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Case Analysis Of Home Depot Inc.

In The New Millennium


03. Jun, 2013

view with charts and images Case Background COMPANY HISTORY Home Depot Inc., the largest retailer of home improvement products and third largest retailer in United States was established in 1978 in Atlanta, Georgia. The company revolutionized the do-it-yourself market in the United States. The stores of the company were warehouses and they sold large volume of goods at low prices. This company was regarded as the only company that successfully brought off the union of low prices and high service. The financial and operating performance had been extraordinary throughout the decade of 1990s.The stock price and earnings per share had risen dramatically over the years. At the end of the decade this company was the largest home improvement retailer in the country and was planning to grow the number of stores. Home Depot, Inc. was a growing company in a growing industry of home improvement products which cannot be drastically affected by economic vicissitudes. In the industry of home improvement products retailers this company had several well operated competitors. But being the largest and competent retailer Home Depot occupied the largest market share among them. The company pursued several growth initiatives to enlarge its market share and generate higher growth in earnings such as going after professional customers, changing store formats, adding to its product line, developing Internet business; which were associated with some risks as well. CURRENT SITUATION On October 12, 2000 the company announced that its earnings in the last two quarter of the year will be good deal lower than expected. And as a result the Companys stock price experienced a one day drop of 28 percen t causing a decline in the market value of the firm by $33 billion. The fall in the price of this company caused the stock prices of other retailers of the kind to fall as well. The U.S. economy had a continuous growth since 1992 but the interest rate was raised for a total of 1.75 percent point which caused the softening of consumer demand. Home Depot, Inc. was not recession proof but the nature of its business protected it from being vulnerable to economic variability. The decline in the stock price was primarily thought as the result of slowing economy but because of the nature of the business and growth initiatives undertaken it was not clear whether the phenomenon was primarily a function of slowing economy, a reaction to overvaluation of the stock or a reflection of possible problems with the companys strategy for future. Framework of Analysis: The analysis part of this case can be segregated into four major sections: 1. Economic Analysis 2. Industry Analysis 3. Company Analysis and

4. Scenario Analysis Economic Analysis the first step of top-down approach of valuation process has been done by addressing the following issues: The U.S. economy The Home Improvement Market Inflation, Interest Rates and Stock Values Estimation of Market Return (Rm) The Industry Analysis includes: Competitors Analysis Porters Five Forces Model The Company Analysis has been done in 6 major parts, consistent with the case requirements. They are: SWOT Analysis: o Involves an examination of a companys strengths, weaknesses, opportunities and threats. Financial Statements Forecast: o Includes the forecasted income statement and balance sheet of Home Depot, Inc. for year ending in January 2oo1. Ratio Analysis: o The areas of ratio analysis are Profitability, Leverage, Asset utilization & Liquidity ratios. DuPont Analysis: o DuPont analysis is an expression which breaks ROE (Return on Equity) into three parts. This analysis enables the analyst to understand the source of superior (or inferior) return. Risk analysis: o Risk analysis examines the uncertainty of income flows for the total firm and for the individual sources of capital. The total risk of the firm has two internal componentsBusiness Risk: Business Risk is usually measured by the variability of firms operating income over time. Other useful measures of business risk are: o Sales Variability

o Operating Leverage Financial Risk: Financial Risk is the additional uncertainty of returns to equity holders due to a firms use of fixed financial obligations. It can be measured by different leverage ratios and coverage ratios, such as: o Financial leverage ratios o Interest coverage ratio o Cash flow to total debt Determination of Home Depot, Inc.s Intrinsic Stock Value Problem Statement- Determining the reasons of the companys stock price decline. The Scenario Analysis is a process of analyzing possible future events by considering alternative possible outcomes (scenarios). Here we considered three possible scenarios for Home Depot, Inc.s intrinsic stock value by taking their growth plans into account. The scenarios are: o The Optimistic Case, o The Pessimistic Case and o The Most Likely Case Economic analysis: Economic analysis is done to find out the general influences of aggregate economy or market that can significantly impact the returns for an individual stock. Studies have found a relationship between aggregate stock prices and various economic series such as employment, income, inflation or production. Therefore when assessing the future value of a security, it is necessary to analyze the outlook for the aggregate economy. In our economic analysis for Home Depot, Inc. we will enumerate the situation of both the US economy and the home improvement market. The U.S. economy: The U.S. economy had experienced uninterrupted growth since 1992. Between June 1999 and May 2000, however the Federal Reserve had raised interest rates six times for a total of 1.75 percentage pointin an effort to slow down the economy. This measures have resulted in somewhat lessening of overall consumer demand. The Home Improvement Market: Since 1981 till now, the home improvement industry in the U.S. had grown at an annual rate of about 6%, or slightly slower than the U.S. economy as a whole. However, with the expectation of some decline in the economy, economists predict an average nominal growth in the industry.

Following is the Home Improvement Research Institutes projection of growth in U.S. market for home improvement products:

YearPercent Change over Previous Year 2000 6.3% 2001 3.2% 2002 4.0% 2003 4.4% 2004 4.6%
During the recent years, several factors such as, low interest rate, strong housing turnover, rising home ownership, and increases in disposable income has helped the home improvement industry to grow at a decent rate. But from March 1994 through February 1995, 30-year mortgage interest rates increased by an average of 24%. In May 2000, they had climbed to 8.6%, before falling a bit below 8% in the fall. Since Home Depot, Inc. has grown to occupy a large share of the market, these macroeconomic changes are going to have far greater impact on them. Inflation, Interest Rates and Stock Values: Although the relationship between inflation, interest rates and stock values is not direct and consistent the cash flows from stocks can change along with inflation and interest rates. If the interest rates rise due to an increase in the rate of inflation it is assumed that the corporate earnings likewise experience an increase in growth because the firms are able to increase prices in line with cost increase. In such case stock price can be fairly stable because the negative effect of an increase in required rate of return is partially or wholly offset by the increase in growth, which means that the return on stock increase in line with the rate of inflation. Estimation of Market Return (Rm): To conduct an economic analysis it is important to estimate the rate of return of the market. The rate of return is the function of nominal risk free rate and market risk premium and here a range of values are used for the risk premium. The alternatives for NRFR are based upon the specification that it should be zero coupon, default free asset with a maturity that approximates the investors holding period. In this case there are different maturity Treasury securities yields given as of early October 2000 such as:

Maturity Yield 1 month 6.00% 3 Months 6.08% 1 year 6.18% 5-10 years5.8% 30 years 5.83%
In determining the risk free rate the belief is reflected that the typical investment horizon is longer than that implied by the bill. Assuming that most investors consider the intermediate time frame (5-10 years) a more appropriate investment horizon 5.8% is considered as the nominal risk-free rate. Studies on equity risk premium suggests that it should be somewhere between 2.5% to 6.00% while using the current intermediary government bond rate as the estimate of the minimal NRFR. So on this case the market risk premium is determined within this range. Industry Analysis

Industry analysis is done because it determines a firms business risk due to sales volatility and operating leverage and its profitability is impacted by competitive environment in the industry. Home Depot, Inc. is in an industry which is not susceptible to business cycle and consists of many other competitive home improvement firms. The major players in the home improvement industry in this case are described in the competitors analysis. COMPETITORS ANALYSIS Home Depot, Inc.: Home Depot is the largest retailer of home improvement products and third largest retailer of any sort in United States. Home Depot had competencies that very few other retailers had and was one of the most successful retailers in American history. This company opened stores containing a huge assortment of building materials and home improvement products and that targeted individual homeowners and small contractors. The stores were warehouses and they sold large volumes of goods at low prices and they also provided knowledgeable customer services. At the end of 1999 was the largest home improvement retailer with a market share close to 24 percent and operated 930 stores with 21-22 percent growth in stores. After including the professional customers and heavy industrial sector in the companys market of residential home repair and remodeling by do -it-yourself it estimated its market share 8.9 percent. Lowes: Among the home improvement retailers Home Depots principal competitor was Lowes and it was about half the size of Home Depot. It had annual sales of $16 billion and a market share of 10 percent. It operated 578 stores and planned to add more in the succeeding year. Lowes began to operate in rural towns with small stores and later it began to copy Hope Depots model, opening huge, warehouse -type stores in metropolitan markets along with special services for its customers. It sold some product lines that Home Depot did not and also tried to appeal more to women shoppers, with wider aisles and bri ghter lightning than Home Depot. In certain markets Lowes went on a though competition with Home Depot. Mernards: The next largest, Mernards was far smaller but geographically more focused. It had annual sales of about $4 billion and a market share of 2.5 percent, operated solely in several Midwestern states and was said to have a loyal customer base. In some areas Mernards had greater market share than that of Home Depot. HomeBase: HomeBase had annual sales of about $1.5 billion and a market share of 1 percent, operated solely in several western states. Its stores were as large as Home Depots and in certain areas it had a number of stores compared to Home Depots. Hechinger: Initially Home Depots most important competitor was Hechinger which was considered the premium home 9improvement chain and were known for very good customer services. When it tried to follow Home Depots warehouse format it lost out in market by market and in 1999 it went out of business. PORTERS FIVE FORCES ANALYSIS Porters five forces is a framework for the industry analysis and business strategy development developed to derive five forces that determine the competitive intensity and therefore attractiveness of a market. Attractiveness in this context refers to the overall industry profitability. The threat of the entry of new competitors:

Profitable markets that yield high returns will attract new firms. This results in many new entrants, which eventually will decrease profitability for all firms in the industry. Unless the entry of new firms can be blocked by incumbents, the abnormal profit rate will fall towards zero. The home improvement product industry is not susceptible to business cycle and is fairly protected from the vicissitudes of the economy. This industry has a growing potential making it an attractive profitable industry to start business and the more profitable the industry the more attractive it will be to new competitors. The government also does not have restricted policies for this industry which makes the entry barriers low. So, there is a threat of new entrants to the existing firms. The intensity of competitive rivalry: There are few home improvement product retailers in the whole industry so the degree of rivalry is moderate. Competitive rivalry is likely to be based on dimensions such as price, quality, and innovation. Technological advances protect companies from competition. Undertaking initiatives such as shifting to a different customer strategy, widening product categories, changing store formats, expanding the business internationally and initiating internet sales, a firm can have competitive advantage until other firms imitate it. Although the customers switching cost is low the market growth and increasing demand allows firms to match their expected sales and attract new customers and it is the growth in the market that decreases the degree of rivalry. The threat of substitute products or services The existence of products outside of the realm of the common product boundaries increases the propensity of customers to switch to alternatives. For individual homeowners and professional customers such as contractors, electricians, plumbers, landscapers, property maintenance managers etc. there are no alternatives to home improvement products to repair homes and operating business respectively. Although the professional segment is apt to business cycle the threat of substitution products or services is very low in this industry. The bargaining power of customers The bargaining power of customers is also described as the market of outputs: the ability of customers to put the firm under pressure, which also affects the customers sensitivity to price changes. In the industry there are several retailers of home improvement products which leave customers with a lot of options for choosing. There is also a large number of customers for the home improvement products which lowers the bargaining power of the customers. The bargaining power of suppliers The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm. Suppliers may refuse to work with the firm, or, charge excessively high prices for unique resources. In this case the retailers of home improvement products are not dependent on one or few suppliers. They have a lot of suppliers in US for purchasing the materials. So the suppler switching cost for the re tailers is low which reduces suppliers bargaining power. Company Analysis: For company analysis of Home Depot, Inc. we discuss the SWOT analysis, Financial Statements forecast, ratio analysis and DuPont Analysis. SWOT ANALYSIS SWOT analysis involves an examination of a companys strengths, weaknesses, opportunities and threats. Strengths and weaknesses involve identifying the firms internal abilities or lacks thereof. Opportunities and threats include external situations such as competitive forces, discovery and development of new technologies, government

regulations and domestic and international economic trends. In this section we would present the SWOT analysis for Home Depot, Inc. STRENGTHS Home Depot, Inc. is the Largest Retailer of home improvement products. One of the most prominent features of Home Depot, Inc. that sets them apart from the rest of the industry is their superior customer service. Since beginning, Home Depot, Inc. was the only company that was known for its knowledgeable customer service. The company had built a strong base of trained employees through making the product knowledge training classes mandatory for all its salespeople. Home Depot, Inc. also provides special services such as renting trucks, propriety credit cards, provision for unsecured loans to make large purchase and brief courses (how-to clinics) to help customers in carrying out projects. There were also longer, four-week courses that were called Home Depot University. Another exceptional strength of Home Depot, Inc. is its ability to sustain extraordinary financial and operating performance over the years. The companys stock price had also risen dramatically. Between the fall of 1981 & End of 1999, stock price had risen at a compound annual rate of 29%. Constantly evolving management style has proved to be a great strength of Home Depot, Inc. the company never seems to regard the way it operate as settled. The management evaluates new ideas on smaller scale before taking to entire store network. One of Home Depot, Inc.s potency is the ability to successfully utilize its capability through further expansion of operations and growth initiatives. They are planning on increasing the no. of stores annually by 21-22 percent so that by the end of 2003 the store no. will be over 1900. Redefining its industry has resulted in product sales to professional customers in addition to do-it-yourself (D-I-Y) customers. By 1999, Home Depot, Inc. increased its market share of professional customer sector from 4% to approximately 8.9%. Among growth initiatives Home Depot, Inc. is pursuing the likes of shifting to Triple Customer Strategy, Store Format Changes, Product Category Expansion, International Growth, and Internet Sales. WEAKNESSES Home Depot, Inc. was primarily involved in selling materials that ordinary people use for home improvement projects. But over the past years it has grown significantly. The growth plans point out some potential weaknesses of the company. Satisfying the need of different customer groups is indeed a strenuous task. It has been observed that many other companies are doing better than Home Depot, Inc. in terms of product mix and focused customer strategy. Many regional wholesalers of electrical products, serving the professional customers, claim to offer better services than Home Depot, Inc. in terms of broader and deeper inventory, more knowledgeable sales help, and reliable delivery. Another likely problem of the company is its inability to effectively handle Cross-Selling. To be successful in this feat the Home Depot, Inc. must be able to properly integrate different products within a given organizational structure. OPPORTUNITIES The proposed growth schemes present certain opportunities for the company. Redefining their market and shifting from D-I-Y to triple customer strategy is going to create more opportunity enhance the scope of Home Depot, Inc.s operations and market presence. Buy-it-Yourself (B-I-Y) Customers has opened the window for serving the new Market for installation services. The total U.S. market for this category is estimated at $75 billion. Home Depot, Inc. serves less than 2% of this market but plans to grow by 40% each year for the next five years. Serving Professional Customers provides a Large Market potential and great propensity for Repeat Business. This strategy is anticipated to influence sales the most out of all of the initiatives.

Changing Product Categories would help in increasing product line, adding appliances to complement current offerings and vertically integrate supply chain. International growth initiative is believed to be very important in the next five to fifteen years as it would allow the company to expand its realm of market presence globally. The company also intends to possess the worlds largest e -commerce site in the industry through its process of developing its Internet Site. THREATS Along with the opportunities, the growth initiatives pose many threats to Home Depot, Inc.s overall financial and operating performance as well. Moreover, macroeconomic factors have a greater impact on the company than before since it has gained a much larger portion of market share and increased its products and services. Home Depot, Inc. was thought to be fairly protected from the vicissitudes of the economy. . Since Home Depot, Inc. has grown to occupy a large share of the market, the company has become much vulnerable to these macroeconomic changes. The U.S. economy had experienced uninterrupted growth since 1992. Between June 1999 and May 2000, however the Federal Reserve had raised interest rates six timesfor a total of 1.75 percentage pointin an effort to slow down the economy. In May 2000, they had climbed to 8.6%, before falling a bit below 8% in the fall. This has been marked as the main reason the companys earnings shortf all. Another threat is the possibility of over-saturation of certain big city-markets. Home Depot, Inc. and its biggest competitor, Lowes are both planning on opening a lot of new stores in the next few years. This poses the threat of excess supply and falling of prices. As Home Depot, Inc. plans to double the number of stores over the next 4 years, it is uncertain if the will be able to uphold its reputation for having the best customer service and most efficient employees. Moreover, the professional segment and the Expo Design Center stores are going to be more sensitive to cyclical changes in the economy. The international growth scheme presents the most complex challenges because of real estate, and logistics of the supply chain as well as the barriers of language and cultural differences. FINANCIAL STATEMENTS ANALYSIS The income statement and balance sheet of Home Depot, Inc. has been forecasted for year ending in January 2oo1. For this purpose following assumptions have been made. Sales have increased at a rate of 21% Operating expenses and operating profit will increase by the same percentage Assume that cash will increase at 21% per year Accounts receivable and inventories will also increase by the same percentage Assume accounts payable and other accrued liabilities will increase by 21% per year Total Debt and equity has been calculated in consistent with previous years debt to capital and debt to equity ratio.

Long term debt has been kept same as previous year but interest expense has been increased by 1.75 percent points. Sighting a 21% annual growth of store number in future years, the property and equipments has been increased by that rate. Common Stock, Paid in Capital & Retained Earnings have been calculated in consistent with previous years ratio with total capital. Income Statement Home Depot, Inc. Years ending January

Year

Net sales Cost of merchandise sold Gross Profit Operating expenses Selling and store operating 5341 Pre-opening 88 General and Administrative 515 Non-Recurring charge Total Operating Expenses 5944 Operating Income 2661 Interest and Investment Income 30 Interest Expense 37 Interest, net 7 Earnings Before Income Taxes(39% Tax Rate)2654 Income Taxes 1040 Net Earnings 1614 Diluted EPS 0.71
Balance Sheet Years ending January

1999 2000 2001 (Forecasted) 302193843446505 216142702332788 8605 1141113717 6832 8265 113 136 671 872 7616 3795 37 28 9 3804 1484 2320 1.00 9273 4444 38 28 10 4454 1737 2717 1.16

Year ASSETS cash & equivalents short term investments receivables Merchandise Inventories Current Assets Total Current Asset Properties & Equipment land Buildings Furniture Leasehold Construction in progress Capital lease Less: Accumulated depreciation Net Properties & Equipment

1999 2000 2001 (Forecasted) 62 168 203.38 2 2 469 587 710.27 4293 5489 6641.69 109 144 174.24 4933 6390 7731.58 2739 3757 1761 419 540 206 9422 1262 8160 3248 3930.08 4834 5849.14 2279 2757.59 493 596.53 791 957.11 245 296.45 1189014386.9 1663 2014.166 1022712372.73

Costs in excess of Fair value 268 311 376.31 others 104 153 185.13 TOTAL ASSETS 134651708120665.75 LIABILITIES AND STOCKHOLDERS EQUITY Accounts Payable 1586 1993 2411.53 Accrued Salaries 395 541 697.89 Sales Tax 176 269 325.49 Other Accrued Expense 586 763 984.27 income tax payable 100 61 71.37 Current part of Long term Debt 14 29 90.08396 Total Current Liabilities 2857 3656 4580.634 long term debt 1566 750 750 Other Accrued Expense 208 237 286.77 Deferred Income 85 87 105.27 Minority Interest 9 10 12.1 Total Long term Debt 1868 1084 1154.14 Stockholders Equity Common Stock 111 115 139.1348 Paid in Capital 2817 4319 5225.42 Retained Earnings 5876 7941 9607.561 Other -64 -34 267.1 TOTAL STOCKHOLDERS EQUITY8740 1234114930.98 Total Liabilities & Stock holders Equity 134651708120665.75
RATIO ANALYSIS From above financial statements following ratios can be found.

year 1999 2000 2001 Profitability Profit Margin (%) 6.00% 6.04% 5.84% Return on equity (%) 26.13%24.94%18.20% Return on assets (%) 22.20%18.02%13.15% Leverage Debt/Equity Ratio 0.54 0.38 0.38 Debt/Total capital 0.35 0.28 0.28 Asset utilization Sales/Assets 3.7 2.99 2.25 Liquidity Current ratio 1.73 1.75 1.75
The profitability ratios show a fall in profit growth in the forecasted year. The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of shareholders equity and debt used to finance a companys assets. The debt-to-capital ratio gives users an idea of a companys financial structure, or how it is financing its operations, along with some insight into its financial strength. The higher the debt-to-capital ratio, the more debt the company has compared to its equity. Home Depot, Inc. remains free of too much debt burden. The current ratio is a financial ratio that measures whether or not a firm has enough resources to pay its debts over the next 12 months. Home Depot, Inc. can cover all of its current obligations with its current assets efficiently96 DUPONT ANALYSIS DuPont analysis is an expression which breaks ROE (Return On Equity) into three parts. This analysis enables the analyst to understand the source of superior (or inferior) return. ROE = (Profit margin)*(Asset turnover)*(Equity multiplier) = (Net profit/Sales)*(Sales/Assets)*(Assets/Equity)

= (Net Profit/Equity) DuPont analysis tells us that ROE is affected by three things: - Operating efficiency, which is measured by profit margin - Asset use efficiency, which is measured by total asset turnover - Financial leverage, which is measured by the equity multiplier The DuPont Break down of Home Depot, Inc

profit marginasset turnoverequity multiplierROE Operating ROA 20005.84% 2.25 1.38 18.20%13.15% 19996.00% 3.70 1.18 26.13%22.20% 19985.40% 3.70 1.14 22.70%19.98% 19974.80% 3.60 1.13 19.50%17.28% 19964.80% 3.50 1.12 18.80%16.80% 19954.70% 3.50 1.29 21.30%16.45% 19944.90% 3.80 1.15 21.50%18.62% 19934.70% 3.40 1.25 19.90%15.98% 19924.80% 4.60 0.97 21.50%22.08% 19914.70% 4.80 1.62 36.50%22.56% 19904.40% 5.60 1.29 31.90%24.64% 19894.10% 5.80 1.23 29.20%23.78% 19883.90% 5.80 1.06 23.90%22.62% 19873.80% 5.50 1.59 33.20%20.90% 19862.90% 3.50 2.64 26.80%10.15%
Return on Equity Return on Equity measures the rate of return on the ownership interest (shareholders equity) of the common stock owners. It measures a firms efficiency at generating profits from every unit of shareholders equity (also known as net assets or assets minus liabilities). ROE shows how well a company uses investment funds to generate earnings growth. Home Depot, Inc. has had a decent to high return on equity ranging from 18.80% to 36.50%. Our forecasted ROE for year 2000 shows a fall in ROE from 26.13% to 18.20%. Profit Margin: The profit margin of Home Depot, Inc. has been steadily growing over the years. The forecasted profit margin for year ending in 2001 shows a slight decrease from 6% to 5.84%. Asset Turnover: Asset turnover is a financial ratio that measures the efficiency of a companys use of its assets in generating sales revenue or sales income to the company. The higher the number the better. Home Depot, Inc.s Asset Turnover has been high in the initial years but slowed down in the recent years, which is reflected in the slowing down of ROE after the initial years. The forecasted turnover drops to 2.25 from previous years 3.7. Equity Multiplier: The companys leverage ratio (Assets Equity), which is equal to the firms debt to equity ratio + 1. This is a measure of financial leverage. st Except for the 1 year, companys equity multiplier has been pretty decent, which means Home Depot, Inc. has been fairly independent in managing their own financing.

Return on Assets The return on assets (ROA) percentage shows how profitable a companys assets are in generating revenue. This tells us what the company can do with what it has, i.e. how many dollars of earnings they derive from each dollar of assets they control. Home Depot, Inc. has had a decent to high return on Asset ranging from 10.15% to 24.64%. Forecasted ROA for year ending in 2001, drops to 13.15%. RISK ANALYSIS Risk analysis examines the uncertainty of income flows for the total firm and for the individual sources of capital. The typical approach examines the major factors that cause a firms income flow to vary. More volatile income flows mean greater risk. The total risk of the firm has two internal components- Business Risk & Financial Risk. Business Risk: Business Risk is the uncertainty of operating income caused by firms industry. It is usually measured by the variability of firms operating income over time. Business Risk = (Coefficient of Variation of Operating Earning) The business risk of Home Depot, Inc. is calculated below.

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 NOPAT$167 $240 $346 $439 $609 $722 $932 $1159 $1618 $2315 Sales $3815$5137$7148$9239$12477$15470$19535$24156$30219$38434 Standard Deviation Of NOPAT =$ 681.0143 Mean of NOPAT = $854.7 CV of NOPAT = 0.796788
Besides overall Business Risk, it is insightful to examine other factors that contribute to operating earnings. Sales Variability: Sales variability is the prime determinant of operating income variability. The variability of sales is mainly caused by firms industry and is largely outside control of management. Sales Variability = (Coefficient of Variation of Sales) The Sales variability of Home Depot, Inc. is calculated below.

Standard Deviation Of Sales =$11472.44 Mean of Sales = $16563 CV of sales= 0.692655


OPERATING LEVERAGE The variability of firms operating income also depends on its mixture of production cost. Fixed production cost causes operating profit to vary more than sales over business cycle. The employment of fixed production cost is called operating leverage. Greater operating leverage causes greater earning volatility. Operating Leverage = The operating leverage of Home Depot, Inc. is calculated below

1990 1991 1992 1993 1994 NOPAT $167.00 $240.00 $346.00 $439.00 $609.00 %chang $0.46 $0.44 $0.44 $0.27 $0.39

1995 $722.00 $0.19

1996 $932.00 $0.29

1997 1998 1999 $1,159.00 $1,618.00 $2,315.00 $0.24 $0.40 $0.43

e $3,815.0 $5,137.0 $7,148.0 $9,239.0 $12,477.0 $15,470.0 $19,535.0 $24,156.0 $30,219.0 $38,434.0 sales 0 0 0 0 0 0 0 0 0 0 %chang e $ 0.38 $0.35 $0.39 $0.29 $0.35 $0.24 $0.26 $0.24 $0.25 $0.27 Operating Leverage =1.169905
This means, if sales of Home Depot, Inc. increases (decreases) by 10% its earnings (NOPAT) will increase (decrease) by 10% X 1.1699 = 11.699%. It can be said that the risks resulting from operating leverage in Home Depot, Inc. is not much. Financial Risk: Financial Risk is the additional uncertainty of returns to equity holders due to a firms use of fixed financial obligations. A higher proportion of debt capital compared to equity capital makes earnings more volatile and increase probability of default. It can be measured by different leverage ratios and coverage ratios. The Financial Risk of Home Depot, Inc. is calculated below-

year 1999 2000 2001 Financial Leverage Debt/Equity Ratio 0.54 0.38 0.38 Debt/Total capital (%)0.35 0.28 0.28 Coverage Ratio Interest Coverage 71.92135.54158.71 Cash Flow-Total Debt 1.0192.198 2.196
The financial leverage ratios of Home Depot, Inc. demonstrates that they have used smaller amount of debt and more equity in financing, which reduces earning volatility for equity holders and results in lower default risk. Interest coverage ratio indicates fixed interest charges are earned, based on the earnings available to pay these expenses. Home Depot, Inc. is in a healthy position to clear these charges. Another coverage ratio- Cash flow to total debt relates cash flow to firms total outstandin g debt. The higher this ratio, the stronger the company- i.e., the lower its financial risk. In this regard too, Home Depot, Inc. is in a strong position. DETERMINATION OF HOME DEPOT,INC.S INTRINSIC STOCK VALUE The calculation of Home Depot, Inc.s stock price for February 1, 2001 requires completing the following steps: Step 1: Drawing the Assumptions: We develop the following assumptions based on realistic inference from Home Depot, Inc.s current state and future prospects: 1. Risk free rate (RF) of 5.8% which is equal to the yields on 10 years treasury securities. 2. Risk Premium (RM-RF) of 3.00% 3. Four-stage growth model:

Multi-Stage Growth Rates Year Dividend Growth Rate (g) 2001-2002 g1=16% 2003-2005 g2=23% 2006-2009 g3=18%

2010 onwardsg4=8%
Step 2: Calculating the Cost of Equity Capital (rs) using Security Market Line (SML): The formula for SML is: rs= RF + * ( RM RF) = 9.07% Where, RF = 5.80% RM = 8.80% RF = 5.80% (yields on 10 years treasury securities) (RM RF)=3.00% HDI = 1.09 Step 3: Determining the intrinsic value by using extended DDM model: In our assumption of multiple growth rate model, the growth rate rises sharply after the first two years then gradually declines to the constant perpetual growth of 8.00%. To get the value, the initial years are examined individually. Then the remaining value of the firm is computed assuming the constant growth using the DDM which is in turn discounted to get the present value. We assumed that, Here, D/E = 11% which is constant over the periods included in valuation. Where, D0 = $0.13 & EPS0 = $1.16 The detailed calculation is given below:

Period 1 2 3 4 5 6 7 8 9 10 Diluted EPS $ 1.35$ 1.56$ 1.92$ 2.36$ 2.90$ 3.43$ 4.04$ 4.77$ 5.63$ 6.08 Dividends $ 0.15$ 0.17$ 0.21$ 0.26$ 0.32$ 0.38$ 0.44$ 0.52$ 0.62$ 0.67 Discounted Dividends$ 0.14$ 0.14$ 0.16$ 0.18$ 0.21$ 0.22$ 0.24$ 0.26$ 0.28$ 28.61
Our calculated value of stock as of February 1, 2001 was, VS = $30.45 Assumptions Leading to Market Value of $48.20 In an efficient market security prices adjust quickly to the arrival of new information and the current prices of securities reflect all information about the security. This market allocates fund to their most productive uses as a result of competition among the wealth maximizing investors and determines and publicizes prices that are believed to be close to their true value. On February 1, 2001 the market value of the stock of Home Depot was $48.20, which was far different from the intrinsic value. This means information about the security is not fully reflected on the price. Much higher return on equity and therefore higher growth rate is consistent with this price keeping the cost of equity constant however.

Multi-Stage Growth Rates Year Dividend Growth Rate (g)ROE 2001-2005 g1=29% 32.5% 2006-2009 g2=28% 31.46% 2010 onwardsg3=8% 8.98%
If the growth rate is assumed to be an average of 29% for nearly a decade as the decade of 1990s and the constant growth rate of assumed to be 8% with constant cost of capital of 9.07% the intrinsic value will be close to $48.20. The detailed calculation is as follows:

Period Diluted EPS Dividends

1 2 3 4 5 6 7 8 9 10 $ 1.35 $ 1.56$ 2.01$ 2.60$ 3.35$ 4.29$ 5.49$ 7.02$ 8.99$ 9.71 $ 0.15 $ 0.17$ 0.22$ 0.29$ 0.37$ 0.47$ 0.60$ 0.77$ 0.99$ 1.07

Discounted Dividends$ 0.14 $ 0.14$ 0.17$ 0.20$ 0.24$ 0.28$ 0.33$ 0.39$ 0.45$45.69 Intrinsic value $48.03
The investors assumption about the growth rates, ROE and cost of capital, mentioned above, can lead to a market price equal to $48.20. Problem Statement On October 12, 2000 Home Depot, Inc. lost $33 billion of its market value because it announced that the earnings of third and fourth quarter would be much lower than expected. The stock price declined by 28% from $49 to $35 as a result of this announcement. But the reason is not clear that whether the decline in market price was a function of slowing economy, a reaction to overvaluation of the stock or possible problems with the companys strategy for future. If we consider the most likely case for the valuation of the stock the intrinsic value on October 12, 2000 is as follows:

Intrinsic Value on October 12, 2000 EPS of 3rd Quarter= $ 0.28 Dividend of 3rd Quarter=$ 0.0308PV= $ 0.0307 EPS of 4th Quarter= $ 0.25 Dividend of 4th Quarter=$ 0.0275 PV= $ 0.02675 PV on Feb 1, 2001= $ 30.45 PV on Oct 12, 2000=$ 29.62 Intrinsic value= $ 29.68
The stock of the company was still overvalued despite the decline in market price. Throughout the year of 2000 the stock was overvalued so the price decline in the market price was the instant reaction to the overvaluation. The decline in price was preceded by the announcement of lower than expected earnings per share. The slowdown of economy was one of the reasons of lower earnings growth. The rise in the interest rate caused a decline in the demand for loan which in turn resulted in a decline in the housing turnover and home ownership. As a result the whole home improvement industry endured earnings. The softening of consumer demand caused the sales growth to decrease resulting in low net earnings. The decline in net earnings can also be attributed to their aggressive expansion and market saturation as their sales had not increased compared to their store growth endeavor. Home Depot had an average increase in sq. footage of 26% per year for period 1986 2000 while average sales growth fall from an average over the same time period of 31% to 21% in 2000. Scenario Analysis Scenario Analysis for the Growth Schemes: Scenario analysis is a process of analyzing possible future events by considering alternative possible outcomes (scenarios). The analysis is designed to allow improved decision-making by allowing consideration of outcomes and their implications. In this segment, we will consider three possible scenarios the optimistic case, the pessimistic case and the most likely case for Home Depot, Inc.s intrinsic stock value by taking their growth plans into account. THE MOST LIKELY CASE Our most likely scenario represents the value we derived in while estimating the intrinsic stock value of Home Depot, Inc.s stock in the company analysis segment. We made the following assumptions: 4. Risk free rate (RF) of 5.8% which is equal to the yields on 10 years treasury securities. 5. Risk Premium (RM-RF) of 3.00% 6. Four-stage growth model:

Multi-Stage Growth Rates Year Dividend Growth Rate (g) 2001-2002 g1=16% 2003-2005 g2=23% 2006-2009 g3=18% 2010 onwardsg4=8%

Justification for the Assumptions:


To estimate the most plausible scenario, couple of issues was considered that we believed to be most realistic. On the premise of these issues we drew our assumption mentioned earlier. These are discussed below: 1. Risk free rate (RF) has been held at 5.8% which is equal to the yields on 10 years treasury securities because we assume that majority of investors would invest in the securities with intermediate maturity. 2. We assumed Risk Premium (RM-RF) of 3.00%. Different studies on equity risk premium suggests that it should be somewhere between 2.5% to 6.00% if while using the current intermediary government bond rate as the estimate of the minimal NRFR. Here we ignored the effect of the expected inflation because we anticipate that the price of Home Depot, Inc.s products will rise consistently as well. 3. The retention ratio is kept constant every year because in general cases retailer companies have a high retention rate and as a growing company with many growing schemes it is reasonable for Home Depot, Inc. to have 89% retention rate and 11% dividend payout rate. This is the reason why the growth rate of earnings will be equal to the dividend growth rate. 4. Though the annual growth rate of Home Depot, Inc.s earnings over the last 10 years had averaged about 30%, in our calculation we assumed a much more modest growth rates in the initial years (16% for the first 2 years). In view of the fact that Home Depot, Inc. has grown to occupy a large share of the market, the company has become much susceptible to these macroeconomic changes. The U.S. economy had experienced uninterrupted growth since 1992. But between June 1999 and May 2000, the Federal Reserve had raised interest rates six times in an effort to decelerate the economy. In May 2000, they had climbed to 8.6%, before falling a bit below 8% in the fall. This is one of the main reasons for the companys earnings shortf all which we presume will continue for a couple of years. 5. After the initial years, our assumed growth rate will see a sharp rise to 23% as a result of benefits derived from the growth schemes. In our most likely case, we believe, following incidents will help Home Depot, Inc. accomplish a moderate growth rate of 23% and 18% for the years 2003-2005 and 2006-2009 respectively: i. Increased sales from successful expansion: Home Depot, Inc. is planning on increasing the no. of stores annually by 21-22 percent so that by the end of 2003 the store no. will be over 1900. Moreover, redefining its industry has resulted in product sales to professional customers in addition to do-it-yourself (D-I-Y) customers. By 1999, Home Depot, Inc. increased its market share of market for professional customers from 4% to approximately 8.9%. This figure is expected to increase to 18% by the end of 2003. ii. Moderate success with Buy-it-Yourself (B-I-Y) Customers: Buy-it-Yourself (B-I-Y) Customers has created an opportunity for serving the new Market for installation services. The total U.S. market for this category is estimated at $75 billion. Home Depot, Inc. serves less than 2% of this market but plans to grow by 40% each year for the next five years. iii. Average achievement with Product Categories and Store Formats:

Extension of products, services, and stores- will allow some growth with the Do it Yourself (DIY) Customers. iv. Reasonable Success in International Growth and Internet sales: In most possible case, an ambitious estimated outcome from these growth schemes will not be practical. Rather a mediocre outcome is more likely. 6. We assume constant perpetual growth rate of 8.0% from the 10 year. This is because no firm can sustain more than the average industry growth rate in a competitive market. Since 1981 till now, the home improvement industry in the U.S. had grown at an annual rate of about 6%, or slightly slower than the U.S. economy as a whole. In 1998 and 1999, home improvement industry growth rates were 10.4% and 7.3% respectively. However, with the expectation of some decline in the economy, economists predict an average nominal growth in the industry. Moreover, mediocre results in recent years and more success in the long run of International Growth and Internet Sales growth schemes will help to sustain a decent constant perpetual growth rate.
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Calculation of Home Depot, Inc.s Intrinsic Value (the Most Likely Case):
The calculation of Home Depot, Inc.s stock price as of February 1, 2001 required completing the fo llowing steps: Step 1: Calculating the Cost of Equity Capital (rs) using Security Market Line (SML): The formula for SML is: rs= RF + * ( RM RF) = 9.07% Where, RF = 5.80% RM = 8.80% RF = 5.80% (yields on 10 years treasury securities) (RM RF)=3.00% HDI = 1.09 Step 2: Determining the intrinsic value by using extended DDM model: In our assumption of multiple growth rate model, the growth rate rises sharply after the first two years then gradually declines to the constant perpetual growth of 8.00%. To get the value, the initial years are examined individually. Then the remaining value of the firm is computed assuming the constant growth using the DDM which is in turn discounted to get the present value. We assumed that, Here, D/E = 11% Where, D0 = $0.13 & EPS0 = $1.16 The detailed calculation is given below:

Period 1 2 3 4 5 6 7 8 9 10 Diluted EPS $ 1.35$ 1.56$ 1.92$ 2.36$ 2.90$ 3.43$ 4.04$ 4.77$ 5.63$ 6.08 Dividends $ 0.15$ 0.17$ 0.21$ 0.26$ 0.32$ 0.38$ 0.44$ 0.52$ 0.62$ 0.67 Discounted Dividends$ 0.14$ 0.14$ 0.16$ 0.18$ 0.21$ 0.22$ 0.24$ 0.26$ 0.28$ 28.61
Our calculated value of stock was, VS = $30.45 The Optimistic Case:

While estimating our most likely value of Home Depot, Inc.s stock we made the following assumptions: 1. Risk free rate (RF) of 5.8% which is equal to the yields on 10 years treasury securities. 2. Risk Premium (RM-RF) of 2.50% 3. Four-stage growth model:

Multi-Stage Growth Rates Year Dividend Growth Rate (g) 2001-2002 g1=17% 2003-2005 g2=23% 2006-2009 g3=19% 2010 onwardsg4=8%

Justification for the Assumptions:


In our Optimistic scenario, we assumed some rather bold outcomes which would occur if most factors work well in the favor of Home Depot, Inc. On the premise of these arguments we drew the assumptions mentioned above. These are discussed below: 1. For reasons mentioned in our most likely case, Risk free rate (RF) has been held at 5.8% which is equal to the yields on 10 years treasury securities. 2. We assumed Risk Premium (RM-RF) of 2.50%, because studies on equity risk premium suggests that it should be somewhere between 2.5% to 6.00% if while using the current intermediary government bond rate as the estimate of the minimal NRFR. Here we assumed the best possible consequences. 3. In our calculation we assumed a humble growth rates in the initial years (17% for the first 2 years) which is still slightly higher than what we presumed for our most likely case. Since Home Depot, Inc. has grown to occupy a large share of the market, the company has become much susceptible to these macroeconomic changes. Between June 1999 and May 2000, the Federal Reserve had raised interest rates six times in an effort to decelerate the economy. This is one of the main reasons why we assumed moderate growth rates for the first two years. 4. After the initial years, our assumed growth rate will see a sharp rise to 23% as a result of benefits derived from the growth schemes. In our optimistic case, we expect, following events will help Home Depot, Inc. carry out a decent growth rate of 23% and 19% for the years 2003-2005 and 2006-2009 respectively: i. Improved sales from successful expansion: We expect that economy will start recovering from its temporary dip by 2003 in the best set of circumstances which will in turn increase the demand of consumer goods. Home Depot, Inc. is planning on increasing the no. of stores annually by 21-22 percent so that by the end of 2003 the store no. will be over 1900. By 1999, Home Depot, Inc. increased its market share of market for professional customers from 4% to approximately 8.9%. This figure is expected to increase to 18% by the end of 2003. Extraordinary success in their expansion plans will help them achieve the expected growth. ii. Immense success with Professional Customers: Serving Professional Customers provides a Large Market potential and great propensity for Repeat Business. This scheme presents a large opportunity with high profit margins. This strategy is anticipated to influence sales the most out of all of the initiatives. iii. Remarkable achievement with Buy-it-Yourself (B-I-Y) Customers:

Buy-it-Yourself (B-I-Y) Customers has created an opportunity for serving the new Market for installation services. The total U.S. market for this category is estimated at $75 billion. Home Depot, Inc. serves less than 2% of this market but plans to grow by 40% each year for the next five years. iv. Expected realization of target sales in Product Categories and Store Formats: Extension of products, services, and stores- will allow continued growth with the Do it Yourself (DIY) Customers. Because changing Product Categories would help in increasing product line, adding appliances to complement current offerings and vertically integrate supply chain. Home Depot, Inc. plans to increase its no. of Expo design Stores, which offers higher gross margin, to 200 within five to six years. Successful realization of these targets will help sustain the estimated growth. v. Excellent success in International Growth and Internet sales: International growth initiative is believed to be very important in the next five to fifteen years as it would allow the company to expand its realm of market presence globally. The company also intends to possess the worlds largest e-commerce site in the industry through its process of developing its Internet Site. Reasonable results in recent years will help accomplish the anticipated growth. 5. For the same reasons mentioned in the most likely situation, we assume constant perpetual growth rate of 8.0% from the 10 year.
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Calculation of Home Depot, Inc.s Intrinsic Value (the Optimistic Case):


The calculation of Home Depot, Inc.s stock price required the completing the same steps as in our previous scenario: Step 1: Calculating the Cost of Equity Capital (rs) using Security Market Line (SML): The formula for SML is: rs= RF + * ( RM RF) = 8.53% Where, RF = 5.80% RM = 8.30% RF = 5.80% (yields on 10 years treasury securities) (RM RF)=2.50% HDI = 1.09 Step 2: Determining the intrinsic value by using extended DDM model: In our assumption of multiple growth rate model, the growth rate rises sharply after the first two years then gradually declines to the constant perpetual growth of 8.00%. To get the value, the initial years are examined individually. Then the remaining value of the firm is computed assuming the constant growth using the DDM which is in turn discounted to get the present value. Here, D/E = 11% Where, D0 = $0.13 & EPS0 = $1.16 The detailed calculation is given below:

Period Diluted EPS

1 2 3 4 5 6 7 8 9 10 $ 1.35$1.56$ 1.92$ 2.36$ 2.90$3.45$ 4.11$ 4.89$ 5.82$ 6.29

Dividends $ 0.15$0.17$ 0.21$ 0.26$ 0.32$0.38$ 0.45$ 0.54$ 0.64$ 0.69 Discounted Dividends$ 0.14$0.15$ 0.17$ 0.19$ 0.21$0.23$ 0.26$ 0.28$ 0.31$ 63.08
Our calculated value of stock as of February 1, 2001 was, VS = $65.00 The Pessimistic Case: While estimating our most likely value of Home Depot, Inc.s stock we made the following assumptions: 1. Risk free rate (RF) of 5.8% which is equal to the yields on 10 years treasury securities. 2. Risk Premium (RM-RF) of 4.50% 3. Four-stage growth model:

Multi-Stage Growth Rates Year Dividend Growth Rate (g) 2001-2002 g1=16% 2003-2005 g2=20% 2006-2009 g3=17% 2010 onwardsg4=7%

Justification for the Assumptions:


For the Pessimistic or worst-case scenario, we considered a few possibilities where things could go wrong for Home Depot, Inc. and adversely affect their earnings and ultimately their stock value. On the assertion of these arguments we drew the assumptions mentioned above. These are discussed below: 1. For reasons mentioned in previous cases, Risk free rate (R F) has been held at 5.8% which is equal to the yields on 10 years treasury securities. 2. Studies on equity risk premium suggests that it should be somewhere between 2.5% to 6.00% if while using the current intermediary government bond rate as the estimate of the minimal NRFR. We assumed Risk Premium (R MRF) of 4.50% which is much higher than both our most likely and optimistic assumptions. 3. In our calculation we assumed discreet growth rates in the initial years (16% for the first 2 years) considering the possible downturn in the economy. Since Home Depot, Inc. has grown to occupy a large share of the market, the company has become much susceptible to these macroeconomic changes. Between June 1999 and May 2000, the Federal Reserve had raised interest rates six times in an effort to decelerate the economy. This is one of the main reasons why we assumed moderate growth rates for the first two years. 4. After the initial years, our assumed growth rate will see a slight rise to 20% as a result of the growth schemes. In our pessimistic case, we assumed unenthusiastic growth rate of 20% and 17% for the years 2003-2005 and 20062009 respectively which are considerably lower than the likes of most likely and optimistic scenarios. The reasons for such restrained assumptions are given below: i. Continued growth in Do It Yourself (DIY) Business at a decreasing rate: We believe that Home Depot, Inc. will continue to maintain a decent growth in their core market segment Do It Yourself Customers through their multiple growth plans. But while projecting the worst case, we presume this growth rate will gradually decrease over time. ii. Moderate Success with Buy-it-Yourself (B-I-Y) Customers: Home Depot, Inc. serves less than 2% of the installation service market for BIY customers, but plans to grow by 40% each year for the next five years. In the pessimistic scenario the company can only barely achieve this target.

iii. Over-saturation of market: If the over-saturation of certain big city-markets should happen the expected earnings of the company will be reduced. Home Depot, Inc. and its biggest competitor, Lowes are both planning on opening a lot of new stores in the next few years. In the worst case scenario, this will result in excess supply and falling of prices. iv. Failure in achieving the target for Professional Customers and Product Categories: Satisfying the need of different customer groups is indeed a strenuous task. It has been observed that many other companies are doing better than Home Depot, Inc. in terms of product mix and focused customer strategy. In our pessimistic scenario, Home Depot, Inc. will find it difficult to cross over with professional customers while ensuring that the DIY customers are not disadvantaged. Moreover the company may suffer from its possible inability to effectively handle Cross-Selling. v. Greater sensitivity to Cyclical changes: The professional segment and the Expo Design Center stores are going to be more sensitive to cyclical changesin the economy. vi. Challenges in International growth and Internet sales: The international growth scheme presents the most complex challenges because of real estate, and logistics of the supply chain as well as the barriers of language and cultural differences. In our pessimistic scenario, it is natural to be more skeptical about any considerable success in this growth scheme. On the other hand internet sales may not prove to be very helpful in near future because it is hard to set up and expensive to maintain. 5. We assume constant perpetual growth rate of 7.0% from the 10 year because the over expansion may result into a deterioration of performance of the company.
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Calculation of Home Depot, Inc.s Intrinsic Value (the Pessimistic Case):


The calculation of Home Depot, Inc.s stock price required the completing the same steps as in our previous scenarios: Step 1: Calculating the Cost of Equity Capital (rs) using Security Market Line (SML): The formula for SML is: rs= RF + * ( RM RF) = 10.71% Where, RF = 5.80% RM = 10.30% RF = 5.80% (yields on 10 years treasury securities) (RM RF)=4.50% HDI = 1.09 Step 2: Determining the intrinsic value by using extended DDM model: In our assumption of multiple growth rate models, the growth rate rises sharply after the first two years then gradually declines to the constant perpetual growth of 7.00%. To get the value, the initial years are examined individually. Then the remaining value of the firm is computed assuming the constant growth using the DDM which is in turn discounted to get the present value. Here, D/E = 11%

Where, D0 = $0.13 & EPS0 = $1.16 The detailed calculation is given below:

Period 1 2 3 4 5 6 7 8 9 10 Diluted EPS $ 1.35$1.56$ 1.87$ 2.25$ 2.70$3.15$ 3.69$ 4.32$ 5.05$ 5.46 Dividends $ 0.15$0.17$ 0.21$ 0.25$ 0.30$0.35$ 0.41$ 0.47$ 0.56$ 0.59 Discounted Dividends$ 0.13$0.14$ 0.15$ 0.16$ 0.18$0.19$ 0.20$ 0.21$ 0.22$ 6.43
Our calculated value of stock on February 1, 2001 was, VS = $8.01 Recommendation & Policy Implication: Home Depot is the largest retailer of home improvement products and third largest retailer of any sort in United States. Home Depot had competencies that very few other retailers had and was one of the most successful retailers in American history. The company has been able to sustain extraordinary financial and operating performance over the years. The annual growth rate of Home Depot, Inc.s earnings over th e last 10 years had averaged about 30%.The companys stock price had also risen dramatically. Between the fall of 1981 & End of 1999, stock price had risen at a compound annual rate of 52%. However, after nearly two decades of spectacular performance, Home Depot reported a disappointing performance in the year 2000. On October 12, 2000, Home Depot, Inc. announced that earnings in the 3 and 4 quarters of 2000 would be much lower. This announcement had an adverse impact on their stocks market price. The s lowing economy in 2000 combined with Home Depots aggressive expansion efforts was thought to be the reason for Home Depots poor financial performance. In this final section of our report, we try to present some indications to Home Depot, Inc. as to what should be their ideal courses of action. We believe, by focusing on the following suggestions they will be able to achieve a desirable growth described in our valuation segment of company analysis. 1. Focus on Quality: Home Depot, Inc. should be more concerned with the quality of their products and services rather than pursuing a farfetched expansion policy because quality of their customer service is one of their core competencies. By focusing on quality Home Depot, Inc. would be able to ensure continued growth in their main target segment of DIY customers as well as achieve considerable success in professional segment. Moreover, to exploit the opportunities presented by BIY customer segment, it is vital to focus on greater service quality. 2. Implement Customer Groups and Product Category Plans with Much Prudence: Fulfilling the needs of different customer groups is a demanding task. Home Depot, Inc. must ensure that DIY customers are not disadvantaged by their pro -initiative. It has been observed that many other companies are doing better than Home Depot, Inc. in terms of product mix and focused customer strategy. Home Depot, Inc. must overcome their limitations and try to achieve comparative advantage in the professional market in terms of broader and deeper inventory, more knowledgeable sales help, and reliable delivery. Home Depot, Inc. should also work hard towards realizing their goal of being the no. 1 in the retail market for major appliances. To be successful in this feat the Home Depot, Inc. must be able to properly integrate different products within a given organizational structure to contend against possible competition. 3. Slow Down with Store Formats Schemes: Home Depot, Inc. plans to increase its no. of Expo design Stores, which involves fewer inventories, higher gross margin, higher payroll expense and a greater sensitivity to cyclical changes in discretionary income, to 200 within five
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to six years. We feel that Home Depot, Inc. should go slow with this strategy because it doesnt fit well with their current strategy & business plan and success from this scheme is much doubtful. 4. Saturate North American Market: Instead of over saturating the big city markets like Atlanta, Georgia, and Dallas, Home Depot, Inc. should look at the bigger picture and increase its no. of stores in cities where competition has not heated up yet and focus on the whole U.S. market. 5. Revise the International Growth plans: Since the international growth scheme is the riskiest of all plans and presents the most complex challenges because of real estate, and logistics of the supply chain as well as the barriers of language and cultural differences, Home Depot, Inc. should reassess this strategy. Home Depot, Inc. should focus on covering the North American market first and then consider joint venture methods for entering the global market. 6. Increase the Debt-Equity Ratio: Home Depot, Inc. can opt to raise their debt to enjoy increased Return on Equity (ROE). However, they must ensure that the interest to be paid on these debts do not exceed their Return on Assets. Our calculation validates this recommendation: On, January, 2001, Home Depot, Inc.s financial statements contained the fo llowing data: a. Profit Margin = 5.84% b. Asset Turnover = 2.25 c. Equity Multiplier = Total Assets/Total Equity = 20663.65/14929.49 = 1.38 Return on equity (%) = a*b*c = 18.20% Debt/Equity Ratio = Equity Multiplier -1 =0.38 Now if we set, Debt/Equity Ratio = 0.45, the Equity Multiplier will be, d. Equity Multiplier = 0.45+1 = 1.45 So, the new ROE = a*b*d = 19.07%

In conclusion, we can assert that, by pursuing our suggested courses of action, Home Depot, Inc. can expect to have an intrinsic stock value that roughly amounts to $30.45 on February 1, 2001. Conclusion A firms ultimate goal is to maximize the owners i.e. the shareholders wealth. In pursuing the firms goal of maximizing the stock price, the financial manager must carefully consider the balance of return and risk associated with each proposal and must undertake only those that create value for owners. By following our suggested course of action Home Depot, Inc. can achieve this goal. On the other hand prudent investors must have a comprehensive understanding about the intrinsic value of the firms stock they want to invest in and make their investment decision based on that. Home Depot, Inc. stocks had a lower intrinsic value at October 2000 than its market value. The investors should be cautious about investing in an overvalued stock. The financial statements and information on firms growth initiatives are periodically published, analyzing which the investors can get an idea of the intrinsic value of the stock to make the correct decision.