B52.FIN.

448 Advanced Financial Management

Professor Roni Kisin

Mercury Athletics
Footwear Case
Group Members:
Chiang Ming Rui
Connie Li
Joe Marshall
Ivan Yong

Question 1
Estimate the value of Mercury using a DCF. Use Liedtkes base case projections and assumptions as a
starting point. Explain your valuation steps along the way. State and motivate any and all assumptions
you make or change.
Using Liedtkes base case projections, we worked backwards to identify if any of his working
assumptions warranted any changes based on the information that the case provided. (Refer to Exhibits)
Assumptions
Footwear is a very well established mature industry and will therefore grow at a rate near that of
the general economy at 2.00%
All forecasts are made under the assumption that T=0 corresponds to 2006
All projections and forecasted financial data provided in the case are reasonable conclusions
based on the economic climate and indicators under which the firm operates.
There are no synergies or increased efficiencies that come about as a result of the combination of
the two firms.
A three-year rolling average of historical expenses as a percentage of revenue is a relatively
accurate barometer of expected future expenses.
All firms are subject to a 40% corporate tax rate.
The Risk Free Rate is assumed to be 4.50% based on an approximate figure gleaned T-Bond
Rates during the time period in question
Market Risk Premium set equal to 5.00% based on historical returns
Methodology
1. Calculate the estimated Net Working Capital for Mercury utilizing the statistics that were
provided in the case under example 7.
o Net Working Capital= Current Assets- Current Liabilities
o Current Assets= Act. Receivable +Inventory Prepaid Expenseso Current Liabilities= Act. Payable Accrued Expenses
Determine the individual free cash flows of each segment with Mercury Athletic
Footwear
o Estimate Revenue and Cost of Goods Sold using Mercury Athletic Footwears Forecast
Data. Gross profit is determined by multiplying projected revenue by a three year rolling
average of historical gross profit margins.
o Selling, General, and Administrative expenses are calculated using a similar three-year
historical rolling average percentage of revenue and multiplied by that years forecasted
revenue.
o Depreciation expense was estimated as a percentage of the average property, plant and
equipment figure.
Depreciation= Estimated Depreciation/(PP&E balance the previous period- PP&E balance at the
end of this period)

This figure was then multiplied by the average PP&E balance over the period to forecast that
years depreciation expense
Depreciation was subtracted to reach EBIT
o Tax expense was subtracted from the EBIT figure, and was estimated using a figure equal
to 38% of EBIT in reaching Net Operating Profit
o The Free Cash Flow equation is then completed using the equation
FCF=NOPAT+ Estimated Depreciation- Change in Net Working Capital- Capital Expenditures
Changes in Other Liabilities
Capital Expenditure estimates were gleaned from Exhibit 7: Mercurys forecasted data.
Changes in other liabilities was estimated to be zero
over the period in question
FCF for the periods in question equal
o 2007: $13,558.71
o 2008: $22,874.91
o 2009: $18,606.96
o 2010: $21,386.46
o 2011: $25,305.68
3. Determine the Cost of Equity of the Firm
Determine a set of comparable companies to use in estimating the equity Beta of the firm
Mercury Athletic Footwear Firm Profile
o Historical EBIT Margin between 8.7-9.8%
o 20% Target Leverage, meaning 25%, D:E Ratio
o LTM Revenue= $431,121 (In Thousands)
o Based on these figures the three firms that most closely resemble Mercury Athletic
Footwear are Kinsley Coulter Products, Alpine Company, and Surfside Footwear.
Historical Levered Betas of firms are unlevered using the formula Beta/(1+Tax
Rate*(D/E) to reduce the effects of financing decisions by the comparable firms, and are
averaged to find the mean unlevered beta of the comparable firms
Unlevered Beta is relevered to fit the target D:E ratio of 25%
Cost of Equity is found to be 11.78% utilizing the CAPM,
o Re=Rf+Beta(Rm-Rf)
o Rf=4.50%
o Levered Beta of the Firm= 1.456
o Rm-Rf=5.00%
4. Find the Weighted Average Cost of Capital by utilizing the WACC Formula
WACC= re(E/A)+rd(D/A)(1-.4)
WACC=10.14% in this case utilizing a cost of debt of 6.00% as was
provided in the case
4. Estimate the Terminal Value of the firm utilizing the equation
Terminal Value= Final Projected FCF (1+Estimated Growth Rate)/(WACC-Long-term growth
rate)
Terminal Value= $317,031.96
Growth Rate=2.00%

WACC=10.14%
6. Discount all of the projected cash flows including the Terminal Value utilizing the present value
formula PV= Sum(Cash Flows/(1+Cost of Capital)^N).
6. Sum the cash flows to find the Net Present Value of the firms cash flows.
NPV= PV(FCF)+PV(Terminal Value)
NPV=$252,815.87, meaning that this is the present value of all the firms
expected earnings priced in todays money
6. Conduct a sensitivity analysis to determine the models sensitivity to both discount rates and
terminal value.

Question 2
How would you analyze the possible synergies or other sources of value not reflected in Liedtkes base
case assumptions? This is a qualitative question only and should not take up more than half a page.
There are a few possible areas of synergy and other sources of saved value that are not reflected in
Liedtkes base case assumptions. By acquiring Mercury and consolidating it under Active Gear, the two
brands will be able to reach a greater target market (from high-end to discount retailers) and achieve more
favorable economies of scale. AGI, with Mercury, would be able to leverage a stronger network with
contract manufacturers because the company would be able to provide longer production runs now that
they have more products. In addition, the greater economies of scale would allow AGI to expand its
presence with key retailers and distributors, as well as expand into big box retailers with Mercurys
products without having to diminish the brand value of AGIs products. AGI also has an excellent
inventory management system which Mercury could adopt, potentially reducing the days sales in
inventory and improving Mercurys working capital efficiency.
Sources of value not reflected in the base case assumptions include consolidating operations between
the two brands. AGI and Mercury both have personnel in China to monitor product quality through
manufacturing. If AGI buys Mercury, they could save cost by maintaining fewer workers since many of
their roles probably overlap. Furthermore, Mercury has its own separate operations for databases,
resource management systems, and distribution facilities. Costs could be saved if these separate
operations were cut, and put under AGIs operations of those areas.
Synergies
Common Target Market
o Stores
Economies of Scale
leverage stronger network with contract manufacturers
expand presence with key retailers and distributors
Minimize the number of professional staff who monitor contract manufacturing on-site
from the initial sourcing of materials all the way through final inspection
o 85 for AGI
o 73 personnel in China
Could consolidate Mercurys separate operations: it has its own databases, resource
management systems, and distribution facilities

Exhibits

Exhibit A

Exhibit B