Nike Example. EBIT = 2,433.7m ( gross margin expenses = )

Transcription

1 Nike Example Background Calculations and Information: The following values are estimated from Nike's financial statements or the related notes to the financial statements and are used in some of the calculations below. Assets = 12,442.7m Equity (book value) = 7,825.0m Debt (book value) = 625.1m Debt (market value) = 628.5m Net Income = 1,883.4m EBIT = 2,433.7m ( gross margin expenses = ) 1. Cost of Debt: Nike is an A bond rating. Using this information and the default spreads listed below, calculate the cost of debt for Nike. The 10-year U.S. Treasury rate is currently 4.0%. Debt Rating 10-year Yield Spread 30-year Yield Spread AAA 1.853% 2.069% AA 2.151% 2.144% A 2.869% 2.775% A 2.866% 2.792% A % 2.936% BBB 3.251% 3.226% BBB 3.519% 3.494% BBB % 3.555% BB 5.349% 5.348% BB 6.927% 6.862% BB % 7.184% B 7.591% 7.579% B 7.879% 7.862% B % 9.819% As shown in the table, the default spread for A rated bonds is 2.869% (we use the 10-year spread to be consistent with our use of the 10-year treasury security). The cost of debt is then equal to: K d = 4.0% 2.87% = 6.87% 1

2 2. Operating Lease Adjustments: Future operating lease commitments for Nike, as listed in the K, are shown below. Use this information to answer the questions below. Year Operating Lease Commitments ($ millions) > a) Using the cost of debt you calculate in question 1, calculate the value of the operating lease debt and operating lease asset for Nike as of Use these values to estimate the adjusted value of debt and assets for Nike. I will assume that Nike continues to pay per year after Based on this assumption, lease payments after 2013 can be approximated as an annuity of $163.9 per year for 4.22 years, since 692.3/163.9 = The present value of lease obligations is then given by: PV = = $ Adjusted Debt( bk) = = Adjusted Debt( mv) = = Adjusted Assets = =

3 b) Calculate the value of after-tax operating income and Net Income before and after adjusting for operating leases. Assume a tax rate of 36.4%. Also, note that the firm paid operating lease expenses in 2008 of $344.2 million. As noted above, Net Income equals prior to any operating lease adjustments. Since Net Income is unaffected by the operating lease adjustment, the value remains following the adjustment. As noted above, operating income (EBIT) equals prior to the operating lease adjustment. After-tax operating income equals: (1-.364) = The operating lease adjustment can be applied in one of two ways: 1395 Adjusted EBIT(1- T) = ( ( 1.364) = $1,670.5 OR Adjusted EBIT(1- T) = (1395)(.0687)(1.364) = $1,608.8 Note that in both cases, the operating lease adjustment is multiplied by (1-T). Also, note that net income appears higher than after-tax operating income here, but this is simply a function of the fact that we applied a tax rate of 36.4% to operating income in our example. 3

4 3. Capitalization of Advertising Advertising expenses for Nike in each of the past four years are listed below. Use this information to answer the subsequent questions. Advertising Year Expense ($ millions) , , , ,308.3 a) (10 points) Assuming a three-year life for advertising, Calculate the Advertising Amortization for Nike in 2008 and the unamortized value of Nike's Advertising asset in Use your answers to calculate the adjusted values of equity and assets on the balance sheet. Mktg Expense ($ million) Equity was unaffected by the operating lease adjustment, so we begin with the book value of equity from the balance sheet (7825.0). Total assets has already been adjusted to reflect the operating lease asset, so we begin with the adjusted value of assets from question #2a ( ). Adjusted Equity = = $11,988.3 Adjusted Assets = = $18,001.0 Unamortized Amount Remaining in Current Year Current Year Year Amortization , % , % , % , % b) (6 points) Calculate the value of after-tax operating income and Net Income after adjusting for the both operating lease and the capitalization of Advertising. Note that Net Income was unaffected by the operating lease adjustment. As a result, we will begin with the reported Net Income of 1, We will then add back the reported Advertising Expense and instead subtract the amortization of Advertising. No tax adjustment is required. Adjusted Net Income = = $2,440.6 Operating Income will be affected by both the operating lease adjustment and the Advertising adjustment. As a result, we will begin with the adjusted value of after-tax operating income from question (2b). We will then add back the reported Advertising Expense and instead subtract the amortization of Advertising (I will base my answer on the second of the two possible answers to question #2b). Again, no tax adjustment is required. Adjusted EBIT(1-T) = = $2,

5 4. Calculate FCFF for Nike in To calculate FCFF, we begin with the adjusted value of after-tax EBIT as calculated in question #3b (2440.6). We then subtract net capex and increases in working capital, where net capex will include expenditures on acquisitions and advertising. From the statement of cash flows, we find that CapEx net of asset divestitures equals ( ). In addition, depreciation equals The footnotes reveal that the firm spent a total of on acquisitions in In problem 3, we determined that the 2008 advertising expense was and the 2008 amortization of Advertising was To define working capital, I exclude cash, investments, and deferred taxes from current assets, and I exclude all debt items from current liabilities. The resulting non-cash working capital increased from in 2007 to in This is an increase in non-cash working capital of FCFF is then defined as: Adjusted EBIT(1-T) (Capex - Depr) - ( ) - Acquisition Costs (Advertising - Amort) - ( ) - Increase in WC = FCFF $ Calculate FCFE for Nike in Note that the cash flow statement shows that the firm raised a net amount of debt equal to $28.5 million. To calculate FCFE, we begin with the adjusted value of Net Income as calculated in question #3b (2440.6). We then subtract the portion of capex and working capital reinvestment that must be funded by equity holders. I will use the method where we add back net debt issues. An alternative would be to multiply the total amount of reinvestment by 1 minus a specified debt ratio. FCFE is then defined as: Adjusted Net Income (Capex - Depr) - ( ) - Acquisition Costs (Advertising - Amort) - ( ) - Increase in WC Net Debt Issues 28.5 = FCFE $1,

6 6. Estimate fundamental growth in EBIT for Nike based on the firm s reinvestment rate and ROC. To estimate the reinvestment rate, we can utilize the calculations used in the determination of FCFF in question 4. Total reinvestment equals: (Capex - Depr) ( ) Acquisition Costs (Advertising - Amort) ( ) Increase in WC , Given the adjusted operating income from question 4, this gives a reinvestment rate of / = 54.0% To estimate the ROC, we take adjusted operating income divided by beginning of period capital. To simplify, I will assume that the adjustments to debt and equity last year were the same as in those in the current year (see questions 2a and 3a). Adjusted Equity (t-1) = = 11,188.7 Adjusted Debt (t-1) = = 1,936.2 ROC = 2166/( ) = 16.5% Fundamental growth in EBIT then equals (54.0%) x (16.5%) = 8.91% 7. Estimate fundamental growth in Net Income for Nike based on the firm s equity reinvestment rate and ROE. To estimate the equity reinvestment rate, we can utilize the calculations used in the determination of FCFE in question 5. Equity reinvestment equals: (Capex - Depr) - ( ) Acquisition Costs (Advertising - Amort) - ( ) Increase in WC Net Debt Issues 28.5 $ Given the adjusted net income from question 5, this gives an equity reinvestment rate of / = 46.77% To estimate the ROE, we take adjusted net income divided by beginning of period equity. Again, to simplify, I will assume that the adjustments to equity last year was the same as in that in the current year (see question 6 above). ROE = / = 21.81% Fundamental growth in Net Income then equals (46.77%) x (21.81%) = 10.20% 6

7 7

8 8