Company analysis and valuation of apple inc , oracle corporation, ibm corporation and microsoft corporation,masters thesis

Dissertation submitted in partial fulfillment of the Requirement for the MSc in Finance FINANCE DISSERTATION ON Company analysis and valuation of Apple Inc., Oracle Corporation, IBM Corporation and Microsoft Corporation NAME OF STUDENT ID No: 16031462 Intake Supervisor: Prof Dr Pham Thi Hoang Anh September 2018 FINANCE DISSERTATION Name: Ngoc Uyen Luu Student no: 16031462 Supervisor: Prof Dr Pham Thi Hoang Anh Project title: Company analysis and valuation of Apple Inc., Oracle Corporation, IBM Corporation and Microsoft Corporation Date submission: September, 26th 2018 Word count: Executive Summary This dissertation studies the global leading companies in the technology sector are Apple Inc., Oracle Corporation, IBM Corporation and Microsoft Corporation It evaluates all internal and external factors which influence these companies’ performance and prospects to give the investment recommendations to investors Based on the macro- economic analysis, the US and Asia- Pacific is recognised as the regions with the most potential for the development of the technology sector Because of that, technology companies should focus on developing and increasing their presence in these markets The industry analysis represents an intense competition between existing companies Thus, they need to come up with more innovative tactics and spend more on R&D to compete more effective for the coming years In the company analysis, it can be seen that Apple Inc and Microsoft Corporation are the companies have an outstanding performance IBM Corporation is having trouble when its financial ratios show a worsening financial position and its sale growth is predicted to be negative in the next few years The valuation models are applied to calculate the intrinsic values of the four companies The target price of Apple Inc., Oracle Corporation, IBM Corporation and Microsoft Corporation are $188.3, $41.43, $124.64 and $64 respectively Combining all analyses, recommendations are made for each stock Acknowledgements This study was the result of a one-year process of researching and putting in writing during the year of 2017/18 First of all, in order to fulfil this study, I would like to express my great thanks to lots of people for their contribution and help during my research process In particular, special mention and sincere thank have to go to Prof Dr Pham Thi Hoang Anh, my supervisor at Banking Academy VIetnam I could not have completed this dissertation without her careful guidance, right direction and constructive suggestions Last but not least, I also would like to thank my lecturers, my friends and all of authors of the journal article and books that I have given references in my research Table of Contents Abbreviations Chapter I: Introduction I An overview on the technology market II Area of the study III Study objectives IV Methodology V Organisation of the study 10 Chapter II: Macroeconomic analysis 11 I Overview of the global economy in 2018 11 1.1 II US Economy 13 PEST analysis: 13 Key macroeconomic factors analysis: 14 1.1.1 Summary of the US economy: 16 1.2 III European economy 17 PEST analysis: 17 1.2.1 Key macroeconomic indicators analysis: 19 1.2.2 Summary of the European economy: 19 1.3 IV Asia- Pacific economy 20 PEST analysis: 20 Key macroeconomic indicators analysis: 21 Summary of the Asia- Pacific economy: 22 Chapter III: Industry analysis Error! Bookmark not defined I Bargaining power of buyers 25 II Bargaining power of suppliers 25 III Threat of new entrants 26 IV Threat from substitutes 26 V Rivalry among existing players 27 Chapter IV: Company Analysis 28 1.4 APPLE INC 30 SWOT analysis 30 Ratio analysis 34 Valuation 37 1.5 ORACLE 43 SWOT analysis 43 Ratio analysis 49 Valuation 51 1.6 IBM CORP 56 SWOT analysis 56 Ratio analysis 60 Valuation 63 1.7 MICROSOFT CORP 68 SWOT analysis 68 Ratio analysis 72 Valuation 75 Conclusion 79 References 81 Appendices 87 Abbreviations APPL Apple Inc CPI Consumer Price Index CSFTA China- Singapore Free Trade Agreement DPS Dividend per Share EBITDA Earnings before Interests, Taxes, Depreciation, and Amortization EPS Earnings per Share EU European Union GDP Gross Domestic Product IBM International Business Machines Corporation IMF International Monetary Fund IT Information Technology MSFT Microsoft Corporation OECD Organisation for Economic Co-operation and Development ORCL Oracle Corporation P/E Price/Earnings R&D Research and Development ROA Return on Assets ROE Return on Equity UK United Kingdoms US United States Chapter I: Introduction I An overview on the technology market The technology sector contains businesses revolving around the manufacturing of electronics, creation of software, computers or products and services relating to information technology (Bloomberg, 2018) It is considered as a leading sector for growth- based investment This sector performed well in 2017, it had increased 15.6% since the January 2017 (Sands, 2018) However, Brexit caused a decline in the performance of technology sector It creates more risk and uncertainty for the business when just in the UK, according to KPMG report in 2018, 70 percent of tech workers are considering leaving the UK The technology sector is dominated by leading companies, namely Apple (APPL), Microsoft (MSFT) and Facebook (FB) The stocks of these companies had returned 10.8%, 14.8% and 13%, respectively, in December 2017 in compared with their performance in the same period in 2016 These firms carry out their business across the world with the main driver of sales in 2017 being focused on regions: Europe, Asia- Pacific and the US (Datamonitor, 2018) In 2018, the technology sector is forecasted to have an explosive growth (Bajarin, 2017) According to researchers, there will be potential tripling of demand for tech- related goods and services over the next decade With the growth of the importance of technology in society, the technology sector has become a bellwether of the overall stock market and economy II Area of the study This dissertation not only focuses on analysing but also assessing the intrinsic values of largest firms in the technology sector are: Apple Inc., Oracle, IBM and Microsoft The analysis consists of main regions: Asia, Europe and US that these companies operate but US is more focused because this in the region that all companies mainly operate By doing all of these analyses, this study wants to understand deeply the technology sector’s leaders and provide some investment recommendations for investors who have purpose to invest in these companies III Study objectives Objectives of this study are having an overview of technology sector and provide investment recommendations 1) Providing current technology sector insights 2) Analysing crucial macroeconomic indicators of the economies in Asia, US, Europe 3) Analysing technology industry in these regions 4) Base on the financial statements, gearing ratios, profitability ratios, investment ratios of Apple Inc., Oracle, IBM and Microsoft are analysed In the next step, this paper uses the valuation models to calculate the intrinsic value of these companies After analysing and assessing the intrinsic value, this project will provide investment recommendations IV Methodology The top- down analysis method will be used in this project It will start with technology sector economic evaluation, consist of macroeconomic analysis and industry analysis By evaluating these, the project wants to analyse industrial and macroeconomic condition, which are vital indicators of the firms’ potential profit Then, it focuses on companies’ performance and recommend a price, using the valuation models Macroeconomic analysis: This project uses PEST analysis which include: political, economic, social and culture impacts, aim at evaluating the important macroeconomic determinants: inflation, unemployment rate, GDP, exchange rate and CPI Industry analysis: This study illustrates technology sector overview before pointing out the impact of market trends on firms in this industry The determinants affect market competition are analysed also Company analysis and valuation: By using the financial statements of companies, financial websites: IMF, MarketLine, WB and financial databases: OSIRIS, Datastream, this study will evaluate profitability and financial situation of these firms After that, the intrinsic values will be calculated and analysed It combines with SWOT analysis to analyse the strengths, weaknesses, opportunities, threats of companies, give an insight into these firms V Organisation of the study This project is divided into chapters Chapter provides a brief introduction to the area of the study and the objectives of the study The next chapter is chapter evaluates global economy in the recent year and three regions: Asia, Europe and US In the third chapter, the study aims at analysing technology industry’s vital indicators and the factors affect market competition To examine this, Porter’s Five Forces is used as an analytical tool From chapter to chapter 7, there are brief descriptions of chosen companies, their performance and their future forecast The calculation of intrinsic values, investment recommendations are also included in these chapters Chapter is the report summarisation 10 Sands, S (2018) How Did the Technology Sector Perform in 2017? - Market Realist Available from: http://marketrealist.com/2018/01/technology-sector-perform-2017/ [Accessed 12 September 2018] World Bank (2018) Global Economy in 2018: Hope and Uncertainty Available from: http://www.worldbank.org/en/news/opinion/2018/02/15/global-economy-in-2018-hope-anduncertainty [Accessed 01 September 2018] Yu, R (2018) IMF raises global economic outlook in 2018 to 3.5% on investment recovery Available from: https://www.usatoday.com/story/money/2018/04/18/imf-raises-globaleconomic-outlook-2018-35-investment-recovery/100592270/ [Accessed 21 July 2018] 85 86 Appendices Apple Inc Free cash flow model (5- years projected model) Assumptions   Sales growth is based on 3- year average Apple is the largest dominant player in the consumer electrics industry Moreover, Apple is expected to post double- digit growth on iPhone 8’s debut IDC’s iPhone forecast calls for 3.8% unit growth in 2018, 7.5% in 2019 and 1.6% in 2019 The Apple’s iPhone sales are expected to increase 8.8% in 2018 to $161.7 billion and 9% in 2019 to $176.3 billion before flattening out in 2019 at $176.4 billion (Bloomberg Intelligence, 2018) Because of that, the growth rate of Apple in long term is assumed at 4% Cost of capital (Source: Bloomberg) - Beta: 1.21 (Bloomberg, 2018) - Risk- free rate: 2.3% - Market risk premium: 7.22% - Cost of equity: 10.94% (CAPM: Risk- free rate + Beta*Market risk premium) - Cost of debt: 1.8% equal weighted average interest rate on long –term debt in FY2017 revealed by Apple annual report - Debt: $98,522m - Market value equity: $747867.38m - Tax rate: 25.56% - Cost of capital: 9.9% given by WACC = x Re + x Rd x (1 – Tc) Where: Re = cost of equity Rd = cost of debt E = market value of the firm’s equity D = market value of the firm’s debt V=E+D E/V = percentage of financing that is equity D/V = percentage of financing that is debt Tc = corporate tax rate Dividend Discount Model G: because from 2007 to 2012, the dividend per share of Apple Inc equalled so growth rate of dividend is based on the historical growth rate in 4- year average from 2014 to 2017 87 Years ended 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 0.00 0.00 0.00 0.00 0.00 0.38 1.63 1.82 1.98 2.18 0.00% 0.00% _ 11.66% 8.8% 10.1% September DPS g 0.00 0.00% 0.00% 0.00% Sales revenue growth Assume 4.00% Other current assets/Sales = Total other current assets / Sales 10.12% Current liabilities/Sales = Total current liabilities / Sales 36.64% Non-current assets/Sales = Total long-term assets / Sales 99.62% Cost of goods sold/Sales = Cost of sales/ Sales 60.92% Depreciation rate = Depreciation property, plant Expense & / (Net 11.2% equipment + Depreciation Expense) Interest rate on debt (finance costs) = Interest expense / (Short-term 1.74% borrowings + Long-term borrowings) Interest paid on CMS (finance income) = Interest income / cash, cash 5.95% equivalent and short investment Income (corporation) tax rate Corporation tax rate in the U.S 25.56% Dividend pay-out ratio = Dividend paid / Net income 26.19% Income Statement Forecast- Apple Inc 88 $ in millions, Years ended September 2017 2018E 2019E 2019E 2020E 2021E 215,639 224,265 233,235 242,565 252,267 262,358 (131,367) (136,622) (142,087) (147,770) (153,681) (159,828) Finance costs (2,969) (2,969) (2,969) (2,969) (2,969) (2,969) Finance income (interest earned on CMS) 14,136 15,088 16,997 18,911 20,811 22,680 Depreciation (8,300) (30,059) (34,665) (39,859) (45,713) (52,306) Profit before tax 87,140 69,704 70,512 70,877 70,716 69,935 (22,273) (17,816) (18,023) (18,116) (18,075) (17,875) 64,867 51,887 52,489 52,761 52,641 52,059 (16,989) (13,589) (13,747) (13,818) (13,787) (13,634) 47,878 38,298 38,742 38,943 38,854 38,425 Income statement Sales revenue Cost of goods sold Income tax expense Profit after tax Dividends Retained earnings (for the year) Balance Sheet Forecast- Apple Inc 2017 2018E 2019E 2019E 2020E 2021E Cash and marketable securities 237,585 269,578 301,763 333,886 365,648 396,696 Other current assets (excl CMS) 21,823 22,696 23,603 24,548 25,529 26,551 At cost 249,055 287,706 331,307 380,460 435,839 498,197 Depreciation (34,235) (64,294) (98,958) (138,817) (184,530) (236,836) Non-current assets 214,820 223,412 232,349 241,643 251,309 261,361 Total assets 474,227 515,686 557,715 600,076 642,485 684,608 Current liabilities 79,010 82,171 85,457 88,876 92,431 96,128 Borrowings (debt) 170,604 170,604 170,604 170,604 170,604 170,604 Shareholders' equity 128,249 128,249 128,249 128,249 128,249 128,249 Accumulated retained earnings 96,364 134,662 173,405 212,347 251,202 289,627 Total liabilities and equity 474,227 515,686 557,715 600,076 642,485 684,608 Profit after tax 51887 52489 52761 52641 52059 Add back depreciation 30059 34665 39859 45713 52306 Subtract increase in current assets (873) (908) (944) (982) (1021) $ in millions, Years ended September Non-current assets Free Cash Flow Calculation- Apple Inc Year Free cash flow calculation 89 Add back increase in current liabilities 3160 3287 3418 3555 3697 (38651) (43601) (49153) (55378) (62358) Add back after-tax finance costs 2210 2210 2210 2210 2210 Subtract after-tax finance income (11232) (12653) (14077) (15492) (16883) 36560 35489 34074 32266 30010 Subtract increase in non-current assets at cost Free cash flow Oracle Free cash flow model (5- years projected model) Assumptions:   Sales growth: Oracle’s cloud infrastructure product which was launched in September 2017, could become a major growth catalyst in the upcoming years (Bloomberg Intelligence, 2018) This product allows Oracle to compete more effectively with other large cloud infrastructure vendors such as Microsoft, Google and Amazon.com Oracle’s fiscal 4Q results pointed out Cloud deferred revenue growth of 63%, suggest that the shift from on- premise databases to the cloud is increasing, which will likely lead to the strong cloud growth in the next years Therefore, the sales growth is assumed at 3% Cost of capital (Source: Bloomberg) - Beta: 1.06 (Bloomberg, 2018) - Risk- free rate: 2.309% - Market risk premium: 7.22% - Cost of equity: 9.95% (CAPM: Risk- free rate + Beta*Market risk premium) - Cost of debt: 2.1% equal weighted average interest rate on long –term debt in FY2017 revealed by Oracle annual report - Debt: $57,909m - Market value equity: $187,778.43m - Tax rate: 18.95% - Cost of capital: 8.1% given by WACC = x Re + x Rd x (1 – Tc) Where: Re = cost of equity Rd = cost of debt E = market value of the firm’s equity D = market value of the firm’s debt V=E+D E/V = percentage of financing that is equity D/V = percentage of financing that is debt 90 Tc = corporate tax rate Residual Income Model B0: $13.11 opening book value of Oracle’s equity ROE: 17.6% derives from year average from FY2014 to FY2019 r: 9.95% cost of equity g: -17.31% growth rate of earnings equal to growth rate of earnings in 2022E that the terminal growth rate derives Years 2014 2015 2016 2017 2018 2019E 2019E 2020E 2021E 2022E -32.17% -6.14% -8.6% -12.06% -17.31% ended May $13.11 Bo ROE 24.74% 23.94% 20.8% 18.55% 18.46% 9.95% R g Sales revenue growth Assume 3.00% Other current assets/Sales = Total other current assets / Sales 7.52% Current liabilities/Sales = Total current liabilities / Sales 64.08% Non-current assets/Sales = Total long-term assets / Sales 160.29% Cost of goods sold/Sales = Cost of sales/ Sales 19.8% Depreciation rate = Depreciation property, plant Expense & / (Net 15.83% equipment + Depreciation Expense) Interest rate on debt (finance costs) = Interest expense / (Short-term 3.1% borrowings + Long-term borrowings) Interest paid on CMS (finance income) = Interest income / cash, cash 1.21% equivalent and short investment Income (corporation) tax rate Corporation tax rate in the U.S 18.95% Dividend pay-out ratio = Dividend paid / Net income 28.21% 91 Income Statement Forecast- Oracle Corp $ in millions, Years ended September 2018 2019E 2019E 2020E 2021E 2022E Sales revenue 37,728 38,860 40,026 41,226 42,463 43,737 Cost of goods sold (7,470) (7,694) (7,925) (8,163) (8,408) (8,660) (724) (724) (724) (724) (724) (724) 800 862 984 1,095 1,192 1,273 Depreciation (1,000) (11,408) (13,685) (16,364) (19,513) (23,213) Profit before tax 29,333 19,896 18,675 17,070 15,011 12,413 Income tax expense (5,559) (3,770) (3,539) (3,235) (2,844) (2,352) Profit after tax 23,774 16,126 15,136 13,835 12,166 10,060 Dividends (6,707) (4,549) (4,270) (3,903) (3,432) (2,838) Retained earnings (for the year) 17,068 11,577 10,866 9,932 8,734 7,222 Income statement Finance costs Finance income (interest earned on CMS) Balance Sheet Forecast- Oracle Corp $ in millions, Years ended September 2018 2019E 2019E 2020E 2021E 2022E Cash and marketable securities 66,078 76,481 86,137 94,824 102,275 108,176 Other current assets (excl CMS) 2,837 2,922 3,010 3,100 3,193 3,289 At cost 65,453 78,675 94,229 112,518 134,013 159,269 Depreciation (4,979) (16,387) (30,072) (46,436) (65,949) (89,162) Non-current assets 60,474 62,288 64,157 66,082 68,064 70,106 Total assets 129,389 141,691 153,304 164,006 173,532 181,571 Current liabilities 24,176 24,901 25,648 26,418 27,210 28,027 Borrowings (debt) 23,369 23,369 23,369 23,369 23,369 23,369 Shareholders' equity 54,246 54,246 54,246 54,246 54,246 54,246 Accumulated retained earnings 27,598 39,175 50,041 59,973 68,707 75,929 Total liabilities and equity 129,389 141,691 153,304 164,006 173,532 181,571 Non-current assets Free Cash Flow Calculation- Oracle Corp Year Profit after tax 16126 15136 13835 12166 10060 Add back depreciation 11408 13685 16364 19513 23213 Free cash flow calculation 92 Subtract increase in current assets (85) (88) (90) (93) (96) Add back increase in current liabilities 725 747 769 793 816 (13222) (15554) (18289) (21495) (25255) Add back after-tax finance costs 587 587 587 587 587 Subtract after-tax finance income (699) (797) (887) (966) (1032) Free cash flow 14840 13716 12289 10504 8294 Subtract increase in non-current assets at cost IBM Free cash flow model (5- years projected model) Assumptions:   Sales growth: From the last few years, IBM has been dealing with the greater competition from lower cost companies such as Tata Consultancy Services, Infosys and Cognizant In order to compete on a global scale, IBM has expanded business in India, offering competitive prices This move of IBM could influence negatively on the company revenue growth, while aiming to improve margins As a results, the IBM’s sale growth is assumed at – 5.59% on the year average Cost of capital (Source: Bloomberg) - Beta: 0.96 (Bloomberg, 2018) - Risk- free rate: 2.3% - Market risk premium: 7.22% - Cost of equity: 9.26% (CAPM: Risk- free rate + Beta*Market risk premium) - Cost of debt: 2.43% equal weighted average interest rate on long –term debt in FY2017 revealed by IBM annual report - Debt: $34,990m - Market value equity: $143,360.38m - Tax rate: 5.54% - Cost of capital: 7.9% given by WACC = x Re + x Rd x (1 – Tc) Where: Re = cost of equity Rd = cost of debt E = market value of the firm’s equity D = market value of the firm’s debt V=E+D E/V = percentage of financing that is equity D/V = percentage of financing that is debt 93 Tc = corporate tax rate Dividend Discount Model Years 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 1.1 1.5 1.9 2.15 2.5 2.9 3.3 3.7 4.25 5.5 ended December DPS 36.36% 26.67% 13.16% 16.28% g 16% 13.79% 12.12% 14.86% 17.65% By using the historical growth rate in 10 year average, we can get g= 17.69% However, this dividend growth rate is higher than cost of equity: 9.26%, cannot using this growth rate for the dividend discount model So, this dividend discount model will use the dividend growth that is estimated for the next years (from 2018 to 2019) Years ended 2018 2019 2019 4.03 4.24 4.41 December g Source: Bloomberg as of 01/08/2018 G= 4.23% Sales revenue growth Assume -5.59% Other current assets/Sales = Total other current assets / Sales 7.03% Current liabilities/Sales = Total current liabilities / Sales 45.39% Non-current assets/Sales = Total long-term assets / Sales 92.07% Cost of goods sold/Sales = Cost of sales/ Sales 52.08% Depreciation rate = Depreciation property, plant Expense & / (Net 20.76% equipment + Depreciation Expense) Interest rate on debt (finance costs) = Interest expense / (Short-term 1.75% borrowings + Long-term borrowings) Interest paid on CMS (finance income) = Interest income / cash, cash 1.27% equivalent and short investment Income (corporation) tax rate Corporation tax rate in the U.S 94 5.54% 10% = Dividend paid / Net income Dividend pay-out ratio 44.24% Income Statement Forecast- IBM Corp $ in millions, Years ended December 2017 2018E 2019E 2019E 2020E 2021E 79,919 75,452 71,234 67,252 63,492 59,943 (41,622) (39,295) (37,099) (35,025) (33,067) (31,218) 2,095 2,095 2,095 2,095 2,095 2,095 108 182 308 391 423 396 Depreciation (2,837) (21,040) (24,987) (29,901) (36,002) (43,562) Profit before tax 37,663 17,393 11,551 4,811 (3,059) (12,346) Income tax expense (2,087) (964) (640) (267) 169 684 Profit after tax 35,577 16,429 10,911 4,545 (2,889) (11,662) (15,739) (7,268) (4,827) (2,011) 1,278 5,159 19,838 9,161 6,084 2,534 (1,611) (6,503) Income statement Sales revenue Cost of goods sold Finance costs Finance income (interest earned on CMS) Dividends Retained earnings (for the year) Balance Sheet Forecast IBM Corp $ in millions, Years ended December 2017 2018E 2019E 2019E 2020E 2021E Cash and marketable securities 8,527 20,088 28,437 33,110 33,518 28,921 Other current assets (excl CMS) 5,618 5,304 5,008 4,728 4,464 4,214 92,884 109,811 130,915 157,150 189,691 229,986 (19,303) (40,343) (65,330) (95,231) (131,233) (174,796) 73,581 69,468 65,585 61,919 58,457 55,190 Total assets 87,727 94,860 99,029 99,756 96,439 88,325 Current liabilities 36,275 34,247 32,333 30,526 28,819 27,208 Borrowings (debt) (119,700) (119,700) (119,700) (119,700) (119,700) (119,700) Shareholders' equity 18,392 18,392 18,392 18,392 18,392 18,392 Accumulated retained earnings 152,759 161,920 168,004 170,538 168,927 162,424 Total liabilities and equity 87,727 94,860 99,029 99,756 96,439 88,325 Non-current assets At cost Depreciation Non-current assets Free Cash Flow Calculation- IBM Corp Year 95 Free cash flow calculation Profit after tax 16429 10911 4545 (2889) (11662) Add back depreciation 21040 24987 29901 36002 43562 314 297 280 264 250 Add back increase in current liabilities (2028) (1914) (1807) (1706) (1611) Subtract increase in non-current assets at cost (16927) (21104) (26235) (32541) (40295) Add back after-tax finance costs (1979) (1979) (1979) (1979) (1979) Subtract after-tax finance income (172) (291) (369) (400) (375) Free cash flow 16679 10906 4336 (3248) (12109) Subtract increase in current assets Microsoft Free cash flow model (5- years projected model) Assumptions:   Sales growth: Microsoft is a multinational company, one of the largest in the softwareinfrastructure industry Therefore, the sale growth of Microsoft is assumed to reach 1.46% on the year average (Bloomberg, 2018) Cost of capital (Source: Bloomberg) - Beta: 1.13 (Bloomberg, 2018) - Risk- free rate: 2.26% - Market risk premium: 7.16 % - Cost of equity: 10.34% (CAPM: Risk- free rate + Beta*Market risk premium) - Cost of debt: 2.07% equal weighted average interest rate on long –term debt in FY2019 revealed by Microsoft annual report - Debt: $86,194m - Market value equity: $531,312.44m - Tax rate: 8.4% (Bloomberg, 2018) - Cost of capital: 9.2% given by WACC = x Re + x Rd x (1 – Tc) Where: Re = cost of equity Rd = cost of debt E = market value of the firm’s equity D = market value of the firm’s debt V=E+D 96 E/V = percentage of financing that is equity D/V = percentage of financing that is debt Tc = corporate tax rate Dividend Discount Model G = 14.81% growth rate of dividend is based on the historical growth rate in 10- year average Years ended 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 0.44 0.52 0.52 0.64 0.8 0.92 1.12 1.24 1.44 1.56 10% 18.18% 0% 23.08% 25% 15% June 0.4 DPS g 21.74% 10.71% 16.13% However, g> cost of equity Because of that, g is calculated based on the dividend growth of the next years average Years ended 2019 2019 2020 2.3 2.5 2.5 June g Source: Bloomberg as of 01/08/2018 G= 2.43% Sales revenue growth Assume 1.46% Other current assets/Sales = Total other current assets / Sales 5.44% Current liabilities/Sales = Total current liabilities / Sales 71.74% Non-current assets/Sales = Total long-term assets / Sales 90.31% Cost of goods sold/Sales = Cost of sales/ Sales 38.09% Depreciation rate = Depreciation property, plant Expense & / (Net 0.00% equipment + Depreciation Expense) Interest rate on debt (finance costs) = Interest expense / (Short-term 0.00% borrowings + Long-term borrowings) Interest paid on CMS (finance income) = Interest income / cash, cash 0.00% equivalent and short investment Income (corporation) tax rate Corporation tax rate in the U.S 8.4% Dividend pay-out ratio = Dividend paid / Net income 56.99% 97 8.33% Income Statement Forecast- Microsoft Corp $ in millions, Years ended September 2018 2019E 2019E 2020E 2021E 2022E 89,950 91,263 92,596 93,948 95,319 96,711 (34,262) (34,762) (35,270) (35,785) (36,307) (36,837) Finance costs - - - - - - Finance income (interest earned on CMS) - - - - - - Depreciation - - - - - - Profit before tax 55,688 56,501 57,326 58,163 59,012 59,874 Income tax expense (4,678) (4,746) (4,815) (4,886) (4,957) (5,029) Profit after tax 51,010 51,755 52,511 53,277 54,055 54,844 (29,071) (29,495) (29,926) (30,363) (30,806) (31,256) 21,940 22,260 22,585 22,915 23,249 23,589 Income statement Sales revenue Cost of goods sold Dividends Retained earnings (for the year) Balance Sheet Forecast- Microsoft Corp 2018 2019E 2019E 2020E 2021E 2022E 132,981 154,926 177,190 199,780 222,700 245,955 4,893 4,965 5,037 5,111 5,185 5,261 At cost 105,413 106,599 107,802 109,023 110,262 111,519 Depreciation (24,179) (24,179) (24,179) (24,179) (24,179) (24,179) 81,234 82,420 83,623 84,844 86,083 87,340 Total assets 219,108 242,310 265,851 289,735 313,968 338,555 Current liabilities 64,530 65,472 66,428 67,398 68,382 69,380 Borrowings (debt) 79,536 79,536 79,536 79,536 79,536 79,536 Shareholders' equity 72,394 72,394 72,394 72,394 72,394 72,394 Accumulated retained earnings 2,648 24,908 47,493 70,407 93,656 117,245 219,108 242,310 265,851 289,735 313,968 338,555 $ in millions, Years ended September Cash and marketable securities Other current assets (excl CMS) Non-current assets Non-current assets Total liabilities and equity Free Cash Flow Calculation- Microsoft Corp Year 51755 52511 53277 54055 54844 0 0 Free cash flow calculation Profit after tax Add back depreciation 98 Subtract increase in current assets (71) (72) (74) (75) (76) Add back increase in current liabilities 942 956 970 984 998 (1186) (1203) (1221) (1239) (1257) Add back after-tax finance costs 0 0 Subtract after-tax finance income 0 0 51440 52191 52953 53726 54510 Subtract increase in non-current assets at cost Free cash flow 99