Upload
vanhanh
View
218
Download
1
Embed Size (px)
Citation preview
1
Dell, Inc.
Cade Carpenter – [email protected]
Chris Fink – [email protected]
Peyton Harris – [email protected]
Josh Jacobsen – [email protected]
Carly Moore – [email protected]
2
Table of Contents
Executive Summary 1
Overview of Firm 6
Business and Industry Analysis 8
Industry Overview 8
The Five Forces Model 8
Rivalry among Existing Firms 9
Industry Growth Rate 10
Concentration and Balance of Competitors 11
Degree of Differentiation 12
Switching Costs 13
Scale of Economies 13
Ratio of Fixed to Variable Costs 13
Excess Capacity 14
Exit Barriers 15
Threat of New Entrants 15
Economies of Scale 16
First Mover Advantage 17
Access to Channels of Distribution 18
Legal Barriers 19
Threat of Substitute Products 20
Relative Price & Performance 20
Buyer’s Willingness to Switch 21
3
Bargaining Power of Customers 23
Price Sensitivity 23
Relative Bargaining Power 24
Bargaining Power of Suppliers 24
Value Creation Analysis 26
Economies of Scale 26
Superior Product Quality & Product Variety 27
Research & Development 27
Brand Image 27
Competitive Advantages of the Firm 29
Formal Accounting Analysis 32
Key Accounting Policies 32
Revenue Recognition 33
Cost Control 33
Operating & Capital Leases 34
Research & Development 35
Accounting Flexibility 36
Research & Development 37
Operating & Capital Leases 37
Revenue Recognition 38
Pension Plans 39
4
Accounting Strategy 40
Research & Development 40
Operating & Capital Leases 41
Pension Plans 42
Cost Control 43
Evaluating Quality of Disclosure 44
Quantitative Disclosure 44
Problems & How They Solve Them 45
Investor Relations 46
Business Strategy Disclosure 47
Explanation of Trends in Revenue & Expenses 47
Qualitative Disclosure 48
Core Sales Manipulation Diagnostics 49
Core Expenses Diagnostics Manipulation 52
Potential Red Flags and Undoing Distortions 55
Financial Analysis, Forecasts, Cost of Capital Estimation 56
Liquidity Analysis 56
Current Ratio 57
Quick Asset Ratio 58
Accounts Receivable Turnover 59
Days’ Supply of Receivables 60
Inventory Turnover 61
Day’s Supply of Inventory 62
Cash-to-Cash Cycle 63
5
Profitability Ratio Analysis 64
Gross Profit Margin 64
Net Profit Margin 65
Asset Turnover 66
Return on Assets and Equity 67
Capital Structure Analysis 69
Growth Rate Analysis 71
Financial Statement Forecasting 72
Income Statement 73
Balance Sheet 77
Statement of Cash Flow 81
Cost of Capital Estimation 81
Cost of Equity 81
Cost of Debt 84
Weighted Average Cost of Capital 85
Valuation Analysis 87
Method of Comparables 87
Residual Income 92
Long Run Residual Income 92
Abnormal Earning Growth 95
Free Cash Flow 97 Appendices 99
References 116
6
Executive Summary
Overvalued, Sell April 1, 2008 DELL- NASDAQ (Apr.1,2008) $20.33 Altman's Z-Score
52 Week Range: $18.87- $30.77 2003 2004 2005 2006 2007
Revenue: 61.13B 5.66 5.21 5.05 5.26 4.84 Market Capitalization: 45.19B Shares Outstanding: 2.22B Valuation Estimates Percent Institutional Ownership: 74.70% Actual Price (Apr.1, 2008) $20.33 Book Value per Share: 1.83 ROE: 68.09% Financial Based Estimates ROA: 11.50% Trailing P/E: $21.67 Forward P/E: $22.11 Cost of Capital Estimate: R^2 Beta Ke PEG: $9.32 3 month 32.96% 1.84 13.51% P/B: $8.32 6 month 33.02% 1.84 13.68% P/EBITDA: $39.13 2 year 33.02% 1.83 13.71% P/FCF: $48.14 5 year 32.96% 1.82 14.50% Enterprise Value/EBITDA: $41.91 10 year 32.94% 1.82 15.47% Intrinsic Valuations Published Beta: 1.53 Dividend Discount: N/A Kd: 3.99% Free Cash Flow: $16.57 WACC BT: 10.28% Residual Income: $4.51
WACC AT: 9.95% Long Run Return on Equity: $5.24
Abnormal Earnings Growth: $0.64
7
Industry Analysis
Dell is a technology company that produces personal and professional computer
systems utilizing an unrivaled direct to consumer business model. Dell’s main
competitors vary in size and business objectives. Competitors include Apple, Hewlett-
Packard, and International Business Machines (IBM). Dell competes in different sectors
with all of these companies from mp3 players to large business servers. These
companies compete on economies of scale, product quality and variety, brand image,
and research and development to become the industry leaders. There is constant
change and innovation in the technology sector forcing companies to invest largely in
research and development. In 2007 alone, these four companies invested over $11
billion dollars into R&D. Economies of scale is also a huge factor in the technology
sector. Large companies like Dell have developed relationships with suppliers and
distributors that allow them to dictate price and delivery options due to such mass
ordering. This also produces a problem for new entrants into the market due to the
large amount of capital required for start up. Firms also compete largely on product
superiority and functionality, the public demands constant innovations in technology
and products. A company’s products and technologies set them apart from their
competitors and help control their market share. Finally brand image is an important
part of any company. In recent years this has become increasingly important with
global trading and the demand for more eco-friendly production facilities.
8
Accounting Analysis
In performing an accounting analysis we examined Dell and its main competitor’s
annual 10-k financial reports to compare the different companies. Company’s 10-k
information is based on their yearly or quarterly accounting information. There are
degrees of accounting flexibility allowing companies to report conservatively or
aggressively altering the value of the firm. When valuing a firm it is important to take
accounting procedures into account when truly valuing a firm. Companies accounting
policies should reinforce its key success factors. Dell’s key accounting polices include
cost control, accounting for operating and capital leases, calculation of pension plans,
and recording research and development (R&D) costs.
When analyzing accounting flexibility analysts and companies have to follow law
determined by generally accepted accounting procedures or GAAP. GAAP offers no
flexibility in the recording of R&D; it must be expensed as incurred. GAAP does allow
firms to estimate their own pension plan and discount rates which if overstated can
cause an understated pension expense and vise versa. For operating/capital leases and
pension plans GAAP allows much more flexibility compared to R&D and other expenses.
After analyzing Dell and its competitors we can conclude that all the companies
have different methods and intentions for annual reporting. Dell puts a larger emphasis
on cost control and R&D than other key accounting policies. These sections of their
financial reports were more detailed and conclusive compared to lease and pension
plans sections. IBM and HP are much larger companies than Apple causing there to be
distortions between those companies’ financials. When we started to analyze these four
companies we thought they were each others main competitors in the technology
sector. After analyzing Dell, Apple, IBM and HP we can conclude that these companies
are really nothing alike. They all operate business in different ways changing them
drastically in comparative models, Apple in particular.
9
Financial Analysis, Forecasting, and Cost of Capital
When valuing a firm one must look at the ratio’s calculated and used by analysts
to understand a company inside and out. These ratios consist of liquidity, profitability,
and capital structure. The second step in valuing a company is forecasting financial
statements out a significant amount of years or 10 years in our case. By running theses
ratios and forecasts we are able to take current conditions and forecast values
accurately into the future. The forecasts and ratios are also used in valuations of Dell’s
stock price determining whether it is fairly, under or overvalued. Cost of equity, cost of
debt, and weighted average cost of capital are also used in intrinsic valuations.
After calculating the ratios for all four companies we noticed that the companies
were similar in some areas and in some cases extremely different. Most of the major
differences resulted from Apple; they are a completely different and much smaller
company compared to IBM, HP and Dell. This hurt when it came to comparing some of
the ratios, Apple numbers would have to be taken out to make reasonable assumptions.
We then forecasted the financial statements for the next ten years in order to
provide statistical data for intrinsic valuations. There are several forecasts that provide
analysts necessary information to value a company. We forecasted out net income,
CFFI, CFFO, book value of equity, and retained earnings. These ratios are considered
the future cash flows to the firms which will then be discounted back in time to
calculate the net present value. Discount rates are calculated by calculating cost of
debt, cost of equity, and weighted average cost of capital. Once these figures are
calculates they are used as the discount rate to find the present value factors. Using
proven analytic techniques consisting of weighted averages and linear regressions we
were able to estimate accurate comparative values for Dell as of April, 1 2008.
10
Valuations Analysis
Financial valuations are the most important and significant part of the equity
analysis. Utilizing the method of comparables and intrinsic valuation models we are able
to very accurately value Dell and its competitors. These valuation numbers truly portray
whether a company is fairly, over or undervalued. Valuations main point is to provide
information to analysts and the public to make well educated investment decisions.
The methods of comparables are tools based on financial ratios that value the
firm based on 7 different aspects. Using these methods we found that the value of the
firm could not be appropriately estimated using these ratios due to such differing
numbers. We calculated trailing price to earnings, forward price to earnings, price to
book, P.E.G., price over EBITDA, price over free cash flows, and enterprise value over
EBITDA. When calculating these values we found that trailing and forward price to
earnings gave Dell a fair value while price to book and the P.E.G ratios undervalued
Dell. All other valuations calculated Dell as overvalued.
Intrinsic valuations are normally a better valuation model compared to the
method of comparables. Intrinsic values include free cash flow, residual income,
abnormal earning growth and, long run residual income. When using these evaluations
we were able to get much more reliable values. When using intrinsic values all values
proved Dell to be overvalued. Given our research and proven values Dell is overvalued
and should be sold.
11
Overview of Firm
Dell, Inc. is one of the leading technology companies in the world. It was
founded in 1984 and is headquartered in Round Rock, Texas. Dell boasts the largest
market share within the United States in the personal computing industry and the
second largest share worldwide. In an industry dependant on innovation and constant
consumer feedback, Dell strives to attain a more personal customer relationship than its
competitors. This is achieved through its direct business model, which provides its
customers a way to interact directly with Dell to tailor each computer to their needs.
Although historically Dell has sold most of its PCs directly to the customer through its
online customization and over-the-phone ordering, Dell has explored new outlets for its
products, most recently placing its products for sale in retail outlets such as Best Buy
and Wal-Mart. A large portion of Dell’s computer sales come from customization of
business and educational institution orders. Dell focuses on selling laptops, desktops,
servers, storage, networking, printers, televisions, software, and accessories. In
addition to these products, Dell provides services such as information technology
management and software support.
In fiscal year ending February 2, 2007 Dell reported sales of $57.4 billion.
Although net income experienced a slight decline from 2006 to 2007, gross revenue
was up 3% on increased sales and an industry record 39.1 million shipments in the
2006 calendar year.1 Dell has experienced an incredible 62.2% increase in revenue up
from $35.4 billion in 2003. The market capitalization of the firms within the industry
vary from Dell, whose market cap is $45.78 billion, to IBM which holds a $146.85 billion
market cap.1 Over the last five years Dell’s stock price has generally moved in
accordance with the firm’s performance. The stock has varied in price from $21.61 to
$42.57 over the last five years.2 Also; the total assets of Dell have increased
tremendously over the last five years ranging from $15.4 billion in 2003 to $25.6 billion
in 2007.
12
2003 2004 2005 2006 2007 Total Sales (mil) $35,404.00 $41,444.00 $49,121.00 $55,788.00 $57,420.00
Total Assets (mil) $15,470.00 $19,311.00 $23,215.00 $23,252.00 $25,635.00 Market
Capitalization $61,534.94 $85,472.64 $102,034.10 $68,175.80 $45,780.00 This is a snapshot of Dell’s total sales, total assets, and market capitalizations for the
past five years.
www.moneycentral.msn.com
13
Business and Industry Analysis
Industry Overview
The technology industry, specifically personal computers, has experienced
exponential growth over the last 30 years. The berth of the technology industry came
when computers were primarily used for business database storage. Initially, few
technology firms dominated the industry because it was so expensive to compete in.
Over time the technology became more affordable to produce allowing new firms to
enter the industry. These firms brought new ideas to the industry that transformed the
computer from the enormous primitive mainframe into the mobile personal computer
we know today.
The Five Forces Model
According to Michael Porter, there are five forces which classify and analyze the
industry in which a company competes. He created a diagram to illustrate this, simply
named The Five Forces Model. This mechanism gives a comprehensive analysis of an
industry and the competitiveness of the firms within it. The five forces model is
comprised of factors that determine the ability of a firm to get a better understanding
of the industry they compete in and their ability to make a profit. The model is divided
into two sections: the degree of actual and potential competition and the bargaining
power in input and output markets. The former consists of rivalry among existing firms,
threat of new entrants, and threat of substitute products. The latter consists of
bargaining power of customers and bargaining power of suppliers. A large portion of
competition in the technology industry is base on Hewlett-Packard, Dell, IBM, and
Apple. These four firms attempt to gain as much market share as possible each year.
Most of these firms thrive on coming out with new innovative products that excite
customers. A great example of this is when Apple has come out with all of their
different “i” products, starting with the iPod. IBM has continued to maintain their
expertise in the computer mainframe industry while HP continues to contain a small
14
portion of each product in the technology industry. Dell competes on the basis of
customization along with customer service. Dell allows customers to order and select
exactly which computer they want along with the accessories. Overall, each of these
companies’ goals are to follow their business strategy as close as possible and continue
to grow their market share each year.
Five Forces Level Of Competition Rivalry Among Existing Firms Moderate
Threat of New Entrants Low Threat of Substitute Products Moderate Bargaining Power of Buyers Moderate
Bargaining Power of Suppliers Moderate OVERALL Moderate
Rivalry Among Existing Firms
Rivalry within the personal computer industry is becoming more and more
competitive as time passes and the consumer becomes more aware of their technology
needs. One of the most obvious competitive factors within the industry is price.
Technology firms are well aware of their market’s purchasing power; that being the
case, they strive to manufacture a product that will meet the value standards which the
consumer holds while maintaining a pricing structure that is affordable. It is important
that firms find a way to stand out in the industry and make themselves different. If
they want to have a successful firm they have to hold on to the market share they
currently have and continue to find a way to gain new market share. If the industry is
growing then firms can each take the new consumers in the market; however, if the
market is not growing firms are forced to steal from each other in order to grow.
15
Industry Growth Rate
The industry growth rate will assist in determining if a firm can expect to grow in
the market. One of the most important factors to a firm’s growth rate is trying to retain
all of the current customers that you have. If a firm is able to effectively retain current
customers then they can have a goal to attain a portion of the new market and/or
existing customers of other clients. During a tight market, taking care of customers
could be vital in retaining and attaining customers.
Growth in the technology industry has continued to increase over the last few
years. The percentages in the graph are based on total revenues of the industry.
When referring to industry, this refers to IBM, Apple, Hp, and Dell. As the graph
shows, there was a decline in the industry growth from 2003 until 2005. Since then the
industry has grown from 6.62% in 2005 to 10.19% in 2007. However, analysts are
predicting that these growths will slow down in 2008. If these predictions turn out to
be true then this will cause little room for firms to enter the industry; therefore,
increasing competition among existing firms which makes new and innovative ideas
vital to the success of individual firms.
16
Concentration and Balance of Competitors
While IBM has been the cornerstone for the technology industry over the past
thirty years, the dynamic changes in the industry have caused a shift in power. The
globalization of the personal computer industry has required a new way of competitive
thinking. This has led to the decentralization of the past technology leaders allowing
firms like Dell, HP Compaq, and Apple to fill in the gaps left by the firms structured for
the consumer of the past. Dell’s innovative customer-first thinking has allowed it to
evolve into the leading market share holder of firms in North America; this is according
to research by Forrester.1 More recently the industry has been marked by a balance of
competition between the top firms. If you refer to the chart above you will see that IBM
led for most years but HP, Dell, and Apple took some of the market share each year.
All of the industry’s firms have done a great job of maintaining a moderate competition
level and competing for market share in the industry. This balance of competition is
proving to be beneficial to both the firms and the consumers. Because there are only a
handful of firms which produce the type of product which are in high demand it allows
them to avoid large destructive price competition.3 Similar to the unspoken agreement
between companies like Coca-Cola and Pepsi whom maintain a certain competition level
without entering into a price-war with each other.
17
Concentration of the industry can be calculated by the number of firms in an
industry and their relative sizes. There is an index called the Herfindahl-Hirschman
Index (HHI) that is used by the U.S. Department of Justice and the Federal Trade
Commission to measure an industry’s concentration.3 The concentration is calculated by
summing the squares of the individual market shares of all the participants. According
to the Department of Justice, a market that has an HHI of 1,800 or above is considered
to be highly concentrated. When comparing Dell, HP Compaq, IBM, and Apple the HHI
comes out to 3,028.4 According to the HHI Index, the industry is highly concentrated
and there is moderate competition among firms.
Degree of Differentiation
It is important to set yourself apart from other firms in the industry by
differentiating yourself in a unique way. In the personal computer industry switching
costs are low and make price competition a regular occurrence. Each firm has to figure
out how they can set themselves apart from others. Dell competes on the fact that they
will custom-build your computer and have it at your doorstep in ten days or less.
(dell.com) By cutting out the middleman they are able to sell their product at a cheaper
price to the consumer. An example of a way that firms like to differentiate themselves
is by coming out with a new innovative product. A great example of this is the Apple
iPod. Apple branded their product very well and set themselves apart in the music
player industry. Apple found features that consumers wanted and continued to improve
them and keep their customers happy. In order to survive in a market as competitive
as it is today, it is important to tweak your business strategy around your special skills
and knowledge. By having a diverse employee base for specialization in separate
areas, this will help companies ensure that they set themselves apart from the pack and
continue to be different than their competitors. With that being said, the technology
industry has a highly competitive market as far as differentiation goes. Customers want
that new, hot item or the product that performs better.
18
Switching Costs
It is important to estimate how much it would cost; as well as, if a firm would be
able to do something else. This is referred to as switching costs. Companies in the
technology industry would have a difficult time attempting to do something else. Most
firms have the warehouse and buildings that would allow them to do something
different; however, they have a large amount of machinery that is worth lots of money.
The amount of money these firms have invested makes it tough for them to decide one
day to pack it up. Switching costs are high also due to Research and Development.
Firms invest a large sum of money each year into R&D in order to try to keep an edge
in the future. Overall, the technology industry has moderate competition due to the
fact that there are high switching costs.
Scale of Economies
The economies of scale in the technology industry are very large because these
firms have to constantly spend money to be innovative in the industry. Research and
development for all firms in the personal computer industry is a very high cost due to
the fact that they must have an advantage on what the next product in the market will
be. It is important to be constantly making current products and future products more
efficient. The consumers are always looking for the firm that comes out with the new
innovative product.
Ratio of Fixed to Variable Costs
Dell has low fixed to variable costs because they outsource most of their
products. Therefore, you don’t have to lower your price if sales decrease. Research and
development is the main way that firms are able to achieve these goals. If you refer to
the chart below you will see the large amounts of money that these firms spend on
Research and Development each year. This shows just how important this category is
to firms. R&D is tough for some to justify, however, R&D is what gets you into the next
19
innovative product. R&D is what helps these firms to compete on a moderate level and
stay successful.
Excess Capacity
When the capacity of an industry becomes larger than the demand of the
customers, firms are forced to cut prices to attempt to fill the capacity. So far, the
technology industry has been fairly successful at keeping from getting an excess
capacity. Everyone from families to businesses have continued to become more and
more reliable on computers and products from this industry. The main time that they
have a problem with capacity is when a new product comes out and customers decide
to switch to the new one, leaving a large supply of inventory from the older product.
One benefit to the computer and electronics industry is that most firms outsource their
products and do not have to worry about excess capacity. They, for the most part, can
prevent themselves from becoming stuck with lots of inventory. Many of them are very
cautious when ordering inventory to make sure that they are not stuck with an obsolete
product. Therefore, management is keeping a close eye on the industry and market to
make sure they know when the capacity and demand are off balance.
20
Exit Barriers
Exit barriers are high in this industry as it is tough for firms to pack up and
switch industries. Many firms have a lot of money invested in Research and
Development that will help them over the next few years. As said before, most firms
have the property and warehouse space available to switch industries, but they have
too much invested in their large machinery and equipment. It would be hard to justify
leaving this information behind and switching products.
Conclusion: Rivalry Among Existing Firms
The rivalry among the firms in this industry represents moderate competition.
When considering Research and Development economies of scale are very high.
Switching costs are also high due to Research and Development. In correlation to the
fact that firms outsource a lot of their products excess capacity is not much of a
problem. There are not many new entrants to the market due to the fact that it is
tough to establish yourself in this industry. This industry is also highly concentrated
creating a moderate competition. Overall, the rivalry among existing firms section has
a moderate competition level.
Threat of new entrants
Within the personal computer market there are only a few very established
companies that consume a large part of the market share. These companies are: Dell,
HP Compaq, and Gateway. These companies have a large economies of scale in the
personal computer market, which limits new entrants. The large economies of scale
make it almost impossible for any new start-up companies to gain any type of market
share. A new company would need to have an incredible amount of capital and
financial backing in order to try and compete with the well-established market leaders.
In the computer market there are basically three main operating systems offered on
computers: Microsoft’s Windows, Apple’s Mac OS X and Oracle; although Oracle is
mainly only used in the business world. A new company would have to create
21
competitive software that is a step ahead of the ever changing technological world
within the computer software market. Aside from all those problems a new company
would have numerous legal hurdles to pass in the form of patents. The market leaders
have hundreds, if not thousands, of patients on their products and technologies. New
start up companies would have to create and develop new and unique technologies to
be able to compete; which again means that new companies would need substantial
capital to start up.
Economies of Scale
The technology industry is dominated by large companies that have substantial
capital backing, extensive research, development, and established production facilities.
Economies of scale are a huge benefit to these large companies and a giant road block
for smaller companies. Small companies wanting to enter the technology industry face
many different problems. The biggest decision for new companies is deciding on the
amount of initial capital needed to compete. Too much or too little capital could lead to
the downfall of a company. They would also have to get companies to invest in the
area where most companies spend a large part of their budget, technology.
Companies are always looking to decrease spending so a new company would have to
be on the leading front of innovation and price. Given all this, the technology industry
is one of the most impenetrable industries to date.
22
First Mover advantage
Some companies exercise a first mover advantage in order to keep them on the
cutting edge. One important factor is attempting to be the biggest computer supplier in
the world by thriving on exceptional customer service and some of the lowest prices in
the industry as a couple of examples.
One of the biggest reasons that a business model can be successful is by having
a complex network of distribution centers and shipping points. This system allows
customization of every computer ordered and the ability to deliver them with the fastest
turnaround in the industry. Dell turns over inventory every six days on average,
keeping related costs low. No other business or company has been able to replicate
Dell’s network of shipping points or customization options.
All these reasons have allowed companies to be constantly increasing their
worldwide market share in the technology sector. Another first mover advantage most
of the technology industry has on its side is patents. Almost every product that is
produced has a patent or copy write of some kind.
23
Companies also spend huge amounts of money on research and development.
The Technology sector spent several hundred billion dollars on research and
development in fiscal year 2007. This investment allows companies to stay at the top of
new developments and technologies keeping them atop of their technology sectors.
Dell spent nearly half a billion dollars on R&D last year. The investment in R&D is
necessary for any company involved in technology. There is new innovations everyday
and developing the newest technology and software can make or break a companies
cash flows.
Access to Channels of Distribution and Relationships
Companies’ ability to get their raw materials and ship finished products is crucial
in making a profitable company. Many companies get parts and products from all over
the world to make their products. Almost all companies utilize some kind of just-in-time
or JIT inventories. Using JIT inventories requires having a successful and strong
relationship with suppliers and distributors. Using a just-in-time inventory system keeps
inventory and raw material costs at a minimum adding profit to the entire company.
This would not be possible without the participation of its thousands of strategic
shipping and distribution points through out the world. These different shipping points
rely on data from Dell research and their own forecasts to estimate how much product
to have on hand or in transit to again, keep costs down and still get orders out
efficiently. Dell has applied this to single consumer and large industry orders alike. The
direct business model also eliminates retailers and middlemen reducing costs which Dell
has been passing on to its customers for years and continues to be a low cost leader.
Another reason for most companies success is their strong partnerships with
some of the largest technology companies in the business including. Having partners
who are the leaders of different sectors in the technology world, benefit companies
tremendously. Microsoft and Intel are two of the biggest worldwide technology
companies with production facilities located in many different countries. Most of these
companies have world wide facilities allowing for easier shipping of components on a
24
global scale. Many of these suppliers actually change how and where they supply
products because large companies like Dell and HP are their biggest customers. Many
of these crucial partnerships in the technology industry have been around for years
giving the companies bargaining power. With those relationships bargaining power top
companies get the lowest price available, once again reducing cost and saving
customers money.
Legal Barriers
The technology industry has become a worldwide business and doing business
internationally can be very complicated. Laws change dramatically from country to
country. Government agencies have placed limitations on business between countries.
Companies trying to enter the market would have difficulties knowing the current
policies in place since they are ever changing. Also companies have patents on almost
everything they produce stopping any business trying to copy their products.
Companies dealing largely with US government agencies are restricted from dealing
with countries supporting terrorism. The US also has historically had trade problems
with different countries, stopping new companies in the US from trading worldwide.
Many of the industry leaders have found gotten around this by opening production
facilities around the world.
Conclusion: Threat of New Entrants
The low amount of competition in the technology industry makes it difficult for
new companies to enter the market and be successful. There are many barriers
stopping these new companies including economies of scale, first mover advantages,
access to channels of distribution and relationships, as well as legal barriers. The
Technology industry adds to these barriers by spending billions of dollars or research
and development to stay on the cutting edge of technology. New companies
production abilities would not be able to compete on the large scale of current
companies, forcing them to try and compete in different sectors or regions. Established
companies also have long term relationships with their suppliers allowing them the best
25
prices. Even with the low amount of competitors in technology there is still competition
to be the low price leader; adding to need of strong supplier relations. Legal barriers
are the final road block for new companies; not meeting the necessary regulations can
cause serious legal problems with sever repercussions. Aside from the barriers listed
above the industry leaders have the capital and resources to stop any new company if
they so wanted to. Overall the threat of new entrants affecting the technology market
is minimal.
Threat of Substitute Products
The threat of substitute products greatly impacts the computer and electronics
industry on several levels. The products these firms produce complete the same task
and fulfill a general technology need for the consumer. For example, a laptop with the
same components, regardless of its manufacturer, should theoretically have similar
capabilities and functionality. Therefore, firms consistently compete on more than just
price. The consumer bases purchasing decisions on a combination of need, price,
quality, and ultimately value.
Relative Price & Performance
Consumers more and more are looking to the computer and electronics industry
for products used on a daily basis. Whether it is a desktop or laptop computer a family
uses to send and receive emails or a data base server used to support the entire IT
division of a fortune 500 company consumers rely on these products everyday. This
emergence of technology into the day-to-day life of almost every person on the globe
has led to the standardization of pricing structure in the computer and electronics retail
markets.
26
Figure T.1
Manufacturer Standard Laptop Price
Dell Inspiron $699.99 HP Compaq Presario $699.99 Apple MacBook $1,499.99 Toshiba Satelite Laptop $749.99
However, the increasing competition of late is driving computer manufacturers to
think outside-of-the-box for new innovative and customer focused products; products
that will demand a slightly higher price in comparison with their competitors.
Manufacturing, marketing, and designing costs are not flexible enough to adjust to
compensate for lost profit margin due to price standardization. Therefore, competing
firms in the industry must seek different avenues to differentiate themselves from
competition.
Design innovation leaders Sony and Apple are a perfect example of firms
differentiating themselves through customer-friendly stylish designing. Apple is gaining
market share at a rapid pace over the last three years. This market share growth can
be attributed mostly to their sleek younger looking iBooks and iMacs, products which
are extremely aesthetically pleasing and moderately easier to use. As seen in Figure
T.1 above, this product differentiation allows Apple to charge a premium for its product
relative to the remaining competitors.
Buyer’s Willingness to Switch
Technology is an industry which experiences rapid change and innovation in both
capability and pricing. In the 30 year history of the industry there has been ups and
downs for firms that manufacture PCs and their components. Consumers, both
enterprise and personal, realize the fast-passed growth and strive to stay up to date on
the latest, faster, bigger computer; granted they can afford the purchase of such
products. This is leading to a 3-5 year replacement life of the average PC. When
27
making a purchasing decision on the next PC for the organization or home there are
many things that consumers consider.
The first is Operating system. Microsoft’s Windows has been the behemoth of the
20th century when it comes to operating systems. An operating system is a platform or
base for which all software and hardware come together and synergize. In addition to
Microsoft’s Windows OS, there is Apple’s Leopard and IBM’s Lenox. Being that Windows
OS has been the mainstream platform for PC users for so many years consumers have
become familiar with and, for the most part, enjoyed its capabilities. A switch to
Leopard or Lenox would take a relearning of applications and software uses that for
most seem foreign ultimately leading to unwillingness to switch.
The second thing a consumer considers when making a purchasing decision is
primary use. This includes mobility, capability, and size. One must decide whether to
purchase a notebook PC or a desktop PC, and consider the tradeoff one will give over
the other. Apple’s PCs are becoming more and more known for their fast processing
speeds and stable computing experiences. However, many software applications for
both business and personal uses are designed to run only on Windows or Leopard; for
the most part, not both. In addition, consumers rarely “downgrade” to a PC that has
fewer capabilities than their previous PC. This is mostly due to the decreasing cost of
better technology. You can purchase a better computer today for the same money you
would have paid three years ago. Data storage is becoming weightier when making a
purchasing decision. The increase in use of video and other media files, which require
large memory usage, has lead the consumer to seek a PC that can store more of such
files. These tradeoffs can lead a consumer who is used to Windows to not even
consider purchasing a Mac.
Conclusion
Because the industry is so competitive and the consumer is provided many
choices there is a moderate level of willingness to switch. The rate at which technology
changes leads the consumer or organization to constantly consider their next PC
28
purchase. This high turnover combined with a competitive pricing structure cultivates
an industry in which the consumer considers every option and is moderately willing to
switch from one firm’s product to another. Keep in mind the variance from this
conclusion that applies to the purchasing a computer with a different operating system
than what is currently used by each purchaser.
Bargaining Power of Customers
Price sensitivity and relative bargaining power are two factors that determine the
bargaining power of customers. Bargaining power in an industry determines the actual
profits of a firm. Price sensitivity determines the degree that buyers are willing to
bargain on price and relative bargaining power determines the degree that buyers will
succeed in lowering the price. In the most recent years, customers have gained more
and more bargaining power in the industry.
Price Sensitivity
One of the most important decisions when purchasing a product is the price.
When the product is less differentiated and switching costs are kept to a minimum then
the customers are more price sensitive. Computer electronics are all very similar in
nature. As a result of this lack of differentiation, one factor that attracts customers to a
certain product over another will be the cost. Because competitors products are closely
related in this industry, switching costs are low. These minimal switching costs allow
customers to select the product of their choice based primarily on price.
Price sensitivity also depends on how relevant the product is to the customer.
Increasingly, personal computers are viewed as a commodity in the eyes of consumers.
This means that price is the main determinant of which product they will buy. More
recently, customers are focusing on price and are not becoming influenced by the brand
name of a product. Computers are very valuable to consumers, which means that they
will shop around to find the best product at a reasonable price. This provides firms with
an idea of how the consumers will react to the price of a certain product. If we are
29
basing our evaluation of bargaining power of customers on price sensitivity, then
customers have a relatively high bargaining power.
Relative Bargaining Power
In order to maintain a lower price, customers have to achieve a relatively strong
bargaining position in the industry they are focusing on. There are several determinants
of bargaining power of customers including the number of buyers in relation to
suppliers, volume of purchases, number of alternative products, and the costs of
switching from one product to another.3 Because of the relatively low number of
computer manufacturers, customers have a moderate amount of bargaining power.
They are capable of going to another supplier for the same product; however, their
choices are limited. As previously stated, low switching costs give the consumer the
ability to shop for the best price in the market. This allows them to achieve a relatively
high amount of bargaining power. Another determinant of relative bargaining power in
the industry is the customer’s volume of purchases. Obviously, this factor depends on
the specific type of buyer. For example, a corporate buyer will purchase a large amount
of units at one time, giving them an extremely high amount of bargaining power. On
the other hand, a household consumer will typically purchase one, on occasion two,
computers or related peripherals. This single purchaser will not achieve nearly as much
bargaining power as the corporate consumer would. Overall, the relative bargaining
power of the consumer is moderate in relation to the bargaining power of customers as
a whole.
Bargaining Power of Suppliers
The bargaining power of suppliers is the amount of power that the suppliers
have over their customer, the firm. The analysis of the bargaining power of suppliers is
exactly the same as an analysis of the bargaining power of customers in a specific
industry. In addition to the bargaining power of customers, the bargaining power of
suppliers influences the actual profits that a firm can make in its industry. When there
are few substitutes available to customers, suppliers have more power over them.
30
They also have more power when the businesses of their buyers depend heavily on the
supplier’s product or service.
In this industry, the suppliers have a varying amount of power over their buyers.
Microsoft and Intel are two suppliers that have a considerable amount of bargaining
power. One reason for this is because both of them dominate their sector of the
industry. If they, for some reason, decided to quit supplying companies with their
operating systems and microprocessors we would have a very limited selection of
replacement suppliers to choose from. For this reason, Microsoft and Intel’s bargaining
power is significantly increased. On the other end of the spectrum, the suppliers of
various other raw materials including, but not limited to, the casing, keyboard keys,
screen, and speakers have little bargaining power. The reason for this is because all of
these products are not differentiated. Companies have the choice to choose the supplier
with the least cost to them for these products. Because customers can get these
products from virtually anyone, these suppliers have very little bargaining power.
Conclusion: Bargaining Power of Customers/Suppliers
The bargaining power of customers and suppliers is very important to a firm. A
company does not want to allow either of these parties to have too much power
otherwise they will have a hard time making any profits. As consumers in the
electronics and computer industry, buyers tend to have a relatively moderate bargaining
power, as they can choose from various products from a number of suppliers. An
electronics supplier would like everyone to buy their products, but in order to
accomplish this, the company needs to compete on various levels of the business
sector. In this particular industry, suppliers on average have a moderate amount of
bargaining power. The software and microprocessor suppliers have a high amount of
bargaining power; however, the hardware suppliers have low bargaining power.
31
Value Creation Analysis
In the industry of personal computers, there are several factors that determine
the profitability of a firm. In order for a firm to be able to make a profit, they must try
to achieve a competitive advantage in the industry in which they compete. Two such
strategies include cost leadership and product differentiation. Cost leadership is the
ability of a firm to supply a product or service at a lower price than competitors. There
are several ways for a business to achieve cost leadership, including economies of scale
and scope, efficient production, simpler product designs, better sourcing and lower
input costs, and efficient organizational processes.3 If a firm can properly apply these
ideas to their cost leadership strategy, they will be able to turn a respectable profit.
Differentiation is the ability of a firm to provide a unique product or service that is in
some way important to the customer. Firms can focus on a variety of strategies to
compete on differentiation which include superior product quality and variety, superior
customer service, and investment in brand image and research and development. Once
a firm can create a unique product or service, they must still attempt to offer it at a
reasonable price to the end user. In order for a business to create and sustain value in
a specific industry, they need to strive to compete on either cost leadership or
differentiation, or a combination of both.
Economies of Scale
Producing low cost products requires companies to have strong relationships
with its suppliers. These relationships allow companies to drive down the purchase
price of components in their products which then allows them to pass those benefits
onto their customers. In the current technology driven world, corporations and
individuals are searching for the best value they can find. Another way to increase
efficiency and drive down the prices is to outsource manufacturing. This allows a
company to focus on other areas of the company and reduce other relative costs.
32
Superior Product Quality and Product Variety
Customers in today’s economy demand the highest quality products when
making a significant investment for their company or home. Quality depends on many
different aspects including production, innovation, research and service. Service is ever
becoming one of the biggest parts of the technology industry, with new innovations
everyday. Consumers demand to be on the leading edge and need to constantly be
taught and updated. Variety is just as important as quality for many companies trying
to cover the entire market. A superior variety allows companies to move production
needs to different sectors when demand changes enabling them to maximize profit.
Research and Development
In the technology industry research and development is one of the biggest
assets of most companies. Technology is the fastest growing and innovative industries
in the world. The leading firms spend billions of dollars every year on research and
development to keep them and their customers on the leading edge. Companies are
creating technology that most people thought could never happen. Products are
competing on size, price, and functionality. Many firms spend hundreds of millions of
dollars on research and development each year. These outstanding numbers show the
dedication of companies to their products and development. These numbers also help
stop new entrants from entering the market because they cannot compete with the
innovations and new developments of the market leaders.
Brand Image
In today’s world brand names dominate most markets. Logos and brand image
have a significant impact on many consumers spending habits. Often people will only
buy certain brands or spend more money to get a certain brand. Companies invest
millions of dollars on advertising to get their names all over the market place.
Advertising is most companies largest source of new business, allowing them to
showcase their new products and innovations in the computer industry.
33
Conclusion
In an industry with just a few major competitors businesses are spending more
and more money to be the innovative, price, and compatibility leaders. Companies do
this with economies of scale, research and development, brand imaging and creating
superior or unique products. Using those key business methods companies differentiate
themselves from competing firms in the industry and create customer loyalty.
Companies in the technology industry that have succeeded in these different areas of
business have become the dominate forces leading the way in the technology
dominated world.
34
Competitive Advantages of the Firm
Dell has dedicated large amounts of resources to achieving and maintaining a
high level of competitive advantage within the personal computing industry. Dell not
only provides its customers with the hardware that they need, it interacts with the
customer on a one-on-one basis in order to customize a system that meets their
specific needs. This includes everything from the computer hardware and software to
the deployment of the information technology system for the customer to the service
and support. This direct customer interaction is one of Dell’s key success factors. Dell’s
customers, as well as perspective customers, are valuing the dedication to customer
service and support more and more as technology needs continue to increase.
For most of the nineties and the first few years of the twenty-first century Dell’s
growth rate exceeded that of the average within the industry. This success can be
attributed to the dedication of the firm’s leadership to its direct business model. From
the conception of Dell in 1984 until now Dell has sought new and innovative ways to
bring its product to market. Though there have been changes to the method of
customer interaction, the intimate relationship Dell has with its customers has been
steadfast. Changes in technology and customer’s needs modified the direct model as
time passed. In the late eighties and early nineties, most of Dell’s sales were made over
the phone and through catalog sales. However, the recent convenience and efficiencies
provided by the internet has directed most of Dell’s sales to that avenue. Dell has been
able to successfully acquire contracts with suppliers that allow them to compete with
others in the industry on pricing. As a result of Dell’s direct business model, which
allows the company to receive payment for product before it has been manufactured,
the firm has been able to leverage its pricing positions against other firms in the
industry.
We have shown how Dell has been extremely successful in a very competitive
industry thus far. However, recent trends in the global technology industry have led to
slumping revenues for the firm. Dell’s market share has seen declines over the last few
35
years. This seems to be due to the increasing innovation of companies like Apple and
Hewlett-Packard. Most of Dell’s customers are reluctant to switch to Apple’s products
because of both hardware and software differences, though there are some that will be
willing to learn and adapt to this different technology. To battle the competition Dell is
furthering previous talks with certain retail outlets about selling its computers in their
stores. These talks have led to selective product placements in Best Buy and Wal-Mart
stores around the nation.1 Talks are still ongoing with international retailers for product
placement. In addition to placing its products in retail stores, Dell has beefed up its
design team in efforts to make their products more aesthetically pleasing to its
customers.1 Apple seems to be the forerunner when it comes to design, and a recent
trend in mobile computing is making the look, color, and feel of the PC much more
important to the consumer. The notebook computer is becoming more and more a
status symbol amongst users rather than just a business tool.
The successful implementation of new products and marketing strategies is vital
to the future success of Dell. This firm has seemed to have what it takes to beat out
competition in the past. It looks like Dell’s leadership has realized that the firm may be
falling behind the curve, and is deploying new plans and strategies that aim to
circumvent the further decline in market share within the computing industry. Dell may
have slipped a little; however, this firm will make a comeback. A comeback of this
nature can only be achieved by a firm that knows what its customers want; and there is
no better company in the industry at customer relations than Dell. The constant transfer
of information between Dell and its customers will springboard this firm back into the
leadership position of the industry within a few years. There are, however, a few things
that could detour Dell’s comeback. Economic recession, which is a current fear around
the globe, could lead to consumers tightening their budgets; meaning less spending on
personal computers and other peripherals. Other risks the firm faces include supplier
contractual agreements, intellectual property lawsuits, government levies and taxes. A
few of the international markets in which Dell sells its products have governments
36
which can, at any given time, without any notice, implement new laws that will make
Dell’s success in their countries difficult if not impossible.
The fast-paced computer industry is extremely competitive. Dell is striving to
once more set itself apart in the eyes of consumers. This will be accomplished through
Dell’s design initiative and continuing strategies to cut costs and reach more markets
with their products. Though there are few firms that are able to compete in the
computer industry there is still a great deal of competition between firms. The industry
has been marked, of late, by pricing pressures from consumers and institutions on tight
budgets of their own. Dell will continue to be successful if they continue to keep their
sights positioned on the competition, while maintaining the same innovative state of
mind that has made Dell a world-wide leader in the computer industry.
37
Formal Accounting Analysis
To truly understand the value of a firm, one must consider the art behind
financial reporting. To do this you must examine the principles behind the methods
used in a firm’s accounting. Generally Accepted Accounting Principles (GAAP) is the
guidelines and standards used in corporate record keeping. These principles are the
basis of the financial reports compiled by each individual firm. Potential investors, credit
analysts, and others wishing to understand a firm’s dynamics read these reports. There
are six steps to effectively analyze the accounting principles of a specific firm. The steps
in performing an accounting analysis are identifying principle accounting policies, assess
accounting flexibility, evaluate accounting strategy, evaluate the quality of disclosure,
identify potential red flags, and undo accounting distortions. These steps are important
because they identify potential accounting discrepancies that may distort the financial
position of a firm. Recognizing and understanding these discrepancies is important to
be able to accurately determine a firm’s value. Discrepancies are due to varying levels
of disclosure in financial reporting.
Key Accounting Policies
A company’s key accounting policies are directly correlated to their key success
factors that were discussed in the business analysis. Firms are either very transparent
and disclose a lot of information or they disclose the bare minimum putting a cloud over
their accounting financials. Some firms believe that they have nothing to lose and are
very open to anyone looking at their accounting procedures. On the other hand, many
firms are afraid that if they disclose too much information it will give firms competing in
and entering the industry an advantage. Disclosing lots of information would show
firms how to structure their accounting department and inventory costs.
As stated previously in the business analysis, Dell’s key success factors are direct
customer interaction, cost control, and research and development. The accounting
procedures that affect the key success factors are revenue recognition, cost control,
38
accounting for operating or capital leases, and recording research and development
(R&D). The preparation of all financial statements is stated in accordance with
Generally Accepted Accounting Principles (GAAP). All firms in the industry must abide
by the rules set by the SEC, who governs GAAP. How these policies are utilized help to
determine the value of a firm. GAAP can either be beneficial, or just the opposite.
GAAP allows flexibility in some categories and is much stricter in others. For example in
categories such as R&D, GAAP requires that firms show this as an expense instead of
an asset.
Revenue Recognition
According to the 10-k, revenue recognition is an important accounting policy.
Dell claims that they frequently enter into sales contracts that have many different
stipulations such as hardware, software, and peripherals. So that they can comply with
GAAP, Dell has to report certain earnings at the appropriate time such as immediately
or at a future date when services occur. An example would be an item such as
extended warranty or a service contract. These revenues are recorded as deferred
revenue and are recognized over the term of the contract. Industry wide firms have to
make decisions on when to recognize revenues. The toughest and most frequent
category that has a gray area of when to recognize is the extended warranty section.
Cost Control
Cost control is a crucial segment of any companies’ business strategy and
accounting procedures. In the technology industry there are multiple items that could
affect accounting statements. One of the main elements is accounting for warranty
expenditures. It is impossible to know the exact amount that will be spent and
obviously every firm would like to keep this item to a minimum. Most companies
reevaluate warranty expenses each quarter and make adjustments accordingly.
Another sector of cost control is income taxes. It is important for a firm to budget for
future tax consequences. According to Dell’s 10-k, the differences between anticipated
39
and actual outcomes of future tax consequences could have a material impact on the
results of operations as well as financial position. Dell uses the asset and liability
method to calculate income taxes. Under this method deferred tax assets and liabilities
are recognized by looking at the differences between tax and accounting purposes.
The other key cost control measures for most companies are pension and retirement
plans. Full time employees are given the option of contributing to a 401k plan.
Companies are willing to match up to 4-6% of each participant’s annual compensation.
It is important for Dell and each firm in the industry to recognize these costs each year
and adjust accordingly. Controlling these costs is vital when looking at financial
statements of firms.
Operating and Capital Leases
Leases have always been a questionable topic when it comes to trying to find the
value of a company. This is a category which can easily change an investor’s outlook
on the firm by switching the accounting procedure. A company using capital leases
when operating leases should be employed assets would be overvalued and vice versa.
Choosing between capital or operating leases can drastically change a firms balance
sheet. Dell leases property and equipment, manufacturing facilities, and office space
under non-cancelable leases. Some of these leases obligate them to pay taxes,
maintenance fees, and repair costs. All of their leases are allocated as operating leases.
This means they are expensed each year and do not show up on the balance sheet.
However, some firms in the industry prefer to show their leases as capital leases.
Capital leases are accounted for as an asset on the balance sheet. Lots of firms decide
which way to account for their leases by looking at different financial ratios and seeing
which one makes the firm’s image look best.
40
Research and Development
Research and Development is an easy accounting policy because GAAP requires
that each firm capitalize these costs and can not record them as an asset. In the
technology industry R&D plays a significant role in future success. Each firm is always
looking for the next innovative product or how to tweak their current products to make
them more efficient. The technology industry as a whole spends billions of dollars
every year investing in the future. Many firms argue that R&D should be an asset since
it has future economic benefits. However, the SEC believes that you can not put an
exact figure on how much, if any, economic benefits will come from R&D. Most
investors will look at R&D as an asset in their mind when deciding the value of a firm.
Therefore, even though GAAP will not allow firms to disclose R&D as an asset on the
balance sheet, investors normally look at R&D as an asset. Below is a chart that shows
R&D expenses for Dell, IBM, HP, and Apple over the last 5 years so that you can see
how much money goes into this sector of business each year.
41
Conclusion
As stated previously, the accounting procedures that affect the key success
factors are revenue recognition, cost control, accounting for operating or capital leases,
and recording research and development. The way these sections are recorded has a
huge impact on the value of a firm. Many of these policies affect the financial standing
of firms industry wide. By making each company abide by GAAP it helps to keep the
industry on a fair playing field. Since each firm has to follow the same rules, it partially
helps investors when looking at multiple firms in the industry. Overall, each firm’s
executives must look at the accounting policies and decide which procedures are most
beneficial for their firm.
Accounting Flexibility
Accounting flexibility is the degree to which a firm can have control over
choosing their accounting policies and estimates for reporting purposes. Some firms
have more flexibility than others regarding this topic which depends on the type of
industry that they compete in. The degree of flexibility for firms determines the quality
of information that will be available for investors to analyze and decide what financial
position the company is actually in. The more flexibility a manager has, there is more
potential for accounting numbers to look favorable. These policies are closely regulated
and monitored by the Financial Accounting Standards Board (FASB) which has
delegated authority from the SEC. Further, the guidelines for accounting are established
by Generally Accepted Accounting Principles (GAAP) which expresses the standards,
rules, and procedures set forth by the FASB. Certain accounting policies are more
regulated than others, which gives managers a different degree of flexibility depending
on the type of policy they are evaluating. For example, managers have no flexibility on
the way that research and development is expensed. According to GAAP, this activity
must be expensed as it is incurred and there is no flexibility in doing so. However, in
regards to other policies such as inventory costing methods, pension plans, and lease
arrangements, managers have some control over how to record such activities as to
42
relate them to the business environment they compete in. The choice that managers
make in conducting accounting policies is very important to the firm, and the way these
are carried out greatly affect the overall position of the company in the economy.
Research and Development
Research and development is a very important accounting policy that firms
conduct in order to increase their economic position. In the industry that Dell competes
in, each firm spends a great amount of money in order to conduct research and
development. According to the 10-K, during fiscal year 2007 Dell spent $ 498 million on
R & D. Firms invest in this activity to stay ahead of competition by finding new
innovations that could potentially increase profits in the future. When it comes to
accounting, this investment that firms undertake is required by GAAP to be expensed as
it is incurred. Even though investment in research and development adds value to a
firm, it must be recorded on the income statement as an expense. Part of the reason
for this is that it is often too difficult to estimate the benefits of research and
development because certain new technologies and products might not ever make it to
the market.
Operating and Capital Leases
When it comes to accounting for lease arrangements, managers of firms have a
much greater degree of flexibility. There are two types of leases that a firm can choose
to report, operating and capital, each with its own set of characteristics that cause a
manager to choose one over the other. If the firm wants to treat a lease as a rental
contract, then they will record it as an operating lease. In this circumstance, the
transaction does not affect the balance sheet because the lease is not recorded as an
asset. The owner of the asset leases it to a firm for a specified time period and expects
to receive it back with value still left on the asset. This transaction will include rent
expense on the income statement for the lessee. On the other hand, if the firm chooses
to use a capital lease, it is considered equivalent to a purchase and therefore written
down as an asset on the books with a corresponding lease liability. This type of lease
43
gives the lessee direct ownership of the asset they are using. Dell leases property and
equipment, manufacturing facilities, and office space under non-cancelable operating
leases as well as other capital arrangements. In large corporations like Dell and its
competitors leases are in the million’s of dollars every year. Firm’s managers will choose
which type of lease they want to use depending on how they want their assets to look
or when they want to recognize expenses when it comes to reporting.
Revenue Recognition
When it comes to recognizing revenue and calculating allowances for doubtful
accounts, there is also some degree of flexibility. Determining when to record revenues
is an important decision for a manager of a firm. When it comes to certain things like
warranties and sales contracts, revenues might need to be recorded as deferred and
should be recognized over a set time period. In Dell’s case, they offer extended
warranty and service contracts to customers which obligates them to perform other
services. Revenue from these practices is recorded as deferred revenues and is
subsequently recognized over the life of the contract or when the service is complete.
The only time that these revenues are not deferred is when a third party sells extended
warranty and service contracts that Dell is not obligated to perform. When these sales
occur, the revenue is recognized at the time of sale on a net basis. When warranties are
sold, Dell records a warranty liability at the time of sale for the amount of cost they
estimate that might be incurred under the specified terms of the warranty. There are
factors that a firm looks at to determine how much liability to record which include
historical claim rates, number of units currently under warranty, and the cost per claim
on a warranty. Estimates that impact the recognition of revenues include returns on
sales as well as allowance for doubtful accounts. Firms have a choice in determining
how to make such estimates. When it comes to estimating returns on sales, Dell bases
them on estimated returns and the number of units that have been shipped that still
have the right to be returned. Historical experience also plays a big factor in estimates
for both returns and allowances. In the decision for allowances for doubtful accounts,
firms including Dell will include factors such as previous customer default rates and they
44
make anticipations on how much they think will default in the accounting period at
hand. The effect on the accounting books is a contra- asset allowance account and also
a Bad Debt expense.
Pension Plans
Another policy that firms must consider when making accounting choices is
determining costs associated with pension plans. Firms have a choice in deciding which
type of plan to offer their employees which include either a defined benefit or a defined
contribution plan. Under a defined benefit plan, an employee receives a set monthly
amount as determined by the employer for a specific time period. On the other hand, a
defined contribution which includes the 401 K and 403 B plans, is where an employer
promises to make contributions to an employees account. The contributions can vary
greatly between firms. For instance, Dell has a defined contribution plan which offers a
4% contribution to its employees according to the 10-K. It is an important decision for
managers to determine what type of plan the firm will have as well as the discount rate
associated with it. Firms are required to make estimates for pension costs based on the
present value of future cash obligations. Firms have a choice in determining what
discount rate to use for the present value but if this rate is too high, the present value
will be too low which will provide an understatement of liabilities on the books. In
practice, doing this would increase the perceived value of the firm because the liabilities
on the balance sheet would not be high enough. Conversely, if they use too low a
discount rate, the present value will be overstated as well as the ensuing liabilities. With
this said, even though there is flexibility on this subject, managers need to be careful in
determining rates for their pension plans.
Conclusion
The degree of accounting flexibility varies widely throughout firms as well as the
industry that a company competes in. Some accounting policies offer firms a choice on
how to report them while others are highly regulated by standards and principles. If a
manager has a choice in accounting, they might be able to manipulate numbers to
45
provide a higher perceived value to potential investors and financial analysts. Otherwise
they have to go by the book even if doing so will decrease the value of the firm or
make it look like they are struggling financially.
Accounting Strategy
Companies have extensive control over how, what, and when they report their
financial statements. Companies, or more so managers, attempt to alter financial
statements in several ways including aggressively recording revenues, hiding expenses,
or diluting liabilities in the short term. Management manipulation is the main concern
of most executives concerning accounting strategies within firms. Financial manager’s
job is to maximize their specific sectors performance. Altering financial statements is
easy and tempting if a sector is underperforming. This construes data sent to
shareholders and other significant readers of a company’s financial reports. Managers
are allowed to be creative in their accounting policies to a certain extent according to
GAAP and other accounting laws. Accounting strategies in the technology industry
consist of research and development, pension plans, cost control, and recognition of
leases have on the financial statements and the overall value of the firm. Depending on
the extent of these financial discrepancies firms will either portray a transparent picture
into the firm’s activities or create a cloud in communicating particular financials to
investors and competitors. Dell is somewhat conservative in reporting when it comes to
certain financial numbers. On the other hand their business strategies and management
decisions are very conclusive. Limited disclosure makes it difficult to determine just
how much these strategies will affect the value of Dell and its competitors.
Research and Development
In the technology industry, research and development is a key accounting
principle due to extremely high investments and the necessity to stay on the cutting
edge. Most of the industries research and development investment is spent purely on
creating innovation and new product creation including Dell. Constant innovation has
actually become a problem in the technology industry from the view of accounting
46
principles. GAAP requires firms to immediately expense any research and development
when recognized. When managers of a company have accounting flexibility, there is
always a chance that a firms’ true economic performance could be slightly manipulated.
To get an accurate value, a large amount of research and development should be
adjusted to the asset account which would allow a firm to recognize the benefits of
their time and effort.
When companies make huge adjustments in research and development it causes
expenses to be overstated conversely causing net income to be understated. When net
income is understated and moves into retained earnings, owner’s equity is also
understated. However, there are balance sheets and protocols in place to ensure
assets are either financed by liabilities or part of owner’s equity. So, if or when owner’s
equity is understated, assets are adjusted or financed to also be understated. This
method is almost exclusively used only in the technology industry.
In most of today’s industries, GAAP regulations work and allow companies to
accurately record their research and development as an expense. However, in an
industry requiring technology innovation each year, GAAP fails to allow firms to
accurately value their company. Most of the technology industry invests a huge
percentage of their company into research and development which can be devastating
to a company’s financial statement after adjustments. Managers under constant
pressure often try to write off high research and development expenses to other areas,
which will again alter financial statements.
Operating and Capital Leases
In large industries such as the technology industry most companies have millions
of dollars invested in leases every year. Most leases are reported as operating leases
and are expensed when incurred. However, some companies report capital leases
which are transferred into an asset account. Companies can change accounting policies
and significantly change their appearance to consumers. Operating leasing decreases
the current ratio while capital leasing increases it. Also, it gives a more realistic picture
47
of the company’s situation. As stated above, Dell states almost all leases as operating
leases even if it does hurt some financial ratios. Dell also owns more property in square
footage than it leases.
Companies face problems here sometimes when managers change reporting
methods to improve their financials. The biggest problem occurs when both the lessee
and leasor report operating leases. One company has to record the lease as an asset
and the other as a liability according to normal lease agreements. Dell has been
consistent for years with its leasing policies and continues to do the same.
Pension Plans
Pensions are one of, if not the biggest, employee incurred expenses for
companies. Pensions can consist of several different expenses like health care and
retirement plans. Retirement is the most volatile of these expenses because they have
to be constantly estimated using different discount and growth rates keeping on track
with changing inflation rates. Again, this is another way for managers to change
financials to satisfy their quotas and ratios. Pension plans are huge assets to a
company’s employees, these quality retirement and health care plans keep employees
loyal. Since Dell’s beginning they have always taken pride in their employees. They
have an excellent benefit package in place for their employees keeping their turnover
ratio down. Having quality pension plans are both good and bad for companies. They
are also very costly to the company and its investors. Discount rates are used to
forecast the present value of future payments. Normally, discount rates are very similar
across industries; rates will vary slightly due to economic outlooks when calculating the
forecast.
Discount rates are the rates that are calculated by projecting profits or in this
case payments in the future and discounting them back in time to calculate their
current net present value. So when discount rates are off, the value of future cash
payments is also off, which either under or overstates current liabilities and expenses.
This is normally done accidentally although managers have the ability to manipulate
48
figures. Companies are trying to impress potential investors and maximize shareholders
wealth. That pressure is often enough to make managers alter their financials, leading
to some companies downfalls.
Cost Control
Cost control is an integral part of any company. Dell is no exception, cost control
is its highest priority and one of the main reasons they have been so successful. Dell’s
direct business model is a huge part of this, they have managed to cut out almost all of
the middlemen and use just-in-time inventory to further reduce costs. Aside from
general everyday cost control measures, companies in the technology industry have to
account for warranty expenses, pension plans and income taxes. Just like pension
plans, warranty expenses and income taxes are forecasted from year to year. It is
inevitable for the forecasts to be off at one time or another. Warranty expenses and
income taxes are recalculated every quarter to accurately record expenses. Cost
control discrepancies normally do not affect financial statements as much as some other
accounting errors or manipulations.
Conclusion
Accounting strategies are a crucial part of all companies’ financial responsibilities.
The ability of managers and companies to manipulate these financial statements can
allow an untrue picture of the companies to the public. Managers do this when
tremendous pressure comes from executives to constantly perform better. There will
always be the possibility for managers to alter numbers. This paints an untrue picture
for investors and consumer’s alike, creating doubt and mistrust. Companies have the
knowledge and abilities to report accurate financials. Companies know all accounting
laws and their severe repercussions.
49
Evaluating the Quality of Disclosure
Every year companies are required to publish reports of their previous fiscal year.
These reports are very important to investors and the public. Every year the SEC audits
these reports for any errors or discrepancies. There are laws that outline the minimum
amount of information that must be published. Companies vary in the amount and
quality of reports. The better and more conclusive companies reports are, allows for
much more accurate and reliable analysts measurements.
Quantitative Disclosure
Dell’s revenue is generated from various segments of its operations. This
segmentation of its products can produce a distorted view of revenue sources if not
properly disclosed. However, Dell outlines the revenue generated from each one of its
product segments in the Management Discussion and Analysis. Dell presents net
revenue by product category in both absolute and relative terms. Being able to look
revenue data in the disaggregated format allows us to see the growth in different
segments and shows us in which product segments Dell really succeeds and where we
should expect growth to
continue.
2-Feb-07 3-Feb-06 28-Jan-05
Dollars% of Revenue Dollars
% of Revenue Dollars
Desktop PCs 19,815.00$ 34% 21,568.00$ 39% 21,141.00$ Mobility 15,480.00$ 27% 14,372.00$ 25% 12,001.00$ Software and peripherals 9,001.00$ 16% 8,329.00$ 15% 6,626.00$ Servers and networking 5,805.00$ 10% 5,449.00$ 10% 4,880.00$ Enhanced Services 5,063.00$ 9% 4,207.00$ 8% 3,121.00$ Storage 2,256.00$ 4% 1,863.00$ 3% 1,352.00$
Net Revenue 57,420.00$ 100% 55,788.00$ 100% 49,121.00$
Fiscal Year Ended:
50
Problems: How to solve them
The Securities and Exchange Commission (SEC) contacted Dell in August of 2005
requesting information about certain aspects of their accounting and financial reporting
methods. While compiling the requested information for the SEC, management was
notified of important matters involving the accounting and financial reporting. Items of
particular concern were whether certain balance sheet items had been properly
adjusted and reported. Management, after careful review and consulting with an
independent auditor, decided that the attention raising issues demanded an internal
investigation into Dell’s accounting and financial reporting standards.
The audit committee of Dell’s Board of Directors, upon the recommendation of
management, approved an internal investigation. Dell hired KPMG, an external
accounting firm, to conduct the investigation. KPMG used several different methods for
determining where errors or adjustments may have been made. Concurrently with
KPMG’s investigation, Dell also initiated an internal investigation into accounting and
financial reporting principles of the firm. The results of these investigations led to the
discovery of several intentional adjustments by Dell employees in order to attain certain
term goals. These adjustments and misstatements were material, significant to the
financial standing of the firm, and intentional. However, some of the reporting errors
that were found were unintentional. In KPMG’s report they stated that several of the
adjustments were in amounts ranging from several hundred thousand to several million
dollars. This type of distortion is extremely significant to a firm with the financial
position of Dell or any firm for that matter.
Dell acknowledges these errors and adjustments and has devised a corrective
plan for the remediation of its deficiencies in accounting and financial reporting. They
have outlined a plan in The Notes to Consolidated Financial Statements of their 10-K for
fiscal year ended 2007. As part of the remediation efforts, Michael S. Dell re-assumed
the position of Chief Executive Officer and Donald J. Carty assumed the role of Chief
Financial Officer. Under this new leadership team and other management members,
51
Dell will be set on a new path dedicated to financial reporting integrity, high ethical
standards, and an increased control environment. The focus of management and all
employees will be shifted from achieving short-term operating goals to that of
increasing shareholder value on a more long-term basis. Reprimands, terminations, and
reassignments of other employees have and will continue to take place as Dell
continues to coordinate the remediation of their past deficiencies. In addition, Dell has
taken steps to segregate the accounting and financial reporting responsibilities from the
planning and forecasting responsibilities to achieve a greater level of integrity amongst
its finance department. These and other processes and procedures are being
implemented to remediate Dell’s acknowledged shortcomings.
Investor relations
Companies make data available to investors in many different ways depending
on the sensitivity of the information. Many post through their website, conference calls,
press releases, and Security and Exchange Commission filings. Investor relations are an
extremely important attribute of a firm’s financial disclosure quality. It is through this
avenue that current and potential investors get all information to base their investment
decisions. The quality of communication that the firm provides through these avenues
must be read and interpreted very carefully. One must understand the intentions of
those responsible for the reporting. This is another example of the Principle-Agent
problem which involves the tendency of members of management to distort information
in a favorable light for their own benefit.
Dell, however, has a very informative investor relations website with excellent
disclosure methods. Since the return of Michael Dell to the Chief Executive Officer
Position in January 2007, Dell has recognized and acknowledged certain shortcomings
in disclosure. In addition, Dell has a renewed dedication to informing its owners and
potential investors of how they will be remediating these, and other, issues.
52
Business strategy disclosure
The business strategy of a firm is important to investors. It tells investors the
manor in which the firm chooses to compete in the industry in which its products and
services are located. Company’s strategies are disclosed in the Management Discussion
and Analysis portion of its annual report. Often business strategies have to evolve as
they continuously adjust to changing market and economic conditions to expand in the
most profitable areas. Expanding relevant technologies and solutions, and developing
more efficient manufacturing and logistics to increase the value added by the core
infrastructure can add tremendous value to a company.
Dell’s core values incorporate simplifying information technology for customers,
offering a large customizable selection of products, and a commitment to environmental
responsibility in all aspects of the business. By providing high-quality products, relevant
technology, and customizable solutions to its customers Dell has acquired a competitive
advantage that will allow the firm to continue its market share growth experienced for
the past few years. In their annual report Dell is very descriptive and informative about
the status of the firm’s business strategy now as well as the direction of future
strategies that leadership plans to implement. This high quality disclosure of business
strategies makes Dell attractive to potential investors and current shareholders.
Explanation of trends in revenue and expenses
In the quarterly and annual reports Dell has filed with the SEC they explain
trends in revenue and expenses in the footnotes and the Notes to Consolidated
Financial Statements. This disclosure describes why Dell has experienced a decline in
revenues from fiscal year 2006 to fiscal year 2007. A descriptive analysis is provided for
investors to decide for themselves the effects of the business decisions made by Dell
leadership.
53
In addition to explaining revenue and expense trends Dell evaluates its exposure
to certain market risks, interest rate risks, and industry conditions. Some of the risks
the firm is exposed to are beyond their control. However, the management of
controllable risk is important to the success of the firm. Dell explains the strategy used
to hedge against fluctuations in foreign currency rates, debt interest rates, and
investment activities. This is yet another example of Dell’s high quality disclosure in
financial reporting.
Conclusion
We have found that Dell’s quality of disclosure is high. They do an excellent job
of describing operational activities as well as business strategy. They disclose
information on where they have made mistakes and they discuss how they are taking
action to correct these mistakes. Quality of disclosure is an important factor to consider
when choosing a firm for an investor, and it is clear that Dell would be an excellent
choice for an investor seeking a firm with high quality disclosure.
Quantitative Disclosure
When analyzing the quantitative disclosure of a firm you examine the core sales
manipulation ratios along with the core expense manipulation ratios in comparison to
those in the same industry. We use these ratios based upon accounting numbers
retrieved from the financial statements to search for inconsistencies in trends. If
inconsistencies are discovered, we must investigate for motive. Management may have
manipulated some methods used in sales and expense accounting.
54
Core Sales Manipulation Diagnostics
Using the sales manipulation ratios allows us to investigate trends in sales
accounting methods used by each firm. We will examine the sales to cash from sales,
sales to receivables, and sales to inventory ratios. These ratios will help us see how the
firm specific trends differ from those of the industry. If there is a drastic difference in
firm specific results relative to industry results we must identify the potential accounting
distortions leading to these differences.
The net sales to cash ratio show us the relationship between total sales and the
cash that was received for sales in the year shown. This ratio tells stockholders how
much of sales is collected in cash every year. We see here that there was a decrease in
the cash collected in fiscal 2006 for Apple. This is most likely due to an increase in sales
to enterprise whom are given a grace period for payment of purchases as opposed to a
consumer who purchases a product and must submit payment at the time the order is
placed. This ratio is desired by investors and managers to be low and consistent.
55
The ratio used to create the chart above is the net sales to net account
receivables ratio. This allows us to see what amount of the net sales within a period
were credit transactions. It is important to see the relationship of sales to receivables
because it is a good indicator of the firm’s ability to generate cash from sales. The
higher the ratio the less the amount of sales that were sold on account, and vise versa.
As we see here Dell has been able to maintain a relatively higher ratio than its
competitors due to the fact that a large portion of their business is directly with the
public keeping accounts receivable low. Investors and companies alike want liability
accounts kept as low as possible.
56
The net sales to inventory ratio displayed in chart form above is an indicator of
inventory costs and unit sales. As we can see Dell has maintained an above industry
average ratio for the past five years. This is due in most part to the customer direct
business model Dell employs. This is another ratio that is desired to be higher, the
lower the inventories are the less liabilities and overhead amount to. Keeping costs
down in all areas of business is curtail to successful companies.
Conclusion
We have reviewed the sales manipulation ratios and have determined that there
are no firm specific inconsistencies that require further investigation. Dell’s ratios do
differ from those of the rest of the industry competitors. However, this is a reflection of
the methods employed on a consistent basis due to Dell’s direct business model.
57
Core Expense Diagnostics Manipulation
The core expense diagnostics manipulation examines the expense accounting of
the firm relative to that of the industry. It allows us to determine if there is a possibility
of manipulation of expense accounting.
The asset turnover ratio shows the relationship between net sales to the net
value of assets. This is important because this ratio is an indicator of a firm’s ability to
generate revenue from its assets. As we see in the chart above Dell has a much higher
asset turnover ratio than its competitors. This is, again, a reflection of the business
model Dell incorporates. Even though there is a variance from the industry norm, there
does not appear to be any material distortion of expense accounting using the asset
turnover ratio.
58
This ratio shows relationship of the change in cash flow from operations to the
operating income. This trend analysis allows us to see if the firm maintains a consistent
ratio. If there is a high variance in the trend it may have been derived from a
manipulation of expenses and accruals in order to achieve period earning targets.
Looking at Dell it seems that there is consistency in the relationship. This is a strong
indicator that there has not been any attempt to manipulate earnings figures. Investors
are interested in this information because it allows them to see if a company’s core
businesses are profiting.
59
The chart above shows the relationship of the change in cash flow from
operations to the value of net operating assets. This relationship tells us about the
firm’s ability to utilize its plants, properties, and equipment. A higher ratio would
indicate that a company is maximizing the use of its assets. Maximizing productivity is
major concern with any company in any business. This being the case, a higher ratio is
always preferred. Variations may be an indicator of manipulated earnings numbers due
to adjustments made to accrual and expense accounts.
Conclusion
Using the manipulation diagnostic tool set gives us a quantitative understanding
of the consistencies and inconsistencies within a firm. This is an important aspect to a
valuation because it is a strong indicator of earnings management if there seems to be
a deviation from the trends set in place. Dell over the past five years appears to have a
consistent set of ratios. This consistency shows an ability to disclose information
without manipulation.
60
Potential Red Flags
By analyzing the 10-K’s and diagnostic ratios of a company, an analyst can
determine if the figures have been manipulated. This manipulation of company data
poses as a “red flag” to a reader and distorts their perception of the financial position of
the firm. After doing a thorough examination of all aspects of Dell, we noticed one area
that needed to be discussed. This potential red flag was the way that they accounted
for their leases. Although this area caught our attention, we feel that Dell has properly
and accurately disclosed all other information. Therefore, there are no other potential
red flags.
Undoing Accounting Distortions
If any “red flags” are found after analyzing a firm, the analyst will have to undo these
red flags to accurately show the financial position of that firm. Red flags can be a
variety of distortions that can alter a company’s financial reports to make them look
better than they actually are. When analyzing Dell, we found one particular red flag that
we thought needed attention. The way Dell records leases could be more accurately
reported. They automatically expense these leases as a rent expense. We feel that
these leases should be capitalized instead of expensed. As a result of expensing these
leases, assets and liabilities are overstated on the balance sheet, misrepresenting actual
figures of the company. Aside from this, we feel that Dell is a high disclosure company
reporting reliable and consistent data to investors and the public.
61
Financial Analysis, Forecast Financials, and Cost of Capital
Estimation
Throughout this section we will go over the financial ratio analysis, financial
statement forecasting methodology, and cost of capital estimation for Dell and the
industry in which Dell competes. The best way to analyze the financials of these firms
is through ratios. Liquidity, profitability, and capital structure ratios are the most
commonly used by analysts to assess the value of a company. All of these ratios help
in monitoring how well a firm is performing. After these ratios are computed, they will
help to forecast the expectations of these firms in the future. Finally, to close out the
financial analysis section we will calculate the cost of capital estimation to see how
expensive it is for these firms to raise capital for use in their future business operations.
Liquidity Analysis
Liquidity ratios measure the ability of a company turn their assets into cash. One
of the main reasons that investors look at this ratio is to see if in case a firm were to
get into debt, what amount would they be able to pay? Most often these ratios are
used to derive the credit risk of a company. There are numerous ratios calculated to
help investors and creditors formulate an analysis of a specific firm. Creditors also use
these ratios to create covenants within their contracts requiring firms to maintain
certain levels of leverage and liquidity. The most commonly used ratios are the current
ratio, quick asset ratio, accounts receivable, days in accounts receivable, inventory
turnover, days in inventory, and cash-to-cash cycle.
62
Current Ratio
The current ratio is calculated by dividing current assets by current liabilities.
This ratio shows the firms’ ability to cover the current assets with the current liabilities.
It is desirable to have a high current ratio. The higher it is, the more capable the
company is to pay off its short-term debt by liquidating most of its current assets. Dell’s
current ratio is lower than most of its competitors because they have been aiming
towards having zero working capital which creates lower cash requirements. As you can
see from referencing the graph above, Apple currently has the highest current ratio and
has been at the top of the industry average over the past 5 years. A reduction in cash
requirements leads to a reduction in the current ratio over time.
63
Quick Asset Ratio
The quick asset ratio is calculated by dividing the “quick” assets by current
liabilities. These quick assets are cash and cash equivalents, securities, and accounts
receivable. This is another ratio calculated to show investors and companies how fast a
company can pay off short-term debt. This breaks it down to only the most liquid of
assets; accounts that can be turned into cash in a very short period of time, normally a
few days. A ratio of close to one or more is desired by most companies. The higher the
ratio the quicker a company can pay back debt even in a sudden financial crisis. Dell
has been hovering around one consistently for the past few years, which is fairly close
to that of its competitors. This is caused by Dell’s consistent low amount of cash on
hand. Apple, once again led the industry in this category. Although, Dell has continued
to stay with other competitors in the industry.
64
Accounts Receivable Turnover
Accounts recievable (A/R) turnover is calculated by dividing sales by accounts
receivable. This allows an analyst to determine how productively the accounts
recievable portion of working capital is being used. Again this ratio is desired to be
high, this actually measures the amout of times a company turns over its accounts
recievables every year. Dell has been keeping a turnover rate of around twelve for the
past few years. Dell has been able to keep this up because it deals with short collection
periods from most of its public customers. There are few places to get Dell products in
stores, when ordered via the web consumers must pay then or create a short term
payment plan. As most of these ratios have turned out, Apple again leads the industry.
Apple has a business plan which was implemented to focus strictly on beating many of
these statistics in the industry.
65
Days Supply Of Receivables
Days supply of receivables is the amount of days it takes a firm or company to
collect its accounts recievables. Calculated by dividing 365 by the accounts recievable
turnover. This is a simple ratio that shows how quickly a company can collect its
money. Dell has an A/R turnover that remains consistenlty around thirty days. This is
close to the market average which shows that Dell is a financially sound company and
that they have the ability to collect recievables in a timely manner. The more efficient a
firm can be at collecting their receivables, the better off they will be. Some investors
look at this statistic as a key principle of the business strategy that is implemented. It
is very important to have a quick turn around of cash in hand. The longer firms allow
customers to wait before paying them, the less cash they have on hand. Many people
invest by the philosophy that money today is worth more than money tomorrow.
66
Inventory Turnover
Inventory turnover is similar to A/R turnover except inventory turnover is the
measure of how many times a company turns over their inventories evey year as
opposed to accounts receivable. This is calculated by dividing cost of goods sold by
inventory. It is desirable for this ratio to be high. The more times the firm has to re-
order and stock their inventory, the higher their sales will be to a certain extent. Some
could also look at a high ratio as the fact that a company does not keep a very large
inventory. Obviously a firm that keeps an inventory of half the size of another
competitor in the industry but has the same amount of sales would have a higher A/R
turnover. Dell has been a consistent leader in this category through the years. The
reason for this is Dell’s unmatched direct model and just-in-time invertory system.
Because they have not been matched, they have a higher inventory turnover than their
competitors.
67
Days Supply Of Inventory
Days supply of inventory is a simple ratio to understand. It is desirable to be low
because it tells how many days it takes a company to turnover its inventories. The more
times you turnover your inventory per year then the lower the days supply of inventory
will be. This is derived by dividing 365 days by inventory turnover. Dell is again a
consistent leader in this category because it utilizes the direct model and just-in-time
inventory systems. Dell has been constantly around 5 to 6 days, its only true competitor
in this aspect is Apple. HP along with IBM both have larger ratios and as of last year
began a downward trend to try and get closer to the industry average.
68
Cash-to-Cash Cycle
The cash-to-cash cycle is calculated by adding days supply of accounts
recievable and days supply of inventory. This ratio shows analysts how long it takes to
convert inventories and labor costs into cash. Basically, it is the amount of time it takes
the company to complete one cash cycle. Starting with the inventories through
accounts recievables and finally when they are collected. Dell averages around 30 days
which leads the industry. Dell and Apple once again have the best ratio in this industry.
It seems that since they have a newer business strategy than HP or IBM, they have
focused on implementing different techniques than the previous firms in the indsutry.
Being able to have a great ratio comes from the extremly fast inventory turnover rates.
Conclusion
After analyzing Dell using various liquidity analysis ratios, we have concluded
that they are performing within the overall average of the market or industry. This
means that Dell is able to pay off its debt in a timely manner. They over-performed in
the areas of inventory turnover, days supply of inventory, and the cash-to-cash cycle.
However, they under-performed on the basis of current ratio and days supply of
receivables. With this said, it brings them closer to the overall average performance of
69
their competitors in the industry. From an investor’s standpoint, a firm that has ratios
around or above the industry average is very appealing.
Profitability Ratio Analysis
The basis for profitability ratios is to determine how efficient a company is in
creating profit. All profitability ratios are divided by sales, which is the basis to
performance of a sales driven company. The more efficient a company is the more
profitable they become, thus attracting investors and debtors. There are five basic
profitability ratios; gross profit margin, net profit margin, asset turnover, and return on
assets, and return on equity.
Gross Profit Margin
Gross proft margin is gross profit divided by sales. Gross profit is calculated by
subtracting cost of goods sold from sales. This ratio is used to analyze how well a
company can cover the costs incurred when purchasing its inventories or anything that
goes into cost of goods sold. “Gross profit margin is affected by two factors, the first is
the price premium that a firms product or service command in the marketplace and
second is the efficiency of the firms procurement and production process.” (Palepu &
70
Healy) Dell is constantly lower than the industry average of almost 31%. This is
because Dell uses its direct model and has been a constant price leader.
Net Profit Margin
Net profit margin is calculated by dividing net income by sales. This is the most
commonly used profitability ratio, where once again bigger is better. This is valuable to
investors because it shows the bottom line profitabliity of a company. This ratio tells
investors how much of every income dollar will be transferred in retained earnings,
possible dividends, or invested into owners equity. Again Dell is lower than most of the
industry. This has to do with Dell’s low prices and direct-to-consumer model. Dell has
been consistent for most of the past years until recently. This has been the result of the
recent economic downturn.
71
Asset Turnover
Asset turnover is calculated by dividing sales by total assets producing a ratio
that shows analysts how many times a company’s assets produce sales every year. This
ratio shows how much money every dollar invested in assets produces in sales dollars.
For example in 2005 Dell’s asset turnover was close to 2.50, this means that $2.50 of
sales was produced for every $1.00 invested in assets. Even though this number may
sometimes be low, it is a good ratio for analysts to use. When numbers are low one
needs to see how much money was invested. Sometimes investing for the future can
decrease this ratio. Dell is the leader here again because it has a high amount of sales
and a consistantly low amount of total assets.
72
Return On Assets
Return on assets (ROA) is calculated by dividing the current year’s net income by
the previous years ending total assets. The previous years assets are used in this
equation because the assets that are already owned are the ones that were used to add
profit to the firm. ROA is a fairly volitale ratio because there are many different
accounts that go into net income and total assets. One or more of those accounts can
dramatically change during a years time. Dell has been fairly consistent for the past few
years. However, as of recent they have dropped due to changes in the company and
the economy as a whole.
73
Return On Equity
Return on equity is calculated by dividing net income by ending owners equity
from the previous year. This is a very similar ratio to return on assets. This ratio shows
investors the overall profitability of a company. “ROE provides an indication of how well
managers are employing the funds invested by the firms shareholders to generate
returns.” (Palepu & Healy) As you can see Dell is a very profitable company, currently
over 70% of every dollar invested is returned in profits. This is relatively high compared
to their competitors.
Conclusion
After analyzing the profitability ratios we have determined that Dell’s overall
performance is average compared to the industry. The profitability ratios tell how
efficient a company is at creating profit. In the areas of return on equity and asset
turnover Dell over-performed compared to its competitors. However, they under-
performed on the basis of gross profit margin.
74
Capital Structure Analysis
The capital structure of a company is the way a company choses to finance their
assets. Assets can be financed by either debt or equity. Financing using debt is done by
borrowing money from a bank or other lender. Equity financing is done by selling
shares of stock to raise equity. Analyzing the capital structure allows investors and
debtors to analyze how efficiently a company is managing its debt and income.
Debt To Equity Ratio
The debt to equity ratio is calculated by dividing total liabilities by owners equity.
This ratio shows how much of a company is financed by debt compared to overall
equity. Dell currently has a ratio of five-to-one, meaning that dell has five dollars of
debt for every every dollar of equity. Dell is higher than the indusry average because of
recent investments. They also depend less on owners investments than do other
companies.
75
Debt Service Margin
Debt service margin (DSM) is calculated by dividing current operating cash flows
by the previous years ending current maturities of long term debt. The previous years
debt is used here because it is the debt that is currently being paid for. DSM is a margin
that analysts perfer to be higher. Dell is currently under-performng the industry due to
its lower profit margin. Also, Dell is less pressured to use operating cash flows to pay
for long term debt. This allows Dell to generate more profit with invested dollars as
seen in return on equity.
Conclusion
After analyzing the capital structure of Dell, we came to the conclusion that they
under-performed compared to the industry. They are not very effective at managing
their debt and equity compared to their competitors.
76
Internal Growth Rate
The internal growth rate is calculated by multiplying return on assets by one
minus the dividend payout ratio. The dividend payout ratio is dividends paid divided by
net income. IGR shows analysts how well a company will perform and grow in the more
distant future without the help of outside investors. This is done by calculating how
much of net income will be used in the future before being added to retained earnings.
Dell has a fairly constant IGR and is above the industry average. Again proving to
analysts how profitable and reliable Dell is as a company.
77
Sustainable Growth Rate
Sustainable growth rate (SGR) is calculated by multiplying the internal growth
rate by one plus the debt to equity ratio. This measures how much a company can
grow their internal growth rate without increasing debt leverage. This estimates how
much a company can grow when they reinvest in retained earnings also allowing for
additional outside investments. It is calculated using a company’s current debt leverage
ratio.
Forecast Financials
The goal of the financial statement forecasting methodology is to determine
future values of a firm using ratio trends and benchmarks, industry averages, and the
firm’s financial statements. These sectors will help to produce the future income
statements, balance sheets, and cash flow statements. We feel that it is important to
take a diverse portfolio of ratios and statements so that we can try to have as accurate
as possible forecasts. We believe that it is important to forecast 10 years of financials.
With that being said, we also understand that the farther out in years that you forecast,
the harder it is to be accurate with your numbers. During this section we will look at
multiple aspects of ratios and financials to get as accurate predictions as possible.
78
Income Statement
To begin our forecasting section, we started with the income statement. We
created a common size income statement which looked at the income statement in
comparison to sales. Creating a common size income statement will help for us to look
at past results and see the different trends in the financials. We will look at these
trends for the firm and compute a five year average of their financials. Along with
Dell’s average over the last five years, we will also look at the industry wide average to
help compute as accurate as possible predictions.
We started off by forecasting Dell’s future sales and sales growth. In order to
come up with the rate to forecast Dell’s sales, we took an industry wide average and
compared it to Dell’s growth average over the past five years. We came up with an
industry weighted average growth rate of 9.6% and Dell’s previous five years growth
rate came to 13.1%. Although, Dell’s 2007 growth rate was 2.9%, we feel that Dell will
grow at a rate of 3.00% over the next 10 years. This rate was figured by looking at
competitor’s trends and Dell’s trend. Dell has recently implemented new sales
strategies by opening new stores and planning to grow their sales numbers in new
ways. Therefore, we feel that although Dell has experienced a reduction in sales over
the last couple of years, now they will rebound starting in 2008 with the new strategies
that have been implemented as well as the industry growth rate.
Ideally, Dell would prefer to keep their gross profit ratio at least at the same rate
if not better than previous years. Therefore, when calculating the cost of goods sold
over the next 10 years we came to the conclusion that cost of goods sold should grow
at the percentage rate of sales. These rates are figured by taking the average over the
last five years divided by sales. The rate of cost of goods sold divided by sales is
81.99%. By achieving this rate they will keep their gross profit margin at a rate that
will keep profits at the same rate as they have been in years past. Dell’s expectations,
like most corporations, are to improve each year. We feel that in order for this to be
possible they must keep this ratio increasing at this rate.
79
Research and development (R&D) is a vital part of the technology industry. This
department is crucial in keeping the company innovative and on top of the newest,
hottest items on the market. Over the last 5 years, Dell has increased R&D by an
average rate of 2.4%. We feel that with the market as tight as it is at this point, R&D is
a very important aspect of the technology industry. We chose a rate of .96% of sales
for R&D to increase over the next 10 years. We believe it will take that much allocation
of funds in order to continue to grow and compete at a high level in this industry.
As the goal of Dell is to grow, obviously it is necessary to expect new plants, new
employees, new equipment, and larger facilities. We feel that they will increase these
operating expenses at a rate of 10.83% of sales each year. This will help them to
gradually use funds to continue to grow. Allocating this percentage over 10 years will
help them offset these costs over that period of time and to continue to grow at a rate
expected. By increasing all of these categories, this will also help to increase the
operating income that Dell will receive in each of the next years. By looking at different
trends in both Dell and the industry, we have forecasted the operating income to
increase at a rate of 7.18% of sales over the next 10 years.
By increasing sales strategies and corporate structure, we are expecting Dell’s
net income to increase at a rate of 5.65% of sales over the next 10 years. They will be
able to do this by utilizing the different strategies discussed on the income statement
previously. Sections such as R&D making sure they utilize their funds to increase the
innovation and efficiency of the company. Becoming cost effective and taking
advantage of sales programs and growth will help Dell get to the level they are
expecting.
The different rates for these items on the income statement were calculated by
looking at the industry average, Dell’s average, Dell’s trends, and the different
benchmarks and trends in the industry. By considering these different strategies, we
were able to use a weighted average to come up with the forecasts of the next 10
years.
80
81
82
Balance Sheet
To forecast the next 10 years of Dell’s assets, liabilities, and owners equity we
first had to link the forecasts from the income statement to the balance sheet. We did
this by employing the total asset turnover ratio. This ratio shows the relationship
between sales for one year and the assets of the firm. We wanted to estimate a growth
rate for this relationship. We felt that sales would level off over the next 10 years while
assets maintained a fairly steady growth rate. This led us to use a slightly lower total
asset turnover than had been the average for the past 5 years of 2.45. This allowed us
to maintain a constant relationship between the balance sheet and the income
statement through sales.
To begin, the current assets grew at the rate of current assets/total assets for
the last five years. The total assets were forecasted by looking back at the income
statement and connecting sales to the total asset turnover. This helped to check our
figures and ensure that our forecasts are as accurate as possible. As liabilities plus
stockholders equity have to equal assets, it is important that these figures all coexist
with each other. The current liabilities are forecasted using the current ratio. This ratio
is the current assets divided by the current liabilities. Therefore, you calculate current
liabilities by dividing the current assets over the current ratio. The stockholders equity
of the firm is equal to last year’s stockholder equity, plus net income, minus dividends.
Since Dell is a non dividend paying company, you leave the dividend part out. To check
your figures you may then add total liabilities to total stockholders equity and see if that
equals total assets. If these figures check to be the same, you have done the correct
calculations.
83
84
85
86
Statement of Cash Flow
The statement of cash flow looks at the amounts of cash that are provided from
various activities in the company. Looking at Dell’s financial averages over the past
year was the way we were able to come up with our forecasting for the cash flow
statement. We looked at our predictions for sales, growth, and income and compared
those statistics to Dell’s average over the last few years to give us the best estimate of
where Dell is expected to be in the next 10 years.
Conclusion
When forecasting Dell’s income statement, balance sheet, and statement of cash
flows for the next 10 years, the most accurate way to attain these numbers is by using
a weighted average method. We were able to look at not just Dell’s numbers, but, the
industry as a whole. By calculating the different firms that compete with Dell and
creating a ratio of how large their sales volume is, we were able to come up with the
most accurate predictions for Dell’s financials. Investors look at most forecasts as a
percentage of sales. They look at previous years sales data and use their figures as a
percentage of sales. We implemented this procedure as well to look at Dell’s figures.
Cost of Capital Estimation
Cost of equity
The cost of equity for any firm is the amount of interest paid to shareholders for
owning stock in that particular firm. As a common stock investor, one would demand a
greater return than that of an investment with less risk. Because stockholders are the
last to be repaid in the event of bankruptcy this type of investment is high risk. The
difference in the return expected of a risk free investment, such as a US Treasury Bill,
and that of a riskier investment is the risk premium paid to the investor. We use a
model called the Capital Asset Pricing Model (CAPM) to calculate the cost of equity for
the firm. This model uses the β (which measures the systematic risk of the firm) of the
87
firms stock, the risk free rate, and the market risk premium to calculate the cost of
equity.
To calculate the cost of equity we needed to gather information on the monthly
return of Dell’s stock, monthly Treasury returns for the 3 month, 6 month, 2 year, 5
year, and 10 year rates, as well as the monthly return for the S&P 500 index (which is
the market return) for the past 7 years. Using this data we ran regressions comparing
the return provided by Dell’s stock to the market risk premium for holding periods of 24,
36, 48, 60, and 72 months. Running 25 regressions enabled us to compare betas and
adjusted R2 for all of the observations and to obtain the appropriate beta for our cost of
equity. The adjusted R2 value tells us the percentage of beta that is explained by Dell’s
stock return and the market risk premium. The appropriate value for beta was
determined by finding the highest adjusted R2 value within all 25 regression outputs
and using the corresponding beta value. We found the highest adjusted R2 in the
regression output using the 2 year treasury yield with 36 month holding period and a
corresponding beta of 1.83. The risk free rate used was the 2 year treasury yield of
1.646% and the market risk premium we used was the average 7% observed in the
S&P 500 adjusted using the size adjusting factor for firms with a market capital similar
to that of Dell’s which resulted in a market risk premium of 6.6%. We used this
information to compute our cost of equity to be 13.71% as indicated by the highlighted
chart below. The following charts display the results of the 25 regressions we ran along
with the CAPM calculations of the cost of equity using the current risk free rates.
3 Month Rate
Months Beta Risk Free Rate
Adjusted R Squared Cost of Equity
72 1.15 1.367% 0.29841 8.97%
60 1.42 1.367% 0.29452 10.76%
48 1.68 1.367% 0.30096 12.45%
36 1.83 1.367% 0.32904 13.41%
24 1.84 1.367% 0.32961 13.51%
88
6 Month Rate
Months Beta Risk Free Rate
Adjusted R Squared Cost of Equity
72 1.15 1.522% 0.29888 9.13%
60 1.42 1.522% 0.29486 10.91%
48 1.68 1.522% 0.30154 12.62%
36 1.83 1.522% 0.32983 13.59%
24 1.84 1.522% 0.33018 13.68%
2 Year Rate
Months Beta Risk Free Rate
Adjusted R Squared Cost of Equity
72 1.15 1.646% 0.29698 9.22%
60 1.42 1.646% 0.29414 11.04%
48 1.68 1.646% 0.29934 12.70%
36 1.83 1.646% 0.33020 13.71%
24 1.84 1.646% 0.33006 13.79%
5 Year Rate
Months Beta Risk Free Rate
Adjusted R Squared Cost of Equity
72 1.14 2.497% 0.29431 10.04%
60 1.42 2.497% 0.29267 11.90%
48 1.66 2.497% 0.29585 13.46%
36 1.82 2.497% 0.32963 14.50%
24 1.83 2.497% 0.32958 14.58%
89
10 Year Rate
Months Beta Risk Free Rate
Adjusted R Squared Cost of Equity
72 1.14 3.443% 0.29267 10.96%
60 1.42 3.443% 0.29141 12.83%
48 1.65 3.443% 0.29338 14.33%
36 1.81 3.443% 0.32915 15.40%
24 1.82 3.443% 0.32940 15.47%
Cost of Debt
The cost of debt for any given company is the interest rate that the company
pays on its liabilities, or the amount it pays on its borrowings. In using a weighted
average cost of debt, we gave a weight to each liability in relation to total liabilities and
multiplied it by the corresponding interest rate. The sum of these multiplications gave
us the effective interest rate for all debt held by the company. The interest rates, all
found in the 10-K, varied from 5.25 % to 5.9% depending on the type of debt issued.
The interest rate used on accounts payable was taken from the St. Louis Fed using the
3 month, non-financial commercial paper rate of 2.35%. The following table displays
the debts and interest rates used in calculating the total cost of debt. We found Dell’s
cost of debt to be 3.99%, using the formula for weighted average cost of debt.
Liabilities Debt Weight Interest Rate WACD
Short-term borrowings $225 0.01 5.30% 0.05%
Accounts payable 11,492 0.48 2.35% 1.44%
Accrued and other 6,809 0.29 5.25% 1.51%
Long-term debt 362 0.02 5.90% 0.09%
Other non-current liabilities 4,844 0.20 5.90% 1.20%
Total liabilities 23,732 1.00 3.99%
90
Weighted Average Cost of Capital
The weighted average cost of capital for a firm is an average of the total cost of
equity and debt. It computes an average interest rate that the firm pays to finance its
total assets. The formula for WACC involves the use of the firms market value of equity
(market cap), value of assets and liabilities, and the percentage costs of debt and
equity; WACC = (MVe/ MVa)* ke + (MVl/MVa)* kd. There are also two ways to look at
this cost of capital, before and after taxes. We calculated Dell’s WACC BT to be 10.28%
and WACC AT to be 9.95%. The effective tax rate used by Dell in 2007 was 23%,
according to the 10-K. The following table summarizes this information and shows the
calculations used to arrive at this conclusion.
Weighted Average Cost of Capital
(Mve/Mva)
Cost of Equity
(MVl/Mva) Cost of Debt
tax rate
WACC
WACC BT
(43510/43510+23732) 0.1371 (23732/43510+23732) 0.0399 0 10.28%
WACC AT
(43510/43510+23732) 0.1371 (23732/43510+23732) 0.0399 (1-.23) 9.95%
91
Credit Risk
In order to determine the bankruptcy risk of Dell and its competitors, we used Altman’s
Z-Score. The higher the score, the lower is the risk of bankruptcy. A score of 1.8 or
below is considered to have a high risk of bankruptcy and a score of 3.0 or higher is
considered to have a low risk of bankruptcy. (www.spireframe.com) The Altman’s Z-
Score is calculated by combining these five ratios:
3.3 x (EBIT/Total Assets)
1.0 x (Net Sales/Total Assets)
0.6 x (Market Value of Equity/Total Liabilities)
1.2 x (Working Capital/Total Assets)
+ 1.4 x (Retained Earnings/Total Assets)
Altman’s Z-Score
Altman's Z-Score 2003 2004 2005 2006 2007Dell 5.66 5.21 5.05 5.26 4.84
Apple 3.82 6.58 11.35 8.55 12.13
HP 16.06 12.51 16.05 12.39 11.09
IBM 2.90 2.48 3.04 3.27 3.01
Dell’s Z-Score is the lowest it has been in 5 years. This is likely due to an increase in
debt and a decreasing market cap. A recent decline in sales is also a contributing factor
to the declining Z-Score. This change in capital structure has led to a slightly higher risk
of bankruptcy according to Altman’s Z-Score. However, Dell still remains a highly
unlikely bankruptcy candidate. The asset turnover ratios, which is net sales divided by
total assets, has also seen a recent decline. This is evidence that the firm’s assets are
producing fewer sales dollars per 1 dollar of assets. Overall, Dell has a very low risk of
bankruptcy.
92
Valuation Analysis
Intrinsic Valuation Models
The most accurate and reliable valuation methods are those derived from
intrinsic analysis. These analysis are called intrinsic valuation models and include the
dividends discount model, the residual income model, abnormal earnings growth model,
and free cash flow models. These models give us a more realistic idea of the value of a
firms equity based on forecast earnings numbers. Using the book value of equity is the
starting point for these models. Then we forecast out numbers for the firm for ten
years. These forecasted numbers must be discounted back to present time numbers. To
do this we use the discount rates provided by the weighted average cost of capital and
the cost of equity. The aggregate of these numbers along with any terminal value
perpetuity is what builds the basis for valuation. Analysis of these numbers is very
important as they are a sound valuation process for any firm.
Method of Comparables
Price to Earnings Trailing
Price to Earnings Trailing
PPS EPS P/E Trailing Industry Average Expected PPS
Dell 20.33 1.33 15.29 16.29 21.67 Apple 149.53 3.93 38.05 Don’t Use HP 47.59 2.93 16.24 IBM 116.49 7.13 16.34
Price to earnings trailing is calculated by dividing the price per share by the
earnings per share. For the trailing you use the current earnings per share number.
When you look at the industry average there is an outlier. What this means is there is
a firm which throws off the industry average. The example of this is the fact that
Apple’s P/E Trailing is 38.05, while the other competitors are 16.24, 16.34, and 17.83.
Therefore you throw that figure out. After you throw out any outliers, you compute the
93
industry average and multiply it by the firm you are valuing earnings per share. After
this number was computed the figure came back that Dell’s price per share is valued at
$18.57. This would say that Dell’s stock is fairly valued; the actual price per share at
that time was $20.33.
Price to Earnings Forward
PPS EPS 1 Year Out P/E Forward Industry Average Expected PPS
Dell 20.33 1.60 12.71 13.82 22.11 Apple 149.53 5.13 29.15 Don’t Use HP 47.59 3.52 13.52 IBM 116.49 8.25 14.12
The price to earnings forward is almost identical to the price to earnings trailing
model. The only difference is that with this model you divide the price per share by the
earnings per share 1 year out. As done in the previous model, Apple’s figure was
thrown out. They are an outlier since they are not within $15 of the closest competitor.
After running this model, Dell’s price per share is valued at $20.73. This would mean
that Dell’s current stock price is fairly valued. When looking at this model the advice
would be to buy this stock. This means that the stock price is predicted to be worth
more than it is currently and will go up in value in the near future.
94
Price to Book PPS BPS P/B Industry Average Expected PPS Dell 20.33 1.68 12.10 5.55 9.32 Apple 149.53 19.13 7.82 HP 47.59 15.09 3.15 IBM 116.49 20.55 5.67
For the most part, the comparables models are a lot alike. The price to book
model is calculated by dividing the price per share by the book value per share. There
was not an outlier when using this model so we were able to use all of the competitors
to calculate the industry average. After running the model, Dell’s price per share came
back valued at $10.15. Therefore, this model suggests that Dell’s stock is overvalued
and would advise stockholders to sell their stock.
PEG Company PE EGR (t+1) P.E.G. Industry Average Expected PPS Dell 15.34 5.75 2.67 1.45 8.31 Apple 38.05 22.96 1.66 HP 16.24 14.59 1.11 IBM 16.34 10.44 1.57
The price to earnings growth rate is a unique model. This model takes your
price per share over earnings per share and then divides that figure again by your
earnings growth rate of (t+1) which means the next year. There are no outliers in this
section either, as all of the competitor’s averages are close together. After computing
the model it generates the price per share of $8.31 which leaves Dell’s stock again
overvalued.
95
Price over EBITDA In Billions
Market Cap EBITDA P/EBITDA Industry Average Expected PPS
Dell 45.19 4.51 10.02 8.68 39.13 Apple 134.54 5.56 24.20 Don’t Use HP 114.39 12.25 9.34 IBM 160.25 19.99 8.02
The price over EBITDA is the price over earnings before income taxes,
depreciation, and amortization. This calculation is determined by dividing the market
cap by the EBITDA. When using this model, it was determined that Apple is an outlier
in the industry. The same structure is used to determine the expected price per share
however. Dell’s expected price per share comes out to $39.13, which again shows that
Dell is undervalued.
Price over Free Cash Flows In Billions Market Cap FCF P/FCF Industry Average Expected PPS Dell 45.19 2.19 20.63 21.98 48.14 Apple 134.54 2.90 46.39 Don't Use HP 114.39 6.02 19.00 IBM 160.25 6.42 24.96
The price over free cash flows model is calculated by dividing, once again, the
market cap by the free cash flows. Your free cash flows are calculated by cash flow
from operations plus or minus cash flow from investments. Apple again is an outlier
when calculating the industry average. After calculating the model it computes a stock
price of $48.14 per share. This model also says that Dell is undervalued.
96
Enterprise Value/EBITDA
Company EV ($bill.) EBITDA ($BILL.) EV/EBITDA
Industry Average
Expected PPS
Dell 76.89 4.51 17.05 9.29 41.91 Apple 116.09 5.56 20.88 Don’t Use HP 117.72 12.25 9.61 IBM 179.38 19.99 8.97
In the enterprise value to EBITDA model the enterprise value is first computed
by adding the market value of equity, plus the book value of liabilities, plus cash, plus
the investments. After computing that number, you divide that by EBITDA. Apple
again was an outlier in the industry and was thrown out in order to computer the
industry average. The expected price per share for Dell’s stock was $41.91 using this
model. This model says that Dell’s stock is undervalued.
97
Residual Income
The residual income model is considered one of the most reliable models used to
estimate the value of a firm. This is true because this model is not as sensitive to
terminal value growth rates and assumptions as the other models put into place. The RI
model relies primarily on the present value of residual income and book value of equity
rather than perpetuities.
The residual income is the actual value created or destroyed by the firm. When
the RI is negative, this means that the firm is destroying value to the shareholders. The
residual income of a firm is calculated by taking the difference between the firm’s actual
earnings and a calculated normal, or benchmark, income. This benchmark is calculated
by multiplying the previous year’s book value of equity by the cost of equity. Once the
difference, residual income, is calculated, the present value of each year is taken by
using the following formula: 1/ (1+ke)t. The total present value of residual income is
calculated by adding the present values of each year, which came out to $ 8592 million.
The next step is to determine the value of the perpetuity and discount it back using the
present value factor of year ten with the following formula:
Perpetuity2017= RI2018/ (ke-g).
Using a cost of equity of 13.71% and the appropriate zero growth rate, this value came
out to be $ (2641) million. Once these calculations are complete, the next step is to add
the present value of residual income, present value of the perpetuity, and the initial
book value of equity. This determines our appropriate market value of equity and that
value is then divided by the number of shares outstanding to determine the estimated
share price at the beginning of 2008. To determine the time consistent share price at
April 1, 2008, the beginning 2008 price is given a future value of 3 months later which
gives us an estimated share price at our valuation date, April 1 2008, of $ 4.50.
98
Growth Rates
0.0% -10.0% -20.0% -30.0% -40.0% -50.0%
10.00% $ 8.52 $ 8.21
$ 8.11 $ 8.06
$ 8.03
$ 8.01
Cost 11.00% $ 7.09 $ 7.16
$ 7.19 $ 7.20
$ 7.21
$ 7.22
of 12.00% $ 5.96 $ 6.27
$ 6.38 $ 6.44
$ 6.48
$ 6.51
Equity 13.71% $ 4.50 $ 5.02
$ 5.23 $ 5.34
$ 5.41
$ 5.46
15.00% $ 3.69 $ 4.26
$ 4.51 $ 4.65
$ 4.74
$ 4.80
16.00% $ 3.18 $ 3.77
$ 4.03 $ 4.18
$ 4.28
$ 4.34
Overvalued <
$17.28 Fairly Valued ($17.28-$23.38) Undervalued > $23.38
When looking at the sensitivity analysis of this model, one can see that Dell is
overvalued no matter what growth rate or cost of equity is used. The cost of equities
used ranged from 10% to 16% and we used negative growth rates up to -50%.
Negative growth rates are used in this model because in effect the residual income
should over time converge to zero. Looking at this sensitivity analysis, it is obvious that
this firm is consistently overvalued no matter what cost of equity and growth rate was
used. This summarizes the fact that the residual income model is not very sensitive to
the changes made.
Long Run Residual Income
The long run RI model is based on such factors as residual income, long run return on
equity, and the growth rate of return on equity. The growth rates stem from the forecasted
financial statements such as the change in equity from the balance sheet. To begin this
valuation model, we took an average of the return on equity in the long run, and this number
came out to be 30%. We also used a growth rate of the return on equity of 5.65%. These two
numbers along with our cost of equity of 13.71% and the book value of equity will be used in
calculating the value of the Long Run Residual Income. The formula for this valuation is as
follows:
Estimated Market Cap= Book value of Equity ( 1 + ((ROE –Ke)/(Ke-g))).
99
In using this formula we arrived at an estimated market cap of $ 11284 million. After
calculating this value, we divided that number by the number of shares outstanding of 2223
million to find an estimated share price of $ 5.08. Once this value is achieved, a time consistent
price of $ 5.24 was calculated by going ahead 3 months to arrive at the valuation date of April
1, 2008.
Long Run Residual Income Sensitivity Analysis Return on Equity
10.00% 20.00% 30.00% 40.00% 50.00%
Cost 11.00% $ 1.40 $
4.63 $
7.85 $ 11.07 $ 14.30
of 12.00% $ 1.18 $
3.91 $
6.63 $ 9.35 $ 12.07
Equity 13.71% $ 0.94 $
3.09 $
5.24 $ 7.39 $ 9.55
15.00% $ 0.81 $
2.67 $
4.53 $ 6.39 $ 8.25
16.00% $ 0.73 $
2.42 $
4.10 $ 5.79 $ 7.47
Growth Rate is held Constant at 5.65% Overvalued < $17.28 Fairly Valued ($17.28-$23.38) Undervalued > $23.38
Long Run Residual Income Sensitivity Analysis Return On Equity
10.00% 20.00% 30.00% 40.00% 50.00%
-5.00% $ 1.39 $
2.32 $
3.25 $ 4.17 $ 5.10
0.00% $ 1.27 $
2.53 $
3.80 $ 5.06 $ 6.33
Growth 5.65% $ 0.94 $
3.09 $
5.24 $ 7.39 $ 9.55
Rates 10.00% N/A $
4.68 $
9.35 $
14.03 $
18.71 15.00% $ 6.72 N/A N/A N/A N/A
Cost of Equity is held Constant at 13.71% Overvalued < $17.28 Fairly Valued ($17.28-$23.38) Undervalued > $23.38
100
Long Run Residual Income Sensitivity Analysis Growth Rates
-5.00% 0.00% 5.65% 10.00% 15.00%Cost 11.00% $ 3.77 $ 4.70 $ 7.85 $ 34.49 N/A
of 12.00% $ 3.56 $ 4.32 $ 6.63 $ 17.28 N/A Equity 13.71% $ 3.25 $ 3.80 $ 5.24 $ 9.35 N/A
15.00% $ 3.04 $ 3.48 $ 4.53 $ 6.96 N/A 16.00% $ 2.91 $ 3.27 $ 4.10 $ 5.81 $ 26.16
Return on Equity is constant at 30% Overvalued < $17.28 Fairly Valued ($17.28-$23.38) Undervalued > $23.38
When conducting sensitivity analysis on this model, several variables are taken
into account including cost of equity, growth rates, and the return on equity. Looking at
the sensitivity analysis, one can see that there is a wide variety of outputs depending
on what variables are taken into account. Overall the estimated prices from these
outputs show the firm to be overvalued.
Abnormal Earnings Growth
When it comes to using different models to value a firm, the abnormal earnings
growth model is one of the most difficult to calculate. To calculate the AEG, the net
income is added to the DRIP income or dividend reinvestment and then the normal
income is subtracted from that number. This figure is your abnormal earnings. For a
firm like Dell, this is just simply the net income minus the normal income. Dell does not
pay dividends; therefore, they have no DRIP income. The normal income is computed
by the net income in the year past times one plus the cost of equity. While first
thought would be that this model is not important or capable of valuing a firm that does
not pay dividends, it actually is. This model works for firms that pay dividends, as well
as, firms that do not pay dividends.
To value the equity of Dell, we first had to use our forecasted net income in the
model. To calculate the normal income we took the net income from the previous year
times one plus our cost of equity which is 13.71%. The best part of this model is the
101
fact that there is a check figure built into the model. The change in the residual income
is the same as the abnormal earnings growth. Therefore, you can compare the residual
income model to the abnormal earnings growth model to make sure you have the most
accurate statistics. When computing this model we come up with a time consistent
price of $.64. Therefore, this model says that Dell’s stock is overvalued.
Growth Rates -10.0% -20.0% -30.0% -40.0% -50.0%
10.00% $ 3.07
$ 4.13
$ 4.66
$ 4.98
$ 5.19
Cost 11.00% $ 2.14
$ 3.08
$ 3.56
$ 3.85
$ 4.05
of 12.00% $ 1.45
$ 2.28
$ 2.71
$ 2.98
$ 3.16
Equity 13.71% $ 0.64
$ 1.30
$ 1.66
$ 1.89
$ 2.04
15.00% $ 0.23
$ 0.79
$ 1.10
$ 1.30
$ 1.44
16.00% N/A $ 0.49
$ 0.77
$ 0.95
$ 1.07
Overvalued < $17.28
Fairly Valued ($17.28-$23.38)
Undervalued > $23.38
When looking at the chart above, you will see that all but one price is
overvalued. We took into consideration different growth rates as well as cost of equity
to get a value of the firm. Using this model it would be apparent that Dell’s stock is
extremely overvalued since stock prices go as low as $.23 and only as high as $5.19.
When comparing this price to the April 1, 2008 price there is a large difference and
according to these values, Dell is extremely overvalued.
102
Free Cash Flow
The valuation model we used to determine the intrinsic value for Dell based on
cash flow was the free cash flow model. This model examines the future expected free
cash flows of the firm to debt and equity. We first forecasted out ten years worth of
cash flows for the firm including cash flow from operations and cash flow from
investment activities. To calculate the free cash flow to equity for one year we must use
the following equation:
Free Cash Flow to Equity = Cash Flow from Operations – Cash outlays for
Capital Investments
After determining the free cash flow for each of the forecasted years we
discounted them back to present value using the weighted average cost of capital rate.
For Dell the weighted average cost of capital (WACC) is 10.28%. In addition to
forecasting ten years of cash flows we also calculated a terminal value for cash flows.
The terminal value is the last forecasted number we use; beyond that we use a
perpetuity growth rate to determine cash flows beyond the foreseeable future. Using
the present value formula PV= FV/(1+KWACC)t and the present value of a perpetuity
PVp=[FV/(KWACC-G)]/(1+KWACC)t-1 we calculated the total free cash flows in the future in
2008 dollars.
We calculated the value of Dell to be $60,076 and since we know that the book
value of liabilities is $23,732 we subtracted the liabilities from the total value of the
firm. What we were left with is the intrinsic market value of equity (MVE) which was
$36,344. This number, however, is the value of equity as of January 1st 2008. To get
the MVE we then multiplied the beginning year price by one plus KWACC raised to 3/12
power then divide the MVE by the shares outstanding of 2,223,000,000 to get the time
consistent share price of $16.57. This discounted free cash flow valuation model shows
that at the current observed stock price per share of $20.33 Dell is overvalued.
103
0.00% 2.00% 4.00% 5.51% 7.00%4.00% 40.50$ 79.74$ N/A N/A N/A
W 6.00% 21.79$ 32.65$ 65.24$ 266.03$ N/AA 8.00% 12.61$ 17.13$ 26.18$ 42.64$ 107.63$ C 10.28% 6.64$ 8.71$ 12.11$ 16.57$ 25.00$ C 12.00% 3.70$ 4.96$ 6.85$ 9.06$ 12.55$
(BT) 14.00% 1.25$ 2.00$ 3.05$ 4.18$ 5.78$
Growth Rates
* N/A represents irrelevant negative share pricesOvervalued < $17.27 $17.27 < Fairly Valued > $23.38 Undervalued > $23.38
The chart shown above is the sensitivity analysis of the discounted free cash flow
valuation model for Dell. By substituting different WACC and Growth rates for the model
we can see that the stock price fluctuates greatly. You can see that at most growth
rates and WACCs Dell is overvalued.
Conclusion
After analyzing all of the intrinsic valuations, it is determined that Dell is
consistently overvalued in the market. The intrinsic models including Residual Income,
Long Run ROE RI, and AEG all prove Dell to be severely overvalued. On the other hand,
the Free Cash Flow model showed the company to be only slightly overvalued
depending on the rates used in the valuations. This is a result of the sensitivity involved
with the different models. The least sensitive being the Residual Income and the most
sensitive to growth rates is the Free Cash Flow Model. With this being said the data
provided by each of these intrinsic valuation models suggests that Dell is overvalued at
April 1 2008, and therefore we set our recommendation to sell.
104
Appendices
Inventory Turnover 2003 2004 2005 2006 2007
Dell 103.25 87.37 78.06 72.58 41.92
Apple 80.34 59.60 59.93 50.80 45.81
HP 8.93 8.57 9.63 8.93 9.78
IBM 28.95 27.88 30.77 18.45 21.42
Days Supply of Inventory 2003 2004 2005 2006 2007
Dell 3.53 4.18 4.68 5.03 8.71
Apple 4.54 6.12 6.09 7.18 7.97
HP 40.85 42.57 37.90 40.89 37.30
IBM 12.61 13.09 11.86 19.78 17.04
Working Capital Turnover 2003 2004 2005 2006 2007
Dell -157.14 17.79 34.42 26.73
Apple 1.71 1.89 1.44 2.39 1.90
HP 4.72 5.58 7.30 7.38 12.81
IBM -146.90 -29.97 8.67 20.01 11.14
Profitability Analysis
Gross Profit Margin 2003 2004 2005 2006 2007
Dell 18.30% 18.36% 17.73% 16.57% 19.09%
Apple 27.52% 27.29% 29.01% 28.98% 33.97%
HP 25.84% 24.13% 23.61% 24.53% 24.63%
IBM 4.62% 3.98% 4.07% 43.30% 42.24%
Operating Profit Margin 2003 2004 2005 2006 2007
Dell 8.53% 8.56% 7.85% 5.35%
Apple -0.02% 3.94% 11.79% 12.70% 18.37%
HP 3.96% 5.29% 4.01% 7.16% 8.36%
IBM 1845% 1450.10% 715.03% 357.48% 901.99%
Net Profit Margin 2003 2004 2005 2006 2007
Dell 6.35% 6.14% 6.46% 4.50% 4.82%
Apple 1.11% 3.33% 9.53% 10.30% 14.56%
HP 3.48% 4.38% 2.77% 6.76% 6.97%
IBM 6.13% 4.91% 5.17% 5.11% 3.72%
Asset Turnover 2004 2005 2006 2007
Dell 2.54 2.40 2.47 2.38
105
Apple 1.21 1.73 1.68 1.40
HP 1.07 1.14 1.19 1.27
IBM 0.92 0.82 0.86 0.96
Return on Assets 2004 2005 2006 2007
Dell 15.63% 15.52% 11.11% 11.50%
Apple 4.05% 16.50% 17.27% 20.32%
HP 4.68% 3.15% 8.02% 8.86%
IBM 7.16% 7.15% 8.98% 10.10%
Return on Equity 2004 2005 2006 2007
Dell 48.06% 55.54% 63.83% 68.09%
Apple 6.54% 26.16% 26.78% 35.02%
HP 9.26% 6.38% 16.68% 19.04%
IBM 26.84% 25.04% 28.68% 36.55%
Capital Structure Analysis
Debt to Equity Ratio 2003 2004 2005 2006 2007
Dell 2.08 2.58 4.75 4.90 6.35
Apple 0.61 0.59 0.55 0.72 0.74
HP 0.98 1.03 1.08 1.15 1.30
IBM 2.75 2.50 2.19 2.62 3.23
Times Interest Earned 2003 2004 2005 2006 2007
Dell 3.42 3.18 4.58 4.39
HP 137.90 120.77 41.84 10.83 19.64
IBM 3.33 3.36 2.89 3.41 3.56
Current Ratio 2003 2004 2005 2006 2007
Dell 0.98 1.20 1.10 1.12 1.07
Apple 2.50 2.63 2.95 2.25 2.36
HP 1.61 1.50 1.38 1.35 1.21
IBM 0.98 0.92 1.30 1.11 1.20
Quick Asset Ratio 2003 2004 2005 2006 2007
Dell 0.81 1.01 0.81 0.84 0.75
Apple 2.26 2.33 2.63 1.76 1.83
HP 0.92 0.81 0.76 0.76 0.63
IBM 0.47 0.53 0.66 0.53 0.62
Accounts Receivable Turnover 2003 2004 2005 2006 2007
106
Dell 11.37 11.13 13.67 12.42 10.26
Apple 8.10 10.70 15.57 15.43 14.66
HP 8.19 7.81 8.75 8.43 7.77
IBM 8.91 9.15 9.55 8.47 8.64
Days Supply of Receivables 2003 2004 2005 2006 2007
Dell 32.10 32.80 26.71 29.38 35.59
Apple 45.04 34.12 23.45 23.66 24.89
HP 44.57 46.71 41.69 43.30 46.97
IBM 40.97 39.88 38.21 43.07 42.23
Cash to Cash Ratio 2003 2004 2005 2006 2007
Dell 35.64 36.98 31.38 34.41 44.30
Apple 49.59 40.25 29.54 30.84 32.86
HP 85.42 89.29 79.60 84.19 84.27
IBM 53.58 52.97 50.07 62.86 59.27
Revenue Manipulation Diagnostics DELL 2003 2004 2005 2006 2007Net Sales/Cash from Sales 0.991 0.975 0.982 0.984 0.988 Net Sales/Net Accounts Rec 13.636 11.369 11.128 13.667 12.423 Net Sales/Inventory 115.235 126.382 107.017 94.878 87.000 Net Sales/Unearned Revenues N/A* N/A* 16.915 15.049 13.603 Net Sales/Warranty Liabilities N/A* N/A* 68.035 58.662 59.937
Price to Earnings Trailing
PPS EPS P/E Trailing
Industry Average
Expected PPS
Dell 20.33 1.14 17.83 16.29 18.57 Apple 149.53 3.93 38.05 Do Not Use HP 47.59 2.93 16.24 IBM 116.49 7.13 16.34
Price to Earnings Forward
PPS EPS 1 Year Out
P/E Forward
Industry Average
Expected PPS
Dell 20.33 1.50 13.55 13.82 20.73 Apple 149.53 5.13 29.15 Don't Use HP 47.59 3.52 13.52 IBM 116.49 8.25 14.12
107
Price to Book
PPS BPS P/B Industry Average
Expected PPS
Dell 20.33 1.83 11.11 5.55 10.15 Apple 149.53 19.13 7.82 HP 47.59 15.09 3.15 IBM 116.49 20.55 5.67
PEG
Company PE EGR (t+1) P.E.G. Industry Average
Expected PPS
Dell 17.83 5.75 3.10 1.45 8.31 Apple 38.05 22.96 1.66 HP 16.24 14.59 1.11 IBM 16.34 10.44 1.57
Price over EBITDA
In Billions Market Cap EBITDA P/EBITDA
Industry Average
Expected PPS
Dell 39.89 4.51 8.84 8.68 39.13 Apple 134.54 5.56 24.20 Don't Use HP 114.39 12.25 9.34 IBM 160.25 19.99 8.02
Price over Free Cash Flows
In Billions Market Cap FCF P/FCF
Industry Average
Expected PPS
Dell 39.89 2.19 18.21 21.98 48.14 Apple 134.54 2.90 46.39 Don't Use HP 114.39 6.02 19.00 IBM 160.25 6.42 24.96
Enterprise Value/EBITDA
Company EV ($bill.) EBITDA ($BILL.) EV/EBITDA
Industry Average
Expected PPS
Dell 71.59 4.51 15.87 9.29 41.91 Apple 116.09 5.56 20.88 Don't Use HP 117.72 12.25 9.61 IBM 179.38 19.99 8.97
108
109
Z-Score
3.3 x (EBIT/Total Assets)
1.0 x (Net Sales/Total Assets)
110
0.6 x (Market Value of Equity/Total Liabilities)
1.2 x (Working Capital/Total Assets)
+ 1.4 x (Retained Earnings/Total Assets)
Altman’s Z-Score
Altman's Z-Score 2003 2004 2005 2006 2007Dell 5.66 5.21 5.05 5.26 4.84
Apple 3.82 6.58 11.35 8.55 12.13
HP 16.06 12.51 16.05 12.39 11.09
IBM 2.90 2.48 3.04 3.27 3.01
Liabilities Debt Weight Interest Rate WACD
Short-term borrowings $225 0.01 5.30% 0.05%
Accounts payable 11,492 0.48 2.35% 1.44%
Accrued and other 6,809 0.29 5.25% 1.51%
Long-term debt 362 0.02 5.90% 0.09%
Other non-current liabilities 4,844 0.20 5.90% 1.20%
Total liabilities 23,732 1.00 3.99%
Weighted Average Cost of Capital
(Mve/Mva)
Cost of Equity
(MVl/Mva) Cost of Debt
tax rate
WACC
WACC BT
(43510/43510+23732) 0.1371 (23732/43510+23732) 0.0399 0 10.28%
WACC AT
(43510/43510+23732) 0.1371 (23732/43510+23732) 0.0399 (1-.23) 9.95%
111
Five Forces Level Of Competition Rivalry Among Existing Firms Moderate
Threat of New Entrants Low Threat of Substitute Products Moderate Bargaining Power of Buyers Moderate
Bargaining Power of Suppliers Moderate OVERALL Moderate
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.598961224
R Square 0.358754547
Adjusted R Square 0.329607027
Standard Error 0.068076164
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.057040845 0.057040845 12.30823549 0.001984141
Residual 22 0.101956012 0.004634364
Total 23 0.158996857
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.008790052 0.013927573 -
0.631125909 0.534460953 -0.037674071 0.020093967 -
0.037674071 0.020093967
X Variable 1 1.839797582 0.524411426 3.508309492 0.001984141 0.752234855 2.927360309 0.752234855 2.927360309
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.5900915
R Square 0.348207978
Adjusted R Square 0.329037624
Standard Error 0.063430313
Observations 36
ANOVA
df SS MS F Significance F
Regression 1 0.073080633 0.073080633 18.16387874 0.000151924
Residual 34 0.136795756 0.004023405
Total 35 0.20987639
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
112
Intercept -
0.015561745 0.01057296 -
1.471843674 0.150259624 -0.037048586 0.005925096 -
0.037048586 0.005925096
X Variable 1 1.825320871 0.42828703 4.261910222 0.000151924 0.954936911 2.69570483 0.954936911 2.69570483
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.561990543
R Square 0.31583337
Adjusted R Square 0.300960183
Standard Error 0.060705485
Observations 48
ANOVA
df SS MS F Significance F
Regression 1 0.07825459 0.07825459 21.23508279 3.2312E-05
Residual 46 0.169517169 0.003685156
Total 47 0.247771759
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.008409746 0.008763793 -
0.959601198 0.342272884 -0.026050345 0.009230853 -
0.026050345 0.009230853
X Variable 1 1.67963997 0.364493025 4.608153946 3.2312E-05 0.945953576 2.413326364 0.945953576 2.413326364
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.553600482
R Square 0.306473493
Adjusted R Square 0.29451614
Standard Error 0.057303827
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.084163755 0.084163755 25.6305454 4.47593E-06
Residual 58 0.19045626 0.003283729
Total 59 0.274620015
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.010502261 0.007556681 -1.38979806 0.169901874 -0.025628602 0.00462408 -
0.025628602 0.00462408
X Variable 1 1.422463752 0.280971509 5.062661888 4.47593E-06 0.860038174 1.984889331 0.860038174 1.984889331
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.555237009
R Square 0.308288136
113
Adjusted R Square 0.298406538
Standard Error 0.06125106
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.117046073 0.117046073 31.19820638 4.15057E-07
Residual 70 0.262618467 0.003751692
Total 71 0.37966454
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.001330376 0.007220691 -
0.184244974 0.854353995 -0.015731589 0.013070837 -
0.015731589 0.013070837
X Variable 1 1.151451991 0.2061489 5.58553546 4.15057E-07 0.74030098 1.562603003 0.74030098 1.562603003
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.599419411
R Square 0.35930363
Adjusted R Square 0.330181068
Standard Error 0.068047012
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.057128148 0.057128148 12.33763796 0.001964296
Residual 22 0.101868709 0.004630396
Total 23 0.158996857
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.008594689 0.013925412 -
0.617194596 0.543442062 -0.037474226 0.020284848 -
0.037474226 0.020284848
X Variable 1 1.841762721 0.524345647 3.512497397 0.001964296 0.75433641 2.929189032 0.75433641 2.929189032
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.590743751
R Square 0.34897818
Adjusted R Square 0.329830479
Standard Error 0.063392825
Observations 36
ANOVA
df SS MS F Significance F
Regression 1 0.07324228 0.07324228 18.22559204 0.000148758
114
Residual 34 0.136634109 0.00401865
Total 35 0.20987639
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.015300597 0.010567822 -
1.447847653 0.156818786 -0.036776996 0.006175802 -
0.036776996 0.006175802
X Variable 1 1.827804846 0.428143152 4.269144181 0.000148758 0.957713281 2.697896411 0.957713281 2.697896411
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.562491763
R Square 0.316396983
Adjusted R Square 0.301536048
Standard Error 0.060680475
Observations 48
ANOVA
df SS MS F Significance F
Regression 1 0.078394237 0.078394237 21.29051638 3.16801E-05
Residual 46 0.169377522 0.00368212
Total 47 0.247771759
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.008143288 0.008759229 -
0.929680916 0.357389597 -0.025774703 0.009488126 -
0.025774703 0.009488126
X Variable 1 1.681702826 0.364465275 4.614164754 3.16801E-05 0.94807229 2.415333363 0.94807229 2.415333363
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.553907993
R Square 0.306814064
Adjusted R Square 0.294862583
Standard Error 0.057289755
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.084257283 0.084257283 25.67163414 4.4104E-06
Residual 58 0.190362732 0.003282116
Total 59 0.274620015
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -0.01030867 0.007546957 -1.36593731 0.177232027 -0.025415545 0.004798205 -
0.025415545 0.004798205
X Variable 1 1.422615566 0.280776528 5.066718281 4.4104E-06 0.860580286 1.984650847 0.860580286 1.984650847
115
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.555657064
R Square 0.308754772
Adjusted R Square 0.29887984
Standard Error 0.061230396
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.117223239 0.117223239 31.26652192 4.05086E-07
Residual 70 0.262441301 0.003749161
Total 71 0.37966454
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.001188712 0.007217673 -0.16469456 0.869659067 -0.015583907 0.013206484 -
0.015583907 0.013206484
X Variable 1 1.152357091 0.206085432 5.591647514 4.05086E-07 0.741332664 1.563381519 0.741332664 1.563381519
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.55326472
R Square 0.30610185
Adjusted R Square 0.294138089
Standard Error 0.057319179
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.084061695 0.084061695 25.58575391 4.54851E-06
Residual 58 0.190558321 0.003285488
Total 59 0.274620015
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.010042005 0.007540857 -
1.331679617 0.188175477 -0.02513667 0.005052659 -0.02513667 0.005052659
X Variable 1 1.423818275 0.281485128 5.058236245 4.54851E-06 0.860364578 1.987271972 0.860364578 1.987271972
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.553965643
R Square 0.306877933
Adjusted R Square 0.296976189
116
Standard Error 0.061313465
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.116510669 0.116510669 30.99231197 4.46665E-07
Residual 70 0.263153871 0.003759341
Total 71 0.37966454
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.000874685 0.007226503 -
0.121038435 0.904007363 -0.01528749 0.013538121 -0.01528749 0.013538121
X Variable 1 1.147939339 0.206201562 5.567073915 4.46665E-07 0.736683296 1.559195382 0.736683296 1.559195382
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.598936964
R Square 0.358725487
Adjusted R Square 0.329576646
Standard Error 0.068077707
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.057036225 0.057036225 12.30668079 0.001985196
Residual 22 0.101960632 0.004634574
Total 23 0.158996857
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.008874236 0.013926297 -
0.637228703 0.530552028 -0.037755608 0.020007136 -
0.037755608 0.020007136
X Variable 1 1.830754142 0.521866666 3.50808791 0.001985196 0.748468923 2.913039361 0.748468923 2.913039361
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.590576654
R Square 0.348780785
Adjusted R Square 0.329627278
Standard Error 0.063402435
Observations 36
ANOVA
df SS MS F Significance F
Regression 1 0.073200852 0.073200852 18.20976164 0.000149564
Residual 34 0.136675538 0.004019869
117
Total 35 0.20987639
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.015293253 0.010569462 -
1.446928172 0.157074563 -0.036772984 0.006186479 -
0.036772984 0.006186479
X Variable 1 1.819263646 0.42632766 4.26728973 0.000149564 0.952861604 2.685665687 0.952861604 2.685665687
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.55752553
R Square 0.310834716
Adjusted R Square 0.295852862
Standard Error 0.060926844
Observations 48
ANOVA
df SS MS F Significance F
Regression 1 0.077016064 0.077016064 20.74741328 3.84733E-05
Residual 46 0.170755694 0.00371208
Total 47 0.247771759
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.007564046 0.008794039 -
0.860133386 0.394176368 -0.025265528 0.010137435 -
0.025265528 0.010137435
X Variable 1 1.661022468 0.364664535 4.554932852 3.84733E-05 0.926990843 2.395054093 0.926990843 2.395054093
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.551959694
R Square 0.304659504
Adjusted R Square 0.292670875
Standard Error 0.05737872
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.083665598 0.083665598 25.41237187 4.84118E-06
Residual 58 0.190954418 0.003292318
Total 59 0.274620015
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.009462091 0.007528007 -
1.256918406 0.213821489 -0.024531034 0.005606853 -
0.024531034 0.005606853
X Variable 1 1.424171236 0.282513762 5.041068525 4.84118E-06 0.858658502 1.989683969 0.858658502 1.989683969
118
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.551592445
R Square 0.304254225
Adjusted R Square 0.294315
Standard Error 0.061429402
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.11551454 0.11551454 30.61146259 5.11833E-07
Residual 70 0.264149999 0.003773571
Total 71 0.37966454
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.000296407 0.007239528 -
0.040942867 0.967457999 -0.014735191 0.014142377 -
0.014735191 0.014142377
X Variable 1 1.142252175 0.206452408 5.532762655 5.11833E-07 0.730495835 1.554008514 0.730495835 1.554008514
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.598799798
R Square 0.358561198
Adjusted R Square 0.329404889
Standard Error 0.068086427
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.057010104 0.057010104 12.29789395 0.001991173
Residual 22 0.101986754 0.004635762
Total 23 0.158996857
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.008593912 0.013933567 -
0.616777558 0.543712147 -0.037490361 0.020302538 -
0.037490361 0.020302538
X Variable 1 1.822438431 0.519681783 3.506835318 0.001991173 0.744684382 2.90019248 0.744684382 2.90019248
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.590180168
R Square 0.348312631
Adjusted R Square 0.329145355
Standard Error 0.063425221
119
Observations 36
ANOVA
df SS MS F Significance F
Regression 1 0.073102597 0.073102597 18.17225559 0.00015149
Residual 34 0.136773792 0.004022759
Total 35 0.20987639
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.015014268 0.010574859 -
1.419807912 0.164768282 -0.036504967 0.00647643 -
0.036504967 0.00647643
X Variable 1 1.811544275 0.424956557 4.262892866 0.00015149 0.947928651 2.6751599 0.947928651 2.6751599
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.555349051
R Square 0.308412569
Adjusted R Square 0.293378059
Standard Error 0.061033817
Observations 48
ANOVA
df SS MS F Significance F
Regression 1 0.076415925 0.076415925 20.51364372 4.18517E-05
Residual 46 0.171355834 0.003725127
Total 47 0.247771759
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.007113049 0.008810161 -
0.807368734 0.423609308 -0.024846983 0.010620885 -
0.024846983 0.010620885
X Variable 1 1.649525471 0.364198055 4.529199015 4.18517E-05 0.916432821 2.38261812 0.916432821 2.38261812
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.550836161
R Square 0.303420476
Adjusted R Square 0.291410484
Standard Error 0.057429819
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.083325336 0.083325336 25.2640036 5.10711E-06
Residual 58 0.19129468 0.003298184
Total 59 0.274620015
120
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept -
0.008896002 0.007515911 -
1.183622623 0.241391002 -0.023940732 0.006148728 -
0.023940732 0.006148728
X Variable 1 1.42299445 0.283107985 5.026331028 5.10711E-06 0.856292251 1.989696649 0.856292251 1.989696649
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.550121069
R Square 0.302633191
Adjusted R Square 0.292670808
Standard Error 0.061500923
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.114899091 0.114899091 30.37759048 5.56634E-07
Residual 70 0.264765449 0.003782364
Total 71 0.37966454
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.000212252 0.007248642 0.02928162 0.976723311 -0.014244709 0.014669212 -
0.014244709 0.014669212
X Variable 1 1.13883458 0.206625532 5.51158693 5.56634E-07 0.726732957 1.550936203 0.726732957 1.550936203
121
References
1. Wall Street Journal www.wsj.com
2. Standard & Poor Stock Report
3. Business Analysis & Valuation, Using Financial Statements (Palepu & Healy)
4. www.unclaw.com/chin/teaching/antitrust/herfindahl.htm
5. Dell, Inc. www.dell.com
www.moneycentral.msn.com
Dell, Inc. 10-K
IBM 10-K
HP 10-K
Apple 10-K
Google Finance finance.google.com
Yahoo! Finance finance.yahoo.com
Associated Press-Brian Bergstein
www.spireframe.com