Table of Contents
Executive Summary …………………………………………………. 2
An Overview of the Problem …………………………………… 2
Why or why not? ………………………………………………………. 2
Discounted Cash Flow Model …………………………………. 3
Weighted Average Cost of Capital (WACC) …………. 3
Free Cash Flows from 2007 to 2011 .………………….. 4
Executive Summary
For the evaluation of the business there are different tools or techniques use by the analyst, financial institutions, investors, suppliers and all the other stakeholders. For the estimation, generally in first phase basic data related to the scenario is collected which workout for getting indicators particularly weighted average cost of capital called WACC. The data is collected for the period of 5 years started from 2007 to 2011. The estimation is made on the basis of this data which includes free cash flows and terminal value along with long term growth rate. In this estimation only relevant data is considered and the data which is irrelevant to the estimation is not used. In this different assumptions are assumed in order to work out the risk free rate and other relevant assumptions. At the end discount cash flow model will be helpful to take appropriate decision. Thus the estimation made in this study highly depending upon the outcome of the discount cash flow model.
An Overview of the Problem
The head of business development of Active Gear Inc John Liedtke was willing to acquire a business unit called Mercury Athletic particularly footwear division of West coast fashion Inc. this division was acquiring by the company when WCF announced divesture of this division. Active Gear started their negotiation with their supplier in order to increase concentration just because of the AGI which slowly becoming the competitor. Though AGI was a small size business organization but it was becoming the strong competitor. It was Liedtke thoughts or opinion that if we acquire Mercury than it will add more value and benefits for the company.
It was his estimation that this transaction will double the benefit for the companyalong with expansion of present retailer’s network and distributors. By increasing the present network of retailers and distributor the company overall revenue will be higher comparatively to previous years. By doing this the market share of the company will also increase which will also increase the enterprise value as well.But John Liedtke did not know as it was the appropriate target of the Active Gear Inc. John Liedtke was in hurried to complete his rough working by evaluating the available opportunity before putting this case before the financial institutions for financial coverage.
Why or why not?
On the basis of the market demand and growth along with challenging business unit of the WCF, this was the best opportunity for Active Gear Inc. As a result after acquiring Mercury, the market share of the company and revenue will increase. So in my point of view it will be a good opportunity for the company get and increase the good will of the company in the market. As overall revue of the Mercury is almost similar to Active Gear Inc. which will definitely almost double the revenue of the company after acquisition took place. There is another benefit of this acquisition will results in better inventory management and financial performance of the company. Once the better management and financial performance of the company improve this will definitely add more values.
In spite of revenue or financial generation increases, the range along with age of different customers will also widen. Due to similar segments and channels of both companies it will also lower the cost of products along with adjusting cost of sale of products on different channels. As AGI and Mercury both have outsource manufacturing in chinawhich later when combines will bring better deals with suppliers. in nut shell the acquiring of Mercury will expand the operation of the Active Gear Inc. which will results in increase the revenue and gain market share for the company. I believe Mercury acquisition must take place and it must be the target of the Active Gear Inc.
Discounted Cash Flow Model
The discounted cash flow model is based on different assumption which are followed.
- The risk free rate is 4.69%.
- Cost of debt of the Mercury is 6.0%.
- Rate of corporates taxes is 40%.
- Degree of leverage: 20%.
- The growth rate on the long run basis is 2%.
This model is basically based on the 5 years forecasting particularly revenue forecasting along with balance sheet projection which is done by the Liedtke. In the model two stage growth strategy is followed in which first five years and then growth rate strategy. The concepts of WACC, terminal value and free cash flows are used.
Weighted Average Cost of Capital (WACC)
The weighted average cost of capital is basically have two parts debt and capital part. As for cost of equity of the company is concerned we use unleveraged and re-leverage beta. On the very first stage unleveraged beta is calculated which is 1.60. After this stage CAPM model is used to calculate the cost equity of the company which is 14.34%. The cost of debt is based on the assumption which is 6 %. In order to cacluate the WACC of the company all the main elements of WACC is now calculated. WACC is followed.
WACC= E/(D+E) * rE + D/(D+E) * (1 – tax rate) * rd
= 0.8 * 14.34% + 0.2 * 0.6 * 6% = 12.19%
Free Cash Flows from 2007 to 2011
Possible Synergies and the Effect on Base Case Valuation
Firstly, AGI could help Mercury reduce its DSI by changing Mercury’s inventory management system, thus improving Mercury’s turnover rate and increasing free cash flow. In addition, Mercury’s women’s casual footwear line could continue as a part of Active Gear’s. In that case, EBIT margin will get improved. What’s more, the acquisition could help
the company cut the cost by using fewer employees and getting a discount of raw materials. The new joint corporation can form an effect of scale and make a better deal with suppliers. Last, entering new market segments will help the joint corporation target the larger market, bring higher sales and roughly double its revenues.
In conclusion, Mercury is an appropriate target for AGI basing on the result of John Liedtke’s case base projection. AGI will obtain more discount from raw material suppliers and acquire more cooperation opportunities with larger manufacturers. Also, AGI may almost double the retailers and distributors after combining. What’s more, it will also potential to double revenues. The two companies are concentrated on different parts, and now AGI is able to enter new market segments and enjoys a larger market to make huge profits.
Appendix
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