GUIDELINES FOR CASE ANALYSES Please submit in an electronic format (pdf works best… but I will take Word files). You are to turn in 1 case analysis: Sneaker 2013. Please see “your task” below to avoid extra work. General Objective: The objective of this case is to practice basic capital budgeting techniques. You are put in the position of a decision maker or someone who recommends courses of action with respect to specific investment decisions. In so doing, you learn to think about the issues at hand, not just about the techniques. Your task: In this case, there are two projects presented (namely, Sneaker and Persistence). The first project (Sneaker) is about a running sneaker with a large capital outlay and a six-year project life. To make the case analysis easier, I have estimated the project net (total/free) cash flows for each year for you as below. You can consider the cash flow estimated for Sneaker is correct: Sneaker: Year Project net cash flow (in $ millions) 2012 2013 2014 2015 2016 2017 2018 -180.0 9.5 29.7 37.3 41.8 46.4 146.6 Project discount rate/cost of capital – 11% The second project (Persistence) is a hiking shoe project with a smaller initial investment in a rapidly growing but unfamiliar market segment. Your goal is to evaluate both projects and make a final recommendation to Rodriguez. In doing so, your assistant, John Culter estimated the net cash flow in the appendix A (in this file) for you. However, John did this analysis in a hurry and you are left to identify and explain the mistakes in the Persistence analysis. Specifically, try to answer the following questions: 1. Try to Identify the mistakes in John’s net cash flow calculation. Please explain why the calculation is incorrect. 2. Calculate your own net cash flows and justify your assumptions 3. Does Persistence appear attractive from a quantitative standard point? To answer this question, estimate the project’s NPV and IRR. Notice the discount rate for Persistence is 14%, which is different from the discount rate for Sneaker (11%). 4. Estimate the NPV and IRR of Sneaker project as well. 5. Based on the NPV and IRR for each project, what is your final recommendation to Rodrigues? Final format: Keep your write-up short and descriptive. Reports will be evaluated on both the quality of the analysis as well as the effectiveness of the communication. Please communicate your arguments in a persuasive, cogent, and jargon-free manner. Constructive use of tables and graphs is encouraged. The reports should not exceed 5 (five) double-spaced typewritten page, excluding tables or graphs. Please use at least a 12-point font and 1- inch margins on each side. Please do not structure your case report to merely answer each individual question. Rather, your report should tell a “story” based on the questions provided. Example of how report should look To: Manager From: XXX Date: XX/XX/2013 Subject: Persistence’s cash flow estimation I estimated Persistence’s future cash flow based on the following assumptions: 1. Revenue Estimating revenue is the first step of cash flow estimation. For Persistence, I estimate revenue for this project as a function of market share and market size (for example, revenue in 2013 would be 15%*350=$52.5 millions). Then I estimate the market size to grow at 15% in each year and find the revenue using the estimated market shares. The whole sale price of $90.00 is not used. 2. Cost I estimated the cost of the project as following: 1. $1.8 million overhead cost per year (as described in item #4 of the case) is included 2. Initial $8 million investment of purchasing manufacturing equipment is included. Depreciation is calculated using 5-year MACRS based on the book value of the equipment at the beginning of each year. 3. The book value of the project at the end of the 2015 (terminal year) is estimated to be $3,525,120 (cell E10). Since the equipment is estimated to be sold at book value. The pre-tax salvage value of equipment is $3,525,120. I estimated the tax associated with this sale to be $1,410,048 (=$3,525,120 *40%). Therefore, the cashflow from sale of equipment is $2,115,072 (=$3,525,120 – $1,410,048) 4. Investment inventory and account receivables leads to a cash outflow of $25 million in time 0 and cash inflow of the same amount at the end of the project. The change in account payable is ignored since it is not current asset. 5. Variable cost of producing is included as COGS. General and administrative expenses, advertising and promotion costs and purchase of outside technologies are included according to the description. 6. Interest expense of $84,000 each year is included. 7. I estimated the operating cash flow as revenue minus all operating expenses and interest expense plus depreciation, since depreciation is not cash expense. 8. The total (or net/free) cash flow each year is estimated using operating cash flow, change in net working capital and cash flow associated with the equipment expenses.
