A94002/F:Strategic Investment and Financial Decisions

Teaching Plan for 2014-16 Batch

UNIT CONTENT NO.OF

CLASSES

REFERENCES

I Introduction:

Concept of Risk and Uncertainty 1 Financial

Risk analysis in Investment Decisions 1 Management ,

Risk Adjusted Rate of Return and Certainty

Equivalence

2 by

Probability Distribution of Cash Flows 1

Decision Tree Sensitivity Analysis 2

Monte Carlo Approach 1

Investment Decisions under Capital constraints 2

Capital Rationing Vs. Portfolio 1

Portfolio risk and Diversified projects 1

12

II Types of Investments and Disinvestments

Project Abandonment Decisions 1

Evidence of IRR 1 I M Pandey

Multiple IRR 1

Pure, Simple and Mixed Investments 1

Adjusted NPV 2

Impact on Inflation on Capital Budgeting 1

7

III Critical analysis of appraisal techniques

Discounted payback, post payback 2

Surplus life and surplus payback, Bail-out payback 1

Return on Investment 1

Equivalent annual cost 1

Single period constraints, Multi-period capital

constraints and unresolved problem

2 Prasanna

Chnadra

NPV Mean Variance analysis 2

Hertz simulation and hiller approaches 1

Significance of information and data bank in project

selection

1

11

IV Strategic analysis of selected investment decisions

Lease financing 1

Leasing vs operating risk and Borrowing vs procuring 1

Hire Purchase and installment decisions 1

Lease risk management 2

Leasing as a financing decision 2

Advantages of leasing 1

Leasing decision in practice 2

10

V Financing decisions:

Mergers and Acquisitions basic issues 1

Strategy, diversification 1

Theories of mergers 2

Types of mergers 1

Cost of mergers 2

Govt. guidelines for takeover 1 M Y Khan &

Problems on mergers and acquisitions & Cases 5 P K Jain

13

Total Number of Classes: 53

Name of the Faculty: Dr. G. Sabitha

Course Material

Unit I

Short Answer Questions:

1. Define the concept of Risk & Uncertainty

2. What is Decision Tree Analysis

3. What is Investment Decision

4. Types of Investment Decisions

5. What is Capital Rationing

6. What is Certainty Equivalent Approach

Long Answer Questions

1. Explain the Investment Process

2. Explain the Risk Evaluation Approaches?

3. A Company uses Certainty Equivalent Approach in its Evaluation of risky investments.

The company has now to make a choice between two proposals X and Y. the necessary

information‟s is as follows

Year, t

Proposal X Proposal Y

Cash

Flow

Prob Cash Flow Prob

0 (40000) 1.00 (30000) 1.00

1 20000 0.90 15000 0.95

2 18000 0.8 12000 0.8

3 12000 0.8 10000 .75

4 10000 0.6 5000 0.70

4. Suppose there is a project which initial cost of Rs20000 (cost at t=0). Is is expected to

generate net cash flows during the first 3 years with the probability as shown below:

Expected Cash flows

Year I Year II Year III

Probability Net Cash

Flows

Probability Net Cash

Flows

Probability Net Cash

Flows

0.10 6000 0.10 4000 0.10 2000

0.25 8000 0.25 6000 0.25 4000

0.30 10000 0.30 8000 0.30 6000

0.25 12000 0.25 10000 0.25 8000

0.10 14000 0.10 12000 0.10 10000

5. Explain about the Sensitivity Analysis

6. Define Monte Carlo Approach to Simulation. Explain the steps of Monte Carlo

Simulation Approach.

7. Explain the Methods of Capital Rationing.

8. Calculate portfolio return and risk form the following information. The portfolio consists

of equal weights of security X and Y

Rx(%) 12 14 12 16 13

Ry(%) 20 22 25 18 23

Unit II:

Short Answer Questions:

1. What is Disinvestment

2. Extended Yield Method

3. Adjusted NPV

4. Advantages of Modified IRR

5. Project Abandonment Decisions

Long Answer Questions

1. Explain briefly about Lorie Savage Paradox

2. A company wishes to evaluate Project R using the decision rule with a 10 % hurdle rate

Year 0 1 2 3

Cash Flow -100 +50 +80 -10

3. Differentiate between Simple, Pure & Mixed Investment

4. A Project to produce solar heaters requires a Rs.10million investment. It the project is

financed on all equity bases, the after tax cash flows are Rs1.8 million for 10 years. The

cost of unlevered equity for such a solar heater project is 12%. The firm intends to raise

Rs.5 million in debt financing that will be rapid in equal installments in 10 years. The

interest rate on the debt is 8%. Is the project worthwhile.

5. Explain the impact of inflation on Cash Flows

Unit III:

Short Answer Questions:

1. What is investment Appraisal

2. Advantages of Return on investment

3. Equivalent Annual Cost

4. Terminal Value Method

5. Multiple period Capital Constraints

Long Answer Questions

1. Explain the model of Hertz‟s Simulation

2. Project A costs Rs 2 lakhs and project B costs Rs.3 lakhs both have a ten year life. Uniform

cash receipts expected are A Rs. 40,000 p.a. and B Rs.80, 000 p.a. salvage values expected

are Rs. 1,40,000 declining at an annual rate of Rs.20,000 and B Rs 1,60,000 declining at an

annual rate of Rs.40,000

3. A Project cost Ts. 25,000 and has a scrap value of Ts.5000 after 5 years. The net profit

before depreciation and taxes for the five years period are expected to be Rs5000, Rs.6000,

Rs.7000, Rs.8000, Rs.10,000. Calculate the ARR assuming 50% rate of tax and

depreciation on straight line method.

4. Describe briefly on Hiller‟s Approach.

5. Project A and Project B require an investment of Rs.20, 00,000 each the life of both

projects is five years. The information about projected cash inflows and probabilities is

given below.

Project

A

Probability Project

B

Probability

Optimistic 8,00,000 0.4 7,00,000 0.2

Moderate 7,00,000 0.2 7,00,000 0.1

Poor 7,00,000 0.3 7,00,000 0.4

Pessimistic 7,00,000 0.1 7,00,000 0.3

1.0 1.0

You are required to calculate NPV and rank the Projects. The cost of capital of the

company is10% P.a.

Unit IV:

Short Answer Questions

1. What is Lease Financing

2. Operating Risk

3. Hire Purchasing

4. What is Equity in finance

5. Merger and Acquisition

Long Answer Questions:

1. Explain the evaluation of Leasing

2. Tapro Ltd. Can purchase an asset for Rs2500. The asset has a salvage value of Rs.500 at

the end of its life of 5 years. The firm charges depreciation at 16% on the asset value as

the fixed line method. If the asset is purchased, the firm‟s revenues will increase by

Rs1500 per year and will raise its operating expenses and interest by Rs.700 per year.

The company is taxed at 50% and has a cost of capital of 10%

Alternatively the firm can lease the asset for an annual rental of Rs.650. the incremental

revenue will be the same at Rs1500 per year and the increase in firms expected non

depreciation expenses is Rs.600 per year. Evaluate the Proposal.

3. Distinguish between Leasing and Borrowing

4. Explain how mergers and Acquisitions is evaluated in capital budgeting

5. Explain the dividend discount model with an example.

Unit V:

Short Answer Questions

1. What is Financing Decision

2. International Capital Structure

3. Hamada Model of Market Risk

4. Agency Cost

5. Signal Model

Long Answer Questions:

1. Explain the model of Modigliani and Miller Model

2. Explain the various methods of determine the financial structure of subsidiary

3. Explain briefly about the Trade off Models

4. Write about the Miller Model and its Importance

5. Describe briefly about the Signaling model

Unit I :Case on Capital Budgeting

The investment Detective:

The essence of capital budgeting and resource allocation is a search for good investments in

which to place the firm‟s capital. The process can be simple when viewed in purely mechanical

terms, but a number of subtle issues can obscure the best investment choices. The capital-

budgeting analyst, therefore, is necessarily a detective who must winnow bad evidence from

good. Much of the challenge is in knowing what quantitative analysis to generate in the first

place.

Suppose you are a new capital-budgeting analyst for a company considering investments in the

eight projects listed inExhibit 1. The chief financial officer of your company has asked you to

rank the projects and recommend the “four best” that the company should accept.

In this assignment, only the quantitative considerations are relevant. No other project

characteristics are deciding factors in the selection, except that management has determined that

projects 7 and 8 are mutually exclusive.

All the projects require the same initial investment, $2 million. Moreover, all are believed to be

of the same risk class. The firm‟s weighted average cost of capital has neven been estimated. In

the past, analysts have simply assumed that 10% was an appropriate discount rate (although

certain officers of the company have recently asserted that the discount rate should be much

higher.)

To stimulate your analysis, consider the following questions:

1. Can you rank the projects simply by inspecting the cash flows?

2. What criteria might you use to rank the projects? Which quantitative ranking methods are

better? Why?

3. What is the ranking you found by using quantitative methods? Does this ranking differ

from the ranking obtained by simple inspection of the cash flows?

4. What kinds of real investment projects have cash flows similar to those in Exhibit 1?

Project 1 2 3 4 5 6 7 8

Initial investment

($2000) ($2000) ($2000) ($2000) ($2000) ($2000) ($2000) ($2000)

1 $330 $1666 $160 $280 $2200* $1200 ($350)

2 $330 $334* 200 $280 900* (60)

3 $330 $165 350 $280 300 60

4 $330 395 $280 90 350

5 $330 432 $280 70 700

6 $330* 440* $280 1200

7 $1000 442 $280 $2250*

8 444 $280*

9 446 $280

10 448 $280

11 450 $280

12 451 $280

13 451 $280

14 452 $280

15 $10000* ($2000) $280

Sum of cash flow benefits

3310 2165 10000 3561 4200 2200 2560 4150

Excess of cash flow over initial investment

1310 165 8000 1561 2200 200 560 2150

*Year in which Payback was accomplished

Unit II: An Investment Analysis Case Study: Nike

This case is a group project that is due on March 28 just before class begins at 10.30.

Format: Each group will turn in one report (sounds obvious, but might as well make it explicit).

Each report should have a cover page that contains the following – the names of the group

members in alphabetical order and the following summary information on the analysis:

Decision on Expansion: Accept or Reject

Return on capital: % value

NPV: $ value

IRR: % value

And please don‟t title it: “Just do it”.

With its dominance of the athletic shoe and sporting apparel businesses, Nike generated $2.81

billion in operating income on revenues of $20.9 billion in the fiscal year that ended in May

2011. While its stock price has rebounded in the last three years (see Exhibit 1), its sales and

earnings are being affected by increased competition from both established firms (like Reebok

and Adidas) and upstarts (such as Under Armour). Exhibit 2 summarizes Nike‟s income

statement for the last 4 years, and Exhibit 3 summarizes its balance sheet for the last 2 years.

Nike, which currently views itself as operating in the sporting wear (shoes and clothes) segment,

is considering an expansion into the fashion apparel business, producing high-priced casual

clothing for teenagers and young adults. You have been asked to collect the data to make the

assessment and have come back with the following information:

1. You estimate that it will cost Nike $ 2.5 billion to establish a presence in this business. Of this

amount, $ 1 billion will have to be spent right now acquiring land, equipment and other assets

needed for the business. There will be an additional $ 1 billion investment a year from now, and

final investment of $ 0.5 billion at the end of 2 years. The business will be operational at the start

of the third year.

2. Of the initial investment of $ 2.5 billion, $1.5 billion is fully depreciable over 10 years starting

in the third year, and will be depreciated using double-declining 2 balance depreciation

(switching to straight line when it provides a higher depreciation).

3. You have employed a major market-testing organization to do a market study. Their initial

study, which has already been completed and expensed, cost $ 250 million and has provided you

with a sense of the magnitude of this market, and Nike‟s potential in the market. 1

4. The total market for casual apparel is estimated to be $ 75 billion currently, growing at 5% a

year. Nike is expected to gain a 2% market share in the first year that it enters the market (which

is the third year), and to increase its market share by 0.5% a year to reach 5% of the market in

the ninth year.2 Beyond that point, Nike‟s revenues are expected to grow at the same rate as the

overall market. Nike expects to generate 50% of the apparel revenues to come from the United

States, 20% from China, 20% from India and 10% from Brazil.

5. The pre-tax gross profit margins (prior to depreciation, advertising expenses and allocations of

corporate costs) are expected to be 23% of revenues.

6. Nike will allocate 5% of its existing general and administrative costs to the new division.

These costs now total $ 2 billion for the entire firm and are expected to grow 5% a year for the

next 12 years, irrespective of whether Nike enters the apparel business. In addition, it is expected

that Nike will have an increase of $ 50 million in general and administrative costs in year 3 when

the new division starts generating revenues, and that this amount will grow with the new

division‟s revenues after that. The latter cost is directly related to the new divisions and will be

charged to them in addition to the allocated corporate G&A costs.

7. While the new business will need distributional support, it is anticipated that Nike can use

excess capacity in its existing distribution network. The shoe business is currently using 60% of

the distribution capacity, and revenues from that business are growing 5% a year (it will use 63%

next year, 66.3% the year after and so on..). The apparel business will use 10% of the capacity in

year 3 (which is the first year of revenue generation) and its usage will track revenue growth

beyond that point. When Nike runs out of distribution capacity, it will have to pay for an

expansion of the distribution network. This is a major endeavor and will cost a substantial

amount and have to be capitalized. (The current estimate of the cost of expansion is $ 1 billion,

but this cost will grow at the inflation rate.)

8. Nike spent $ 1 billion in advertising expenses in the most recent year and expects these

expenses to grow 4% a year for the next 12 years, if the casual apparel division is not created. If

the casual apparel division is added to the company, total advertising expenses are expected to be

7% higher than they would have been without the apparel division each year from year 3 (the

first year of sales for the division) to year 12.

9. The apparel division will create working capital needs, which you have estimated as follows: •

The sale of apparel on credit to wholesalers and large retailers will create accounts receivable

amounting to 5% of revenues each year. • Inventory (of both raw material and finished goods)

will be approximately 10% of the cost of goods sold (not including depreciation, allocations or

advertising expenses). • The credit offered by suppliers will be 7.5% of the cost of goods sold

(not including depreciation, allocations or advertising expenses). All of these working capital

investments will have to be made at the beginning of each year in which goods are sold. Thus,

the working capital investment for the third year will have to be made at the beginning of the

third year.

10. The beta for Nike is 0.91, calculated using monthly returns over the last 5 years and against

the S&P 500 Index. The details of the beta calculation are included in Exhibit 4. Nike is

currently rated A+, and A+ rated bonds trade at a default spread of 1.0% over the long-term

treasury bond rate. The current stock price for the firm is $ 106.79 and there are 368.94 million

shares outstanding.

11. Nike expects to finance this apparel division using the same mix of debt and equity (in

market value terms) as it is using currently in the rest of its business. Nike‟s interest bearing debt

(short term and long term) has average maturity of 5 years but it has lease commitments for the

future:

Years out Operating lease commitments

Next year 374

Year 2 310

Year 3 253

Year 4 198

Year 5 174

Beyond year 5 535

The lease payment for the most recent financial year was $390 million. 12. Nike‟s effective tax

rate is 24%, but its marginal tax rate is 40%. 13. The current long-term US treasury bond rate is

3%, and the expected inflation rate is 2%. Exhibit 5 includes the equity risk premiums that you

can use, broken down geographically. 14. You have collected information on other apparel

companies that you believe will be the competitors to your apparel division in Exhibit 6. The

data includes the betas of these companies and relevant information on both market value and

operations. You can assume a 40% tax rate for these firms, as well.

Added Clarifications

1. Time: You can assume that the current year has just ended and that now is time 0. Year 1

begins today and the end of year 1 is a year from today.

2. Depreciation: For any assets that you may invest in, where no depreciation schedule is given,

assume straight line depreciation and a reasonable life.

3. Accounting allocations: If you have to allocate any expenses, where an allocation schedule is

not provided, make a reasonable assumption about allocation and move on.

Appendix: How to estimate double declining balance depreciation

Step 1: Estimate the straight line depreciation rate based upon the life of the asset (for example,

with a 10 year life, your depreciation would be 10%)

Step 2: Double the straight line rate. With a 10-year life, you would get 20%.

Step 3: For each year, estimate the double declining balance depreciation DDB Depreciation =

Remaining book value * DDB rate (from step 2) For instance, assume that you have an asset

with depreciable value of $ 5 billion and a 10-year life. The double declining balance

depreciation for the first two years will be: Depreciation in year 1 = $ 5 * 20% = $ 1 billion

Remaining BV = $ 4 billion Depreciation in year 2 = $ 4 * 20% = $0.8 billion Remaining BV =

$3.2 billion

Step 4: Each year, also estimate the straight-line depreciation if you switched in that year… This

would require that your divide the remaining depreciable book value by the remaining life of the

asset each year. Straight line Depreciation in year 1 = Depreciable BV * (1/n) = 5*(1/10) = $0.50

Straight line Depreciation in year 2 = Remaining Depreciable BV * (1/n) = 4*(1/9) = $0.45 Note

that the depreciable book value in year 2 is based upon the BV of $ 4 billion left over and that

the remaining life is reduced to 9 years.

Step 5: Pick the higher of the two numbers. Once you switch to straight line, remain with straight

line for the remaining life of the asset.

Questions on the Project

1. Accounting Return Analysis

Estimate the operating income from the proposed apparel division investment to Nike over

the next 12 years. • Estimate the after-tax return on capital for the operating portion of this

period (Years 3-12) • Based upon the after-tax return on capital, would you accept or reject

this project?

(This will require you to make some assumptions about allocation and expensing. Make your

assumptions as consistent as you can and estimate the return on capital.)

2. Cash Flow Analysis

Estimate the after-tax incremental cash flows from the proposed apparel investment to Nike

over the next 12 years. • If the project is terminated at the end of the 12th year, and both

working capital and investment in other assets can be sold for book value at the end of that

year, estimate the net present value of this project to Nike. Develop a net present value

profile and estimate the internal rate of return for this project. • If the apparel division is

expected to have a life much longer than 12 years, estimate the net present value of this

project, making reasonable assumptions about investments and cash flows after year 12.

Develop a net present value profile and estimate the internal rate of return for this project.

3. Sensitivity Analysis

Estimate the sensitivity of your numbers to changes in at least three of the key

assumptions underlying the analysis (You get to pick what you think are the three key

assumptions).

(Based upon your analysis, and any other considerations you might have, tell me whether

you would accept this project or reject it. Explain, briefly,

UNIT IV: PUBLIC SECTOR COMPANIES WARM UP TO LEASING

Read on to find out how Maharatnas and Navratnas and other PSUs realised substantial savings

& convenience through their fleet outsourcing

Company

Country‟s largest public sectors with offices and plants spread across the nation

Background

• Company hired fleet that included various makes & models of cars used by their Top

Management and Executives.

Challenges in the existing system of hiring of vehicles

• Vehicles registered as Yellow plate commercial vehicles• Additional financial burden of entry

tax while plying interstate

• Vehicle supplied is not uniform; it may change from day to day

• Cars were not maintained as per manufacturer‟s guidelines

• Multiple Vendors

• Multiple revenue leakage areas

• Consumables in vehicles changed based on need and not on manufacturer‟s guideline

• Cars did not stay with users for 24 hours

• Average age of vehicle at start of contract : 2 years

Opportunity

• LeasePlan‟s fleet audit revealed that costs could be brought down significantly besides

providing new vehicles to the PSUs

• Comparative analysis convinced the company of the cost savings through outsourced fleet

management and enhanced comfort and convenience

Roadblocks

• 5 decade old system of hiring prevalent in almost all PSUs

• Handling of chauffeurs independently

Solution

• LeasePlan‟s „Total Cost of Ownership‟ (TCO) model for vehicle outsourcing made sure only

efficient car models are used by the company; thereby reducing costs significantly.

• LeasePlan‟s fixed monthly outflows provided budgeting of transportation expenses for top and

middle level management besides immunity from maintenance and damage risks.

• Executives provided with monthly driver allowance. So, every executive hires his/ her own

driver. • Benefit of individual reporting reaped instead of centralized hiring of drivers.

• Provision of cashless maintenance and insurance facilities even at remote plant locations. This

ensures zero involvement of cash in maintenance of vehicles thus giving convenience to all users

spread across the country.

• Vehicle procurement done centrally as it brings in benefits of price and delivery timelines.

• Choice remains with the users to buy the vehicle at the fair market price on expiry of lease

term.

Result

• Savings! Company hived off their entire fleet to LeasePlan. Cost reduction between 20- 25%

• Better accounting and peace of mind! Outflows have become predictable and under control.

• Increased acceptability of LeasePlan services within the company and other PSUs as well.

• Seamless Mobility

• Employee Satisfaction

Unit V: The Adidas - Reebok Merger

Issues:

» The recent trends and structure facing the sporting goods industry

» The reasons for the ongoing mergers and acquisitions in the industry and its future

» The rationale behind the Adidas and Reebok merger

» Whether the merger will be successful in the long-term

Introduction

On August 03, 2005, Adidas-Salomon AG (Adidas), Germany's largest sporting goods maker

announced acquisition of the US-based Reebok International Limited (Reebok) for $3.8 billion.

The share prices of both the companies recorded an increase on the day of the announcement of

the deal.

The share price of Adidas increased by 7.4% from €147.52 on August 02, 2005 to €158.45 on

August 03, 2005 on the Frankfurt stock exchange, while Reebok's share price at the New York

Stock Exchange rose to $57.14 on August 03, 2005, an increase of 30% over the August 02,

2005 share price of $43.95. The deal would result in the union of two cutthroat competitors

through a "friendly takeover". Adidas and Reebok claimed that the merger was decided upon

because of the realization that their individual (company) goals would be best accomplished by

joining instead of competing. Nike International Inc. (Nike) was the common competitor for both

Reebok and Adidas.

Analysts said that the merging companies were alike in many ways. Both the companies had a

reputation of using cutting-edge technologies to produce innovative products and both had

eminent brand ambassadors from the sports and entertainment worlds.

Thus, the merger would help spreading the global appeal of the brands in places where they had

not made a mark as individual brands. However, some analysts had doubts about the success of

the merger of the companies.

They cited that the merger would not generate much synergy because the individual brand

identities would be maintained even after the merger.

Analysts also doubted the effectiveness of the merger, as a strategy to beat Nike. They felt that

the combined entity would have to work really hard to further expand its market share in the US

market and globally.

Background Note

Adidas

The story of Adidas dates back to the year 1920 when Adolf Dassler (Adi) produced a handmade

shoe fitted with black spikes. On July 01, 1924, Adi and his brother Rudolf Dassler (Rudolf)

started a company under the name "Dassler Brothers OHG".

In 1956, Adi's son Horst Dassler (Horst) promoted Adidas strongly during the Olympic Games at

Melbourne. He also signed a licensing agreement with the Norwegian Shoe factory, located in

Gjovik, Norway.

In 1959, Horst was assigned the job of establishing production facilities in France. A factory in

Schweinfeld, Germany was started in the same year. In 1960, Adidas was the dominant brand at

the Olympic Games held in Rome; 75% of the track and field athletes used Adidas shoes. Adidas

stepped into the production of apparel and balls (soccer balls, basketball balls) in 1961and started

manufacturing track suits in 1962. The company launched its first jogging shoe called, "Achille"

in 1968. The "Trefoil Logo" was introduced in 1972. The essential feature of the logo was three

leaves representing the Olympic spirit, joining the three continental plates...

EXCERPTS

The Sporting Goods Industry

Mergers and Acquisitions (M&As) had become quite common in the sporting goods industry

during the late 1990s and the early 2000s. Adidas acquired the Salomon Group for $1.4 billion in

1997. Nike acquired Converse in 2003 for $305 million, while Reebok acquired The Hockey

Company in 2004 for $330 million. These mergers were prompted by the increasing competition

and growth in the industry.

The US market is the largest market for sporting goods. Experts estimate that the US sporting

goods market will grow at a rate of approximately 8.9% between 2004 and 2008 to reach a value

of $51 billion, forming 47.6% of the world market. It is estimated that 33% of the athletic

footwear purchased by the US consumers is used for sports and fitness activities and bought on

the basis of price, comfortability and fashion. In 2004, 40% of the consumers of sports apparel

lay in the age group 12-24. T-shirts and running shoes were considered as the top selected

categories. In 2004, sports apparel retail sales in the US were worth $38.8 billion - compared

with $37 billion in 2003. Athletic footwear retail sales were $16.4 billion in 2004, compared with

$15.9 billion in 2003...

The Merger

According to the merger deal, Adidas would buy all the outstanding shares of Reebok at $59 per

share in cash. This price represented a premium of 34.2%, as per the closing share price of

$43.95 on August 02, 2005. Adidas proposed to fund the purchase through an arrangement of

debt and equity. The deal price was equal to the latest twelve month sales of Reebok and 11.7

times its EBITDA . Some analysts felt that the deal was priced too high. As Uwe Weinrich, an

analyst at HVB Group remarked, "The price Adidas will pay for Reebok is ambitious." He added

that acquisitions in the sporting goods industry rarely brought in good returns...

The Synergies

Both the companies claimed that their missions were complementary. As Fireman remarked,

"Adidas is a perfect partner for Reebok.

Reebok's mission is to enroll global youth inclining towards the music-and-lifestyle image that it

promotes through sports, music and technology.

This complements Adidas's mission to be the leading sports brand in the world, with a focus on

performance and international presence"...

Integration Issues

Adidas said the companies would grow as a combined entity but would retain separate

management. The companies also ruled out any workforce reductions.

The new entity would continue to have separate headquarters and their individual sales forces.

The companies would also keep most of the distribution centers independent and would have

separate advertising programs for their brands. Hainer said, "The brands will be kept separate

because each brand has a lot of value and it would be stupid to bring them together.

The companies would continue selling products under respective brand names and labels."

Adidas declared that the deal would involve investment in both Adidas and Reebok. These

investments would guide the companies towards effective consolidation.

The Track Ahead

Analysts had varied opinions about the deal. Some analysts felt that Adidas could beat Nike to

become the industry leader. Al Ries said that, "The biggest benefit is that it removes a

competitor. Now, all they need to do is to focus all their efforts on competing with Nike."

However, a few analysts opined that it was impossible to dislodge Nike from its No. 1 position.

Nike was a preferred brand because of its fashion status, colors, and combinations. Although

Adidas was perceived to have good quality products that offered comfort and Reebok was

perceived as a 'cool' brand, Nike was perceived as having both 'hipness' and quality...

Exhibits

Exhibit I: Share Price Movement of Adidas-Salomon AG, August 2005

Exhibit II: The Three Stipes Logo of Adidas

Exhibit III: Product Profile of Adidas-Salomon AG

Exhibit IV: Financial Summary of Adidas

Exhibit V: Financial Summary of Reebok

Exhibit VI: Product profile of Reebok International Limited

Exhibit VII: Corporate Mission of Adidas

Exhibit VIII: Financial Summary of Nike

Exhibit IX: Top Sponsorship Deals of Adidas, Reebok and Nike

Exhibit X: The Swoosh Logo of Nike