Corporate Financial Management: A Case Analysis of New Balance
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Executive Summary
In the United States, New Balance is a well-known shoe brand with a long history. When it comes to global recognition, the company’s brand is well-known. In order to meet market demand, high-quality shoes in a variety of styles are being made. For the purpose of marketing their goods, New Balance has partnered up with a number of well-known sportsmen, including Michael Jordan and LeBron James. Monte Holiday, senior vice president of product development, recognized an opportunity in the 12-to-18-year-old male market that most of his competitors had failed to see. New Balance, on the other hand, lacked the financial resources necessary to compete effectively. Because of the success of their marketing and advertising campaign, which focused on the ideal player, New Balance recognized an opportunity to reach a younger consumer. Kirani James, a Grenada native who won a gold medal in the 400-meter sprint at the 2012 Olympics in London, has been acknowledged for his accomplishments in the sport. Given his youth, he has the potential to become an outstanding athlete who will be of interest to a younger generation of fans. He is still developing. As a result of the severe rivalry, new products were introduced on a consistent basis. Despite the economic slump, the shoe sector has maintained a moderate but steady growth rate. Michele Rodriquez was tasked by the Vice President with doing market research on two separate products: Sneakers 2013 and Persistence. Additionally, the Vice President need recommendations in order to determine which choice would be the best fit for kicking off the project.
INTRODUCTION AND BACKGROUND
New Balance is a shoe company that is based in Brighton, Massachusetts. The company’s shoes are known all over the world for their high quality and variety. Unlike its competitors, the business saw a chance in the male 12- to 18-year-old market (Babson College and The Case Centre, 2014). The company doesn’t have enough money or notoriety to compete in this field. On the other hand, the business might be able to reach a younger group through effective marketing and promotion. There were a lot of people who were excited about the Sneaker 2013 (Babson College and The Case Centre, 2014). It was meant for kids ages 12 to 18, but the market was expected to become more crowded as people grew old. In the future, the company would make shoes called “persistence.” Despite not being in this area, the company was said to be one of the fastest growing in the industry. Sneaker 2013 is a good example of how to spend money. It can be used to figure out how much money a project will cost, how much money it will make each year, and how much money it will make when it is done (Babson College and The Case Centre, 2014). This case study also looks at how the Sneaker 2013 and Persistence programs have helped people. Calculate and look at financial features like WACC, NPV, IRR, and payback time to see if a project is likely to make money. It’s not just money that led New Balance to buy the Sneaker 2013 running shoe or the Persistence hiking shoes.
PROBLEM STATEMENT
Two projects in the sports footwear business are the subject of this case study, which applies capital budgeting techniques to them. However, although Sneaker 2013 requires considerable capital infusions and a high risk of endorsement, Persistence requires just a little amount of capital outflows and has a greater development potential, despite the fact that it is a new field of research (Babson College and The Case Centre, 2014). The company must determine their ability to do their duties.
SITUATIONAL ANALYSIS
Evaluation of Cash Flow Components
The cash flow diagram components for the project’s net present value (NPV), internal rate of return (IRR), and return on investment (payback period) are represented below.
Cash Flow Component Sneaker 2013 Project Persistence Project
Building and equipment In the calculations, this cost will be taken into consideration. It’s just a cost the company has to bear to get the idea off the ground.
Investments in new factories will be omitted owing to the firm’s existing production facilities, however acquisitions and installations of equipment will be considered investments in future estimates.
R&D This component must not be a part of the discounted cash flow calculations since it is an initial investment. Will not be included in the calculations.
Cannibalization (The loss of current product’s sales) Given that this expense is connected to the company’s other items, which would be influenced by shoe sales, it will be included in predictions. Excluded it from the calculation since it is related with the company’s other goods, which are unaffected by sustained sales.
Interest costs As a result, it will not be removed because the cash flows after interest will not be included in the forecasts.
This will have no effects on the prediction since after-interest cash flows will not be included.
Working cap When a corporation pays taxes and interest, the working capital account is deducted from the total amount of money paid to the government. It will make a difference since net cash flow is determined by subtracting changes in working capital from gross cash flow in the accounting period.
Taxes It also has an influence on estimates since future predictions are generated using the after-tax amount, which has an impact on estimations. Because the after-tax amount will be included in the computation, it will have an influence on future forecasts.
Product cost The cost of a product has an impact on projections since it is deducted from sales in order to calculate net cash flows, which are then utilized in capital planning calculations. It will also have an impact since manufacturing expenses must be deducted from revenue in order to calculate net cash flow.
A&P expenses This is an operational expense that will be removed from gross profit in order to arrive at net cash flows that will be included in future forecasts of earnings. Due to the fact that they must be subtracted from gross revenue in order to arrive at the net cash flow that will be employed in the computation, these operational expenditures have an influence on future estimates.
Dep expense In this case, it will be treated as a tax shield, and any proceeds will be deducted from future cash inflows. Included since it offers tax shield and later deducted from the cash inflows.
ANALYSIS OF FINANCIAL PERFORMANCE
Sneaker 2013 is strongly reliant on financial flows that are directly tied to the project in order to function. Sneaker 2013 sales, growth in inventory and accounts payable, equipment purchase and installation costs, the construction of a facility in Vietnam, interest on loans used to support the business, and advertising and marketing expenses are all factors that affect cash flows (Babson College and The Case Centre, 2014). Cash flows are also affected by the company’s financial condition. When it comes to the Sneaker 2013 project, taxation is an important source of revenue. Revenue is being lost as a result of lower sales of current New Balance shoes, which is also producing an increase in incremental cash flow. Even while depreciation lowers the cost of equipment, installation, and real estate, it does not result in a cash flow. The $2 million that was spent on Sneaker 2013 research and development should be disregarded entirely.
Sales revenue, working capital expansion, equipment expenditures, the requirement for new hiking shoe design and production, loan interest charges, taxes, and net income after taxes are all important cash flows for Persistence (Babson College and The Case Centre, 2014). Factory overheads are considered sunk expenditures by the company and are therefore not shown in relevant cash flow statements. As a result, there is no opportunity cost involved. The fact that depreciation is a noncash item means that it has no impact on cash flow.
The difference between the present value of future cash flows and the cost of original investment is known as the present value of future cash flows. Costs include equipment and installation (15 million), the establishment of a facility in Vietnam (150 million), as well as an increase in working capital (25 million) (the gap between current assets and liabilities). Estimated startup costs for Sneaker 2013 include (Babson College and The Case Centre, 2014):
The initial investment for Sneaker 2013 calculated as:
15,000,000 + 150,000,000 + 10,000,000 = 175,000,000
(Information from: Babson College and The Case Centre, 2014)
ANALYSIS, EVALUATION, SYNTHESIS FOR THE SNEAKER INDUSTRY
Over the previous century, the number of pairs of shoes purchased per person has more than quadrupled, growing from an average of one pair in 1950 to 2.6 pairs in 2005 and three pairs per individual in 2013. Nearly all shoes are thrown away in landfills, with just a small percentage of them being recycled. Seasonality and impulsive purchases, which can account for up to half of overall sales, are to blame for this growth. As a result of today’s more educated clients, shoemakers must rely on advanced information and logistical tools that include precise and dependable forecasting systems. This industry uses a lot of resources and creates a lot of pollutants, but its usage and disposal frequently has the most devastating consequences.
The following are New Balance’s biggest competitors in terms of market share:
Figure: Market share competitive analysis
(Source: Pacheco-Blanco et al., 2018)
Baby boomers, who constitute the largest segment of the population that purchases sneakers, may obtain high-quality athletic shoes at a reasonable price (Chang, 2021). The corporation wants to provide innovative concepts and designs to its products in order to increase sales and profits. In a competitive firm, market share would be greater, resulting in a more favorable situation for the corporation. The following are the primary factors that contribute to a project’s success:
Building a factory and purchase / installation of the equipment.
Research and development cost
Cannibalization of other sneakers sales
Interest cost
Changes in current assets / current liabilities
Taxes
Cost of goods sold
Advertisement and promotion expense
Capital budgeting is the process of estimating the costs of constructing a facility and purchasing/installing equipment in order to determine the initial expenditure required. However, when calculating the new present value, just the initial cost of investment in equipment is always included since removing it from the positive present value of future cash flows allows the decision on whether or not to accept the proposal to be made more straightforward. R&D costs are excluded from the computation of Net Present Value due to the fact that they are negligible and difficult to discern. When calculating the Sneakers NPV, it is vital to consider cannibalization because it represents a sort of future cash stream for the firm. All interest charges incurred on borrowed money are included in the cost of capital used to discount the investment, which is equal to the amount borrowed plus interest charges. As a result, the interest expense is not taken into consideration when calculating the NPV. When calculating the net present value (NPV), changes in current assets and current liabilities are referred to as incremental changes. As a result, it should be taken into consideration while calculating the NPV. Tax is represented as a cash flow in the schedule. As a result, it plays a significant role in NPV estimations. Because they are so directly tied to the project’s cost and profitability, advertising and promotion should be included in the Net Present Value calculations. However, due to the fact that this spending suggests a future monetary outflow, it is considered to be substantial.
CONCLUSIONS AND RECOMMENDATIONS
The duration of a project is critical for forecasting future project durations. Because Persistence has a shorter shelf life than Sneakers 2013, you must use greater caution and critical thinking while making decisions. The projects are in different markets and have varying lengths of time to run. Persistence necessitates a greater initial financial commitment than Sneaker, making it a riskier investment than Sneaker. Both of these concepts look to be high-risk for New Balance. The Persistence project, on the other hand, is more dangerous than Sneakers 2013. A number of variables make the Persistence project appear to be riskier than others. To begin with, the category and market are considered to be relatively young. As a result, its market share is anticipated to stay steady, making it a high-risk investment option. First and foremost, the financial projections for Sneakers 2013 look to be worse than those for Persistence, increasing the possibility that management would quit the project. However, if some criteria, like as market share, increase, the Persistence project might prove to be extremely valuable to New Balance. In order to improve results, New Balance may also implement cost-cutting strategies. The Persistence project produces a lot of money in the second and third years of its life; nevertheless, it is possible that the project will last longer, altering its image and making the net present value (NPV) positive.
References
Babson College and The Case Centre (2014). Sneaker 2013.
Chang, C. W. (2021). Supply chain movement risk in the sneaker industry: an empirical study. Quality & Quantity, 1-20.
Pacheco-Blanco, B., Martínez-Gómez, M., Collado-Ruiz, D., & Capuz-Rizo, S. F. (2018). Sustainable information in shoe purchase decisions: Relevance of data based on source. Sustainability, 10(4), 1170.
Appendix 1
Persistence Assumptions Year 0 Year 1 Year 2 Year 3 Source
($ millions) Hiking/Walking market $ 350.0 $ 402.5 $ 462.9 Case p.4, #3
Growth of market 15% 15% Case p.4, #3
Market share 15% 18% 20% Case p.4, #3
Var Costs (% of Sales) 38% 38% 38% Case p.4, #7
SG&A Expenses (% of sales) 12% 10% 8% Case p.4, #9
Other advertising and promotion $ 3.0 $ 2.0 $ 2.0 Case p.4, #10
Tax rate 40% Case p.4, #11
Purchase of technology $ (50.0) Case p.4, #12
Equipment costs $ (8.0) Case p.4, #5
Inventory & A/R $ (25.0) Case p.4, #6
A/P $ 10.0 Case p.4, #6
MACRS Depreciation %: Equipment 20.0% 32.0% 19.0% Depreciation expense – Equipment 1.60 2.56 1.52 BV of Equipment 6.40 3.84 2.32 Appendix 2
Year 0 Year 1 Year 2 Year 3 Calculation Persistence Projected Cash Flow Statements ($ millions) Revenues $ 52.50 $ 72.5 $ 92.6 Market share x market size Var Costs $ (20.0) $ (27.5) $ (35.2) Revenue x Var Cost % G & A Expenses $ (6.3) $ (7.2) $ (7.4) Revenue x % Line 7 Advertising and Promotion $ (3.0) $ (2.0) $ (2.0) Line 8 Equipment Depreciation (5 years MACRS) $ (1.6) $ (2.6) $ (1.5) 10 million x Depreciation % Technology Purchase $ (50.0) $ – $ – $ – Pre tax cost EBIT $ (50.0) $ 21.7 $ 33.1 $ 46.5 Subtotal 8.68 Taxes $ 20.0 $ (8.7) $ (13.2) $ (18.6) Tax impact EBIAT $ (30.0) $ 13.0 $ 19.9 $ 27.9 Subtotal Plus Depreciation of Equipment $ 1.6 $ 2.6 $ 1.5 Change in NWC $ (15.0) $ – $ – $ 15.0 Change in Fixed Assets $ (8.0) Machinery sold for book value Project Net Cash Flows $ (53.0) $ 14.6 $ 22.4 $ 46.7 Total Cumulative Net Cash Flows $ (53.0) $ (38.4) $ (16.0) $ 30.7 Project Analysis: Assumed Cost of Capital 0.14 Payback 2.34 years Net Present Value $ 8.59 IRR 21.80% Profitability index 16.21% EAA 3.70 Appendix 3
Sneaker 2013 Assumptions 2012 2013 2014 2015 2016 2017 2018 Source
($ millions) Sales (millions of pairs) 1.20 1.60 1.40 2.40 1.80 0.09 Case p.2, #2
Price/Pair $ 115.0 $ 115.0 $ 115.0 $ 115.0 $ 115.0 $ 115.0 Case p.2, #3
Cannibalization $ 35.0 $ 15.0 Case p.2, #4
Var Costs (% of Rev) 55% 55% 55% 55% 55% 55% Case p.3, #8
SG&A Expenses $ 7.00 $ 7.00 $ 7.00 $ 7.00 $ 7.00 $ 7.00 Case p.3, #9
Endorsement $ 2.00 $ 2.00 $ 2.00 $ 3.00 $ 2.00 $ 2.00 Case p.3, #10
Other advertising and promotion $ 25.0 $ 15.0 $ 10.0 $ 30.0 $ 25.0 $ 15.0 Case p.3, #11
A/R (% of net revenue) 8% 8% 8% 8% 8% 0% Case p.3, #7
Inventory (% of Var Costs) 25% 25% 25% 25% 25% 0% Case p.3, #7
A/P (% of Var Costs) 20% 20% 20% 20% 20% 0% Case p.3, #7
Factory Expansion $ (150.0) Case p.2, #5
Equipment $ (15.0) Case p.3, #6
Freight and Installation $ (5.0) Case p.3, #6
Inventory $ (15.0) Case p.3, #7
A/P $ (5.0) Case p.3, #7
Tax rate 40% Case p.3, #7
Factory MV (Year 6) $ 102.0 Case p.2,3, #5
Equipment MV (Year 6) 3.0 Case p.3, #6
Appendix 4
MACRS Depreciation %: Factory 2.6% 5.0% 4.7% 4.5% 4.3% 4.0% Case p.2,3, #5 MACRS Depreciation %: Equipment 20.0% 32.0% 19.0% 12.0% 11.0% 6.0% Case p.3, #6 BV Factory $ 150.0 $ 146.1 $ 138.6 $ 131.6 $ 124.8 $ 118.4 $ 112.4 Original factory cost-cumulative depreciation BV Equipment $ 20.0 $ 16.0 $ 9.6 $ 5.8 $ 3.4 $ 1.2 $ – Original equipment ship inst cost- depreciation Account receiveable $ 8.2 $ 13.5 $ 12.9 $ 22.1 $ 16.6 $ – 8% of Net Revenue Inventory $ 15.0 $ 14.2 $ 23.2 $ 22.1 $ 38.0 $ 28.5 $ – 25% of Var Costs A/P $ 5.0 $ 11.3 $ 18.6 $ 17.7 $ 30.4 $ 22.8 $ – 20% of Var Costs NWC (CA-CL) $ 10.0 $ 11.1 $ 18.2 $ 17.3 29.722.3 $ – A/R + Inv-A/P Cash impact from NWC changes $ (10.0) $ (1.1) $ (7.1) $ 0.9 $ (12.4) $ 7.4 $ 22.3 2012 2013 2014 2015 2016 2017 2018 Calculation Sneaker Projected Cash Flow Statements ($ millions) Revenues $ 138.0 $ 184.0 $ 161.0 $ 276.0 $ 207.0 $ 103.5 Volume sale x Price/Pair Cannaibalization $ (35.0) $ (15.0) $ – $ – $ – $ – Case p.2, #4 Net Revenues (after cannabilazation) $ 103.0 $ 169.0 $ 161.0 $ 276.0 $ 207.0 $ 103.5 Subtotal Var Costs $ (56.7) $ (93.0) $ (88.6) $ (151.8) $ (113.9) $ (56.9) Var Cost % x Net Revenue SG & A Xpenses $ (7.0) $ (7.0) $ (7.0) $ (7.0) $ (7.0) $ (7.0) Case p.3, #9 Endorsement $ (2.0) $ (2.0) $ (2.0) $ (3.0) $ (2.0) $ (2.0) Case p.3, #10 Other advertising and promotion $ (25.0) $ (15.0) $ (10.0) $ (30.0) $ (25.0) $ (15.0) Case p.3, #11 Factory Depreciation (39 years MACRS) $ (3.9) $ (7.5) $ (7.1) $ (6.8) $ (6.5) $ (6.0) Factory Costs x Depreciation % Equipment Depreciation (5 years MACRS) $ (4.0) $ (6.4) $ (3.8) $ (2.4) $ (2.2) $ (1.2) Equipment, Ship, Ins x Depreciation % EBIT $ 4.4 $ 38.2 $ 42.6 $ 75.1 $ 50.5 $ 15.4 Subtotal Taxes $ (1.8) $ (15.3) $ (17.0) $ (30.0) $ (20.0) $ (6.2) EBIAT $ 2.7 $ 22.9 $ 25.6 $ 45.0 $ 3.0 $ 9.2 Plus Depreciation of Factory $ 3.9 $ 7.5 $ 7.1 $ 6.8 $ 6.5 $ 6.0 44 Plus Depreciation of Equipment $ 4.0 $ 6.4 $ 3.8 $ 2.4 $ 2.2 $ 1.2 45 Change in NWC $ (10.0) $ (1.1) $ (7.1) $ 0.9 $ (12.4) $ 7.4 $ 22.3 Annual Change New Factory $ (150.0) $ 106.1 Equipment , Freight and Installation $ (20.0) $ 1.8 Project Net Cash Flows $ (180.0) $ 9.5 $ 29.7 $ 37.3 $ 41.8 $ 46.4 $ 146.6 Total Cumulative Net Cash Flows $ (180.0) $ (170.5) $ (140.8) $ (103.5) $ (61.7) $ (15.4) $ 131.3 Project Analysis: Assumed Cost of Capital 0.11 Payback 5.10 years Net Present Value $ 13.36 IRR 12.82% Appendix 5
2012 2013 2014 2015 2016 2017 2018 Discount rate
Sneaker 2013 Cash flows $ (180.0) $ 9.5 $ 29.7 $ 37.3 $ 41.8 $ 46.4 $ 146.6 11% Persistence Cash Flows $ (53.0) $ 14.6 $ 22.4 $ 46.7 14% Persistence Cash Flows 2 $ (53.0) $ 14.6 $ 22.4 $ 46.7 Persistence Cash Flows Total $ (53.0) $ 14.6 $ 22.4 $ (6.3) $ 14.6 $ 22.4 $ 46.7 Persistence Replacement Chain NPV $ 14.39 Persistence Equivalent Annual Annuity $ 3.70 Sneaker 2013 Equivalent Annual Annuinity $ 3.16
