Sneaker 2013 Case Solution

As new items were introduced by competitors, the competition was strong. Despite the slump in the economy, the shoe market continues to rise. The VP requested Michele Rodriquez to analyze two goods, Sneakers 2013 and Persistence, and she agreed to do so. The VP also wanted recommendations in order to choose the best choice for the project's commencement.

1. Produce a projected capital budgeting cash flow statement for the Persistence project by answering the following: (a) What is the project’s initial (year 0) investment outlay? (b) What are the project’s annual net operating cash flows? (c) What is the project’s terminal (2018) net cash flow? 

a) Among the initial investment outlay in year zero is the capital expenditure for manufacturing equipment of $8 million, the change in NWC of $15 million, and the expenditure for design technology and manufacturing specifications of $50 million, all of which are expensed immediately for taxation. Consequently, the original investment in year 0 includes a tax advantage ($50 million x 40% = $20 million), resulting in a total net cost of the initial investment outlay of $53 million (in the absence of the tax benefit, the cost of the initial investment would be $73 million).

b) The projected net cash flows for the years 2013, 2014, and 2015 are $14.5 million, $22.4 million, and $46.7 million respectively. The cash flows were calculated by starting with the Persistence revenue and then subtracting variable cost, selling general & administrative expense, advertising & promotion expense, and cost of technology. This led us to the Earnings before Interest and Taxes (EBIT). The EBIT figure was then adjusted for the taxes and depreciation was added back since it was a non-cash expense. Then, the changes in (NWC) were added to the figure which led us to the final figure of the net cash flows for 2013, 2014, and 2015.

c) The terminal cash flow for the Persistence project came out to be $44.4 million. The figure was calculated by using the net income which was calculated by taking the total market value of $462 million multiplied by 20% which gave us the revenue of $92.5 million for the year 2015. Then the total variable cost, selling general & administrative expense, advertising & promotion expense, and cost of technology were subtracted from the revenue to arrive at the Earnings before Interest and taxes (EBIT) from which the taxes were subtracted to arrive at the net income of $27.8 million. The depreciation for the equipment of $1.5 million and the Net Working Capital (NWC) was added to the net income which gave the value for the terminal cash flow of $44.4 million.

2. Which project do you think is riskier? How do you think you should incorporate differences in risk into your analysis?

We believe that Persistence is the riskier of the two initiatives when compared to Sneaker 2013 in terms of financial risk. Net present value (NPV), payback time, and internal rate of return are the three factors that we use to account for variations in risk in our research (IRR). Based on the analysis above, it shows that the highest internal rate of return is the Persistence project with 22% compared to Sneaker 2013 project with 13%. Next, the Net Present Value (NPV) of the Persistence project is more than the Sneaker 2013 project with a positive value of $13.75 million and $8.59 million respectively. Lastly, the payback period of the Sneaker 2013 project is longer than the Persistence project with 5.1 years and 2.34 years respectively.