SECOND SEMESTER SESSION 2019/2020 (A192)

BWFF2043 ADVANCED FINANCIAL MANAGEMENT

(GROUP A)

GROUP ASSIGNMENT

SNEAKER 2013

PREPARED FOR :

ASSOC. PROF. DR. ROHANI MD RUS

PREPARED BY :

NAME MATRIC NO.

DHAYALAN CHANDRAN 259059
RESHANA PRIYA KUMARESAN 261060
THIVYAA KALAIARASAN 261182
HIROSHA VEJIAN 264096
SHAMIL BIN ABDUL KADIR 264171

SUBMISSION DATE :

25TH JUNE 2020

1. SNEAKER 2013 PROJECT

a) Project’s initial (year 0) investment outlay

$ $
Factory outlay (150,000,000)
Equipment outlay – Purchase equipment 15,000,000
Freight and installation 5,000,000 (20,000,000)
Depreciable asset (170,000,000)
Working capital – Inventory increase 15,000,000
Account payable increase (5,000,000) (10,000,000)
TOTAL INITIAL OUTLAY (180,000,000)

b) Project’s annual (year 2013-2018) net operating cash flows

2013 2014 2015 2016 2017 2018

Million ($)
Unit 1.2 1.6 1.4 2.4 1.8 0.9
(x) price 115 115 115 115 115 115
Revenue 138 184 161 276 207 103.5
Less: loss of sales (35) (15) - - - -
Net revenue 103 169 161 276 207 103.5
Less: Variable cost (56.65 (92.95) (88.55 (151.8) (113.85 (56.925)
(55% x net revenue) ) ) )
Endorsement fee (2) (2) (2)
Olympic bonus (2) (2) (1) (2)
Selling, general and (7) (7) (7)
administrative (7) (7) (7)
Advertising and (15) (30) (15)
promotion costs (25) (10) (25)
Depreciation factory (7.5) (6.75) (6)
Depreciation (3.9) (6.4) (7.05) (2.4) (6.45) (1.2)
equipment (4) (3.8) (2.2)

EBIT 4.45 38.15 42.6 75.05 50.5 15.375

Tax (40%) (1.78) (15.26) (17.04 (30.02) (20.2) (6.15)
)
Net income 2.67 22.89 25.56 45.03 30.3 9.225
Add back non-cash item:
- Depreciation factory 3.9 7.5 7.05 6.75 6.45 6
- Depreciation 4 6.4 3.8 2.4 2.2 1.2
equipment
NET OPERATING CASH 10.57 36.79 36.41 54.18 38.95 16.425
FLOWS

* depreciation
 2013 2014 2015 2016 2017 2018 TOTAL
(million $)
Factory outlay 2.6% 5% 4.7% 4.5% 4.3% 4%
($150 million) $3.9m $7.5m $7.05m $6.75m $6.45m $6m 37.65
Equipment 20% 32% 19% 12% 11% 6%
outlay $4m $6.4m $3.8m $2.4m $2.2m $1.2m 20
($20 million)

* working capital

$ $
Year 0 – Inventory increase 15,000,000
Account payable increase (5,000,000)
Net working capital 10,000,000
Year 1 – Account receivable (8% x $103m) 8,240,000
Inventory (25% x $56.65m) 14,162,500
Account payable (20% x $56.65m) (11,330,000)
Net working capital 11,072,500
Increase in working capital (Year 1 – Year 0) 1,072,500
Working to be recovered (Year 0 – increase in WC) 8,927,500

c) Project’s terminal (2018) cash flow

($) ($)
Salvage value 105,000,000
Tax on capital gain 2,940,000
Recapture of net working capital 8,927,500
TERMINAL CASH FLOW 116,867,500

* Tax on Capital Gain/Loss

($) ($)
Salvage value - Factory 102,000,000
Equipment 3,000,000 105,000,000
(-) Book value
Depreciable Asset 170,000,000
(-) total amount depreciated - factory equipment (37,650,000)
(20,000,000) (112,350,000)
Capital loss (7,350,000)
Tax saving (40%) 2,940,000
d) Quantitative standpoint

 Project’s Payback
 Year Cash flow Amount recover and balance
($) ($)
2012 - 0 (180,000,000)
2013 - 1 10,570,000 180,000,000-10,570,000 =169,430,000
2014 - 2 36,790,000 169,430,000-36,790,000 = 132,640,000
2015 - 3 36,410,000 132,640,000-36,410,000 = 96,230,000
2016 - 4 54,180,000 96,230,000-54,180,000 = 42,050,000
2017 - 5 38,950,000 42,050,000-38,950,000 = 3,100,000
2018 - 6 16,425,000 3,100,000/ 16,425,000 = 0.1887

PAYBACK PERIOD: 5 + 0.1887= 5.1887 years

 Net Present Value ((NPV)

Year Cash flow i (11%) Present Value

($) ($)
2012 - 0 (180,000,000)
2013 - 1 10,570,000 10.570,000 / 1.11 9,522,500
2014 - 2 36,790,000 36.790,000 / 1.112 29,859,600
2015 - 3 36,410,000 36.410,000 / 1.113 26,622,700
2016 - 4 54,180,000 54.180,000 / 1.114 35,690,000
2017 - 5 38,950,000 38.950,000 / 1.115 23,114,900
2018 - 6 16,425,000 16.425,000/ 1.116 8,781,500
Total Discounted cash flow 133,591,200
(-) Initial outlay 180,000,000
NET PRESENT VALUE (NPV) (46,408,800)

NET PRESENT VALUE (NPV) = ($ 46 408 800)

 Internal Rate of Return (IRR)

Try at 1%

Year Cash flow Try at i = 1% Discounted cash flow

($) ($)
 2013 - 1 10,570,000 10.570,000 / 1.01 10,465,300
2014 - 2 36,790,000 36.790,000 / 1.012 36,065,100
2015 - 3 36,410,000 36.410,000 / 1.013 35,339,200
2016 - 4 54,180,000 54.180,000 / 1.014 52,065,900
2017 - 5 38,950,000 38.950,000 / 1.015 37,059,600
2018 - 6 16,425,000 16.425,000/ 1.016 15,473,100
TOTAL DISCOUNTED CASH FLOW 186,468,200

Try at 2%

Year Cash flow Try at i = 2% Discounted cash flow

($) ($)
2012 - 0 (180,000,000)
2013 - 1 10,570,000 10.570,000 / 1.02 10,362,700
2014 - 2 36,790,000 36.790,000 / 1.022 35,361,400
2015 - 3 36,410,000 36.410,000 / 1.023 34,310,000
2016 - 4 54,180,000 54.180,000 / 1.024 50,053,900
2017 - 5 38,950,000 38.950,000 / 1.025 35,278,200
2018 - 6 16,425,000 16.425,000/ 1.026 14,584,900
TOTAL DISCOUNTED CASH FLOW 179,951,100

Interpolation

i - 1% =$ 186,468,200

i-? = $ 180,000,000

i - 2% = $ 179,951,100

$186,468,200  $180,000,000
IRR  1%  X (1%)
$186,468,200  $179,951,100

$6,468,200
IRR  1%  X (1%)
$6,517,100

IRR  1.99%
INTERNAL RATE OF RETURN (IRR) = 1.99%

Sneaker 2013 does not seem viable from a quantitative standpoint because the NPV is -

$46,408,800 at the end of year 6 which is less than zero. This indicates the project would result

in a net loss of $46,408,800 and will decrease the wealth of the shareholders. Furthermore, the

IRR of Sneakers 2013 is 1.99% which is less than required rate of return amounted 11%.
Although, the payback period of this project would take 5.1887 years, which is shorter year

taken than projected 6 years, it is advisable to not invest in this project as the project would

accumulate losses to the company as stated above based on the NPV and IRR calculation.

2. PERSISTENCE PROJECT

a) Project’s initial (year 0) investment outlay

$ $
Equipment outlay (8,000,000)
Depreciable Asset (8,000,000)
Outside source outlay (1-0.4) x 50 million (30,000,000)
Working capital – Inventory and account 25,000,000
 receivable
Account payable (10,000,000) (15,000,000)
TOTAL INITIAL OUTLAY (53,000,000)

b) Project’s annual (year 2013-2015) net operating cash flows

2013 2014 2015

($) ($) ($)
Shoe market - 1 x 350 million 350,000,000
1.15 x 350 million 402,500,000
1.15 x 402.5 million 462,875,000
Sales - 15% x 350 million 52,500,000
18% x 402.5 million 72,450,000
20% x 462.875 million 92,575,000
Less: Variable costs (38% x sales) (19,950,000) (27,531,000) (35,178,500)
General and administrative
expenses -12% x sales (6,300,000)
10% x sales (7,245,000)
8% x sales (7,406,000)
Advertising and promotion (3,000,000) (2,000,000) (2,000,000)
costs
Depreciation equipment
- 20% x 8m (1,600,000)
- 32% x 8m (2,560,000)
- 19% x 8m (1,520,000)

EBT 21,650,000 33,114,000 46,470,500

Tax (40%) (8,660,000) (13,245,600) (18,588,200)
Net income 12,990,000 19,868,400 27,882,300
Add - Depreciation equipment 1,600,000 2,560,000 1,520,000
NET OPERATING CASH FLOWS 14,590,000 22,428,400 29,402,300

d) Project’s terminal (2015) cash flow

($)
Salvage value 2,320,000
Tax on Capital Gain 0
Recapture of net working capital 15,000,000
TERMINAL CASH FLOW 17,320,000

* Tax on capital gain/loss

 ($) ($)
Salvage value 2,320,000
(-) Book value
Depreciable Asset 8,000,000
(-) total amount depreciated (1.6m+2.56m+1.52m) 5,680,000
(2,320,000)
Capital Gain/ Loss 0
Tax saving (40%) 0

e) Quantitative standpoint

 Project’s Payback Period

Year Cash flow Amount recover & balance

($) ($)
Initial CF - 0 (53,000,000)
1 – 2013 14,590,000 53,000,000 - 14,590,000 = 38,410,000
2 – 2014 22,428,400 38,410,000 - 22,428,400 = 15,981,600
3 - 2015 29,402,300 15,981,600/29,402,300
= 0.5435

PAYBACK PERIOD = 2.5435 years

 Net Present Value (NPV)

Year Cash flow I (14%) Present Value

( $) ($)
Initial CF – (53,000,000)
0
1 - 2013 14,590,000 14,590,000/1.14 12,798,245.61
2 – 2014 22,428,400 22,428,400/1.14² 17,257,925.52
3 – 2015 29,402,300 29,402,300/1.14³ 19,845,715.01
Total Discounted cash flow 49,901,886.14
(-) Initial outlay (53,000,000)
NET PRESENT VALUE (NPV) (3,098,113.86)
  Internal Rate of Return (IRR)

Try at 10%

Year Cash flow Try at i = 10% Discounted cash flow

( $) ($)
0 (53,000,000)
1 - 2013 14,590,000 14,590,000/1.1 13,263,636.36
2 – 2014 22,428,400 22,428,400/1.1² 18,535,867.77
3 – 2015 29,402,300 29,402,300/1.1³ 22,090,383.17
TOTAL DISCOUNTED CASH FLOW 53,889,887.30

Try at 11%

Year Cash flow ($) Try at i = 11% Discounted cash flow

($)
0 (53,000,000)
1 - 2013 14,590,000 14,590,000/1.11 13,144,144.14
2 – 2014 22,428,400 22,428,400/1.11² 18,203,392.58
3 – 2015 29,402,300 29,402,300/1.11³ 21,498,708.35
TOTAL DISCOUNTED CASH FLOW 52,846,245.07

Interpolation

i - 10% = $ 53,889,887

i -? = $ 53,000,000

i - 11 % = $ 52,846,245

$53,889,887  $53,000,000
IRR  10%  X (1%)
$53,889,887  $52,846,245
 $889,887
IRR  10%  X (1%)
$1,043,642

IRR  10.58%

INTERNAL RATE OF RETURN (IRR) = 10.85%

Persistence does not attractive from a quantitative standpoint because the NPV for this project

is in negative at the end of year 3. Negative NPV reduce the indication value to the firm and it

will decrease the wealth of the owners. Moreover, the IRR for Persistence is 10.85% which is

less than required rate of return of 14%. Although the payback period for this project is 2.5435

years which is shorter than the preset limit, it is advisable to reject the project because investing

in this project will get a loss of $(3,098,113.86).

3. Between the two projects, which project do you think is more risky? How do you think you

should incorporate differences in risk in your analysis?

For Persistence, the obvious risk that can be seen is risk of new product not selling well in

market. Although there is a promising return as hiking and active walking sector are currently

one of the fastest growing areas in footwear and thus, leading to more revenue and greater

advantage for the company to seize the fast growing shoe trend, there is certain risk to be

incurred as New Balance Company has never ventured in this segment before. By entering a

new market segment, there is always a risk of not succeeding in new product line as there are

other current and stable competitors in this segment already. This project can be say having a

small speculative risk as undertaking this project may end up with slight uncertainty of loss or

gain.

For Sneakers 2013, it can be considered having a few risks. This project has relatively

higher short-term debt compare to the Persistence project. Having higher short -term debt
means debt need to be repaid earlier than equity, thus leading to riskier cash flow. If the

company has unstable cash flow, this can cause problems as company need to give priority

repay debts first. Besides, the payback period for Sneakers is longer by having 5.1887 years

compared to Persistence which is only 2.5435 years. Longer payback period induces more risk

than shorter ones as they are more uncertain. This is because, the longer it takes investment to

obtains its cash inflows, riskier that the investment will not make profit. Since Sneakers is

another running shoes in same product line, it reduces sales of existing New Balance Shoes

compared to Persistence which does not impact sales of other shoes. Thus, there is risk between

weighing cost-benefit of undertaking Sneakers shoes which will impact others sales in company.

Thus, it can be considered Sneakers 2013 may have higher risk than Persistence Project

due to having higher cash flow risk and other risk.

4. 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?

SNEAKER 2013 PERSISTENCE

Payback Period 5.1887 years 2.5435 years
NPV ($46 408 800) ($3 098 200)
IRR 1.99% 10.85%

Required Rate of Return – 11% Required Rate of Return – 14%

Payback period helps to determine how long it takes to get back the cash for initial investment
Both projects has payback period within their project life which is considered good. However,

when compared, Sneaker 2013 has longer payback period than Persistence. Persistence is

better than Sneaker 2013 as having shorter payback period, means having investment’s risk

level associated with initial investment cost for only a short time. It is better because shorter

payback period induces lesser risk and uncertainty.

Besides that, both projects provide negative NPV amount. A desirable investment is an

investment with positive NPV, therefore both projects should be rejected. This is because our

goal is to increase owner’s wealth and positive NPV helps to add value to the firm, increases

owner’s wealth. However, since New Balance have to undertake one of the projects, Persistence

will be a better choice. Although it is negative value, it has higher NPV compared to Sneakers.

Thus, Persistence project is better than Sneaker.

Moreover, Internal Rate of Return (IRR) is the expected rate of return that will be

earned on project. Both projects have IRR lower than required rate of return. However, taking

into account IRR value that is closer to required rate of return, Persistence is better than

Sneaker. This is because it has a closer IRR value to required rate of return, providing a better

chance of strong growth. Overall, Persistence project looks better New Balance shareholder.

5. Should Rodriguez be more critical or less critical of cash flow forecasts for Persistence than of

cash flow forecasts for Sneaker 2013? Why?

Rodriques must be more critical of cash flow forecast for Persistence than for cash flow forecast

for Sneakers 2013. Cash flow forecast determined by every year’s changes and cash flow in

cycle. Rodriques should be more focus on Persistence cash flow forecast as it seems more

desirable than Sneaker 2013.

6. What is your final recommendation to Rodriguez?

The final recommendation is to undertake Persistence project as it is more desirable than

Sneakers 2013. Looking at the financial and investment perspective, Persistence has better

performance in terms of capital budgeting techniques which is IRR, NPV and payback period

than Sneaker 2013. Since NPV is first priority primary investment criteria, it is important to

undertake project with higher NPV. In this case, choosing Persistence.

Besides looking at market perspective, Persistence project has lower risk and

uncertainty than Sneaker 2013. Since hiking and active walking sector is fastest growing areas

in footwear and targeting segment of this project is 25 to 40-year-old age category, Persistence

can be considered as a suitable prospective to meet the market demands. Besides, taking

account of not only younger consumer, but also ultimate purchase which is the parents,

Persistence becomes a better choice than Sneakers 2013.