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Financial analysis. Weighted average cost of capital, decision making, dividend policy, loan covenants, future projects. Charts. Graphs.... More...
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Paper Abstract:
Financial analysis. Weighted average cost of capital, decision making, dividend policy, loan covenants, future projects. Charts. Graphs.

Paper Introduction:
Introduction Reebok International is a multinational company which designs and markets sports and fitness products, including footwear and apparel, as well as similar products for nonathletic ("casual") use. Reebok has three major business groups: the Reebok Division, which is responsible for the Reebok brand, the Greg Norman Division, responsible for the Greg Norman brand, and the company's major subsidiary, the Rockport Company, responsible for the Rockport brand, as well as footwear sold under the Ralph Lauren brand. The company is listed on the New York Stock Exchange, and competes primarily with Nike in the Reebok division. Like Nike, Reebok is listed on the New York Stock Exchange. Recent Financial Performance As indicated in the a

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[pic] Recent Stock Price The following graph is plotted on a logarithmic scale to illustraterates of change ("NYSE Quotes" n.p.). At this point, the company has severely limited its ability to borrowadditional funds due to the covenants attached to its current capitalstructure. For a company such as Reebok,which has recently repurchased considerable amount of its own stock, thiscan work to its favor since the influence of any one shareholder can bereduced as split shares are sold. Recent Financial Performance As indicated in the attached graph (page 9), Reebok's recent financialperformance has been lackluster. As aresult of these new credit arrangements, Reebok faces significantlyincreased interest expense and debt amortization. Introduction Reebok International is a multinational company which designs andmarkets sports and fitness products, including footwear and apparel, aswell as similar products for non-athletic ("casual") use. The credit arrangementscontain certain covenants (including restrictions on asset acquisitions,capital expenditures and future indebtedness, and the requirement tomaintain a minimum interest coverage ratio) which are intended to limitReebok's future actions and which may also limit Reebok's financial,operating and strategic flexibility and options. This is strongincentive to a company seeking to bolster its dominant market position. Earnings The following chart is plotted on a logarithmic scale to illustraterates of change (Chappell 1672). In addition, Reebok entered into a $75 million revolving credit linewhich replaced its prior $3 million revolving credit facility. This has led to the development of theweighted average cost of capital (WACC) as a way to determine the actualcost of capital to a company with a particular market structure (Ross,Westerfield, & Jordan 317). As a result,stockholders may be confident that they will retain their percentages inthe company, but they may also be driven to seek better returns elsewherein the market. Recommendation Reebok's best course of action at this point is to continue to reduceits debt position (some of its debt will be retired in 1998) before takingon additional projects. In the following WACC calculation, a discount of .95 is assumed forcalculation purposes (these figures are applied to all long-term debt forthe sake of simplicity). Dividend cuts are not undertaken lightlyby companies since they can have a devastating effect on the stock price,and Reebok's stock price has not performed well in recent years. Stoughton, MA: Reebok, 1997.Chappell, Jonathan B. However,the fall in dividends reflects the company's inability to realizesignificant profits on its activities in recent years, and may be perceivedas a prudent move for a company seeking to shore up its market shareagainst Nike. The following chart illustrates key financial ratios for the companyin recent years. If, on the other hand,the project under consideration does not exceed the cost of capital, itshould not be undertaken.|WACC Component |Calculation |Value ||E |44.25*5551 659 |2456346661 ||D |.95*8888 3 |84436285 ||V |E+D |33 7 9511 ||Market Risk Premium |8.5 % | . Sales v. While this strategy may result in the loss of somemarket opportunity, the long-term results are likely to provide a betterfinancial situation for the company. In addition, Reebok'sfailure to make timely payments of interest and principal on its debt, orto comply with the covenants, could result in significant negativeconsequences. A., Westerfield, R. Dividend Policy The company has paid dividends since 1986 (Chappell 1672); however,the company cut its dividend from 3 cents per share to 22.5 cents pershare annually from 1995 to 1996. Reebok has threemajor business groups: the Reebok Division, which is responsible for theReebok brand, the Greg Norman Division, responsible for the Greg Normanbrand, and the company's major subsidiary, the Rockport Company,responsible for the Rockport brand, as well as footwear sold under theRalph Lauren brand. "Reebok, Inc." Value Line Investment Survey (February 21, 1997): 1672.---. 85 ||U.S. This forces the company to consider equity financing as theprimary financial instrument, but the recent stock performance suggeststhat the company may have difficulty in raising equity through this method. The company is listed on the New York Stock Exchange,and competes primarily with Nike in the Reebok division. Thesecalculations lead to a WACC to Reebok of 15.4 percent. [pic]|Date |Price ||2/3/97 |47.75 ||2/4/97 |47.5 ||2/5/97 |47 ||2/6/97 |47.25 ||2/7/97 |47.875 ||2/1 /97 |48.75 ||2/11/97 |48.625 ||2/12/97 |49.25 ||2/13/97 |5 ||2/14/97 |5 ||2/18/97 |51.875 ||2/19/97 |52.625 ||2/2 /97 |51.375 ||2/21/97 |49.875 ||2/24/97 |49.25 ||2/25/97 |49.25 ||2/26/97 |47.75 ||2/27/97 |47 ||2/28/97 |46.75 ||3/3/97 |46 ||3/4/97 |48.75 ||3/5/97 |5 .875 ||3/6/97 |49 ||3/7/97 |5 .125 ||3/1 /97 |49.75 ||3/11/97 |49.875 ||3/12/97 |49.875 ||3/13/97 |49.25 ||3/14/97 |49.75 ||3/17/97 |49.75 ||3/18/97 |49.5 ||3/19/97 |48.875 ||3/2 /97 |48.875 ||3/21/97 |48.375 ||3/24/97 |48 ||3/25/97 |47.875 ||3/26/97 |47.25 ||3/27/97 |46.875 ||3/31/97 |44.875 ||4/1/97 |44.25 | Pro Forma Statements| |Y1 |Y2 |Y3 |Y4 |Y5 ||Sales |14 |17 |22 |22 |22 ||COGS |91 |11 5 |143 |143 |143 ||Gross Profit |49 |595 |77 |77 |77 ||Taxes |18375 |223125 |28875 |28875 |28875 ||Net Profit |3 625 |371875 |48125 |48125 |48125 ||Dividends to parent |153125 |1859375 |24 625 |24 625 |24 625 ||Proceeds of project |153125 |1859375 |24 625 |24 625 |24 625 || | | | | | ||Cash |7 |85 |11 |11 |11 ||Inventories |14 |17 |22 |22 |22 ||Current Assets |21 |255 |33 |33 |33 ||Land |3 |3 |3 |3 |3 ||Building Gross |18 |1764 |172872 |16941456 |166 2627 ||Less: Depreciation |36 |3528 |345744 |338829 |332 53 ||Building Net |1764 |172872 |16941456 |166 2627 |1627 574 ||Equipment Gross |1 |9 |81 |729 |6561 ||Less: Depreciation |1 |9 |81 |729 |6561 ||Equipment Net |9 |81 |729 |6561 |59 49 ||Net Assets |3174 |3 9372 |3 531456 |29463627 |28475474 | ROI Analysis |Sum of Proceeds |1 6 9375 ||Ending Assets |28475474 ||Total Return |39 84849 || | ||Cost of Project |31 || | ||Net Proceeds |8 84849 || | ||ROI |26% | Works Cited1996 1 -K SEC Filing. Thecompany also has several medium term notes, with interest rates rangingbetween 6 percent and 6.75 percent (due in 2 and 1998), and 6.75 percentdebentures due in 2 5; interest on all of these debt instruments ispayable semiannually (1996 1 -K, 37). Actual prices are shown in the charton the next page. Although Reebok has had two stock splitssince 1986 (a three for one split in 1986 and a two for one split in 1987),such an event is unlikely to occur again in the near future. However, one advantage of using debtfinancing over equity financing is that interest payments on debt aredeductible while dividend payments to stockholders are not. Dividends to stockholders,which is one of the ways in which stockholders reap profit (marketappreciation is the other) are not tax deductible, but interest payments tobondholders are deductible. In addition, current shareholders may be reluctant to see their holdingsdiluted through the issuance of additional shares, which could furtherhamper stockholder relations. The overall dividend policy and lack of recent stock splits present animage of a company which is concerned about its stock price and which wantsto court favor with the investment community. Reebok mustmaintain a leveraged position which is in keeping with loan covenants; thedetails of these covenants are not generally known. The formula for WACC is (Ross, Westerfield, & Jordan 317): (E/V) X Re + (D/V) X Rd X (1 - Tc) where E is equity (found by multiplying the number of sharesoutstanding multiplied by the market price); V is value (the combinedmarket value of debt and equity); Re is the cost of equity found using thesecurity market line approach (SML) (risk-free rate X company's beta Xmarket risk premium); D is the market value of the company's debt (found bymultiplying the market price of a bond by the number of bonds outstanding);Rd is the cost of debt (found by trial and error based on the currentselling price of the debt in the market); and Tc is the tax rate for thecorporation (1 - Tc yields the aftertax rate). This indicates that Reebok will have difficulty raisingadditional long-term funds at previous cost levels as investors are likelyto see additional risk which was not previously present.| |1996 |1995 |1994 ||Profitability | | | ||ROE (%) |36.45% |18.41% |25.69% ||ROA (%) |7.78% |9.95% |15.43% ||Liquidity | | | ||Current |2.83 17 941 |3.1 9 6177 |2.645323861 ||Quick |1.776857442 |1.638894 34 |1.4 9881168 ||Leverage | | | ||Debt/Equity |233% |32% |15% ||LT Debt/Equity |224% |28% |13% ||Activity | | | ||Inventory |6.388362637 |5.482494819 |5.251819892 ||Asset |1.9475 5968 |2.1 2 41814 |1.98878179 ||Fixed Asset |18.77363297 |18.129436 9 |19.899653 1 ||Times Interest Earned |5.62581 728 |1 .2838 952 |24.73339388 ||ROI |7.78% |9.95% |15.43% ||Receivable Turnover |61.9599 116 |53.1 876 72 |59.24652742 | Weighted Average Cost of Capital There are two ways that companies can raise capital: selling stock,and issuing bonds. Long-term, this could represent a significantproblem for the company, which has also suffered a loss of market sharerelative to Nike in recent years (Chappell 1666). Stock splits have the potential of diluting overall ownership in acompany, but only to the extent that shares are sold. In this way,shareholders who maintain their positions in a company are able to maintaintheir same percentages, while the total number of shareholders may increaseas others sell off some of their stock. 594 ||Beta |1.3 |1.3 ||Re |(8.5%+5.94%)*1.3 | .18772 ||Rd |8.8 % | . T-Bills |5.94% | . Currently, the bulk of Reebok's debt is in the form of a variable rateterm loan with the final payment due in 2 2 and interest payablequarterly; the outstanding balance at the end of 1996 was $64 , . Sales have remained flat over the pastseveral years, but the company's net profit has actually declined. The weighted average cost of capital can be used as a way to determinethe company's return on investment for a particular project. Equity financing might bepossible, but the company's current equity position precludes this being aviable option since the recent stock price has fallen and the dividend hasbeen cut. Proposed Project The proposed project, with a projected return of 26 percent (see pages11 and 12) represents a favorable opportunity for Reebok, but the company'scurrent capital structure may well prohibit the company's entering intothis project, or any other project, in the immediate future. 88 ||Tc |37.5% | .375 ||E/V | | .74418747 ||D/V | | .25581253 ||1-Tc | | .625 ||WACC |((E/V)*Re)+((D/V)*Rd)*(1-Tc) | .153768561 | Recent Capital Structure Decisions Reebok recently incurred $64 million in additional debt to financethe repurchase of shares; $5 million of this was prepaid in February 1997. Like Nike, Reebokis listed on the New York Stock Exchange. Given that the companyhas indicated an inability to take advantage of some market opportunitiesas a result of these covenants, it must be assumed that debt financing isnot available to engage in the proposed project. The recent acquisition ofsignificant levels of debt may hamper the company's ability to raiseadditional equity through the stock market as investors wait to see whetherthe company can turn around its performance, which may place additionalpressure on the organization to increase its dividends at the earliestpossible time. Thus, if aproject has a projected return on investment which exceeds the company'scost of capital, the investment should be pursued. Essentials of Corporate Finance, Chicago: Irwin, 1996. Stock dilutes the equity in the company; bonds increasethe leveraged position of the organization. The company is in a strong financial position with regardto its liquidity, but its long-term borrowings have increased substantiallyfrom 1995 to 1996. D. "Shoe Industry." Value Line Investment Survey (February 21, 1997): 1666."NYSE Quotes." Wall Street Journal (February 1, 1997 through April 2, 1997): n.p.Ross, S. Thisindicates that the company's cost structure may be inefficient, or that thecompany is unable to manage its resources such that it is able to realize aprofit on its activities. W., & Jordan, B. The recent price, number of shares outstandingand corporate tax rate come from Value Line (as does the beta).

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