Executive Summary
The footwear industry is highly competitive industry with fairly stable profit margins. Active Gear is a profitable firm in the industry; however Active Gear is a smaller firm than many other competitors and its small size is becoming a competitive disadvantage. The rise of large retailers has also endangered Active Gear’s growth.
Mercury Athletic Footwear designs and distributes athletic and casual footwear dominantly to the youth market. Mercury competes in four main product lines: men’s and women’s athletic and casual footwear. Men’s athletic footwear is the leading product for Mercury Athletic. Women’s casual footwear is Mercury’s worst performing product and post-acquisition the line may be discontinued by Active
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The free cash flows are demonstrated in the chart below: The next step was to determine the cost of debt and cost of equity. Case assumptions made by Liedtke of a 40% corporate tax rate, 6% estimated cost of debt, and 20% leverage were used in calculating the cost of debt. The cost of debt was determined to be 3.6% (= Debt*(1-Tax Rate). The cost equity was determined using the CAPM approach. Looking at the last 78 years, the historical S&P market returns would suggest using a 10.5% to 11.0% rate to project future returns. The average industry revenue growth rate in footwear is 10%. However, to be more conservative, a market return rate of 8% was used. The risk free rate was determined to be 4.69% using the 10 year US Treasury Bills yield given in the case footnotes on page 7 of the case. This results in a market risk premium of 3.31%. The cost of equity was determined to be 12.80% (Risk free rate + Beta x Market Risk Premium) (See Exhibit 1). The cost of equity and debt was used to calculate an estimate of Mercury’s Working Assumption Cost of Capital (WACC) to discount the free cash flows. Applying the cost of equity with the cost of debt resulted in a WACC of 10.67% (See Exhibit 1). Using the discounted rate of 10.67% results in the present value of cash flows of the acquisition is $59,440,000 (See Exhibit 1). Typically its assumed businesses will continue on in perpetuity unless information

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