Valuation of Sears

In this study, you are going to analyze and value a company using ratios across time, comparing them to industry averages, calculate a growth rate in several different ways, determine the cost of capital, and use two-stage valuation models to value Sears stock as of December 2002. For the two-stage growth models, we will use a dividend model, a Free Cash flow to the firm, and a Free cash flow to equity model to determine the value of Sear’s stock.

Here is a quick glance at Sears performance from Jan. 1998 to Dec. 2002.

Below are Sear’s Income statements, Balance Sheets, and Statement of Cash Flows for 1998, 1999, 2000, and 2001. Industry averages for key ratios are also given.

SEARS ROEBUCK & CO	ANNUAL BALANCE SHEET
TICKER:	S			($ MILLIONS)
	2-Dec	1-Dec	Dec-00	Dec-99	Dec-98
ASSETS
Cash & Equivalents	1,962.00	1,064.00	3,947.00	3,873.00	4,789.00
Net Receivables	31,622.00	28,813.00	17,823.00	18,437.00	18,369.00
Inventories	5,115.00	4,912.00	5,618.00	5,069.00	4,816.00
Prepaid Expenses
Other Current Assets	1,284.00	1,316.00	1,406.00	1,288.00	1,297.00
	------------------	------------------	------------------	------------------
Total Current Assets	39,983.00	36,105.00	28,794.00	28,667.00	29,271.00
Gross Plant, Property & Equipment	12,979.00	13,137.00	12,585.00	11,912.00	11,326.00
Accumulated Depreciation	6,069.00	6,313.00	5,932.00	5,462.00	4,946.00
	------------------	------------------	------------------	------------------
Net Plant, Property & Equipment	6,910.00	6,824.00	6,653.00	6,450.00	6,380.00
Investments at Equity
Other Investments
Intangibles	1,648.00
Deferred Charges	277
Other Assets	1,591.00	1,388.00	1,452.00	1,837.00	2,024.00
	------------------	------------------	------------------	------------------
TOTAL ASSETS	50,409.00	44,317.00	36,899.00	36,954.00	37,675.00
LIABILITIES
Long Term Debt Due In One Year	4,808.00	3,157.00	2,560.00	2,165.00	1,414.00
Notes Payable	4,525.00	3,557.00	4,280.00	2,989.00	4,624.00
Accounts Payable	7,485.00	7,176.00	7,336.00	6,992.00	6,732.00
Taxes Payable	0	0	0	0	0
Accrued Expenses
Other Current Liabilities	1,779.00	1,694.00	1,620.00	1,555.00	1,339.00
	------------------	------------------	------------------	------------------
Total Current Liabilities	18,597.00	15,584.00	15,796.00	13,701.00	14,109.00
Long Term Debt	21,304.00	18,921.00	11,020.00	12,884.00	13,631.00
Deferred Taxes	0	0	0	0	0
Investment Tax Credit	0	0	0	0	0
Minority Interest
Other Liabilities	3,755.00	3,693.00	3,314.00	3,530.00	3,869.00
EQUITY
Preferred Stock - Redeemable	0	0	0	0	0
Preferred Stock - Nonredeemable	0	0	0	0	0
	------------------	------------------	------------------	------------------
Total Preferred Stock	0	0	0	0	0
Common Stock	323	323	323	323	323
Capital Surplus	3,463.00	3,437.00	3,442.00	3,420.00	3,408.00
Retained Earnings	7,441.00	6,582.00	6,730.00	5,665.00	4,424.00
Less: Treasury Stock	4,474.00	4,223.00	3,726.00	2,569.00	2,089.00
	------------------	------------------	------------------	------------------
Common Equity	6,753.00	6,119.00	6,769.00	6,839.00	6,066.00
------------------	------------------	------------------	------------------	------------------
TOTAL EQUITY	6,753.00	6,119.00	6,769.00	6,839.00	6,066.00
	------------------	------------------	------------------	------------------
TOTAL LIABILITIES & EQUITY	50,409.00	44,317.00	36,899.00	36,954.00	37,675.00
COMMON SHARES OUTSTANDING	316.734	320.4	333.2	369.128	383.508
SEARS ROEBUCK & CO	ANNUAL INCOME STATEMENT
($ MILLIONS, EXCEPT PER SHARE)
	2-Dec	1-Dec	Dec-00	Dec-99	Dec-98
Sales	41,366.00	41,078.00	40,937.00	41,071.00	41,322.00
Cost of Goods Sold	25,646.00	26,322.00	26,899.00	27,212.00	27,257.00
	------------------	------------------	------------------	------------------
Gross Profit	15,720.00	14,756.00	14,038.00	13,859.00	14,065.00
Selling, General, &
Administrative Expense	11,510.00	10,236.00	9,526.00	9,289.00	9,605.00
	------------------	------------------	------------------	------------------
Operating Income Before Deprec.	4,210.00	4,520.00	4,512.00	4,570.00	4,460.00
Depreciation, Depletion, &
Amortization	875	863	826	848	830
	------------------	------------------	------------------	------------------
Operating Profit	3,335.00	3,657.00	3,686.00	3,722.00	3,630.00
Interest Expense	1,148.00	1,426.00	1,252.00	1,273.00	1,428.00
Non-Operating Income/Expense	41	56	40	11	33
Special Items	225	-1,064.00	-251	-41	-352
	------------------	------------------	------------------	------------------
Pretax Income	2,453.00	1,223.00	2,223.00	2,419.00	1,883.00
Total Income Taxes	858	467	831	904	766
Minority Interest	11	21	49	62	45
	------------------	------------------	------------------	------------------
Income Before Extraordinary
Items & Discontinued Operations	1,584.00	735	1,343.00	1,453.00	1,072.00
Preferred Dividends	0	0	0	0	0
	------------------	------------------	------------------	------------------
Available for Common	1,584.00	735	1,343.00	1,453.00	1,072.00
Savings Due to Common
Stock Equivalents	0	0	0	0	0
	------------------	------------------	------------------	------------------
Adjusted Available for Common	1,584.00	735	1,343.00	1,453.00	1,072.00
Extraordinary Items	-208	0	0	0	-24
Discontinued Operations	0	0	0	0	0
	------------------	------------------	------------------	------------------
Adjusted Net Income	1,376.00	735	1,343.00	1,453.00	1,048.00
Earnings Per Share Basic -
Excluding Extra Items & Disc Op	4.99	2.25	3.89	3.83	2.76
Earnings Per Share Basic -
Including Extra Items & Disc Op	4.34	2.25	3.89	3.83	2.7
Earnings Per Share Diluted-
Excluding Extra Items & Disc Op	4.94	2.24	3.88	3.81	2.74
Earnings Per Share Diluted -
Including Extra Items & Disc Op	4.29	2.24	3.88	3.81	2.68
EPS Basic from Operations	4.37	4.23	4.46	3.91	3.43
EPS Diluted from Operations	4.33	4.22	4.45	3.89	3.4
Dividends Per Share	0.92	0.92	0.92	0.92	0.92
Com Shares for Basic EPS	317.4	326.4	345.1	379.2	388.6
Com Shares for Diluted EPS	320.7	328.5	346.3	381	391.7
SEARS ROEBUCK & CO	ANNUAL STATEMENT OF CASH FLOWS
($ MILLIONS)
	2-Dec	1-Dec	Dec-00	Dec-99	Dec-98
INDIRECT OPERATING ACTIVITIES
Income Before Extraordinary Items	1,584.00	735	1,343.00	1,453.00	1,072.00
Depreciation and Amortization	875
Extraordinary Items and Disc. Operations	0	0	0	0	13
Deferred Taxes	0	0	0	0	0
Equity in Net Loss (Earnings)
Sale of Property, Plant, and Equipment
and Sale of Investments - Loss (Gain)	-347	-21	-19	-10	332
Funds from Operations - Other	2,396.00	3,173.00	2,053.00	1,825.00	2,194.00
Receivables - Decrease (Increase)	-4,833.00	-1,569.00	-93	277	-555
Inventory - Decrease (Increase)	45	610	-560	-305	-167
Accounts Payable and Accrued Liabs -
Income Taxes - Accrued - Increase (Decrease)	0	0	0	0	0
Other Assets and Liabilities - Net Change	-225	-666	-22	457	201
Operating Activities - Net Cash Flow	-505	2,262.00	2,702.00	3,697.00	3,090.00
INVESTING ACTIVITIES
Investments - Increase	15	21	40	0	0
Sale of Investments
Short-Term Investments - Change				0	0
Capital Expenditures	1,035.00	1,126.00	1,084.00	1,033.00	1,212.00
Sale of Property, Plant, and Equipment
Acquisitions	1,840.00	0	1	68	34
Investing Activities - Other	568	59	75	118	220
Investing Activities - Net Cash Flow	-2,322.00	-1,088.00	-1,050.00	-983	-1,026.00
FINANCING ACTIVITIES
Sale of Common and Preferred Stock	157	75	58	61	126
Purchase of Common and Preferred Stock	427	625	1,233.00	570	528
Cash Dividends	293	302	322	355	278
Long-Term Debt - Issuance	6,565.00	4,124.00	824	1,491.00	2,686.00
Long-Term Debt - Reduction	3,256.00	3,552.00	2,277.00	1,516.00	3,375.00
Current Debt - Changes	964	-708	1,295.00	-1,653.00	-576
Financing Activities - Other	11	33	118	57	23
Financing Activities - Net Cash Flow	3,721.00	-955	-1,537.00	-2,485.00	-1,922.00
Exchange Rate Effect	4	3	-2	5	-5
Cash and Equivalents - Change	898	222	113	234	137
DIRECT OPERATING ACTIVITIES
Interest Paid - Net	1,100.00	1,300.00	1,200.00	1,200.00	1,300.00
Income Taxes Paid	918	341	868	327	366
SEARS ROEBUCK & CO	ANNUAL RATIO REPORT
(RATIO, EXCEPT AS NOTED)
LIQUIDITY	2-Dec	1-Dec	Dec-00	Dec-99	Dec-98
Current Ratio	2.15	2.32	1.82	2.09	2.07
Quick Ratio	1.81	1.92	1.38	1.63	1.64
Working Capital Per Share	67.52	64.05	39.01	40.54	39.54
Cash Flow Per Share	7.76	4.99	6.51	6.23	4.96
ACTIVITY
Inventory Turnover	5.12	5	5.03	5.51	5.53
Receivables Turnover	1.37	1.76	2.26	2.23	2.14
Total Asset Turnover	0.87	1.01	1.11	1.1	1.08
Average Collection Period (Days)	263	204	159	161	168
Days to Sell Inventory	70	72	72	65	65
Operating Cycle (Days)	333	276	231	227	233
PERFORMANCE
Sales/Net Property, Plant & Equip	5.99	6.02	6.15	6.37	6.48
Sales/Stockholder Equity	6.13	6.71	6.05	6.01	6.81
PROFITABILITY
Operating Margin Before Depr (%)	10.18	11	11.02	11.13	10.79
Operating Margin After Depr (%)	8.06	8.9	9	9.06	8.78
Pretax Profit Margin (%)	5.93	2.98	5.43	5.89	4.56
Net Profit Margin (%)	3.83	1.79	3.28	3.54	2.59
Return on Assets (%)	3.14	1.66	3.64	3.93	2.85
Return on Equity (%)	23.46	12.01	19.84	21.25	17.67
Return on Investment (%)	5.65	2.94	7.55	7.37	5.44
Return on Average Assets (%)	3.34	1.81	3.64	3.89	2.81
Return on Average Equity (%)	24.61	11.41	19.74	22.52	17.97
Return on Average Investment (%)	5.97	3.43	7.16	7.37	5.55
LEVERAGE
Interest Coverage Before Tax	3.14	1.86	2.78	2.9	2.32
Interest Coverage After Tax	2.38	1.52	2.07	2.14	1.75
Long-Term Debt/Common Equity (%)	315.47	309.22	162.8	188.39	224.71
Long-Term Debt/Shrhldr Equity(%)	315.47	309.22	162.8	188.39	224.71
Total Debt/Invested Capital (%)	109.2	102.38	100.4	91.46	99.86
Total Debt/Total Assets (%)	60.78	57.84	48.4	48.81	52.21
Total Assets/Common Equity	7.46	7.24	5.45	5.4	6.21
DIVIDENDS
Dividend Payout (%)	18.43	40.95	23.53	24.02	33.4
Dividend Yield (%)	3.84	1.93	2.65	3.03	2.16

1. Examine the Liquidity, Activity, Performance, Profitability, and Leverage Ratios for Sears over the last five years. For each category, discuss overall whether the ratios are improving or getting worse over time. Use at least one concrete example to back up your conclusion within each category. I expect at least five complete sentences and an overall conclusion.

2. Relative to the industry, how attractive does Sears appear as a company? Back up your conclusion with at least two concrete examples. Use the following table to answer the question.

Industry Ratio Analysis	2002		2001		2000		5 yr averages
	S	Industry	S	Industry	S	Industry	S	Industry
Leverage
Debt to Total Equity	4.54	1.55	4.19	1.52	2.64	1.3	1.43	3.45
Times Interest Earned	2.4	2.5	1.5	1.9	2.1	1.7	2.2	1.97
Liquidity
Current Ratio	2.15	2.14	2.32	2.21	1.82	1.92	2.09	2.09
Cash Flow Per Share ($)	7.76	4.78	4.99	3.66	6.51	3.22	3.67	6.09
Activity
Operating Cycle (Days)	333	199	276	179	231	168	178	260.08
Fixed Asset Turnover	6	4	6.1	4	6.2	4.1	4.3	6.25
Profitability
Return on Avg Total Assets (%)	3.34	3.64	1.81	2.61	3.64	2.09	3.78	3.1
Return on Avg Total Equity (%)	24.61	12.84	11.41	8.96	19.74	6.83	12.89	18.85
Net Profit Margin (%)	3.83	3.1	1.79	2.13	3.28	1.64	3.03	3.01

3. Relative to the industry, how does Sears look based on the ratios under market information? Back up your conclusion with at least two concrete examples. Use the following table to answer the question.

	2002		2001		2000		5 yr averages
	S	Industry	S	Industry	S	Industry	S	Industry
Market Information
Price Close *	23.95	32.98	47.64	46.35	34.75	46.83	39.02	35.84
Dividends Per Share (Exdate) *	0.92	0.34	0.92	0.41	0.92	0.38	0.67	0.92
Earnings Per Share *	4.99	2.36	2.25	1.75	3.89	1.43	2.02	3.54
EPS from Basic Operations *	4.37	2.33	4.23	2.24	4.46	2.15	2.21	4.08
Price-Earnings Ratio *	4.8	13.98	21.17	26.51	8.93	32.67	19.3	11.65
Price/EPS from Basic Operations *	5.48	14.16	11.26	20.66	7.79	21.82	17.63	8.94
Market Value **	7,575.67	15.94	15,368.62	21.83	11,612.79	17.37	21.83	12,463.83
Price to Book Value *	1.12	2.57	2.51	3.94	1.72	4.99	3.55	1.94

VALUATION

To value Sears, we need estimates for future earnings, dividends, cash flows, capital costs, and growth rates. Let’s start with the estimation of the cost of capital.

4. We need to estimate the cost of equity and the weighted average cost of capital.

a. For the cost of equity capital, let’s just use the CAPM. Recall the CAPM is R_i = r_f + Beta(R_m – r_f). In 2002, the yield on the 10-year Treasury bond was 5% and for an estimate of the equity risk premium, assume the 80 year historical average of 5.5%. Note that this risk premium is just (R_m – r_f). Sear’s Beta in 2002 was 0.7. However, this seems a bit low based on the recent drop in the stock price and recent results. Let’s increase this beta estimate to 0.9 which is closer to the average riskiness of a typical stock in the market. Again, the beta is calculated on past numbers. We are just trying to estimate what it will be in the future and 0.7 seems a bit low. Calculate the cost of equity capital here using .9 as the beta estimate.

Answer = 5 + .9*5.5 = 9.95%

b. For the weighted average cost of capital, we need to find the after tax cost of debt. First find Sear’s marginal tax bracket. To do this, simply divide total taxes by income before taxes. What tax rate does Sears face?

Answer = $858/$2,453 = 35%

c. Next, find the yield on Sear’s debt. This can be done in one of two ways. Find out what Sear’s debt is rated(by Moody’s or Standard and Poors) and see what bonds of this rating yield, or calculate the yield directly from the market price of Sear’s bonds. In 2002, Sear’s debt was rated Baa1/A. One could simply add the risk premium associated with A rated bonds to the 10 year Treasury rate to get an estimate of the cost of debt. Alternatively, one can calculate the yield on Sear’s bonds directly. After a quick search on the web, a Sear’s 6.25% $1,000 par value bond was selling for $930 in 2002. At the time, it had 6.5 years to maturity. Calculate the yield for this bond as an estimate of Sear’s debt cost.

Answer = 7.65%, Find this by setting PV = -$930, N = 6.5, FV =$1,000, PMT = $62.50, compute I/Y.

d. Since Sears does not have any preferred stock, we can simply find the WACC for Sears by multiplying the % of debt and equity Sears uses to finance itself by their respective yields. Don’t forget to use the after tax yield for debt. The formula for the WACC is % debt * Yield(1-tax bracket) + % Preferred * Preferred Yield + % Equity * Cost of Equity. Note that the percentages need to add to 100. To find the percentage of debt and equity Sears uses for capital, simply add up total long-term debt and equity. However, this will not add up to total assets since part of these assets are financed through notes payable, accounts payable, ect. We will simply assume that the cost of these other forms of capital is the average cost of the debt and equity. To find long-term debt in this case, add up long-term debt plus long-term debt due this year as this amount will likely need to be refinanced. Once you have the total amount of long-term debt and equity, divide equity by this total amount for percentage of equity used and total debt divided by (debt + equity) for percentage of debt Sears has.

Answer = Total debt is $4,808 + $21,304 = $26,112. Total equity is $6,753. Thus % debt = $26,112/($26,112 + $6,753) = 79.5%, Equity = 20.5%.

WACC = .795(7.65(1-.35) + .205(9.95%) = 6.0%. Since the firm does use a fair amount of notes payable and accounts payable which is generally a higher cost of capital, I’m going to increase the WACC by 1% to err on the side of caution. Thus, lets use WACC = 7.0% for our calculations.

You should now have the cost of equity from answer “a.” and the WACC from answer d. We will use these numbers in our valuation models.

5. Now let’s get estimates for growth. We are going to try to estimate the growth over the next seven years. There are a variety of ways to do this. We will use three ways and estimate growth by simply averaging the results.

a. Use historical estimates. Determine the sales, earnings, and dividend growth rates for Sears. To do this, take the numbers in 1998 and determine what growth rate was experienced by Sears over the last five years. Believe it or not, there are several ways to do this as well including using regressions. We will simply calculate a geometric average. I will do the sales growth rate for you. In, 1998, Sear’s sales was $41,322 and in 2002 sales were $41,366. Since this covers 4 years, simply solve for r in the equation FVF = PVF(1+r)ⁿ. This is the future value of a fixed sum equation. R = (FVF/PVF)^(1/n) – 1. So $41,366/$41,322^(1/4) – 1 = .0003 or .03%. Not too good. Alternatively, plug into your calculator(FV=41,366, PV=-41,322, n=4, pmt=0 and solve for I/Y).

Now you do the same for earnings(use EPS basis from operations for your earnings growth estimate) and dividends. Average theses three growth rates. Remember, we are just trying to estimate what this firm is going to grow at in the future.

Answer: for earnings, $4.37/$3.43^.25 – 1 = 6.24%; for dividends, growth was zero. Thus, average for all three is (6.24 + .03 + 0)/3 = 2.1%.

b. Use intrinsic growth rate. Recall that g = ROE(1-payout ratio). We could solve this equation using just 2002 numbers but after examining the ratios over time, I think we would likely attain a better estimate for the future by using average ROE and average payout ratios over the last five years. Remember the ROE is Net Income/Average equity. The payout ratio is simply dividends/earnings. The ROE and payout ratios are given in the ratio analysis.

Year	2002	2001	2000	1999	1998
Return on Average Equity (%)	24.61	11.41	19.74	22.52	17.97
Dividend Payout (%)	18.43	40.95	23.53	24.02	33.4

Answer: Average ROE was 19.25%, average payout was 28%;

Thus, g = 19.25(1-.28) = 13.86%

c. Finally, let’s just look at what everyone else was saying, i.e. using analysts estimates. Quicken.com along with several other sites give analysts estimates. I’ve listed these estimates below.

These are 5 year estimates:

Analyst’s low = 7,

Analyst’s average = 8.86,

Analyst’s high = 12.

Let’s just use the average of 8.86 for this group. (Nothing to calculate here.)

Answer: 8.86%

d. Now if you are more confident about one of these estimates over another, you can change the weights to your three answers above. I’ll assume they are all equally likely and weight each one by 1/3. Thus, to estimate our growth rate for Sears, find the average of your numbers in a, b, and c and write this down here.

Answer: (2.1 + 13.86 + 8.86) / 3 = Average of three estimates which is 8.27%.

6. So, we should now have our growth rate and cost of capital estimates. Let’s see what else we need.

a. For the dividend model, let’s just use the current dividend. Note that it hasn’t changed in five years but we will assume that it could grow in the future.

Answer: $.98.

b. Let’s find free cash flow to equity(FCFE). The formula is Net Income + depreciation – Cap. Expend. – change in working capital – principal debt repayments + new debt issues. Note, we definitely want to look out for capital expenditures since they can be very volatile. Thus, for that figure, let’s just use the average purchases over the last five years(see cash flow statement). Let’s do the same for debt issues and repayments, see cash flow statement. In a steady state, depreciation and capital expenditures should just offset each other as the firm just replaces worn out equipment each year as with debt issues and repayments. Recall that change in working capital is just the change in (Current Assets – current liabilities.)

Capital Expenditures

1,035.00

1,126.00

1,084.00

1,033.00

1,212.00

Answer: Average capital expenditures: (1035 +1126 + 1084 + 1033 + 1212)/5 = $1098.

Long-Term Debt – Issuance	6,565.00	4,124.00	824	1,491.00	2,686.00
Long-Term Debt – Reduction	3,256.00	3,552.00	2,277.00	1,516.00	3,375.00

From the cash flow statement.

Average debt issues: 3,138

Average debt repayments: 2,795.2

Change in Working capital was found by finding working capital in 2002 and subtracting working capital in 2001, Working capital in 2002 was $21,386 and working capital in 2001 was $20,521. Thus, change in working capital is 865.

FCFE = 1385 + 875 – 1098 – 865 – 2,795.2 + 3,138.

FCFE = 639.8, on a per share basis, divide by 317.4 to arrive at $2.01 per share.

c. Finally, let’s find free cash flow to the firm(FCFF). The formula is EBIT(1-tax rate) + depreciation – Cap. Expend. – change in working capital – change in other assets. Note when we are valuing the firm, the proper discount rate to use is the WACC. For your calculation, ignore change in other assets.

Answer: Net Income + interest expense = EBIT: 2453 + 1158 = 3,611.

FCFF = $3,611(1-.35) + 875 – 1,098 – 865 = $1,259.15.

7. Now we are ready to plug all of our numbers into a two-stage valuation formula. We will assume the first stage covers the next seven years. After that time, we will assume a growth rate of 4.5%(which is 1.5% below the average nominal growth of our economy.) Why 4.5%? A haphazard guess at this point but I’m assuming Sears retail business is not a high growth industry. Competition form WalMart, Lowes, Target, etc. is likely to limit growth. You may want to use 6% as a long-term estimate, but for the purposes of this exercise, use 4.5%.(This is where valuation can get tricky and may be subject to operator manipulation.) Remember, try to come up with these values before you start playing with the model and then avoid changing them. You want to come up with an independent valuation. Regardless of the value you end up arriving at, you should always check your assumptions and see how slight deviations in your inputs will change your calculated values. A worst case and best case scenario could help you define a range.

A spreadsheet has been developed that will do all the grunt work for you. http://faculty.etsu.edu/trainor/FNCE 3300/divgrowth2.xls

The actual model that we will be using is written below:

V_cs = +

Using this model, let’s value Sears Stock.

a. Dividend model, simply plug in the current dividend for D₀. Again let n = 7, g₂ = .05. You should have found k and g earlier.

Inputs, k₁ = 9.95%, g₁ = 8.27%, g₂ = 4.5%, k₂ = 9.95%, n = 7, D₀ = .98.

Answer is

b. Free cash flow to equity model, plug in free cash flow to equity on a per share basis for D₀. Proceed as usual to find your value per share.

Inputs, k₁ = 9.95%, g₁ = 8.27%, g₂ = 4.5%, k₂ = 9.95%, n = 7, FCFE = 2.01.

Answer is

c. Free cash flow to firm model. The number you will find for this will be the value for the firm. Also note that for k, use the WACC value you found earlier. DON’T FORGET TO CHANGE K! To find the value per share of equity, subtract off the total liabilities of the firm(find this by subtracting total equity from total assets since this is everything that is owed) and then divide by the number of shares outstanding. No. of shares outstanding is 317.4 and total liabilities are $50,409 – $6,753 = $43,656.

Inputs, k₁ = 7.0%, g₁ = 8.27%, g₂ = 4.5%, k₂ = 7.0%, n = 7, FCFF = 1,259.15.

Answer is

d. Again, if you are more confident in one model over another, you can apply different weights. For our example, let’s just find the average value for our a-c numbers. This will be our “best guess” intrinsic value estimate of Sear’s stock.

Use this as a check:

Answer is $47.61.

8. Now using all of the information you have looked at in questions 1-7, make a recommendation. This should be written up in at least two paragraphs.(1/2 page). Back up your conclusion with the information you have gained from going through 1-7. Is Sear’s stock a buy, sell, or hold? Sears stock was selling for $24 in March of 2003 when all this information was approximately available. See what Sears is selling for now, (after you make your recommendation). Did you call it right?

CAVEATS, CAVEATS, CAVEATS. I’ve made a lot of assumptions in guiding you through the above valuation. Only time will tell if I made good ones. Change a few numbers, estimate different growth rates, reduce or increase the cost of capital, etc. and you will get different answers, sometimes drastically different answers. All this work is hopefully just increasing the odds in our favor. Keep that in mind. Predicting the future is always plagued with error.