91919337 case-home-depot

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PREFACE
After the successful completion of the course named “Investment Analysis” (F-307) of the BBA
program, preparation for the term paper provides us an opportunity to reduce the gap between the
theoretical knowledge & practical experience. To enhance the analytical competence, we were
given the onus to prepare a case study on Home Depot which has undoubtedly put fresh impetus
to our understanding of the Stock markets, interest rates and the growth rate of the company.
We tried to demonstrate the objective of the case analysis which is to illustrate the stock price
valuation breakdowns and the fall of the stock price. Moreover, we attempted to portray an
unbiased analysis and information about the company.

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ACKNOWLEDGEMENT
First, our heartfelt gratitude should go to the Beneficent, the Merciful & Almighty Allah
for giving us the strength and patience to prepare this report within the scheduled time.
We are deeply indebted to our course teacher, Dr. M. Sadiqul Islam, Professor,
Department of Finance, University of Dhaka, for his kind cooperation and valuable
contribution in preparing the report.
We also like to convey our thanks to those who helped us by providing necessary
information regarding the Analysis.
At last, all the members of Group-04 should be acknowledged for their nice & dedicated
service behind the making of the report.

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EXECUTIVE SUMMARY
The purpose of this project paper is to analyze the Home Depot, which was the first to really
commercialize the big-box format back in 1978. Home Depot has grown since then to become
the largest home improvement retailer in the world. The Home Depot is considered one of the
largest retail employers today. With the intensely competitive nature of the home improvement
retail segment, it becomes vital to not only make the exact product available to the customers at
the right price, but having sensitivity to serving what the customer needs will make the
difference in who gains competitive advantages. Although Home Depot has delivered superb
financial results since its inception, over the last six years they have encountered their share of
challenges to include eroding market share to Lowes, and severe organizational discontent from
shareholders, employees as well as customers with a deteriorating housing market. From the in
depth analysis of Home Depot and its primary competitors, it seems that Home Depot is
positioned well to move into the next millennium. Financially, Home Depot is very sound which

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is good considering they will need vast amounts of capital to continue growth. Home Depot also
appears to be realizing investments from IT as well as operational efficiencies provided to them.
They should also be careful not to grow out of control due to imminent market saturation and
overall industry slowdown.
Table of Contents
Executive Summary Page |06
Chapter 01 Background of the Study Page |08
Chapter 02 Introducing Home Depot Inc. Page |11
Chapter 03 Analysis of the Economy Page |14
Chapter 04 Industry Analysis Page |18

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BACKGROUND OF THE STUDY
The Home Depot was formed in 1978 by Bernie Marcus and Arthur Blank in Atlanta, Georgia.
Home Depot virtually revolutionized the do-it-yourself home improvement industry in the
United States almost overnight. The two entrepreneurs opened their stores which were no frills
warehouses. Home Depot has grown so quickly, it has been able to garner significant
concessions in prices from suppliers. Home Depot was considered one of the largest retail
employers that time. With the intensely competitive nature of the home improvement retail
segment, it became vital to not only make the exact product available to the customers at the
right price, but having sensitivity to serving what the customer needs will make the difference in
who gains competitive advantages. Home Depot had also been able to establish and successfully
execute a market saturation strategy coupled with low prices and high service.
It had been reported that prior to the first store opening, Bernard Marcus was “so intent on
creating a warehouse feel that he raced around on a forklift, throwing on the brakes to create skid
marks on the floors”. The co-founders envisioned a huge warehouse store where all products
would be acquired and delivered almost instantaneously from the manufacturer’s production
floor. The hook for the customer was the promise of amazingly low prices, in an environment
where the do-it-yourself customer would be assisted by knowledgeable sales people, who
through their expertise, would instruct motivate and encourage customers towards what was
needed to fix and improve the home environment.
ORIGIN OF THE REPORT
The BBA program under the department of finance offers a course named “INVESTMENT
ANALYSIS” (F-307) which requires every group to submit a report on a specific topic
determined by the course instructor. The report under the headline “Case Analysis on home
Depot, Inc” has been prepared towards this purpose.
Objectives of the Study
The primary objective of this study is the partial fulfillment of the course requirement. The
objectives of this report are as follows:
To familiarize with practical functions of Stock valuation of Home Depot.

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To have an exposure on analysis of Stock and its fall of price.
To relate the rules and regulations with the practical functions of that company.
To present an overview of the financial performance of the company.
To appraise the Performance of it in the stock market over time.
Scope of the Study
Our honorable teacher assigned us the case and work on it. As per requirement we worked on
that case to make a report on Home Depot, Inc. In this report, we work on the data regarding the
financial performance of Home Depot, Inc. Here we create a overview on this sector. We only
clarify the subject matters which is relevant to our report topics assigned by our Course
instructor.

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CHAPTER 02
INTRODUCING HOME DEPOT INC.

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INTRODUCING HOME DEPOT INC.
HOME DEPOT INC.
 An American retailer of home improvement and construction products and services.
 Headquartered in Vinings, just outside Atlanta in unincorporated Cobb County, Georgia,
 Established in 1978 by Bernie Marcus and Arthur Blank, the Home Depot Corporation
opened its first store in Atlanta, becoming the world’s largest home improvement retailer.
 They are now the second largest retailer in the United States, offering different types of
home improvement supplies and building materials products.
 They carry a wide assortment of low-cost products, and offer expert advice and
exceptional customer service.
 As an innovator of the home improvement industry, Home Depot has expanded into
Canada, Mexico, Argentina, Chile, and Puerto Rico.
 Home Depot caters to Do-It-Yourself customers, as well as home improvement,
construction and building maintenance professionals.
 Home Depot’s stock went public in 1981 and is traded in the New York Stock Exchange.
 IN 1988 Fortune magazine viewed Home Depot as “the only company that has
successfully brought off the union of low prices and high service”
 At the end of 1999 it operated 930 stores, almost all of them in the US and Canada.
HISTORY OF HOME DEPOT
 The Home Depot was formed in 1978 by Bernie Marcus and Arthur Blank in Atlanta,
Georgia.
 Home Depot virtually revolutionized the do-it-yourself home improvement industry in the
United States almost overnight.
 The two entrepreneurs opened their stores which were no frills warehouses. Products
varied from well known national brands to propriety Home Depot brands.
 Home Depot held its IPO in 1981 and listed on the New York Stock Exchange three years
later.

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 In 1997, however, Blank succeeded Marcus as CEO of the company, with Marcus
remaining as chairman.
 In 1999 Home Depot acquired a company named Georgia Lighting a specialty lighting
designer, distributor and retailer.
 In 1998 it opened two stores in Chile and on in Pueto Rico
PRODUCTS & SERVICES
 The Home Depot provides various product and services, including:
 Home Improvement Goods
 Rental services
 Installation services
 Appliances
CUSTOMER SEGMENTATION
Home Depot has three distinct customer segments. Since the company’s incorporation, they have
been primarily focused with the Do-It-Yourself (DIY) customers. These customers are non-
professional consumers interested in doing their own home improvement projects. More
recently, Home Depot has also begun to redefine the market in which they operate. This
redefinition has opened up the buy- it-yourself and professional customer segments to Home
Depot. Specifically the buy-it-yourself customer segment are those consumers that like to pick
out the materials being used in their homes, but want a professional to install them. Moreover the
professional customer segment that Home Depot now associates it with is contractors,
electricians, plumbers, landscapers, etc. This group has been able to get Home Depot to offer
products in larger quantities due to their larger scale projects. Recently they have started to serve
heavy industrial sector customers.
.

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CHAPTER 03
ANALYSIS OF THE ECONOMY

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ANALYSIS OF THE ECONOMY
MACROECONOMIC ANALYSIS
The macroeconomic analysis of a company is in the response to the belief that company future
earnings, growth and stock prices are heavily affected by money supply, interest rates, taxing,
government spending and other economic indicators such as consumer expectations,
unemployment, productivity, domestic and foreign legislation, gross domestic product(GDP)
growth and capacity utilization that is output by the firm. Security market also reflects what is
expected to go in the economy, because the value of an investment is determined by its expected
cash flows and its expected required rate of return. Both of these valuation factors are influenced
by the aggregate economic environment.
ECONOMIC ACTIVITY AND HOME DEPOT STOCK PRICES
Stock prices consistently turn before the economy does. On October the company’s stock prices
dropped to $35. The reason behind this was that stock prices reflect expectations of earnings,
dividend and interest rates. As investors of Home Depot securities attempted to estimate their
future variables, their stock price decisions reflect future economic activity not current and past.
As Home Depot announced that their earrings will be lower for the next few quarters and there
was a possibility of slowing economic activity. During the period in which Home Depot had
existed, the home improvement industry in U.S. had grown at an annual rate of about 6 percent
or slightly slower than the U.S. economy as a whole. But in June 2000, with expectation of some
slowing in the economy, Home Depot their nominal growth will be lower over the next several
years. That is why company EPS and subsequently stock price would fall down.
MONETARY POLICY, THE ECONOMY AND STOCK PRICES
Declines in the growth rate of money supply have preceded business contraction while increases
in the growth rate of money supply have consistently preceded economic expansion. The Federal
Reserve controls the money supply through various tools, the most useful of which is open
market operations. Since 1992 the U.S. economy had experienced consistent growth. But June
1999 and May 2000, however, the Federal Reserve had raised interest rates six times- for a total
of 1.75 percentage points- in an effort to slow the economy and softening overall consumer

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demand. To slow down the overall consumer demand Federal Reserve declined the growth rate
money supply, Federal Reserve sold bonds to reduce banks reserves and the money supply. For
the reduced money supply commercial banks got less opportunity give potential investor and
home owners. Reduced money supply reduced the home ownership and discretionary income
and result in weak housing turnover. During the recession of 1990-1991 Home Depot
experienced only a small decline in sales, but at that point it occupied a far smaller share of the
market. As Home Depot market share increased the impact of reduced money supply that is
Federal Reserve step to slow down consumer demand affected the company sales that result in
decline in the stock prices. As Federal Reserve planned to continue it next several there is a
possibility of declining hosing owner ship and discretionary income that will significantly reduce
the EPS, growth and with a low expectations of dividend stock prices will decline as well.
INFLATIO N, INTEREST RATES AND STOCK PRICES, GROWTH, EARNINGS
The relationship between inflation, interest rates and stock prices is not direct and consistent. The
reason is that the cash flows from stocks can change along with inflation and interest rates and
we cannot be certain whether this change in cash flows will augment or offset the change in the
interest rates. Inflation and interest rates had very negative impact on Home Depot stock prices,
growth and earnings. A recent rise of inflation that was result in an increase in interest rates was
caused to decline cash flows because the inflation that caused the rise in interest rates had a
negative impact on earnings. During 1999 and 2000, interest rates increased and that caused
economic decline and sales and earnings to decline. On the other hand a period of inflation
wherein the costs of production increased, but Home Depot was not able to increase prices,
which caused a decline in profit margins. The impact of this set of event was become more
disastrous when stock prices had experienced a significant decline because k increased as g
declined, causing a large increased in the k-g spread. In future Home Depot can make the
scenario with an increase in prices of its products for additional cost due to inflation. In this case,
stock prices might be fairly stable because negative effect of an increase in the required rate of
return (k) is partially or wholly offset by the increase in the growth rate of earnings and
dividends(g), which means that the return on stock increase in line with the rate of inflation.

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OTHER ECONOMIC INDICATO RS AND ITS POTENTIAL IMPACT ON HOME
DEPOT’S GROWTH & PROFIT
Home Depot currently has limited scale foreign operation but company’s plan to increase its
international operation could be seriously affected by foreign country economic framework as
well as potential currency exchange risk. Future unemployment problems can decrease as well as
increase the company’s overall growth rates.
Productivity of labor can also be a good example potential growth or decline. GDP can play a
significant role in future growth and earnings.
Future growth and prospect will also be increased if Home Depot able to utilize its full capacity.

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CHAPTER 04
INDUSTRY ANALYSIS

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INDUSTRY ANALYSIS
The industry to which Home Depot Inc. belongs to expects the following growth rates over the
years 2000 to 2004:
Year Projected Growth in the US Market for Home Improvement Products
2000 6.3%
2001 3.2%
2002 4.0%
2003 4.4%
2004 4.6%
The US retail industry for home improvement products show a cyclical pattern as the stock
prices were low throughout the year 2000 whose primary reason is considered to be the slowing
US economy. It means the retail industry for home improvement products moves with or follows
the economic trend of the US economy resulting in the cyclical pattern of the industry.
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
2000 2001 2002 2003 2004
Projected Growth in the US
Market for Home
Improvement Products
Projected Growth
in the US Market
for Home
Improvement
Products

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INDUSTRY ANALYSIS OF HOME DEPOT INC. IN THE PORTER’S FIVE
FORCES FRAMEWORK:
Porter’s Five Forces model can be used as a tool to analyze the industry of Home Depot, Inc.
Five Forces Analysis assumes that there are five important forces that determine competitive
power in a business situation. These are:
 The Threat of The Entry of New Competitors
 The Intensity of Competitive Rivalry
 The Threat of Substitute Products or Services
 The Bargaining Power of Customers (Buyers)
 The Bargaining Power of Suppliers
These forces are used to analyze the US retail home improvement products industry:
THE THREAT OF THE ENTRY OF NEW COMPETITORS
Home Depot Inc. the largest retailer of home improvement products in the United States
possesses almost 24 percent of the total market share of home improvements product. Home
Depot operated 930 stores spread over United States and Canada and has plans to reach the target
of having over1900 stores by the end of 2003. Recent data suggests that the recently opened
stores were in the existing markets to increase customer service levels and enhance long term
market penetration. Home Depot’s principal competitor Lowe’s had 576 stores at the end of
1999 and planned to add 78 new ones in 2000 in the existing market. So the competition in the
home improvements products’ market was high. In this situation it is quite difficult for a new
entrant to capture the market. A new entrant must have extremely strong competitive advantage
to penetrate the market to which Home Depot belonged. So, for Home Depot Inc. threat of the
entry of new competitors was fairly low.
THE INTENSITY OF COMPETITIVE RIVALRY
The competition that Home Depot Inc. faces is quite intense. Lowe’s is considered to be the
principal competitor of Home Depot Inc. having $16 billion as annual sales. At the end of 1999
Lowe’s was operating 576 stores and had plans to open 78 new ones in 2000. Lowe’s is the

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second largest home improvement retailer in the world just behind Home Depot Inc. Lowe’s
copied Home Depot’s business model and made its stores more attractive to the customers.
Lowe’s also sold many products which Home Depot was not offering. In certain markets Lowe’s
was competing neck to neck with Home Depot and opened a few stores within the virtual eye
sight of Home Depot’s stores creating much difficulty for them to sell their products.
Menards and HomeBase a firm that was more focused geographically was considered to be the
next largest competitor of Home Depot although it was a far smaller company. Menards and
HomeBase had a loyal customer base that allowed it to have 35% of the market share of the
home improvement products whereas Home Depot had only 15% in certain areas in the year
1998.
Although Home Depot is the market leader in terms of having the competitive advantage of
implementing a successful business model, its competitors follow them quickly eliminating its
competitive edge over its competitors. It indicates an intense competitive rivalry in the US retail
home improvement products’ industry. Home Depot Inc. has less bargaining power over its
competitors as it was facing a tough fight from its competitors.
THE THREAT OF SUBSTITUTE PRODUCTS OR SERVICES
Home Depot provides its customers with best quality products at a relatively competitive price.
Home Depot’s core products are home improvement products. As long as there are homes,
improvements will be needed. Substitute of home improvement products can be if people stop
improving their homes and start purchasing new homes instead. But this is a very rare
possibility. For Home Depot Inc. the threat of substitution is not a huge factor.
THE BARGAINING POWER OF CUSTOMERS (BUYERS)
Customers had a huge role in the products that Home Depot offered. Every time Home Depot
wanted to introduce a new product or service, it was done as an experiment to check the reaction
of the customers. Home Depot’s main concern was always the customer needs. Starting from the
products they designed to the store format was decided on the basis of customer needs and
reaction to experiments. To serve the customer needs it changed its strategy of serving only
nonprofessionals to a triple customer strategy which included installation services and serving
professionals as well as nonprofessionals. To mitigate the need of the customers it also plans to

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introduce Internet Sales. So, the customers have a great impact on the operating style and
decisions of Home Depot Inc. Home Depot planned to expand its business in the same market
and for this reason the customer group concentration was limited within that market. It enabled
the customers to have more impact on Home Depot’s activities. The customers’ bargaining
power is higher.
THE BARGAINING POWER OF SUPPLIERS
Home Depot is the largest retailer of home improvement products and possesses a huge portion
of total market share. As such suppliers of Home Depot largely depend on them. To be more
efficient, Home Depot acquired two firms of its suppliers. To provide Installation services Home
Depot arranged for approximately 6,200 third party contracts for which it collected fees. So,
Home Depot has a greater bargaining power over its suppliers.
The next section summarizes the US retail home improvement products industry to which Home
Depot belong, in the Porter’s Five Forces Framework.

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US RETAIL HOME IMPROVEMENT PRODUCTS INDUSTRY IN
THE PORTER’S FIVE FORCES FRAMEWORK:
This graphical illustration indicates that competitive rivalry and customers’ bargaining power
pose grave threat to the industry, while other three factors pose less threat to this industry.
US Retail
Industry for
Home
Improvement
Products
Less Threat of
The Entry of
New
Competitors
HighIntensity
of
Competitive
Rivalry
Less Threat
of Substitute
Products or
Services
High
Bargaining
Power of
Customers
Less
Bargaining
Power of
Suppliers

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CHAPTER 05
COMPANY ANALYSIS

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COMPANY ANALYSIS
SWOT ANALYSIS
Analysis of a company includes the analysis of the company’s internal and external factors. To
analyze these factors SWOT analysis is used. SWOT Analysis of Home Depot Inc. illustrates the
strengths, weaknesses, opportunities and threats of the company.
SWOT ANALYSIS OF HOME DEPOT INC.
STRENGTHS
The Home Depot brand name itself is a significant strength.
 Home Depot controls approximately 20% of the home improvement market.
 Customer Satisfaction
 Innovation
 Financial Stability
 Economies of Scale
 Leadership
 Stable Cash Flow
WEAKNESSES
 Stores are not geared toward attracting female customers, who make most
 Household buying decisions
 Declining stock prices
 Rising costs
OPPORTUNITIES
 Untapped heavy industrial sector
 North American growth potential
 Service sector

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THREATS
 Slowing economy
 High interest rates
 Potential lower industry growth rate
GRAPHICAL ILLUSTRATION OF SWOT ANALYSIS
Strengths
Brand name
Innovation
Leadership
Stable cashflows
Economics of scale
Customer satisfaction
Weaknesses
Inattractive Stores
Declining stock prices
Increased costs
Opportunities
Untapped heavy industrial
sectors
North American growth potential
Huge service sectors
International Expansion
Threats
Economic Slowdown
High Interest Rates
High Competition
SWOT
ANALYSIS

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ESTIMATING GROWTH
COMPANY GROWTH RATE
DIVIDEND GROWTH RATE
Let assume, D0= $139 million dividend in 1998 and D2=$ 255 million dividend in 2000. By
using the formula we get the average dividend growth rate is 35.44%.
√
255
139
2
− 1 = 0.3544491
IMPACT OF THE GROWTH INITIATIVE ON COMPANY’S GROWTH RATE
CUSTOMER GROUPS:
 Buy-it-Yourself Customers:
Key points of this customer group are summarized below:
 These people choose Products but Installed by Third-Party
 6,200 third-party contractors is arranged by the company
 Aging demographics creating opportunity for market expansion.
 Market for installation services estimated at $75 billion.
 Less than 2% of the installation market.
Dividend per
share
Earnings
per share
Dividend
payout
ratio
Retention
ratio
ROE Growth
(1) (2) (3)=(1)/(2) (4)=1-(3) (5) (6)=(4)*(5)
1999 0.1088 1.00 0.1088 0.891119 .265 0.236146
1998 0.0724 0.71 0.1019 0.898009 .227 0.203848
1997 0.0607 0.52 0.1168 0.883119 .195 0.172208

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 Expected to grow by 40% each year for the next five years.
The initiative of increasing number of services offered to the buy it yourself customers will be
having positive impact of growth rate. As the market size for installation services is large and
this customer segment is less exposed to cyclical changes, it will definitely have a positive
impact on growth rate.
 Professional Customers:
 Large Market potential
 ‘Job Lot’ quantities
 Different needs for different customers
 Effect of professional customers on DIY
 Anticipated to influence sales the most out of all of the initiatives
 More cyclical then DIY business
Expanding market share for professional customers unveiled another opportunity for the
company. This market emerges as the most profitable and largest market. Unique strategy is
needed to capture this market and cyclical characteristics will set challenges before the company.
Nevertheless this market segment will have positive impact on the company growth rate.
STORE FORMATS
 Extending into specialty shops
 Very high end product range
 Required retainer fee
 Sales goal for each customer ($10,000)
 Investigating smaller stores to compete more directly with Home Hardware etc.

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The store format home depot Inc is experimenting do not fully compatible with current business
plan and strategy. Two focused customer group cannot be well served with such store formats.
Maintenance cost of Expo design center stores will be higher than others warehouse stores.
Again economy is supposed to be slowdown. It will lead the customers choosing products which
costing lower. On the other hand direct competitions can slower the sales potentiality of the
small stores.
PRODUCT CATEGORIES
 Increasing product lines
 Adding appliances to complement current offerings
 Vertically integrate supply chain
 Tool rentals and truck rentals
Expansion of rental services and current offering of appliances definitely make the Home depot
Inc an affectionate destination for shopping having positive effect on firm’s growth rate.
INTERNATIO NAL GROWTH
 Expansion into South America
 Joint venture in Chile
 Looking into expansion into the Far East
Entering into international market will make the firm more exposed to the exchange rate risk.
Again differences in culture and customer needs will create more difficulties in managing
venture and create a strong position in market.
INTERNE T SALES

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 Information centre for customers
 Adding e-commerce abilities
 Intended to complement brick stores
Extending business operations through internet will dignify the corporate image and facilitate
customers with pre shopping information. Along with raising operational cost it will have a
positive impact on the growth rate.
SALES FORECAST AND NOPAT GROWTH RATE
Year Sales Sales growth NOPAT NOPAT growth
2000 42563.45 0.262369 2511.111 0.429385
2001 48392 0.136938 2918 0.162035
2002 54220.56 0.120445 3324.889 0.139441
2003 60049.11 0.107497 3731.778 0.122377
2004 65877.67 0.097063 4138.667 0.109034
2005 71706.23 0.088475 4545.555 0.098314
2006 77534.78 0.081284 4952.444 0.089514
2007 83363.34 0.075173 5359.333 0.082159
To forecast sales and NOPAT we use double moving average technique. By analyzing data we
can conclude that there is a possibility of declining growth rate of earnings in future. Again, we
can say that this is the state of the firm which induced the firm to take growth initiatives to
increase its company growth rate. Considering the initiative taken by the firm we expect the firm
will be enabling to achieve a greater growth rate then our forecasted value. So, here we are
considering these values as the minimum rate which can be attained by the firm even without any
growth initiatives.

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SUMMARY OF THE OBSERVATION
Growth initiatives Impact on earnings
growth
Impact on stock price
Customer groups + +
Store Formats - -
Product Categories + +
International Growth + +
Internet Sales + +
Growth rate
Average dividend growth rate 35.44%
Simple Annual sales growth rate 32.45%
Simple Average NOPAT growth 40.53%
Current company growth rate 23.61%
Growth range for year 2000 23.61% to 35.44% and declining there
after
ESTIMATED GROWTH RATE
After considering all the facts mentioned, we are expecting a moderate earnings growth rate over
the next few years because of a slow economy. Again we assume that effect of competitive
advantages and the growth initiatives will be sustaining for a definite time period. As a result in
absence of any new strategy growth rate will be declining in later years. For our valuation
purpose we assume that the growth will remain unchanged for the years afterward.

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Year Growth rate (%)
Normal Optimistic Pessimistic
2001 24 25 22
2002 24 25 22
2003 24 25 22
2004 24 25 21
2005 24 24 21
2006 23 24 19
2007 22 24 18
2008 21 23 17
2009 18 20 16
2010 16.5 17 16
ASSUMPTI ONS
OPTIMISTIC
Affirmation Negation
 Favorable industry growth because of Low
interest rate, strong housing turnover, rising
home ownership and increases in discretionary
income.
 Continued growth with Do It Yourself Business
 Successful expansion of stores and product
categories will lead toward a high sales volume.
 40% growth in Buy It Yourself Customers.
 Growth with Professional Customers with high
margin.
 Rise in Federal Reserve interest rate.
 Slowdown in economy and squeeze
in consumer spending.
 High competition.

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As interest rate on mortgage loan is low, it is creating a favorable market condition for Home
Depot. We are also expecting a rise in growth rate in later years. As both the average dividend
and NOPAT growth is higher, it implies having a high growth rate potentiality in future. Again,
company is planning to add new stores. Market of home depot products is growing too. This
favoring external situation will help to implement their growth strategies more accurately. When
starting phase of the growth initiatives lead the growth rate rising, expansion of these strategy
and their ending result must be ameliorating. The company will be able to expand market share
and capture more and more customers. All these fact will lead earning growth rate raising later
future.
MOST LIKELY
 Slow economy will slow down the
company growth rate, less so with
Professional customers.
 Some success with in Buy it Yourself
Customers.
 Extension of products, services, and
stores- allows some growth with the Do
it Yourself Customers.
 Difficult to manage.
 High probability of reduction in
employee quality and customer
satisfaction.
 Higher cost of capital due to rise in
interest rate.
PESSIMISTIC
 Some continued growth with Do It Yourself
Business via store expansions & bundling.
 Moderate success in Buy it Yourself
Customers.
 Difficult to cross over with the Professional
Customer base.
 Sustaining competitive
advantage due to differentiation
strategy.

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As a growth company, home depot will keep growing in future. It is following differentiation
strategy, which enables it to maintain its strong position in market. But as the economy will be in
squeezed position over next few years, company will be unable to attain a higher growth rate.
And later competitors will imitate their strategy lowering their market share. Considering this
fact the growth rate will be even lower in future.
PROBABILITY OF OUTCOMES
Considering all possible situation we assigned the following weights to the possible outcomes.
Optimistic .3
Most likely .6
Pessimistic .1
RATE OF RETURN
Risk free rate of return(RFR) 6.18% (yields on 90 day treasury securities)
Home Depot’s beta(β) 1.09
Market return(Rm) 16.39% GM of last 9 year S&P 500 return on
stock
CAPM MODEL
Using this model we got the following estimations:
Market Risk premium 10.21% (Rm- RFR)
Risk premium 11.13% β (Rm- RFR)
Expected rate of return(k) 17.31% RFR + β (Rm- RFR)
E(R) = RFR + β (Rm- RFR)

32 | P a g e
ASSIGNING WEIGHTS
WACC
Cost of equity (Ke) 17.31%
Cost of debt (Kd) 4.8% mortgage interest rate in fall after tax
Weight (We) .92
Weight (Wd) .08 (long term debt + capital lease)
Tax 40%
WACC 16.31

34 | P a g e
PRESENT VALUE OF DIVIDENDS MODEL (DDM)
Applying the DDM model with the values of g, k and D estimated in previous section, here we
estimate the stock price of stock price of Home Depot for year 2000. dividend in year 1999 is
considered as D0.
MOST LIKELY OUT COMES
Here, D0 = $0.1089, k= 17.31%, and the estimated most likely growth rates are considered as
values for g.
Year D g Dividend per share Present value factor17.31% Present value
2001 1 0.24 0.133947 0.852442 0.114182
2002 2 0.24 0.166094 0.726658 0.120694
2003 3 0.24 0.205957 0.619434 0.127577
2004 4 0.24 0.255387 0.528032 0.134852
2005 5 0.24 0.316679 0.450116 0.142543
2006 6 0.23 0.389516 0.383698 0.149456
2007 7 0.22 0.475209 0.327081 0.155432
2008 8 0.21 0.575003 0.278817 0.160321
2009 9 0.18 0.678503 0.237676 0.161264
2010 10 0.165 0.790457 0.202605 0.16015
Constant growth period value =
0.790457 ∗(1.165)
0.1731 −0.165
= $22.9351
1. Present value of dividends
$1.426470012
2. Present value of constant growth period dividends
$22.9351
Total present value of dividends
$24.36157

35 | P a g e
OPTIMISTIC OUTCOMES
Here, D0 = $0.1089, k= 17.31%, and the estimated optimistic growth rates are considered as
values for g.
2001 1 0.25 0.136125 0.852442 0.116039
2002 2 0.25 0.170156 0.726658 0.123645
2003 3 0.25 0.212695 0.619434 0.131751
2004 4 0.25 0.265869 0.528032 0.140387
2005 5 0.24 0.329678 0.450116 0.148393
2006 6 0.24 0.4088 0.383698 0.156856
2007 7 0.24 0.506912 0.327081 0.165801
2008 8 0.23 0.623502 0.278817 0.173843
2009 9 0.2 0.748203 0.237676 0.17783
2010 10 0.17 0.875397 0.202605 0.17736
0.875397∗(1.17)
0.1731−0.17
= $ 66.93897
1. Present value of dividends
$1.511905
2. Present value of constant growth period dividends
$66.93897
Total present value of dividends
$68.45088

36 | P a g e
PESSIMISTIC OUTCOME
Here, D0 = $0.1089, k= 17.31%, and the estimated pessimistic growth rates are considered as
values for g.
2001 1 0.22 0.132858 0.852442 0.113254
2002 2 0.22 0.162087 0.726658 0.117782
2003 3 0.22 0.197746 0.619434 0.12249
2004 4 0.21 0.239272 0.528032 0.126343
2005 5 0.21 0.28952 0.450116 0.130318
2006 6 0.19 0.344528 0.383698 0.132195
2007 7 0.18 0.406544 0.327081 0.132973
2008 8 0.17 0.475656 0.278817 0.132621
2009 9 0.16 0.551761 0.237676 0.13114
2010 10 0.16 0.640043 0.202605 0.129676
0.640043∗(1.16)
0.1731−0.16
= $ 11.48273
1. Present value of dividends $1.268791
2. Present value of constant growth period dividends $11.48273
Total present value of dividends $12.75152

37 | P a g e
EXPECTED SHARE PRICE
Outcomes Probability Share Price
Most Likely 0.6 24.36157 14.61694
Optimistic 0.3 68.45088 20.53526
Pessimistic 0.1 11.48273 1.148273
Expected Share Price 36.30047
PRESENT VALUE OF FREE CASH FLOW TO EQUITY
This techniques attempts to determine the free cash flow that is available to the stock holders
after payments to all other capital suppliers and after providing for the continued growth of the
firm. Definition of free cash flow to equity (FCFE) is:
Value =
𝐹𝐶𝐹𝐸
𝑘−𝑔
Here, we applied the formula assuming super normal growth rates estimated earlier. FCFE in
period 2000 was $ 409 million. So, stock price = present value of cash flows/numberof shares.
MOST LIKELY OUT COMES
Here, FCFE0 = $409 million, k= 17.31%, and the estimated most likely growth rates are
considered as values for g.
Year Period Growth rate FCFE Present value factor17.31% Present value
2001 1 0.24 507.16 0.852442 432.3246
2002 2 0.24 628.8784 0.726658 456.9794
Net income + Depreciation expense - capital expenditure e- change in
working capital - principal debt payments + new debt issues

38 | P a g e
2003 3 0.24 779.8092 0.619434 483.0402
2004 4 0.24 966.9634 0.528032 510.5872
2005 5 0.24 1199.035 0.450116 539.7051
2006 6 0.23 1474.813 0.383698 565.883
2007 7 0.22 1799.271 0.327081 588.5067
2008 8 0.21 2177.118 0.278817 607.0183
2009 9 0.18 2569 0.237676 610.5887
2010 10 0.165 2992.885 0.202605 606.3727
2992.885∗(1.165)
0.1731−0.165
= $ 87212.86 million
OPTIMISTIC OUTCOMES
Here, FCFE0 = $409 million, k= 17.31%, and the estimated optimistic growth rates are
2001 1 0.25 511.25 0.852442 435.8111
2002 2 0.25 639.0625 0.726658 464.3797
2003 3 0.25 798.8281 0.619434 494.8211
1. Present value of cash flows $ 5401.006 million
2. Present value of constant growth period cash flows $ 87212.86 million
Total present value of cash flows $ 92613.86763
million
Stock price $ 39.54478

39 | P a g e
2004 4 0.25 998.5352 0.528032 527.2581
2005 5 0.24 1238.184 0.450116 557.3267
2006 6 0.24 1535.348 0.383698 589.1102
2007 7 0.24 1903.831 0.327081 622.7062
2008 8 0.23 2341.712 0.278817 652.9099
2009 9 0.2 2810.055 0.237676 667.8816
2010 10 0.17 3287.764 0.202605 666.1166
3287.764∗(1.17)
0.1731−0.17
= $ 251405.3 million
PESSIMISTIC OUTCOME
Here, FCFE0 = $409 million, k= 17.31%, and the estimated pessimistic growth rates are
2001 1 0.22 498.98 0.852442 425.3516
2002 2 0.22 608.7556 0.726658 442.357
2003 3 0.22 742.6818 0.619434 460.0422
2004 4 0.21 898.645 0.528032 474.5129
2005 5 0.21 1087.36 0.450116 489.4388
Total present value of cash flows $ 257083.6 million

40 | P a g e
2006 6 0.19 1293.959 0.383698 496.4898
2007 7 0.18 1526.872 0.327081 499.41
2008 8 0.17 1786.44 0.278817 498.0903
2009 9 0.16 2072.27 0.237676 492.5281
2010 10 0.16 2403.833 0.202605 487.0281
2403.833∗(1.16)
0.1731−0.16
= $ 43126.15 million
EXPECTED SHARE PRICE
Outcomes Probability SP E(SP)
Normal 0.6 39.54478 23.72687
Optimistic 0.3 109.771 32.93129
Pessimistic 0.1 20.44893 2.044893
Expected Share Price 58.70305
Total present value of cash flows $ 47891.4 million

41 | P a g e
SUMMARIZATION OF THE VALUATIONS: ESTIMATED STOCK PRICE
The market price of stock of Home Depot Inc currently is $35 while the PV of Dividends is
estimated to be $ 36.30. The Present Value of FCFE is $ 58.703. It is the amount that Home
Depot can afford to pay as dividend per share. It indicates that the expected dividend payment
from the stocks of Home Depot Inc. is higher than the current market price. So, currently the
stock of Home Depot is undervalued and the stocks seem to be growth stocks. It will be a wise
decision for the investors to purchase the stocks of Home Depot now.
RELATIVE VALUATION TECHNIQUES
Earnings ($
millions)
Cash flow($ millions) Sales($ millions)
Values in 1999 2320 168 38434
Estimated values in
2000
2879.12 208.488 47696.59
Values per share 1.23 .089 20.37
RELATIVE VALUATION RATIOS
P/E ratio P/CF2000 P/S2000
Present value of
dividends
29.5122 407.7674 1.782404
Present value of
FCFE
47.74797 659.4261 2.882437
Present value
of dividends
$ 36.30
Present value
of FCFE
$58.703
Market price
$35

42 | P a g e
 P/E Ratio measures the price paid for a share relative to the annual net income or profit
earned by the firm per share. The P/E ratio of Home Depot Inc. calculated based on the
PV of dividends is 29.5122. It is estimated that Home Depot’s earnings to be 29.5122
times its share price. While P/E ratio based on the PV of FCFE is 47.74797 indicating the
earnings to be 47.74797 times the share price. Home Depot’s shares have a very high
P/E. Investors can expect a high future growth in earnings.
 P/CF ratio is a ratio used to compare a company's market value to its cash flow. The P/CF
ratio calculated based on PV of Dividends is 407.7674 and P/CF calculated based on PV
of FCFE is 659.4261. The P/CF is similar to a company's P/E ratio, but it does not take
into account earnings that have not actually been received. P/CF ratio allows its users to
assess risk relative to the company's cash on-hand, instead of the cash it ought to have.
When compared to P/CF ratios of other firm, the lower the P/CF is, the better value that
stock is.
 P/S ratio is the ratio of a stock's price to its per-share sales. This ratio is used to find
whether a stock's current market price is expensive or cheap. A low price to sales ratio
(below 1.0) is usually thought to be a better investment since the investor is paying less
for each unit of sales. The P/S ratio based on PV of Dividends of Home Depot is 1.78 and
P/S ratio calculated based on PV of FCFE is 2.88. The P/S ratio of Home Depot is higher
than one. But whether investment in Home Depot’s share is good or not must be decided
by comparing the P/S ratio of other firms in the same industry.

43 | P a g e
DU PONT ANALYSIS
The return on investment (ROI) ratio is used by many firms to evaluate how effectively assets
are used. The ROI of Home Depot Inc. for the year 2000 is:
=
2511.111
47696.59
×
47696.59
21197.521
=0.1185
The return on equity (ROE) ratio is a measure of the rate of return to stockholders. Du Pont
Analysis decomposes the ROE into various factors influencing company performance. The ROE
of Home Depot Inc. for the year 2000 is:
=
2511.111
3515.56
×
3515.56
3543.56
×
3543.56
47696.59
×
47696.59
21197.521
×
21197.521
12341
=0.2034
Where,
Net profit = net profit after taxes
Equity = shareholders' equity
EBIT = Earnings before interest and taxes
Sales = Net sales

44 | P a g e
RATIO ANALYSIS
 Profit Margin or Net Profit Ratio: a measure of profitability calculated by finding
the net profit as a percentage of the revenue. The profit margin is mostly used for internal
comparison. The profit margin ratio of Home Depot Inc. in 2000 is:
𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 𝑅𝑎𝑡𝑖𝑜 =
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝑃𝑟𝑒𝑡𝑎𝑥 𝑃𝑟𝑜𝑓𝑖𝑡
=
2511.111
3515.56
= 0.714
Home Depot Inc. has a net income of 0.714 dollars for each dollar of sales.
 Asset Turnover Ratio: a financial ratio that measures the efficiency of a company's use
of its assets in generating sales revenue or sales income to the company. Asset Turnover
ratio is calculated by dividing average total assets by net sales. The asset turnover ratio of
Home Depot Inc. for the year 2000 is:
𝐴𝑠𝑠𝑒𝑡 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝑆𝑎𝑙𝑒𝑠
𝐴𝑠𝑠𝑒𝑡𝑠
=
47696.59
21197.521
= 2.25
Home Depot has an asset turnover ratio of 2.25 which is high indicating a low profit
margin because of competitive pricing.
 Leverage Ratio: measures a company’s ability to meet its financial obligations. The
leverage ratio of Home Depot Inc. in the year 2000 is:
𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑠𝑠𝑒𝑡𝑠
𝐸𝑞𝑢𝑖𝑡𝑦
=
21197.521
12341
= 1.72
Home Depot’s Leverage ratio is 1.72.

45 | P a g e
RISK ANALYSIS
MM EEAASSUURREESS OOFF RRIISSKK
RANGE OF GROWT H
Year Optimistic growth rate Pessimistic growth rate Range
2001 0.25 0.22 0.03
2002 0.25 0.22 0.03
2003 0.25 0.22 0.03
2004 0.25 0.21 0.04
2005 0.24 0.21 0.03
2006 0.24 0.19 0.05
2007 0.24 0.18 0.06
2008 0.23 0.17 0.06
2009 0.2 0.16 0.04
2010 0.17 0.16 0.01
In the table above growth can vary year to year by range mentioned in the last column.
STANDARD DEVIATION1
Standard deviation is a measure of the variation of possible outcomes from the expected
outcomes. The larger the standard deviation, the greater the dispersion of expected outcomes and
the greater the uncertainty. In the table below we have shown standard deviation for the
forecasted values for earnings, cash flow and sales.
Earnings ($ millions) Cash flow ($ millions) Sales ($ millions)
541.14 39.42 8964.80
BETA VALUE
1 Calculations are shown in appendix
Range = optimistic outcome – pessimistic out come

46 | P a g e
SENSITIVITY TOWARD STOCK PRICE DUE TO CHANGE IN DIVIDENDS
CHANGE IN STOCK PRICE
CHANGE IN DPS
=
3.7
0.0112
=330.36
Beta represents the covariance of returns with the market portfolio. Here company beta = 1.09. it
indicates that if market return increases by 1%, company’s return will increase by 1.09% and
vice versa.
SENSITIVITY ANALYSIS
In this section we will analyze company’s stock price sensitivity toward change in some input
variables.
Variables to be changed:
 Required rate of return
 Dividends
 Free cash flow to equity
C H A N G E IN D IV ID E N D
In the table below, changes in stock price using Dividend Discounting Model due to changes in
amount of dividend to stock holders.
Dividend per share ($) Stock price($)
PV OF DDM PV OF FCFE
Base case 0.1088 36.30 58.703
increase 0.12 40 58.703
Decrease 0.08 26.67 58.703
INTERPRETATION: IF THE DIVIDEND INCREASES BY $1, COMPANY’S STOCK PRICE
WILL INCREASE BY $330.36

47 | P a g e
SENSITIVITY TOWARD STOCK PRICE DUE TO CHANGE IN REQUIRED RATE
OF RETURN
=
𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒔𝒕𝒐𝒄𝒌 𝒑𝒓𝒊𝒄𝒆
𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒓𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝒓𝒂𝒕𝒆 𝒐𝒇 𝒓𝒆𝒕𝒖𝒓𝒏
C H A N G E IN RE Q U IRE D RA T E O F RE T U RN
REQUIRED RATE OF
RETURN
STOCK PRICE ($)
BASE
CASE
17.31% 36.30 58.703
INCREASE 18% 15.72 48.42
INTERPRETATION: CHANGE IN REQUIRED RATE OF RETURN WILL A FFECT BOTH OF THE
PRICES. IF THE REQUIRED RATE OF RETURN INCREASES BY 1%, COMPANY’S STOCK
PRICE WILL DECREASE BY $2982.61 USING THE DDM MODEL AND $1489.86 USING
THE FCFE MODEL.
C H A N G E S IN F RE E C A S H F L O W T O E Q U IT Y
FREE CAS H FLOW TO
EQUITY ($)
STOCK PRICE ($)
BAS E CAS E 409 36.30 58.703
INCREAS E 489 36.30 70.19
DECREAS E 289 36.30 41.48
PV of DDM
−20.58
.0069
= −2982.61
PV of FCFE
−10.28
. 0069
= −1489.86

48 | P a g e
SENSITIVITY TOWARD STOCK PRICE DUE TO CHANGE IN FREE CASH
FLOW TO EQUITY
=
𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒔𝒕𝒐𝒄𝒌 𝒑𝒓𝒊𝒄𝒆
𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒇𝒓𝒆𝒆 𝒄𝒂𝒔𝒉 𝒇𝒍𝒐𝒘 𝒕𝒐 𝒆𝒒𝒖𝒊𝒕𝒚
=0.1436
INTERPRETATION: IF THE FREE CASH FLOW TO EQUITY INCREASES BY $1,
COMPANY’S STOCK PRICE WILL INCREASE BY $0.1436.
CHANGE IN GROWTH RATE
CHANGE IN COMPANY’S ESTIMATED GROWTH RATE CAN CHANGE THE STOCK PRICE
DRASTICALLY. A SLIGHT CHANGE IN GROWTH RATE AT YEAR 2010 CAN CHANGE
STOCK PRICE TO A GREAT EXTENT.
SSOOUURRCCEESS OOFF RRIISSKK
BUSINESS RISK
Business risk is the uncertainty of income flows caused by the nature of a firm’s business. In the
previous section calculation of standard deviation of earnings and sales has been shown. The
large values indicate that, there are large variations in estimated earnings and sales. So the firm is
operating a high business risk.
FINANCIAL RISK
Financial risk is the Uncertainty caused by the use of debt financing. As in current year firm is
operating at 17% financial leverage, we can say that the financial risk for the firm is moderate. If
the proportion of debt capital increases, firm’s financial risk will increase as well.
Company’s stock price is more sensitive towards growth rate and required
rate of return.

49 | P a g e
EXCHANGE RATE RISK
Exchange rate risk is Uncertainty of return is introduced by acquiring securities denominated in a
currency different from that of the investor. As the firm is planning for expansion in foreign
market, exchange rate risk will increase.
COUNTRY RISK
The U.S economy had experienced uninterrupted growth since 1992. Assuming a stable political
state, firm’s exposure to country risk is lower.

50 | P a g e
CHAPTER 06
PROBLEM STATEMENT

51 | P a g e
POTENTIAL PROBLEMS OF THE COMPANY
NEGATIVE OPERATING FREE CASH FLOW
The object is to determine a value for the total firm and subtract the value of the firm’s debt
obligations to arrive at a value for the firm’s equity.
While free cash flow doesn't receive as much media coverage
as earnings do, it is considered by some experts to be a better
indicator of a company's financial health. Negative free cash
flow is not necessarily an indication of a bad company,
however, since many young companies put a lot of their cash
into investments, which diminishes their free cash flow. But if
a company is spending so much cash, it should have a good
reason for doing so and it should be earning a sufficiently
high rate of return on its investments. As the firm is expected
to earn a high rate of return on investment, there is higher
probability of positive OFCF in near future.
HIGH OPERATING LEVERAGE
At the end of 1999 the company owned 77% of its store and leased 23% of them. Again the
company planned to increase proportion of owned stores. This will cause rise in fix cost and a
high operating leverage. By leasing the store firm can reduce its operating leverage and there by
the operational risk.
Calculation of OFCF
EBIT (1-tax rate) 2299.2
Add : depreciation
expense
463
less: capital
expenditure
-2581
less: change in
working capital
-301
OFCF -119.8
Operating free cash flow = EBIT (1-tax rate) + Depreciation expense - capital expenditure -
change in working capital – change in other asset

52 | P a g e
CHAPTER 07
RECOMMENDATION

53 | P a g e
RECOMMENDATION
Management of risk is important. But It is also important to choose cost effective approaches. If
the cost to eliminate the risk is higher than the potential loss, there is no point in spending more
to eliminating a risk. Often, it may be better to accept the risk than to use excessive resources to
eliminate it.
RISK MAY BE MANAGED IN A NUMBER OF WAYS
 BY USING EXIST ING ASSET S:
Here existing resources can be used to counter risk. This may involve improvements to
existing methods and systems, changes in responsibilities, improvements to
accountability and internal controls, etc.
 BY CONT INGENCY PLANNING:
Home Depot may decide to accept a risk, but choose to develop a plan to minimize its
effects if it happens. A good contingency plan will allow Home Depot to take action
immediately, with the minimum of project control if Home Depot finds them in a crisis
management situation.
 BY INVEST ING IN NEW RESOURCES:
Home Depot risk analysis gives it the basis for deciding whether to bring in additional
resources to counter the risk. This can also include insuring the risk: Here they may pay
someone else to carry part of the risk.

54 | P a g e
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