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Mercury Athletic
$431,121 m
79 % athletic / 21 % casual
$42,299 m
12.5 %
By looking at this table superficially and keeping in mind that Active Gear is one of the
most profitable firms in the footwear industry, Mercury seems to be an attractive
investment because they have almost the same revenues as AGI while being smaller in
the market. Then we can see that the % revenue product compensates for the lack in both
companies. The revenue for the athletic shoes in AGI is low therefore taking Mercury
under their wing would increase that revenue and vice versa for the casual shoes as well.
Finally when looking at revenue growth the industry average is 10 % and AGI is below it
putting the company at risk while Mercury is above it by 2.5 % more, it would be good to
acquire the company to stay on top of the market.
Free cash Flow of Mercury
Revenue
2006
431,121.0
0
2007
111,333.
00
57,605.0
0
23,042.0
0
34,563.0
0
10,643.0
0
121,138.
00
2010
570,319.
00
498,535.
00
10,098.0
0
61,686.0
0
24,674.4
0
37,011.6
0
11,406.0
0
129,825.
00
2011
597,717.
00
522,522.
00
10,583.0
0
64,612.0
0
25,844.8
0
38,767.2
0
11,954.0
0
136,059.
00
4,569.00
2,648.00
9,805.00
8,687.00
6,234.00
11,983.00
12,226.0
0
13,303.0
0
14,258.0
0
14,943.0
0
479,329.00
423,837.00
8,487.00
EBIT
42,299.00
47,005.00
Less: taxes
16,919.60
18,802.00
25,379.40
28,203.00
Plus: depreciation
9,506.00
9,587.00
104,116.0
0
7.65%
2.00%
2009
532,137.
00
465,110.
00
8,659.00
9,422.00
53,036.0
0
21,214.4
0
31,821.6
0
9,781.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
21,238.00
Terminal Value
Discount Rate
Growth rate
108,685.00
2008
489,028.
00
427,333.
00
26,728.6
0
22,098.0
0
25,472.6
0
29,544.2
0
522,906.
19
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19,728.75
23,064.7
2
17,713.7
6
18,967.8
1
461,615.5
8
186,215.8
0
275,399.7
8
Quantitative valuation:
In the Mercury Segment Data 2004-2006 exhibit the EBIT margin is 9.8 % that means
knowing that the industry average is 10 % it shows us Mercurys profitability after
removing all expenses but excluding taxes and interest. It is important to look at it
because it is a measure that investors can use to evaluate the financial health of the
company. However Liedkte being more conservative he says that the combined
businesses could achieve and EBIT of 9 % and when looking at the projections for
Mercury from 2007-2011 we can see a growth in earnings. So then what are the cash
flows if Liedtke thinks the combined businesses will have a revenue growth of 2% in
year 2011 considering we discounting back to 2006. We need to calculate the Free Cash
Flow (FCF) in order to determine if the Net profit Value is positive or negative. Knowing
that we will know if the acquisition should be undertaken. When looking at the excel
sheet we can see that the NVP using the discount rate given by the case 7.65 % with a
growth rate of 3 % gives us an NVP= $ 275,399.78. Therefore the NVPs value compares
the value of the investment made today to the same value of the amount in the future. So
that is the amount AGI needs to pay up front. The free cash flows are made from the
financial statement given in the case and were determined using the FCF method; EBIT
(1-Tax Rate) + Depreciation & Amortization - Change in Net Working Capital - Capital
382,140.
54
Expenditure. If AGI pays the acquisition price of $186,215.80, the will get in 5 years $
461,615.58 as a total discounted cash flow.
Taking the Total Discounted cash flow minus the acquisition price will gives us the NVP,
which as mentioned above will be the amount that needs to be paid up front.
The discount rate is an interest rate that is used for calculating the present value of future
cash flows. It shows us what our money is worth in the future. The importance of using
the discount rate is that it will show the risk that comes with future income. In this case
we are using three different discount rates, one as shown in the book, one with less risk,
and one with more risk. In the process of using discount rate we believe we utilize the
time value of money; this concept is used, when (for example) a company makes an
investment. The idea (and importance) of this concept is that your money is worth more
in the present than in the future, and allows you to see your income stream in the future.
The process that occurs is that the money you make now will earn you interest, the
interest earned on that money will also gain interest in the future, which is called
compounding interest. It can show you if an investment will gain you money or will lose
you money.
We have made two other scenarios one with a lower discount rate then the 7.65 % which
means that less risks and inflation has been taken into consideration. With a lower
discount rate has the NPV has increased however taking in less risk can actually be more
riskier because you plan on having that amount of money but if something happens in the
course of the future years that amount wont be that exact amount set earlier therefore
that is why we have to increase the discount rate to 15 % to make sure that there are no
surprises, of course with increasing it, NPV goes down but its better to be safe than sorry.
Free cash flow with lower Discounted rate
Revenue
2006
431,121.0
0
42,299.00
2007
2008
489,028.
00
427,333.
00
2009
532,137.
00
465,110.
00
8,487.00
8,659.00
9,422.00
47,005.00
53,036.0
57,605.0
479,329.00
423,837.00
2010
570,319.
00
498,535.
00
10,098.0
0
61,686.0
2011
597,717.
00
522,522.
00
10,583.0
0
64,612.0
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111,333.
00
0
23,042.0
0
34,563.0
0
10,643.0
0
121,138.
00
0
24,674.4
0
37,011.6
0
11,406.0
0
129,825.
00
0
25,844.8
0
38,767.2
0
11,954.0
0
136,059.
00
4,569.00
2,648.00
9,805.00
8,687.00
6,234.00
11,983.00
12,226.0
0
13,303.0
0
14,258.0
0
14,943.0
0
Less: taxes
16,919.60
18,802.00
25,379.40
28,203.00
Plus: depreciation
9,506.00
9,587.00
104,116.0
0
108,685.00
0
21,214.4
0
31,821.6
0
9,781.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
21,238.00
26,728.6
0
22,098.0
0
25,472.6
0
29,544.2
0
687,074.
42
19,979.30
23,654.2
8
18,397.2
6
19,949.8
8
527,985.
22
Terminal Value
Discount Rate
Growth Rate
6.30%
2.00%
609,965.9
4
186,215.8
0
423,750.1
4
Revenue
2006
431,121.0
0
2007
479,329.00
423,837.00
8,487.00
EBIT
42,299.00
47,005.00
Less: taxes
16,919.60
18,802.00
2008
489,028.
00
427,333.
00
2009
532,137.
00
465,110.
00
8,659.00
9,422.00
53,036.0
0
21,214.4
57,605.0
0
23,042.0
2010
570,319.
00
498,535.
00
10,098.0
0
61,686.0
0
24,674.4
2011
597,717.
00
522,522.
00
10,583.0
0
64,612.0
0
25,844.8
111,333.
00
0
34,563.0
0
10,643.0
0
121,138.
00
0
37,011.6
0
11,406.0
0
129,825.
00
0
38,767.2
0
11,954.0
0
136,059.
00
4,569.00
2,648.00
9,805.00
8,687.00
6,234.00
11,983.00
12,226.0
0
13,303.0
0
14,258.0
0
14,943.0
0
25,379.40
28,203.00
Plus: depreciation
9,506.00
9,587.00
104,116.0
0
108,685.00
0
31,821.6
0
9,781.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
21,238.00
26,728.6
0
22,098.0
0
25,472.6
0
29,544.2
0
227,263.
08
18,467.83
20,210.6
6
14,529.7
9
14,564.0
4
127,678.
60
Terminal Value
Discount Rate
Growth rate
15.00%
2.00%
195,450.9
3
186,215.8
0
9,235.13
Qualitative valuation:
Besides the numbers there are other methods to valuate the company and that it by
looking at the opportunities it has for the company. Even though this acquisition may not
generate any amount of money for example, which is not the case for AGI and Mercury.
Sometimes entering such an investment can get you to acquire a larger market share,
which later on will end up generating some sort of revenue. Other reasons for acquiring
would be to prevent competitors from taking over, diversify in products, gain more
technologies and distribution channels and finally to simply grow as a company which in
the case of AGI is important in order to stay at the top of the competition.
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To see if the investment should be pursued AGI can use WACC, in this case it was use
only in the determination of the discount rate. The purpose of the WACC measures the
cost of a company to borrow money to finance its assets (capital), which are financed
either through debt or equity. This method averages the cost of debt or equity by looking
at how its going to be used and so allows us to see how much the company has to pay in
interest for each amount of money it finances. For example lets say the WACC is said to
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be 10 % then any returns under the same % or lower will not be considered. That 10 % is
the minimum rate of return which produces value for investors if the actual rate of return
is lets say 15 % then for each dollar the company makes 5 more dollar of value. In this
case however not being given where the financing is coming from; whether its equity,
debt or both; the investor has to know if it allows him to pay pack the interest rate of rate
of return.
The other method that could be use to utilized to define the companys cost of equity
would be the Capital Asset Pricing Model which measures the relationship between risk
and expected returns of a security (bond, common stock, preferred stock, long- term debt)
or portfolio (risky stocks combined to lower the risk). CAPM is used to compensate
investors either through time value money; putting money into an investment over a
period of time) or through risk. If the expected value does not come to the require rate of
return (hurdle rate) or beat it shouldnt be undertaken. This helps investors evaluate and
anticipate the risk and returns of their investments.
Recommendations:
Liedtke, we believe has sufficient financial data to decide whether to for go with the
acquisition or not. The project itself at a given rate or 7.65 % has a positive Net Present
Value and even when the discount rate is increased it remains positive, which is better for
him to take into consideration because it includes more risks taken into account. Many
other reasons mentioned earlier make it a good investment especially due to the fact that
they are at the top of the industry but are relatively small and risk of being overtaken by
others, acquiring Mercury would give them the opportunity to grow bigger. Besides that
it would increase revenue, boost the capacity utilization and expand itself to a bigger
numbers of retailers and distributors and increase the leverage with the manufacturers,
the more leverage AGI has the more likely it can make money.