Financial Statement Memo (6 hours due)

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Front Page

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Memo

TO: FROM: DATE: SUBJECT: <text follows>

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Table of contents

Appendix 1: Pro Forma FCF Page 4

Appendix 2 : Weighted Average Cost of Capital Page 5

Appendix 3 : Balance Sheets Page 6

Appendix 4 : Income Statements Page 8

Appendix 5 : Statements of Cash Flows Page 10

Appendix 6 : 10K Data Collection Page 11

Appendix 7: Market Return and Beta Page 12

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Pro Format FCF

Value Drivers Sales Growth 4.07%

Directly related to sales

Operating Expenses (excluding depreciation) 89.86%

Operating Current Assets 17.16%

Operating Current Liabilities 14.31%

Capital Expenditures 4.22%

Not directly related to sales

Depreciation Rate 6.09%

Interest Rate on Debt 5.53%

Interest Rate on ST Investments 1.73% <-- 1-year treasury yield (https://www.federalreserve.gov/releases/h15/) Tax Rate 36.34%

Long term growth rate 0.00%

Unlevered Free Cash Flows Jan-20 Jan-21 Jan-22 Jan-23 Jan-24 Jan-25 Jan-26 Jan-27 Jan-28 Jan-29

Sales $17,255,546 $17,958,617 $18,690,334 $19,451,865 $20,244,425 $21,069,276 $21,927,736 $22,821,174 $23,751,014 $24,718,741 Operating Expenses $15,506,519 $16,138,326 $16,795,877 $17,480,219 $18,192,444 $18,933,688 $19,705,135 $20,508,013 $21,343,605 $22,213,242 Depreciation $620,940 $665,274 $711,414 $759,435 $809,412 $861,425 $915,557 $971,895 $1,030,529 $1,091,552

Earnings Before Interest And Taxes $1,128,087 $1,155,017 $1,183,043 $1,212,212 $1,242,569 $1,274,163 $1,307,044 $1,341,265 $1,376,881 $1,413,947 Taxes $409,958 $419,745 $429,930 $440,530 $451,562 $463,044 $474,993 $487,429 $500,372 $513,842

Net Income $718,129 $735,272 $753,114 $771,682 $791,007 $811,120 $832,051 $853,836 $876,509 $900,105 Depreciation $620,940 $665,274 $711,414 $759,435 $809,412 $861,425 $915,557 $971,895 $1,030,529 $1,091,552 Capital Expenditures $727,890 $757,548 $788,414 $820,538 $853,970 $888,765 $924,977 $962,665 $1,001,888 $1,042,710 ONWC $491,595 $511,625 $532,471 $554,166 $576,745 $600,245 $624,701 $650,155 $676,645 $704,215 Change in ONWC -$216,405 $20,030 $20,846 $21,695 $22,579 $23,499 $24,457 $25,453 $26,490 $27,570

Free Cash Flows $827,584 $622,968 $655,268 $688,884 $723,869 $760,280 $798,175 $837,613 $878,659 $921,377 Terminal Value $16,207,764

PV of FCFs $15,011,177 Equity Value $15,131,177

Fair price per share $39.00

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Weighted Average Cost of Capital

Gap WACC calculation

Debt Average value $1,292,833

Cost of debt 5.53%

Proportion of debt in capital structure 16.44%

Equity # Shares outstanding 388,000 <----- Diluted weighted-average number of shares from 10-K Current price per share $16.94 <----- As of 11/3/2019 Market capitalization $6,572,720

Cost of equity 6.11%

Beta 0.68 <----- Beta calculated using 3 years data (se Returns tab) Rf 1.73%

Rm 8.21% <----- Annualized market return from Returns tab Proportion of debt in capital structure 83.56%

WACC 5.68%

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Balance Sheets

Gap Balance Sheets (in $1,000) (in $1,000) PERIOD ENDING Jan-19 Jan-18 Jan-17 Jan-16 Jan-15 Jan-14

Assets

Current Assets

Cash And Cash Equivalents 1,081,000 1,783,000 1,783,000 1,370,000 1,515,000 1,510,000 Short Term Investments 288,000 - - - - - Net Receivables 359,000 282,000 335,000 - - - Inventory 2,131,000 1,997,000 1,830,000 1,873,000 1,889,000 1,928,000 Other Current Assets 392,000 506,000 367,000 742,000 913,000 992,000

Total Current Assets 4,251,000 4,568,000 4,315,000 3,985,000 4,317,000 4,430,000

Long Term Investments - - - Property Plant and Equipment 2,912,000 2,805,000 2,616,000 2,850,000 2,773,000 2,758,000 Goodwill 109,000 109,000 109,000 - - - Intangible Assets 92,000 95,000 95,000 - - - Other Assets 685,000 412,000 475,000 638,000 600,000 661,000

Total Assets 8,049,000 7,989,000 7,610,000 7,473,000 7,690,000 7,849,000

Liabilities

Current Liab ilities

Accounts Payable 1,126,000 1,181,000 1,243,000 2,114,000 2,213,000 2,420,000 Short/Current Long Term Debt - - 65,000 421,000 21,000 25,000 Other Current Liabilities 1,048,000 1,280,000 1,145,000 - - -

Total Current Liabilities 2,174,000 2,461,000 2,453,000 2,535,000 2,234,000 2,445,000

Long Term Debt 1,249,000 1,249,000 1,248,000 1,310,000 1,332,000 1,369,000 Other Liabilities 1,073,000 1,135,000 1,005,000 1,083,000 1,141,000 973,000

Total Liabilities 4,496,000 4,845,000 4,706,000 4,928,000 4,707,000 4,787,000

Stockholders' Equity

Common Stock 19,000 19,000 20,000 20,000 21,000 55,000 Retained Earnings 3,481,000 3,089,000 2,830,000 2,440,000 2,797,000 14,218,000 Treasury Stock - - - (14,245,000) Capital Surplus - - - 2,899,000 Other Stockholder Equity 53,000 36,000 54,000 85,000 165,000 135,000

Total Stockholder Equity 3,553,000 3,144,000 2,904,000 2,545,000 2,983,000 3,062,000

Total L&E 8,049,000 7,989,000 7,610,000 7,473,000 7,690,000 7,849,000

Total LT Debt 1,249,000 1,249,000 1,248,000 1,310,000 1,332,000 1,369,000

Average 1,292,833

Jan-20 Jan-19 Jan-18 Jan-17 Jan-16 Jan-15 Jan-14

Operating Current Assets 2,882,000 2,785,000 2,532,000 2,615,000 2,802,000 2,920,000 Average % of Revenues 17.38% 17.57% 16.32% 16.55% 17.05% 18.08% 17.16%

Trend 17.89%

Operating Current Liabilities 2,174,000 2,461,000 2,388,000 2,114,000 2,213,000 2,420,000 Average % of Revenues 13.11% 15.52% 15.39% 13.38% 13.47% 14.99% 14.31%

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Balance Sheet Analysis

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Income Statements

Gap Income statements (in $1,000) PERIOD ENDING Jan-19 Jan-18 Jan-17 Jan-16 Jan-15 Jan-14

Total Revenue $16,580,000 $15,855,000 $15,516,000 $15,797,000 $16,435,000 $16,148,000 Cost of Revenue $10,258,000 $9,789,000 $9,876,000 $10,077,000 $10,146,000 $9,855,000 Gross Profit $6,322,000 $6,066,000 $5,640,000 $5,720,000 $6,289,000 $6,293,000

Selling General and Administrative $4,960,000 $4,587,000 $4,449,000 $4,196,000 $4,206,000 $4,144,000 Operating Income or Loss $1,362,000 $1,479,000 $1,191,000 $1,524,000 $2,083,000 $2,149,000

Other Income/Expenses $33,000 $19,000 $8,000 $6,000 $5,000 $5,000 Earnings Before Interest And Taxes $1,395,000 $1,498,000 $1,199,000 $1,530,000 $2,088,000 $2,154,000

Interest Expense $73,000 $74,000 $75,000 $59,000 $75,000 $61,000 Income Before Tax $1,322,000 $1,424,000 $1,124,000 $1,471,000 $2,013,000 $2,093,000

Income Tax Expense $319,000 $576,000 $448,000 $551,000 $751,000 $813,000 Net Income $1,003,000 $848,000 $676,000 $920,000 $1,262,000 $1,280,000

Interest on Debt 5.84% 5.93% 5.86% 4.47% 5.55%

Average 5.53%

Tax Rate 24.13% 40.45% 39.86% 37.46% 37.31% 38.84%

Average 36.34%

Revenue Change YoY 4.57% 2.18% -1.78% -3.88% 1.78% Trend (on % change) 4.07%

Operating Expenses (excluding depreciation)

Regression Ys $14,607,000 $13,858,000 $13,786,000 $13,740,000 $13,847,000 $13,524,000 Regression Xs $16,580,000 $15,855,000 $15,516,000 $15,797,000 $16,435,000 $16,148,000

Slope 51.73% Intercept $5,587,662

R2 0.32 Too low value to accept Slope/Intercept as valid value drivers

Operating Expenses (excluding depreciation) $14,607,000 $13,858,000 $13,786,000 $13,740,000 $13,847,000 $13,524,000 % of revenue 88.10% 87.40% 88.85% 86.98% 84.25% 83.75%

Average 86.56% Trend 89.86%

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Income Statement Analysis

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Statements of Cash Flows

Gap statements of Cash flows (in $1,000) PERIOD ENDING Jan-19 Jan-18 Jan-17 Jan-16 Jan-15 Jan-14

Net Income 1,003,000 848,000 676,000 920,000 1,262,000 1,280,000

Operating Activities, Cash Flows Provided By or Used In

Depreciation 578,000 499,000 531,000 527,000 500,000 470,000 Adjustments To Net Income 103,000 195,000 191,000 103,000 118,000 119,000 Changes In Accounts Receivables - - - - - - Changes In Liabilities (78,000) (53,000) 221,000 (83,000) 18,000 73,000 Changes In Inventories (154,000) (142,000) 46,000 (6,000) (9,000) (193,000) Changes In Other Operating Activities (184,000) 33,000 54,000 133,000 240,000 (44,000) Total Cash Flow From Operating Activities 1268000 1,380,000 1,719,000 1,594,000 2,129,000 1,705,000

Investing Activities, Cash Flows Provided By or Used In

Capital Expenditures (705,000) (731,000) (521,000) (726,000) (714,000) (670,000) Investments (287,000) - - - - 50,000 Other Cash flows from Investing Activities (9,000) 63,000 (5,000) (4,000) 118,000 (4,000) Total Cash Flows From Investing Activities -1001000 (668,000) (526,000) (730,000) (596,000) (624,000)

Financing Activities, Cash Flows Provided By or Used In

Dividends Paid (373,000) (361,000) (367,000) (377,000) (383,000) (321,000) Sale Purchase of Stock - (285,000) 29,000 (950,000) (1,089,000) (882,000) Net Borrowings - (67,000) (421,000) 379,000 (21,000) 144,000 Other Cash Flows from Financing Activities (1,000) (18,000) (18,000) (70,000) (52,000) 55,000 Total Cash Flows From Financing Activities (374,000) (731,000) (777,000) (1,018,000) (1,545,000) (1,004,000)

Effect Of Exchange Rate Changes (10,000) 19,000 16,000 (19,000) (21,000) (36,000) Change In Cash and Cash Equivalents (107,000) (19,000) 416,000 (154,000) (12,000) 41,000

Capital Expenditures 4.25% 4.61% 3.36% 4.60% 4.34% 4.15%

Average 4.22%

Dividends Paid 37.19% 42.57% 54.29% 40.98% 30.35% 25.08%

Average 38.41%

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10K Data Collection

Gap 2014 10K - Note 2. Additional Financial Statement Information (p. 48) Gap 2015 10K - Note 2. Additional Financial Statement Information (p. 47) Gap 2019 10K - Note 2. Additional Financial Statement Information (p.51) Gap 2018 10K - Note 2. Additional Financial Statement Information (p.51)

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation and consist of the following:

($ in millions) January 30, January 30, January 30, January 30, January 31, January 31,

2018 2018 2017 2016 2015 2014

Leasehold improvements 3,104 3,140 3,099 3,252 3,220 3,211

Furniture and equipment 2,732 2,623 2,508 2,603 2,560 2,793

Software 1,525 1,703 1,600 1,433 1,349 1,173

Land, buildings, and building improvements 1,123 1,037 1,000 1,019 1,009 1,106

Construction-in-progress 183 264 222 187 167 176

Property and equipment, at cost 8,667 8,767 8,429 8,494 8,305 8,305

Depreciation rate 6.67% 5.69% 6.30% 6.20% 6.02% 5.66% Average useful life (years) 16.4

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Time Series of T-Bills, S&P500, and Gap Inc.

T-Bills S&P500 Gap Inc. Mean 0.22% 0.68% 1.25% Median 0.20% 1.07% 0.58% St. Dev. 0.0019 0.0411 0.1114