INSTITUTE OF MANAGEMENT AND STUDIES

MBA (FA) SESSION (2018-2020)

ASSIGNMENT ON- Financial cases

1) Value line publishing
2) The investment detective

SUBMITTED BY:- SUBMITTED TO:-

Sakshi Lambhate Dr. M.K Arya
(SEC-A, 4TH SEM)
66494
 Value Line Publishing,
October 2002
Slow but positive economic growth, low interest rates, a strong housing market, rising
unemployment, uncertain consumer confidence, and concern over corporate misdeeds—such was
the economic environment in early October 2002. Carrie Galeotafiore had followed the retail
building-supply industry for nearly three years as an analyst forthe investment-survey firm Value
Line Publishing. Next week, Value Line would publishher quarterly report on the industry,
including her five-year financial forecast forindustry leaders Home Depot and Lowe’s.

The Retail Building-Supply Industry

The Economist Intelligence Unit (EIU) estimated the size of the 2001 U.S. retail building- supply
industry at $175 billion. The industry was traditionally divided among three retail formats:
hardware stores, with 15% of sales; lumberyards, with34% of sales; and the larger-format home
centers , with 51% of sales. Annual growth had declined from 7.7% in 1998 to 4.2% in 2001, yet
was arguably still high considering the recessionary nature of the economic environment in 2001.
Low interest rates and a robust housing-construction market provided ongoing strength to the
industry. The EIU expected the industry to reach $194 billion by 2006. Exhibit 1 provides
the details of the EIU’s forecast. The industry was dominated by two companies: Home Depot and
Lowe’s. Together, the two players captured more than a third of the total industry sales. Both
companies were viewed as fierce competitors whose rapid-expansion strategies had more than
doubled own-store capacity in the past five years with the opening of 1,136new stores. The
penetration by the large Lowe’s/Home Depot warehouse-format stores had had a profound impact
on the industry. Independent hardware retailers were struggling to remain competitive. Some
hardware stores had shifted their locations to high rent shopping centers to attract more people or
remained open for longer hours. Some of the smaller players were protected by segmentations in
the market between the professional market that remained loyal to the lumberyards and do-it-
yourself customers who were attracted to the discount chains. Exhibit 2 provides selected company
data and presents recent stock-market performances for the two companies.

Future Growth Opportunities for Home Depot and Lowe’s

Galeotafiore expected that future growth for Home Depot and Lowe’s would come from a variety
of sources.

Acquisition/Consolidation

The industry had already experienced a substantial amount of consolidation. In 1999,Lowe’s had
acquired the 38-store, warehouse-format chain Eagle Hardware in a $1.3-billion transaction. In the
past few years, Home Depot had acquired the plumbingwholesale distributor Apex Supply, the
 specialty-lighting company Georgia Lighting,the building-repair-and-replacement-products
business N-E Thing Supply Company,and the specialty-plumbing-fixtures company Your “Other”
Warehouse. Just last week,Home Depot had announced the purchase of three flooring companies
that “whencompleted would instantly make Home Depot the largest turnkeysupplier of flooringto
the residential construction market.”

Professional Market

Both Home Depot and Lowe’s had recently implemented important initiatives to attract
professional customers more effectively, including stocking merchandise in larger quantities,
training employees to deal with professionals, and carrying professional brands. Home Depot had
developed Home Depot Supply and the “Pro Stores”to reach out to the small-professional market.
The company was also on track to install professional-specific desks at 950 stores by the end of
2002.

International Expansion

Home Depot had already developed some international presence with its acquisition of the
Canadian home-improvement retailer Aiken head in 1994, and it continued to expand its reach in
that market with 11 new-store openings in 2001. More recently, the company had targeted the
$12.5-billion home-improvement market in Mexico by acquiring the Mexican chains Total HOME
and Del Norte. By the end of 2001, 10% of Home Depot’s stores were located outside the United
States. In 2002, Lowe’s did not yet have an international presence.

Alternative Retail Formats

Home Depot and Lowe’s both maintained online stores. Lowe’s specifically targeted the
professional customer with a section of its Web site: “Accent & Style” offered decorating and
design tips on such subjects as kitchens and baths. Home Depot was developing new retail formats
for urban centers, showcased by its recently opened Brooklyn store, which offered convenient
shopping to densely populated markets.
These “urban” stores provided Home Depot products and services in a compact format.
The acquisition of EXPO Design Centers provided an additional format for Home Depot and
expansion beyond the traditional hardware and building-supply retailer.
EXPO Design Centers were a one-stop design and decorating source, with eight showroom sin one
location, highlighting kitchens, baths, carpets and rugs, lighting, patio and grills, tile and wood,
window treatments, and appliances. Lowe’s published Creative Ideas, Garden Club, and
Woodworker’s Club magazines to target customers with certain hobbies.

Alternative Products

Both Home Depot and Lowe’s were expanding into installation services. The “at-home”business
for Home Depot was currently at $3 billion. Home Depot expected its at-homebusiness to grow at
an annual rate of 30% in the near term.
 Head-to-Head Competition

Home Depot had traditionally focused on large metropolitan areas, while Lowe’s hadconcentrated
on rural areas. To maintain its growth trajectory, Lowe’s had begun systematicexpansion into
metropolitan markets. The investment community was becomingincreasingly concerned about the
eventuality of increased price competition. AramRubinson, of Bank of America Securities, had
reported in August, “Since Lowe’scomps [comparable store sales] have been outpacing Home
Depot’s, we have beengrowing increasingly concerned that Home Depot would fight back with
increasedpromotions and more aggressive everyday pricing.”

Financial Forecast for Home Depot and Lowe’s

Home Depot’s new CEO, Bob Nardelli, had expressed his intention to focus onenhancing store
efficiency and inventory turnover through ongoing system investments.He expected to generate
margin improvement through cost declines from product reviews, purchasing improvements, and
an increase in the number of toolrentalcenters. Recently, operating costs had increased owing to
higher occupancycosts for new stores and increased energy costs. Home Depot had come under
criticismfor its declining customer service. Nardelli hoped to counter this trend with aninitiative to
help employees focus on customers during store hours and restockingshelves only after hours.
Home Depot management expected revenue growth to be15% to 18% through 2004. Some of the
growth would be by acquisition, which necessitatedthe company’s maintaining higher cash levels.
Home Depot stock was tradingat around $25 a share, implying a total equity capitalization of $59
billion.
Galeotafiore had been cautiously optimistic about the changes at Home Depot in her July
report:Though the program [Service Performance Improvement] is still in the early stages, thedo-it-
yourself giant has already enjoyed labor productivity benefits, and received positive feedback from
customers. The Pro-Initiative program, which is currently in place at roughly 55% of Home
Depot’s stores, is aimed at providing services that accommodate the pro customer. Stores that
provide these added services have generally out performed strictly do-it-yourself units in
productivity, operating margins, and inventoryturnover. Home Depot shares offer compelling price-
appreciation potential over the coming 3-to-5-year pull.
Other analysts did not seem to share her enthusiasm for Home Depot. Dan Wewer and Lisa
Estabrooks observed ,Home Depot’s comp sales fell short of plan despite a step-up in promotional
activity. In our view, this legitimizes our concerns that Home Depot is seeing diminishing returns
from promotional efforts. Our view that Lowe’s is the most attractive investment opportunity in
hard-line retailing is supported by key mileposts achieved during 2Q’02.
Highlights include superior relative EPS momentum, robust comp sales, expanding operating
margin, improving capital efficiency, and impressive new-store productivity.
Importantly, Lowe’s outstanding performance raises the hurdle Home Depot must reach if it is to
return to favor with the investment community. Lowe’s management had told analysts that it
expected to maintain sales growth
of 18% to 19% over the next two years. Lowe’s planned to open 123 stores in 2002,130 stores in
2003, and 140 stores in 2004, and to continue its emphasis on cities with populations greater than
500,000, such as New York, Boston, and Los Angeles. To date, the company’s entry into
metropolitan markets appeared to be successful. Lowe’s planned to continue improving sales and
margins through new merchandising ,pricing strategies, and market-share gains, especially in the
 Northeast and West. Lowe’s stock was trading at around $37 a share, implying a total equity
capitalization of $29 billion.
Donald Trott, an analyst at Jefferies, had recently downgraded Lowe’s based ona forecast of a
deflating housing-market bubble and a view that the company’s stock price was richly priced
relative to Home Depot’s. Galeotafiore countered that Lowe’s had now shown that it could
compete effectively with Home Depot. She justified the Lowe’s valuation with an expectation of
ongoing improvement in sales and gross margins. Lowe’s is gaining market share in the appliance
category, and its transition into major metro politan areas (which will likely comprise the bulk of
the company’s expansion in the next years) is yielding solid results. Alongside the positive sales
trends, the homebuilding supplier’s bottom line is also being boosted by margin expansion,
bolstered, in part, by lower inventory costs and product-mix improvements.
Galeotafiore’s financial forecast for Home Depot and Lowe’s would go to print next week. She
based her forecasts on a review of historical performance, an analysis of trends and ongoing
changes in the industry and the macro economy, and a detailed understanding of corporate strategy.
She had completed a first-pass financial forecast for Home Depot, and was in the process of
developing her forecast for Lowe’s. She estimated the cost of capital for Home Depot and Lowe’s
to be 12.3%and 11.6%, respectively (see Exhibit 3). Exhibits 4 and 5 provide historical financial
statements for Home Depot and Lowe’s. Exhibit 6 details the historical and forecast values for
Value Line’s macroeconomic-indicator series. Exhibits 7 and 8 feature Galeotafiore’s first-pass
historical ratio analysis and financial forecast for Home Depot.
 SUMMARY-

Carria Galeotafiore, an analyst of Value Line, at July 2002 mentioned that this case is about thecompetition between
two major players in the industry, which are Home Depot and Lowe’s. Recently,they have been operating in more
of the same markets, which are seeking new ways to boost both theirtop and bottom lines, such as bettering
customer service, attracting professional customers, and creating amore favorable merchandise mix.

The Retail Building-Supply Industry

Economist Intelligence Unit (EIU) estimated the size of the 2001 U.S. retail building-supply industry at$175 billion.
The size of this industry is relatively growing strong, with low interest rates and a robusthousing-construction
market provided ongoing strength to the industry. EIU expected the industry toreach $194 billion by 2006. The
industry itself was dominated by two companies, which are Home Depotand Lowe’s, which has total industry sales
over a third. These two companies are fierce competitorswhose strategies are rapid-expansion with the opening of
1.136 new stores.

Future Growth Opportunities for Home Depot and Lowe’s

Galeotafiore expected that future growth for Home Depot and Lowe’s would come from a variety ofsources, such
as: acquisition/consolidation, approaching professional market with “Pro Stores”, havinginternational expansion,
alternative retail formats (to target customers with certain hobbies such asgardening, woodworking, or other creative
ideas), providing alternative products (having installationservices), and head-to-head competition (by having
promotions and aggressive everyday pricing).

Financial Forecast for Home Depot and Lowe’s

Home Depot’s new CEO, Bob Nardelli enhances store efficiency and inventory turnover through ongoingsystem
investments with hope of generating margin improvement through cost declines from productreviews, purchasing
improvements, and an increase in the number of tool-rental centers. Home Depotmanagement expected revenue to
grow at 15-18% through 2004, some by acquisition, whih necessitatedthe company’s maintaining higher cash
levels. Home Depot stock was trading at around $25 per share,which means a total equity capitalization of $59
billion.Galeotafiore’s July report about the changes at Home Depot shows that the service performanceimprovement
program is still at the early stages, but it received positive feedback from customers. ThePro-Initiative program
currently in place at 55% of Home Depot’s stores, aiming to provide services thataccommodate pro customers.
Home Depot shares offer compelling price-appreciation potential over the
coming 3-to-5-year pull.
Dan Wewer and Lisa Estabrooks, another analyst seem to have interest for Home Depot, and
comes to a conclusion that Home Depot’s comp sales fell short of plan despite a step-up in promotionalactivity.
They viewed that this legimitizes their concerns that Home Depot is seeing diminishing returnsfrom promotional
efforts. Lowe’s is the most attractive investment opportunity in hard-line retailing.Highlights include superior
relative EPS momentum, robust comp sales, expanding operating margin,improving capital efficiency, and
impressive new-store productivity. Lowe’s outstanding performanceraises the hurdle Home Depot must reach to
return to favor with the investment community.
Lowe’s management had told analysts that it expected to maintain sales growth of 18-19% overthe next two years.
Lowe’s planned to open 123 new stores in 2002, and 130 in 2003, then 140 in 2004(focusing on cities with
populations greater than 500,000). Lowe’s planned to improve sales and marginsthrough new merchandising,
pricing strategies, and market-share gains, especially in the Northeast andWest. Lowe’s stock was trading at $37 per
share, means a total equity capitalization of $29 billion.Jefferies’ analyst, Donald Trott, recently downgraded
Lowe’s based on a forecast of a deflating housingmarketbubble and a view that the company’s stock price was
richly priced relative ro Home Depot’s.While Galeotafiore said that Lowe’s could compete effectively with Home
Depot, since Lowe’s valuation
had an expectation of ongoing improvement in sales and gross margins.
Lowe’s is achieving greater market share in the appliance category, and its transition into majormetropolitan areas is
yielding solid results. With the positive sales trends, the homebuilding supplier’sbottom line is also being boosted
by margin expansion, bolstered, in part, by power inventory costs andproduct-mix improvements. Lastly,
 Galeotafiore’s financial forecast for Home Depot and Lowe’s arebased on her forecasts on a review of historical
performance, an analysis on trends and ongoing changesin the industry and the macroeconomy, and a detailed
understanding of corporate strategy. She estimated
the cost of capital for Home Depot and Lowe’s to be 12.3% and 11.6%

Questions

1. What do the financial ratios in case Exhibit 7 tell you about the operating performance of Home
Depot? What additional information do the different ratios provide? Complete and compare a
similar analysis for Lowe’s.

Answer:
• Growth rates capture the year-on-year percentage change in a particular line item. The
revenue growth for Home Depot is due to an increase in number of existing stores, new
stores, and square footage per store. So the growth rates help us to see the development of
both companes from their sales growth that is calculated based on new and existing stores’
growth. So we can say that in this case, the calculation of growth is using the unit stores’
growth.
• Margin ratios capture the percentage of revenue accounted for by profit or, alternatively, the percentage ofrevenue
not consumed by business costs. The margin also measures the cost structure of business. How tomeasure margins
is we used what we want to measure divided with sales or total revenue. For example, ifyou want to measure Gross
margin, the formula is Gross margin = Gross profit/Sales. From this ratio we can calculate the cost that is used to
get profit. We calculate how much cash spent to receive revenue. Sowe get the ratio to calculate the margin through
profit / sales.
• Turnover ratios measure the productivity, or efficiency, of business assets. The turnover ratio is constructed by
dividing a related measure of volume from the income statement by a measure of investment from the balance sheet.
This ratio calculates how fast the turnover of units.
• Return on investment captures the profit generated per dollar of investment. This ratio measures how fast the
investment we used makes profit. So usually investors use this ratio to know how long they might be receiving
profit from their investments.
• Leverage measure how much total capital is provided by equity. This ratio measures whether the company is using
more from its own capital or capital from investors (like stocks).

Financial Ratio Analysis Comparison between Home Depot and Lowe’s.

As we can see the result of the calculation, we can say that receivable turnover for Lowe is higherthan Home Depot.
It means Lowe’s credit sales are more likely to be collected than Home Depot. Forthe growth of both companies,
Home Depot was increasing in 1998-1999, but slowly decreasing from2000-2001. From the leverage ratio, we can
see that Lowe had the higher ratio than Home Depot, itmeans Lowe’s capital is much more come from debt than
Home Depot’s capital. From the margins,Home Depot is higher than Lowe except for depreciation/sales and
depreciation/P&E. It means that ithas higher profitability from the sales and Home Depot was efficient because
Home Depot sales was lower than Lowe’s, but it nevertheless it had a higher profit. The profitability tells that Home
Depot’sperformance is better than Lowe’s, and it tells us that how fast investment generates the capital.
From ratio analysis that has been done, we can say that Lowe’s gave smaller accounts receivablethan Home Depot
and that’s why the receivable turnover for Lowe’s is bigger than Home Depot.Lowe’s held cash more than Home
Depot as the result of its receivable turnover. If the economic is declining, the declines of Lowe’s will not as much
as Home Depot’s, even though Lowe’s growth notas high as Home Depot’s either.
Investors surely will be more interested in Home Depot’s, looking at its return on investment, butlike the phrase
always said, “high risk high return”. Receivable turnover for Lowe’s is bigger thanHome Depot so the refund of
receivables will be faster at Lowe’s than Home Depot, this why we think it will be more safe for investors to invest
in Lowe’s. The long period in return of receivables will make greater chance for credit default. Besides, we consider
that Lowe’s is better for investors than Home Depot because it has stable growth.
 Table. Ratio Analysis for Lowe’s

Fiscal
year
1997 1998 1999 2000 2001
Working capital (CA-NIBCL*) 771.537 1011.833 1459.585 1538.598 2062.821
Fixed assets 3109.67 3758.968 5319.167 7200.741 8815.827
5
Total capital 3881.21 4770.801 6778.752 8739.339 10878.64
2 8
Tax rate 0.35997 0.363913 0.367156 0.367999 0.369782
5 4 2 2 2
NOPAT (EBIT*(1-t)) 399.448 529.9599 741.9124 886.2324 1132.997
5 4 8 8

PROFITABILITY
Return on capital (NOPAT/Total 10.29% 11.11% 10.94% 10.14% 10.41%
capital)
Return on equity (Net earnings/S. 13.75% 15.38% 14.33% 14.74% 15.35%
Equity)

MARGINS
Gross margin (Gross profit/Sales) 26.53% 26.91% 27.54% 28.17% 28.80%
Cash operating expenses/Sales 18.00% 17.88% 18.05% 18.53% 18.25%
Depreciation/Sales 2.38% 2.22% 2.12% 2.18% 2.42%
Depreciation/P&E 8.02% 7.48% 6.53% 5.82% 6.17%
Operating margin (EBIT/Sales) 6.16% 6.80% 7.37% 7.47% 8.13%
NOPAT margin (NOPAT/Sales) 3.94% 4.33% 4.66% 4.72% 5.12%

TURNOVER
Total capital turnover (Sales/Total 2.61 2.57 2.35 2.15 2.03
capital)
P&E turnover (Sales/P&E) 3.37 3.37 3.07 2.67 2.56
Working capital turnover (Sales/WC) 13.14 12.10 10.90 12.20 10.72
Receivable turnover (Sales/AR) 85.61 85.08 107.54 116.65 133.54
Inventory turnover (COGS/M. 4.34 4.25 4.10 4.11 4.36
inventory)
Sales per store ($ millions) 21.25 23.55 27.61 28.89 29.72
Sales per sq foot ($) 254.31 256.20 279.14 277.08 273.98
Sales per transaction ($) 43.88 45.65 53.16 54.88 55.96

GROWTH
Total sales growth 20.80% 29.90% 18.06% 17.75%
Sales growth for existing stores 10.81% 17.27% 4.62% 2.87%
Growth in new stores 9.01% 10.77% 12.85% 14.46%
Growth in sq footage per store 9.99% 7.63% 5.40% 4.03%

LEVERAGE
Total Capital/Equity 1.492 1.521 1.444 1.590 1.630
 1. a). How sensitive is return on capital to the forecast assumptions in case Exhibit 8? b). What
independent changes in Carrie Galeotafiore’s estimates are required to drive the 2002 return-on-
capital estimate below Home Depot’s cost-of-capital estimate of 12.3%? Look specifically at gross
margin, cash operating expenses, receivable turnover, inventory turnover, and P&E turnover. c). What
effect does sales growth have on return on capital? Explain your findings.

a) Return on capital consists on so many items in financial forecast that are:

• Cash Operating Expense

• Depreciation & Amortization

• Net Sales

• Cost of Sales

• Working Capital

• P&E

• Other Assets

So we can say that return on capital is quite sensitive because with the change of the items
above, the return on capital will change too. When total operating expenses increase,
NOPAT will decrease and it will make ROC decrease too. If COGS increase then ROC
also decrease because the cost is greater than the income. Inventory turnover can also be a
factor that will affect ROC because when inventory turnover decrease then ROC will also
decrease.

b) Independent changes in Carrie Galeotafiore’s estimates are required to drive the 2002 return-
on-capital estimate below Home Depot’s cost-of-capital estimate of 12.3% are taxes, interest
in current asset and current liablities, depreciation, sales.

c) We can get Return on Capital by dividing NOPAT to Total Capital.

• NOPAT = EBIT(1-Tax)

EBIT = Gross Profit – Cash Operating Expense – Depreciation & Amortization.

Gross Profit = Net sales – Cost of sales.

• Total Capital = Working Capital + P&E + Other Assets

So we can get the conclusion that Sales growth will increase the percentage in Return on
Capital.
 2. Do you agree with Galeotafiore’s forecast for Home Depot? How would you adjust it?

Not entirely, because there are several values in forecasted ratio that should be affecting one
another, that Galeotafiore didn’t consider it well. In order to do the adjustments, we are using the
available information from company’s historical financial relationship, macroeconomy condition,
industry, and corporate strategy.

Historical Financial Report

Table Historical Financial Data: Home Depot from 1998 – 2001

1998 1999 2000 2001 Linear Regression

Total Sales Growth 25.1% 27.2 19% 17.1 Y = 29.85 – 3.04X
% %
Sales growth for existing stores 2.6% 4.1 -2.4% -0.4% Y= 4.85 – 1.55X
%
Growth in new stores 22.0% 22.2 21.9% 17.5 Y = 24.35 - 1.38X
% %
Growth in sq foot per store 0.6% 1.0 0.9% 1.0 Y = 0.6 + 0.11X
% %
Using historical data, we conduct linear regression to see the trend from the past 4 years, with the
function of y = a +bx, we can use the calculation as one of the input in determining the value of
growth. The table below shown the value of regression (blue) and Galeotafiore’s forecast (red) on
growth.

Table Comparison with Regression & Galeotafiore Forecast

2002E 2003E 2004E 2005E 2006E

Growth in new stores
Regression 17,5% 16,1% 14,7% 13,3% 11,9%
Galeotafiore 15,0% 9,0% 9,0% 7,0% 5,5%
Average 16,2% 12,5% 11,8% 10,2% 8,7%

Sales growth for existing

stores
Regression -2,9% -4,5% -6,0% -7,6% -9,1%
Galeotafiore 3,0% 4,0% 8,3% 8,3% 8,3%

Total sales growth

Regression 14,7% 11,6% 8,6% 5,5% 2,5%
Galeotafiore 18,0% 17,2% 17,3% 15,3% 13,8%
Average 16,3% 14,4% 12,9% 10,4% 8,2%

Despite of the calculation above, we also consider the other informations that nearly describe the
current condition and corporate strategy in doing their business. Here are the information we gather
from the case.

Macroeconomy, Industry, and Corporate Strategy

Information
 A. Economic condition in 2002
i. Slow but positive economic growth
ii. Low interest rates
iii. Strong housing market
iv. Rising unemployment Uncertain consumer confidence
v. Concern over corporate misdeeds

B. Company
i. Planning on 20011 there will be 11 new stores in international market.
ii. Acquisition in Mexico by US$ 12.5 billion.
iii. The total store in international market is 10%.
iv. Home Depot open in densely populated markets.
v. Expansion in its productline and make another acquisition.
vi. Product line: At-home grow at annual rate of 30%.
vii. Competitor such as Lowe, starts to do head-to-head competition in metropolitan area.

C. Forecasting
i. CEO intent to focus on enhancing store efficiency and inventory turnover.
ii. Margin improvement through cost decline from R&D (product review, purchasing,
improvement tools rental center, etc.)
iii. Operating cost or overhead cost increase due to higher occupancy for new stores and
energy cost.
iv. Revenue growth about 15% - 18% through 2004 by acquisition and maintaining higher
cash levels

D. Expert Opinion
i. Galeotafiore argues that Home Depot is still in early stages in at-home product lines but
seems promising in capital gain over 3-5 year.
ii. Estrabooks believes that there is diminshing return through promotional efforts, since the
corporate strategy tends to open many new stores.

Adjustments
We can conclude from all the information above, the main focus of Home Depot is to increasing the
margin expansion and cutting the cost, in order to improve store efficiency and inventory turnover.
Therefore, we use the financial ratios as the focus of our adjustments.
- Gross Margin
- Inventory Turnover
- P&E Turnover.
Before we determine the key ratios, we have to see the potential growth for the next 5 years (2002-2006).
Determining sales growth:
- From the market sales in the industry forecast, (1997 – 2006) the annual growth from the sales
keep declining from 7,7%, 6,8%, 5,2%, 3,7%, and 2,3%. This event cause the relatively small
growth in terms of sales growth for existing stores. Even though the industry annual growth
shows lack of improvement, from the historical data of sales (1997-2001) the annual growth are
25%, 27%, 19%, and 17% respectively. With the market share of 22, 09% the sales from Home
Depot
still dominating.
- The use of online shopping helps to increase the accesibility from any stores to improve the sales.
- To improve the gross margin, we have to increase the sales. We use the average calculation,
combine the regressin and Galeotafiore forecast, but in the year 2005 and 2006 as the impact of
online shopping, help to maintain the growth stable.
 - Home Depot expected revenue growth to be 15% to 18% through 2004. Some of it be by
acquisition.
Determining gross margin:
- Gross margin is proportional to the changes in sales. Thus, we get the decrease in sales impact
decrease in gross margin.
- The international market, can cause the risk of currency exchange. In fortunate condition the
company can benefit from the strong current currency over the foreign currency. But in
unfortunate condition can reduce the gross profit of the company.
Determining Inventory Turnover (COGS /Inventory)
- The corporate strategy is to increase the store efficiency, due to addition of product lines and
focusing cost on overhead cost.
- The methods of selling demand Home Depot to give the best effort in availability and delivering
the package. So, the reliability and speed are challenged and Home Depot should be able to keep
up with the competitor as a respond to head-to-head competition in metropolitan area.
- The online shopping also act as a 24/7 open store and demand can happen in anytime. Inventory
turnover can be roll even faster than the traditional store does.
Determining P&E Turnover (Sales / P&E)
- The property and equipment cannot be remain stable, due to growth in sales and increase in the
number of new stores. Thus, the P&E turnover can be varied through time to time.
The decrease in sales impacts the increase in PE turnover.
The summary of the key ratios adjustments:

Table Summary of Key Ratios Adjustments

Assumptions Fiscal
year
2001 2002E 2003E 2004E 2005E 2006E
Total sales growth 17.1% 17.3% 17.8% 18.0% 17.4% 17.8%
Gross margin 31.6% 32.0% 32.2% 32.3% 31.7% 31.8%
Inventory Turnover 5.4 5.0 4.8 4.8 4.5 4.0
P&E Turnover 3.5 3.8 4.0 4.2 4.6 4.8
Return on Capital 15.2% 16.6% 17.8% 18.4% 18.3% 18.0%
3. How would your forecast assumptions differ for Lowe’s? Complete and recommend a five-year
Lowe’s forecast to Galeotafiore.
Percentage change growth in new stores for Lowe’s is expected to increase from the yesteryears
because the company wanted to open 123 stores in 2002, 130 stores in 2003, 140 stores in 2004, and
continue to emphasis on cities with populations greater than 500,000 like NY, Boston and Los
Angeles. For 2005-2006 and other forecasts, we will use naïve forecasting and considerate the other
factors that might influence the forecasts (like macroeconomy, ratio, and consideration from the other
analyst). We choose naïve forecast because it is the most cost-effective forecasting model, and provide
a benchmark against which more sophisticated models can be compared. Using the naïve approach,
forecasts are produced that are equal to the last observed value. This method works quite well for
 economic and financial time series, which often have patterns that are
difficult to reliably and accurately predict.
Table . Financial Forecast for Lowe’s

Fiscal
year
ASSUMPTIONS 2001 2002E 2003E 2004E 2005E 2006E
Growth in new stores 14.5% 16.5% 15.0% 14.0% 11.3% 4.3%
Sales growth for existing 16.2% 5.8% 4.2% 3.4% 2.9% 2.5%
stores
Total sales growth 30.6% 22.3% 19.2% 17.4% 14.2% 6.8%

Gross margin 28.80% 29.54% 29.85% 30.08% 30.28% 30.46%

Cash operating 18.25% 19.77% 20.27% 20.62% 20.89% 21.11%
expenses/Sales
Depreciation/Sales 2.42% 2.45% 2.46% 2.47% 2.47% 2.48%
Income tax rate 38.6% 37.6% 37.5% 37.5% 37.5% 37.5%

Cash & ST Inv/Sales 3.9% 4.5% 4.7% 4.7% 4.9% 5.1%

Receivable turnover 133.2 140.6 146.3 153.6 159.1 160.7
Inventory turnover 4.36 4.35 4.53 4.47 4.55 4.51
P&E Turnover 2.555 2.464 4.310 4.505 5.713 5.136
Payables/COGS 10.89% 10.11% 9.92% 9.89% 9.86% 10.03%
Other curr liab/Sales 4.17% 4.20% 4.57% 4.86% 5.06% 5.20%

FORECAST
Number of stores 744 867 997 1,137 1,266 1,320
Net sales 22,111 26,019 27,638 28,880 29,927 30,850
Cost of sales 15,743 18,448 20,429 21,792 22,876 23,299
Gross profit 6,368 7,571 7,209 7,088 7,051 7,551
Cash operating expenses 4,036 4,760 5,009 4,867 5,185 5,245
Depreciation & 534 500 411 346 211 175
amortization
EBIT 1,798 2,311 1,789 1,875 1,655 2,131
NOPAT 1,104 1,442 1,118 1,172 1,034 1,332

Cash and ST investments 853 1,183 1,319 1,424 1,590 1,725

Accounts receivable 166 185 192 199 204 212
Merchandise inventory 3,611 4,245 4,508 4,880 5,030 5,166
Other current assets 291 367 399 423 444 463
Total current assets 4,921 5,980 6,418 6,926 7,268 7,566
Accounts payable 1,715 1,865 2,026 2,156 2,255 2,338
Accrued salaries and 221 272 294 310 324 336
wages
Other current liabilities 922 1,092 1,263 1,405 1,513 1,605
Current liabilities 2,858 3,229 3,583 3,871 4,092 4,279
Working capital 2062.821 2,422 2,781 2,873 2,222 2,870
Net property and 8,653 10,558 6,517 6,784 5,682 6,632
equipment
Other assets 162 185 194 202 208 213
Total capital 10,878 13,165 9,492 9,859 8,112 9,715
Return on capital 10.15% 10.95% 11.78% 11.89% 12.75% 13.71%

After growth in new stores, we forecast other items in financial forecast using with
‘forecast’ package that is naïve forecasting. There are some number we choose
by ourselves instead of following the output of, because some of them might
not fit the situation.
Our forecast assumptions for Lowe’s is based on the Lowe’s management’s plans
to expand their stores on some countries too. That’s why we believe that
Lowe’s will do better on the next years to come. As number of stores increases,
the sales will increase too, so does the NOPAT and resulting the increasing
return on capital.

Analysis & Recommendation

Now we want to compare between two largest companies in retail-building-supply
industry, Home Depot and Lowe’s. We see that the main question in here is
comparing between Home Depot and Lowe’s about how their performances in
years ahead. Galeotafiore used the historical data to forecast the financial report of
Home Depot and she was very optimist that Home Depot will be doing great in the
next years to come. We are given task to do the forecasting for the other company,
that is Lowe’s. We use different approach from Galeotafiore’s (see in Questions).
So our analysis will focus more on what’s the best approach to forecast the
performance between Home Depot and Lowe’s.
 SWOC Analysis
Home Depot Swoc Analysis

Strengths

1. Home Depot operates in more than 2000+ locations

2. The companies financial strength can be seen from its NYSE and S&P 500 index
3. Home Depot is one of the largest home improvement retailers in the United States
4. More than 400,000 people are employed with the organization
5. Strong financial position and growing opportunities for the company
6. Home Depot has a high brand recall as it is a leading market player
7. The company has been involved with several sponsorships in sports, political and
entertainment events
8. The online brand of Home Depot has also been able to engage users in the USA
9. Out the US, it has stores in Canada, UK, China

Weaknesses

1. Home Depot is primarily dependent on US market and has limited global presence
2. Intense competition means limited market share growth

Opportunities

1. Diversifying product portfolio and catering to more customer needs

2. The Home Depot exclusively carries several major brands
3. Global expansion to other countries can help boost business for the company
4. Acquisition of smaller companies can help Home Depot increase sales

Challenge-

1. Competition within industry can affect Home Depot's business

2. Bargain power of buyer is higher and brand switching can cost loyal customers
3. Government policies and taxation can affect business margins

Lowe’s company SWOC anaysis

Strengths

1. Lowe's Companies serves more than 14 million customers a week

2. Globally it is one of the largest home improvement retail brand along with The Home
Depot
3. The company has its presence on NYSE & S&P 500 Component
4. Lowe's Companies has been recognized in the Fortune 500 companies
5. Strong brand reputation and financially stable
6. One of the top 50 trademark applicants according to the United States Patent and
Trademark Office

Weaknesses
 1. Lowe's Companies is decentralized
2. Geographical expansion is not at very large extent and limited global presence

Opportunities

1. Global expansion to tap newer markets can boost Lowe's business

2. Increasing product and service offerings
3.Free parcel shipping to increase customer experience

Challenge-

1. Cut throat competition with respect to margins

2. Touch and feel of product is not available prior to purchase in case of shipment
3. People opting for ecommerce portals for home deliveries & services can degrow business
CASE STUDY 2
 The Investment Detective
The essence of capital budgeting and resource allocation is a search for good investments to
place the firm’s capital. The process can be simple when viewed in purel mechanical terms,
but a number of subtle issues can obscure the best investment choices. The capital-
budgeting analyst, therefore, is necessarily a detective who mu winnow bad evidence from
good. Much of the challenge is in knowing what quantitative analysis to generate in the first
place.

Suppose you are a new capital-budgeting analyst for a company considering investments in
the eight projects listed in Exhibit 1. The chief financial officer of your company has asked
you to rank the projects and recommend the “four best” that the company should accept.

In this assignment, only the quantitative considerations are relevant. No other project
characteristics are deciding factors in the selection, except that management has
determined that projects 7 and 8 are mutually exclusive.
All the projects require the same initial investment: $2 million. Moreover, all are believed to
be of the same risk class. The firm’s weighted average cost of capital ha never been
estimated. In the past, analysts have simply assumed that 10% was a appropriate discount
rate (although certain officers of the company have recent asserted that the discount rate
should be much higher).
To stimulate your analysis, consider the following questions:

1. Can you rank the projects simply by inspecting the cash flows?

2. What criteria might you use to rank the projects? Which quantitative ranking methods
are better? Why?

3. What is the ranking you found by using quantitative methods? Does this ranking differ
from the ranking obtained by simple inspection of the cash flows?

4. What kinds of real investment projects have cash flows similar to those in Exhibit 1
 EXHIBIT 1 | Projects’ Free Cash Flows (dollars in thousands)

Project number: 1 2 3 4 5 6 7 8

Initial investment $(2,000) $(2,000 $(2,000 $(2,000 $(2,00 $(2,00 $(2,000 $(2,000)
) ) ) 0) 0) )

Ye 1 $ 33 $1,66 $ 160 $ 280 $ $1,200 $ (350)

ar 0 6 2,200*

2 33 33 200 280 900* (60)

0 4*

3 33 16 350 280 300 60

0 5

4 33 395 280 90 350

0

5 33 432 280 70 700

0

6 33 440* 280 1,200

0

7 33 442 280 $ 2,250*

0*

8 $1,000 444 280

*

9 446 280

10 448 280

11 450 280

12 451 280

13 451 280

14 452 280

15 $10,00 $(2,000 $ 280

0* )

Sum of cash

flow benefits $3,310 $2,16 $10,00 $ 3,5 $4,20 $ $2,560 $ 4,150

5 0 61 0 2,200

Excess of cash
flow

over initial investment $ 16 $ $ 1,5 $2,20 $ 200 $ 560 $ 2,150

$1,310 5 8,000 61 0

*Indicates year in which payback was accomplished.

 The Investment Detective Solution

1. We can not rank the projects by only simple inspection of the cash flows because of the
time value of money and cost of capital of companies. We use capital budgeting tools to
measure financial performance of projects. The major available tools are IRR, MIRR and
NPV. By using these tools we can conclude whether sum of the cash flows of a project
exceeds expected return rate or cost of capital of a company or not.
Also there are qualitative factors that should be considered. A project can be critical
for the company and even it has negative NPV, it could be accepted.
Also a company would prefer to have small experiments to identify possible
profitable businesses before making a heavy investment to enter the market. In this
case quantitative methods would not be enough to analyze the project.
Because most of the cash flows are estimated in most of the projects, quality of
estimation is another factor to be considered besides numerical capital budgeting
tool results.

2. I would use NPV since it is superior compared with IRR. I would also use profitability
index. I would use also MIRR to enable easy communication among non-financial
managers in the company by giving them a percentage score to evaluate projects. Finally
I would calculate pay back information.

3. Project analysis

Project # 1 2 3 4 5 6 7 8

NPV 73.09 -85.45 393.9 707.0 129.7 0.00 165.0 182.9

2 1 0 4 8

PI 1.037 0.957 1.197 1.285 1.065 1.000 1.083 1.077

MIRR 10.49 8.41% 11.33 11.86 10.46 10.00 11.76 11.18

% % % % % % %

Payback 6.06 2.00 14.20 6.05 7.14 0.90 1.88 6.08

 Ranking with NPV

Project # 2 6 1 5 7 8 3 4

NPV - 0.00 73.09 129.7 165.0 182.9 393.9 707.0

85.4 0 4 8 2 1
5

PI 0.95 1.000 1.037 1.065 1.083 1.077 1.197 1.285

7

MIRR 8.41 10.00 10.49 10.46 11.76 11.18 11.33 11.86

% % % % % % % %

Payback 2.00 0.90 6.06 7.14 1.88 6.08 14.20 6.05

I would suggest to accept project 4, 7, 5 and 1.