The results of my financial analysis based on the Free Cash Flow Method considering the base case of financial projections and assumptions for Mercury Athletic Footwear collated and developed by John Liedtke indicate that that the project to acquire Mercury Althletic has a positive net present value at $243,025 (in thousands) [ given by PV(FCF)=86,681+ PV (Terminal Value) =156,343] which is also greater than the recommended acquisition price of $186,216 (in thousands),therefore Active Gear Inc. should proceed with the acquisition of Mercury’s operation.
Free Cash Flow
The free cash flow from Mercury’s business operations was determined using the base case for the consolidated operating income, expenses, tax rate and depreciation to determine the net operating profits after tax (NOPAT) for the years 2007-2011. Free cash flow was then calculated using the formula (FCF= NOPAT + Depreciation-∆ Net Working Capital -∆Fixed Assets) which was evaluated at $21,240, $26,727, $ 22,097, $25,473 and $29,545 for the years 2007, 2008, 2009, 2010 and 2011 respectively.
The Cost of Debt and the Cost of Equity
The next step was to determine the coast of debt, using the assumptions made by Mr. Liedtke which outlines a tax rate of 40%, the cost of debt of 6% for a leverage of 20% debt. The after-tax cost of debt (RD) was determined to be 3.6% [using RD =(R*(1-Tax Rate), where RD =after rate cost of debt, R= cost of debt] The cost equity estimated using the CAPM approach, Surfside Footwear was selected as a comparable company since its EBIT Margin of 9.3% was the same as the average consolidated EBIT Margin of Mercury Athletic for period 2004-2006, the Equity Beta for Surfside from Exhibit 3 was 2.13. The risk free was determined to be 4.69% using US Treasury Bills Yield given in the case Footnotes on page 7. The 5 year T-bill yield was selected as...