Expert answer:Budget analysis

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20171030094754milestone_4__1_.pdf

fin550_milestone_iv_modified___final_project___17tw1_2_.doc

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Running​ ​head:​ ​MILESTONE​ ​4(SECTION​ ​5)
Milestone​ ​4:​ ​Section​ ​5
Seynabou​ ​Dicko
SNHU
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MILETSONE​ ​4(SECTION​ ​5)
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Macroeconomic​ ​Analysis
Home​ ​Depot​ ​is​ ​the​ ​largest​ ​retail​ ​home​ ​improvement​ ​store​ ​in​ ​the​ ​United​ ​States.​ ​It​ ​has
55%​ ​of​ ​the​ ​market​ ​cap​ ​in​ ​the​ ​home​ ​improvement​ ​industry.​ ​The​ ​company​ ​recorded​ ​revenue​ ​of
$94,595​ ​million​ ​in​ ​Jan​ ​2017​​ ​(“HD​ ​Income​ ​Statement​ ​|​ ​Home​ ​Depot,​ ​Inc.​ ​(The)​ ​Stock​ ​-​ ​Yahoo
Finance”,​ ​2017).
Investor’s​ ​decision​ ​about​ ​investing​ ​in​ ​a​ ​project​ ​is​ ​determined​ ​by​ ​the​ ​value​ ​of​ ​the​ ​stock
of​ ​the​ ​company.​ ​The​ ​stock​ ​price​ ​of​ ​the​ ​company​ ​is​ ​significantly​ ​affected​ ​by​ ​the​ ​overall
market​ ​of​ ​the​ ​economy.​ ​In​ ​other​ ​words,​ ​the​ ​higher​ ​the​ ​stock​ ​price​ ​of​ ​the​ ​company,​ ​the​ ​higher
is​ ​it’s​ ​growth​ ​prospects.​ ​One​ ​of​ ​the​ ​ways​ ​to​ ​measure​ ​company’s​ ​stock​ ​valuation​ ​is​ ​to​ ​use​ ​the
PE​ ​ratio.​ ​It​ ​is​ ​the​ ​price​ ​to​ ​earnings​ ​ratio​ ​representing​ ​the​ ​ratio​ ​between​ ​company’s​ ​stock​ ​price
and​ ​it’s​ ​earning​ ​per​ ​share.​ ​A​ ​positive​ ​issue​ ​from​ ​the​ ​stock​ ​market​ ​has​ ​a​ ​positive​ ​effect​ ​on
company’s​ ​PE​ ​ratio.​ ​For​ ​example,​ ​during​ ​the​ ​economic​ ​recession​ ​of​ ​2008,​ ​the​ ​PE​ ​ratio​ ​of
Home​ ​Depot​ ​decreased.​ ​However,​ ​when​ ​the​ ​economy​ ​recovered​ ​the​ ​PE​ ​ratio​ ​also​ ​increased
as​ ​shown​ ​in​ ​the​ ​below​ ​figure.
Fig​ ​1​.Home​ ​Depot​ ​PE​ ​ratio​ ​from​ ​2006​ ​to​ ​2017.Retrieved​ ​from​ ​macrotrends.net
MILETSONE​ ​4(SECTION​ ​5)
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The​ ​overall​ ​market​ ​conditions​ ​can​ ​be​ ​represented​ ​by​ ​the​ ​S&P​ ​share​ ​price​ ​which​ ​is​ ​shown
below.
Fig​ ​2​.S&P​ ​Share​ ​price.​ ​Retrieved​ ​from​ ​finance.google.com
Cost​ ​of​ ​equity​ ​is​ ​defined​ ​as​ ​the​ ​rate​ ​of​ ​return​ ​investors​ ​require​ ​from​ ​a​ ​stock​ ​before
searching​ ​for​ ​other​ ​opportunities.The​ ​cost​ ​of​ ​equity​ ​is​ ​inversely​ ​related​ ​to​ ​the​ ​value​ ​of​ ​the
stock.​ ​Thus,​ ​when​ ​the​ ​share​ ​price​ ​goes​ ​up​ ​the​ ​cost​ ​of​ ​equity​ ​goes​ ​down.​ ​For​ ​HD,​ ​we​ ​can​ ​say
that​ ​higher​ ​value​ ​of​ ​HD’s​ ​common​ ​stock​ ​would​ ​result​ ​in​ ​a​ ​decrease​ ​in​ ​cost​ ​of​ ​capital​ ​in​ ​its
WACC.When​ ​a​ ​company​ ​borrows​ ​money​ ​in​ ​a​ ​promise​ ​to​ ​pay​ ​back​ ​at​ ​a​ ​future​ ​date​ ​with
interest,​ ​it​ ​is​ ​called​ ​debt​ ​financing.​ ​A​ ​company​ ​may​ ​use​ ​loans,​ ​bonds​ ​and​ ​other​ ​forms​ ​of​ ​debt
which​ ​gives​ ​the​ ​company​ ​an​ ​idea​ ​of​ ​overall​ ​rate​ ​to​ ​be​ ​paid​ ​by​ ​the​ ​company​ ​to​ ​use​ ​debt
financing.​ ​Small​ ​business​ ​firms​ ​only​ ​use​ ​debt​ ​financing​ ​for​ ​their​ ​business​ ​activities,​ ​whereas
other​ ​may​ ​use​ ​only​ ​equity​ ​finance​ ​if​ ​they​ ​are​ ​funded​ ​by​ ​equity​ ​investors.​ ​With​ ​the​ ​growth​ ​of
these​ ​small​ ​business​ ​firm,​ ​it​ ​is​ ​likely​ ​that​ ​they​ ​will​ ​use​ ​a​ ​combination​ ​of​ ​equity​ ​and​ ​debt
financing.​ ​The​ ​cost​ ​of​ ​debt​ ​is​ ​normally​ ​less​ ​than​ ​the​ ​cost​ ​of​ ​equity​ ​(r​s​).Cost​ ​of​ ​debt​ ​is​ ​equal​ ​to
rd​ ​(1-T),​ ​where​ ​T​ ​is​ ​the​ ​tax​ ​rate​ ​and​ ​r​d​​ ​is​ ​the​ ​borrowing​ ​rate.Thus,​ ​as​ ​long​ ​as​ ​the​ ​company​ ​is
not​ ​debt-financed,​ ​the​ ​WACC​ ​will​ ​be​ ​greater​ ​than​ ​r​d​(1-T).
WACC​ ​is​ ​the​ ​rate​ ​used​ ​by​ ​the​ ​firm​ ​to​ ​discount​ ​cash​ ​flows​ ​in​ ​the​ ​net​ ​present​ ​value
(NPV)​ ​calculation​ ​at​ ​the​ ​firm​ ​level.​ ​They​ ​are​ ​inversely​ ​related​ ​to​ ​one​ ​another.​ ​In​ ​other​ ​words,
MILETSONE​ ​4(SECTION​ ​5)
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increase​ ​in​ ​WACC​ ​will​ ​cause​ ​NPV​ ​to​ ​decrease,​ ​and​ ​a​ ​decrease​ ​in​ ​WACC​ ​would​ ​cause​ ​NPV
to​ ​increase.
External​ ​factors​ ​can​ ​significantly​ ​affect​ ​company’s​ ​financial​ ​position.​ ​When​ ​the​ ​US
economy​ ​expands,​ ​it’s​ ​GDP​ ​increases​ ​which​ ​represent​ ​the​ ​value​ ​of​ ​the​ ​economic​ ​output​ ​of
the​ ​country.​ ​Increase​ ​in​ ​GDP​ ​will​ ​cause​ ​an​ ​increase​ ​in​ ​production,​ ​and​ ​hence​ ​more​ ​people
would​ ​buy​ ​HD​ ​products​ ​causing​ ​an​ ​increase​ ​in​ ​net​ ​profit​ ​or​ ​sales.​ ​Thus,​ ​market​ ​expansion
would​ ​have​ ​a​ ​positive​ ​impact​ ​on​ ​company’s​ ​performance.
Nominal​ ​and​ ​real​ ​GDP​ ​are​ ​considered​ ​as​ ​a​ ​financial​ ​metric​ ​for​ ​evaluating​ ​company’s
economic​ ​growth​ ​and​ ​development.​ ​However,​ ​there​ ​exists​ ​difference​ ​between​ ​nominal​ ​and
real​ ​GDP.Real​ ​GDP​ ​is​ ​the​ ​GDP​ ​made​ ​at​ ​a​ ​constant​ ​price,​ ​whereas​ ​nominal​ ​GDP​ ​is​ ​the​ ​GDP
at​ ​the​ ​current​ ​price​​ ​(Mankiw,​ ​2017).​ ​Nominal​ ​GDP​ ​is​ ​the​ ​GDP​ ​without​ ​the​ ​effect​ ​of​ ​inflation,
whereas​ ​real​ ​GDP​ ​is​ ​inflation-adjusted​ ​GDP.As​ ​HD’s​ ​CEO,​ ​I​ ​would​ ​prefer​ ​real​ ​GDP
compared​ ​to​ ​nominal​ ​GDP​ ​as​ ​real​ ​GDP​ ​monitor​ ​the​ ​growth​ ​of​ ​output​ ​in​ ​an​ ​economy.​ ​Real
GDP​ ​use​ ​the​ ​method​ ​of​ ​constant​ ​price​ ​to​ ​track​ ​the​ ​total​ ​value​ ​produced.​ ​When​ ​GDP​ ​is
adjusted​ ​for​ ​inflation,​ ​a​ ​lower​ ​GDP​ ​indicates​ ​a​ ​decrease​ ​in​ ​output,​ ​whereas​ ​nominal​ ​GDP
decrease​ ​may​ ​be​ ​due​ ​to​ ​a​ ​decrease​ ​in​ ​price​ ​or​ ​output.​ ​Thus,​ ​I​ ​would​ ​prefer​ ​real​ ​GDP​ ​to
measure​ ​the​ ​output​ ​of​ ​an​ ​economy.
The​ ​FED​ ​can​ ​use​ ​three​ ​tools​ ​to​ ​either​ ​increase​ ​or​ ​decrease​ ​the​ ​interest​ ​rate​ ​to​ ​achieve
its​ ​monetary​ ​policy.​ ​These​ ​are​ ​open​ ​market​ ​operations,​ ​reserve​ ​requirement​ ​and​ ​the​ ​discount
rate.​ ​Among​ ​the​ ​three​ ​monetary​ ​policy​ ​tools,​ ​FED​ ​mostly​ ​uses​ ​open​ ​market​ ​operation​ ​as​ ​it​ ​is
flexible.​ ​The​ ​Federal​ ​Open​ ​market​ ​Committee​ ​purchase​ ​and​ ​sell​ ​government​ ​securities
through​ ​open​ ​market​ ​operations.​ ​Home​ ​Depot​ ​Inc.​ ​will​ ​be​ ​significantly​ ​influenced​ ​by
increase​ ​in​ ​overall​ ​interest​ ​rates.​ ​Lower​ ​rates​ ​for​ ​home​ ​financing​ ​will​ ​boost​ ​HD’s​ ​sale​ ​as
people​ ​have​ ​to​ ​pay​ ​less​ ​interest​ ​to​ ​buy​ ​HD​ ​products.However,​ ​if​ ​the​ ​interest​ ​rate​ ​is​ ​increased,
MILETSONE​ ​4(SECTION​ ​5)
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the​ ​sale​ ​of​ ​HD’s​ ​products​ ​will​ ​get​ ​reduced​ ​as​ ​loans​ ​for​ ​home​ ​financing​ ​will​ ​be​ ​offered​ ​by​ ​the
bank​ ​at​ ​higher​ ​interest​ ​rate.
MILETSONE​ ​4(SECTION​ ​5)
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References
HD​ ​Income​ ​Statement​ ​|​ ​Home​ ​Depot,​ ​Inc.​ ​(The)​ ​Stock​ ​-​ ​Yahoo​ ​Finance​.
(2017). ​Finance.yahoo.com​.​ ​Retrieved​ ​29​ ​October​ ​2017,​ ​from
https://finance.yahoo.com/quote/HD/financials?p=HD
Home​ ​Depot​ ​(HD)​ ​EPS​ ​&​ ​PE​ ​Ratio​ ​History.​ ​(2017). Macrotrends.net.​ ​Retrieved​ ​28​ ​October
2017,​ ​from
http://www.macrotrends.net/stocks/charts/HD/pe-ratio/home-depot-pe-ratio-history
Mankiw,​ ​N.​ ​(2017). ​Macroeconomics​.​ ​New​ ​York:​ ​Worth​ ​Publishers.
​S&P​
​500:​ ​INDEXSP:.INX​ ​historical​ ​prices​ ​-​ ​Google​ ​Finance.​ ​(2017). Finance.google.com.
Retrieved​ ​29​ ​October​ ​2017,​ ​from
https://finance.google.com/finance/historical?cid=626307&startdate=Aug+1%2C+20
08&enddate=Oct+29%2C+2017&num=30&ei=eCz2WdGMAcmZuQTBzIPAAQ
Instructions for Milestone #4 (Section 5) & Final Project Submission
The following additional information should be used when you write up your Milestone #4
(Section 5) assignment and your Final Project Submission. The CEO of the company is
convinced that a financial analysis should hinge only on what is happening internally within HD.
Using the Home Depot balance sheet on page 32 and the income statement on page 33, conduct
the following financial analysis by computing the ratios below:
Macroeconomic Items to Cover for Milestone #4 (Section 5):
1. How might a positive issue from the stock market impact the company’s stock valuation
numbers? For example, since the November 2016 election, there has been a considerable
increase in all major stock market indices. Would higher values for HD’s common stock result
in an increase or decrease in cost of equity capital in its WACC as we discussed in class and in
Chapter 9 (i.e., the value of rs in the DCF model for the cost of equity)? In addition, explain how
such a change in the cost of rs might lead the firm to use more or less debt financing in its
WACC? Finally, briefly explain how a change in HD’s WACC would impact (increase or
decrease) the NPV of the capital budgeting project you analyzed in Milestone #3 (Section 4) of
your term project.
2. Suppose the US economy continues to expand as it has most recently. How might this
external event impact HD (in terms of its sales, net income, etc.)? Briefly distinguish between
nominal GDP versus real GDP. As the firm’s CEO, if you were to analyze changes in nominal
GDP versus real GDP data briefly explain which of the two would you argue is most relevant.
Furthermore, it has been widely speculated that the FED will continue to increase interest rates in
the future. Based on our macroeconomics discussions in class on 10/16, what are the three (3)
tools of monetary policy which the FED can use to change interest rates? Which of these three
monetary policy tools is most often used by FED policymakers? How might an increase in
overall market interest rates impact HD? Explain your answer.
For your Final Project Submission and Financial Analysis, Please Cover the Following
Items:
1. Determine the current and quick ratios for 2015 and 2014 and briefly comment on the
changes between these two years.
2. Determine days sales outstanding (DSO) for 2015 and 2014 and briefly comment on the
changes between these two years. Note: Here use Net Receivables and Net Sales as well as a
365-day year.
3. Determine the total asset turnover ratios (TATO) for 2015 and 2014 and briefly comment on
the changes between these two years.
4. Determine the Operating Cycle for HD in 2015 and 2014 as well as HD’s Cash Conversion
Cycle in both 2014 and 2015. Based on your CCC for Home Depot, has operating liquidity
increased or decreased over these two years? Briefly explain.
Note: Use Merchandise Inventories from the balance sheet on page 32 and Accounts Payable
from the balance sheet when you determine the turnover ratios and the Operating Cycle for HD.
Similarly, use Net Sales and Cost of Sales (as cost of goods sold) from the income statement on
page 33 when you determine DSO (question #2 above) and payables turnover for HD and then
its Payables Deferral Period.
5. Determine the profit margin (PM) for 2015 and 2014 and briefly comment on the changes
between these two years.
Note: Here use the value of Net Earnings for each of the two years and the values of Net Sales
for the two years as well.
6. Determine the value of return on assets (ROA) for 2015 and 2014 and briefly comment on the
changes between these two years. Once again, rely on the value of Net Earnings (from the
income statement and Total Assets from the balance sheet).
7. Determine the value of return on equity (ROE) for 2015 and 2014 and briefly comment on the
changes between these two years. In your calculation of ROE, once again rely on the value of
Net Earnings (from the income statement) and Total Stockholders’ Equity (in the next-to-last
line of the balance sheet on page 32 of the 10-K report).
…
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