- Executive Summary
Nike Inc. is a leading sportswear and athletic equipment manufacturing company incorporated in 1967 in Oregon, United States of America. Their primary business model is focused on the design, development, and global marketing of athletic footwear, apparel, equipment, accessories and services (Nike Annual Report and Accounts, 2021). The company has six broad product lines. The company outsources all product manufacturing to independent contractors ((Nike Annual Report and Accounts, 2020). Products are primarily marketed through company-owned retail stores with a total outlet count of 1048 in US and non-US markets as at December 2021. Other marketing channels include digital platforms, independent distributors, licensees, and sales representatives.
Between 2018 and 2021, the company grew its revenue from $36.3 billion to $44.5 billion, and its net income from $1.9billion to $5.7billion. This growth was however severely dampened in 2020 with revenue and net income dropping year-on-year by 1.87% and 36.98% respectively. This was primarily due to the effect of the COVID-19 pandemic.
Purpose of the report
The purpose of this report is to evaluate the feasibility of a proposed investment in the sport TV industry and analyze the potential impact of this investment on the financial performance of Nike Inc.
The proposed investment is feasible since it presents a short payback period, positive NPV and IRR > interest rate. Furthermore, sensitivity analysis reveals very wide margins of safety for all variables simulated.
Nike Inc. should undertake the project and invest in the TV station. Debt financing would be preferred since interest rates are low (3%) and the interest cover is high (29 times).
2. Motivation of the proposed investment
It is proposed that Nike Inc. diversify into the electronic media industry by acquiring and out fitting a new TV station, that will specialize in broadcasting both localized and global sporting events.
The year on year drop in Nike Inc.’s net profits in 2020 from ($4 billion to $2.5 billion), occasioned by the covid-19 pandemic, had unveiled a new dimension of risk (fluctuations in profit levels) which could inhibit the company’s growth and sustainability potentials.
If Nike Inc. is to maintain and achieve it growth objectives, there is a need to maintain a stable and increasing level of profits, and these profit levels are expected to hold steady, to a reasonable extent, against shocks occasioned by various forms of disruptions like the covid-19 pandemic.
A primary reason for the reduced profits is the temporary closure of the company’s sales outlets in most countries during the peak of the covid-19 pandemic (Nike news march 26 2020) as well as supply chain disruptions due to border closures and import restrictions during the same period. Although it was noted that the company’s profit recovered significantly in 2021 ($5.7 billion), there is still a need to achieve and maintain a profit pattern that will be reasonably stable and immune to shocks arising from economic, market and demographic factors.
An investment in the electronic media industry (TV broadcasting) with a special focus on airing sporting events is a good way to achieve such sustainable profits. People will always watch TV. The average American family spends 4 hours daily on the TV (Richter 2020) and statistics show that sport is ranked very high on the list of programme preferred by viewers. (Stoll 2021).
Thus, the stability of the revenue stream from this investment is relatively assured and the investment will lead to a sustained growth in Nike’s profitability.
- Investment appraisal
It is proposed that Nike invests the sum of $6.85 billion in acquiring and out fitting a new TV station or an existing TV station in the US for the purpose of broadcasting local and global sporting events all year round. The breakdown of the capital outlay and the expected inflow is as follows;
The estimated cost of capital of Nike Inc, based on the effective interest rate as at 2021, is 3%.
There is a need to appraise the viability of the proposed investment. According to Bamber and Parry (2014) the most common and useful techniques used in evaluating capital investment decisions are payback period (PP), accounting rate of return (ARR), and discounted cash flow (DCF). DCF can further be divided into internal rate of return (IRR) and net present value (NPV).
The payback period primarily measures the period, expressed in years, over which the project generates enough revenue to recover its initial capital outlay.
From the table above, the proposed TV station will achieve a positive net cash flow after its third year and before completion of its 4th year. Essentially the payback period is 3.74 years. This means that, before the end of the 4th year, all initial capital outlays will be recovered, in other words, the project would have broken-even. This relatively short payback period is to the advantage of the company and hence the proposed investment is deemed attractive.
The Net present Value (NPV)
NPV is a discounted cashflow method of investment appraisal that recognizes the time value of money. As Porterfield (1965) pointed out, it recognizes that bigger cash flows are better than smaller ones and earlier cash flows are better than later ones. The NPV method aims to determine what value will be added by undertaking a given investment. The NPV is the difference between the Present value of cash inflows and the present values of total cash outflow. A positive NPV indicates that the project is viable since it will produce an inflow greater than its outflow.
The table below illustrates the NPV of the proposed investment in the TV station. As can be seen from the table below, the proposed TV station has a positive NPV of $2.8 billion at the end of year 5. Thus, the project is viable.
The Internal Rate of return (IRR)
According to Pandey (2005), the IRR is the rate of return that equates the investment outlay (outflows) with the present value of all inflows. This implies that the IRR is the rate of return that makes the NPV = 0. At any rate of return that is higher than the IRR, the project will definitely return a negative NPV and hence will be unprofitable. The IRR will indicate Nike corporation’s appetite for risk and also the maximum interest rate payable on debt financing, if the investment is expected to be viable.
As illustrated in the table above, manipulating the excel template revealed that the NPV of the proposed TV station project will be zero or near zero (-$10,000) when Nike’s cost of capital rises as high as 25.9%. It indicates that the project is highly viable since Nike corporation can take loans at any interest rate up to the IRR of 25.9% to finance the project, easily pay back the loan solely out of the net cashflows from the project, and yet make a profit, since the internal rate of return (IRR) on the project (21.42%) is higher than Nike Inc’s cost of capital (3%).
It is important to also appraise the impact of the external environment on the feasibility of the project. The following external factors and their expected impact is discussed below.
Political environment. Government legislations, licensing, quality standards and other regulatory issues are what makes up the political environment of the TV station. Any of these can potentially impact significantly on the operations of the proposed TV station. The station would have to comply with all relevant regulatory and licensing requirements.
Economic Factors: Economic factors like inflation, employment rate, income distribution, GDP growth, demographics etc have a great impact on the revenues of the TV industry. Consumer spending on entertainment depends on their level of disposable income. Advertisement revenue depends on the ability of the advertising clients (businesses) to remain in business, generate cashflow and meet their obligations. Notwithstanding the rising consumer prices in the US, it is expected that economic factors would remain favorable to the proposed project.
Technological factors: Technological factors have significant effect on TV industry. The fast pace of technological change creates will require the proposed TV station to always keep up with technological developments. A major area of potential technological disruption is the internet TV and live streaming of online content.
Social factors: These are factors and institutions that influence society’s values, perceptions, preferences and behaviors. The demographic distribution of the society will require the TV station to adapt their content to fit into demographic preferences.
Environmental factors: The increased cost of energy and other resources might significantly impact upon the proposed TV station, which might compel it to either contend with reduced profit levels, seek for cheaper options and/or increase the pricing for advertisers and TV subscribers. There are also concerns about radiation produced from TV sets.
Legal Factors: Certain laws and regulations implied in the entertainment industry are strictly enforced. TV stations need to be always complaint with laws concerning copyrights and patents protection as the violation of these laws may lead to expensive litigations and payment of huge fines. Furthermore, taxation rules and filing requirements are very strict and must not be defaulted.
- RISK ASSESSMENT.
Risk is the probability that the expected return would defer from the actual return. The return here is the NPV of the project which will increase Nike Inc’s ROCE from 48.8% to 72%, ROA from 15.77% to 19.7% and net profit margin from 12.85% to 15.61%. (All initial ratios were computed from Nike Inc 2021 annual reports).
Risk would be assessed by simulating the extent to which various factors influencing the NPV (cost of capital, cash outflow and cash inflow) would have to change for the NPV to become zero or negative, thus affecting the projected ROCE, ROA and Net profit margin of Nike Inc. The result of the simulations is displayed in the tables below.
Figure 1 Original NPV line
Sensitivity to the project’s cost of capital
The graph above indicates that a 800% rise in interest rate (from 3% to 25%) will result in a negative NPV. Further indications from the graph shows that the project will only breakeven in year 5. This level of increase in interest rates will reduce Nike Inc’s ROE from 44.86% to 28.2% and the company’s interest cover from 29 times to 2.53 times.
Sensitivity to the project cost
The gragh above shows a 50% change in project cost will result in 116% change in NPV. Where the increased costs were incurred from additional investment in assets, a 50% increase in the project costs will reduce Nike Inc’s projected ROA to 12%.
The Consultant does not expect inflation rate or other factorsto cause such a massive increase in projected costs.
Sensitivity of NPV to the project benefit (cash inflows)
Table above indicates there will be a 166.9% decline in NPV if projected cash inflows from the TV broadcasting business declines by 50%. Likewise, a 50% decrease in projected cash inflows will lower projected net profit margin from 15.61% to 8.58%.
In conclusion, discounted payback period of the investment is approximately 4 years, thus, this relatively short timeframe makes the project acceptable.
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Nike Inc. 2020, Nike statement on COVID-1, viewed 5th May 2022, https://news.nike.com/news/nike-coronavirus-statement Nike Statement on COVID-19
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Pandey I. M 2005. Financial Management. Ninth edition. Vikas publishing house PVT ltd, New Delhi
Porterfield, J. T1965. Investment Decisions and Capital Costs. Prentice hall, 1965Richter, F 2020, The Generation Gap in TV Consumption, viewed 5th May 2022 https://www.statista.com/chart/15224/daily-tv-consumption-by-us-adults/
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Stoll, J 2021, Top TV shows by total viewer numbers in the U.S. 2020-2021, viewed 5th May 2022, https://www.statista.com/statistics/804812/top-tv-series-usa-2015/