Sneaker 2013 Case Study Solution
Risk Associated to Each Cash Flow
A detailed capital budgeting analysis has been carried out in order to analyze the risks associated with the expected projects. Firstly, the total inflows and outflows were calculated to project the NPV, IRR and payback period for the projects. After analysis, it has been suggested that the persistence shoe product is riskier than the sneaker project. The initial investment for persistence requires a huge investment,because of outsourcing the technology design of the product, while sneaker requires less investment as compared to persistence shoe. Furthermore, the new balance has a vast experience in the field of sneaker shoes already, but persistence shoe market is new for the company to capture.(See exhibit 3 and 4 for payback period calculations of sneaker and persistence projects respectively).
Another risk associated is the- different life times of the projects. The sneaker shoe project consists of 6-year period, while persistence shoe project consists of 3 years period. The result indicates that the IRR for sneaker shoe is greater than the IRR of persistence shoe. (A Arya, JC Felling ham, 1998)
A major risk associated with the sneaker show project is cannibalization. It means that this project will affect the existing product line of the new balance. In the first two years,the existing product line will decrease by a major margin. If the project will not generate the projected revenues; it will be riskier for the company to carry on with this cannibalization risk. While the persistence shoe project shows a safe side in this respect.(RE Shrieves and JM Wachowicz Jr, 2001)
Qualitative Considerations
The main qualitative aspect associated with the persistence project is that the new balance has no experience in this field along with targeting the new age group segment. While company has a vast experience in the field of sneaker shoe market. Another qualitative concern is the outsourcing in the project. The company will have to outsource the technology design for the persistence shoe project, which would cost the company a whopping amount of 50 million. This could be considered a huge riskier investment for the company. There are many other qualitative concerns present in each project, which the company should address and analyze.
Recommendations
A detailed capital budget analysis has been done in the attached excel file. The results indicate that the IRR of the sneaker shoe is greater than the persistence shoe. The NPV for the sneaker shows a positive amount, while the NPV for the persistence shoe shows a negative amount. This result indicates that the persistence shoe project is more likely to fail in generating profit out of its invested amount, within its termination period. The company could only recover its invested amount in the last year of the project. This project will cause loss to the organization. So, it is strongly recommended to the new balance, not to invest in this project. (See exhibit 1 and 2 for NPV calculations of sneaker and persistence projects respectively).
While on the other hand, the sneaker project shows a recovery of its invested amount with in four and a half year of the project, which will eventually help in generating better revenues for the company. The IRR for the project is 15%, which is greater than its discounted rate i.e.,5%. Also, the project involves less initial investing amount as compared to the persistence project. So, it is recommended to the new balance to invest in this project, because it will generate a remarkable profit to the organization.
Exhibits
Exhibit: 1
| NPV calculation | |||||||
| year 0 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | |
| TOTAL OUTFLOW | |||||||
| FACTORY | (150,000,000) | ||||||
| EQUIPMENT | (20,000,000) | ||||||
| WORKING CAPITAL | 10,000,000 | ||||||
| (160,000,000) | 11,762,750 | 38,388,400 | 36,391,100 | 54,147,600 | 38,925,700 | 113,983,900 | |
| RATE | 5% | ||||||
| IRR | 15% | ||||||
| NPV | 77,561,240 | ||||||
Exhibit: 2
| NPV Calculatins | ||||
| year 0 | 2013 | 2014 | 2015 | |
| TOTAL OUTFLOW | (23,000,000) | (38,090,000) | 23,373,400 | 48,036,060 |
| RATE | 20% | |||
| IRR | 8% | |||
| NPV | (10,711,493.06) | |||
Exhibit: 3
| PAYBACK PERIOD | |||||||
| 0 | 1 | 2 | 3 | 4 | 5 | 6 | |
| (160,000,000) | (148,237,250) | (109,848,850) | (73,457,750) | (19,310,150) | 19,615,550 | 133,599,450 | |
| PAYBACK PERIOD | 4.02 | ||||||
Exhibit: 4
| PAYBACK PERIOD | ||||
| 0 | 1 | 2 | 3 | |
| (23,000,000) | (61,090,000) | (37,716,600) | 10,319,460 | |
| PAYBACK PERIOD | 2.14 | |||
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