Part of Nike's strategy to revitalize the company was aimed at addressing their revenues which had been fixed

for four years and their net income which had fallen to almost $220M. Additionally, Nike had been losing overall market share and the strong dollar had adversely affected revenue. To address those issues, management was planning to; (1) raise revenue by developing increased levels of athletic-shoe products in the mid-priced segment. (2) Push its well performing apparel line, and (3), control expenses. Kimi Ford, a portfolio manager at a mutual fund management firm, was considering adding Nike's shares to the portfolio she managed. To come to a decision she asked Joanna Cohen, her assistant, to develop a discounted cash flow forecast. Her analysis had a few flaws that will be pointed out in this paper through a new analysis. Cohen's first mistake was to use Nike's book value of equity in her calculation of the WACC; $3,494.50. Though the book value is an accepted estimate of the debt value, the equity's book value is an inaccurate measure of the value perceived by the shareholders, therefore an irrelevant source when finding the equity value. Moreover, Nike is a public traded firm, therefore its equity value can be best reflected by its market value. Market Value of Equity = Market price of the share * Number of Shares Outstanding = $42.09* 271.5 = $11,427.44 Book Value of debt = Current portion of long term debt + Notes payable = $855.3 + $435.9 = $1,291.2 E / (D+E) = $11,427.44 / ($11,427.44 + $1,291.2) = 0.89847 which is 90% of total capital D / (D+E) = $1,291.2 / ($11,427.44 + $1,291.2) = 0.1015 which is 10% of total capital D + E = $12,718.635 million There is an enormous difference between the book value of equity and its market value. Therefore, the portion of equity to debt (E/D+E) is much higher now as 89.8% compared to Cohen's estimate of 73% of total capital. Cost of debt By calculating the weighted average of the interest on Commercial paper outstanding, notes payable to banks and interestbearing accounts payable, I calculated the cost of debt to be 4.5%, which is similar to Cohen's estimate. Consequently, the cost of debt to Nike is 2.8 percent [(1-38%)*4.5%]. I used a 38% tax rate, which I obtained by calculating the historical average which coincides with the rate obtained by taking the U.S. statutory tax rate and adding the historical average of the tax variation. Cost of equity There are several methods to estimate the cost of capital; Cohen did it using the Capital Asset Pricing Model (CAPM), which states that Ke = Kf + b(Km-Kf) Kf: Risk free rate. Derived from the current yield on the 20-year U.S. Treasury Bond; 5.74%. b: Company's risk that cannot be diversified away. Nike's six year historic average: 0.80 Km-Kf: The market's risk premium; the historical equity risk premium used is 5.9%, which is the geometric mean return. CAPM= 5.74 +.8(5.9) = 10.46 When a firm like Nike uses both equity and debt to finance itself, the cost of capital is the weighted average of each. After inputting these figures into the WACC we get a cost of capital equivalent to 9.68%. 2002200320042005200620072008200920102011 Total CF764.2 663.1 777.6 866.1 1,014.0 1,117.6 1,275.2 1,351.7 1,483.7 14,306.0 PV of CF @ 9.68%696.7 551.2 589.3 598.5 638.8 641.9 667.8 645.4 645.9 5,677.9 WACC = Kd (1-t) * D / (D+E) + Ke * E / (D+E) = 2.8% * 0.1015 + 10.46% * 0.8984 = 9.68% Enterprise Value11,108.7 Less: Current outstanding debt1,296.6 Equity Value9,812.1 Equity value per share36.1 Discounting the cash flows at a rate of 9.68% Nike's share price goes down to $36.1 per share. DDM = ((D0(1+g))/P0)+g Do$0.48 G5.50% Po$42.09 Ke6.7031361% WACC = 0.063058733 6.3059% A different approach to estimating the cost of capital is the dividend Valuation Model, which values a company using its dividends. Nike had a long dividend payout history, therefore, an alternative model, the Dividend Capitalization Model,

should also be used to determine Nike's cost of equity. It is true that this model has some complications such as the large forecasting period, but Nike's growth opportunities promise an increase on sales and revenues, and even if there are some flaws the expected dividends' increase is very logical. 20012002200320042005200620072008200920102011 Total CF764.2 663.1 777.6 866.1 1,014.0 1,117.6 1,275.2 1,351.7 1,483.7 14,306.0 PV of CF @6.3%718.9 586.8 647.2 678.2 746.9 774.3 831.1 828.7 855.7 7,761.5 Enterprise Value14,429.4 Less: Current outstanding debt1,296.6 Equity Value13,132.8 Equity value per share48.4 With the dividend valuation model the share price rises to $48.4 per share showing the stock to be undervalued by $6.30 per share. A final approach to estimating the cost of capital is the earnings capitalization model. A firm's earnings growth is another aspect we should take into account to determine its long-term value. During the past 6 years, Nike's share price has fluctuated, and in 2000, the company was under performed compared to the S&P500. However, a change can be observed in 2001 (see exhibit 4) and it seems that Nike's share price is running smoothly against the S&P500. Because this method relies on earnings which are influenced by accounting conventions and practices, I find it quite misleading. Especially in Nike's case because the company was in the middle of a restructure in order to revitalize itself. ECM = [(1+g) * Eo / # of share outstanding]/ Po g = Retention ratio * ROE g = 0.914093576 Retention Ratio =Retained Earning / Net Income Retention Ratio =5.416822113 ROE = net income/total equity ROE = 0.168750894 Ke =9.8775% WACC = 0.09157944 = 9.16% The Earnings Capitalization Model reveals the cost of equity of 9.87%, this result in a WACC of 9.16% and a share price of $38.6, which indicates Nike's current share price, is over valued by $3.5 per share. 2002200320042005200620072008200920102011 Total CF764.2 663.1 777.6 866.1 1,014.0 1,117.6 1,275.2 1,351.7 1,483.7 14,306.0 PV of CF @ 9.16%700.1 556.5 597.8 610.1 654.3 660.6 690.5 670.5 674.3 5,956.1 Enterprise Value11,770.8 Less: Current outstanding debt1,296.6 Equity Value10,474.2 Equity value per share38.6

Recommendation The different valuation methods applied to this case yielded different numbers complicating the decision; CAPM and ECM suggest that Nike's current share is over valued, while only the Dividend Model shows it to be undervalued by $6.30. Ford needs to rely on her instincts and knowledge and use different valuation methods such as EVA (Economic Value Added, see attachment 3) in order to come to a conclusion. In my opinion, Nike should be added to the portfolio; Nike has been growing since Jan 2001 and its new revitalization strategy is a guarantee of success. In addition, Ford should consider the correlation between the holdings in her portfolio; Nike outperformed Exxon Mobil, General Motors, McDonald's and 3M over the past 10 years (See attachment 2). Nike is one of the leading firms in the sports industry, adding Nike to the portfolio will increase diversification, which reduces risk, therefore enhancing return.

ATTACHMENT 1 From Nike's annual report 2001 (http://www.nike.com/nikebiz/invest/reports/ar_01/financials.html) Short-Term Borrowings and Credit Lines: Commercial paper outstanding and notes payable to banks are summarized below: May 31, 2001 2000 Interest Interest Borrowings Rate Borrowings Rate (In millions) (In millions) Notes payable and commercial paper: U.S. operations $710.0 4.07% $691.9 6.42% Non-U.S. operations 145.36.50% 232.3 3.72% $855.3 $924.2 The Company has outstanding loans at interest rates at various spreads above the banks' cost of funds for financing nonU.S. operations. Certain of these loans are secured by accounts receivable and inventory. ATTACHMENT 2 ATTACHMENT 3 EVA is used to determine Nike's future investments capacity to add value to the firm, therefore increasing shareholder's value. Net Operating Profit = Net Income for 2001 = $589.7M Invested Capital = (Cash + Accounts Receivable + Inventory) - (Accounts Payable + Accruals) + (Property, Plant & Equipment) = $4,064.2 EVA = ((Net operating profit/Invested Capital) - WACC) * Invested Capital = $212.1 Given that the ROIC, or the Operating Profit/Invested Capital, is greater than the WACC, we can conclude that the Nike adds value from investments and that with the new strategy shareholder's value will increase due to a raise in the stock price. EVA strengthens my point of adding Nike to Ford's portfolio.