Why or why not? Mercury is an appropriate target for AGI. AGI is looking to increase its revenue and profit by utilizing synergies. The initial aim of AGI for acquiring Mercury Athletics is to increase leverage with contract manufacturers and to boost the cooperation with the retailers and distributors. AGI was one of the most profitable and successful companies in the market segment, but the firm’s size remained rather small in comparison with the main competitors. Therefore, with the acquisition of Mercury, AGI planned to build competitive advantage.
Besides, the target company had well developed operation infrastructure, impressive labor facilities in China and numerous possibilities in reaching the markets in Asia. 2. Review Liedtke’s projections stated in the case. Are they reasonable? How would you recommend modifying them?Calculate ratios and margins for the projections and compare these to the historical relationships. ] Mercury’s EBIT margin for 2006 was 9. 8%. Liendke’s 2007 projected EBIT reflects a conservative increase in EBIT of 9% compared to the average industry growth rate of 10%.
According to the forecast for 2007 to 2011, the company is forecasted to show gradual and stable growth of consolidated income from $479. 3 million to $597. 7 million. This growth rate was estimated by assuming that men’s athletic department sales will be declining from 15% in 2007 to 5% in 2011. Similar trends are assumed for women’s athletic department which the growth rate is forecasted to decrease from 12% in 2007 to 5% in 2011. Men’s casual footwear department, on the other hand, is expected to slowly increase its revenue growth rates when added to AGI assets. Women’s casual footwear department was not projected to grow at all.
Operating income was forecasted using an assumption that the management of the company will be able to sustain EBIT margins at 13% for men’s athletic, 16% for men’s casual and 10% for women’s athletic departments. All forecasts shown below, net operating profit after tax (NOPAT) for 2007 to 2011 was derived by subtracting corporate tax from forecasted operating income (tax rate is assumed to be 40%). Forecasted FCF for 2007 to 2011 were calculated after subtracting capital expenditures and changes in working capital from NOPAT and adding depreciation. The FCFs will be used to assess the firm’s PV. 3.
Estimate the value of Mercury using a discounted cash flow (DCF) approach and Liedtke’s base case projections. Justify any additional assumptions that you make. In answering this question you should provide a quantitative and detailed analysis of the following parts of the valuation: a. Projected cash flows, including projected capital expenditures and changes in net working capital. b. The appropriate discount rate (assume a market risk premium of 5. 0%). c. Various approaches to terminal value (growing perpetuity and multiplesbased). d. Sensitivity analysis of the parameters you consider most relevant. a) Cash Flow Forecasts
Return on net operating assets can be expected to increase from current 12. 9% to the industry’s average 20% due to this synergy and optimization of inventory. The second synergy that can be enjoyed by the companies is merging women’s causal departments instead of getting rid of the division at Mercury. This is projected to lead to 9% of operating profit margin and growth of revenue of the department by 3%. After feeding the projected changes in growth rates and profit margin in cash flow forecasts and applying the formulas described above, the enterprise value of Mercury has increased to $326,452,000.
Thus, the value of synergies is $326,452,000 – $308,458,000 = $17,994,000. Acquisition premium is the difference between the actual cost for acquiring a target firm and the estimated value of the firm before the acquisition. Indeed, with the succession of time initially estimated cost of Mercury Athletic may change under the influence of various economic fluctuations. These fluctuations are to be foreseen by the management of AGI. Since the estimated value of Mercury is $308,458,000, any amount that is to be paid in excess of this value will be considered as acquisition premium.