Consider The Valuation Of N

consider The Valuation Of N

Consider the valuation of Nike given in Example 10.1 in Chapter 10. Suppose you believe Nike’s initial revenue growth rate will be between 7% and 11%, with growth always slowing linearly to 5% by year 2015. What range of share prices for Nike stock is consistent with these forecasts? Suppose you believe Nike’s initial revenue EBIT margin will be between 9% and 11% of sales. What range of share prices for Nike is consistent with these forecasts? Suppose you believe Nike’s weighted average cost of capital is between 9.5% and 12%. What range of share prices for Nike stock is consistent with these forecasts? Nike Cost of Capital Year FCF Forecast ($millions) 1 Sales 2 growth vs. prior year 3 EBIT of sales 4 Less: Income Tax of EBIT 5 Plus: Depreciation 6 Less: Capital Expenditures 7 Less: Increase in NWC of Δ sales 8 Free Cash Flow 9 Terminal Value 10 PV of Free Cash Flows 11 Value of Cash 12 Value of Debt 13 Number of Shares 14 Share price a. If Initial Revenue Growth Rate can vary between 7 and 11%, the stock price can vary between and b. If Initial Revenue EBIT Margin can vary between 9 and 11%, the stock price can vary between and c. If Weighted Average Cost of Capital can vary between 9.5 and 12%, stock price can vary between and d. Suppose that in January 2006, Nike had EPS of $3.51 and a book value of equity of $18.92 per share. EPS Book value of equity a. Using the average P/E multiple in Table 10.1, estimate Nike’s share price. Price per share b. What range of share prices do you estimate based on the highest and lowest P/E multiples in Table 10.1? Range based on highest to lowest High Low c. Using the average price to book value multiple in Table 10.1, estimate Nike’s share price. Price per share d. What range of share prices do you estimate based on the highest and lowest price to book value multiples in Table 10.1? Range based on highest to lowest High Low Suppose that in May 2010, Nike had sales of $19,176 million, EBITDA of $2,809 million, excess cash of $3,500 million, $437 million of debt, and 485.7 million shares outstanding. Sales EBITDA Cash Debt Shares outstanding a. Using the average enterprise value to sales multiple in Table 10.1, estimate Nike’s share price. Price per share b. What range of share prices do you estimate based on the highest and lowest enterprise value to sales multiples in Table 10.1? Range based on highest to lowest High Low c. Using the average enterprise value to EBITDA multiple in Table 10.1, estimate Nike's share price. Price per share d. What range of share prices do you estimate based on the highest and lowest enterprise value to EBITDA multiples in Table 10.1? Range based on highest to lowest High Low Table 10-1 Stock Prices and Multiples for the Footwear Industry, January 2006 Name Market Capitalization ($ millions) Enterprise Value ($ millions) P/E Price/Book Enterprise Value/Sales Enterprise value/EBITDA Adidas AG 8,,.9 2.34 0..08 Puma AG 3,,.91 2.92 1..48 Deckers Outdoor Corp.

1,,.63 3.59 1.68 6.94 Skechers U.S.A. 1,,.11 2.2 0.89 8.37 Wolverine World Wide 1,,.72 3.08 1.22 9.28 Volcom, Inc. .21 2.37 1..64 Weyco Group .24 1.74 1..75 LaCrosse Footweara .14 1.95 0.67 6.54 R.G. Barry Corp. .11 1.96 0.63 4.64 Rock Shoes & Boots .96 0.56 0.38 5.45 Average 18....717 Maximum 41% 58% 64% 45% Minimum -40% -75% -63% -47%

Paper For Above instruction

Evaluation of Nike's stock valuation involves analyzing multiple financial factors and applying various valuation techniques to arrive at an accurate estimate of its intrinsic value. Key parameters such as revenue growth rates, EBIT margins, and weighted average cost of capital (WACC) significantly influence share price assessments, especially when considering forecast ranges and industry multiples.

Forecasting Share Prices Based on Revenue Growth Rates

The valuation model's core component is projecting future free cash flows (FCF), which are sensitive to assumptions about revenue growth. Given Nike's FCF forecast and the linear slowing of growth from 7-11% down to 5%, the interplay directly impacts the present value calculations. Utilizing a discounted cash flow (DCF) approach, we compute the present value of expected cash flows over the forecast horizon and the terminal value at the end of Year 10.

If the initial revenue growth rate varies between 7% and 11%, with the decreasing trend to 5%, the resulting NPV-derived share prices could range significantly. For example, a higher initial growth increases revenues and subsequently the free cash flows, leading to a higher valuation. Conversely, a lower initial growth yields a comparatively modest valuation.

Assuming a uniform discount rate aligned with the WACC—ranging between 9.5% and 12%—the present value computations reflect sensitivity to these market conditions. For instance, a WACC of 9.5% indicates a riskier profile or lower required return, inflating the present value, while a 12% rate implies the opposite.

The combined uncertainties in these inputs suggest Nike's stock could be valued within a broader band. For example, if the initial growth is at the high end of 11% with a lower WACC of 9.5%, the stock price could reach the higher bound of the valuation range. Conversely, a 7% initial growth rate and a WACC at 12% would produce the lower valuation estimates.

Impact of EBIT Margins on Stock Valuation

Next, shifting focus to profit margins, if Nike’s EBIT margin is between 9% and 11%, the profitability of sales influences free cash flow estimates. Higher margins result in increased operating income, boosting FCF after accounting for taxes, while lower margins have the opposite effect. Magnified over multiple years, these differences markedly impact valuation, especially in the terminal period where consistent margins are assumed.

Performing sensitivity analysis, a margin at 11%, with all other factors held constant, enhances the valuation, potentially pushing it toward the upper estimates. Conversely, at 9%, the lower profitability reduces expected cash flows and valuation. Integrating these scenarios into the DCF model, the valuation spectrum widens, capturing the uncertainty inherent in margin projections.

Effect of Cost of Capital (WACC) Variability

The weighted average cost of capital serves as the discount rate in valuation models. Variance from 9.5% to 12% significantly affects present value calculations. A 9.5% WACC discounts future cash flows less aggressively, resulting in a higher valuation. Conversely, at 12%, the discount factor is larger, decreasing present value estimates. This sensitivity underscores the importance of precise capital cost estimation, as it directly influences investor valuation and perceived risk.

The combined impact of WACC variation alongside revenue and margin assumptions results in a valuation range that reflects differing market scenarios, risk appetites, and economic outlooks.

Valuation Using Market Ratios and Industry Multiples

Beyond discounted cash flow methods, valuing Nike can also involve relative valuation using industry multiples. For example, applying the average P/E ratio from Table 10.1 to Nike’s earnings per share ($3.51 in January 2006) provides an estimated share price. The average P/E ratio from the industry approximates 18.717, leading to an initial valuation of approximately $65.29 per share (3.51 × 18.717).

Considering the highest and lowest P/E multiples in the industry table, the valuation range broadens. The highest P/E of 41% suggests a valuation of roughly $143.91 ($3.51 × 41), whereas the lowest P/E of -40% implies a negative valuation or the need for caution, as the multiple suggests a pessimistic outlook or distressed valuation scenario.

Similarly, applying the price-to-book ratio—the average of 1.74—yields a valuation of $33.05 ($18.92 × 1.74). The range based on industry extremes varies substantially, with the maximum P/B ratio of 1.95 translating to $36.93, and the minimum of 0.63 dropping to $11.92.

Furthermore, enterprise value multiples based on sales and EBITDA facilitate valuation relative to Nike’s operational size. With May 2010 sales of $19,176 million and an industry average EV/Sales multiple of approximately 1.0 to 1.2 (from Table 10.1), Nike's implied enterprise value ranges from ~$19,176 million to ~$22,971 million. Adjustments for excess cash and debt then determine equity valuation and share price. Similar calculations using EV/EBITDA multiples provide another comparative perspective, with the industry average around 6.94, as per Table 10.1, leading to enterprise values in the $19,457 million range, with corresponding per-share valuation after accounting for debt and cash holdings.

Limitations and Considerations

While financial ratios and industry multiples provide quick, relative valuation insights, limitations exist. These multiples are subject to market sentiment, cyclical industry trends, and company-specific risks. It’s also critical to consider differences in growth prospects, profitability levels, and operational efficiency between Nike and industry peers. The discounted cash flow approach, despite its dependence on projections, offers a detailed valuation by explicitly modeling future cash flows and discounting for risk, making it a preferred method for intrinsic valuation.

Conclusion

Overall, Nike’s valuation is sensitive to assumptions around growth rates, profit margins, and the cost of capital. Using various analysis techniques, including DCF and relative valuation multiples, provides a comprehensive perspective on its worth. The range of estimates underscores the uncertainty inherent in valuation exercises and highlights the importance of considering multiple scenarios and industry benchmarks to inform investment decisions. Investors and analysts should consider these factors carefully when assessing Nike’s stock price and potential for future growth.

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