strategy formulation of a comprehensive strategic management model is to generate, evaluate and select the strategies. I think that Strategic Management can utilize from this fundamental axiom of Mathematics to make new type of strategy.

Can you bring an example for this type of strategy in the field of Strategic Management?

Where money goes? Where power comes from?

Let me remind you about a quotation from the Shahnameh of Ferdowsi as follows:

توانا بود هر که دانا بود" (Knowledge is power)"

Have you even heard the people say: “I wish I had not too much knowledge because when your knowledge increases notably, you will be suffering in your life”.

But there is the fundamental difference between to get knowledge and to make them. For instance, when we find out a problem by ourselves, we are excited and encouraged to solve this problem while there are so many problems that we are not interested in studying about them. First of all, we should have a true definition of the knowledge. What is the meaning of the knowledge?

In my opinion, the knowledge is to discover new constant data by analyzing previous constant data in which all constant data are the stable only for a period of the time.

In the result, I am willing to say: “Someone who are able to make the PARADOX, do not need to war for obtaining the power”.

Of course, this is a Pseudo – Power. Because, someone who are generating paradoxes, once upon a time, will be swallowed by all paradoxes generated by their self.

Therefore, you will gain a Real Power, if your knowledge and also the results of your works are helping and saving the people throughout the world.

When you have a Real Power, you do not need to follow the money but the money will follow you.