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Sneaker 2013 – Case Solution
The case study Sneaker 2013 introduces the basics of capital budgeting. It allows the computation of a project’s initial investment outlay, the project’s annual net operating cash flows, and the project’s terminal net cash flow. This case study likewise discusses the valuation of both the Sneaker 2013 and the Persistence project. To determine which project is likely to be profitable and accept that project, it is important to calculate and consider some financial determinants such as WACC, NPV, IRR, and payback period. It also looks into other factors affecting New Balance's decision whether to invest in the Sneaker 2013 running shoe or the Persistence hiking shoe by delving into an in-depth analysis of both projects’ cash flows and financial metrics and looking into a few nonfinancial factors relevant to the project.
Richard Bliss and Mark Potter Harvard Business Review ( BAB166-PDF-ENG ) March 01, 2015
Case questions answered:
Case study questions answered in the first and second solutions:
- Produce a projected capital budgeting cash flow statement for the Persistence project by answering the following: (a) What is the project’s initial (year 0) investment outlay? (b) What are the project’s annual net operating cash flows? (c) What is the project’s terminal (2018) net cash flow?
- Which project do you think is riskier? How do you think you should incorporate differences in risk into your analysis?
- Based on the calculated payback period, net present value (NPV), and internal rate of return (IRR) for each project, which project looks better for New Balance shareholders? Why?
- Should Rodriguez be more or less critical of cash flow forecasts for Persistence than of cash flow forecasts for Sneaker 2013? Why?
- What is your final recommendation for Rodriguez?
Case study questions answered in the third solution:
- Which cash flows should be incorporated into the project’s forecast? Why or why not?
- Produce a projected capital budgeting cash flow statement for the Persistence project by answering the following: a.) What is the project’s initial (year 0) investment outlay? b.) What are the project’s annual net operating cash flows? c.) What is the project’s terminal (2018) net cash flow? d.) Does Persistence appear attractive from a quantitative standpoint? To answer this question, estimate the project’s payback, net present value, and internal rate of return.
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Sneaker 2013 Case Answers
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New Balance, a shoe manufacturing company, is located in Brighton, United States. The company is well known globally due to the high quality and wide variety of shoes provided to customers. The company saw an opportunity in the 12-18-year-old male segment of the market while other competitors had ignored it.
Due to the lack of resources or star power, the company can’t compete in this segment. However, the company saw an opportunity to target younger customers if effective marketing and advertising were used. Thus, Sneaker 2013 was initiated in response to this opportunity.
Although the target of this project was between 12 and 18 years old, the market trend was expected to be 27 years and older as the population ages. So, the company began to review another hiking shoe proposal called Persistence. Even though the company had not yet entered this market, this market was considered one of the fastest-growing in the footwear industry.
This report provides an analysis and valuation of both the Sneaker 2013 and the Persistence project. To determine which project is likely to be profitable and accept that project, it is important to calculate and consider some financial determinants such as WACC, NPV, IRR, and payback period.
Moreover, this report consists of the project sensitivity analysis of some financial determinants, the comparison between both projects and some recommendations for the company in order to decide which project is better.
Finally, with careful and thorough consideration, the company is recommended to go ahead with the Sneaker 2013 project and use Kirani James as their newest athlete endorser.
Introduction
In consideration of market share to compare with the competitors of New Balance, the major competitors are as follows:
source: The Statistics Portal, Share of the athletic footwear market
High-quality athlete shoes are purchased at a reasonable price by baby boomers, who are the primary target market of sneakers.
The company demands to renovate the products created with new ideas and designs that will stimulate sales and profitability. The market share would be larger in this competitive industry.
Presenting 2 projects, Sneaker 2013 and Persistence in the athletic footwear industry, the first project (Sneaker 2013), with a 6-year venture life from 2013 to 2018, contains customary cash flow.
This cash flow also includes uncertainty(risk) of endorsing the market product for promotion. With the small size of investment in a competitive market, the second project evaluates a new hiking shoe venture.
Sneaker 2013
Capital budget projection..
The capital budgeting of Sneaker 2013 depends on new equipment installation to make progress. The initial cost for investment is usually integrated into the Net Present Value (NPV) calculation and is mostly in a negative value. The valuation is to determine whether to…
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Question: Sneaker 2013 The business case team had compiled the following baseline information surrounding the Sneaker 2013 project: 1. The life of the Sneaker 2013 project was expected to be six years. Assume the analysis took place at the end of 2012. 2. The suggested retail price of the shoe was $190. Gross margins for high-end athletic footwear averaged about 40%
Sneaker 2013
The business case team had compiled the following baseline information surrounding the Sneaker 2013 project:
1. The life of the Sneaker 2013 project was expected to be six years. Assume the analysis took place at the end of 2012.
2. The suggested retail price of the shoe was $190. Gross margins for high-end athletic footwear averaged about 40% at the retail level, meaning each pair sold would net New Balance $115.
3. The global athletic footwear market in 2011 totaled approximately $74.5 billion and was expected to grow at a CAGR of 1.8% from 2011 to 2018, reaching $84.4 billion by 2018.3 Based on market research and analysis of other recent athlete endorsements, the New Balance marketing division estimated the following sales volumes for Sneaker 2013:
Year 2013 2014 2015 2016 2017 2018
Pairs sold (millions) 1.2 1.6 1.4 2.4 1.8 0.9
The 2016 number assumed Kirani James participated in the 2016 games in Rio de Janeiro, Brazil, and won at least one medal.4
4. For the first two years, the introduction of Sneaker 2013 would reduce sales of existing New Balance shoes as follows:
Lost sales: 2013: $35 million 2014: $15 million
Assume the lost revenue had the same margins as Sneaker 2013.
5. In order to produce the shoe, the firm needed to build a factory in Vietnam. This required an immediate outlay of $150 million, to be depreciated on a 39-year MACRS5 basis. Depreciation percentages for the first six years respectively were: 2.6%, 5%, 4.7%, 4.5%, 4.3%, and 4.0%. The firm’s analysts estimated the building would be sold for $102 million at project termination. This “salvage value” has not been taken into consideration when computing annual depreciation charges.6
6. The company must immediately purchase equipment costing $15 million. Freight and installation of the equipment would cost $5 million. The cost of equipment and freight/installation was to be depreciated on a five-year MACRS basis. Depreciation percentages for the six years respectively were: 20%, 32%, 19%, 12%, 11%, and 6%. It was believed the equipment could be sold for $3 million upon project termination.
7. In order to manufacture Sneaker 2013, two of the firm’s working capital accounts were expected to increase immediately. Approximately $15 million of inventory would be needed quickly to fill the supply chain, and accounts payable were expected to increase by $5 million. By the end of 2013, the accounts receivable balance would be 8% of project revenue; the inventory balance would be 25% of the project’s variable costs; and accounts payable would be 20% of the project’s variable costs. All working capital would be recovered at the end of the project by the end of the sixth year.
8. Variable costs were expected to be 55% of revenue.
9. Selling, general, and administrative expenses were expected to be $7 million per year.
10. Kirani James would be paid $2 million per year for his endorsement of Sneaker 2013, with an additional $1 million Olympic bonus in 2016.
11. Other advertising and promotion costs were estimated as follows:
A&P Expense (millions) $25 $15 $10 $30 $25 $15
12. New Balance had already spent $2 million in research and development on Sneaker 2013.
13. The Sneaker 2013 project was to be financed using a combination of equity and debt. The interest costs on the debt were expected to be approximately $1.2 million per year. The New Balance discount rate for new projects such as this was 11%.
14. New Balance’s effective tax rate was 40%.
Rodriguez was worried about the marketing approach for Sneaker 2013 targeting 12- to 18- year-old males. Recent market data showed the average age of athletic footwear purchasers to be just over 27 years, up from 24 three years earlier. This trend was expected to continue as the population aged. Success would depend on an effective marketing and advertising campaign which targeted not only the younger consumer, but which reached the ultimate purchaser who was more likely to be a parent.
Produce a projected capital budgeting cash flow statement for the Sneaker 2013 project by answering the following:
a. What is the project’s initial (year 0) investment outlay?
b. What are the project’s annual (years 2013-2018) net operating cash flows?
c. What is the project’s terminal (2018) non-operating net cash flow?
d. Does Sneaker 2013 appear viable from a quantitative standpoint? To answer this question, estimate the project’s payback, net present value, and internal rate of return.
Initial investment outlay: The initial investment outlay includes the costs for building the factory...
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