TABLE OF CONTENTS - Texas Tech Universitymmoore.ba.ttu.edu/ValuationReports/Fall2006/NIKE.pdf ·...

Executive Summary 1

Overview of Firm 3

Five Forces Model 4

Value Chain Analysis 12

Competitive Advantage Analysis 14

Key Accounting Policies 16

Accounting Flexibility 19

Evaluation of Accounting Strategy 22

Evaluation of Disclosure Quality 24

Potential Red Flags 26

Undoing Distortions 28

Financial Ratio Analysis 29

Statement Forecasting Methodology 45

Weighted Average Cost of Capital 46

Discounted Free Cash Flows 50

LR ROE Residual Income 50

Abnormal Earnings Growth 51

Method of Comparables 52

Final Recommendation 58

References 59

Appendices 60

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TABLE OF CONTENTS

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SUMMARY FINDINGS

NKE--- NYSE 80.31$ Eps Forecast52 Week Range $75.52 - $99.30 FYE 2006(A) 2007(E) 2008(E) 2009(E)Revenue (2006) $14.955 billion EPS 5.44 6.23 7.21 8.35Market Capitalization $24.6 billion

Shares Outstanding 256 million Valuation Ratio Comparison NIKE Ind AvgTrailing P/E $14.84 $19.59

Dividend Yield 1.50% Forward P/E $17.43 $24.753-month Avg Daily Trading Volume 1,830,510 Forward PEG 0.1855 0.3254Percent Institutional Ownership M/B

Book Value Per Share 88.83 Valuation Estimates

ROE 24.66%ROA 14.10% Actual Current Price $80.71Est. 5 year EPS Growth Rate 22.71%

Ratio Based Valuations

Cost of Capital Estimates Beta R2 Ke P/E Trailing $14.84Ke estimated P/E Forward $17.435-year Beta 0.580 0.138 4.39% PEG Forward $18.353-year Beta 0.360 0.143 4.35% Dividend Yield 1.53%2-year Beta 0.970 -0.077 4.45% M/BPublished Beta

Intrinsic Valuations

Kd Discount Dividends 98.35$ WACC(bt) 7.83% Free Cash Flows 152.24$

Residual Income 87.08$ Altman Z-Score 3.47811 Abnormal Earnings Growth 96.90$

Long-Run Residual Income Perpetuity 91.01$

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STOCK CHARTS

In the sportswear apparel industry, there are three main

companies: NIKE, The Adidas Group, and Under Armour, and K-Swiss. Under

Armour, a relatively new firm, is a main competitor in the apparel industry

because of their major contracts and endorsements with athletic teams. New

entrants do not have the strong reputation to back them up and give them the

ability to purchase millions of units of a product and would have a more difficult

time finding a manufacturer to produce a large amount of goods for a low price.

With this said, professional sport teams and league still have the power to

bargain for lower prices because they have sufficient capital to commit to

purchasing large quantities of new items for several years. In a report on

corporate responsibility, NIKE brand presidents write that their goals are, “to

effect positive, systemic change in working condition within the footwear, apparel

and equipment industries; to create innovative and sustainable products; [and]

to use sport as a tool for positive social change and campaign to turn sport and

physical activity into a fundamental right for every young person.”

This is one of those areas that cannot be accurately assessed because

there is no way to tell exactly how long an endorsee’s peak performance will

impact an audience and influence them to purchase NIKE products; just as a

marketing campaign’s full effect on consumers can never be measured. For

example, if NIKE had predicted that Terrell Owens would have a season-long

performance peak and then an accident with prescription drugs caused him to be

out for the rest of the season; would NIKE continue to expense a royalty to him

over the predetermined period or absorb the rest of the cost when it is

determined the peak-performance period is over? Under cooperative advertising

programs, NIKE records selling and administrative expenses to reimburse their

retail customers that advertise NIKE products in their commercials etc. For

endorsements, accounting measures depend on their specific contract provisions

Valuation of NIKE, Inc. 1 of 59

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EEXECUTIVE SUMMARY

such as particular achievements that are expensed to S&A. With any company,

there is the risk of their management influencing accounts in order to show

better numbers for the end of the year or show a larger amount of assets, fewer

liabilities, or a higher net income.

Overall, NIKE's operating efficiency was favorable as there was an

increase in gross profit margin; although there was not a substantial change in

the operating expense ratio, the decrease remains favorable. Nike has a current

ratio between 2 and 3 which is below the industry average, however is still within

a range that shows they are able to pay off their current liabilities yet is low

enough to show their assets are being utilized. Nike being lower than the

Industry average is not surprising since their net profit margin and asset turnover

(ROA= net profit margin x asset turnover) were both lower than the Industry

average.

It is valid to include NIKE’s interest income into these computations

because the interest they earn off of lending their assets or keeping cash money

in the bank means they have to borrow less money to finance their assets. This

means that an increasing WACC because of increasing world interest rates would

not put the firm at a disposition to other firms in the same industry because it is

likely their WACC would rise by the same amount, if not more. In comparison, if

a company’s ROE is not high, it shows that they do not use their money wisely to

spend on their own company; the money put into the firm is not used to their

advantage to make profits. It is a good thing if NIKE’s equity value increases

each year, as it indicates that they can use more of what they invested to

generate profits and growth of the company. The price to free cash flows ratio

shows how much actual cash can be generated per dollar of stock equity.


NIKE, Inc. is one of the top sellers world-wide of athletic footwear,

apparel, equipment and accessories. NIKE and its subsidiaries sell everything

from athletic and casual footwear to apparel and accessories for men, women

and children. Largely because of their reputation of quality products, NIKE has

an extremely loyal customer base. NIKE products are sold online at nike.com,

through its own retail stores dubbed NikeTown, and through a mix of

independent distributors and licensees in over 160 countries. NIKE owns five

domestic footwear and apparel distribution facilities as well as 21 distribution

centers spread across Canada, Europe, Asia, Australia, Latin America, and Africa.

HISTORY. The company was founded in Oregon by Phil Knight and Bill

Bowerman in Oregon in 1968 and has since successfully developed into an

internally well-known brand. The company’s mission statement, written by

Bowerman, states their goal is “to bring inspiration and innovation to every

athlete in the world”, and he also adds “If you have a body, you are an athlete.”

NIKE continues to improve their products and service for their customers. NIKE

remains in the sportswear and apparel industry throughout its subsidiary brands:

Cole Haan, Bauer, Converse, and Hurley.

RECENT FINANCIALS. The sales volume and growth for NIKE has differentiated

in the past five years. The sales volume for

fiscal year 2006 (June 1, 2005 – May 31,

2006) was $14.9 billion, growing over $5

billion over the past five years. In

comparison, The Adidas Group grew less

than $2 billion over the same time period.

The sportswear industry as a whole had a


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EOVERVIEW OF FIRM

sales volume of $265.4 million in 2006. NIKE’s dominance in the industry is

clearly shown by it’s above- industry-average growth in sales over the past five

years.

The market capitalization for NIKE is $20.95 billion, which is the highest among

its rivals. The total asset value has steadily increased over the past five years by

3.4 billion. The stock price is currently between $81 and $83 for the 255.4

million shares outstanding. Last year’s high and low were $91.54 and $76.53

respectively. Stock Scouter rates NIKE, Inc. stock a 7 on a 10-scale because it is

expected to outperform over the next six months and has a very low risk with a

medium-to-high return.

Strategy analysis is important to assess a specific firm’s profit drivers and

key risks. This enables the analyst to easily evaluate a firm’s current and past

performance and make an educated guess of the firm’s future production.

COMPETITIVE FORCE 1: EXISTING FIRM RIVALRY

INDUSTRY GROWTH. According to sales, earnings, and assets in the industry as

a whole, the sportswear apparel industry has experienced significant growth over

the past five years. This growth can largely be attributed to the recent interest

in health and physical wellness. The government, as well as companies from

many other industries, have funneled billions of dollars into convincing Americans

to increase their level of exercise. Everyone in the sportswear apparel industry

has experienced the spill-over effects of these health campaigns. However, this

industry is a luxury market, and being such, experiences a decline in sales when

the economy is in recession.


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NIKE is an aggressive price competitor that continues to flourish by taking

over market share from other companies and by building strong customer

satisfaction with their loyal clientele and newcomers.

CONCENTRATION AND BALANCE OF COMPETITORS. In the sportswear apparel,

industry, the main companies include: NIKE, The Adidas Group, KSwiss, and

Under Armour. Before The Adidas Group and Under Armour became major

players in the industry, NIKE could set their prices to create a larger gross

margin. However, recently, NIKE has had to price its products more

competitively in order to remain the dominant force in the industry. For example,

in recent years, NIKE has based the price for it’s footwear apparel in accordance

to Adidas footwear prices, which average slightly over $110 a pair, depending on

the sport and gender the shoe is intended for.

The sportswear apparel industry is generally broken into two categories,

footwear and apparel/accessories. The Adidas Group, which owns both Adidas

and Reebok, is the main competitor in the footwear division, however, they are

an active player in the apparel and accessories market. Under Armour, a

relatively new firm, is a main competitor in the apparel industry because of their

major contracts and endorsements with athletic teams. Under Armour only

recently entered the footwear segment and may rise to become a strong

competitor within the next few years. NIKE has also entered the skating

equipment and apparel industry with its acquisition of Hurley. Quicksilver,

alongside Hurley, controls the skating equipment and apparel industry.

NIKE is the dominant industry according to sales and revenues, however,

it still has challenging competitors. NIKE and Adidas must steer clear of

extensive price competition by cooperating with each other to maintain a

reasonable, yet profitable price, for their footwear and apparel.

DIFFERENTIATION & SWITCHING. The increase in competition has created a

greater demand for lower-priced luxury sports apparel. A strong brand name


attributes to a relatively smooth expansion process. In order to survive in this

industry, companies constantly attempt to differentiate themselves from other

companies and develop innovative ideas to attract new generations of customers.

For example, NIKE has expanded its sportswear line to include consumer

electronics like watches, MP3 players, and iPod accessories. Thanks to the NIKE

brand’s reputation of quality, these electronics are identified with same standard

of quality even though NIKE had no experience in the consumer electronics

industry ten years ago. Under Armour hopes to use this same concept to break

into the footwear segment. Price is going to become a larger competitive force if

Under Armour successfully completes a move into footwear.

In this industry, companies must successfully differentiate their products

to avoid destructive price competition. If a company can distinguish their goods

from their competitors effectively, then low switching cost should not be a threat.

FIXED/VARIABLE COSTS. Since NIKE is involved in a product, not service,

industry, variable costs are more of a concern than fixed costs. Since, NIKE is

involved in a more product-demand-driven industry, they do not experience the

intense price wars that go on in the airline industry. However, price has now

become a factor that significantly affects demand. With the new major

contenders, NIKE has had to price its products more competitively. Even though

the industry is not growing as aggressively as it was a few years ago, it is still

growing, therefore it is important that NIKE continues to steal market share from

their top competitors.

EXCESS CAPACITY/EXIT BARRIERS. NIKE is spread across so many industries

that exit barriers are almost non-existent. The name “NIKE” is so recognizable

that they could seamlessly leave one segment and move to another. Excess

capacity is generally shipped to any of NIKE’s 193 factory outlet stores and sold

at a discount price.

Companies in this industry share the same goal of making their brand

familiar and identifiable by their target consumers. Companies, such as The


Adidas Group, are just as identifiable as NIKE and share the same ability to

branch out and experience other segments, making their exit barriers just as

absent as NIKE’s.

There are significant rivalries in this industry, yet NIKE continues to lead

ahead of the others with higher revenues and sales on average than other

companies.

COMPETITIVE FORCE 2: THREAT OF NEW ENTRANTS

In this industry, the higher the earnings are for a particular firm, the more

attractive the industry will seem to incoming firms. If more companies enter the

industry, then the new competition will lead to a restraint in pricing and

subsequently, lower profits for existing firms. It’s not extremely difficult to enter

this industry of shoes and apparel, but with firms such as, NIKE and The Adidas

Group, it will be a challenge for new comers to compete with the existing firms.

ECONOMIES OF SCALE. It would be very difficult to start a company that could

compete with NIKE, The Adidas Group, or Under Armour because of their world-

wide recognition. A new company would require an initial investment in a

nation-wide marketing campaign that would rival the funds the big three have

budgeted for marketing. Funds would be better spent on increasing brand

recognition than a larger inventory. At worst, a small inventory could make a

new brand considered exclusive and prices would increase.

The best place for a potential competitor of NIKE to develop and start

would most likely be in a country where NIKE does not dominate the market.

This would allow the new company to slowly gain capital and expand into more

developed countries. However, this option is not as feasible because it would

take much longer to turn a profit in a less wealthy country.

Relationships and pre-negotiated prices with manufacturers are other

advantages that those already in the market would benefit from. New entrants


don’t have the strong reputation to back that they will be able to purchase

millions of units of a product and would have a more difficult time finding a

manufacturer to produce a large amount of goods for a low price. If

manufacturing costs are high then the newcomer would not be able to compete

very effectively on a cost-basis.

A new firm will most likely endure a significant loss from entering this

industry, at least in the first few years. New firms will have to undergo intensive

research and development, brand advertising, and plant and equipment costs

that will ultimately consume a large portion of their capital.

FIRST-MOVER ADVANTAGE. First-mover advantage brings leverage to a

company. By setting high industry standards, a company may discourage other

companies from entering the industry. NIKE has had the first-big-mover

advantage with sports-performance footwear. With the apparel industry,

however, brand recognition seems more important than the first-mover

advantage. Under Armour, the leader in that segment, has had many

predecessors: Champion and Rawlings just to name a few. With clothing,

consumers find a brand that has the look and fit they like and generally stick

with that brand. If NIKE gets to the consumers first, then there is a higher

chance that consumers will stick with them. Companies like Under Armour have

convinced their customers to switch from NIKE or Champion with an elaborate

marketing campaign identifying their products with those of warriors.

NIKE has established high standards as the first-movers into this industry.

However, incoming companies such as Under Armour, are acquiring knowledge of

the market at a rapid pace and NIKE will have to improve quality and reduce

costs if they want to stay ahead.

CHANNELS OF DISTRIBUTION AND RELATIONSHIPS. Major purchasers of

sportswear apparel are major league sports teams. The NFL currently has

contracts with NIKE, Adidas, and Under Armour so that no other brands can be

displayed on the football field. NIKE has been developing relationships with


American sports major leagues since it’s conception. Major league sports

contracts not only directly lead to increased sales, but increase brand

recognition. Consumers look up to sports heroes and want to wear the same

kind of jersey their role models wear.

LEGAL BARRIERS. The sportswear industry is not heavily regulated by the

government. However, as NIKE enters the consumer electronics industry, all

electronics must be approved by the FCC before sale can begin. Another legal

barrier would be that since the industry is changing so rapidly, it is often too

difficult to acquire a patent for a product before it is made available for sale.

This gives competitors the chance to copy the product before it is protected.

Legal barriers such as patents and copyrights limit the possibility of

entering the industry for other companies. NIKE should implement a way to

patent some of their products in advance to eliminate any possible replication of

their products.

COMPETITIVE FORCE 3: SUBSTITUTE PRODUCTS

The sports apparel market has a variety of substitute products. The

luxury sporting goods now have to begin to compete on price because there are

more companies in the industry. One could easily purchase an Adidas shoe, a

NIKE shoe, or a Reebok shoe from the same store for relatively the same price.

Quality is another strategy that must be focused on. NIKE and Under Armour

are both known for their high quality of goods. They are both also the most

expensive.

Innovative new styles and products are other ways to differentiate

products. NIKE uses its “Shox” shoes that have springs under the soles to sell

both on a performance aspect and a fashion aspect. Adidas does not have a

shoe with springs under the soles. NIKE also has partnered with Apple to create

the NIKE+iPod Nano running kit. This product logs your running distance and


speed and is only compatible with Apple’s iPod Nano and NIKE’s NIKEplus

running shoes.

Entering new markets is another way to weed out substitute products.

Creating a product that no one has a substitute for not only eliminates this

threat, but also gives them the first-mover advantage.

The most effective way for NIKE to confront the problem of competing

with other companies that are creating substitute products would be to improve

their bargaining power with suppliers, thereby reducing costs, and providing a

genuine product at a lower cost for its customers.

COMPETITIVE FORCE 4: BARGAINING POWER OF BUYERS

Price sensitivity and bargaining power are important because they establish the

amount of control a buyer attains. Price sensitivity refers to how far a customer

will go to bargain on the price of a product while bargaining power refers to their

ability to force the price down.

PRICE SENSITIVITY. In the sportswear industry there are three types of

consumers: teams, enthusiasts, and average purchasers. Professional and

college sports teams have large amounts of money to spend and are looking for

the best quality. Professional sports team endorsements are worth millions of

dollars in sales and marketing. Athletic enthusiasts are also looking for the best

quality, however may not have the amount of cash that sports teams have

available. This means that price per product is much more of an issue than with

professional sports teams. Value will appeal to this group of consumers.

Average purchasers are consumers who are just looking for a good pair of tennis

shoes or a cool t-shirt. These consumers will either be drawn to the company

because of its popular brand name, history with the product, or its price.

RELATIVE BARGAINING POWER. Buyers generally do not have a strong

bargaining power with a large corporation unless they are buying in very large


quantities or are gathered together in large numbers. Individual buyers

indirectly choose whether to keep a product on the market or not by purchasing

it or declining to purchase it.

In this industry, the three large companies set the prices for average

consumers and all other brands must follow suit in order to stay afloat. However,

professional sports teams and leagues have the power to bargain for lower prices

because they have the capital to commit to purchasing large quantities of new

items for several years. Nike, The Adidas Group, and Under Armour have some

say when it comes to pricing with pro sports teams. They are all diverse enough

so that losing a contract with a team would not mean going out of business.

NIKE, especially, has spread investments across so many industries that it has

the capital to support turning down unreasonably low offers. This could be a

reason why NIKE products are not sold in Wal-Mart. Wal-Mart is known for

asking unusually low prices from its vendors. NIKE is too big of a company and

doesn’t need a contract with Wal-Mart for survival.

COMPETITIVE FORCE 5: BARGAINING POWER OF SUPPLIERS

The threat of bargaining suppliers exists on a different level for each firm.

For larger firms like NIKE, bargaining suppliers pose less of a threat since NIKE is

so large of a company. However, up and coming smaller companies would have

to succumb to the prices that their suppliers demand because they do not have

the necessary infrastructure to backwards or forwards integrate. Furthermore,

most major companies in this industry are not limited to a single supplier. Since

these companies generally sell a variety of products, they have a variety of

specialty manufacturers to choose from.

Backwards integration would mean to manufacture your own goods

instead of outsourcing them to other countries. Forward integration would be to

open one’s own retail stores to distribute directly to the public. The cheapest

way to sell directly to the public is online. There is a very small setup fee in

comparison to opening a “brick and mortar” store. Selling apparel and footwear


online is oftentimes difficult because customers prefer to see clothing and try

them on before purchasing. This has made the cheap online outlet very difficult

to convince customers to purchase from. This is being combated by offering free

shipping and loose 30-day return policies.

NIKE is a critical buyer from their suppliers, therefore NIKE has a lot of

influence over them.

The only way to survive in an industry like the sportswear and

apparel industry is to create an unparalleled competitive advantage.

INDUSTRY GROWTH. The industry’s growth goes hand-in-hand with NIKE’s

success. If the industry is experiencing a decline in sales, then it is probable that

NIKE will suffer as well. This luxury industry’s growth fluctuates with the

economy. Only over the most recent years has the sportswear apparel market

experienced significant growth. These items are considered a luxury because

their high quality would make them comparable to the “Lexus” of sportswear.

Industry growth could also be attributed to an increased variety of

products sold. No longer do the companies that make up this industry focus on

just sports apparel and footwear. NIKE and its competitors have expanded into

the consumer electronics industry, such as the NIKEplus, as well as the fashions

outside of sporting goods. There are also new players in the industry that have

recently experienced tremendous growth, namely Under Armour. Over the past

four years, Under Armour has increased revenues by over 200%. Industry

growth overall has increased 9.5% over the past five years, an encouraging

increase that NIKE contributed to.


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EVALUE CHAIN ANALYSIS

DIFFERENTIATION, INNOVATION, AND SUBSTITUTES. This specific luxury

industry uses brand recognition as an avenue to avoid competition based on

price. All three major players – NIKE, Adidas, and Under Armour – are known

for producing a quality good. Clever advertising campaigns are used to entice

customers when there is little differentiation. For example, NIKE ads generally

just show a variety of people participating in athletics followed by their swoosh

logo and “Just Do It” slogan. Comparably, Under Armour ads generally are very

high-paced and show athletes prevailing in intense, intimidating situations; and

of course, their logo and slogan “Protect This House” follow.

In an industry with so many similar and substitutable products, the major

brands are constantly having to innovate new ways to attract buyers. For

example, NIKE introduced its NIKE+iPod system to track running and attract

runners to its shoes. Similarly, Adidas created an “intelligent” shoe that

automatically adjusts pressure in the shoe to conform to your foot.

FIRST-MOVER ADVANTAGE. The first-mover advantage closely ties in with

innovation because the first company to create a new product is essentially the

first-mover in that segment. Furthermore, the first in the industry is often

regarded as an “innovator” and those who follow are regarded as “imitators.”

The first to move into an industry often wins the public’s trust. First-movers are

also associated with a higher level of customer loyalty.

BUYER RELATIONS. Professional sports teams are among the most important

endorsements a company can make in this industry. All three main companies

have contracts with major league and NCAA sports teams. These endorsements

not only consist of millions of dollars worth of purchase agreements but also

include marketing and promotional benefits. Since the sporting apparel is so

closely related to sports, having professional athletes represent your company’s

products is extremely important.

Sporting enthusiasts and other customers can find sporting apparel at a

variety of locations. Almost all brands have an online store where anyone with a


credit or debit card can purchase their goods. However, most sporting apparel

and footwear is sold through retailers like Foot Locker.

It’s imperative that NIKE remain competitive in the industry to survive. In

a report on corporate responsibility, NIKE brand presidents write that their goals

are, “to effect positive, systemic change in working condition within the footwear,

apparel and equipment industries; to create innovative and sustainable products;

[and] to use sport as a tool for positive social change and campaign to turn sport

and physical activity into a fundamental right for every young person.” There are

several ways they do this.

INDUSTRY GROWTH. Expansion and growth in the industry of the textile and

athletic apparel industry has enabled growth in the NIKE Corporation.

Controlling over 20% of the athletic shoe market, NIKE is the number one

shoemaker in the nation, not to mention the world. Compared to its

competitors, NIKE controls most of the industry and is growing rapidly. Over the

past five years, NIKE has had increasing revenues of $5 billion while Adidas had

just under $2 billion. The increasing number of sales has been largely attributed

to their increasing number of distributors worldwide. The easier it is to transport

the products to the buyers, the easier it is to see how the number of sales has

risen worldwide in the past five years. NIKE’s subsidiaries also provide for their

rapid growth because they only add to their total sales; the wide-variety of

products from the different stores also contributes to their increasing sales. Since

NIKE has a large customer base, there are many loyal customers who contribute

to year-to-year revenues.


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COMPETITIVE ADVANTAGE ANALYSIS

DIFFERENTIATION, INNOVATION, AND SUBSTITUTES. NIKE, from meager

beginnings has, through the years, become a leader in the footwear and apparel

industry based on their brand identification. This was not all accomplished in

one day but over many years of research, product development, and creative

innovation. Historically Nike's innovation has been unsurpassed and rarely

equaled. This began with the waffle iron used to produce a new rubber sole for

the first Nike running shoe. Since that time Nike has had much success with the

Nike "Air" cushion system developed for the running shoe and popularized by the

1990s basketball craze surrounded by Michael Jordan. The most recent

innovation by NIKE is the combining of NIKEplus shoes and Apple iPod Nano

“tune your run” system.

FIRST-MOVER ADVANTAGE. When it comes to must-haves, NIKE took innovation

to the next level by teaming up with Apple, the leading innovator in music. NIKE

footwear now provides customers with a detailed report of their workouts by

tracking a runner's progress through sensors within the shoes and transferring

the information to the iPod Nano. However, NIKE's innovation was soon imitated

by Sony's MP3 player that includes a built in pedometer to measure calories,

distance, and the number of steps taken. Sony also allows consumers to upload

information to a website, that charts a runners progress, just like the

NIKEplus.com site provides. As long as NIKE's innovations continue to win over

customers, there will always be the threat of imitators.

BUYER RELATIONS. The better the buyer relations a company such as NIKE has,

the better the numbers are in their sales. NIKE is very skilled in connecting the

buyer to the product. Through online stores, customers are met with

convenience as they can access their favorite shoes or clothing at their very own

home. NIKE has made it possible to order products conveniently online to keep

the customers easily connected without having to go shopping. Also, NIKE has

their own upscale retail stores named NikeTown in New York and outlet stores

that sells their products spread throughout the world. NIKE’s number one outlet


for sales is through resellers. Footlocker, for example, accounts for 10% of

Nike's sales.

Their relationships made with professional teams and professional athletes

that account for NIKE’s growth. Endorsement deals are presently worth $1.7

billion, down from $1.9 billion from 2005. For example, Lebron James of the

Cleveland Cavaliers has an endorsement deal worth $90 million and Tiger Woods

has a $100 million endorsement deal. Since Nike uses their name with these

athletes, customers associate NIKE’s image with well-known and skilled

professional athletes.

NIKE, Inc. is a retail company that competes on product quality and

innovation. Because they have been around significantly longer than some of

their competitors, NIKE has certain strengths such as brand loyalty that newer

companies may not have. However, several other advantages remain in the

industry regardless of the firm’s time in practice. Unfortunately for NIKE, these

benefits go hand and hand with critical success factors, and are each very

possible for any firm to take part in. Research and development is one of NIKE’s

main focus for studies, and this advantage enables NIKE to get a head of the

competition in terms of developing their products to their loyal customers. They

also compete mainly on differentiation to set themselves apart from their

competitors. Innovative new products are one of the key success factors that

NIKE depends upon as well.

ACCRUAL ACCOUNTING. NIKE uses the accrual accounting method conforming

to the most recent GAAP standards. Revenue is recognized at the time of sale

and accounts receivable are created if cash is not paid immediately. Customers


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KEYACCOUNTING POLICIES

must accept the product, along with its risks and rewards, for revenue to be

recognized. International receipt dates are estimated because the exact date of

receipt might not be readily available. If estimates are significantly inaccurate,

net revenue is adjusted for the erroneous period.

INVENTORY MANAGEMENT. Inventory assets are priced at the lower of their net

realizable value or the price they were bought at. If the two are not equal, the

difference of the two is taken and is added to the inventory reserve account.

This ensures that assets equal the sum of liabilities and equity. Inventory is

managed on a FIFO or moving average basis. NIKE does not own any factories

to manufacture their goods so all inventories are finished goods.

ADVERTISING AND PROMOTIONAL EXPENSES. NIKE lists their endorsement

contracts under a “demand creation expense” account. Their endorsement

contracts are generally expensed evenly throughout the life of the contract.

However, certain contract provisions may prevent uniform amortization of

endorsement expenses. Extra expenses in regards to endorsements are

recognized when the expenses happen. Other expenses related to endorsement

contracts could include endorsement bonuses for being a top-ranked player in a

sport or winning a championship. However, when it is probable that a peaked

performance will be maintained throughout a period of time, the outlay is

expensed throughout the estimated period. Royalty payments are also paid

based on predetermined percentage of sales. These are expensed as a “cost of

sales” expense and are expensed out when sales are made. However, if sales do

not meet those goals and NIKE committed to paying a minimum fixed royalty, it

is expensed throughout the contract.

Advertising production expenses are realized when the advertisement is

first published. The actual cost of advertising is realized the month the

advertisement runs. Some advertising expenses are reimbursed to distributors

who have advertised NIKE products. These expenses are filed under selling and

administrative expenses and are not part of the demand creation account.


Advertising reimbursements are recorded when the customer demands the funds

which may be before the actual advertisement is ran.

GOODWILL. Goodwill and intangible assets with indefinite lives are measured for

impairment in the fourth quarter of the fiscal year. The estimated fair value is

compared to the carrying value to test for impairment. NIKE will recognize

impairment if the carrying value exceeds the estimate of fair value, and calculate

the surplus of the carrying value over the fair value estimate to get impairment.

These estimates are subject to change in future years because of changes in the

economy, technological changes, inability to meet business requirements, etc.

Any impairment calculated for goodwill will be classified on the consolidated

statement of income as part of income before taxes.

Over the past five years, NIKE has not written any of their Goodwill assets

off. Having tendencies towards not writing expenses off indicates an aggressive

accounting policy. Certainly some of the value of NIKE’s Goodwill assets has

used up their extra earnings capacities since five years ago.

FOREGIN CURRENCY EXCHANGE. NIKE is involved in the global market which

exposes them to risks such as changes in foreign currency exchange rates and

interest rates. NIKE uses forward exchange and option contracts to hedge

transactions made in foreign currency. Changes in fair values are recorded in the

comprehensive income once the particular criteria required, under the

"Accounting for Derivative and Hedging Activities," has been met. After the

maturity of the derivative, the losses and gains are transferred to net income. In

this accounting treatment, the forward exchange contract should not exceed the

anticipated transactions. If anticipated or actual transactions fall below hedged

levels, NIKE readjusts their comprehensive income, or they make adjustments to

the hedge contract to correlate with the revised anticipated transaction.

NOTES. For the exception its stock option plan for executives, NIKE does not list

the retirement benefit liabilities for its 28,000 employees. They also do not


disclose whether they offer a defined benefit or contribution plan. Enforcement

of intellectual property rights is declared “not material” to the financial position of

the company. NIKE’s management team takes on the full responsibility of

maintaining a set financial statement schedule.

After overlooking NIKE’s recent financial statements, we have

determined that NIKE has a fairly strict set of accounting policies. There is little

room for flexibility in most areas.

RESEARCH AND DEVELOPMENT. Research and development is a significant part

of NIKE’s pioneering products. Their unparalleled success depends on the

constant innovation of new products. NIKE’s reputation is based on being the

first to create new lines of footwear and sportswear. “NIKE strives to produce

products that help to reduce injury, enhance athletic performance and maximize

comfort.” Unfortunately, research and development cannot be adequately valued

as an asset. Therefore, there is not much flexibility in terms of laying out the

expensing of research and development costs.

ACCRUAL ACCOUNTING AND DELAYS WITH RECEIPT DATES. NIKE’s financial

statement says that revenue is recognized when the customer receives

shipments. However, international receipt dates cannot be tracked immediately

and are generally just estimates. Oftentimes, this leads to inaccuracies in

financial statements. NIKE says that all inaccuracies are corrected in the

financial statements.

When estimates are made, there is plenty of room for flexibility. An early

estimated receipt date of a large shipment to a European retail chain could


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ACCOUNTING FLEXIBILITY

significantly boost revenues and raise stock prices. While this could be

corrected, it will take longer and would likely not cause as much of a downfall in

stock prices as the boosted revenues caused a stock price raise.

A more accurate way of measuring when international revenues are

recognized would be to track shipments electronically and give buyers only one

week to verify that the shipment is correct before declaring it received by default.

This way estimates could be avoided in this area all together.

INVENTORY MANAGEMENT. NIKE’s inventory is valued on either a first-in, first-

out (FIFO) or moving-average cost basis. This demonstrates NIKE’s wide range

of flexibility when it comes to recording inventory. The financial statement does

not state which inventories are valued on a FIFO basis and which are valued on a

moving-average basis. It also neglects to state if that changes on a year-to-year

basis.

We are assuming that the same type of inventory would be valued

according ot the same standards of the previous year unless it is disclosed in the

financial statement notes under the “Inventory” section. However, since their

financial statement doesn’t specifically say that they use the same method year-

after-year so this leaves the option to use whichever method makes the financial

statements look better.

Since NIKE does not own any factories and all manufactured merchandise

delivered to them are finished goods, they do not have to concern themselves

with recording the value of unfinished goods.

ADVERTISING AND PROMOTIONAL EXPENSES. Endorsement contracts amount

for a large portion of NIKE’s promotional expenses. Payments are based upon

specific contract provisions and are generally expensed equally throughout the

term of the contract. They reimburse retail clientele for a portion of the costs of

advertising their products. This induces flexibility in recording advertisement and

promotional costs since it all depends on the terms and length of the individual

contracts with companies such as footlocker or key spokesmen and supporters


like Tiger Woods. Royalties for peak performances of endorsement contractors

are often expensed over a period of time that the company determines the

“peaked performance” will last.

The financial statements disclose no guidelines or limits as to how long a

endorsee’s peak performance period can last. This is one of those areas that

cannot be accurately assessed because there is no way to tell exactly how long a

an endorsee’s peak performance will impact an audience and influence them to

purchase NIKE products; just as a marketing campaign’s full effect on consumers

can never be measured. However, NIKE expenses print and media advertising

campaigns when they are run. Using this same concept, NIKE should declare the

royalty expense when it is incurred and not spread it across several months time.

Expensing royalty payments over long periods of time could be used as a

tactic to overstate income. Furthermore, if NIKE’s estimation is overstated, it is

not disclosed how they would correct the overstatement. For example, if NIKE

had predicted that Terrell Owens would have a season-long performance peak

and then an accident with prescription drugs caused him to be out for the rest of

the season; would NIKE continue to expense a royalty to him over the

predetermined period or absorb the rest of the cost when it is determined the

peak-performance period is over? If it is absorbed at the end of the peak-

performance period, this could cause a very high increase in expenses.

NIKE does not reveal how they expense specific promotional scenarios

such as, for example, footlocker advertising a sale and promoting NIKE’s

merchandise. We are not informed of how or when it is expensed, and therefore

circumstances such as these require NIKE to be flexible in their expenses.


NIKE is considered to be aggressive based in their industry. They tend to

overestimate their earnings and underestimate their expenses. This could be a

potential problem for NIKE despite the fact that they do dominate the market.

NIKE’s disclosure of accounting strategies conveys how well they account for this

aggressive stature. The following strategies coincide with their result in being

aggressive.

The Textile – Apparel Footwear and Accessories – industry can be very

difficult to survive in. It is an industry with only a handful of dominant

competitors. These competitors however, are extremely large firms that have

enough impact to lead the product direction of the entire industry, as well as

completely diminish other participating companies. NIKE is the dominant force in

this industry. NIKE, for the most part, appears to provide their consumers with

detailed, honest statistics. Although the majority of the leading players in this

industry follow the same guidelines, there are still a few differences that explain

how NIKE stays ahead of the game. NIKE is aggressive in

MANAGERIAL CONTROL. Almost every firm in the apparel and footwear

accessories industry uses the same regulations when disclosing their controls and

procedures. There is a tight list of events and time periods that are specified by

the General Accepted Accounting Principles delegated by the Securities and

Exchange Commission. Once all of the necessary information is gathered it is

sent to upper management, usually the CEO and CFO decide the specifics of the

disclosures presented to the public. This process is called the “Management’s

Report on Internal Control over Financial Reporting,” and is listed in Item 8.

Nike is described as flexible in their accounting procedures. Because they

are considered flexible, they have an incentive to skew their numbers to where


NK

EEVALUATION OF ACCOUNTING STRATEGY

they look like they are doing financially well. As opposed to being strict, NIKE has

leeway associated with their statements to convey that they are doing well, even

when they are not. This is not a favorable characteristic for NIKE.

The main purpose of this procedure is to provide ‘reasonable assurance’

concerning the preparation and dependability of financial reporting for external

purposes, in agreement with the generally accepted accounting principles.

Clearly, NIKE is restricted to some very specific accounting guidelines, along with

the rest of the industry.

INVENTORY MANAGEMENT. The inventory management techniques required for

NIKE and their top competitive market threats (Skechers, Coach, and K Swiss)

are very comparable. With the identical decision to use FIFO and straight-line

depreciation methods, these firms see similarities relating to their revenue

recognition, inventory reserves, advertisement contracts, and foreign exchange

risks. Based on the terms of sale, wholesale revenues are recorded when the

title passes to the customers. This may differ for those companies who have

their own manufacturers because it requires keeping record of the different

stages their products go through, whereas NIKE has only finished goods to keep

track of.

Other resemblances include how various estimations are made based on

historical records and credits; or how goodwill and other intangible assets are

measured for impairment instead of amortized. Finally, all of these companies

have the unpleasant risk of the foreign rate exchanges. After translating these

foreign currencies into US dollars, the accumulated amount is added as a

component of comprehensive income in shareholders’ equity

MARKETING CAMPAIGNS. Not only does NIKE have greater resources than their

competition, they also spend a significant amount of money on marketing

strategies such as advertisements, endorsements, and promotions. Under

cooperative advertising programs, NIKE records selling and administrative

expenses to reimburse their retail customers that advertise NIKE products in


their commercials etc. For endorsements, accounting measures depend on their

specific contract provisions such as particular achievements that are expensed to

S&A. We also provide endorsement contracts that promise minimum guaranteed

royalty payments. In the 2006 fiscal year alone, NIKE has recorded $1.7 billion

in their total advertising and promotion expenses. By doing this, NIKE has

captured their priceless brand image that has helped them stay on top.

With all of the impressive information NIKE discloses, one has to be

curious about the degree of honesty the Company presents. However, along

with those strict guidelines for accounting policies are the intricate agreements of

any debt covenant that NIKE could be involved in. Loaded with precise ratio

minimums and stern deadlines, NIKE would not even approach these types of

obligations if they didn’t have the means to keep up with them. Finally, if there

is anything suspicious on a financial statement, it will be properly explained. The

2006 cash flow activity report is an example of NIKE’s trustworthiness when they

clarified an unusual increase in inventories, explaining that it was only a result of

supporting expansion of NIKE-owned retail stores. They have minimal, if not,

zero incentive for false accounting disclosure. NIKE is the trend of the industry

that the rest of the companies follow.

! NIKE, Inc. regularly supplies its investors with a well-stated financial

disclosure document. NIKE follows the GAAP standards to expose the essence

of the company and how they conduct business activities. Their financial

statement is separated into different sections to make it easy to distinguish

particular points of interest in the disclosure.

NIKE shows year-to-year comparisons as far back as four years. These

comparisons enable the public to see the company's growth and success


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EVALUATION OF DISCLOSURE QUALITY

patterns. An increase in data, such as revenues, allows investors to see NIKE's

progress, and since the information falls back on the last five years, it is easy to

see the progression to the present and provides encouragement for future

growth.

! Very few decreasing trends were shown. This could either be because

there were very few decreasing trends or because NIKE chooses to make

decreasing trends less apparent than increasing trends.

Although NIKE does offer warranties on their products, there is no mention

of warranty expense in the recent financial statements. Since NIKE is known for

their quality products, the reason for this lack of disclosure could be because

they have such a low rate of product failure that the warranty expense is too

insignificant to report. Research and development expenses are disclosed to

display the dedication to the new product innovation that has been the backbone

of NIKE"s success.

Since NIKE purchases all their products overseas, they disclose

international operations and trade policies that explain that it is cheaper to

assume the risk of a change in the foreign currency exchange rate rather than to

manufacture the products in the United States. NIKE clearly presents the risks

involved showing that they are confident enough to present any threats the

company might face.

Additionally, NIKE examines and discloses any significant fluctuations in

their financial statements. Increases or decreases in certain sections, such as

sales, are explained with reasoning like an increase in unit sales or consumer

demands. The explanation of information helps the public understand why NIKE's

changes occur and further the quality of the disclosure. There are also

numerous note sections – including inventories, long-term debt, and common

stock – that explain their activities and reasons for significant balances.

NIKE focuses on a tax minimization strategy by choosing between FIFO

and moving-average cost basis to value their inventory. However, year-to-year

trends in inventory management are not shown which leads to some question as

to whether the same method is used year-after-year.


The audit report disclosed further shows the quality of information

presented to the public as the activities NIKE engages follow those requirements

by GAAP.

RETIREMENT PLANS. NIKE does not clearly disclose how they account for

employee pension plans. The company briefly discusses in “Notes to

Consolidated Financial Statements, Note 12” how the company contributes cash

or common stock to a savings plan, such as a 401(k). The following amounts (in

millions) were contributed to these accounts in the past five fiscal years.

2006 2005 2004 2003 2002

$22.5 $20.3 $17.0 $15.6 $13.7

The contributions are included in selling and administrative expenses.

However, there is no apparent portion in the income statements or disclosure

notes showing how those exact contributions are given out to their employees.

Furthermore, it does not state whether these stock option plans are defined

benefit or contribution based.

CASH-FROM-SALES RATIO. Another potential “red flag” found was the

differences between 2004, 2005, and 2006 net sales: cash-from-sales ratio.

Pre-2004, this ratio has remained relatively steady each year. However, in 2004,

the ratio was 14.80. The ratio then dropped dramatically to 9.90 in 2005 and

rose again in 2006 to 15.67. This difference was not disclosed anywhere in the

annual 10-K for any of the three years.


NK

EPOTENTIAL RED FLAGS

This immense difference is most likely attributed to the amount of cash

from sales in the year 2005, because the net sales have remained at a sound

increase. An explanation for the decrease in this ratio in 2005 and then the

increase again in 2006 would have been appropriate to disclose in the company’s

respective year’s 10-Ks.

OTHER RATIONS MEASURED. Other ratios that were measured did not reveal

any significant red flags.

2006 2005 2004 2003 2002

Net Sales/ Cash from Sales 15.67 9.90 14.80 16.87 17.19

Net Sales/ Net accounts receivable 5.84 5.79 5.36 5.09 5.48

Net Sales/ Unearned Revenue n/a n/a n/a n/a n/a

Net Sales/ Warranty Liabilities n/a n/a n/a n/a n/a

Net Sales/ Inventory 7.20 7.59 7.50 7.06 7.20

Sales/ Assets 1.52 1.56 1.55 1.59 1.54

Changes in CFFO/ OI 0.05 0.03 0.39 -0.15 0.42

Changes in CFFO/ NOA 0.03 0.01 0.19 -0.05 0.14

Total Accruals/ Change in Sales 0.36 0.22 0.02 0.26 0.16

Pension Expense/ SG&A n/a n/a n/a n/a n/a

Other Employment Expense/ SG&A n/a n/a n/a n/a n/a


In any company there is the possibility that in their accounting they have

moved numbers or made up accounts to distort certain things for the average

investor. With any company, there is the risk their management will put accounts

where they show better ending numbers or show a larger amounts of assets,

fewer liabilities, or a higher net income.

GOODWILL. In the goodwill and amortization section NIKE does not write down

their expense at the end of each year. Instead they have a total which can

distort the net income and liabilities section of the income statement. In 2002

182.2 million dollars was put in their amortization account and then dropped to

87 million in 2003. After two years NIKE adds another 341.5 million to this

account and has yet to depreciate the amount over the years. If the 341.5 was

allocated throughout the past five years there would be a 68 million dollar yearly

goodwill amortization expense, which would bring assets down and raise

expenses.

OFF BALANCE-SHEET ASSETS. NIKE also discusses "off-balance sheet'

arrangements but goes no further other than mentioning them, following with a

brief statement explaining that they do not believe they will affect the financial

position. These "off balance-sheet" items are contracts and various agreements

that are not further discussed. NIKE does not manufacture their goods, they

lease facilities and create contracts to have their goods externally manufactured.

Operating leases are usually expensed as rent, but in the case of NIKE where the

various leases do not expire until 2034 this could be considered a capital lease.

NIKE, by calling these long term "operating leases," uses a more aggressive

accounting strategy. When the estimates for 2007 through 2011 are changed to


NK

EUNDOING DISTORTIONS

meet a more conservative method of accounting the lease expense for the years

2007 and 2008 are less. In the year 2009 the expense becomes higher which is

going to reduce income for that year. The increase in expense for the last three

years averages 29.84 million dollars a year. This could potentially cause a

significant reduction in net income when added to other expenses.

Overall, NIKE’s disclosure is very good. Many things that could be potential

distortions have been disclosed and explained in footnote sections.

RATIO ANALYSIS & FORECASTING FINANCIALS. In order for us to properly

evaluate NIKE, we had to look at their past financial performances to achieve an

understanding of what NIKE can do in the future. We looked at the growth

trends to better an understanding of what NIKE can do in the future as well as

the industry and competitors. In this section, we analyzed different ratios to gain

information relevant for the future. The ratios in this section include those from

liquidity, profitability, and capital structure. Along with these ratios we received

from NIKE, we then compared these to the industry and their competitors,

mainly Kswiss and Under Armour. With these ratios, we also forecasted several

relevant ones of NIKE and its competitors in the market for comparison.

In this section, NIKE’s liquidity, profitability, and capital structure ratios are

taken out of yearly SEC filings from the past five years to break down elements

more specifically. By studying and relating the Basic 14 growth ratios, many

pertinent success dynamics are exposed for our knowledge. With this, we can

see the interactive links between different financial statements.


NK

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FINANCIALRATIO ANALYSIS

Again, we study the firm by itself along with main competitors and the

industry average. Out of the hundreds of companies in this industry, we believe

that it will be most beneficial to compare numbers with the market

representation of K- Swiss Inc. and Under Armour, as other main competitors are

in the international market and difficult from which to receive information.

In the ratio analysis, we illustrate several methods to compare numbers

and provide our public with a solid framework of NIKE’s stature. To start out, the

trend or time-series study compares the firm’s ratios over the past five years and

shows us the sustainable and internal growth rates. Next is the cross-sectional

interpretation. While excluding NIKE, benchmark ratios are found from top

competitors and from the industry averages. After that, NIKE is added back in to

see where they stand. Finally, after finding this desired information, NIKE can

confidently proceed with forecasting its future.

LIQUIDITY RATIO ANALYSIS

Liquidity Analysis 2002 2003 2004 2005 2006 Evaluation

Current Ratio 2.27 2.32 2.71 3.18 2.8 increase

Quick Asset Ratio 1.29 1.36 1.75 2.1 1.87 increase

Account Receivable Turnover 5.48 5.09 5.36 5.79 5.75 increase

Days 66.56 71.69 68 63 63.5 decrease

Inventory Turnover 4.37 4.17 4.29 4.21 4.03 decrease

Days 83.47 87.57 85 86.7 90.5 increase

Working Capital Turnover 4.26 4.01 3.5 3.15 3.16 decrease

The liquidity ratios make it easy to comprehend how well a company

repays its current liabilities by analyzing the ability to maintain enough cash on

hand to meet their future debt. NIKE's quick asset ratio and current asset ratio

are favorable which gives the company the ability to convert its current liabilities

into liquid assets. In addition, NIKE improved their accounts receivable turnover,

thus minimizing the number of days of collecting accounts by three days.


Although, the company's inventory turnover was not as favorable as it decreased

from 4.37 to 4.03 causing an increase in days their products stayed in inventory.

Finally, working capital turnover was not favorable as well since there was an

increase in current assets which increased working capital. This increase in

working capital caused a decrease in working capital turnover.

PROFITABILITY ANALYSIS

Profitability Analysis 2002 2003 2004 2005 2006 Evaluation

Gross Profit Margin 0.393 0.4098 0.429 0.445 0.44 increase

Operating Expense Ratio 0.285 0.293 0.43 0.29 0.28 no change

Net Profit Margin 0.067 0.0443 0.077 0.088 0.093 increase

Asset Turnover 1.536 1.593 1.55 1.56 1.52 no change

Return on Assets .0983 .0787 .1198 .1378 .141 increase

Return on Equity 0.179 0.119 0.197 0.214 0.221 increase

The various ratios used to determine the overall profitability convey

operating efficiency, asset productivity, return on assets and return on equity.

The operating efficiency shows different items from the income statement as a

percentage of sales. Overall, NIKE's operating efficiency was favorable as there

was an increase in gross profit margin; although there was not a substantial

change in the operating expense ratio the decrease is favorable. The net profit

margin increase is favorable as well. The asset turnover did not have that much

of a relevant change, but the return on assets and equity turned out to be

favorable. Profits increased allowing the return on equity and assets to increase.

Return on assets measures how the company changes their assets into profits.


CAPITAL STRUCTURE ANALYSIS

Capital Structure Analysis

2002 2003 2004 2005 2006 Evaluation

Debt to Equity Ratio 0.6775 0.6823 0.65 0.56 0.57 decrease

Times Interest Earned 22.435 29.039 61.988 394.5 -57.32 decrease

Debt Service Margin 5.544 12.167 10.401 22.5 38.43 increase

The debt to equity ratio is a measure of how well NIKE uses their available

assets to cover their debt. This decrease in debt to equity indicates that NIKE did

not use as much money from the profits of their shareholders to pay for their

debt. Their credit risk is also evaluated using the debt to equity ratio, as Nike

shows they have less credit risk. As NIKE’s ratio decreased, their assets had to

increase to cover their liabilities, making them less credit risky. Times interest

earned did increase which means there is sufficient income from operations to

meet the necessary interest that is owed. The severe fluctuations in the times

interest earned was caused by the interest expense differences, particularly the

interest income expense in 2006. Since the interest expense was so low in 2005,

it caused a substantial increase in the times interest earned. In 2002, the notes

payable account was large enough to bring down the debt service margin to

5.544. Aside from that, the overall capital structure analysis was favorable due to

the decreases in the debt to equity ratio and times interest earned ratio.

INDIVIDUAL RATIO ANALYSIS

All of the following numbers for 2002 are not available and the numbers

for 2006 are an average from the previous years. The graphs could be

misleading but are the closest numbers for comparison.


CURRENT RATIO

2002 2003 2004 2005 2006

NIKE 2.27 2.32 2.74 3.18 2.80

KSWISS N/A 5.86 5.12 6.67 5.88

UNDER ARMOUR N/A N/A 1.21 3.81 2.51

INDUSTRY AVG. N/A 5.86 3.07 5.24 4.20

The current ratio is a ratio that shows the number of current assets,

assets that can easily be converted to cash, to the number of current liabilities,

liabilities that will be due within one year. When a company has a current ratio

larger than one, this is good, but a current ratio that is too large shows that the

company is not using its assets efficiently. Nike has a current ratio between 2

and 3 which is below the industry average but is still within a range that shows

they are able to pay off their current liabilities yet is low enough to show their

assets are being utilized. In the industry, NIKE is steadier and more stable

compared to the other competitors as their line in the graph is straighter. The

graph also shows that Nike is not moving or gaining any more or less assets than

any other company and has steady numbers over the years.


QUICK RATIO

2002 2003 2004 2005 2006

NIKE 1.30 1.36 1.75 2.10 1.87

KSWISS N/A 3.71 3.75 5.20 4.22


INDUSTRY AVG. N/A 3.71 2.12 3.82 2.84

The quick ratio shows a closer representation of assets that can be

liquidated more quickly with cash, short-term investments, and accounts

receivable being the accounts used for the asset portion of the ratio. This graph

shows many of the same things as the current ratio graph in that Nike is below

the Industry average yet still has a strong enough number to be acceptable. The

acceptable range for the quick ratio is between 1 and 1.8. Lower numbers are

not uncommon for this ratio since there are fewer assets being divided by the

same number of liabilities as the current ratio.


ACCOUNTS RECEIVABLES RATIO

2002 2003 2004 2005 2006

NIKE 5.48 5.09 5.36 5.79 5.75

KSWISS N/A 7.95 8.95 10.90 9.27


INDUSTRY AVG. N/A 7.95 7.14 8.09 7.29

The account receivable ratio is used to determine how long a company

has a receivable before it is collected. The larger this number the less time it

takes the company to collect on the account. If the company has a receivable

turnover of 1 or lower this means that the company has as and equal amount of

receivable and sales or even worse more receivables. Nike has a receivable ratio

around 5.5. This translates to 66 days for Nike to collect their money on sales.

This number is lower than the industry average and is not growing at a rapid

pace. Slow rising numbers or a plateau are not bad but a decreasing number is

bad because fewer days to collect on receivables means quicker cash that can be

used in other places. We had difficulty finding reasonable benchmarks since

other top competitors, like Adidas and Reebok, are international firms on an

international market, different from NIKE. This is the reason we had to use

Kswiss and Under Armour for the benchmarks.


INVENTORY TURNOVER

2002 2003 2004 2005 2006

NIKE 4.37 4.17 4.29 4.21 4.03

KSWISS N/A 3.19 4.05 4.43 3.89


INDUSTRY AVG. N/A 3.19 3.17 3.57 3.19

The inventory turnover will show how long a company keeps inventory before it

is sold. The number given by the ratio is not in days but can be converted easily

by dividing Inventory by the average Cost of Goods Sold per day. Inventory

turnover is Cost of Goods Sold divided by Inventory. This ratio can be confusing

in that if the ratio is low this could be a sign of overstocking or a deficiency in the

product but a ratio that is high could be that the company has inadequate

inventory levels. Nike has a fairly constant ratio around 4 which has been

declining slowly. There is no problem with a declining ratio in the case of Nike

because it is still above the Industry average but is not so high to raise

questions.


WORKING CAPITAL TURNOVER

2002 2003 2004 2005 2006

NIKE 4.26 4.01 3.50 3.15 3.16

KSWISS N/A 2.42 2.22 1.91 2.18


INDUSTRY AVG. N/A 2.42 7.26 2.00 4.69

Working Capital Turnover is sales divided by working capital (current

assets-current liabilities). This ratio is a measurement of dollars that are

generated from each dollar that is invested in working capital. A high number is

desired for this ratio showing that there is money coming from the money being

invested in working capital. This graph is not an accurate representation

because the Industry average is skewed from the extremely high beginning ratio

from Under Armor. Nike and K-Swiss have more information and therefore gives

a better comparison. As shown Nike and K-Swiss do follow the same pattern

both having decreases followed by slow growth. We can make an assumption

since both companies follow a very similar pattern that the Industry average


would be closer to their lines than Under Armor and the Industry Average are

showing.

GROSS PROFIT MARGIN

2002 2003 2004 2005 2006

NIKE 0.39 0.41 0.43 0.45 0.44

KSWISS N/A 0.45 0.46 0.47 0.46


INDUSTRY AVG. 0.45 0.46 0.48 0.47

The Gross Profit Margin is found by subtracting cost of sales from sales

and dividing this by sales. The graph shows that all the companies are very

similar and have not had any major decreases or increases from year to year.

This shows that sales and cost of sales has been very steady. Nike has a lower

GPM than the other companies which indicate it could be obtaining and

producing its products at a lower cost or Nike may be able to demand a higher

price premium since their products are seen as unique.


OPERATING EXPENSE RATIO

2002 2003 2004 2005 2006

NIKE 0.29 0.29 0.30 0.29 0.28

KSWISS N/A 0.24 0.25 0.25 0.25


INDUSTRY AVG. N/A 0.24 0.30 0.30 0.30

This ratio is found by dividing the operating expenses by sales. The

number found by this ratio will be a decimal but actually represents the

percentage of revenue used for operations. As shown by the graph Nike uses

around 30% of its revenue for operating expenses. Nike’s 30% is very close to

the Industry average so can be seen as a positive. This shows that most

companies in the Industry are using around the same amount of their revenues

to pay for their operations.


NET PROFIT MARGIN

2002 2003 2004 2005 2006

NIKE 0.07 0.04 0.08 0.09 0.09

KSWISS N/A 0.12 0.15 0.15 0.14


INDUSTRY AVG. N/A 0.12 0.11 0.11 0.11

The Net Profit Margin is a measure of profitability dividing Net Income by

revenues. This is another ratio that is expressed in a percentage which

represents how much the company actually gets to keep after production costs

and taxes. It is a representation of the companies pricing policy and/or how well

a company is able to control cost. This graph shows that in the early years Nike

had a low Net Profit Margin but has been steadily increasing to present day

where they are much closer to the Industry average. Nike has a Net Profit

Margin of around 9%. Nike had its lowest profit margin in 2003 where they may

have tried a new pricing policy or were not as efficient in controlling their cost.


ASSET TURNOVER

2002 2003 2004 2005 2006

NIKE 1.54 1.59 1.55 1.56 1.52

KSWISS N/A 1.83 1.64 1.51 1.66


INDUSTRY AVG. N/A 1.83 1.74 1.44 1.64

This ratio shows how much revenue a company is able to generate from the

amount of assets it has. Asset Turnover is sales divided by total assets. The

graph shows that all competitors and Nike are staying very close to the Industry

average. In the earlier years all competitors had a higher Asset Turnover but

have been on the decline until recently. A higher asset turnover would be nice

for Nike because this would mean they are utilizing all of their assets.


2002 2003 2004 2005 2006

NIKE 9.8% 7.9% 12% 13.8% 14.1%

KSWISS 15.6% 22.9% 24.2% 22.4% 21.3%

UNDER ARMOUR 9.5% 10.4% 14.4% 9.7% 11%

INDUSTRY AVG. 11.6% 13.7% 16.9% 15.3% 14.4%

Return on assets is a measure of the revenue produced by the dollar

amount of assets invested. The ROA for Nike is substantially lower than the

Industry average in the earlier years but is shows positive growth. Nike being

lower than the Industry average is not surprising since their net profit margin

and asset turnover (ROA= net profit margin x asset turnover) were both lower

than the Industry average. Since the graphing is in an upward trend the

operating performance is improving. In relation to ROE, both have steadily

increased along with the industry, and the ROA is lower than ROE. This number

is expected to be lower than ROE since the ratio involves total assets; total

assets should be larger than total equity, making the ratio smaller.


2002 2003 2004 2005 2006

NIKE 17% 12% 20% 21% 22%

KSWISS 21% 28% 31% 27% 29%

UNDER ARMOUR 98% 48.00% 77% 13% 45%

INDUSTRY AVG. 43% 28% 54% 20% 37%

Return on Equity is a measure of how well the funds are being used to

generate returns for the shareholders and their investment. This graph is

skewed because of the extremely high ROE of Under Armour in the year 2002

(the first publicly traded year). Nike’s ROE is beginning to plateau at a little

above .2 where many large companies in the United States are usually at .11 to .

13 in the long run. Again, the information seems non-comparable from Under

Armour and Kswiss compared to NIKE’s other competitors, such as Adidas and

Reebok because of the international market. The information from Kswiss and

Under Armour was not as consistent as the other competitors may have been.


DEBT-TO-EQUITY RATIO

2002 2003 2004 2005 2006

NIKE 0.68 0.68 0.65 0.56 0.57

KSWISS N/A 0.31 0.30 0.22 0.28


INDUSTRY AVG. N/A 0.31 2.26 0.29 1.28

This ratio is a measure of the amount of debt a company has compared to

the equity of that company. The Industry average has been skewed in 2004 by

the high ratio of Under Armor therefore making it a non-comparable. K-Swiss

and Nike have very similar debt to equity ratio patterns in this graph which can

produce the assumption the rest of the industry would have a similar pattern.


Because forecasting for the future is some what of an unpredictable and

intricate study, we tried to keep our calculations and methods as simple as

possible. This way, instead of being distracted by excess details that are not

necessary, we can keep all of our attention on what the future looks like for our

company. We have conducted a 10 year line – item forecast for each of our

financial statements by using an uncomplicated five year moving average. This

way we can easily detect the common trend of each important line item. The

forecast percentages and figures came from taking the average of the previous

five years for the next year in question. Computing the figures this way made our

information consistent.

We feel it is truly important to do an overall, comprehensive forecast

including our income earnings, cash flows, and balance sheet. Even if we were

only interested in one component of performance such as sales or profit margin,

the background and support from the rest of the forecasts will be stronger and

more reliable. Linking forecasts of such amounts to sales forecasts helps avoid

internal inconsistencies; however it would do us no good to look at a sales ratio

if we had nothing else to relate with which to relate. Computing overall items

will safeguard against any unrealistic or unspoken assumptions. Because of this

decision, we are given more reason to keep gathering our ratios from the five

year moving averages. If we keep that aspect very consistent, we think it will

keep our guesses to a minimum, as well as helpfully prevent a cluttered web of

assumption after assumption that can lead to forecast distortion. We continued

with these identical calculations with all of the figures for the 10 years of

estimates.

With any form of estimation and/or information gathering, there will

always be strengths and weaknesses along with limitations. Some of the


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ESTATEMENT FORECASTING METHODOLOGY

restrictions that we face while making these forecasts include the obvious point

that no one can 100% predict everything correctly. While we can get extremely

close to real life numbers as they happen, we could also be completely wrong

and be set back from mistaken preparation. Another limitation that we face is

the quality of disclosure that is presented to us in the filings. There could be

matter that is entirely left out or even items that are presented but are not

accurate. Our strengths relate to our methods trying to keep things as simple as

possible. Since we focused on keeping a minimum amount of assumptions, we

can more easily portray NIKE’S future forecasts with a lesser amount of

interference or deformation. Another strength we uphold is by using the moving

averages, as long as there are no significant external changes or policy changes

that take place in the next 10 years, our method’s simplicity we enable us to

forecast a longer, more precise future. Finally, as we all know, all strengths must

be accompanied by weaknesses. Our primary weakness deals with the fact that

the future is in no way completely predictable. Our moving average ratios do not

leave room for any unexpected change that could happen in the future. Ten

years is a long time in which many things could be the cause of a big adjustment

with one thing or the other. Although we have disadvantages that accompany

our forecasting methods, NIKE remains very confident in its strengths.

NIKE’s weighted average cost of capital (WACC) is very important because

it is the average rate of interest that NIKE pays to finance all of its assets. This

cost of capital may be paid in the form of interest to their lenders or to their

shareholders in the form of dividends. Either way, it costs money to make

money. The NIKE’s WACC is how much they pay to retain and purchase new

assets.


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WEIGHTED AVERAGE COST OF CAPITAL

COST OF DEBT (Kd). It is important to know a firm’s cost of debt because it can

give you an idea on the creditworthiness of a firm. If a firm is borrowing at

double the prime rate, it is likely a very risky firm. Banks who have seen their

financial data deem them to be less reliable than a firm they would lend to at

prime rate. This could be because the firm is a new firm, they are investing their

assets into risky projects, or because they are nearing bankruptcy.

NIKE, Inc. is a longstanding, credible firm. They have established

themselves as a prime competitor and penetrated their market effectively. NIKE

also has many assets to back up their loans. They are at a low risk for lenders.

COST OF EQUITY (Ke). The cost of equity is how much it costs to persuade

investor to give a firm their money. When a firm’s stock price has remained

stagnant for a while – experiencing neither dramatic increases or decreases – it

can entice investors to invest their money by paying dividends. A longstanding,

stable firm may not experience a dramatic increase in stock prices for a long

time. When investors feel they will not be making much money by investing in a

firm, they will not invest. However, if a firm of this nature pays dividends to its

stockholders on a regular basis then more stock holders will be inclined to invest

because of hopes of receiving dividends.

It should be noted that paying dividends to common stock holders is not

required and is done specifically to entice new investors. This means there is

always the risk that a firm will not pay dividends even if they have a long

standing record of paying them (as NIKE does). Because of this risk, they must

pay higher levels of dividends to satisfy the investors.

NIKE has a history of paying dividends to their common stock holders.

They are able to pay dividends with confidence because they continue to turn a

profit every quarter. They also are forecasted to continue to turn a profit in the

future. If they have a constant history of turning a profit and furthermore paying

dividends because of their large profits, then investors will feel confident that

they will receive dividend payments from NIKE once they become a stockholder.


COST OF CAPITAL. To determine NIKE’s cost of capital we first determined their

cost of debt and equity. We computed their respective weights, multiplied them

by their cost, and added them together. Below is a 5-year history of NIKE, Inc.’s

cost of debt, cost of equity, and weighted average cost of capital (WACC).

2002 2003 2004 2005 2006

Kd 2.00% 2.25% 1.40% 0.41% 3.37%

Ke 6.95% 6.95% 7.80% 8.25% 7.89%

WACC 5.84% 6.14% 6.85% 7.31% 7.43%

We will use these cost of capital computations throughout the remainder

of this valuation. Cost of debt seems to be low because NIKE discloses their net

interest expense which includes their interest income. Including their interest

income would make their cost of capital significantly lower than not including it.

However, it is valid to include their interest income into these computations

because the interest they earn off of lending their assets or keeping cash money

in the bank means they have to borrow less money to finance their assets. It

offsets some of their other liabilities.

NIKE’s weighted average cost of capital seems to be a steady, strong rate.

Over the past five years, as the chart above shows, NIKE’s cost of capital has

steadily increased. However, we do not attibute this to NIKE being a less credit-

worthy or riskier firm. We attribute this to international interest rates steadily

rising. The graph below shows NIKE’s cost of capital rate for each year with

each year’s respective London Inter-Bank Offer Rate, and with the prime rate.

Both the LIBOR and prime rates are the June 1 of the respective year rates.

The graph shows that NIKE’s WACC has grown less than both the LIBOR

and the prime rate. It also shows the prime rate exceeding NIKE’s WACC for

fiscal year 2006. NIKE has an extremely favorable cost of capital if it is below

the prime rate. Most banks lend over the prime rate.

Cost of capital should not be looked at over time without comparison with

other international offer rates. This is because a firm’s cost of capital could rise


significantly but it could be at no fault to the firm. If interest rates around the

globe are rising at the same amount or more, then the firm’s real WACC has not

increased. The firm will be paying more money out to borrow money, but not

relative to the other firms in the industry. This means that an increasing WACC

because of increasing world interest rates would not put the firm at a disposition

to other firms in the same industry because it is likely their WACC would rise by

the same amount, if not more.

CAPITAL ASSET PRICING MODEL

The CAPM (Capital Asset Pricing Model) is basically a model to measure

the cost of equity that expresses the cost of equity as the sum of a required

return on risk less assets plus a premium for systematic risk. Using the CAPM

the cost of equity was found to be .01058 or 1.058 percent which is some what

low. The numbers that are found using the CAPM will later be used in a WACC

analysis (Weighted Average Cost of Capital).


The Discounted Free Cash Flows (DCF) valuation model is calculated by

computing the present value of future cash flows. After forcasting ten years, we

examined financial data from NIKE’s statement of cash flows. To compute the

discounted free cash flows, we used each year’s cash flows from operating

activities and cash flows (used) from investing activities.

Our model says that the market over values NIKE, Inc. by just over $3 per

share. Our DCF model ended up with a value for NIKE of $152.24 per share.

However, the actual market price per share was $80.31. At a difference of

$71.93 per share and 256 million shares out standing, that makes NIKE, Inc.

undervalued.

The valuations that we found for the long run return on equity are an

actual perpetuity based on the model of residual income. This measurement of

return on equity is useful in comparing the profitability of NIKE to that of other

firms in the same industry of apparel and textile accessories.

We concluded that our firm was fairly correctly valued as we generated a

price of $79.53 as NIKE’s estimated value, and the actual price per share was

$80.31. As we found the beginning equity for each year, we used it for each year

after that to derive the return on equity for each consecutive year after 2006.

With these values, we ended up with the estimated price per share to be $79.53.

Since the ROE depends on how well a company uses its money invested, it is a

positive thing if the firm has a high ROE. The company reveals how much profit


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LR ROERESIDUAL INCOME

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EDISCOUNTEDFREE CASH FLOWS

it generates with the money shareholders have put into the company. In

comparison, if a company’s ROE is not high, it shows that they do not use their

money wisely to spend on their own company; the money put into the firm is not

used to their advantage to make profits. We learned through the ROE model,

that NIKE does use their equity wisely.

In the ROE valuation, we used various sorts of information to compute the

final result. For the Ke, we used 7.89% in NIKE’s valuation model to compute the

ROE as well as the equity calculated from an equation we used for each year.

Subsequently, as we found the ROE for each year, we also found the growth in

BVE steadily increasing. It is a good thing if NIKE’s equity value increases each

year, as it indicates that they can use more of what they invested to generate

profits and growth of the company. The more NIKE grows, the more attractive it

is for investors to invest their money into the company to do well in the industry.

The abnormal earnings growth valuation values the company based on

earning per share and dividends paid per share. The link between earnings per

share and dividends per share is what enables us to value a firm based on these

attributes. Generally, there is a positive correlation between earnings and

dividends per share. If earnings per share increase, often dividends per share

increase.

NIKE, Inc.’s earnings per share are forecasted to increase steadily over the

next ten years. They will see their most significant rise in 2014 when it will jump

from $14.90 in 2013 to $17.23. Dividends per share do not change at a steady

increase or decrease. DPS starts at a price of $1.14 in 2006 and will decrease to

$0.76 in 2007. It increases the next three years to $0.81 in 2008, $0.87 in 2009,

and $0.90 in 2010 where it will hold steady for the next year. The dividends per


NK

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ABNORMALEARNINGS GROWTH

share will fall to $0.85 in 2012. However, DPS will rise in the next two years to

$0.86, and $0.87 in 2013 and 2014 respectively. EPS rose by $0.80 to $5.28. In

the coming ten years, NIKE’s earning per share will rise from $5.44 to $17.23.

Since there is such a large expected increase in earnings per share, it is expected

to have one or two different stock splits. There have been three 2/1 stock splits

since 1980.

However, when the cost of equity, 7.89%, is factored into the abnormal

earnings growth model, the resulting value is $96.90 per share. This is a

difference of $16.59 from the book value of $80.31. The AEG valuation shows

that the market significantly over-values NIKE. Hopes of future growth could be

what cause the public to purchase shares at an overvalued price.

Core EPS $5.44

Total PV of AEG $4.35

PV of Terminal Value $5.49


Total Average EPS Perp (t+1) $15.28

Capitalization Rate (perpetuity) 0.0789

Value Per Share $96.90

The following ratios are very important in valuing a firm’s worth. They are

also useful when compared to other firms in the industry. In keeping with the

rest of this valuation, we will compare NIKE, Inc. with the Under Armour and K-

Swiss apparel and sportswear companies.

PRICE PER SHARE/EARNINGS PER SHARE. The price per share/ earnings per

share ratio is most importantly used to compare the value of stocks of different

companies. This ratio measures how expensive or cheap a companies share price

is. This is important because the amount a company earns per share


NK

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METHOD OF COMPARABLES

accumulates to the total wealth. The lower the P/E ratio is, the less expensive

the price of a share of stock. The less expensive stock is more attractive to

investors looking to buy shares of stock.

The higher the P/E ratio, the company is most likely over-valued compared

to other companies in the same industry. Management has a higher incentive to

create the stock at the right price because management is paid primarily from

the company’s stock prices. NIKE’s P/E ratio is calculated at 18.84 while the

industry average is 19.59. Under Armor’s P/E ratio is 50.11 which most likely

means that the company is over-valued. Because NIKE has a lower ratio, this

means that the stock price is not too high and is desirable to investors.

PRICE PER SHARE/BOOK VALUE PER SHARE. The market to book ratio is also

known as the price per share/ book value per share ratio. This ratio shows how

liquid a company is and how much would be left over if a company went

bankrupt. The purpose of this ratio is to compare the market value to the value

of equity, or the value of total assets minus total liabilities. This ratio is calculated

by dividing the current value of stock by the amount of common stockholders

equity per share. The lower the P/B ratio, the company is said to be under-

valued. The industry P/B ratio is 3.96. K-Swiss has a P/B ratio of 3.48 while

Under Armor has a P/B ratio soaring at 11.56. NIKE has a P/B ratio of 3.98,

which is just above the industry average. Since NIKE is just about at the industry


average, this means that NIKE’s P/B is not under-valued or over-valued.

Investors should want to buy this stock because it will remain a strong

competitor of the industry.

DIVIDENS PER SHARE/PRICE PER SHARE. The dividends per share/ price per

share ratio is also known as the dividend yield. This ratio is an indication of the

amount of income caused by a share of stock. Not only does the dividend yield

reflect on the company but also the industry as a whole. The dividend yield for

the entire industry is calculated by adding each average dividend price by the

entire cumulative stock prices. An investor would think this is important because

not only would the investor know information on the specific company, but also

how the industry is performing as a whole. A higher yield is more desirable to

investors because it is under-priced, so it would be wise to invest.

[PRICE/EARNINGS] / 1-YEAR AHEAD EARNINGS GROWTH RATE. Otherwise

known as the PEG ratio, dividing the price to earnings ratio by the year over year

earnings growth rate is included in the method of comparables as well. This is

yet another, more extensive way of valuing the firm. It is a positive sign that

NIKE’s PEG ratio is a low number. This is provides our investors with a cheaper

price per unit of earnings growth. However, NIKE’s figure still lies higher than


our two valued competitors. This requires investors to prioritize different

financial values that affect their success.

PRICE PER SHARE / SALES. The price per share/ sales ratio is calculated by

dividing the current price of stock for a company by the amount of sales or

revenue that the company received. This ratio compares information to other

companies, the industry as a whole, or even past performance of the same

company. The P/S ratio can differ significantly from company to company so it is

more useful when it is compared with companies with similar sales. For instance,

it would not be useful to compare NIKE with McDonalds because it would be

comparing two different types of companies. This ratio can be deceiving because

it does not take into account any debt or expenses. When NIKE is compared with

its competitors and the industry, NIKE has the lowest P/S ratio. Under Armor has

a P/S ratio of 5.94. K-Swiss has a ratio of 2.38, while the industry has a P/S ratio

of 1.78. NIKE is below the industry average with a P/S ratio of 1.59.

PRICE / EARNINGS BEFORE INTEREST AND TAXES. When dividing the price per

share by EBIT, the resulting value provides very similar information given by the

price earnings ratio. It gives NIKE a significant indicator that shows the number

of times the market price exceeds the earnings per share (before any effects of

interest and taxes). EBIT is a very considerable portion of this ratio because it


shows NIKE’s ability to pay off creditors therefore is observed very closely. This

particular ratio gives highly beneficial information coming from various aspects of

our statements. We want each of our investors, creditors, and shareholders to

be as informed as possible.

PRICE/EARNINGS BEFORE INTEREST, TAXES, DEPRICIATION, AND

AMORTIZATION. The price per share of a firm over it’s EBITDA value is

important because it compares the earnings with each dollar of stock equity.

This ratio is similar to price/ebit but does not include in depreciation and

amortization expenses. This is an important difference because depreciation and

amortization are not recognized on a cash basis. Earnings before depreciation

and amortization show a more real value of what earnings are. However, these

cannot be considered net earnings.

NIKE is significantly lower than industry leader Under Armour (UARM),

however they are slightly higher than competitor K-Swiss (KSWS). It is also

lower than the industry average. However, it is our opinion that the extreme

Under Armour skews the industry average. The reason they are so out of the

norm on all the ratios is because they just recently went public and experienced

exponential growth because of it.


PRICE/FREE CASH FLOWS. A firm’s free cash flows are important because it

means nothing for a firm to have a high net income if they have no cash flows to

build upon. Free cash flows show how much cash the firm has at its disposal.

The price to free cash flows ratio shows how much actual cash can be generated

per dollar of stock equity. This is different from net income or earnings because

net income and earnings do not completely dictate free cash flows. For example,

one could have a negative net income but a positive free cash flows. This is

because non-cash expenses, like depreciation and amortization, are not counted

in free cash flows.

The industry leader for ratios, Under Armour, did not have a Price/Free

Cash Flows ratio. NIKE, Inc. shows significantly lower than the industry average,

as was K-Swiss’.


NIKE is an apparel company that is well recognized in all parts of the

United States and around the world. Whether a person is playing pick up games

in the back yard or making a run for a world championship Nike has been part of

their lives in some manner. With their equipment and clothing, super-start

athlete endorsements, world renown Nike Swoosh, and close financial analysis

the conclusion is that Nike is an under valued firm that has a “buy”

recommendation. The ratios computed for Nike showed that they have a strong

position regarding their assets to liabilities, debt to equity, and other crucial ratio

calculations. When the forecast is evaluated the conclusion can be made that

Nike will have a steady growth and retain their strong position in the athletic and

apparel industry. When compared to other companies in the industry Nike

outperforms in most areas. In conclusion these are the reasons the Nike

Company has been given an undervalued valuation and a buy recommendation.

This is a confident analysis not withstanding Nike change management,

accounting policies or standards.


NK

EFINAL RECOMMENDATION

COACH Inc. (2006). Form 10-K July 1, 2006.

Retrieved October 3, 2006, from, Deloitte & Touche LLP. http://

finance.yahoo.com/q/sec?s=coh

(2006) “Hoover’s Inc” Retrieved October 3, 2006.

http://www.hoovers.com/free/

K-Swiss Inc. (2006). Form 10-K February 9, 2006.

Retrieved October 3, 2006, from, GRANT THORNTON LLP. http://

finance.yahoo.com/q/sec?s=ksws

Larson, Annette. (2006) “MORNINGSTAR” Retrieved October 3, 2006.

http://corporate.morningstar.com/

(2006) “nikebiz.com the inside story” Retrieved October 3, 2006.

http://www.nike.com/nikebiz/nikebiz.jhtml?page=0

NIKE Inc. (2006). Form 10-K July 28, 2006.

Retreived October 3, 2006, from P RICEWATERHOUSE C OOPERS LLP.

http://finance.yahoo.com/q/sec?s=NKE

SKECHERS U.S.A. Inc. (2005). Form 10-K December 31, 2005.

Retrieved October 3, 2006, from, KPMG LLP. http://finance.yahoo.com/

q/sec?s=skx

(1996-2006) “VentureLine” Retreived October 3, 2006.

http://www.ventureline.com/


NK

EREFERENCES

NKE

APPENDICES

NIKE, Inc. - Balance Sheet2002 2003 2004 2005 2006

ASSETS

CURRENT ASSETS:

Cash and cash equivalents $575.5 $643.0 $828.0 $1,388.1 $954.2

Accounts receivable $1,804.1 $2,101.1 $2,120.2 $2,262.1 $2,395.9

Inventories, net $1,373.8 $1,514.9 $1,650.2 $1,811.1 $2,076.7

Deferred income taxes $140.8 $163.7 $165.0 $110.2 $203.3

Prepaid expenses and other assets $260.5 $266.2 $364.4 $343.0 $380.1

Total current assets $4,154.7 $4,679.9 $5,528.6 $6,351.1 $7,359.0

Property and equipment, net $1,614.5 $1,620.8 $1,611.8 $1,605.8 $1,687.7

Deferred income taxes $140.8 $163.7 $165.0 $110.2 $203.3

Goodwill $232.7 $65.6 $135.4 $135.4 $130.8

Moore Total Current Assets $4,154.7 $4,679.9 $5,528.6 $6,351.1 $7,359.0

Total Non Current Assets $2,285.3 $2,034.0 $2,380.1 $2,442.5 $2,510.6

TOTAL ASSETS $6,440.0 $6,713.9 $7,908.7 $8,793.6 $9,869.6

LIABILITIES AND EQUITY

CURRENT LIABILITIES:

Accounts payable $504.4 $572.7 $780.4 $843.9 $952.2

Accrued liabilities $765.3 $1,054.2 $979.3 $984.3 $1,286.9

Income taxes payable $83.0 $107.2 $118.2 $95.0 $85.5

Current portion of long-term debt $55.3 $205.7 $6.6 $6.2 $255.3

Total current liabilities $1,833.2 $2,015.2 $2,030.5 $1,999.2 $2,623.3

Deferred income taxes and other liabilities $141.6 $156.1 $413.8 $462.6 $550.1

Long-term debt $625.9 $551.6 $682.4 $687.3 $410.7

TOTAL LIABILITIES $2,600.7 $2,722.9 $3,126.7 $3,149.1 $3,584.1

SHAREHOLDERS EQUITY:

Common stock $2.8 $2.8 $2.8 $2.8 $2.8

Capital in excess of stated value $538.7 $589.0 $887.8 $1,182.9 $1,451.4

Retained earnings $3,495.0 $3,639.2 $3,982.9 $4,396.5 $4,713.4

Accumulated other comprehensive income (loss) $192.4 $239.7 ($86.3) $73.4 $121.7

Total shareholders equity $3,839.0 $3,990.7 $4,781.7 $5,644.2 $6,285.2

TOTAL LIABILITIES AND SHAREHOLDERS EQUITY$6,440.0 $6,713.9 $7,908.7 $8,793.6 $9,869.6

Forecasts2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

$1,153 $1,266 $1,390 $1,526 $1,675 $1,839 $2,019 $2,217 $2,434 $2,672

$2,137 $2,203 $2,224 $2,244 $2,241 $2,210 $2,224 $2,229 $2,230 $2,227

$1,685 $1,748 $1,794 $1,823 $1,825 $1,775 $1,793 $1,802 $1,804 $1,800

$157 $160 $159 $158 $167 $160 $161 $161 $161 $162

$323 $335 $349 $346 $347 $340 $343 $345 $344 $344

$5,615 $5,907 $6,152 $6,277 $6,262 $6,042 $6,128 $6,172 $6,176 $6,156

$1,628 $1,631 $1,633 $1,637 $1,643 $1,634 $1,636 $1,637 $1,637 $1,638

$157 $160 $159 $158 $167 $160 $161 $161 $161 $162

$140 $121 $133 $132 $131 $131 $130 $131 $131 $131

$7,932 $8,708 $9,561 $10,497 $11,524 $12,653 $13,891 $15,251 $16,744 $18,384

$2,644 $2,903 $3,187 $3,499 $3,841 $4,218 $4,630 $5,084 $5,581 $6,128

$10,576 $11,611 $12,748 $13,996 $15,366 $16,870 $18,522 $20,335 $22,326 $24,512

$731 $776 $817 $824 $820 $793 $806 $812 $811 $808

$1,014 $1,064 $1,066 $1,083 $1,103 $1,066 $1,076 $1,079 $1,081 $1,081

$98 $101 $99 $96 $96 $98 $98 $97 $97 $97

$106 $116 $98 $116 $138 $115 $117 $117 $121 $121

$2,400 $2,400 $2,400 $2,400 $2,400 $2,400 $2,400 $2,400 $2,400 $2,400

$345 $385 $431 $435 $429 $405 $417 $424 $422 $419

$592 $585 $591 $573 $550 $578 $576 $574 $570 $570

$3,913 $4,296 $4,717 $5,178 $5,685 $6,242 $6,853 $7,524 $8,261 $9,069

$2.8 $2.8 $2.8 $2.8 $2.8 $2.8 $2.8 $2.8 $2.8 $2.8

$930 $1,008 $1,092 $1,133 $1,123 $1,057 $1,083 $1,098 $1,099 $1,092

$6,113 $6,559 $7,209 $7,930 $8,773 $9,755 $10,889 $12,038 $13,310 $14,722

$174 $186 $205 $225 $249 $277 $309 $342 $378 $418

$6,663 $7,315 $8,031 $8,817 $9,681 $10,628 $11,669 $12,811 $14,065 $15,442

$10,576 $11,611 $12,748 $13,996 $15,366 $16,870 $18,522 $20,335 $22,326 $24,512

NIKE, Inc. - Income Statement2002 2003 2004 2005 2006

Revenues $9,893.0 $10,697.0 $12,253.1 $13,793.7 $14,954.9Cost of sales $6,004.7 $6,313.6 $7,001.4 $7,624.3 $8,367.8Gross profit $3,888.3 $4,383.4 $5,251.7 $6,115.4 $6,587.0Operating expenses:Selling and administrative $2,835.8 $3,154.1 $3,702.0 $4,221.7 $4,477.8Operating income $1,067.9 $1,245.8 $1,549.7 $1,893.7 $2,109.2Interest expense, net $34.0 $28.8 $25.0 $4.8 ($36.8)Income before provision for income taxes $1,017.3 $1,123.0 $1,450.0 $1,859.8 $2,141.6Provision for income taxes $349.0 $382.9 $504.4 $648.2 $749.6Net income $663.3 $474.0 $945.6 $1,211.6 $1,392.0

Forecasts

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016$16,419 $18,026 $19,791 $21,729 $23,856 $26,191 $28,756 $31,571 $34,662 $38,055

9,459 10,385 11,402 12,518 13,743 15,089 16,566 18,188 19,969 21,9236,960 7,641 8,389 9,211 10,113 11,103 12,190 13,383 14,693 16,132

4,890 5,369 5,894 6,471 7,105 7,800 8,564 9,403 10,323 11,3342,438 2,817 3,256 3,763 4,349 5,026 5,808 6,712 7,758 8,965

11 7 2 -2 -4 3 1 0 -1 02,426 2,811 3,254 3,765 4,352 5,023 5,807 6,712 7,758 8,966

832 964 1,116 1,292 1,493 1,723 1,992 2,303 2,662 3,0761,594 1,846 2,137 2,473 2,859 3,300 3,815 4,410 5,097 5,890

NIKE, Inc. - Statement of Cash Flows2002 2003 2004 2005 2006

CASH FLOWS FROM OPERATING ACTIVITIES:Net income $663.3 $474.0 $945.6 $1,211.6 $1,392.0Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization $271.6 $262.5 $313.5 $287.7 $290.9Tax benefit related to exercise of stock options $13.9 $12.5 $47.2 $63.1 $54.2Deferred income taxes, net $15.2 $50.4 $19.0 $21.3 -$26.0Changes in assets and liabilities, net of effects of business acquisitions:Accounts receivable ($135.2) ($136.3) $97.1 ($93.5) ($85.1)Inventories $55.4 ($102.8) ($55.9) ($103.3) ($200.3)Net cash provided by operating activities $1,081.5 $917.4 $1,518.5 $1,570.7 $1,667.9CASH FLOWS FROM INVESTING ACTIVITIES:Additions to PPE and other ($282.8) ($185.9) $214.8 $257.1 $333.7Disposals of PPE and others $15.6 $14.8 $11.6 $7.2 $1.6Other Liabilities ($6.9) $1.8 ($4.1) $11.1 ($4.3)Other assets ($28.7) ($46.3) ($53.4) ($39.1) ($30.3)Net cash used in investing activities ($302.8) ($215.6) ($950.6) ($360.4) ($1,276.6)CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from long term debt issuance $329.9 $90.4 $153.8 $0.0 $0.0Notes Payable, Long term debt including current portion ($371.5) ($405.7) ($206.9) ($90.9) ($24.2)Dividends ($128.9) ($137.8) ($179.2) ($236.7) ($290.9)Net proceeds from proceeds from exercise of stock options and other stock issuances$59.5 $44.2 $253.6 $226.8 $225.3Repurchase of stock ($226.9) ($196.3) ($419.8) ($556.2) ($761.1)Net cash used in financing activities ($478.2) ($605.2) ($398.5) ($657.0) ($850.9)Effect of exchange rate changes on cash ($29.0) ($38.1) $24.6 $6.8 $25.7Net increase in cash and cash equivalents $271.5 $58.5 $194.0 $560.1 ($433.9)Cash and cash equivalents, beginning of period $304.0 $575.5 $634.0 $828.0 $1,388.1Cash and cash equivalents, end of period $575.5 $634.0 $828.0 $1,388.1 $954.2Supplemental cash flow information:Cash paid during the year for:Interest $54.2 $38.9 $37.8 $33.9 $54.2Income taxes (net of refunds received) $262.0 $330.2 $418.6 $585.3 $752.6

Forecasts

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

1,594 1,846 2,137 2,473 2,859 3,300 3,815 4,410 5,097 5,890

$326 $326 $327 $327 $329 $327 $327 $327 $327 $328$38.2 $43.0 $49.1 $49.5 $46.8 $45.3 $46.8 $47.5 $47.2 $46.7$16.0 $16.1 $9.3 $7.3 $4.5 $10.7 $9.6 $8.3 $8.1 $8.2

$259 ($67) ($20) ($21) $4 $31 ($15) ($4) ($1) $3($81) ($109) ($110) ($121) ($124) ($109) ($115) ($116) ($117) ($116)

$2,152 $2,056 $2,392 $2,716 $3,119 $3,605 $4,069 $4,673 $5,361 $6,159

($326) ($326) ($327) ($327) ($329) ($327) ($327) ($327) ($327) ($328)$10.2 $9.1 $7.9 $7.2 $7.2 $8.3 $7.9 $7.7 $7.7 $7.8($0.5) $0.8 $0.6 $1.5 ($0.4) $0.4 $0.6 $0.6 $0.6 $0.4

($39.6) ($41.7) ($40.8) ($38.3) ($38.1) ($39.7) ($39.7) ($39.3) ($39.0) ($39.2)($621) ($685) ($779) ($744) ($821) ($730) ($752) ($765) ($763) ($766)

$114.8 $71.8 $68.1 $50.9 $61.1 $73.4 $65.1 $63.7 $62.8 $65.2($219.8) ($189.5) ($146.3) ($134.1) ($142.8) ($166.5) ($155.8) ($149.1) ($149.7) ($152.8)

($195) ($208) ($222) ($230) ($229) ($217) ($221) ($224) ($224) ($223)$162 $182 $210 $201 $196 $190 $196 $199 $197 $196

($432) ($473) ($528) ($550) ($549) ($507) ($521) ($531) ($532) ($528)($195) ($208) ($222) ($230) ($229) ($217) ($221) ($224) ($224) ($223)($2.0) $3.4 $11.7 $9.1 $9.6 $6.4 $8.0 $9.0 $8.4 $8.3($199) ($113) ($124) ($136) ($149) ($164) ($180) ($198) ($217) ($238)$954 $1,153 $1,266 $1,390 $1,526 $1,675 $1,839 $2,019 $2,217 $2,434

$1,153 $1,266 $1,390 $1,526 $1,675 $1,839 $2,019 $2,217 $2,434 $2,672

44 42 42 43 45 43 43 43 44 44832 964 1,116 1,292 1,493 1,723 1,992 2,303 2,662 3,076

NIKE, Inc. - Common Size Balance Sheet

2002 2003 2004 2005 2006

ASSETS

CURRENT ASSETS:

Cash and cash equivalents 8.94% 9.58% 10.47% 15.79% 9.67%

Accounts receivable 28.01% 31.29% 26.81% 25.72% 24.28%

Inventories, net 21.33% 22.56% 20.87% 20.60% 21.04%

Deferred income taxes 2.19% 2.44% 2.09% 1.25% 2.06%

Prepaid expenses and other assets 4.05% 3.96% 4.61% 3.90% 3.85%

Total current assets 64.51% 69.70% 69.91% 72.22% 74.56%

Moore Total Current Assets

Property and equipment, net 25.07% 24.14% 20.38% 18.26% 17.10%

Deferred income taxes 2.09% 1.25% 2.06%

Goodwill 0.98% 1.71% 1.54% 1.33%

TOTAL ASSETS 100.00% 100.00% 100.00% 100.00% 100.00%

Total Non-Current Assets 35.49% 30.30% 30.09% 27.78% 25.44%

LIABILITIES AND SHAREHOLDERS EQUITY

CURRENT LIABILITIES:

Accounts payable 7.83% 8.53% 9.87% 9.60% 9.65%

Accrued expenses and other current liabilities 11.88% 15.70% 12.38% 11.19% 13.04%

Income taxes payable 1.29% 1.60% 1.49% 1.08% 0.87%

Current portion of long-term debt 0.86% 3.06% 0.08% 0.07% 2.59%

Total current liabilities 28.47% 30.02% 25.67% 22.73% 26.58%

Deferred income taxes 2.20% 2.33% 5.23% 5.26% 5.57%

Long-term debt, net of current portion 9.72% 8.22% 8.63% 7.82% 4.16%

TOTAL LIABILITIES 40.38% 40.56% 39.53% 35.81% 36.31%

COMMITMENTS AND CONTINGENCIES

SHAREHOLDERS EQUITY:

Preferred stock

Common stock 0.04% 0.04% 0.04% 0.03% 0.03%

Additional paid-in capital 8.36% 8.77% 11.23% 13.45% 14.71%

Retained earnings 54.27% 54.20% 50.36% 50.00% 47.76%

Accumulated other comprehensive income (loss) 2.99% 3.57% -1.09% 0.83% 1.23%

Total shareholders equity 59.61% 59.44% 60.46% 64.19% 63.68%

TOTAL LIABILITIES AND SHAREHOLDERS EQUITY 100.00% 100.00% 100.00% 100.00% 100.00%

Forecasts

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

10.90% 10.90% 10.90% 10.90% 10.90% 10.90% 10.90% 10.90% 10.90% 10.90%

20.20% 18.98% 17.44% 16.04% 14.58% 13.10% 12.01% 10.96% 9.99% 9.08%

15.94% 15.05% 14.07% 13.03% 11.88% 10.52% 9.68% 8.86% 8.08% 7.34%

1.48% 1.38% 1.25% 1.13% 1.09% 0.95% 0.87% 0.79% 0.72% 0.66%

53.09% 50.87% 48.26% 44.85% 40.75% 35.82% 33.08% 30.35% 27.66% 25.11%

75.00% 75.00% 75.00% 75.00% 75.00% 75.00% 75.00% 75.00% 75.00% 75.00%

15.39% 14.05% 12.81% 11.70% 10.69% 9.69% 8.83% 8.05% 7.33% 6.68%

1.48% 1.38% 1.25% 1.13% 1.09% 0.95% 0.87% 0.79% 0.72% 0.66%

1.32% 1.05% 1.04% 0.94% 0.85% 0.78% 0.70% 0.65% 0.59% 0.53%

100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

25.00% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00%

6.91% 6.68% 6.41% 5.89% 5.34% 4.70% 4.35% 3.99% 3.63% 3.30%

9.59% 9.16% 8.36% 7.74% 7.18% 6.32% 5.81% 5.30% 4.84% 4.41%

1.00% 1.00% 0.77% 0.83% 0.90% 0.68% 0.63% 0.57% 0.54% 0.50%

22.69% 20.67% 18.83% 17.15% 15.62% 14.23% 12.96% 11.80% 10.75% 9.79%

37.00% 37.00% 37.00% 37.00% 37.00% 37.00% 37.00% 37.00% 37.00% 37.00%

0.03% 0.02% 0.02% 0.02% 0.02% 0.02% 0.02% 0.01% 0.01% 0.01%

8.79% 8.68% 8.57% 8.09% 7.31% 6.27% 5.85% 5.40% 4.92% 4.45%

57.80% 56.49% 56.55% 56.66% 57.09% 57.82% 58.79% 59.20% 59.62% 60.06%

1.64% 1.60% 1.61% 1.61% 1.62% 1.64% 1.67% 1.68% 1.69% 1.71%

63.00% 63.00% 63.00% 63.00% 63.00% 63.00% 63.00% 63.00% 63.00% 63.00%

100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

NIKE, Inc - Common Size Income Statement2002 2003 2004 2005 2006

Net sales 100.00% 100.00% 100.00% 100.00% 100.00%

Cost of goods sold 60.70% 59.02% 57.14% 55.27% 55.95%

Gross profit 39.30% 40.98% 42.86% 44.33% 44.05%

S&A Expenses 28.66% 29.49% 30.21% 30.61% 29.94%

Operating income 10.79% 11.65% 12.65% 13.73% 14.10%

Interest expense, net 0.34% 0.27% 0.20% 0.03% -0.25%

Income before provision for income taxes 10.28% 10.50% 11.83% 13.48% 14.32%

Provision for income taxes 3.53% 3.58% 4.12% 4.70% 5.01%

Net income 6.70% 4.43% 7.72% 8.78% 9.31%

Forecasts

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

57.61% 57.61% 57.61% 57.61% 57.61% 57.61% 57.61% 57.61% 57.61% 57.61%

42.39% 42.39% 42.39% 42.39% 42.39% 42.39% 42.39% 42.39% 42.39% 42.39%

29.78% 29.78% 29.78% 29.78% 29.78% 29.78% 29.78% 29.78% 29.78% 29.78%

14.85% 15.63% 16.45% 17.32% 18.23% 19.19% 20.20% 21.26% 22.38% 23.56%

0.07% 0.04% 0.01% -0.01% -0.02% 0.01% 0.00% 0.00% 0.00% 0.00%

14.78% 15.59% 16.44% 17.33% 18.24% 19.18% 20.19% 21.26% 22.38% 23.56%

5.07% 5.35% 5.64% 5.94% 6.26% 6.58% 6.93% 7.29% 7.68% 8.08%

9.71% 10.24% 10.80% 11.38% 11.99% 12.60% 13.27% 13.97% 14.70% 15.48%

Ratios

Average 2002 2003 2004 2005 2006LIQUIDITY RATIOS

Current Ratio 2.66 2.27 2.32 2.72 3.18 2.81

Quick Asset Ratio 1.44 1.30 1.36 1.45 1.83 1.28

EFFICIENCY RATIOS

Accounts Receivable Turnover 5.74 5.48 5.09 5.78 6.10 6.24

Days' Receivables 63.95 66.56 71.69 63.16 59.86 58.48

Inventory Turnover 4.20 4.37 4.17 4.24 4.21 4.03

Days' Invenory 86.88 83.51 87.58 86.03 86.70 90.58

Working Capital Turnover 3.62 4.26 4.01 3.50 3.17 3.16

PROFITABILITY RATIOS

Gross Profit Margin 0.42 39.30% 40.98% 42.86% 44.33% 44.05%

Net Profit Margin 0.07 6.70% 4.43% 7.72% 8.78% 9.31%

Asset Turnover 1.55 1.54 1.59 1.55 1.57 1.52

Return on Assets 0.11 10.30% 7.06% 11.96% 13.78% 14.10%

Return on Equity 0.22 12.35% 23.70% 25.34% 24.66%

CAPITAL STRUCTURE ANALYSIS

Debt to Equity Ratio 0.63 67.74% 68.23% 65.39% 55.79% 57.02%

Times Interest Earned 92.24 30.92 39.99 59.00 388.46 -57.20

Debt Service Margin 102.79 19.56 4.46 230.08 253.34 6.53

OTHER RATIOS

Accounts Payable Turnover 9.94 11.90 11.02 8.97 9.03 8.79

Days' Payables 37.28 30.66 33.11 40.68 40.40 41.53

Goodwill to Total Assets 0.02 3.61% 0.98% 1.71% 1.54% 1.33%

Forecasts

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

2.34 2.46 2.56 2.62 2.61 2.52 2.55 2.57 2.57 2.57

1.37 1.45 1.51 1.57 1.63 1.69 1.77 1.85 1.94 2.04

7.68 8.18 8.90 9.68 10.65 11.85 12.93 14.17 15.55 17.09

47.50 44.61 41.01 37.70 34.28 30.79 28.23 25.76 23.48 21.36

5.61 5.94 6.35 6.87 7.53 8.50 9.24 10.09 11.07 12.18

65.03 61.42 57.44 53.16 48.48 42.94 39.51 36.17 32.97 29.97

5.11 5.14 5.27 5.60 6.18 7.19 7.71 8.37 9.18 10.13

42.39% 42.39% 42.39% 42.39% 42.39% 42.39% 42.39% 42.39% 42.39% 42.39%

9.71% 10.24% 10.80% 11.38% 11.99% 12.60% 13.27% 13.97% 14.70% 15.48%

1.55 1.55 1.55 1.55 1.55 1.55 1.55 1.55 1.55 1.55

15.07% 15.90% 16.77% 17.67% 18.61% 19.56% 20.60% 21.68% 22.83% 24.03%

25.36% 27.71% 29.22% 30.80% 32.43% 34.09% 35.89% 37.79% 39.78% 41.87%

58.73% 58.73% 58.73% 58.73% 58.73% 58.73% 58.73% 58.73% 58.73% 58.73%

218.42 427.36 1514.03 -1555.14 -1125.57 1845.01 5602.65 -90224.64 -14936.84 -64349.54

20.33 17.74 24.42 23.37 22.56 31.39 34.89 40.01 44.47 50.73

12.94 13.38 13.96 15.19 16.76 19.02 20.55 22.40 24.62 27.12

28.20 27.27 26.14 24.02 21.77 19.19 17.76 16.29 14.82 13.46

1.32% 1.05% 1.04% 0.94% 0.85% 0.78% 0.70% 0.65% 0.59% 0.53%

change In RI 0.47 0.58 0.66 0.76 0.86 0.96 1.12 1.28

1 2 3 4 5 6 7 8 9

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Beginning BE (per share) 57.5 61.80 67.27 73.67 81.15 89.91 100.19 112.23 126.27

Earnings Per Share $5.44 $6.23 $7.21 $8.35 $9.66 $11.17 $12.89 $14.90 $17.23

Dividends per share $1.14 $0.76 $0.81 $0.87 $0.90 $0.90 $0.85 $0.86 $0.87

Ending BE (per share) 57.5 61.80 67.27 73.67 81.15 89.91 100.19 112.23 126.27 142.62

Ke 0.0743

"Normal" Income 4.27 4.59 5.00 5.47 6.03 6.68 7.44 8.34 9.38

Residual Income (RI) 1.17 1.63 2.21 2.88 3.63 4.49 5.45 6.56 7.84

Discount Factor 0.931 0.866 0.807 0.751 0.699 0.650 0.606 0.564 0.525

Present Value of RI 1.08 1.42 1.79 2.16 2.54 2.92 3.30 3.70 4.12

ValuePercent

BV Equity (per share) 2014 59.95 68.84% g

Total PV of RI (end 2014) 23.02 26.43% 0 0.05 0.1 0.15

Continuation (Terminal) Value 0.11 $136.40 $138.70 $141.00 $143.30

PV of Terminal Value (end 2014) 4.12 4.73% 0.13 $133.90 $136.20 $138.50 $140.80

Estimated Value (2014) $87.08 100.00% 0.15 $130.60 $132.90 $135.20 $137.50

0.17 $127.83 $130.13 $132.43 $134.73

0.19 $124.93 $127.23 $129.53 $131.83

Actual Price per share $57.50

Growth

RESIDUAL INCOME VALUATION

Sensitivity Analysis

1 2 3 4 5 6 7 8

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

EPS $5.44 $6.23 $7.21 $8.35 $9.66 $11.17 $12.89 $14.90 $17.23

DPS $1.14 $0.76 $0.81 $0.87 $0.90 $0.90 $0.85 $0.86 $0.87

DPS invested at 17% (Drip) $0.09 $0.06 $0.06 $0.07 $0.07 $0.07 $0.07 $0.07

Cum-Dividend Earnings $6.32 $7.27 $8.41 $9.73 $11.24 $12.96 $14.97 $17.29

Normal Earnings $5.87 $6.72 $7.78 $9.01 $10.42 $12.05 $13.91 $16.08Abnormal Earning Growth (AEG) $0.45 $0.55 $0.63 $0.72 $0.82 $0.91 $1.06 $1.22 $0.80

PV Factor 0.927 0.859 0.796 0.738 0.684 0.634 0.588 0.545

PV of AEG $0.42 $0.48 $0.50 $0.53 $0.56 $0.58 $0.62 $0.66

Core EPS $5.44


Continuing (Terminal) Value $10.08

PV of Terminal Value $5.49


Total Average EPS Perp (t+1) $15.28

Capitalization Rate (perpetuity) 0.0789

Value Per Share 2014 $96.90 $16.59

Ke 0.0789

g 0

Actual Price per share $80.31

ABNORMAL EARNINGS GROWTH

(Amounts in millions of dollars except per share data)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Cash Flow from Operations 2,152 2,056 2,392 2,716 3,119 3,605 4,069 4,673 5,361Cash Provided (Used) by Investing Activities (621) (685) (779) (744) (821) (730) (752) (765) (763)

Free Cash Flow (to firm) 1,530 1,372 1,613 1,972 2,297 2,875 3,317 3,908 4,599

discount rate (7.43% WACC) 0.931 0.866 0.807 0.751 0.699 0.650 0.606 0.564 0.525

Present Value of Free Cash Flows 1424.6 1188.4 1301.2 1480.4 1605.5 1869.9 2008.7 2202.5 2412.8

Total Present Value of Annual Cash Flows 1,635

Continuing (Terminal) Value (assume no growth) 61897.25

Present Value of Continuing (Terminal) Value 8,722

Value of the Firm (end of 2014) 10,357

Book Value of Debt and Preferred Stock $1,337

Value of Equity (end of 2014) 9,020Estimated Value per Share 152.24 80.31

d

debt % equity % wacc debt wacc wacc-dwac

Ke based on WACC 12.90% 87.10% 0.0743 0.03370 0.04060 0.04662 0

DISCOUNTED FREE CASH FLOW VALUATION

change In RI 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01

1 2 3 4 5 6 7 8 9

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Beginning BE (per share) 79.53 83.83 89.30 95.70 103.18 111.94 122.22 134.26 148.30Earnings Per Share $5.44 $6.23 $7.21 $8.35 $9.66 $11.17 $12.89 $14.90 $17.23Dividends per share $1.14 $0.76 $0.81 $0.87 $0.90 $0.90 $0.85 $0.86 $0.87

Ending BE (per share) 79.53 83.83 89.30 95.70 103.18 111.94 122.22 134.26 148.30 164.65Ke 7.89%

ROE 6.84% 7.43% 8.08% 8.72% 9.36% 9.98% 10.55% 11.10% 11.62%Growth inBVE 5.41% 6.52% 7.17% 7.82% 8.49% 9.18% 9.85% 10.46% 11.03%

Actual Price per share $80.31g

Average ROE 9.30% 79.53 0 0.05 0.1 0.15

Average Growth in BVE 8.44% 0.09 92.12 $93.82 $95.52 $97.22

0.1 $93.15 $94.85 $96.55 $98.25

Estimated Value 91.01 0.11 $94.19 $95.89 $97.59 $99.29

0.12 $95.26 $96.96 $98.66 $100.36

0.13 $96.36 $98.06 $99.76 $101.46

LONG RUN RETURN ON EQUITY/RESIDUAL INCOME

Sensitivity Analysis

TABLE OF CONTENTS - Texas Tech Universitymmoore.ba.ttu.edu/ValuationReports/Fall2006/NIKE.pdf ·...

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