Sneakers 2013

Memorandum

Executive Summary

New Balance Is a one of the largest shoe manufacturing company in United States. Company’s brand is
well known around the world. High quality and wide varieties of shoes being manufactured to satisfy the
market demand. New Balance produce mostly athletic shoes and also used some of famous athletic
figures to endorse their product.

Currently, the senior VP of product development, Monte Holiday, saw an opportunity in the 12-to 18-
year-old male market segment, which most of the competitors had ignored. However, New Balance did
not have the resource to compete in this segment. However, New Balance saw an opportunity to target a
younger consumer if they could craft and effective marketing and advertising campaign around the right
athlete. A potential young athlete was spotted, a young promising phenomenon from Grenada, Kirani
James, a gold medal winner in the 400-meter dash in London. Since he is still young, he could still be
improved and made him an excellent athlete which will appeal to younger audience.

Competition were fierce as competitor will come out with new products. The shoe market is still growing
steadily despite economic downturn. Michele Rodriquez was asked by the VP to provide analysis on two
different products, Sneakers 2013 and Persistence. Recommendation was also needed in order for the VP
to choose which option is better suited to start the project.

1. Sneakers 2013 Table

(in millions) Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Revenues $138.00 $184.00 $161.00 $276.00 $207.00 $103.50
-Cannibalization $35.00 $15.00
Net Revenues $103.00 $169.00 $161.00 $276.00 $207.00 $103.50
-Variable Costs $56.65 $92.95 $88.55 $151.80 $113.85 $56.93
-S, G, & A Expenses $7.00 $7.00 $7.00 $7.00 $7.00 $7.00
-Endorsement $2.00 $2.00 $2.00 $2.00 $2.00 $2.00
-Advertising $25.00 $15.00 $10.00 $30.00 $25.00 $15.00
-Depreciation (Factory) $3.90 $7.50 $7.05 $6.75 $6.45 $6.00
-Depreciation (Equipment) $4.00 $6.40 $3.80 $2.40 $2.20 $1.20
EBIT $4.45 $38.15 $42.60 $76.05 $50.50 $15.38
-Taxes $1.78 $15.26 $17.04 $30.42 $20.20 $6.15
EBIAT $2.67 $22.89 $25.56 $45.63 $30.30 $9.22
+Depreciation (Factory) $3.90 $7.50 $7.05 $6.75 $6.45 $6.00
+Depreciation (Equipment) $4.00 $6.40 $3.80 $2.40 $2.20 $1.20
Net Operating Cash Flows $10.57 $36.79 $36.41 $54.78 $38.95 $16.43
Change in NWC ($10.00) ($1.07) ($7.10) $0.86 ($12.36) $7.42 $22.25
Factory Purchase ($150.00)
 Equipment Purchase ($20.00)
Factory Salvage $102.00
-Taxes on Factory Salvage $4.14
Equipment Salvage $3.00
-Taxes on Equipment Salvage ($1.20)
Project Net Cash Flows ($180.00) $9.50 $29.70 $37.27 $42.42 $46.37 $146.62
Cumulative CF ($180.00) ($170.50) ($140.81) ($103.54) ($61.12) ($14.75) $131.87
NWC $10.00 $11.07 $18.17 $17.31 $29.67 $22.25 $0.00
Change in NWC ($10.00) ($1.07) ($7.10) $0.86 ($12.36) $7.42 $22.25

WACC NPV IRR Payback

11% $13.76 13% 5.32 years
According to the calculations, the NPV is $13.76 at the end of year 6 (greater than zero). It means that this
project could be taken and can bring profit. The IRR (13%) is also greater than WACC (11%). Looking at the
payback period, which is 5.32, it is no longer than 6 years. Therefore, this project will be able to get the
break even point and can be profitable when it comes to the termination. Hence, this project should be
taken.

2. Persistence 2013 Table

(in millions) Year 0 Year 1 Year 2 Year 3

Revenues $52.50 $72.45 $92.58
-Variable Costs $19.95 $27.53 $35.18
-S, G, & A Expenses $6.30 $7.25 $7.41
-Advertising & Promotion $3.00 $2.00 $2.00
-Depreciation (Equipment) $1.60 $2.56 $1.52
-Technology Purchase $50.00
EBIT ($50.00) $21.65 $33.11 $46.47
-Taxes ($20.00) $8.66 $13.25 $18.59
EBIAT ($30.00) $12.99 $19.87 $27.88
+Depreciation (Equipment) $1.60 $2.56 $1.52
Net Operating Cash Flows $14.59 $22.43 $29.40
Change in NWC ($15.00) $0.00 $0.00 $15.00
Equipment Purchase ($8.00)
Equipment Salvage $2.32
-Taxes on Equipment Salvage ($0.93)
Project Net Cash Flows ($53.00) $14.59 $22.43 $45.79
Cumulative CF ($53.00) ($38.41) ($15.98) $29.81
NWC $15.00 $15.00 $15.00 $15.00
Change in NWC ($15.00) $0.00 $0.00 $15.00

WACC NPV IRR Payback

14% $7.97 21% 3.49 years
 Based on the calculation, by the end of the year 3, NPV is $7.97 (greater than zero) therefore, this
project is profitable and could be taken. IRR is 21% which is higher than WACC. The payback period
is 3.49 years. Based on the quantitative calculation NPV is greater than zero, IRR is higher than
WACC. However, the payback period is longer than 3 years, which means at the end of the
termination of the project, this project will not be able to break even. Conclusion, this project
should not be taken based on the quantitative calculation.

3. According to two proposal projects mentioned above, hiking shoe - Persistence is new
product line in area that NB had not yet entered. Although hiking and active walking
sector was one of the fastest growing areas of footwear but still contain a certain risk
since it is new trend. The cost of capital (WACC) for this project is relatively high (14%) to
compensate for some certain potential risks. Sneaker 2013 project, on the other hand,
maintains relatively high short-term debt, which can make cash flows riskier because that
debt has to be repaid earlier than equity. The annual cost of long-term debt is as twice as
Persistence’s project, at 1.2 millions. Payback period of Speaker’s project is also almost
two times longer than Persistence’s. Therefore, Sneaker 2013 seems to has higher risk
than other project.

4.

WACC NPV IRR Payback

Sneaker 2013 11% $13.76 13% 5.32 years
Persistence 14% $7.97 21% 3.49 years

On table above, we can easily see that Net Present Value of both projects are positive,
means they are both accepted. Nevertheless, NPV of Sneaker 2013 is larger than
Persistence’s project. In this case of mutually exclusive projects, higher NPV of Sneaker is
more desirable. Let’s consider another metric, Internal Rate of Return; they both are
profitable since both IRRs are larger than their cost of capital. Since the IRR can be seen
as the rate of growth a project is expected to generate, project with a substantially higher
IRR value than other would provide a much better chance of strong growth, which means
project of Persistence is definitely more attractive in this case. Last metric, Payback, can
help determining how long it will take to pay back the initial investment that is required
to undergo a project. As New Balance shareholders, it is more likely to go for a shorter
payback period, which is only 3.49 years for Persistence project rather than 5.32 years for
Sneaker 2013 project.

5. In general, these both projects are profitable since IRRs higher than discount rate and
NPVs are larger than zero. However, because Sneaker 2013’s initial investment cost is
obviously higher than Persistence’s project, Sneaker 2013’s project has a lower IRR but a
higher NPV, meaning that while the pace at which New Balance company sees returns on
that project may be slow, the project may also be adding a great deal of overall value to
the company. On another hand, when we use IRR in comparison of these both projects if
different lengths, Sneaker 2013 with a longer duration have a lower IRR, earning returns
slowly and steady could add a large amount of value to the company over time. Because
of a longer payback period so in long-term, Sneaker 2013’s project is a better choice.