sneaker 2013 case study

Persistence and Sneakers 2013 Case Study

Relevant cash flows for Sneaker 2013 are those that are directly associated with the project. Among such cash flows are sales of Sneaker 2013, variable costs, an increase in inventory, an increase in accounts payable, the cost of equipment that needs to be purchased and its installation, the cost of building a factory in Vietnam, the interest cost on debt which needs to be employed to finance the project, and the advertising and promotion costs. Tax expense is also a relevant cash flow as it concerns Sneaker 2013 project. The reduction in sales of existing New Balance shoes should be regarded as the lost revenue, which is also incremental cash flow. Even though the cost of equipment and its installation and the cost of real estate are depreciated, depreciation is not a cash flow. $2 million spent on research and development on Sneaker 2013 is a sunk cost that should be ignored.

Relevant cash flows for Persistence include revenue generated from sales, an increase in the working capital, the cost of equipment, the cost of the design technology and manufacturing specifications for a new hiking shoe, interest expense on debt, taxes, and net income after tax. The allocation of overheads associated with the use of the company’s factories is a sunk cost and not a component of relevant cash flows. There is no opportunity cost as the introduction of the product is not expected to impact the existing sales. Depreciation is a non-cash item, which is why it is not a relevant cash flow.

The net present value of a project can be calculated as the difference between the present value of future cash flows and the initial cost of investment. The initial cost of investment includes the cost of equipment and its installation (15 million in total), the cost of building a factory in Vietnam (150 million), and an increase in the working capital, which is equal to the difference between an increase in current assets and an increase in current liabilities. The initial cost of investment for Sneaker 2013 can be calculated as:

Tables 1 and 2 show total cash flows and discounted cash flows for Sneaker 2013 for 2013-2018. Revenue was calculated by multiplying sales volume by net price. Gross profit was calculated by subtracting variable costs from revenue. Tax expense was calculated by multiplying the tax rate by income before taxes. Discounted cash flows were calculated using the following formula:

Table 1. Cash Flows for Sneaker 2013.

Table 2. Discounted Cash Flows for Sneaker 2013.

At the end of the project, the company will gain an additional 115,000,000 million if it sells the equipment and the factory and recovers the working capital. Thus, the NPV of the project is:

The lost revenue (or opportunity cost) is equal to the lost sales multiplied by the gross margin:

The IRR can be calculated by solving the following equation for R:

Using What-If analysis in Excel, the value of R is equal to 48.35%, which is the internal rate of return for Sneaker 2013.

The payback period is calculated by subtracting each individual annual cash inflow from the cost of investment until a positive amount is achieved. The payback period for Sneaker 2013 is equal to five years (see Table 3).

Table 3. Cumulative Cash Flows for Sneaker 2013.

The discounted payback period is calculated similarly to the payback period, yet the annual cash flows are discounted. The discounted payback period for Sneaker 2013 is equal to six years (see Table 4).

Table 4. Cumulative Discounted Cash Flows for Sneaker 2013.

Profitability index for Sneaker 2013 is equal to:

The initial cost of investment for Persistence includes the cost of manufacturing equipment (8 million) and an increase in the working capital (15 million). The initial cost of investment for Persistence is equal to:

Tables 5 and 6 show total cash flows and discounted cash flows for Persistence for 2013-2015. Total sales were calculated by multiplying the total sales for the athletic footwear market by the market share projections for Persistence with consideration of the annual growth rate. The gross profit was calculated by subtracting variable costs from total sales. Purchase of intangible assets is recognized as an immediate expense, which is why it is not amortized. The tax expense was equal to zero in 2013 since the company did not generate any income.

Table 5. Cash Flows for Persistence.

Table 6. Discounted Cash Flows for Persistence.

At the end of the project, the company will gain an additional 17,320,000 if it sells the equipment and recovers the working capital. Thus, the NPV of the project is:

Using What-If analysis in Excel, the value of R is equal to 42%, which is the internal rate of return for Persistence.

The payback period for Persistence is equal to three years (see Table 7).

Table 7. Cumulative Cash Flows for Persistence.

The discounted payback period is equal to three years (see Table 8).

Table 8. Discounted Cumulative Cash Flows for Persistence.

Profitability index for Persistence is equal to:

Tables 9 and 10 show the capital budgeting cash flow statements for Sneaker 2013 and Persistence, respectively.

Table 9. Projected Capital Budgeting Cash Flow Statement for Sneaker 2013 for 2013-2018.

Table 10. Projected Capital Budgeting Cash Flow Statement for Persistence for 2013-2015.

Sneaker 2013 can be considered a more attractive choice for New Balance shareholders because it offers a higher return on the initial investment and has a greater net present value. Even though the implementation of Sneaker 2013 entails the revenue loss, which is equal to 20 million, this project is expected to generate more positive cash flows, compared to Persistence. On the other hand, Persistence is a good option, too, because its profitability index is slightly higher and its net present value is positive. However, the main reason why Persistence is worse than Sneaker 2013 is that it has a too high cost of intangible assets that should be purchased immediately.

Based on all the above-said, Rodriguez may be recommended to undertake Sneaker 2013. Despite the fact that this project is slightly less profitable, its internal rate of return and net present value are much higher. If the company found a way to minimize costs associated with the purchase of the design technology or the project had a longer life cycle, Persistence could be a more feasible choice. As for now, however, shareholders will gain more from Sneaker 2013 than from Persistence.

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Time period, geographical setting, featured company, featured protagonist.

Michelle Rodriguez (female)

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Sneaker 2013 – Case Solution

The case study Sneaker 2013 introduces the basics of capital budgeting. It allows the computation of a project’s initial investment outlay, the project’s annual net operating cash flows, and the project’s terminal net cash flow. This case study likewise discusses the valuation of both the Sneaker 2013 and the Persistence project. To determine which project is likely to be profitable and accept that project, it is important to calculate and consider some financial determinants such as WACC, NPV, IRR, and payback period. It also looks into other factors affecting New Balance's decision whether to invest in the Sneaker 2013 running shoe or the Persistence hiking shoe by delving into an in-depth analysis of both projects’ cash flows and financial metrics and looking into a few nonfinancial factors relevant to the project.

Richard Bliss and Mark Potter Harvard Business Review ( BAB166-PDF-ENG ) March 01, 2015

Case questions answered:

Case study questions answered in the first and second solutions:

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?
Which project do you think is riskier? How do you think you should incorporate differences in risk into your analysis?
Based on the calculated payback period, net present value (NPV), and internal rate of return (IRR) for each project, which project looks better for New Balance shareholders? Why?
Should Rodriguez be more or less critical of cash flow forecasts for Persistence than of cash flow forecasts for Sneaker 2013? Why?
What is your final recommendation for Rodriguez?

Case study questions answered in the third solution:

Which cash flows should be incorporated into the project’s forecast? Why or why not?
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? d.) Does Persistence appear attractive from a quantitative standpoint? To answer this question, estimate the project’s payback, net present value, and internal rate of return.

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Sneaker 2013 Case Answers

This case solution includes an Excel file with calculations.

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New Balance, a shoe manufacturing company, is located in Brighton, United States. The company is well known globally due to the high quality and wide variety of shoes provided to customers. The company saw an opportunity in the 12-18-year-old male segment of the market while other competitors had ignored it.

Due to the lack of resources or star power, the company can’t compete in this segment. However, the company saw an opportunity to target younger customers if effective marketing and advertising were used. Thus, Sneaker 2013 was initiated in response to this opportunity.

Although the target of this project was between 12 and 18 years old, the market trend was expected to be 27 years and older as the population ages. So, the company began to review another hiking shoe proposal called Persistence. Even though the company had not yet entered this market, this market was considered one of the fastest-growing in the footwear industry.

This report provides an analysis and valuation of both the Sneaker 2013 and the Persistence project. To determine which project is likely to be profitable and accept that project, it is important to calculate and consider some financial determinants such as WACC, NPV, IRR, and payback period.

Moreover, this report consists of the project sensitivity analysis of some financial determinants, the comparison between both projects and some recommendations for the company in order to decide which project is better.

Finally, with careful and thorough consideration, the company is recommended to go ahead with the Sneaker 2013 project and use Kirani James as their newest athlete endorser.

Introduction

In consideration of market share to compare with the competitors of New Balance, the major competitors are as follows:

Sneaker 2013 - Share of the athletic footwear market

source: The Statistics Portal, Share of the athletic footwear market

High-quality athlete shoes are purchased at a reasonable price by baby boomers, who are the primary target market of sneakers.

The company demands to renovate the products created with new ideas and designs that will stimulate sales and profitability. The market share would be larger in this competitive industry.

Presenting 2 projects, Sneaker 2013 and Persistence in the athletic footwear industry, the first project (Sneaker 2013), with a 6-year venture life from 2013 to 2018, contains customary cash flow.

This cash flow also includes uncertainty(risk) of endorsing the market product for promotion. With the small size of investment in a competitive market, the second project evaluates a new hiking shoe venture.

Sneaker 2013

Capital budget projection..

The capital budgeting of Sneaker 2013 depends on new equipment installation to make progress. The initial cost for investment is usually integrated into the Net Present Value (NPV) calculation and is mostly in a negative value. The valuation is to determine whether to…

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Sneaker 2013 Harvard Case Solution & Analysis

Home >> Harvard Case Study Analysis Solutions >> Sneaker 2013

Answer No. 1

For capital budgeting cash flow projection of project “Sneaker 2013”, we will include all of the following,

Building a factory and purchase/ installation of the equipment because New Balance is incurring these expenses solely for the purpose of undertaking the project “Sneaker 2013”.
Research and development is also done for the project’s feasibility, so its cost should also be included.
Cannibalization cost will also be considered while finding cash flows, this is opportunity cost of undertaking the project.
Interest cost, related to financing undertaken for the project will also considered.
All the changes in current asset and current liability account will aslo be considered, which are solely changed due to project.
Taxes shall also be included, as every business has an obligation of paying taxes on earnings.
Cost of goods sold of specific project will also be included in finding net income.
Advertising and promotion cost incurred for the project will also be included.

Answer No. 2

Following are the consolidated results of NPV, IRR and pay back period.

Sneaker 2013 Harvard Case Solution & Analysis

Answer No.3

For “Persistence” project, all the variables except cannibalization and building and factory cost. As because there is no any effect of cannibalizing if persistence project is undertaken and also it don’t require any new factory building, as cost of existing building is fixed, irrespective of New Balance’s decision to undertake the project. So following will be included.