Under Armour, Inc. (UA) is a sportswear company engaged in the development, marketing and distribution of branded performance apparel, footwear and accessories for consumers
UA has been exploring a proprietary new fabric technology that offers many advantages over current fabrics to include: waterproof, breathable, low cost and easily recyclable. If successful, the company believes the fabric could be used in a wide range of products to include shoes, shirts, shorts, etc. UA has some concerns about the fabrics durability and is considering bringing it to market in a casual athletic shoe (avoids regular washing that shirt / shorts would have to endure and avoiding specific specifications required of performance footwear). UA has already invested $15 million in research and $5M in test marketing and believes their product will be competitive with product offerings from other companies. You have been approached by the president of the company to analyze the proposed project and make a recommendation on whether UA should launch the initial line of athletic shoes with the new fabric or not.
In the current year 2.5 billion pairs of shoes are expected to be sold in the United States and forecast to grow at 3% per year. Of that total, 15% of the sales are classified as athletic shoes. UA expects its new product to get a 1% share of the athletic shoe market in the first year of sales and that share will grow by 0.5% each year. UA’s first product line is expected to be sold for 5 years, in the 6th year UA plans to transition to a second generation of shoes as well as explore other possibilities for the new fabric. In that 6th year half of the sales are expected to be comprised of the initial product line and the other half comprised of the second generation. Athletic shoe prices currently average $65 / pair and are expected to increase in price by 2% per year. The company is fairly confident in most of its projections, but market share and price are the two items with the most variability.
The variable cost of goods sold is forecast to be $42 / pair at time of product launch and is forecast to decrease by 2% / year as the company gains experience with the manufacturing process. Selling, general and administrative expenses are expected to be 35% of sales.
Prior to launching the new fabric technology, UA will need to spend an additional $70 million on R&D over the next two years (2016 and 2017) to complete development the new fabric technology ($35M each year), $15 million on test marketing and $120M on capital equipment to support the manufacturing process. The equipment purchase and test marketing will be done one year prior to the start of sales. The equipment will be depreciated using the seven year MACRS schedule. The equipment will have a $25 million salvage value after all sales of the initial product line have been completed. Also, the company will need to invest $30 million in inventory prior to the first year of sales. Once sales begin the company will plan to maintain 40 days of accounts receivable, 90 days of inventory and 35 days of accounts payable.
The corporate tax rate is 40%.
To establish a discount rate, please estimate UA’s estimated weighted average cost of capital (WACC). UA hasn’t previously developed its own fabric technology, but Columbia Sportswear (COLM) and VF Corp (VFC) have so please use those two companies to estimate Beta under the pure play (industry) approach.
In your recommendation please include the payback period, NPV, IRR, and MIRR. Also include an analysis to assess potential risk.
In estimating the WACC for UA, be sure to describe the sources of capital the firm uses to finance operations. Include specific assumptions that support the calculations for: cost of debt, cost of equity, market values of debt and equity. To be consistent, please refer to UA’s 2015 10K filing for its financial statements and current capital structure. Please include a definition of WACC and why it is relevant to the firm.
To estimate the weighted average cost of capital you will need to:
 Utilize the Capital Asset Pricing Model to estimate the cost of equity: o Risk Free Rate: The proxy for the Risk Free Rate should be a US Treasury note bond o Beta: To estimate beta you can utilize published betas which can be found at a variety of finance sites to include: Morningstar, Yahoo! Finance, Google Finance and databases available at the PSU Library and / or calculate your own estimate of beta. o Market Risk Premium: Decide on an appropriate approach to estimate the Market Risk Premium and incorporate the necessary assumptions.
 Utilize the after tax yield to maturity of debt for the company to estimate the cost of debt: o A company will often have multiple bonds outstanding at any one time. If so, calculate a weighted average YTM for the bonds outstanding. o A list of bonds outstanding can be found in the company’s 10Q or 10K o The current pricing and YTM on publically traded bonds
Note: if the debt is not publicly traded, the cost of debt may be estimated by:
 Company disclosures in their financial statements and notes, or  Using the default spread methodology, or  Observing the YTM from companies of similar risk
 Financing weights. Calculate the market value of debt and equity. The value of debt plus equity is equal to the overall value of the firm. Based on the values of debt and equity you can calculate the weights of each type financing. For this case, please use the market value weights to estimate the weighted average cost of capital. o The market value of equity is also known as market capitalization and can be determined by finding the current stock price per share and multiplying it by the number of shares outstanding. o The market value of debt can be calculated from the bond site listed above. o Market prices of bonds are often quoted as a percentage of par value. For example, if a bonds current price is 110, it is currently trading at 110% of par. o The book values of debt and equity can be obtained from the company’s balance sheet.
Papers should be between 4-5 pages in length (line spacing between 1 – 1.5) plus any exhibits in an appendix.