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American Eagle Apparel Stores

American Eagle Apparel Stores. Module 8: Valuation Using Abnormal Enterprise Income Growth By: Nick Cecero. Abnormal Enterprise Income Growth Model.

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American Eagle Apparel Stores

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  1. American EagleApparel Stores Module 8: Valuation Using Abnormal Enterprise Income Growth By: Nick Cecero

  2. Abnormal Enterprise Income Growth Model • The abnormal enterprise income growth model along with the residual enterprise income model utilizes accounting information that is readily available to readers of the financial statements. • There is a difference between the AEIG Model & the REI Model which is the AEIG Model anchors on the capitalized forecast of next year’s EPAT versus the REI Model which anchors on the forecast of current NEA.

  3. Difference in Value? • Again, with the AEIG Model even if American Eagle or any company for that matter were to change their accounting choices there will still be no effect on the value of the company. • Also, the AEIG Model will still yield the same value as produced by the DCF Model, and also the REI Model. The reason as to why all three models produce the same value is because they are all mathematically equivalent, and this makes sense because the AEIG Model and REI Model can be algebraically derived from the DCF Model.

  4. Two Values to be Calculated • Finite Horizon Period (Terminal Value) – The first five years through 2018 and these are our explicit forecasts of agr. • Period Beyond the Horizon(Continuing Value) – The period from 2019 to infinity. This continuing value as captured by the AEIGModel will be different from the value that we calculated using the DCF Model or the REI Model. (Enterprise Value will still be the same though) • Additional Notes: • Discount Rate > Growth Rate (Must Hold True) • We will also assume that the growth rate beyond the horizon will be the same as the growth rate in sales of 3%. (Notion is that firm’s growth is driven by its ability to grow sales)

  5. Continuing Value • In the AEIG Model the continuing value equals the expected difference between intrinsic value and capitalized earnings of the enterprise operations at the horizon. • Also, we only need to be able to capture excess intrinsic value over capitalized earnings (the anchor) which could even be equal to zero. This is far superior to the DCF Model which required us to know the value several periods in the future to determine the value today.

  6. Abnormal Enterprise Income Growth Formula • V0 = (1/rEnt) [EPAT1 + (EPAT2+rEnt*FCF1 – (1+rEnt)*EPAT1/(1+rEnt)) + (EPAT3+rEnt*FCF2 – (1+rEnt)*EPAT2/(1+rEnt)2) + (EPAT4+rEnt*FCF3 – (1+rEnt)*EPAT3/(1+rEnt)3) + (EPAT5+rEnt*FCF4 – (1+rEnt)*EPAT4/(1+rEnt)4) + (1/ 1+rEnt)4 * [(EPAT5+rEnt*FCF4 – (1+rEnt)*EPAT4)*(1+g)/(rEnt – g)] This formula above will provide us with the same results as did the formula that was used with the free cash flow approach and the residual enterprise income formula.

  7. Parsimonious Forecasts

  8. AEO Multiyear Forecasts of Sales, EPAT, & NEA

  9. AEO Multiyear Forecasts of FCF

  10. Computing the Cost of Enterprise Capital (WACC) rEnt = (0% * ($-488,524/$2,064,016)) + (8.88% * ($2,552,540/$2,064,016)) rEnt= 10.99%

  11. Abnormal Enterprise Income Growth Model (WAAC Calculation)

  12. Residual Enterprise Income Model (WAAC Calculation)

  13. DCF Model (WAAC Calculation)

  14. Abnormal Enterprise Income Growth Model (Bloomberg WAAC)

  15. Residual Enterprise Income Model (Bloomberg WAAC)

  16. DCF Model (Bloomberg WAAC)

  17. Is there a Difference Between DCF, REI, & AEIG Models? • As shown using three different WAAC estimates one of which was my own and the other was taken from Bloomberg the enterprise values were the same regardless of the model chosen amongst the three choices.

  18. Which Model is the Most Accurate? • In order to decide which model to use we must look at the forecasting horizon to see if it is sufficient enough to achieve steady state. Steady state is achieved when three things happen: 1) Sales are growing at a constant rate 2) The EPAT from each dollar of sales is constant & 3) The NEA required for each dollar of sales is constant • So in essence steady state is achieved when everything is growing at the sales growth rate and until this point, steady state has not been achieved. • Assuming the AEIG Model has reached steady state (reaches this state one year later as compared to the other models) this model is far superior to the DCF, and REI because less of a reliance is based on the continuing value. This is crucial because it is easier to forecast values within the horizon but once you go outside the horizon and start forecasting the values become more speculative.

  19. The Best Model to Apply to AEO • AEO has not yet reached a steady state of growth and has undergone significant structural changes in its management and therefore relying on the AEIG Model as of now would warrant some speculation from those looking at the valuation. I would rather use the DCF Model because although a majority of the value comes from the continuing value (which is usually more speculative) I believe that American Eagle will not reach a steady state of growth within the forecasted horizon period. I think their steady state growth will come after the period which is why I would choose the DCF Model as my choice of valuation for American Eagle.

  20. The End Any Questions?

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