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test 101, week 1 notes

by: Alex Rech

test 101, week 1 notes Test 101

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Alex Rech

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Alex Rech
Class Notes
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This 3 page Class Notes was uploaded by Alex Rech on Tuesday October 4, 2016. The Class Notes belongs to Test 101 at Ohio State University taught by Alex Rech in Fall 2016. Since its upload, it has received 2 views.


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Date Created: 10/04/16
Alex Rech 10/05/2016 Mercury Athletic Case Overview The head of business development for Active Gear, John Liedtke, is considering acquiring Mercury Athletic, a division of West Coast Fashion. Active Gear is in the industry of footwear retail. The footwear industry is marked by slow growth, high competitiveness and stable revenues. Competitors are constantly trying to anticipate and exploit the next footwear trend, desperate to gain competitive advantage. Active Gear has been a high-end specialty shoes producer since its founding in 1965. The company had found great success by producing high-quality shoes with long life cycles. The company has been growing steadily and slowly for several decades. By developing simple, classic products, Active Gear was able to maintain a simple supply chain and consistent, positive margins. However, management is worried that the relatively small size of Active Gear is a competitive disadvantage. Large Chinese contract manufacturers were in the process of consolidation, a move that favored firms larger than Active Gear. Mercury is a shoe manufacturer, and its acquisition would approximately double Active Gear’s revenue and create new relationships with suppliers. Now, Liedtke needs to calculate a valuation of Mercury to present to the bankers of Active Gear. There are several parties to be considered in the investment decision. John Liedtke is heading up the valuation project to determine the benefits and costs of acquiring Mercury. Active Gear Inc. is the company looking to expand its portfolio and acquire Mercury. Mercury Athletic is a division of West Coast Fashions that manufactures footwear. Active Gear’s Bankers will make the decision on whether or not to acquire Mercury. Independent contractors in China are consolidating, putting pressure on Active Gear to expand its product portfolio. Active Gear is facing a few different financial and strategic problems that this acquisition looks to address. Most notably, they face competition from larger footwear producers that have deals with the most of the independent contractors that manufacture the shoes. These contractors are a much cheaper alternative for US footwear companies because of low labor costs. Active Gear’s competitors are much more likely to reach deals with these large contractors because of the volume they need to meet demand. The rise of big box retailers is diminishing the 1 company’s sales growth. This is because Active Gear is unwilling to sell through discount retailers so as not to devalue their brand image. For a long time, no single supplier accounted for a large percentage of Active Gear’s production volume. Recently, a supplier has gained 20% of their business and the next two largest suppliers have gained 22% in total. According the Porter’s Five Forces Model, the bargaining power of suppliers is high in this case. The suppliers have a high amount of leverage in negotiating contracts with Active Gear. The company also has sluggish growth rates around 2.2% for the last three years compared to industry competitors who are growing at 10%. Active Gear has a very limited target market constituted of those ages 25-45. The addition of Mercury would target teenagers and anyone interested in extreme sports, making it an attractive acquisition. Mercury also faces a few strategic and financial issues. It is suffering from shrinking profit margins due to its price discounts in order to reach deals with large retailers. The company is suffering large losses in its women’s footwear line, which has been unprofitable since they stopped an aggressive marketing campaign. Managers believed this was due to the high cost of building brand image and awareness among women. Many of their products competed with one another, resulting in cannibalization of revenue. Overall, Mercury has under-achieved relative to its high expectations. John Liedtke needs to make several assumptions to come up with a valuation for Mercury. First, he assumes that Mercury’s Women’s Casual Footwear segment will be discontinued a year after the acquisition. He provides forecasts on revenues and operating income for the coming years. He also assumed the corporate overhead to revenue ratio would be similar to historical averages. Liedtke also believed there was no need to assume debt or equity accounts since Mercury would not have a separate balance sheet once acquired. To compute a discount rate, he assumed a cost of debt of 6% based on market values. He will need to calculate the cost of equity using shares outstanding and the price per share in order to accurately calculate the weighted average cost of capital. Historical financial statements and balance sheets are provided for both Mercury and Active Gear. Liedtke is missing a viable way to calculate the cost of equity. He will need to find an appropriate risk free rate and beta for the company. He also believes that operational synergies will allow Active Gear to increase EBIT margin to 9% and revenue growth of 3%. 2 3


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