Case Project

Case # 1: Valuation
Mercury Athletic Footwear : Valuing the Opportunity

FIN 321
Dr. Ghosh

Edward Pinela
Adriana Nava
Kristie Tillett
Grace Tung
Zhibin Yang

Mercury Athletic Footwear

1. Is Mercury an appropriate target for AGI? Why or why not?
There is sufficient evidence to suggest it will be advantageous for AGI to acquire Mercury
Athletics. Factored into the decision is the lack of information on the work culture both firms currently
possess. Culture is important, because if the cultures drastically differ, it could possibly inhibit
efficiency and effectiveness of strategic planning. If one culture empowers employees, while the other
gives very limited power to employees to make decisions, the other group will be forced to change.
Change is often difficult and is viewed negatively by the employees forced to change.
The team still believes there is adequate information from the financial statements and
forecasting, that acquiring Mercury is appropriate. Both firms strive in opposing target markets and
since the markets differ so greatly, AGI should not experience a measurable amount of cannibalism.
Diagram 1 displays revenue and the market advantage of each company. The revenues are comparable,
and through the acquisition, they will have more leverage with producers.

2. Review the projections formulated by Liedtke. Are they appropriate? How would you
recommend modifying them?
The biggest assumption in this model is using Constant Annual Growth Rate as the market risk
or expected return in the CAPM model. CAGR is a great formula for evaluating how different

investments have performed. Investors can compare the CAGR in order to evaluate how well one stock
performed against other stocks in a peer group or against a market index. Due to the fact that it is used
to compare against a market index, makes it a substitute. The intended purpose of calculating the
market premium is to estimate the additional risk or cost between the market risk and the risk free rate.
Market index is the representation of systematic risk. CAGR although a substitute, only accurately
calculates a smooth risk of return, but does not have any risk variables in the formula. Therefore the
market risk premium only in this case is only a representation of the possible expected return, and is
not a calculation of risk.
An assumption we also point out as possibly manipulating the calculated value is the
assumption of 3 percent revenue growth. When using the discounted cash flow approach, we estimate
the terminal value. The terminal value is an estimation of a value at a future point in time using the
estimated growth and discounted cash flows to infinite. Calculating a value with the assumption that
there is fixed revenue growth implies there will be zero change to revenue until the end of time,
regardless of economic, political, or competitive conditions. If this assumption of 3 percent growth is
inaccurate, and due to the terminal value estimating the values from a point in time to an infinite
amount of years, we will have an infinite amount of inaccuracy or deviation from the actual value if we
were able to compare the actual values over an infinite amount of years. The team finds this to be an
appropriate estimation, but we also understand the limitations and possible inaccuracy of this value,
which is a large weight in our enterprise value.

3. Estimate the Value of Mercury using a discounted cash flow approach and the base
projections.
Diagram 2: Free Cash Flows

Revenue
Operating
Expenses
Corporate
Overhead
EBIT
Taxes
(EBIT*40%
tax rate)

Less:
Less:
Less:

Add:
Less:

Depreciation
Capital
Expenditures
Increase in
Net Working
Capital
Free Cash
Flows

Less:

WACC:
Growth
Rate:

2007
$479,329
$423,837

2008
$489,028
$427,333

2009
$532,137
$465,110

2010
$570,319
$498,535

2011
$597,717
$522,522

$8,487

$8,659

$9,422

$10,098

$10,583

$47,005
$18,802

$53,036
$21,214

$57,605
$23,042

$61,686
$24,674

$64,612
$25,845

$28,203
$9,587
$11,983

$31,822
$9,781
$12,226

$34,563
$10,643
$13,303

$37,012
$11,406
$14,258

$38,767
$11,954
$14,943

$4,569

$2,648

$9,805

$8,687

$6,234

$21,238

$26,728

$22,097

$25,473

$29,544

11.08
%
3%

CAP
M

KRF + (KM KRF)

4.93+1.6(9.7= 4.69)
=
12.95%

WAC
C
WDCOSTD(1-T) + WSCOSTS
= .20*.06(1-.40)+.80(.1295)
= .0072+ .1036
=
11.08%
Vn
=

$29,544
(1+.03)

=$376,613

(.1108-.03)

2007
V0 =

$21,238 +

$26,728 +
(1+.1108)
^2

(1+.1108)
=
=

$19,120 +
$313,804
Enterprise
Value=

2008

$21,662 +

2009
2010
2011
$22,097
$25,473
$29,544
+
+
+
$376,613
(1+.1108 (1+.1108 (1+.1108 (1+.1108
)^3
)^4
)^5
)^5
$16,122
$16,732
$17,470
+
+
+
$222,698

V0 + Cash0 - Debt0
$313,804-$56,525+
= $106476
=
$359,653

The enterprise value of Mercury is $359,653. In order to figure it out we have to first get the
cash flows for the years 2007-2011. Diagram 2 shows the calculations for those cash flows.

The

formula for calculating free cash flows is EBIT X (1-Tax Rate) + Depreciation Capital Expenditures
Increases in Net Working Capital. Depreciation and capital expenditures are given and to get the
increase in net working capital we look at the difference between current assets and current liabilities
from the current year compared to the prior year.
Next, we calculated CAPM, the Capital Asset Pricing Model. The formula to computer CAPM
is KRF + (KM - KRF ). To calculate CAPM we need the risk free rate and the market free rate and beta.
We are given all three of these variables. The risk free rate for the market is 4.69% and the risk free rate
is 4.93% and beta was calculated using the industry average of 1.6. When we input these values we get
12.95% as the equity cost of capital.
Then we calculated the weighted average cost of capital (WACC). To compute WACC we used

the following formula WD ( CostD (1-T) + WS Costs We are given the weight to debt to be 20% and the
cost of debt to be 6%. We are given the tax rate of 40% and by knowing the weight of debt to be 20%
then we know that the weight of equity is 80%. We calculated the cost of equity my using CAPM and
when we input all of these values into the WACC formula we get a result of 11.08% as the WACC.
Next we calculated the terminal value. To calculate the terminal value we used the following
formula VN = FCFN (1+GFCF) / WACC GFCF. When we input the values of $29,544 as the free cash
flow and the 3% of the growth and we use the 11.08% WACC that we calculated the result is $376,613
as our terminal value.
Then we use the terminal value to calculate the present value of the future cash flows, using the
terminal value as the last cash flow we evaluate. We used the present value formula to find the present
value of these future cash flows.
Now we are able to substitute this into the formula to find our enterprise value. The formula to
find the enterprise value is V0 - Debt + Cash. We determined the V0 to be $313,804 and we are given
cash of $10,676 and debt of $56,525 for the year 2006. The result is $359,653 which is our enterprise
value.