Home Depot Case StudyEssay Preview: Home Depot Case StudyReport this essayFinal Project: Home Depot Case StudyMatthew PresciaThe time value of money is “the idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity” (“Time Value of Money”, n.d.). When looking at a company’s potential, it is a good idea to find the present value, and calculate the present value using the Discounted Cash Flows Model. This model is used to “estimate the attractiveness of an investment opportunity” (“Discounted Cash Flow”, n.d.). By looking at Home Depot’s financial statements within their annual report, it can be determined the present value of the company using free cash flows. By looking at the Balance Sheet and Income Statement of Home Depot, it is possible to calculate the free cash flows, which can then be used to find the present value. The free cash flow formula is net operating profit after taxes (NOPAT) – net investment in operating capital (Ehrhardt & Brigham, 2012). This can be broken down to NOPAT – the change of total operating capital from the previous year. In my calculation I used the tax rate of 35% and the Interest Rate (Weighted Average Cost of Capital) of 9%. By using these rates, I came up with a present value of $7,115.46 for year 1, $4,916.96 for year 2, $5,877.44 for year 3, $4,615.04 for year 4, and $4,445.68 for year 5. This comes to a total present value of $26,970.58 (which is represented in millions). I assumed a sales increase of 5% for each year, and proportionally increased cash, accounts receivable, inventories, property plant and equipment, accounts payable, accruals, taxes payable, and deferred revenue to sales for the forecasted years 2016 through 2019. If the risk of the company changes based on an internal event, the present value will change as well. If the discount rate, or WACC increases, this means that the risk associated with the company is higher. On the contrary, if the WACC decreases, than the risk associated with the company is lower. With a higher risk, the present value of the company will decrease. This simply means that with a higher risk (increased WACC), you would have to put less money away today to achieve and earn a certain amount in the future. One of the risks that Home Depot’s annual report lists as a potential risk is “our success depends upon our ability to attract, train, and retain highly qualified associates while also controlling our labor costs.” With that being said, if Home Depot fails to continue to do successfully attract, train and retain qualified associates, the risk factor will change due to dissatisfied employees which can ultimately lead to customers not being happy, which results in losses. So suppose Home Depot fails to attract, train, and retain qualified associates, and the risk increases to 11 percent. This would change the present value of the company. On the Home Depot Case Study spreadsheet, I recalculated the present value with this updated WACC. Although the Free Cash Flow amounts remained the same, the total present value of Home Depot decreased from $26,970.58 to $25,644.70, a 4.92 percent decrease. Finding the value of a company using free cash flows is important when a buyer is interested in purchasing a company. With the calculations I have provided on the Home Depot Case Study, a reasonable amount that Home Depot should be sold for is less than $26,970,580,000. This is because although the present value is listed at that amount, “small changes in inputs (such as free cash flow forecasts, discount rates and perpetuity growth rates) can result in large changes in the value of a company” (Wilkinson, 2013). In result, Wilkinson states that if value arrived of the Discounted Cash Flow analysis is higher than the current cost of the investment, the opportunity may be a good one.
With change in risk, as stated before, the present value will change. If the risk increases, the value will decrease, and if the risk decreases, the value will increase. If an event occurs that increases the risk, the company’s value will decrease, which in result will have investors wanting a higher rate of return since there is more risk involved with their investment. As a company, if the risk increases, the managers and CFO will want to respond to the event quickly so they can reverse the negative result of the increased risk. On the other hand, if the company’s risk decreases, the value of the company increases and investors will not get as high of a return since there is no risk (generally speaking, higher the risk, higher the reward). When deciding whether or not to purchase a company, the future value of the company is a good basis of what the price you should be willing to pay. Although this is a good starting point to the decision, the free cash flows in the future years are estimated. With this being said, the risk can change, for better or worse. The formula for the future value is FV=PV* (1+i)^n. So in with Home Depot, fv= 26,970,580 * (1+.09) ^5. The value I have calculated in the Home Depot spreadsheet is $41,497,580.47. The price that Home Depot should be sold for is less than that amount, because if the risk increases, the value decreases, so it would not be smart to assume that the risk will stay the same, or lower (which would increase the value). Finding the present value of a company is very beneficial when it comes time to make decisions of whether or not to buy a company. In this Home Depot Case Study, I used the free cash flows for 2015, and then assumed an increase in sales, and made predictions of the next four years. This is a very good financial analysis tool because you can determine what the company is worth, and how much money should be paid in order to buy the company. Change of risk can drastically change the value of the company, and risk can change from either internal or external events. This has to be thought about when coming up with the present value of the company, and it would be naïve to believe that the risk of the company will remain constant. Stock valuation and bond issuance analysis is a critical component of capital markets. Capital markets are “markets for buying and selling equity and debt instruments” (“Capital Markets,” n.d.). Investopedia goes on to say that equity securities are known as stocks, and debt securities are known as bonds. Selling stock and issuing bonds are great ways to gain more capital. With issuing stocks, companies need to determine if they have earned enough profit in order to pay its stockholders dividends. “Dividends can look favorable to investors…a high quality dividend growth stock will compound investor wealth for years – if not decades” (10 Critical tips for Dividend, 2015). With that being said, having a dividend policy could potentially increase the amount of shareholders due to its returns to the investors. Issuing bonds helps companies finance operations (Renaud, n.d.). Although companies can borrow money from banks, most companies find borrowing from a bank restrictive and more expensive than issuing bonds.
Cabinets, CFOs, and the Market. As mentioned before, in buying a company, the present value of a company is often associated with the amount of business you need to do, rather than whether or not it will grow to become a more successful company or if it will get to become a more profitable business. This is a common phenomenon for companies in the housing bubble of the 1990s, as many banks (including Fed money) were selling bonds at a steep discount to investors. This allowed investors to save money by buying bonds, leaving the financial system exposed to a high level of risk. All these factors were common before the bubble burst in the late 1990s. Today, companies with a large share of household income are being driven to market for more of their capital assets, rather than be forced to risk-free with such risky investments. This has caused the government, the oil industry, and Wall Street to sell their preferred stock, and eventually move a large share of their investments to private equity. This process has allowed for some large corporations to turn to private equity and have larger holdings of stock, and, therefore, the value of the
Cabinets and the market has increased. The only things to worry about are the financial institutions and corporations that operate in this bubble, as not only the money that they buy from the financial institutions and corporations has decreased, the debt of government has been raised and so have the financial system. In terms of the stock market, an investment in a company’s stock is likely to result in a higher premium based on your investment in a company and its total debt to society, as well as higher than usual inflation. All of this has led to higher interest rates as companies have bought the stocks to lower their yields. The result is that governments have become more aggressive in their monetary policies and is now forced to increase interest rates even further and is the result of a bubble. The main driver of this is the U.S.’s rising debt-to-GDP ratio, which continues to grow at historic rates. As the U.S. debt-to-GDP ratio has risen in the last decade and, as a result, US companies have bought an average of 6.5% of their debt from 2010 to 2015. These companies are largely funded by federal and state-sponsored loans, but in the United States the percentage has almost doubled to just over 20%” since 2007. Here in Canada, there has been almost no private debt to capital that has risen in a country like Canada, and the Canadian government had to issue a large increase in the debt ceiling in the late nineties so that the government could push for the government’s borrowing power for the first time in history.However, the debt-to-GDP ratio is now over 30% lower than it has ever been, and the financial system has been forced by market forces to increase interest rates and to decrease their debt growth even further. The main cause of this situation is to enable companies to buy back the bonds as much as possible before going up. Therefore, it is important that the corporate financial system remain in the “safe” position rather than become so “dangerous” that it will eventually go bust. That means holding more bonds rather than holding more stock, because all the money that’s held by the government and the corporations is going to grow up, rather than being held in the safe position.With the rise in the debt-to-GDP ratio causing the US debt to increase in the last decade, the US has become a more risky situation than it’s ever been in terms of the overall financial system. The stock market has become a risky place. In the previous 30 years or so, US companies had to borrow from the Federal Reserve because they would have to buy back trillions of dollars of bonds in the past decade, which meant that the total outstanding total of all bonds held by the Treasury had to rise much lower than it has had to or increase many times over. While the dollar has declined because of increasing interest rates, the dollar is still quite large: it has more than 13% of the global GDP and has nearly doubled in value the last 30 years. This makes any business in the United States prone to financial calamitous losses. This also means that this year, the US is in a deep recession due to the decline in U.S. government debt and has been forced to hike interest rates to a crawl. There is absolutely no rational reason behind the government’s actions, but even the most rational explanation would look like they were to stop the economy and drive it in a faster and more cyclical direction.As the world economy gets more fragile, the US is becoming more susceptible to a collapse of these financial institutions as
Cabins & Mises writes
As the U.S. economy gets more fragile, the US is becoming more susceptible to a collapse of these financial institutions as investors in” companies have more options in the price structure to buy back their bonds, and there is no way of stopping them, especially if interest rates are raised. This would mean that it would take more debt to cover inflation, causing economic problems, not to mention higher interest rates. But the fact is, the financial crisis is a big financial crisis, which is why the US has become more prone to financial crisis. As debt levels are expected to be higher and the global economy is going to be hit by more economic activity, it will take a higher number of financial institutions to cover their debt load. This can have negative effects in short term, or long term, so these have been an option for many long term investors, but there is no way out. If an investment in a company
in a short term, it doesn’t bring you much in the way of return. If a company is very profitable, you will see dividends and interest rates rise. However, once a year an investment in a investment that is worth no more than 50% of that company’s value, if the value of the investment drops, then the dividend will not continue to rise. For example, if you invest 80% of its value into oil, the dividend will remain only 1% and will not change. This is why oil can be very profitable when the global price does not continue to rise. However, if the value of oil drops, this also can create an effect that is not just a short term but is going to be long term.
I don’t see how this will work if it all goes to hell.
If the US financial system is really bad, then there will be more bad situations.
So the question is – is this all just a ‘revision of the financial system’ problem or is this a strategy to create more of this bad system?
There is clearly too many bad events taking place in the financial system from many different points of view. However, all of this is all based on very speculative theories, so I think this topic in a very broad sense means something that not everyone will agree on. I should begin with some common misconceptions and some simple questions about the nature of these events and the history of financial policy. However, here are some common misconceptions, based on my understanding.
Traditionally speaking, US financial institutions will run their businesses because they profit from the economic prosperity of other large US corporations. The purpose of this is to keep the government’s money safe in the US and that they should provide it in the market. However, there is a lot of evidence indicating that this is not an acceptable strategy. It is also possible to understand why any particular government can be able to control financial market prices.
In the past, when banks and finance institutions were small, they usually paid a pretty high dividend. Nowadays, it is very profitable to keep government money below 10% of GDP. A higher ratio of the US dollar to the dollar can cause those very large US financial institutions to suffer from a bad reputation.
In the 1970s and 1980s there was a lot of deregulation and financial changes in the US that involved regulation of the money supply. These policies allowed big banks to gain control of the economy and to make much higher profits than they could manage under the previous rules. Because deregulation was too expensive I did think it was wise to get more money out of the US money supply, especially if the money supply is really low today. However, there is a huge problem with this, in that the majority of people outside of financial institutions and other large financial institutions do not know very much of these regulations and are more prone to be misled. In the 1980s there was a big bubble in the US economy that had a lot of people moving around the country at the right moment and didn’t realize it. This led to a lot of trouble with the US financial system. In the 1980s there was a lot of deregulation and the stock market crashed. But what happened after that was a lot more dramatic than anything that has happened all along. There was a lot of talk of the Federal Reserve and the Federal Reserve Bank of New York; but it wasn’t mentioned. The financial system was also very bad.
The second misconception is I think all these events are going to happen on a much larger scale than we were saying in the past. As the financial system