Discount-Variety Stores Industry
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Discount-Variety Stores Industry Module 6: Cost of Capital and Valuation Kate Johnson PowerPoint PPT Presentation


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Discount-Variety Stores Industry Module 6: Cost of Capital and Valuation Kate Johnson. Agenda. Industry Overview and Company Specifics Objective of Module 6 Step 1: Cost of Debt Capital Computation Step 2: Cost of Equity Step 3: Calculate Beta Step 4: Determining Return on Market

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Discount-Variety Stores Industry Module 6: Cost of Capital and Valuation Kate Johnson

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Discount variety stores industry module 6 cost of capital and valuation kate johnson

Discount-Variety Stores Industry

Module 6: Cost of Capital and Valuation

Kate Johnson


Agenda

Agenda

  • Industry Overview and Company Specifics

  • Objective of Module 6

  • Step 1: Cost of Debt Capital Computation

  • Step 2: Cost of Equity

  • Step 3: Calculate Beta

  • Step 4: Determining Return on Market

  • Step 5: Calculating Cost of Equity

  • Step 6: Calculating MV Equity

  • Step 7: Calculating WACC

  • Step 8:Forecasting and DCF


Save time save money

“Save Time. Save Money.”

  • Largest discount retailer in the US by number of stores

  • Goodlettsville, Tennessee

  • 11,000 stores

  • 40 States

  • Southern, Southwestern, Midwestern, Eastern US

  • Merchandise is typically $10 or less

  • Founded in 1939

  • Stock publicly traded in 2009


Product types

Product Types

  • Two brands:

    1)High quality nationalbrands from leading manufacturers 2)Comparable quality privatebrand selections

    10,000 SKUS/store

    10$ or less


How are they profitable

How are they profitable?

  • Convenient Locations

  • Time Saving Shopping Experience

  • Everyday Low Prices on Quality Merchandise

  • Key items in a broad range of general merchandise categories

  • Most basic shopping needs are met in one trip


Discount variety stores

Discount-Variety Stores

**Costco is least comparable


But dg is a dollar store

But DG is a Dollar Store?

  • Dollar General is more suited to be compared with Walmart, Target, and Costco, as not everything is $1 (DLTR) and they have produce (unlike FDO)

  • Characteristics such as industry and size are often chosen for comparable


Store growth

Store Growth

  • 2010-2011 Growth: 6.02%

  • 2011-2012 Growth: 5.72%


Objective

Objective

  • To calculate the Cost of Capital for Enterprise Operations

  • Using:

  • Cost of capital for equity

  • Cost of capital for debt


Cost of debt capital

Cost of Debt Capital

  • Risk to the company’s debt holders of default

  • For DG, what its the riskiness of their ability to pay debts as they come due?

  • Will adjust due to changes in the amount of debt outstanding and maturity dates due to changing possibility of default

  • Relativelyeasy to measure as it is approximated by:

    Interest expense

    Average amount of interest bearing debt


Cost of equity capital

Cost of Equity Capital

  • Risk to the company’s equity holders of getting distributions

    • Dividends

    • Increases in share price

  • For DG, what is the riskiness of the dividend payments or increases in equity value?

  • Will adjust due to changes in amount of debt outstanding and maturity dates due to changing possibility of default

  • Will also adjust due to changes in enterprise activities

  • Moderately easy to measure (CAPM)


Cost of enterprise capital

Cost of Enterprise Capital

  • Captures the risk of the company’s enterprise operations

  • For DG, what is the riskiness of selling the products they do?

  • Will adjust due to changes in enterprise activities

  • Will not adjust due to shift from debt to equity financing

  • Very hard to measure directly


Three different cost of capitals

Three Different Cost of Capitals

  • Cost of capital for the enterprise operations

  • Cost of capital for debt

    -debt holders demand for investing in firm

  • Cost of capital for equity

    -equity holders demand for investing in firm

    WACC for enterprise operations=

    Weighted average cost of debt and equity


Step 1 cost of debt capital

Step 1: Cost of Debt Capital

  • Represents “The risk that DG will default on its debt”

  • 3 methods used:

    1) FEAT/NFL

    2) Weighted Average Interest Rate (from 2012 10-K)x (1-Tax Rate)

    3) Interest expense

    Average amount of interest bearing debt


Cost of debt capital computation

Cost of Debt Capital Computation


Issues with cost of debt capital computation

Issues with Cost of Debt Capital Computation

CONCLUSION:

2.64%+2.4% Avg

=2.52%

Method 1: Not confident

-Computed using reformulated Financial statements

-Negative FEAT

Method 2: Closest to Bloomberg, however rate on long-term debt unsure of

-Difference between subordinated senior notes and senior notes

Method 3: Average debt not used, simply just the total interest bearing debt, as it was not broken up in the 10-K


Cost of equity capital using capm

Cost of Equity Capital using CAPM

CAPM expresses the expected return on a particular asset as the sum of three components:

  • The RF rate of return 30-year return on LT U.S. treasury bills

  • Beta Risk

  • Stock specific risk diversified away in large portfolios


Cost of equity

Cost of Equity

  • Inputs:

  • Beta

  • Alpha

  • Return on the market


Discount variety stores industry module 6 cost of capital and valuation kate johnson

Beta

  • Beta: The extent to which the return on equity varies with the return on the market

Conclusion: .367 Beta Value, the average of Bloomberg, Regression, and Beta Values from Various Sources


A note on dg data

A Note On DG Data

  • DG didn’t go public until 11/12/2009

  • Therefore, only 51 months of data

  • 2013 data unavailable (February 1 year

    end)

  • Simple regression used (X=IV, S&P, Y=DV, DG)


Regression monthly

Regression (Monthly)

Very low

β

α

95% Confident that Beta falls between (-.22, .69)


Return on the market

Return on the Market

  • Despite the fact that the PowerPoint was using a value around 7%, I believe that a more accurate return on the market is around 4.5%

  • The market has been predicted to not grow as much in the future

  • Analysts estimate the value around 4%-5%

  • Therefore, I chose 4.5%


Cost of equity calculation

Cost of Equity Calculation


Market value of equity

Market Value of Equity


Discount variety stores industry module 6 cost of capital and valuation kate johnson

WACC


Uncertainties

Uncertainties


Forecasting and dcf model

Forecasting and DCF Model


Assumptions and multiyear forecasts for dg

Assumptions and Multiyear Forecasts for DG

  • Because FYE is February 1, 2013 data is not available yet

  • Thus, 2013 data was the first year forecasted

  • Parsimonious forecasting will thus have to be adjusted when these numbers are released


Fcf epat nea

FCF=EPAT-ΔNEA


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