Mercury Athletic Footwear:

Valuing the Opportunity

Group 1
Bushra Javed Butt
M. Sharjeel Shahid
Mahnoor Malik
Uzair Nasir

MBA II Section A

Submitted To: Sir Nawazish Mirza

Introduction
West Coast Fashions, Inc. (WCF), a large designer and marketer of mens and womens
apparel decided to dispose of one of their divisions; Mercury Athletic. John Liedtke, head of
the business development for Active Gear, Inc. (AGI), saw a possible opportunity for his
company in acquiring Mercury.
The footwear industry is very competitive, with low growth and stable profit margins. AGI is
very profitable but it is smaller than its competitors, which is becoming a disadvantage.
Therefore, Liedtke believes that if they takeover Mercury, it will double AGIs revenue,
increase its leverage with contract manufactures and expand its presence with key retailers
and distributions. Liedtke has to evaluate the company to justify that whether investing in the
Mercury would be profitable and at what maximize price could AGI offer in order to acquire
the division.
Analysis
In order to achieve the above set goal, Liedtke needs to analyze the financial data from 2006
to 2011 (Exhibit 6 and 7), and calculate free cash flows. This data will enable him to identify
the strengths and weaknesses of this acquisition. Following is the snapshot of AGI and
Mercury operations based on year 2006, the last year before AGI plans to acquire Mercury.
Active Gear, Inc

Mercury Athletic

Revenues

$470, 286 m

$431,121 m

Operating Income

$60.4 m

$42,299 m

Days Sales in Inventory

42.5

61.1

It can be seen that AGI and Mercury has somewhat the same revenues and considering the
profitability of AGI, Mercury seems to be an attractive investment opportunity.
Calculation
After calculating NOPAT, we proceed to calculate FCFs for Mercury. The Depreciation
expense, change in WC, and Capital Expenditure are adjusted back. Here we are actually
subtracting all of the net reinvestment from the firms operations (NOPAT).

Next step is to calculate an appropriate WACC and then a growth rate in order to find the
terminal value.

WACC Calculation

The risk free rate is given in the case as 4.93% and we have assumed risk premium to be 5%.
Cost of Equity and D/E ration are also given in the case as per Liedtkes assumption. For Beta
(Equity) computation, we have taken the average of the industrys beta. Using the CAPM, we
have calculated the cost of equity, and hence our calculated WACC comes out to be 10.9%.

Calculating Terminal Value

If we assume that Mercury has reached a steady state by 2011, we can say that the firm would
have a stream of cash flows that would grow at a constant rate forever, hence making it a
growth perpetuity. As we have already calculated the FCF and WACC, we now need to
calculate a long term growth rate.
Growth Rate

We have assumed the growth rate to be depended on two things, the profitability of the firm
(ROC) and its reinvestment rate. Given we had already calculated NOPAT and have
investment capital available; ROC comes out to be 11.7%. Similarly, Reinvestment rate is
calculated which comes out to be 23.79%. Multiplying the two ratios will give us the growth
rate for the perpetuity.
ROC = NOPAT/Total Capital Investment
Net Reinvestment Rate = (Change in WC + Change in net FA)/NOPAT
Using the above calculated growth rate and WACC, we can calculate the Terminal Value and
thus computing new FCFs, through which we will evaluate the Free Cash Flow to the Firm.
The FCFF comes out to be 314,452.49. Deducting total debt of year 2006 minus the cash
would give us the FCFE which comes out to be 268,603.49.
So the maximum price that AGI could offer in order to acquire Mercury is $268,603.49.