The Valuation of Mercury Athletic

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Executive Summary

The main problem of the Mercury case is the valuation of Mercury Athletic. John Liedtke- the head of business development for Active Gear, Inc. - foresaw an opportunity as West Coast Fashions Inc. was planning to divest Mercury Athletic. He wanted to create a valuation on his own before hearing a valuation from another party. To correctly value Mercury Athletic, Liedtke should compose a Discounted Cash Flow model. The model finds the present value of all future cash flows for the proposed acquisition. Ultimately, the discounted cash flow will give Liedtke the ability to decide whether the acquisition will provide value to Active Gear, Inc., or if it is an acquisition that should be avoided by his company.

Overview of Problem

AGI is a footwear company with the customer target for 25-45-year-old urban family and price range in the middle-high market, looking to expand into other markets. West Coast Fashions is currently selling Mercury Athletic, one of their less profitable footwear division. Mercury has not been as profitable in recent years whereas AGI has maintained a steady growth rate and profit margin. The main problem AGI is facing is to value this acquisition.

So we need to estimate the firm value of Mercury.

Analysis

【Question 1】

Firstly, we think that Mercury is an appropriate target for AGI.

Based on the case, we make a comparison of the background of AGI and Mercury (The comparison is in Exhibit 1). Both AGI and Mercury develop athletic footwear industry in North America and manufacture their shoes in China. Mercury’s target market is youths aged 15-25 while AGI’s target market is 25-45 affluent urbans. Acquiring Mercury would roughly double AGI’s revenue, increase its leverage with contract manufacturers, and expand its presence with key retailers and distributors. Mercury sells shoes at a cheaper price, which appeals to more frugal buyers; this will open up a market AGI has not occupied before. Due to these reasons, Mercury is a good target. But we need to estimate the firm value of Mercury to decide whether it is a smart acquisition. So we will do the estimation in the following part.

【Question 2】

Secondly, we use the Discounted Cash Flow Method to estimate the value of Mercury step by step.

1. Estimate the weighted average cost of capital

From case material, we could have the following assumptions:

(1) Proportion of leverage is 20%. Therefore, leverage ratio would be: 20%/ (1-20%)=0.25; (2) Beta of debt(industry) is 0; (3) Cost of debt is 6.0%; (4) Tax rate is 40%;

1. First of all, in order to calculate unlevered equity beta, we conduct the ‘Unlevered’ process:

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We decide to use average cost of equity of all other firms in footwear industry to determine the unlevered beta we use, then we can have the result: (Exhibit 2)