Question

Nike had sales of $40 billion in 2019. Suppose you expect its sales to grow at a rate of 4% forever. Based on Nike’s past profitability and investment needs, you expect EBIT to be 10% of sales, increases in net working capital requirements to be 12% of any increase in sales, and capital expenditures to equal depreciation expenses. Nike pays 22% income tax. The opportunity cost of capital is 10%. Nike has 0.9 billion shares outstanding, $3.3 billion in cash, $1.2 billion in debt.

Calculate the share price for 2020 using the discounted free cash flow model. Round your final answer to one decimal place.

Answer 1

Free cash flow = net income + depreciation - capital expenditure - increase in net working capital

net income = EBIT*(1-tax rate)

EBIT is 10% of sales. sales in 2020 would be: $40 billion*(1+0.04) = $40 billion*1.04 = $41.6‬ billion. EBIT = $41.6‬ billion*10% = $4.16 billion

0.04 is the growth rate in sales of 4%.

net income = $4.16 billion*(1 - 0.22) = $4.16 billion*0.78 = $3.2448‬ billion

increase in net working capital is 12% of any increase in sales. so increase in net working capital = ($41.6 - $40)*12% = $0.192‬ billion

capital expenditures are equal to depreciation expenses. in free cash flow formula, we add depreciation and subtract capital expenditures. so, its net effect will be zero because same amount will be added and subtracted.

Free cash flow 2020 = $3.2448‬ billion - $0.192‬ billion = $3.0528 billion

terminal value of firm = Free cash flow 2020/(opportunity cost of capital - constant growth rate) = $3.0528/(0.10 - 0.04) = $3.0528/0.06 = $50.88‬ billion

terminal value is calculated at the end of 2020. so, it's value at beginning of 2020 is:

firm value = $50.88‬ billion/(1+0.10) = $50.88/1.10 = $46.25454545454545‬ billion

0.10 is opportunity cost of capital of 10%.

equity value = firm value + cash - debt = $46.25454545454545‬ billion + $3.3 billion - $1.2 billion = $48.35454545454545‬ billion

share price = equity value/no. of shares outstanding = $48.35454545454545‬ billion/0.9 billion = $53.7