Home Depot, Inc. In The New Millenium
HOME DEPOT, INC. IN THE NEW MILLENNIUM
Question 1: Estimation of intrinsic value of Home Depot’s stock as of Feb 1, 2001
To simplify the question, let’s Supppose ROE of Home Depot Inc would be constant during the following years as 20%:
β=1.09
Re=Rf+β(ROE-Rf)=5.99%+1.09*6.5%=12.97%
By doing this we assume: the Market risk premium during 2001 would be 6.4%. Acctually, according to the lecturer, the risk premium during year 1998-2008 should be within the range of 4% to 8%. Therefore the assumption of 6.5% seems probable.
Abnormal earnings=Net Income – Shareholders’ Equity at the beginning of the year*Re=(20%-12.76%)BVE0=1086.3M
BVE0=15004M
Stock Value=BVE0+pv(AE)=15004M+1086.3/12.97%=23379.4M
So the intrinsic value of Home Depot’s stock of Feb 1, 2001 is 23379.4 millions …show more content…
Question 2: Assumptions regarding Home Depot’s future growth rate, ROE, and cost of equity support for Home Depot’s observed stock price of $48.20 on Feb 1, 2001: ✓ Investors perceive investment opportunities in terms of a probability distribution defined by expected return and risk.
✓ Investors’ expected utility is an increasing function of return and a decreasing function of risk (risk-aversion) ✓ Investors are
rational ✓ There would not be any significant capital structure change in the future. ✓ Home Depot company can maintain its competitive advantage and thereby earning a stable profit ✓ The risk premium in the future would be similar to the rate during 1998-2008 ✓ Introduction of Home Depot’s Service Performance Improvement (SPI) program since 2000 and is planned to implement in every store by the year-end 2001, which simultaneously increased sales productivity and customer satisfaction and is expected to bring out benefits in future such as: lower operating cost and higher sales revenue. Its commitment to rollout best practices is appreciated in investors’ view. ✓ Its growth initiatives in terms of customer groups, product categories, store formats, store location, and sales channel are also indicators for its expected growth. Also, these initiatives require considerable investment fund capital. ✓ As SalomonSmithBarney report on 8/23/2000, when the stock was trading at $50, he expected a deceleration in the company’s earnings growth to about 25% per year due to macroeconomic environment – higher interest rates and a slowing economy ✓ Assuming a long-term earnings growth rate of 20% ✓ It wasn’t operating in enough stores to have a material impact on earnings growth
Question 1: Estimation of intrinsic value of Home Depot’s stock as of Feb 1, 2001
To simplify the question, let’s Supppose ROE of Home Depot Inc would be constant during the following years as 20%:
β=1.09
Re=Rf+β(ROE-Rf)=5.99%+1.09*6.5%=12.97%
By doing this we assume: the Market risk premium during 2001 would be 6.4%. Acctually, according to the lecturer, the risk premium during year 1998-2008 should be within the range of 4% to 8%. Therefore the assumption of 6.5% seems probable.
Abnormal earnings=Net Income – Shareholders’ Equity at the beginning of the year*Re=(20%-12.76%)BVE0=1086.3M
BVE0=15004M
Stock Value=BVE0+pv(AE)=15004M+1086.3/12.97%=23379.4M
So the intrinsic value of Home Depot’s stock of Feb 1, 2001 is 23379.4 millions …show more content…
Question 2: Assumptions regarding Home Depot’s future growth rate, ROE, and cost of equity support for Home Depot’s observed stock price of $48.20 on Feb 1, 2001: ✓ Investors perceive investment opportunities in terms of a probability distribution defined by expected return and risk.
✓ Investors’ expected utility is an increasing function of return and a decreasing function of risk (risk-aversion) ✓ Investors are
rational ✓ There would not be any significant capital structure change in the future. ✓ Home Depot company can maintain its competitive advantage and thereby earning a stable profit ✓ The risk premium in the future would be similar to the rate during 1998-2008 ✓ Introduction of Home Depot’s Service Performance Improvement (SPI) program since 2000 and is planned to implement in every store by the year-end 2001, which simultaneously increased sales productivity and customer satisfaction and is expected to bring out benefits in future such as: lower operating cost and higher sales revenue. Its commitment to rollout best practices is appreciated in investors’ view. ✓ Its growth initiatives in terms of customer groups, product categories, store formats, store location, and sales channel are also indicators for its expected growth. Also, these initiatives require considerable investment fund capital. ✓ As SalomonSmithBarney report on 8/23/2000, when the stock was trading at $50, he expected a deceleration in the company’s earnings growth to about 25% per year due to macroeconomic environment – higher interest rates and a slowing economy ✓ Assuming a long-term earnings growth rate of 20% ✓ It wasn’t operating in enough stores to have a material impact on earnings growth