I need some help in Finance projects

2

Research term paper Five major sections: l  Company background / introduction l  Competitive strengths l  Financial analysis (focus section) l  Stock valuation analysis l  Investment summary & recommendations

Company Competitive strengths

•  Cost / price leadership •  Differentiated products •  Industry positioning:

•  market share, brand & reputa1on, corporate culture, management track record, etc.

An Economic moat An economic moat is a barrier that protects a firm's margin and profits from competing firms, thus better able to sustain its high margin and profitability.

• An economic moat comes from a firm’s sustainable competitive advantages over similar companies.

Example: • Wal-Mart's buying power, economy scale and distribu1on infrastructure create a wide and sustainable economic moat.

Economic moats

•  A cost advantage •  A size advantage: economic scale •  Intangible assets: patents, brand recognition, government licenses, etc. •  High switching cost •  Network effect: a firm's value increases as number of users increase •  Soft moats: exceptional management, unique corporate culture.

Example: Intel Corporation

Competitive strengths: l  Low cost producer / economy of scale l  Generally superior products l  Dominant market share l  Well capitalized balance sheet l  Manufacturing expertise / vertical integration l  Brand recognition: Intel Inside

Intel: economic moats

Sustainable advantages: l  Dominant market share position

l  well capitalized balance sheet

l  Strong technology and R&D expertise

l  Deep manufacturing knowhow

Financial analysis

•  Sales / growth analysis •  Profitability and margin analysis •  Asset turn over analysis •  Liquidity analysis •  Financial leverage •  ROE analysis (DuPont formula) •  WACC analysis and Enterprise value •  Free cash flow projections

Sales / growth analysis • Sales by business segments and by regions • Historic sales growth rate (last 5 years) • Es1ma1ng growth rate next 5 years based on the historic sales growth

Ra1o analysis •  Profitability and margin analysis:

•  EBIT margin and net margin •  Asset turn over analysis:

•  Total asset turnover •  Inventory turnover

•  Liquidity analysis •  Quick ratio

•  Financial leverage •  Debt/equity ratio •  EBIT/interest coverage

ROE analysis

The DuPont Identity:

•  ROE = Net margin * total asset turnover * equity multiplier

Free cash flow projections

Using the % of sales approach: •  Look up 2015 year sales, EBITDA, taxes, capex and working

capital change •  Estimate sales growth rate for next 3 years; •  estimate growth rates for other income statement items: EBIT,

Taxes, capex and working capital change •  Estimate free cash flows for next 3 years (see FCF forecast template)

WACC analysis • Market value of debt • Market value of equity • Total enterprise value • Cost of debt es1mate • Cost of equity es1mate using CAPM • WACC calcula1on

Financial analysis example: Apple Inc.

Company Compe11ve strengths: 1.  Integrated products and services (one eco-system): hardware, soQware, apps store,

iclouds, Pay, etc 2.  Brand 3.  Customer loyalty 4.  Financial strength and profitability 5.  Ability to leverage current plaWorm: Apple Pay, Watch 6.  Management

Apple Inc.

Compe11ve strategies: 1. Differen1ated products 2. Product quality and innova1ons 3. Integrated offerings: hardware, soQware and services 4. Third party developer contents and apps 5. Company-own distribu1on network: retail stores 6. New products/ services: Pay

Apple: Free cash flow projections

From Yahoo/finance: For FY2015:

•  EBIT: $71.2 b •  D&A: $11.2 b •  Taxes: 19.1 b •  Capex: 11.2 b •  w/capital increase: $4 b

Apple FCF forecast (see template)

17

Free Cash Flow Forecast Template

Appl Inc. (billions of dollars)

2015 2016 2017 2018 Sales $233.7 $252.4 $272.6 $294.4 % increase 8.0%

EBIT 71.2 Depreciation 11.2 EBITDA 82.4 89.8 97.9 106.7

% increase 9.0%

Tax Expenses 19.1 20.8 22.7 24.7 % increase 9.0%

Operating Cash flow 63.3 69.0 75.2 82.0

Capex 11.2 12.0 12.8 13.7 % increase 7.0%

YoY increse in w/capital 4 4.3 4.7 5.0 % increase 8.0%

Levered Free cash flow $48.10 $52.69 $57.72 $63.22 growth rate 9.55% 9.54% 9.53%

Apple: WACC analysis • Market value of debt:

•  use book value of debt at $64.5 b •  Cost of debt: average about 1.5%

• Market value of equity •  Market capitaliza1on at $528 b

• Total enterprise value •  Debt + equity = 64.5 + 528 = $592.5 b •  Debt % = 64.5 / 592.5 = 11% •  Equity % = 528 / 592.5 = 89%

Apple: stock data (from yahoo/finance)

Stock Price: $95 (as of 2/24/2016) •  Current dividend: $2.08 per share •  Beta: 1.35 (will use 1.1) •  Growth rate (next 5-year): 12.7% •  Total shares outstanding: 5.5 billion Stock Market assump1ons: •  Market beta: 1.0 •  Long term risk free rate: 4.5% •  Long term risk premium: 6%

Apple: WACC analysis

Cost of equity es1mate using CAPM: • Re = 4.5% risk free rate + 1.1 beta* 6% risk premium = 11.1%

WACC calcula1on: • WACC = Re * (E%) + Rd *D% (1 – t) •  = 11.1% * 89% + 1.5%*11% (1 -35%) •  = 10%

20

Stock valuation analysis

•  Estimate the stock beta •  Estimate stock discount rate using CAPM •  Estimate dividend growth rate •  stock valuations model:

•  Dividend Growth Model •  Discount Free Cash Flow model

•  Set weighted price target •  Use the investment criteria to make buy /sell decision

Investment buy criteria

To buy a stock: •  Strong competitive strengths •  Strong financial conditions •  Free cash flow generation •  Stock price target from DGM and DCF models:

•  upside potential from current price at least 20%

Apple: stock data (from yahoo/finance)

Stock Price: $95 (as of 2/24/2016) • Current dividend: $2.08 per share • Beta: 1.35 (will use 1.1) •  Growth rate (next 5-year): 12.7% •  Long term growth rate: • Total shares outstanding: 5.5 billion Market assump1ons: • Market beta: 1.0 • Long term risk free rate: 4.5% • Long term risk premium: 6%

Apple: discount rate & growth rate

Apple Beta = 1.1 •  Discount rate using CAPM: k = 4.5% + 1.1 *6% = 11.1%

•  5-year growth rate es1mate: 11.9% (yahoo/finance) •  For my models, I will use 9% 5-year growth rate.

Apple Inc: Perpetual DDM model

•  Current dividend: $2.08 per share •  dividend growth rate: 9% (assump1on) •  Equity discount rate: 11.1%

•  Fair value = $2.08 (1+9%) / (11.1% - 9%) •  = $108

( ) k)g :(Important

gk D

gk g1D

P 100 < −

= −

+× =

Apple: DCF Model

From the DCF spread sheet: • 3-year growth rate: 9.55% • Discount rate: WACC = 10%

• Equity fair value = $133

26

27

Discount free cash flow model

Apple Inc. Date: 2/24/16

assumptions: 3-year growth rate 9.55% discount rate (wacc) 10.0% discount factor 1.10 1.21 1.33

2015 2016 2017 2018 terminal value free cash flow 48.1$ 52.70$ 57.70$ 63.20$ 632.0$ growth rate 9.55% 9.55% 9.55% discount factor 1.10 1.21 1.33 1.33

Present value 47.9$ 47.7$ 47.5$ 474.8$

total firm value per share 617.9$ billions debt 64.5$ cash 180.0$

total equity value 733.4$ shares outstanding 5.5$

equity value per share $133.3

terminal value calculation: using the 10 factor 632.0$

Note: Red numbers indicate required inputs

Apple: Sejng price target

• DDM fair value : $108 • DCF fair value: $133 • Weighted average price target: $120.5

• Current price: $95 • Stock upside poten1al: 26.8%

• Investment recommenda1on: buy

Apple: Investment summary & recommendation Investment summary: •  Strong compe11ve posi1ons with leading market share, integrated products and services (one eco-system), strong brand and customer loyalty

•  Strong financial strength and profitability •  Stock fair value: over 20% upside from current price

Recommenda1on: buy

Team discussions items:

•  What are the company’s competitive strengths? •  How are the company’s financial conditions? •  What are reasonable estimates for company beta and growth

rate and discount rate? •  What is the fair value from the DDM and DCF models? •  Does the price target from the stock valuation models provide

20% upside? •  What’s the investment recommendation based on the buy

criteria?