Companies can acquire others depending on a number of factors. For instance, Nike can acquire Lululemon with the aim of expanding its business and making significantly high profits. Thetrading pattern of Lululemon is a good indicator that the acquiring company will stand to benefit because it trades at a good valuation in the market. Additionally, Nike is stable and has a high valuation, capable of issuing stock in the bid to buy the company (Lululemon). However, even if Nike has been established as one of the largest apparel design makers, Lululemon is amongst its key competitors, meaning that a purchase will increase its competitive advantage. Buying Lululemon will involve significantly higher costs because the acquiring company has to part with reasonable figures depending on the current market valuations as outlined below.
A summary of performance tests and analysis of Lululemon
Lululemon Athletica abbreviated as LULU recorded a profit increment of 10% to $423.5 million for the first quarter of 2016 as compared to the previous year. However, the companys business is affected by the high dollar value since up to 30% of its market is from outside the U.S. the company was able to expand its sales through e-commerce activities, enabling it to continue with its business of roll out some stores in North America and other countries across the world. The company increased its number of stores by 53 in the first financial quarter of 2016 (1Q16) as compared to that of 2015 (1Q15). Also, 13 Ivivva stores were added, resulting to an increment of the overall square footage to 931,000, representing 21.7% growth. Like its main peers such as Nike and Under Armour, the company is vertically integrated and targets at expanding its footprints stores as a strategy of benefiting from direct sales to the final consumers, thus avoiding intermediaries.
LULUs value in terms of operations
Determining the value of organizations operations, the main factor that should be considered is the operating cash flows. This means that the present value of LULU cash flows will have to be determined in this case. This means that the acquiring company must determine the projected future demand, enabling it to predict the payback period.
Operating free cash flows = EBIT(I-T)+depreciation + CAPEX-D working capital- D any other assets.
In this case, EBIT is the earnings before interest and taxes,
CAPEX is the capital expenditure,
Moreover, D working capital is the working capital changes.
Source, LULU financials
From the figures above, it can be noted that the company has not been doing well in terms of cash flows since there is a decline in the changes in cash and cash equivalents, even if the net income increased between 2015 and 2016.
Weighted average cost of capital (WACC) for LULU.
The WACC represents an average of after tax costs that have been associated with the companys sources of capital. This includes preferred stock, common stock, long-term debt and bonds. Companies have two main sources of financing, equity and debt, and the average costs associated with the acquisition of such funds is referred to as the WACC.
WACC = * Re + * Rd * (1 Tc)
Rd is the cost of debt
Re represents the cost of equity
D=market value of debt
E=market value of equity
D/V = debt financing as a percentage
E/V = equity financing as a percentage
Tc= the charged rate of corporate tax.
According to gurufocus.com, LULUs current weight of equity
E/(E+D) = 7967.720/(7967.720+ 0) and the answer is one.
The weight of debt is D/(E+D), representing
0/(7967.720 +0). Meaning that this value is Zero
From the gurufocus.com, the current cost of equity is 1.775%
While the cost of debt is zero, and the average tax rate of 32.705%
This means that
WACC = 1 * 1.775% +0 * % * (1-32.705%)
Resulting to 1.78% as the current WACC for LULULULUs intrinsic value
The intrinsic value represents a companys actual value and this involves both intangible and tangible variables. This value may differ with the market value in a particular period. The value is determined by applying the following formula.
Calculate the firm's market value.
Determine the firm's book value.
Determine what the parent company will pay for the target acquisition company.
Be sure to include how the target company provides synergies and opportunities to the parent company.
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