Investments in Nike - Essay Example

The dividends discount model makes a comparison between future forecasted dividends with the firm’s current share price and then applies the firm’s growth rate to get the total figure. Many experts believe that the dividend discount model (DDM) greatly benefits investors because it makes investors think about the different market scenarios depending on how the stock is performing. Furthermore, the dividend discount model relies upon a lot of speculation in attempting to predict future dividends. This implies that the outcomes of this model are based on generalizations that are made. It is usually hard to determine the correct growth rate because a company most likely has a wide range of growth rates over a long period due to the fluctuating economy. It is for this reason alone that analysts do not tend to make projections based on past growth rates. Above all, there are no direct adjustments for risk with the dividends discount model.

The earnings capitalization model (ECM) is basic and easy enough to understand by practically anyone because it determines the value of a business by looking at the current benefit of realizing cash flow in the short-term, rather than in the long-term. However, this model does not accurately estimate equity costs for firms that are expanding, so it is predominantly used only for firms that are experiencing zero growth.

The Discounted Cash Flow Analysis in Exhibit 2 demonstrated that, at a discount rate of 12 per cent, Nike’s current share price was overvalued at $42.09. But a sensitivity analysis disclosed that Nike was undervalued at discount rates lower than 11.2 per cent. We came up with an appropriate discount rate—Weighted Average Cost of Capital (WACC). This formula showed that the discount rate was less than 11.2 per cent at around 10.59 per cent. All of this points to the fact that Nike is a good investment because it is undervalued at the discount rate in terms of WACC.

Nevertheless, because the North Point Large Cap Fund invests predominantly in Fortune 500 companies, and with an emphasis on value investing, we gauged Nike’s Economic Value Added (EVA). Our findings come up with a positive EVA for Nike at $304.5. This ultimately means that the company adds value to its shareholders.

Because Nike’s common stock is rated too low, in addition to the company having a positive EVA, it should be added to the North Point Large Cap Fund.

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