goodyear tire co. equity valuation and analysis valued...
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GOODYEAR TIRE CO. EQUITY VALUATION AND ANALYSIS VALUED AT NOVEMBER 1, 2005
Brady Campbell: [email protected] Clements: [email protected]
Robert. M. Reece II.: [email protected] Sharapata: [email protected]
James Stokes: [email protected] Vorhees: [email protected]
Jason Wood: [email protected]
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GOODYEAR TIRE CO. VALUATION TABLE OF CONTENTS Executive Summary 3 Business/Industry Analysis 6 Firm Competitive Analysis 14 Accounting Analysis 16 Ratio Analysis/Forecasting 28 Cross Sectional Analysis 34 Forecasted Financials 44 Valuation Analysis 47 Cost of Capital 51 Intrinsic Evaluations 52 Recommendation 56 Appendices Appendix A 58 Appendix B 60 Appendix C 65 Appendix D 69
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EXECUTIVE SUMMARY
GOODYEAR TIRE CO. Investment Recommendation: Over-valued, Sell 11/01/05
GT-NYSE $17.89 52 week range $9.75-$19.31 Revenue (2005) $19.273 Bil. Market Capitalization $2.98 Bil. Shares Outstanding 176,509,751 Dividend Yield N/A 3-month Avg Daily Trading Volume 2,977,600 Percent Institutional Ownership 97.6% Book Value Per Share $0.99 ROE 312.33% ROA 1.46% Est. 5 year EPS Growth Rate Cost of Capital R² Beta Ke Ke Estimation 16.9% 10-year .012 .622 16.9% 5-year .129 1.635 17.1% 1-year .241 2.838 17.2% 3-month .171 2.442 16.9% Published 1.81 -5.1% Kd 6.31% WACC 6.79%
EPS Forecast FYE 12/31 2005(A) 2006E 2007E 2008E EPS 1.38 1.10 1.74 1.86 Ratio Comparison Goodyear Industry Trailing P/E 12.59 13.6 Forward P/E 13.85 55.05 P/S 0.16 1.96 M/B 42.39 0.77 P/FCF 3.42 11.09 Valuation Estimates Actual Current Price $17.89 Ratio Based Valuations Trailing P/E $18.77 Forward P/E $75.97 P/S $0.80 M/B $85.51 P/FCF $56.35 Intrinsic Valuations Discounted Dividends N/A Free Cash Flows $9.05 Residual Income $9.02 Abnormal Earnings Growth $10.14 Long-Run Residual Income Perpetuity N/A
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Goodyear Tire Co. is one of the world's leading tire companies. They are
the number one in North America and Latin America, and number two in Europe.
Goodyear's focus has been on becoming a market-focused tire company
providing superior products and services to end-users and to their channel
partners, leading to superior returns for their shareholders. Since the founding
of Goodyear, by 38 year old Frank Seiberling in 1898, the company has been
based on high morals and values centered on the phrase "Protect Our Good
Name". The main competitors within the tire industry are Michelin, and
Bridgestone. The industry based on innovation and trends, making it difficult for
the emergence of a new company because the learning curve is so steep in order
to gain competitive entry. It is also an industry based on good relationships
with suppliers and being efficient in every facet of the production process. Brand
name recognition and advertising are also crucial to an entity's survival.
When looking at Goodyear's Accounting policies, it is apparent that for the
most part little room is left to have aggressive standards. The only notable
discrepancy was in an overstatement of income by using an aggressive accrual of
revenues, but these were quickly assessed in a SEC investigation where
Goodyear was made into an example forever changing the methods of inaccurate
reporting within the industry. The investigation forced the company to be
forthright with all information, good or bad, when the company published its
annual reports. It is now a policy to regain the reputation of a company that has
accurate financials and honest management.
When we computed the ratios for Goodyear Tire Co. we gained a great
deal of insight into the health of the company and how it compares to the
players in the industry. Overall there have been some favorable results, the
current ratio, the inventory turnover, and the gross profit margin have all been
on a steady increase within the past five years showing a growing ability of
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Goodyear to compete and practice strong financial health. These numbers are
growing equivalently or better than that of any of the competitors.
In or ten year forecasts, we were able to have an idea where Goodyear
would be in the future. We found that according to past results and our best
estimate our company is on a steady trend of growth barring any disasters within
the industry or our company. We took great care in the calculation of these
forecasts because it is a key factor in the valuation of our company.
Within our analysis, we have found, throughout our models, that
Goodyear is a great deal overvalued as a company. We do not have any
evaluations involving dividends because Goodyear does not pay dividends so we
cannot value our company using them. The recommendation for this company is
to sell. It is obvious that the price we found, $9.02 per share, is a great deal
lower than the $16.80 per share that the stock is currently trading for. If the
efficient market hypothesis holds there should be a decline in the stock price of
Goodyear Tire Co. within the near future meaning that you should sell that stock
gaining the added value that the company currently retains.
OVERVIEW
Goodyear manufactures tires, worldwide, for a variety of applications
from ATV tires to racing and even aviation tires. Tires are the main staple at
Goodyear as their sales comprised 92% of the firm’s $19.7 billion in total sales
during 2005. The company also sells aftermarket belts and hoses for the
automotive industry, as well as a full line of industrial rubber products and
produces a collection of rubber related chemicals. Goodyear focuses on
innovation and vibration control technology through the use of rubber products
has helped them to become an industry leader in tire and rubber manufacturing.
Independent tire retailers including over 1,800 Goodyear tire centers across the
United States help the company distribute its products and services to
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customers. Since being founded in 1898 Goodyear has developed from a
company offering only small lines of bicycle tires, carriage tires and horseshoe
pads into one of the largest tire and rubber manufacturers worldwide. The firm
ranks second in the industry with a market capitalization exceeding $2.5 billion.
Currently leading North America and Latin America in tire sales and dominating a
multitude of international markets, net sales have seen a $5 billion increase.
Goodyear’s stock price experienced a sharp decrease during 2002, due to the
return of inventory resulting from the closing of Penske Auto stores nationwide,
but has otherwise shown steady progress in creating value to date.
GOODYEAR TIRE & RUBBER CO. (* all values in millions)
Year 2001 2002 2003 2004 2005
Net Sales 14,162 13,856 15,102 18,353 19,723
Assets 13783 13,039 14,701 16,101 15,627
FIVE FORCES MODEL
INDUSTRY OVERVIEW
When determining who is competitive within the market you have to look
at your rivals as well as the industry as a whole. The tire industry is a very
competitive market because of the many firms that participate in this field.
Goodyear’s competitors compete on price, while Goodyear tries to distinguish
itself with the utmost quality in tires to go with their reputable name. Although
discounted tires are a big factor to Goodyear, they try to cut costs in other ways
to be able to compete with lower discount tire stores as well as compete with
other top brands such as Firestone and Michelin. Since there are many price
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levels, the market is very fragmented. Goodyear is one of the largest world
competitors and is number one in the United States. With their partners and
joint ventures, Goodyear’s ability to introduce and deliver new tires to the market
in a short-time period allows Goodyear to have a competitive advantage while
making it very difficult to lose market share of the tire industry. Since there are
many respected tire companies there is not a whole lot of room for new startup
companies. As a result, customer power points tend to be very high, making this
one of the most important points of consideration.
Tire Industry Competitors High
Threat of new Entrants Low Substitute Products High
Customer Power Very High Supplier Power Very Low
COMPETITORS
One of the most important factors in global business is being able to have
an edge on the market. Therefore, in order to control the most market share
you must focus on the other players in the industry. Goodyear does not
necessarily compete on price, but rather competes on the quality and innovation
of their tires. They also concentrate on their technological breakthroughs to
have the best tires in the industry. With their many new brands it is no surprise
why Goodyear is a top competitor. Many of the major competitors such as
Firestone and Michelin also try to compete on technology, but with Goodyear’s
partnership with Sandia National Laboratories to test their tires it is not difficult
to see why they can create new lines of tires. Some of their new technology
tires include Eagle which features ResponsEdge, and carbon fiber reinforced
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sidewalls are designed specifically for precise handling and luxury performance
vehicles. Fortera is a triple tread technology with silent armor that is used
specifically for SUV’s in the rain or snow. Wrangler is also a silent armor
technology that is used for on and off road situations for great traction and
ruggedness. Assurance triple tread and comfort tread is for the luxury passenger
for any type of weather. With these new advances it allows Goodyear to have a
competitive advantage over the competition to successfully market new tires to
the industry and in a shorter time period.
As the tire industry grows throughout the world, Goodyear intends to
expand as well. They have around one hundred plants in twenty-nine different
countries. Out of these one hundred plants, over twenty-five are located in
North America. Goodyear is also a part of rubbernetwork.com which was started
in 2000. This allowed Goodyear to buy and sell supplies, exchange information,
control inventory, facilitate billing, organize shipments, and develop product
design all in real time. This cut costs immensely by creating a forum for all of
the top tire companies globally. As the demand for tires grows around the world
every manufacturer in the industry is fighting for a larger share of the market.
Aided by technology and over a century of experience, Goodyear is attempting to
edge out the competition by differentiating a product that has, for most, always
been considered a commodity. The following graph expresses the market
breakdown of net sales, as a percentage, for the four top tire manufacturers in
the United States for the year 2005.
2005 Net Sales (in billions)
28%8%
34%30% Goodyear
MichelinPirelliBridgestone
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THREAT OF NEW ENTRANTS
In any industry, one of your strongest concerns may not even exist yet.
The same can be said about the ability of a new company to enter the tire
market to steal valuable customers from any of the participants. One valuable
attribute that protects Goodyear, from the competition, is that the company
owns 5,827 patents world-wide. Furthermore, they have joint ventures with
Dunlop, Kelly, Fulda, and Sava brands to sell their product. This allows them to
gain more of the market share. With these contacts this is why Goodyear is very
established within the tire industry. New entrants may find it very difficult to
contract with these companies. Without the financial freedom that Goodyear
bestows it would be extremely difficult to obtain partnerships or joint ventures
like Goodyear’s. Despite the fact that some new entrants may not have a
reputation that is needed to succeed, there has been one Japanese tire company
that recently stepped into the picture. The Nitto Tire Company has been enjoying
a high reputation for its product originality, especially in the area of high
performance tires for passenger cars and SUVs. Nitto sales have grown steadily
as the demand for the larger and much more stylish tire rims has risen. Nitto has
found a niche in the global market for their specialty tires. They are one of the
first companies to make tires for twenty inch rims. Nitto is an ideal example of
how one small company, can manage to break into an industry dominated by a
large few. A company like Goodyear would have to be able to evaluate this new
threat, and find a way to gain back the edge. Although small tire companies,
such as Nitto, work their way into the industry by exploiting certain market
niches the probability is low that such a company would ever grow enough to
compete on the same level as Goodyear. New firms may try to enter, but the
larger manufacturers maintain a stronghold on the industry that is not likely to
ever be broken.
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SUBSTITUTE PRODUCTS
While there is plenty of room for improvement, there is no know
substitute for the tire. The only option consumers face are design
differentiations among an almost identical product. Goodyear does business
throughout the entire world and earns profits as a result of their reputation for
making quality products. When it comes to the tire industry customers have
options to choose that are much less expensive, but customers insist on
Goodyear to insure the high quality they demand. However, many customers do
not recognize the difference of quality, thus leading to customers choosing
substitute products. Since tires are very standardized, except for some of the
new innovations, most people do not care what type of tires they are getting
unless they live in hazardous weather conditions. This leads tire manufacturers
to focus on new tire design and technology because it is apparent that the tire
will never be obsolete. It is a fact of life that tires will carry people and products
for many years to come, so the threat of a substitute product is almost non-
existent.
BARGAINING POWER OF BUYERS
The market is an instrument easily manipulated by the everyday
consumer. It seems that buying habits change with the seasons and it is
important to keep your product a necessity to every client. The bargaining power
of buyers is very high in Goodyear’s industry due to the combination of their
price sensitivity and relative bargaining power upon sales. Goodyear Tire and
Rubber Company offers an assortment of automobile goods that are
undifferentiated from a leading company, i.e. Firestone. The average citizen
worldwide only supports a certain budget to spend on tire products which makes
them very price sensitive. A buyer considers several factors when buying tire
products with quality, cost, and convenience among the top considerations. In
the importance of quality, having a brand that is reliable and credible is
important to the buyer. Since Goodyear’s product is undifferentiated, buyers will
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try to attain the maximum quality with the lowest cost among competitors. A
positive reputation of the firm and its credibility are what will allow Goodyear to
capture market share away from competitors. An average buyer will most likely
go the store nearest to them to buy tires and select from their convenience set.
Goodyear’s mass availability is important to buyers with limited distribution
outlets.
However, although Goodyear has an overall low effect on the buyer’s
power it does limit their relative bargaining power. People must have tire
products for regular maintenance of their automobiles which give tires a constant
demand. The tire industry has a limited number of competitors with absolute
substitute’s available in a global market with industry high sales. Since the tire
companies provide high value it allows them to set tire prices at a competitive
price floor. Goodyear provides multiple tire and rubber products that are an
established necessity for automobile owners and therefore gives the buyer a high
relative cost of not doing business with Goodyear. Another factor on Goodyear’s
relative bargaining power is the annual volume of sales. Tires and rubber
products are often sold in multiple units which make buyers consume multiple
products at once. The offsetting combination of the two forces of price
sensitivity and relative bargaining power still give the consumer a high effect on
Goodyear in aggregate because of the importance of price competition and the
ability to switch brands seamlessly. In effect, Goodyear must focus on
consumers by keeping their products on the cutting edge, at an affordable price
for the average buyer, because there business does not exist without someone
to purchase the product.
BARGAINING POWER OF SUPPLIERS
The most important relationship a company can have is with their
suppliers. They control the raw materials you need to keep your business afloat,
and the prices at which you get them. Goodyear has suppliers that provide
manufacturing with raw materials i.e. petroleum, rubber, etc. The rubber
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manufactures association reports that in 2001, 281 million scrap tires were
generated annually. There is high demand for raw materials to produce tires
annually with multiple suppliers. Goodyear is a very large company that would
prefer to have an extensive and trusting relationship with a supplier in order to
lower costs. “Net sales in 2005 were 19.7 billion, increasing 1.4 billion. Net
Income of $228 million.”
(http://www.goodyear.com/investor/pdf/2005_annual_report.pdf) By having an
increase in sales, Goodyear is very important to their supplier’s profits. This is
because being one of their major customers Goodyear can impact pricing
contracts. Therefore Goodyear is able to make a high net income by having a
competitive pricing of the costs of goods by suppliers.
Suppliers of rubber cannot dominate bargaining power over Goodyear
because although it is a critical material for making tires it is also a commodity.
There is minimal cost of switching suppliers which also allows Goodyear to
maintain bargaining power over suppliers. This encourages a supplier to stay
with Goodyear as a mutually benefited business partner. Goodyear’s sales are
growing within the industry and because of discounted large volume sales costs,
suppliers become price takers. The suppliers offer the raw materials that are
undifferentiated from other competitors with absolute substitutes and make
Goodyear very price sensitive. Goodyear also has the advantage to participate in
a futures market with the chance of lowering costs. Overall Goodyear has a
marginally high relative bargaining power over a supplier which gives Goodyear
the ability to have a proprietary interest when a bargaining contract is
established.
Although Goodyear has leverage over suppliers of raw rubber, their
influence does not reach directly to the petroleum industry. Therefore when oil
prices reach extremes there is little Goodyear can do to counteract these events.
When this happens Goodyear must raise their prices to continue doing business,
but this condition applies to all players in the industry. There is a parallel
relationship between the price of oil and the tire industry, leaving the bargaining
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power decisively in the hands of oil suppliers. With the exception that all
members of the market have to endure, noted above, Goodyear maintains strong
bargaining power on the suppliers they use. Suppliers are the key for your
production to maintain a high level of efficiency, and it is quite possibly one of
the most important factors in the manufacturing cycle.
VALUE CHAIN INDUSTRY ANALYSIS
Tire and non-tire companies compete on the basis of numerous factors.
Tire manufactures do business in an industry as a whole, that can be classified
as being commoditized. Since the tire industry is dominated by a relatively small
number of large firms, they all tend to produce tires in the most economic
fashion. This leaves little of no room for tire manufactures to gain cost leadership
advantage. However, with this being said, many tire companies turn their focus
to creating more differentiated lines of tires.
Certainly, as noted already, developing close relationships with different
suppliers can lead to lower costs advantages. This is how large companies such
as Goodyear try and maintain cost leadership. Today, some of the larger firms
can be seen involved in different smaller developing countries. They often obtain
concessions on taxes, incentives for exports, and restrictions on imports in order
to have an advantage on obtaining over seas raw materials, in our case, natural
rubber. The larger firms tend to be the low-cost producers. As we said earlier,
tires in general, are an undifferentiated product, so the lower the cost to produce
them, generates even more value to a firm. If a company is able to produce the
same product as its competitors, but receive materials from suppliers at a much
lower cost, they will have a much needed advantage.
Another strategy used in the tire industry, is to invent a brand image for
their tire lines through heavy promotion. Many firms use electronic and print
media in order for the public to see. Tire firms often take full page ads in daily
and Sunday newspapers. Distribution is usually through company-owned stores
and also through independent dealers.
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An article from DSN retailing today, states that there currently is an
increasing popularity for high performance tires. In response to greater demand
for these higher-priced tires, some companies are investing billions to address
the shift toward high-performance tires and tires with larger rims, adding or
converting production capacity in several countries. Beyond general industry
trends favoring higher priced performance tires, interesting innovations are also
taking place in order to improve all types of tires. If a company can get the edge
on current trends, then they can create a unique brand of tire to take over a
market which is normally involved in very little differentiation and innovation.
Current areas of research in the tire industry include investigations aimed at
reducing rolling resistance, improved handling in harsh weather, longer life, and
improved safety. Tire companies are putting more and more emphasis on the
development of better tires in order to meet the trends of the buyers and to gain
their trust by producing safer tires. By spending money on this type of
technology, tire companies are creating value to their name for years to come.
FIRM COMPETITIVE ADVANTAGE ANALYSIS
Having an edge on the competition is what every entity in every industry
in the world is striving for. In the world of tires, Goodyear Tires has developed a
great deal of respect in all areas of business. Goodyear now has more than sixty
shipping locations and five hundred plus vendors. On a daily basis, there will be
four thousand tire shipments all over the United States. Managers have worked
hard to develop strong supplier relationships, and in the past they have
marketed the tires with recognizable distance tests like trips to the moon and
revolutions around earth to show the durability and wear of the tires. Products
and icons with any association to the industry have the imprint of Goodyear Tires
powered by historical innovation, growing success, and a keen eye to the ever-
changing future.
Without suppliers and healthy demand for products, big business could
not survive in the marketplace. It has been one of the most important
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relationships that Goodyear has focused on in the existence of the company, and
they have the awards to prove it. The company has received the transportation
service provider's “Tire Supplier of the Year” for six consecutive years. Penske
Truck Leasing Company, a leading global transportation service provider, rated
Goodyear Tires number one according to their highly challenging vendor quality
rating system. In 2004, General Motors Company gave their own award
"Supplier of the Year Award for Tires", that may have some correlation with the
fact that more new vehicles in the U.S. are fitted with Goodyear Tires than any
other brand including GM’s Chevrolet Corvette, Cadillac CTS, and Chevrolet
Trailblazer.
The days of measuring value of tires by overwhelming distance traveled is
over for Goodyear Tires due to a new innovation called Global Tire Performance
Prediction (GTPP). GTPP is a new system developed to quickly do predictive
testing and a host of other methodologies to reduce field and lab test time.
Goodyear is also connecting the customer as well as its engineers and designers
with another advancement called CAPE (Computer-Aided Performance
Engineering). The CAPE model accesses the companies’ global database and
provides a vast amount of information available in a structured format for use by
designers, compounders and analysts to keep the customer’s preference a top
priority. That priority, in many situations, is the performance of the tires.
Goodyear’s Eagle F1 tire has answered the call earning tirerack.com approval in
their wet and dry track, when compared to Bridgestone and Michelin’s
performance rated tires, it was said to have “predictable handling and enough
grip to run the fastest average lap times of the three tires in the test”.
In the future, Goodyear will be continuing their groundbreaking research
with Sandia National Laboratories, and the expected outcomes are nothing less
than top secret. The cooperation will lead to the development of more efficient
production, and accelerated new product development leaving the competitors
with a great deal of ground to make up. This business giant is making all of the
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competitive moves to keep a strong hold on the world market they have had in
the past, and they will continue to do so for many years to come.
Formal Accounting Analysis
Accounting is the true driver of a company, big or small, and honest and
true representation of a company’s financial standing is the key to making the
proper decisions whether they are internal or external. With every bit of financial
material that a company compiles they must make an active decision on many
factors including disclosure, capitalization, aggressive vs. conservative
accounting, and general compliance with law making bodies. Management
needs the information to produce a profit greater than in years past and
investors need the numbers to make decisions for their wellbeing. Although the
technique may be different from industry to industry the economic situation of
the company is depicted in the end. Further complicating the accounting
process is the inability to have exact measures of many of the important
determinants. Managers must make estimates on areas such as general and
product liability, goodwill and other intangible assets, deferred tax asset
valuation, allowance and uncertain income tax positions, and pension and other
postretirement benefits. As a result, a strong focus must be on the accounting
policies used, to accurately assess a firm’s financial operations, due to the
immense number of varying methods of reporting.
Key Accounting Policies
Goodyear Tires uses many significant accounting policies when preparing
their consolidated financial statements. The main competitive strategy that is
employed is based on product differentiation. Our strategy, as well as the
industry puts emphasis on certain areas of accounting. The key policies, in
regard to financial reporting, recognized by Goodyear include research and
development, inventory management, and goodwill and intangibles.
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Research and Development is probably the most important key success
factor for Goodyear. According to GAAP requirements research and development
costs must be expensed to the cost of goods sold section leaving little flexibility
in reporting methods. Although it is expensed, R&D indirectly creates future
value for the firm in a number of ways; however, many benefits maybe difficult
to capitalize. One notable figure of R&D that can be measured and reported in
financial statements is the overwhelming number of patents granted to Goodyear
in relation to the competition in the past five years. Further value produced from
R&D comes in the form of superior product quality in new tire lines. In 2005,
Goodyear introduced the Fortera featuring TripleTred Technology, a premium
SUV tire incorporating the same technology that was introduced with the
successful launch of their Assurance line of tires in 2004. In Europe, they used
the same model introducing two new high performance winter tires, the
Goodyear Ultra Grip 7 and Dunlop SP Winter Sport 3D, both of which have
received highly favorable consumer reviews. Both successful tire innovations are
direct results of the cash flows expended in the R&D department. For the 2005
expenditures totaling $365 million, $364 and $339 million in 2004 and 2003
respectively, the influence to future events far exceeds that of what can be
realized, and it can lead to an understatement of true value of assets.
Patent Grants 2001 2002 2003 2004 2005 Total
Goodyear 27 55 45 25 34 186
Michelin 5 16 30 18 25 94
Bridgestone 0 10 4 5 4 23
With sixty shipping locations, five hundred vendors, and more than four
thousand tire shipments a day it is crucial to have strong inventory management.
Inventory management can drastically affect the assets on the balance sheet.
Warehousing of excessive inventory can raise your facility costs, while having too
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little inventory can slow down the overall production of your final goods. The
method that has been chosen by Goodyear is FIFO. A first-in first-out method
assumes that the first unit making its way into inventory is the first sold. FIFO
gives us a better indication of the value of balance sheet ending inventory, but it
also increases net income because inventory that might be several years old is
valued at the current cost of goods sold. This can decrease the amount of
income tax that the company will be responsible for at the end of the period.
Through the use of the FIFO inventory system Goodyear effectively accounts for
the flow of inventory while reporting lower income tax expense, boosting net
income, in effect.
Goodwill and other intangible assets are also an important key success
factor for Goodyear Tire & Rubber Co., as they comprise a considerable portion
($110 million in 2005) of Goodyear’s assets on the balance sheet. In every
business acquisition Goodyear considers goodwill the cost less the fair value of
the net assets of the business. Although the original assessment of goodwill is
straightforward, writing off the asset account tends to be a more complicated
process. Likewise, intangibles such as trademarks, patents and brand names are
often difficult to value because they are not physical assets. Each year Goodyear
takes necessary actions to measure its goodwill and intangible asset accounts.
Both accounts are revalued annually based on the firm’s earnings before taxes,
depreciation and amortization; accordingly any impairments are written down to
fair value. This method of accounting for intangibles results in a more precise
calculation of the assets value than a standard amortization, providing higher
quality accounting information and reducing the chances of overstating assets
and large write-offs.
The key accounting policies identified by Goodyear are based on the key
success factors the firm focuses on to maintain a competitive advantage. A
firm’s chosen accounting policies have the potential to misstate its financial
standing. Goodyear actively addresses this problem and has chosen accounting
policies least likely to cause accounting distortions.
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ACCOUNTING FLEXIBILITY
The amount of flexibility a firm has in choosing their accounting policies
can determine how informative accounting numbers are for that firm. The key is
how the manager chooses to use the flexibility.
Research and Development is a very vital aspect of Goodyear Tire
& Rubber Co., however managers have no accounting choices on how R&D is
reported. Therefore, R&D is expensed as incurred and is included in cost of
goods sold. The lack of accounting flexibility in reporting research and
development prevents managers from matching R&D expenses to financial
benefits derived from those activities.
Inventory accounting policies give managers the ability to choose between
LIFO, FIFO, or Average Cost. The flexibility of inventory accounting policies
allows managers to lower costs or overstate assets depending on the method
used. The use of FIFO inventory management eliminates the extreme inventory
understatements typical of the LIFO method. The risk of overstating inventory
through the FIFO method is ever-present, but Goodyear’s rapid inventory
turnover and low supplier bargaining power help prevent overstated inventory by
holding product costs relatively constant.
The increasing importance of intangible assets lead to the creation of the
Statement of Financial Accounting Standards No. 142, “Goodwill and Other
Intangible Assets” which defines the proper methods of accounting for goodwill
and other intangible assets. This statement provides that intangible assets with
an indefinite lifespan cannot be amortized, instead their fair value is assessed
annually and the amount of impairment is written-off. The ability to revalue and
write-off intangibles on a yearly basis provides for more appropriate accounting
than amortization, however, Statement No. 142 has drawbacks. The annual
impairment is an estimate facilitated by the firm’s management and too often
managers, either intentionally or unintentionally, make errors in estimation.
Accounting for goodwill and other intangible assets plays a major role in
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Goodyear’s financial statements, but the methods used have a large margin for
error.
The key accounting policies at Goodyear lack flexibility in some areas and
allow for it in others. Flexibility in accounting is imperative to any firm’s success.
For accounting to be effective GAAP must be rigid to standardize reporting from
one firm to the next, while allowing enough flexibility for firms choose the best
suited policies to account for and disclose a variety of financial information.
EVALUATE ACTUAL ACCOUNTING STRATEGY
Goodyear Tire and Rubber is a public company with financial statements
that must adhere to GAAP standards as well as being governed by the SEC.
Goodyear has done well in recent past financial statements after having an
incident of accounting irregularities in 1999. “Goodyear, based in Akron, Ohio,
said it expected a net loss of $75 million to $85 million, compared with a net loss
of $196.5 million a year earlier. The company also said it expected to take a
restructuring charge of about $20 million, or about 11 cents a
share.”(http://query.nytimes.com) Goodyear has employed an accounting
strategy that overstated income by using aggressive accrual of revenues. This
led to a slight slide in the industry with the credibility of the firm’s interior
management. The managers exercised their accounting flexibility over the firm’s
allocation of expenses to manipulate earnings. Goodyear officially underwent an
investigation by the SEC to understand the judgment of the firm’s cash flows.
However, the firm has gone under an aforementioned massive cost of
compliance to help eliminate accounting discrepancies. The SEC made the
company a public example by imposing large fines and restrictions to show the
market the price of cavalier compliance. In regard to liabilities off the balance
sheet, the firm does own operating leases on its stores that distribute product.
Goodyear has a variety of outlets where it pays the expense of operating leases
because of the higher net effect it gives to the income statement. Goodyear is a
worldwide company, with a high number of locations required to sell to a
21
majority of the public and Goodyear can’t afford capital leases around the world.
The company also offers limited warranty on product that increases the
company’s long term liabilities. Goodyear still has goodwill to the extent of a
brand image and advertising (Goodyear Blimp) that would also inflate the
balance of assets.
Goodyear has corrected its recent past mistakes with accounting
discrepancies and seems to be headed to a positive position with regard to
aggressive accounting. The firm’s strategy has since become more conservative
and seeks to regain its reputation by always giving accurate full disclosure
through transparent financial statements. As Goodyear has expanded into a
global corporation it must comply with all accounting standards abroad with
regard to practice and implementation. If Goodyear continues to adhere to
proper standards; its standing in the marketplace should be favorable because of
its relative size and service in the industry.
QUALITATIVE AND QUANTITATIVE ANALYSIS
To really get the perspective of whether or not Goodyear distorts their
accounting numbers, we first have to evaluate the entire industry’s analysis using
a method of diagnostic ratios. Both qualitative and quantitative factors will be
discussed to evaluate the quality of Goodyear’s disclosures. Many companies
can manipulate their sales and expenses to gain more profit or puff up their
revenue when having a bad quarter. This manipulation will be apparent by
doing a sales and expense manipulation diagnostic table. Each table will have
three different ratios for the years 2001-2005. The results for the sales
diagnostics are shown below in the table.
Goodyear (Sales) 2001 2002 2003 2004 2005Net Sales/Cash from sales 1.01624 1.004 1.00106 1.0153 1.0008Net Sales/Net Accounts Receivable 9.6 9.49 5.77 5.4 6.25Net Sales/Inventory 5.95 5.91 6.12 6.59 6.89
22
As you can see, Goodyear’s ratios tend to stay pretty even year to year.
All the numbers in the table seem to be pretty even to one another. Net sales
divided by cash from sales has been around 1 for the past five years
respectively. This allows investors to see that this is a stable company that is
more than likely not distorting this information. Goodyear receives a large
portion of cash compared to the net sales made. Net sales divided by net
accounts receivable has been close to around 6 for the last three years, with
numbers being slightly higher in the earlier years. This could mean in the recent
years payments have not came in as rapidly as expected, or people are not
coming in for business as often. The Net sales divided by inventory has been
right around 6 every year, showing a very consistent amount of sales for every
item in inventory that is in stock.
Net Sales/Cash From Sales
0.96
0.98
1
1.02
1.04
1.06
1.08
2001 2002 2003 2004 2005
Goodyear
Michelin
Bridgestone
As shown in the graph above Goodyear sits right in between its competitors. It is a
very consistent number throughout the years staying right around 1. This is caused by the
amount of sales divided by the cash from sales. As for Goodyear’s competitors they seem to
be right around 1 as well. Besides the sudden jump from Michelin in the last year there is a
lot of consistency between all three of these companies. This means that this industry is very
well informed with one another and in this situation not distorting their accounting numbers
with this ratio.
23
Net Sales/Accounts Receivable
0
2
4
6
8
10
12
2001 2002 2003 2004 2005
Goodyear
Michelin
Bridgestone
In this graph, it is a clear indication that Goodyear, within the past 5 years, has been
more liquid than the other companies in question. The liquidity has declined, in recent years,
to level-off close to the industry average while still holding a slight advantage on the other
companies.
Net Sales/Inventory
012345678
2001 2002 2003 2004 2005
Goodyear
Michelin
Bridgestone
As an industry net sales/inventory has been reasonably equal among competitors.
Goodyear has increased over time from the middle of the pack to the leader in this section of
the market. Their positive trend seems to be breaking the mold of the industry from 2003 to
2005.
24
Michelin (Sales expressed in Euros) 2001 2002 2003 2004 2005Net Sales/Cash From Sales 1.0002 1.0025 1.0009 1.0067 1.0718Net Sales/Net Accounts Receivable 4.65 4.97 4.81 5.16 4.76Net Sales/Inventory 4.78 5.47 5.55 4.94 4.78
Bridgestone (Sales expressed in Yen) 2001 2002 2003 2004 2005Net Sales/Cash From Sales 1.00614 1.01961 1.01674 1.01677 1.01786Net Sales/Net Accounts Receivable 4.35 5.09 5.76 5.43 5.75Net Sales/Inventory 6.25 6.93 6.59 6.47 6.37
To decide whether or not Goodyear is normal for its industry, we have to
analyze the competitor’s ratios as well. After comparing all the ratios it seems
that Goodyear is very normal for the industry because the ratios in all three
companies tend to be very steady. Net sales/cash from sales is around the same
with the competitors, but Goodyear seems to be quite a bit lower. This may be
an effect of different currencies, but all three seem to be very consistent to the
industry within their own country. Net sales divided by net accounts receivable
is consistent throughout all three companies as well as the last ratio net
sales/inventory. With these consistencies across the industry it is fair to say
that Goodyear is most likely not manipulating their sales numbers.
Goodyear (Expenses) 2001 2002 2003 2004 2005Asset Turnover 1.03 1.06 1.03 1.14 1.26Changes in CFFO/NOA 0.25 0.13 -0.04 0.09 0.10Changes in CFFO/OI -3.97 -36.11 0.39 2.43 1.81
In this expense diagnostics table, the negative numbers and inconsistency
of numbers stand out immediately when first glancing at the table. The asset
turnover ratio has been increasing over the last five years except for the
25
exception in 2003. This shows that Goodyear has been acquiring more assets
with their amount of sales increase. Changes in cash flow from net operating
assets have been pretty steady over the last five years excluding 2003. This is
because in 2003 Goodyear struggled with relationships and dealers that are now
their number one concern, which took them to a higher level of profit in more
recent years. The last ratio cash flow from operating divided by operating
income has fluctuated greatly with the negative numbers in 2001 and 2002.
Goodyear has been putting much time and effort throughout these years to grow
globally as a company. Also, this is a time they were paying off a large portion
of their liabilities.
CFFO/NOA
-5
-4
-3
-2
-1
0
1
2
2001 2002 2003 2004 2005
Goodyear
Michelin
Bridgestone
26
Changes in CFFO/OI
-40
-30
-20
-10
0
10
2001 2002 2003 2004 2005Goodyear
Michelin
Bridgestone
Asset Turnover
0
0.2
0.4
0.6
0.8
1
1.2
1.4
2001 2002 2003 2004 2005
Goodyear
Michelin
Bridgestone
27
Michelin (Expenses expressed in Euros) 2001 2002 2003 2004 2005Asset Turnover 0.91 0.95 0.95 0.92 0.92Changes in CFFO/NOA -4.1 -4.39 1.17 1.06 0.89Changes in CFFO/OI 1.21 1.25 1.23 1.19 0.94
Bridgestone (Expenses expressed in Yen)
2001 2002 2003 2004 2005
Asset Turnover 0.87 1.04 1.04 1.04 1.09Changes in CFFO/NOA -0.2 0.17 0.24 0.24 0.28Changes in CFFO/OI -0.7 0.6 0.88 0.91 1.14
To determine whether or not Goodyear’s expense ratios are normal
compared to the industry, we had to look at the competitors ratios as well.
When looking at the first ratio, sales/assets, we learn that although all three
companies are very close together Goodyear seems to be slightly higher than the
rest. For the next ratio, all three companies seem to be very inconsistent to one
another. This makes it extremely difficult to make any assumptions within the
industry norm. The last ratio tests also seem to be very unpredictable within the
industry, which again becomes hard to come to any real conclusions.
POTENTIAL RED FLAGS
We have found no apparent Red Flags in the analysis of Goodyear Tires.
Research & Development offers little accounting flexibility; therefore the threat of
any undisclosed information is very little. As stated before, Goodyear uses FIFO
and the average cost accounting methods. This leaves us to believe that there
are no potential red flags in Inventory management, because FIFO and average
cost are the most commonly used and accepted methods when accounting for
inventory. For Goodwill and other intangibles, Goodyear revaluates each year,
and then marks them down to fair-market value. These yearly revaluations and
mark downs are the best way to accurately account for items such as Goodwill.
This is why we feel there are no apparent near future threats in that area of
accounting. It is also important to note the significance of the footnotes
28
Goodyear places in its financial statements. Information is properly disclosed in
these footnotes so investors and other outside onlookers can receive and
interpret the right information. Overall, we feel that after evaluating each of
Goodyear’s accounting policies in R&D, Inventory management, Goodwill, and
other intangibles, it proves that there are not potential threats.
RATIO ANALYSIS AND FORECAST FINANCIALS
In this next phase of evaluation for Goodyear Tire Company, we will be
computing many different financial ratios in order to assess the performance of
the company. In order to make a proper assessment, we will perform a ratio
analysis for the past 5 years. By calculating the ratios with information we get
from the financial statement, we can evaluate our company’s performance
individually, and also determine where Goodyear ranks in its industry by
evaluating their competitors. By looking at these ratios, we can get in an in
depth look at Goodyear’s past and present performance, and then take that
information in order to make the most logical forecasts for the next ten years.
This type of analysis is very important to investors because is gives a clear inside
picture of the company.
We will be using a variety of different ratios in this section such as
liquidity ratios, profitability ratios, and even capital structure ratios. These types
of ratios are very important when one analyzes a company because they can
show us very much. A liquidity ratio refers the cash equivalence of assets and
the firm’s ability to maintain sufficient near-cash resources to meet its obligations
in a timely manner. This is very important because it shows how easily assets
can be turned into cash. By looking at the profitability ratios we can evaluate the
four critical factors related to profits such as operating efficiency, asset
productivity, rate of return on assets, and the rate of the return on equity. These
leverage ratios are crucial in order to analyze a firm’s working capital
management. The Capital Structure Analysis of a company refers to the sources
29
of financing used to acquire assets and is shown by the liabilities and owner’s
equity section of the balance sheet. This section is important because is shows
the company’s ability to finance it’s debt by looking at the business risk and the
firms attitude towards business risk.
TREND ANALYSIS
The purpose of this section is to show the trends within our company for
the next ten years. These ten years of ratios will allow us to show how
Goodyear competes within this industry as well as to be able to forecast out
what the company’s progress will be in the future. The trend analysis will consist
of how liquid, profitable, and capital mobile Goodyear is. This analysis is very
important for investor’s purposes as well as public knowledge for future insight
into the company as a whole.
Goodyear's Trend Analysis 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005LIQUIDITY Current Ratio 1.53 1.28 1.90 1.65 1.80Quick Asset Ratio 0.71 0.59 1.14 1.06 1.16A/R Turnover 9.59 9.49 5.77 5.40 6.25A/R Days 359.17 363.41 364.78 359.49 364.70Inventory Turnover 4.88 4.77 5.06 5.28 5.51Inventory Days 74.79 76.51 72.09 69.17 66.23Working Capital Turnover 7.79 11.99 4.57 5.44 5.10PROFITABILITY Gross Profit Margin 17.87% 18.31% 17.36% 19.95% 20.03%Operating Expense Ratio NA NA NA NA NANet Profit Margin -1.44% -7.98% -5.34% 0.63% 1.18%Asset Turnover 1.03 1.05 1.01 1.14 1.26Return on Assets -1.48% -8.41% -5.38% 0.71% 1.46%Return on Equity -7.11% -169.97% 6.16% 155.41% 312.33%CAPITAL STRUCTURE Debt to equity ratio 3.81 19.21 -0.47 2.17 2.13Times interest earned -0.66 -0.05 -2.57 5.57 5.15
Debt service margin NA NA NA NA NA
30
LIQUIDITY
Throughout the last five years the current ratio has improved and has
shown that it will be stable for future years since the current assets have
increased over current liabilities. The quick ratio allows us to look at the overall
debt of the company. With this ratio it shows that numbers have been
increasing over time, which shows Goodyear has sufficient funds to cover their
upcoming liabilities. This allows us to see that Goodyear is credible by being
able to pay for their liabilities. The accounts receivable turnover and days
turnover is very consistent from year to year except for the mild fluctuations in
year 2001 and 2002. This number is very close to one year turnover because of
the one year financing that Goodyear offers to their customers on tires. This in
turn then shows that majority of the time it takes around a year to collect
payments. The inventory and days turnover ratio has been increasing over time.
This is because of growth and new product lines that have been developed in the
past few years. As for the working capital ratio it has been fluctuating over time,
but mostly shows a trend of decreasing. Besides this ratio, the trend analysis
below has shown that Goodyear is a fairly liquid company.
LIQUIDITY 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005 Current Ratio 1.53 1.28 1.90 1.65 1.80 Favorable Quick Asset Ratio 0.71 0.59 1.14 1.06 1.16 Favorable A/R Turnover 9.59 9.49 5.77 5.40 6.25 No Change A/R Days 359.17 363.41 364.78 359.49 364.70 No Change Inventory Turnover 4.88 4.77 5.06 5.28 5.51 Favorable Inventory Days 74.79 76.51 72.09 69.17 66.23 Favorable Working Capital Turnover 7.79 11.99 4.57 5.44 5.10 Unfavorable
31
PROFITABILITY
Profitability of Sales 2001 2002 2003 2004 2005 Sales 100.00% 100.00% 100.00% 100.00% 100.00%Cost of Goods Sold 82.13% 81.69% 82.64% 80.05% 79.97%Gross Profit 17.87% 18.31% 17.36% 19.95% 20.03%Selling & Admin Exp 15.90% 16.06% 15.72% 15.44% 14.58%Income from Operations 1.97% 2.25% 1.64% 4.52% 5.46%Interest Expense 2.07% 1.74% 1.96% 2.01% 2.08%Income Before Taxes -0.10% 0.51% -0.32% 2.51% 3.37%Income Tax Expense 0.08% 0.19% 2.10% 0.13% 0.35%Net Income -0.18% 0.33% -2.42% 2.38% 3.02%
The best way to evaluate operating efficiency is to construct an income
statement. Above is this income statement which shows exactly how profitable
Goodyear is. With the gross profit margin averaging over 18% for the last five
years, this shows that Goodyear is very stable within the industry considering
they compete on differentiation and cost. This high profit margin is fairly high
because of the brand recognition and reputable name Goodyear has became.
Although the gross profit margin looks like a good number, selling and
administrative expenses have taken a big part of this percentage which is shown
above. Although we could not calculate the operating expense ratio because we
could not find the definite operating expenses, we did evaluate the net profit
margin. This ratio has been increasing throughout the last five years. These
numbers were negative in years earlier because of the increase in price of raw
materials. This would impact negatively because Goodyear still had to compete
competitively on price as well as take a hit with the new high costs of raw
materials. With the asset turnover ratio it has consistently went up over time
which shows that Goodyear is utilizing their assets. Goodyear has a negative
return on assets and return on equity for the first few years as a result of
32
staggering research and development costs. Goodyear during these years has
integrated many new technologies into their tires. These expenses in turn have
caused net income to decrease and therefore cause the rate of return on assets
to also decline. The profit margin has not been as big in 2001-2003 as would
like, but is caused by increasing costs to expand. In 2004 and 2005 Goodyear’s
expansion has leveled off and they are beginning to see a positive return on their
equity.
PROFITABILITY 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005 Gross Profit Margin 17.87% 18.31% 17.36% 19.95% 20.03% Favorable Operating Expense Ratio NA NA NA NA NANet Profit Margin -1.44% -7.98% -5.34% 0.63% 1.18% Favorable Asset Turnover 1.03 1.05 1.01 1.14 1.26 Favorable Return on Assets -1.48% -8.41% -5.38% 0.71% 1.46% Favorable Return on Equity -7.11% -169.97% 6.16% 155.41% 312.33% Favorable
CAPITAL STRUCTURE
The debt to equity ratio measures a company’s total liabilities as a ratio of
liabilities to owner’s equity. Goodyear experienced unprecedented growth in
2002 causing their total debt to increase which negatively impacted 2003 when
paying off debt. In 2004 and 2005 Goodyear’s expansion leveled off and began
growing at a constant rate and began paying off old debt. The number of times
interest is earned is a signal to creditors of how credit worthy a company is. The
lower the ratio, the less trustworthy you appear to creditors and vice versa.
Goodyear in times of expansion had a lot of outstanding debt and therefore
caused the number of times interest was earned to be lower. From the debt
service margin, we have concluded that Goodyear has become more efficient in
collecting its debt in a shorter period of time. This is a favorable change from
recent years. In succeeding years, Goodyear paid off their debt and is now a
credit worthy company.
33
CAPITAL STRUCTURE 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005 Debt to equity ratio 3.81 19.21 -0.47 2.17 2.13 Favorable Times Interest Earned -0.66 -0.05 -2.57 5.57 5.15 Favorable Debt Service Margin 11.97 1.83 -2.37 0.78 1.95 Favorable
SUSTAINABLE GROWTH RATE
To understand the firm’s growth rate relative to equity dividends
distributed to shareholders as a function of net income, a dividend payout ratio
must be computed.
12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005ROE -7.11% -169.97% 6.16% 155.41% 312.33% Dividend Payout Ratio -0.798 -0.072 0 0 0 IGR -0.127658 -1.81168 25.06 1.55 3.12 SGR -0.61505028 -36.60680608 25.06 1.55 3.12
Goodyear has reported experiencing operating losses in both 2001 and
2002 even with the economy returning from recession. Starting in 2003
Goodyear, in spite of diminishing returns to equity suspended the payment of
dividends to shareholders. “AKRON, Ohio - The Goodyear Tire & Rubber Co.
board on Tuesday eliminated the world's largest tire company's dividend.
Goodyear said eliminating the dividend will improve the company's annual cash
flow by approximately $84 million. The quarterly dividend rate was 12 cents per
share (http://www2.jsonline.com/bym/news)”. Goodyear’s current stock value is
15.05 which is up with the current 2005 boom in the DOW despite having a
recent strike with workers. The 3 year old IGR/SGR with negative returns makes
the process of forecasting dated and very difficult to recognize growth within the
company. However the company has had positive gains in operations as well as
rise in equity in the recent past. The company is still in a very vulnerable state
within the industry because of the massive losses in 2001 and 2002 but shows
34
positive signs in recent liquidity, profitability, and capital structure ratios.
Goodyear has gone under a restructuring in 2003 and replaced the CEO to help
aid recovery. Goodyear was under heavy debt because of previous acquisitions
but after the restructuring it has been profitable every quarter since. The
company’s debt is still regarded as junk but net income has been positive and
perhaps the company is nearing the date to again release dividends to its
shareholders. The company’s growth is not easily predicted but simply
examining net income and ROE, the firm seems to be having a positive internal
growth rate at present.
CROSS-SECTIONAL ANALYSIS
When looking at the current ratio of the industry, there is a strong
indication that all companies fall within close distance of one another. It is clear
that all involved in the industry are capable of paying their short term liabilities.
Goodyear seems to be a bit behind the competition, but they still show good
signs that the company is in good financial health.
Current Ratio
0
0.5
11.5
2
2.5
3
2001 2002 2003 2004 20050
0.5
11.5
2
2.5
3
Industry Avg.BridgestoneMichelinGoodyear
With the inclusion of inventory in the Quick Asset Ratio, it is clear that the
companies seem to stay right along the same paths as the current ratio. In
35
relation to short-term financial strength, Goodyear, is the clear winner from 2004
to 2005. This is a good sign of a Goodyear being very capable of turning
inventory into cash, and avoiding the downturn that the industry as a whole has
experienced. In the event that short-term obligations need to be paid off
quickly, Goodyear has shown recent strength in the test.
Quick Asset Ratio
00.5
11.5
22.5
3
2001200220032004200500.511.522.53
IndustryAvg.Bridgestone
Michelin
Goodyear
Receivables Turnover is a measure of a firms overall ability to extend
credit as well as collect debt. It also is a measure of how effectively assets are
used in the business. For Goodyear, the ratio is reasonably low, this shows that
there maybe a need to reassess its credit policies and to ensure timely
repayment of funds that are not gaining interest for the firm. Bridgestone is the
clear leader in this field showing a dominant cash and credit collections
department running at a high level of efficiency.
36
A/R Turnover
0
2
4
6
8
2001 2002 2003 2004 2005024681012
Industry Avg.BridgestoneMichelinGoodyear
Working Capital Turnover is a valuation that assesses how much working
capital (current assets – current liabilities) a company uses to fund operations
and purchase inventory then being converted into revenue for the company. It
is a great measure of the relationship between money being used to fund operations
and the sales being generated from it. From 2001 to 2003, Goodyear was
generating sales well above the industry average when compared to how much
working capital that the company invested. This is a very good competitive sign
for any firm.
Working Capital Turnover
02468
101214
2001 2002 2003 2004 200502468101214
Industry Avg.BridgestoneMichelinGoodyear
37
With respect to Inventory Turnover, Goodyear has an above industry
average. There are two things that can lead to this result. One, it can mean
that the company is practicing excessive buying overstocking inventory. Second,
the ratio can imply above average sales in comparison to the market. Goodyear
falls into the second category as can clearly be seen by this ratio, as well as
previous measures based on sales. (Ratios for Michelin were not found)
Inventory Turnover
0123456
2001 2002 2003 2004 20050123456
Industry Avg.BridgestoneMichelinGoodyear
PROFITABILITY Gross Profit Margin is a measure of a percentage in excess of cost of
goods sold resulting in revenue. It is not an exact measure of a particular firm’s
pricing strategy, but it is a good measure of the financial well being. From my
perspective, this graph is an indication that Goodyear does not make as much
money per tire as the competition. I do not see this as a cause for alarm, but if
costs can be avoided within production that does not take away from the quality
of the product, it should be a future consideration. (Ratios for Michelin were not
available)
38
Gross Profit Margin
0%
20%
40%
60%
80%
100%
2001 2002 2003 2004 20050.00%
20.00%
40.00%
60.00%
80.00%
100.00%
Industry Avg.BridgestoneMichelinGoodyear
Net Profit Margin is how much of every dollar of sales goes into earnings.
The volatility that Goodyear has experience in the past is a definite red flag for
the company. Their inability to control costs in relation to the industry has lead
to a less profitable firm in the past. The ability to climb back to even with
Michelin is a good step, but it is still a great deal off pace from the leader,
Bridgestone.
Net Profit Margin
-10
-5
0
5
10
2001 2002 2003 2004 2005
-10
-5
0
5
10
Industry Avg.BridgestoneMichelinGoodyear
Asset Turnover is a measure of how a firm uses assets to generate sales
and revenue. From the graph, the industry has been using assets, as a whole,
39
efficiently according to competitive trends. Goodyear has shown an increase
from 2004 to 2005, and has made the first move, from the average, of any
company in our analysis.
Asset Turnover
-0.10.10.30.50.70.91.11.31.5
20012002200320042005-0.10.10.30.50.70.91.11.31.5
Industry Avg.BridgestoneMichelinGoodyear
Return on Assets (ROA) is a measure of a company’s ability to take on a
new project by monitoring the return on a company’s investments or assets.
Michelin far outperforms the competition showing an ability to take on new
projects to further the company. Goodyear shows a very poor result dropping
into the red for three of the years studied. It is important for Goodyear to
continue its upward trend if they would like a favorable future opportunity for
growth.
40
Return on Assets
-10
-5
0
5
10
15
20
2001 2002 2003 2004 2005
-10
-5
0
5
10
15
20
Industry Avg.BridgestoneMichelinGoodyear
Return on Equity is a measure of profit generated from money invested by
shareholders. The initial negative numbers from 2001 to 2003 were a direct
result of having a net loss on the income statement; however, from 2003 to the
present Goodyear has more that out performed the industry standard. This
indicates a favorable outcome for the future of the firm.
Return on Equity
-200
-100
0
100
200
20012002200320042005
-200
-100
0
100
200
Industry Avg.BridgestoneMichelinGoodyear
CAPITAL STRUCTURE
Debt to Equity Ratio is an overall measure of a company’s financial
leverage or how much the company is financed by debt. It is a very good
41
indicator of financial risk for the firm. Goodyear, in reaction to poor earnings in
2001 to 2003, financed much of its growth with debt leading to the
overwhelming spike in the ratio. Since 2003, all debt to equity ratios in the
industry have settled to an even level.
Debt to Equity Ratio
-5
0
5
10
15
20
2001 2002 2003 2004 2005 -5
0
5
10
15
20
Industry Avg.BridgestoneMichelinGoodyear
Times Interest Earned is a model of how well a company can cover its debt
obligations on a pre tax basis. It is mostly a measure of how well a company
can sustain earnings. Referring to the graph, Goodyear exhibits a good chance
for bankruptcy from 2001 to 2003; it is much more promising than the numbers
from Bridgestone from 2002 to 2005. (Ratios for Michelin were unavailable)
42
Times Interest Earned
-20
-15
-10
-5
0
5
10
2001 2002 2003 2004 2005
-20
-15
-10
-5
0
5
10
Industry Avg.BridgestoneMichelinGoodyear
LIQUIDITY
The tire industry as a whole is reasonably illiquid, so the majority of the
ratios stay within a similar range regardless of which company they are a
measure of. Goodyear seems to be lagging behind in every category except for
their use of Inventory until 2004 when the current asset and the quick asset
ratios showed an improvement better than that of any competitor. I believe that
it is important for Goodyear to improve its efficiency of their Accounts Receivable
Turnover in order to make up some valuable ground lost to Bridgestone. A
strong working capital ratio was an indicator that Goodyear has shown a superior
ability to generate sales efficiently with little invested in operations.
PROFITABILITY
Goodyear has struggled for most of the past five years, but throughout
the ratios a positive trend has emerged from 2004 to 2005. Gross Profit Margin
has remained steady, while Net Profit margin and Return on Assets have finally
emerged from the dungeon and back into positive territory, but they are still
behind the competition. The only ratios with bright spots are Asset Turnover
and Return on Equity. Asset Turnover has been consistent with the industry
average until 2004 when Goodyear separated itself from the competition. The
most notable positive outcome for profitability is the dramatic increase in Return
43
on Equity that the firm has experienced since 2002. It is valuable gauge to the
possible future of the company’s profits.
CAPITAL STRUCTURE
Goodyear, in the beginning of the five year study, performed poorly when
it was clear where and how they were obtaining their funding for operations and
growth. A sharp peak in the Debt to Equity Ratio from 2001 to 2003 was an
indication that the company was risky, particularly at its peak in 2002. From
2003 to 2005, the company has shown a consistency that has led to a lower risk
for default. In reference to the Times Interest Earned Ratio, Goodyear was on
the verge of bankruptcy in 2003 only to rebound back to an increasingly
respectable level. The most important factor to gain from this section is the
growing consistency of the firm as a whole.
(Below is a Table of the Ratio Analysis used in the graphs for Michelin)
Michelin'sTrend Analysis 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005 LIQUIDITY Current Ratio 2.51 2.21 2.21 1.49 1.49 Quick Asset Ratio 1.08 1.01 1.10 0.94 0.27 A/R Turnover 9.59 9.49 5.77 5.40 6.25 A/R Days 364.91 364.08 364.67 362.57 340.56 Inventory Turnover Inventory Days Working Capital Turnover 2.61 2.98 2.93 5.61 5.96 PROFITABILITY Gross Profit Margin Operating Expense Ratio NA NA NA NA NANet Profit Margin 1.65% 3.71% 2.07% 4.35% 5.70% Asset Turnover 0.91 0.96 0.95 0.94 0.92 Return on Assets 1.70% 3.56% 1.96% 4.07% 5.27% Return on Equity 7.41% 13.42% 7.34% 18.44% 19.64% CAPITAL STRUCTURE Debt to equity ratio 2.28 1.93 2.02 3.53 2.73 Times interest earned Debt service margin NA NA NA NA NA
44
(Below is a Table of the Ratio Analysis used in the graphs for Bridgestone)
Bridgestone's Trend Analysis 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005 LIQUIDITY Current Ratio 1.53 1.68 2.06 1.67 1.54
Quick Asset Ratio 0.88 0.95 1.23 0.99 0.85 A/R Turnover 4.47 5.64 6.36 5.97 5.75
A/R Days 81.62 64.69 57.40 61.16 63.43 Inventory Turnover 4.03 4.33 4.12 4.11 3.77
Inventory Days 90.52 84.23 88.50 88.89 96.87 Working Capital Turnver 4.86 4.90 3.85 5.05 5.85
PROFITABILITY Gross Profit Margin 35.49% 37.48% 37.43% 36.56% 34.91%
Operating Expense Ratio NA NA NA NA NA Net Profit Margin 0.81% 2.02% 3.85% 4.74% 6.72% Asset Turnover 0.87 1.05 1.04 1.04 0.99
Return on Assets 0.71% 2.12% 4.00% 4.90% 6.67% Return on Equity 2.08% 5.90% 9.99% 4.90% 6.67%
CAPITAL STRUCTURE Debt to equity ratio 1.88 1.64 1.46 1.46 1.37
Times interest earned 4.80 -6.85 -13.55 -15.96 -16.06 Debt service margin NA NA NA NA NA
FINANCIAL STATEMENT FORECASTING AND METHODOLOGY
Forecasting the future outcomes for a company is an everyday occurrence
in most industries. It is very important for firms to forecast in order to make
long-term decisions. Understanding the possible financial impact of your
decisions is critical to future business growth and profitability. It is a measure of
your company’s future abilities to give every interested party an idea of what is
expected to come from your entity in the future. The focus of the forecast is on
the Balance Sheet, Income Statement, and the Statement of Cash Flows. Each
of these sections have highly important information that can be forecast by
average growth, a percentage of sales, percentage of assets, or a percentage of
total liabilities and stockholder’s equity. The method was chosen specifically to
each measure by taking into account all of the prior knowledge that we
possessed from prior financials.
45
INCOME STATEMENT
In order to begin forecasting for Goodyear Tire a reasonable growth rate
needs to be calculated from historical numbers. A reasonable rate to use would
be the average of the SGR for the five previous years. The problems we
encountered when calculating the SGR were the ROE was either outrageously
high or low, and Goodyear Tire has not paid dividends for the past three years.
Due to these circumstances, SGR did not have a reasonable growth rate or a
trend; so we needed to obtain a growth rate using a different calculation. The
growth rate for our forecasts was generated from sales from the previous two
years. After analyzing the income statement it was easy to determine that years
2001, 2002, and 2003 were outliers due to the large fluctuations in many line
items, including net income. Sales do in fact have a reasonable trend for all five
years, but we are going to exclude the outliers for many of the other line items.
It only seems reasonable to use a trend when while forecasting; which is why we
also excluded years 2001, 2002, and 2003 when estimating the growth rate for
sales. Plus, the previous two years show the beginning of a steady incline after
several years of interruptions. A growth rate of 7.5% was used steadily
throughout the ten years of forecasting due to the companies age. The basic
assumption here is that Goodyear and Tire is getting back on track at a steady
growth rate after some long-term debt came due. A growth rate of 7.5% is
credible, based on the average growth rate for a company of Goodyear and
Tire’s age. The remaining lines items of the income statement, excluding gross
profit and net income, were forecasted from a common size income statement.
The line items were taken as a percent of sales for the previous two years,
excluding the outliers, and averaged. The average percentage rate for each line
item was then multiplied by forecasted sales for that year, resulting in a
forecasted amount. Gross profit was derived from the use of a common size
statement, but from cost of goods sold, as a percentage of sales, subtracted
46
from sales. Net income was calculated by adding and subtracting the remaining
line items from gross profit, when appropriate.
BALANCE SHEET
The balance sheet was forecasted relatively similar to the income
statement. Total assets were forecasted by dividing the sales growth rate by the
asset turnover ratio, which resulted in a 6.25% growth rate. Current assets and
the remaining asset line items were also forecasted with a common size
statement. They were taken as a percentage of total assets for the previous two
years and averaged together. The average percentage rate for each line item
was used throughout the ten year forecast. Total liabilities were forecasted by
dividing total assets by total liabilities for the previous two years and then finding
the average. This amount was then divided by the growth rate that was
estimated for total assets. Total assets and liabilities were relatively the same
resulting in a ratio of one and a growth rate of 6.25%. The same strategy used
to find current assets was also used to find current liabilities and the remaining
liability line items. A common size statement was created in the same manner as
for the assets. After the assets and liabilities sections of the balance sheet were
forecasted out, we checked our forecasts with the average current ratio from the
previous two years. Our forecasts of current assets divided by forecasted
current liabilities matched perfectly to the average current ratio of 1.72. Since
the data for the previous two years of shareholders equity did not follow the
same growth as total shareholders equity, we used a different methodology.
Each line item was forecasted using a different growth rate based on the
previous two years data. The growth rate determined for each line item was
then used steadily throughout the forecasted ten years. Forecasts are never
100% accurate, but history tends to repeat itself, giving us a good idea of future
performance.
47
STATEMENT OF CASH FLOWS
Forecasting the statement of cash flows was a simpler task compared to
the income statement and balance sheet. Many of the internal line items were
difficult to forecast, at least not accurately, which is partial reasoning for the
simplicity in the forecasting. Net income has already been forecasted in the
income statement; so we simply transferred the data over to the statement of
cash flows. A growth rate for total cash flows from operating activities was
estimated from the average of changes in CFFO/NOA in 2004 and 2005. A
growth rate of 10% was estimated and used throughout the ten year forecast,
resulting in a continuous increase for cash flows to the firm. The forecasts give
us a good idea of what to expect from the company in terms of future
performance, but are always subject to change.
FIRM VALUATIONS
A number of methods were employed in order to properly value
Goodyear’s share price. Each method values the firm from a different angle, as
analysts we can pool the information derived from each valuation model and
choose the best fit model or models to estimate the firm’s share price. The
valuation models performed in this section rely on both historical (actual) and
intrinsic (forecast) values to estimate a fair stock price for Goodyear.
METHOD OF COMPARABLES
The method of comparables valuation is constructed using earnings
multiples for Goodyear’s competitors. We used earnings per share, book value of
equity per share, price per share, sales per share and free cash flows per share
in an attempt to derive, what we consider, a fairly valued share price for the
firm. A typical valuation based on the method of comparables also includes
dividends per share, but was excluded from this model because Goodyear does
48
not pay dividends regularly. The measures of relevant industry multiples
computed are the price to earnings ratio (trailing and forecast), the price to book
ratio, the price to sales ratio and the price to free cash flows ratio. The industry
average for each multiple is computed and then applied to the relevant multiple
for Goodyear to estimate the relative share price.
2004 EPS BPS PPS SPS FCFPSGoodyear 0.14 0.41 14.66 104.60 3.30Michelin ( € ) 3.59 32.09 47.19 109.42 9.06Cooper 0.37 16.45 21.55 29.26 1.97Carlisle 3.77 22.61 64.92 72.10 5.53Bandag 2.87 27.36 49.81 43.90 4.32
2005 EPS BPS PPS SPS FCFPSGoodyear 1.38 0.41 17.38 111.74 5.08Michelin ( € ) 6.13 31.44 47.48 108.26 -124.00Cooper -0.24 15.31 15.32 35.15 1.64Carlisle 4.29 24.05 69.15 72.79 6.15Bandag 2.52 28.76 42.67 47.04 3.90
2006 EPS BPS PPSGoodyear 1.10 1.75 17.89Michelin ( € ) 4.62 22.90 65.00Cooper 0.42 14.25 13.80Carlisle 5.40 26.75 81.48Bandag 2.50 29.90 45.43
To compute P/E trailing each of the competition’s P/E was computed and an
industry average, excluding Goodyear, was found for each year. This average is
multiplied by Goodyear’s EPS to find the share price. The P/E forecast is
computed in the same manner, but the industry average is multiplied by the EPS
of the firm for the subsequent year. The P/B, P/Sales and P/Free cash flows
measures are computed in similar fashion by finding an industry average for
each of the multiples then multiplying the average by Goodyear’s respective BPS,
Sales per share and FCF per share.
49
2004 P/E (trailing)
P/E (forecast) P/B P/S P/FCF
Goodyear 104.71 144.51 35.76 0.14 4.44Michelin 13.14 80.58 1.47 0.43 5.21Cooper N/A N/A N/A N/A N/A Carlisle 17.22 73.87 2.87 0.90 11.74Bandag 17.36 43.74 1.82 1.13 11.53Industry Average 15.91 66.06 2.05 0.82 9.49Share Value 2.23 9.25 0.84 85.99 31.33
2005 P/E (trailing)
P/E (forecast) P/B P/S P/FCF
Goodyear 12.59 13.85 42.39 0.16 3.42Michelin 7.75 35.78 1.51 0.44 N/A Cooper N/A N/A N/A N/A N/A Carlisle 16.12 87.04 2.88 0.95 11.24Bandag 16.93 42.33 1.48 0.91 10.94Industry Average 13.60 55.05 1.96 0.77 11.09Share Value 18.77 75.97 0.80 85.51 56.35
This method failed to provide much conclusive evidence because Goodyear tends
to be an outlier in its own industry, making it impossible to select a group of
comparable firms. However, for the trailing P/E in 2005 Goodyear did post
numbers similar to those of the industry as a whole. Based on the valuation for
the trailing P/E in 2005 Goodyear’s estimated stock price is $18.77, slightly
higher than the observed share price of $17.89. This valuation would lead us to
believe Goodyear’s share price is slightly overvalued, although other valuations
performed suggest otherwise.
COST OF EQUITY
In order to value the cost of equity, you must consult CAPM, the Capital
Asset Pricing Model. This was the most applicable model for our valuation of the
cost of equity for Goodyear tires, and it is found by using the CAPM formula.
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Ke = Rf + B ( Rm – Rf)
Where Ke is cost of equity, Rf is the risk-free rate, Rm is the expected return to
the market, and B is the beta volatility for the firm. The market risk premium is
the expected return to the market less the risk-free rate. The next step was to
find values for all of the variables. The first step we took was finding the stock
price of Goodyear at the end of the sixty months in our analysis, then we
calculated the returns for the company during these months. Next we found all
of the closing prices for the S&P 500, for the sixty months in question, and
calculated the returns in for S&P in the same fashion. Then we found the
historical data for the risk free rate on MSN money. The next step was to find the
market risk premium. We did this by subtracting the monthly risk free yield from
the monthly S&P 500 returns. Next, we found an average annual risk free rate by
averaging all of the monthly returns and multiplying that number by 12. The
last variable is Beta. We calculated beta by taking the slope of the firm's returns
versus the market risk premiums which came out to equal 1.635 in the 5- year
evaluation, compared to the published 1.81 it seems to be reasonable. Once we
obtained all of the values needed for CAPM we inserted them and calculated our
cost of equity to be 17.1%.
ESTIMATING COST OF DEBT
In order for us to estimate Cost of Debt (Kd), we needed to find the
interest rates for Goodyear’s debt structure. With this, we then could weight it
out as of total debt structure to get a weighted average cost of debt. We
summed up the short term and long term debts and then calculated the weights
of each component by dividing the principle amount by the total amount. Then
to find the value-weighted interest rate of each component, we multiplied its
interest rate by the weight assigned to it. After totaling this amount, we found
that our cost of debt is 6.31%.
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WEIGHTED AVERAGE COST OF CAPITAL
It is very necessary to compute the cost of equity and the cost of debt,
because now we can begin to estimate weighted average cost of capital. The
formula to calculate weighted average cost is as follows:
MVd: $15,554, 000, 000
MVe: $73,000,000
To calculate the market value cost of debt and equity, you next must add
together value of debt and value of equity.
$15,554,000,000 + $73,000,000 = $1,628,400,000 = BVf
Once you find the value of debt, value of equity, and the market value of
debt and equity, you can now calculate the Weighted Average Cost. (WACC)
WACC= (15,554,000,000/1,628,400,000)(.0631) +
(73,000,000/1,628,400,000)(.169) = 6.79%
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INTRINSIC VALUATION MODELS
FREE CASH FLOWS
In order to estimate the value of a firm’s equity using the free cash flows
or discounted cash flow model, cash flows to the firm’s assets must be
forecasted for a reasonable time period. In this case forecasts were made ten
years into the future. To estimate the firm’s free cash flows, forecasted cash
from investments are deducted from forecasted cash from operations each year
for ten years. Once the firm’s annual free cash flows are estimated a discount
factor for each year is computed based on Goodyear’s WACC. The present value
of the future free cash flows for each year are added together to find the total
present value of the free cash flows. After the total present value of free cash
flows for the forecast period are found, the terminal year perpetuity is divided by
the difference between WACC and the growth rate. The perpetuity is then
discounted back at the present value of the previous year to derive the present
value of the terminal value perpetuity. The present value of the firm’s terminal
value perpetuity is then added to the total present value of the free cash flows to
the firm for the forecast period to find Goodyear’s estimated value. The
difference between the value of the firm and the book value of its liabilities
provides our estimate for the market value of equity for the firm. The share
price for Goodyear is then estimated by simply dividing the estimated market
value of equity by the number of shares outstanding for the corresponding year.
According to our estimates, conducting the free cash flows valuation model
results in a share price of $9.05, considerably lower than Goodyear’s observed
share price of $17.89 in 2006. In conclusion, the observed share price for
Goodyear in 2006 is overvalued.
53
SENSITIVITY ANALYSIS
WACC g 0.055 0.06 0.065 0.0679 0.07 0.075 0.08
0 37.44 24.93 14.41 9.05 5.45 -2.26 -8.970.01 58.88 41.88 28.05 21.15 16.58 6.93 -1.290.02 92.58 67.31 47.74 38.30 32.16 19.46 8.940.03 153.23 109.69 78.69 64.50 55.52 37.57 23.270.04 294.74 194.46 134.41 109.49 94.47 66.03 44.76
Overvalued (< 90%) 16.1 Undervalued (> 110%) 19.68
The drastic changes in the estimated price per share, shows that the free
cash flows valuation model is the most sensitive. Increases in the growth rate
for WACC on the perpetuity increase the estimated value of the firm, which in
turn increases the estimated market value of equity. Since the price per share is
derived from the estimated market value of equity divided by the number of
shares, explains why the price per share increases along with the growth rate.
Though very sensitive to small changes, the model proves to be consistent with
valuation of being overvalued. We concluded that this model proves to be too
sensitive to effectively estimate the value of a share when a growth rate is in the
equation.
RESIDUAL INCOME
Accurate estimates of a firm’s share price can be obtained using the
residual income model. To conduct the model for Goodyear earnings per share
are forecast ten years into the future, for each year the book value of equity for
the prior year is multiplied by Goodyear’s cost of equity. That number is then
deducted from the forecasted earnings per share in order to determine an
estimated residual income for each year. The residual income estimates are then
discounted to reflect the present value and the present value of the terminal year
perpetuity is added to the sum of the present value of future residual income to
54
obtain an estimated present share price. Based on forecasted earnings per share
amounts the present value of Goodyear’s residual income for the next ten years
will be $7.09 and the terminal value of the residual income perpetuity is
estimated to be $0.94. These two present values are added to the previous
year’s book value of equity per share ($0.99) to find our share price estimate of
$9.02. The share price estimate of $9.02 for 2006 is considerably lower than
Goodyear’s observed share price of $17.89 leading analysts to conclude
Goodyear’s equity is overvalued. From this point a sensitivity analysis was
constructed to determine various growth rates and costs of equity needed to
yield share prices comparable to Goodyear’s observed share price for 2006.
These computations are illustrated in the following table.
SENSITIVITY ANALYSIS Ke
g 0.06 0.07 0.08 0.09 0.1 0.11 0.116 0 23.56 18.77 15.42 12.99 11.16 9.73 9.02
0.01 25.83 20.01 16.13 13.40 11.39 9.87 9.12 0.02 29.24 21.75 17.07 13.92 11.69 10.04 9.24 0.03 34.92 24.36 18.39 14.63 12.08 10.25 9.39 0.04 46.28 28.71 20.36 15.61 12.59 10.52 9.57 0.05 80.37 37.40 23.65 17.08 13.30 10.89 9.82
Overvalued (< 90%) 16.10 Undervalued (> 110%) 19.68
This sensitivity analysis clearly displays that a properly valued share price is
unattainable at Goodyear’s current cost of equity given a feasible growth rate,
therefore the only method to obtain a fairly valued stock price based on this
valuation is for Goodyear to dramatically lower its cost of equity
ABNORMAL EARNINGS GROWTH
The abnormal earnings growth valuation model begins with the forecasted
earnings per share as well as the forecasted dividends per share. The dividends
per share for 2006 are then multiplied by the cost of equity or the rate at which
55
dividends will be reinvested. For a company that pays dividends, this would
result in the value of the reinvestment recognized in the following problem.
Unfortunately Goodyear Tire does not pay dividends currently which makes our
forecasted dividends zero; giving this valuation model a more simplistic angle.
Cumulative-dividend earnings are then calculated, but are equal to earnings per
share for that year due to the lack of dividend payments. Normal earnings are
then calculated by growing earnings per share by the cost of equity, which are
the earnings a company recognizes without any reinvestment of dividends. The
normal earnings are then subtracted from cumulative-dividend earnings to find
abnormal earnings growth. The same calculations previously explained are
completed for the next nine years to find the abnormal earnings growth. The
total present value of all nine years is then determined by discounting back at
the cost of equity. The present value of the terminal value is valued at zero
because of perpetuity equal to zero. The total present value of abnormal
earnings growth is equal to $-0.56 and is added to initial earnings per share used
to determine the normal earnings, $1.74. Total average earnings per share of
$1.18 is calculated and divided by the cost of equity to determine a $10.14 value
per share ending 2006. This value per share is consistent in relation to our share
values in other models.
SENSITIVITY ANALYSIS
Ke G 0.06 0.07 0.08 0.09 0.1 0.11 0.116
0 31.17 24.55 19.76 16.17 13.40 11.23 10.14 0.01 31.17 24.55 19.76 16.17 13.40 11.23 10.14 0.02 31.17 24.55 19.76 16.17 13.40 11.23 10.14 0.03 31.17 24.55 19.76 16.17 13.40 11.23 10.14 0.04 31.17 24.55 19.76 16.17 13.40 11.23 10.14 0.05 31.17 24.55 19.76 16.17 13.40 11.23 10.14
Overvalued (< 90%) 16.1 Undervalued (> 110%) 19.68
56
According to the sensitivity analysis the price per share does not change
with different growths rates factored in. The fact that we have a perpetuity of
zero makes it impossible for a growth rate to affect the valuation because it is
not even considered. The prices per share values are much less sensitive to
changes in the cost of equity compared to our other valuation models. Though
less sensitive, it still has the same valuation as our other models, overvalued.
CREDIT RISK ANALYSIS: Z-score Discriminate Analysis Model
2005 0.24758 0.08306 0.072182 0.00469 1.26211045 1.916505052004 0.20961 0.0664 0.05012 0.0046172 1.1398 1.652458322003 0.22009 0.06533 -0.02623 0.00486 1.0075 1.2794272002 0.0941 0.1367 0.01748 0.01997919 1.06269 1.4366612001 0.131738 0.23163 0.0014 0.26228 1.0263 1.6706556
1.2 1.4 3.3 0.6 1 Z-Score
The Altman test is based on several variables including many forms of income
divided over total assets. Goodyear has shown many past problems within the
company and its ability to produce steady residual income. The company
suspended its dividends and this led to a higher retained earnings. Over the past
couple years, Goodyear has chosen positive investments that have lifted it above
it past rating as a company below 1.81 which would signal bankruptcy.
Goodyear has increased its z-score and therefore it’s credit rating since 2004.
Goodyear still has a lot of ground to gain in the credit industry but this score at
least helps give it the option to produce commercial paper and show it
shareholders some positive signals for future quarters.
RECOMMENDATION
The models introduced earlier in this draft are the methods we used to
value Goodyear Tire Company. We performed all of the measures to the best of
57
our ability, in the area that valuation was possible with available information.
For instance, we were unable to perform the Discount Dividends model because
our firm simply does not pay dividends, so the valuation had to application to our
project. Also, the lack of dividends had an effect on our method of comparables.
Without dividends, the stock price fluctuated above the listed price, as well as all
of the other valuations, rendering that particular measure insignificant. The
calculation of the majority of our valuations resulted in Goodyear being
overpriced, and a recommendation to sell.
` In order to determine the average stock price we agreed as a group that
our most accurate models were Free Cash Flows, Residual Income, and
Abnormal Earnings Growth. From the three in consideration we calculated, on
average, the value of our firm to be $9.04 versus the observed stock price of
$17.89. This is a clear indication that Goodyear is over-valued and shareholders
should sell the stock immediately. The three methods we used produced values
that were within the most logical pricing range, making the decision of which to
use reasonably straightforward.
The models that we performed were done with a great deal of care and
attention, but we are always at risk for human error within our calculations. The
lack of dividends left our analysis with only three valuation models that we, as a
group, truly believed in. Estimation is also a pivotal part, of the valuation
process, leaving an even greater margin for error. However, the time and effort
we have put into our analysis leads us to believe that we have accurately valued
Goodyear Tire Company and we stand by our results.
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APPENDIX
APPENDIX A - Core Financial Ratios
Goodyear's Trend Analysis 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005LIQUIDITY Current Ratio 1.53 1.28 1.90 1.65 1.80Quick Asset Ratio 0.71 0.59 1.14 1.06 1.16A/R Turnover 9.59 9.49 5.77 5.40 6.25A/R Days 359.17 363.41 364.78 359.49 364.70Inventory Turnover 4.88 4.77 5.06 5.28 5.51Inventory Days 74.79 76.51 72.09 69.17 66.23Working Capital Turnover 7.79 11.99 4.57 5.44 5.10PROFITABILITY Gross Profit Margin 17.87% 18.31% 17.36% 19.95% 20.03%Operating Expense Ratio NA NA NA NA NANet Profit Margin -1.44% -7.98% -5.34% 0.63% 1.18%Asset Turnover 1.03 1.05 1.01 1.14 1.26Return on Assets -1.48% -8.41% -5.38% 0.71% 1.46%Return on Equity -7.11% -169.97% 6.16% 155.41% 312.33%CAPITAL STRUCTURE Debt to equity ratio 3.81 19.21 -0.47 2.17 2.13Times interest earned -0.66 -0.05 -2.57 5.57 5.15Debt service margin NA NA NA NA NA
Michelin'sTrend Analysis 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005LIQUIDITY Current Ratio 2.51 2.21 2.21 1.49 1.49Quick Asset Ratio 1.08 1.01 1.10 0.94 0.27A/R Turnover 9.59 9.49 5.77 5.40 6.25A/R Days 364.91 364.08 364.67 362.57 340.56Inventory Turnover Inventory Days Working Capital Turnover 2.61 2.98 2.93 5.61 5.96PROFITABILITY Gross Profit Margin Operating Expense Ratio NA NA NA NA NANet Profit Margin 1.65% 3.71% 2.07% 4.35% 5.70%Asset Turnover 0.91 0.96 0.95 0.94 0.92Return on Assets 1.70% 3.56% 1.96% 4.07% 5.27%Return on Equity 7.41% 13.42% 7.34% 18.44% 19.64%CAPITAL STRUCTURE Debt to equity ratio 2.28 1.93 2.02 3.53 2.73Times interest earned Debt service margin NA NA NA NA NA
59
Bridgestone's Trend Analysis 12/31/2001 12/31/2002 12/31/2003 12/31/2004 12/31/2005LIQUIDITY Current Ratio 1.53 1.68 2.06 1.67 1.54Quick Asset Ratio 0.88 0.95 1.23 0.99 0.85A/R Turnover 4.47 5.64 6.36 5.97 5.75A/R Days 81.62 64.69 57.40 61.16 63.43Inventory Turnover 4.03 4.33 4.12 4.11 3.77Inventory Days 90.52 84.23 88.50 88.89 96.87Working Capital Turnver 4.86 4.90 3.85 5.05 5.85PROFITABILITY Gross Profit Margin 35.49% 37.48% 37.43% 36.56% 34.91%Operating Expense Ratio NA NA NA NA NANet Profit Margin 0.81% 2.02% 3.85% 4.74% 6.72%Asset Turnover 0.87 1.05 1.04 1.04 0.99Return on Assets 0.71% 2.12% 4.00% 4.90% 6.67%Return on Equity 2.08% 5.90% 9.99% 4.90% 6.67%CAPITAL STRUCTURE Debt to equity ratio 1.88 1.64 1.46 1.46 1.37Times interest earned 4.80 -6.85 -13.55 -15.96 -16.06Debt service margin NA NA NA NA NA
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APPENDIX B - Forecasted Financials I. Balance Sheet
Actual Financial Statements Forecast Financial Statements2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
2001/12/31 2002/12/31 2003/12/31 2004/12/31 2005/12/31
AssetsCurrent Assets: Cash and cash equivalents $959,400,000 $918,100,000 $1,564,900,000 $1,968,000,000 $2,178,000,000 $2,108,668,313 $2,240,460,082 $2,380,488,837 $2,529,269,389 $2,687,348,726 $2,855,308,022 $3,033,764,773 $3,223,375,071 $3,424,836,013 $3,638,888,264 Short term securities $0 $24,300,000 $0 Restricted cash $152,000,000 $231,000,000 $265,659,000 $282,262,688 $299,904,105 $318,648,112 $338,563,619 $359,723,845 $382,206,586 $406,094,497 $431,475,403 $458,442,616 Accounts and notes receivable (Note 5) $1,475,300,000 $1,438,100,000 $2,621,500,000 $3,398,000,000 $3,158,000,000 $3,436,963,313 $3,651,773,520 $3,880,009,365 $4,122,509,950 $4,380,166,822 $4,653,927,248 $4,944,797,701 $5,253,847,557 $5,582,213,030 $5,931,101,344 Inventories (Note 5) $2,380,900,000 $2,346,200,000 $2,465,000,000 $2,784,000,000 $2,862,000,000 $2,955,456,375 $3,140,172,398 $3,336,433,173 $3,544,960,247 $3,766,520,262 $4,001,927,778 $4,252,048,265 $4,517,801,281 $4,800,163,861 $5,100,174,103 Prepaid expenses and other current Assets $448,600,000 $453,700,000 $336,700,000 $272,000,000 $251,000,000 $265,659,000 $282,262,688 $299,904,105 $318,648,112 $338,563,619 $359,723,845 $382,206,586 $406,094,497 $431,475,403 $458,442,616 Total Current Assets $5,264,200,000 $5,180,400,000 $6,988,100,000 $8,574,000,000 $8,680,000,000 $9,032,406,000 $9,596,931,375 $10,196,739,586 $10,834,035,810 $11,511,163,048 $12,230,610,739 $12,995,023,910 $13,807,212,904 $14,670,163,711 $15,587,048,943Long Term Accounts and Notes Receivable $132,300,000 $242,800,000 $255,000,000Investments in Affiliates $101,200,000 $139,200,000 $177,500,000Goodwill and Other Intangible Assets (Note 6) $706,300,000 $764,000,000 $784,300,000 $886,000,000 $796,000,000 $879,995,438 $934,995,152 $993,432,349 $1,055,521,871 $1,121,491,988 $1,191,585,237 $1,266,059,315 $1,345,188,022 $1,429,262,273 $1,518,591,165Deferred Income Tax $924,700,000 $187,000,000 $397,500,000 $83,000,000 $102,000,000 $99,622,125 $105,848,508 $112,464,040 $119,493,042 $126,961,357 $134,896,442 $143,327,470 $152,285,436 $161,803,276 $171,915,981Prepaid and Deferred Pension Costs and other Assets $1,273,400,000 $1,166,400,000 $943,200,000 $1,105,000,000 $870,000,000 $1,029,428,625 $1,093,767,914 $1,162,128,409 $1,234,761,434 $1,311,934,024 $1,393,929,900 $1,481,050,519 $1,573,616,177 $1,671,967,188 $1,776,465,137Deferred Charges $215,300,000 $202,700,000 $252,700,000Properties and Plants (Note $5,166,000,000 $5,156,200,000 $5,207,200,000 $5,453,000,000 $5,179,000,000 $5,562,235,313 $5,909,875,020 $6,279,242,208 $6,671,694,846 $7,088,675,774 $7,531,718,010 $8,002,450,386 $8,502,603,535 $9,034,016,256 $9,598,642,272 Total Assets $13,783,400,000 $13,038,700,000 $15,005,500,000 $16,101,000,000 $15,627,000,000 $16,603,687,500 $17,641,417,969 $18,744,006,592 $19,915,507,004 $21,160,226,192 $22,482,740,328 $23,887,911,599 $25,380,906,074 $26,967,212,704 $28,652,663,498
LiabilitiesCurrent Liabilities: Accounts payable-trade $1,359,200,000 $1,515,400,000 $1,572,900,000 $1,970,000,000 $1,945,000,000 $2,049,239,500 $2,177,316,969 $2,313,399,279 $2,457,986,734 $2,611,610,905 $2,774,836,587 $2,948,263,873 $3,132,530,365 $3,328,313,513 $3,536,333,108 Compensation and benefits $897,200,000 $913,600,000 $983,100,000 $1,029,000,000 $1,121,000,000 $1,123,776,500 $1,194,012,531 $1,268,638,314 $1,347,928,209 $1,432,173,722 $1,521,684,580 $1,616,789,866 $1,717,839,233 $1,825,204,185 $1,939,279,446 Other current liabilities $479,600,000 $512,300,000 $572,200,000 $718,000,000 $671,000,000 $727,149,500 $772,596,344 $820,883,615 $872,188,841 $926,700,644 $984,619,434 $1,046,158,149 $1,111,543,033 $1,181,014,472 $1,254,827,877 United States and foreign taxes $347,700,000 $358,200,000 $306,100,000 $245,000,000 $393,000,000 $330,522,500 $351,180,156 $373,128,916 $396,449,473 $421,227,565 $447,554,288 $475,526,431 $505,246,833 $536,824,760 $570,376,308 Notes payable (Note 10) $255,000,000 $283,400,000 $137,700,000 $227,000,000 $233,000,000 $247,891,875 $263,385,117 $279,846,687 $297,337,105 $315,920,674 $335,665,716 $356,644,823 $378,935,125 $402,618,570 $427,782,231 Long term debt due within one year $109,700,000 $369,800,000 $113,500,000 Long term debt and capital leases due within one year $1,010,000,000 $448,000,000 $760,201,750 $807,714,359 $858,196,507 $911,833,789 $968,823,400 $1,029,374,863 $1,093,710,792 $1,162,067,716 $1,234,696,948 $1,311,865,508 Total Current Liabilities $3,448,400,000 $3,952,700,000 $3,685,500,000 $5,199,000,000 $4,811,000,000 $5,238,781,625 $5,566,205,477 $5,914,093,319 $6,283,724,151 $6,676,456,911 $7,093,735,468 $7,537,093,934 $8,008,162,305 $8,508,672,449 $9,040,464,477Long Term Debt and Capital Leases $3,203,600,000 $2,989,800,000 $4,826,200,000 $4,443,000,000 $4,742,000,000 $4,809,102,375 $5,109,671,273 $5,429,025,728 $5,768,339,836 $6,128,861,076 $6,511,914,893 $6,918,909,574 $7,351,341,422 $7,810,800,261 $8,298,975,277Compensation and Benefits $2,848,900,000 $4,497,300,000 $4,540,400,000 $4,645,000,000 $4,480,000,000 $4,776,050,125 $5,074,553,258 $5,391,712,836 $5,728,694,889 $6,086,738,319 $6,467,159,464 $6,871,356,931 $7,300,816,739 $7,757,117,785 $8,241,937,647Deferred and Other Noncurrent Income Taxes $402,000,000 $304,000,000 $363,574,750 $386,298,172 $410,441,808 $436,094,421 $463,350,322 $492,309,717 $523,079,074 $555,771,516 $590,507,236 $627,413,938Other Long Term Liabilities $630,900,000 $615,700,000 $1,140,800,000 $495,000,000 $426,000,000 $479,257,625 $509,211,227 $541,036,928 $574,851,736 $610,779,970 $648,953,718 $689,513,325 $732,607,908 $778,395,902 $827,045,646Minority Equity in Subsidiaries $787,600,000 $727,800,000 $825,700,000 $843,000,000 $791,000,000 $859,358,500 $913,068,406 $970,135,182 $1,030,768,630 $1,095,191,670 $1,163,641,149 $1,236,368,721 $1,313,641,766 $1,395,744,377 $1,482,978,400 Total Liabilities $10,919,400,000 $12,783,300,000 $15,018,600,000 $16,027,000,000 $15,554,000,000 $16,526,125,000 $17,559,007,813 $18,656,445,801 $19,822,473,663 $21,061,378,267 $22,377,714,409 $23,776,321,560 $25,262,341,657 $26,841,238,011 $28,518,815,386
Commitments and Contingent LiabilitiesShareholders' EquityPreferred Stock $0 $0 $0 $0 $0Common Stock $163,200,000 $175,300,000 $175,300,000 $176,000,000 $177,000,000 $178,008,900 $179,023,551 $180,043,985 $181,070,236 $182,102,336 $183,140,319 $184,184,219 $185,234,069 $186,289,903 $187,351,756Capital Surplus $1,245,400,000 $1,390,100,000 $1,390,200,000 $1,392,000,000 $1,398,000,000 $1,404,011,400 $1,410,048,649 $1,416,111,858 $1,422,201,139 $1,428,316,604 $1,434,458,365 $1,440,626,536 $1,446,821,231 $1,453,042,562 $1,459,290,645Retained Earnings $3,192,700,000 $1,782,500,000 $980,400,000 $1,070,000,000 $1,298,000,000 $1,256,512,500 $1,335,044,531 $1,418,484,814 $1,507,140,115 $1,601,336,373 $1,701,419,896 $1,807,758,639 $1,920,743,554 $2,040,790,026 $2,168,339,403Accumulated Other Comprehensive Income ($1,737,300,000) ($3,092,500,000) ($2,559,000,000) ($2,564,000,000) ($2,800,000,000) (2,760,970,300) (2,841,706,575) (2,927,079,867) (3,017,378,150) (3,112,907,388) (3,213,992,661) (3,320,979,356) (3,434,234,437) (3,554,147,799) (3,681,133,693) Total Shareholders Equity $2,864,000,000 $255,400,000 ($13,100,000) $74,000,000 $73,000,000 $77,562,500 $82,410,156 $87,560,791 $93,033,340 $98,847,924 $105,025,919 $111,590,039 $118,564,417 $125,974,693 $133,848,111 Total Liabilities and Shareholders Equity $13,783,400,000 $13,038,700,000 $15,005,500,000 $16,101,000,000 $15,627,000,000 $16,603,687,500 $17,641,417,969 $18,744,006,592 $19,915,507,004 $21,160,226,192 $22,482,740,328 $23,887,911,599 $25,380,906,074 $26,967,212,704 $28,652,663,498
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II. ProForma Balance Sheet
Actual Financial Statements Forecast Financial Statements2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
2001/12/31 2002/12/31 2003/12/31 2004/12/31 2005/12/31AssetsCurrent Assets: Cash and cash equivalents 6.96% 7.04% 10.43% 12.22% 13.94% 12.70% 12.70% 12.70% 12.70% 12.70% 12.70% 12.70% 12.70% 12.70% 12.70% Short term securities 0.00% 0.19% 0.00% Restricted cash 0.94% 1.48% 1.60% 1.60% 1.60% 1.60% 1.60% 1.60% 1.60% 1.60% 1.60% 1.60% Accounts and notes receivable (Note 5) 10.70% 11.03% 17.47% 21.10% 20.21% 20.70% 20.70% 20.70% 20.70% 20.70% 20.70% 20.70% 20.70% 20.70% 20.70% Inventories (Note 5) 17.27% 17.99% 16.43% 17.29% 18.31% 17.80% 17.80% 17.80% 17.80% 17.80% 17.80% 17.80% 17.80% 17.80% 17.80% Prepaid expenses and other current Assets 3.25% 3.48% 2.24% 1.69% 1.61% 1.60% 1.60% 1.60% 1.60% 1.60% 1.60% 1.60% 1.60% 1.60% 1.60% Total Current Assets 38.19% 39.73% 46.57% 53.25% 55.54% 54.40% 54.40% 54.40% 54.40% 54.40% 54.40% 54.40% 54.40% 54.40% 54.40%Long Term Accounts and Notes Receivable 0.96% 1.86% 1.70%Investments in Affiliates 0.73% 1.07% 1.18%Goodwill and Other Intangible Assets (Note 6) 5.12% 5.86% 5.23% 5.50% 5.09% 5.30% 5.30% 5.30% 5.30% 5.30% 5.30% 5.30% 5.30% 5.30% 5.30%Deferred Income Tax 6.71% 1.43% 2.65% 0.52% 0.65% 0.60% 0.60% 0.60% 0.60% 0.60% 0.60% 0.60% 0.60% 0.60% 0.60%Prepaid and Deferred Pension Costs and other Assets 9.24% 8.95% 6.29% 6.86% 5.57% 6.20% 6.20% 6.20% 6.20% 6.20% 6.20% 6.20% 6.20% 6.20% 6.20%Deferred Charges 1.56% 1.55% 1.68%Properties and Plants (Note 37.48% 39.55% 34.70% 33.87% 33.14% 33.50% 33.50% 33.50% 33.50% 33.50% 33.50% 33.50% 33.50% 33.50% 33.50% Total Assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
LiabilitiesCurrent Liabilities: Accounts payable-trade 12.45% 11.85% 10.47% 12.29% 12.50% 12.40% 12.40% 12.40% 12.40% 12.40% 12.40% 12.40% 12.40% 12.40% 12.40% Compensation and benefits 8.22% 7.15% 6.55% 6.42% 7.21% 6.80% 6.80% 6.80% 6.80% 6.80% 6.80% 6.80% 6.80% 6.80% 6.80% Other current liabilities 4.39% 4.01% 3.81% 4.48% 4.31% 4.40% 4.40% 4.40% 4.40% 4.40% 4.40% 4.40% 4.40% 4.40% 4.40% United States and foreign taxes 3.18% 2.80% 2.04% 1.53% 2.53% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% 2.00% Notes payable (Note 10) 2.34% 2.22% 0.92% 1.42% 1.50% 1.50% 1.50% 1.50% 1.50% 1.50% 1.50% 1.50% 1.50% 1.50% 1.50% Long term debt due within one year 1.00% 2.89% 0.76% Long term debt and capital leases due within one year 6.30% 2.88% 4.60% 4.60% 4.60% 4.60% 4.60% 4.60% 4.60% 4.60% 4.60% 4.60% Total Current Liabilities 31.58% 30.92% 24.54% 32.44% 30.93% 31.70% 31.70% 31.70% 31.70% 31.70% 31.70% 31.70% 31.70% 31.70% 31.70%Long Term Debt and Capital Leases 29.34% 23.39% 32.13% 27.72% 30.49% 29.10% 29.10% 29.10% 29.10% 29.10% 29.10% 29.10% 29.10% 29.10% 29.10%Compensation and Benefits 26.09% 35.18% 30.23% 28.98% 28.80% 28.90% 28.90% 28.90% 28.90% 28.90% 28.90% 28.90% 28.90% 28.90% 28.90%Deferred and Other Noncurrent Income Taxes (Note 2.51% 1.95% 2.20% 2.20% 2.20% 2.20% 2.20% 2.20% 2.20% 2.20% 2.20% 2.20%Other Long Term Liabilities 5.78% 4.82% 7.60% 3.09% 2.74% 2.90% 2.90% 2.90% 2.90% 2.90% 2.90% 2.90% 2.90% 2.90% 2.90%Minority Equity in Subsidiaries 7.21% 5.69% 5.50% 5.26% 5.09% 5.20% 5.20% 5.20% 5.20% 5.20% 5.20% 5.20% 5.20% 5.20% 5.20% Total Liabilities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Shareholders' EquityPreferred Stock 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Common Stock 5.70% 68.64% -1338.17% 237.84% 242.47% 229.50% 217.23% 205.62% 194.63% 184.22% 174.38% 165.05% 156.23% 147.88% 139.97%Capital Surplus 43.48% 544.28% -10612.21% 1881.08% 1915.07% 1810.17% 1711.01% 1617.29% 1528.70% 1444.96% 1365.81% 1291.00% 1220.28% 1153.44% 1090.26%Retained Earnings 111.48% 697.92% -7483.97% 1445.95% 1778.08% 1620.00% 1620.00% 1620.00% 1620.00% 1620.00% 1620.00% 1620.00% 1620.00% 1620.00% 1620.00%Accumulated Other Comprehensive Income -60.66% -1210.85% 19534.35% -3464.86% -3835.62% -3782.15% -3892.75% -4009.70% -4133.39% -4264.26% -4402.73% -4549.29% -4704.43% -4868.70% -5042.65% Total Shareholders Equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
62
III. Income Statement
Actual Financial Statements Forecast Financial Statements2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
2001/12/31 2002/12/31 2003/12/31 2004/12/31 2005/12/31Net Sales $14,147,200,000 $13,850,000,000 $15,102,000,000 $18,353,000,000 $19,723,000,000 $21,202,225,000 $22,792,391,875 $24,501,821,266 $26,339,457,861 $28,314,917,200 $30,438,535,990 $32,721,426,189 $35,175,533,154 $37,813,698,140 $40,649,725,501Cost of Goods Sold $11,619,500,000 $11,313,900,000 $12,481,000,000 $14,691,000,000 $15,772,000,000 $16,961,780,000 $18,233,913,500 $19,601,457,013 $21,071,566,288 $22,651,933,760 $24,350,828,792 $26,177,140,951 $28,140,426,523 $30,250,958,512 $32,519,780,400Gross Profit $2,527,700,000 $2,536,100,000 $2,621,000,000 $3,662,000,000 $3,951,000,000 $4,240,445,000 $4,558,478,375 $4,900,364,253 $5,267,891,572 $5,662,983,440 $6,087,707,198 $6,544,285,238 $7,035,106,631 $7,562,739,628 $8,129,945,100Selling, Administrative and General Expense $2,248,800,000 $2,223,900,000 $2,374,000,000 $2,833,000,000 $2,875,000,000 $3,180,333,750 $3,418,858,781 $3,675,273,190 $3,950,918,679 $4,247,237,580 $4,565,780,399 $4,908,213,928 $5,276,329,973 $5,672,054,721 $6,097,458,825Interest Expense (Note 14) $292,400,000 $241,300,000 $296,000,000 $369,000,000 $411,000,000 $434,645,613 $467,244,033 $502,287,336 $539,958,886 $580,455,803 $623,989,988 $670,789,237 $721,098,430 $775,180,812 $833,319,373Other (Income) and Expense (Note 3) $11,800,000 $25,800,000 $317,000,000 $23,000,000 $70,000,000 $74,207,788 $79,773,372 $85,756,374 $92,188,103 $99,102,210 $106,534,876 $114,524,992 $123,114,366 $132,347,943 $142,274,039Foreign Currency Exchange $100,000 ($10,200,000)Equity in (Earnings) Losses of affiliates $40,600,000 $8,800,000Minority Interest in Net Income of Subsidiaries $200,000 $55,800,000 $33,000,000 $58,000,000 $95,000,000 $84,808,900 $91,169,568 $98,007,285 $105,357,831 $113,259,669 $121,754,144 $130,885,705 $140,702,133 $151,254,793 $162,598,902
Income (Loss) before Income Taxes and cumulative effect of acct. change ($273,000,000) ($17,900,000) ($690,000,000) $323,000,000 $489,000,000 $466,448,950 $501,432,621 $539,040,068 $579,468,073 $622,928,178 $669,647,792 $719,871,376 $773,861,729 $831,901,359 $894,293,961United States and Foreign Taxes on Income Loss Note 13 ($69,400,000) $1,087,900,000 $117,000,000 $208,000,000 $250,000,000 $177,250,601 $190,544,396 $204,835,226 $220,197,868 $236,712,708 $254,466,161 $273,551,123 $294,067,457 $316,122,516 $339,831,705Income (Loss) before Cumulative Effect of acct change ($807,000,000) $115,000,000 $239,000,000Cumulative Effect of Accounting Change, net of $0 $0 ($11,000,000)income taxes and minority interest (Note 19)Net Income (Loss) ($203,600,000) ($1,105,800,000) ($807,000,000) $115,000,000 $228,000,000 $289,198,349 $310,888,225 $334,204,842 $359,270,205 $386,215,471 $415,181,631 $446,320,253 $479,794,272 $515,778,843 $554,462,256
IV. ProForma Income Statement
63
Actual Financial Statements Forecast Financial Statements2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
2001/12/31 2002/12/31 2003/12/31 2004/12/31 2005/12/31Net Sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%Cost of Goods Sold 82.13% 81.69% 82.64% 80.05% 79.97% 80.00% 80.00% 80.00% 80.00% 80.00% 80.00% 80.00% 80.00% 80.00% 80.00%Gross Profit 17.87% 18.31% 17.36% 19.95% 20.03% 20.00% 20.00% 20.00% 20.00% 20.00% 20.00% 20.00% 20.00% 20.00% 20.00%Selling, Administrative and General Expense 15.90% 16.06% 15.72% 15.44% 14.58% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00% 15.00%Interest Expense (Note 14) 2.07% 1.74% 1.96% 2.01% 2.08% 2.05% 2.05% 2.05% 2.05% 2.05% 2.05% 2.05% 2.05% 2.05% 2.05%Other (Income) and Expense (Note 3) 0.08% 0.19% 2.10% 0.13% 0.35% 0.35% 0.35% 0.35% 0.35% 0.35% 0.35% 0.35% 0.35% 0.35% 0.35%Foreign Currency Exchange 0.00% 0.00%Equity in (Earnings) Losses of affiliates 0.00% 0.00%Minority Interest in Net Income of Subsidiaries 0.00% 0.40% 0.22% 0.32% 0.48% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40% 0.40%
Income (Loss) before Income Taxes and cumulative effect of acct. change -1.93% -0.13% -4.57% 1.76% 2.48% 2.20% 2.20% 2.20% 2.20% 2.20% 2.20% 2.20% 2.20% 2.20% 2.20%United States and Foreign Taxes on Income Loss Note 13 -0.49% 7.85% 0.77% 1.13% 1.27% 0.84% 0.84% 0.84% 0.84% 0.84% 0.84% 0.84% 0.84% 0.84% 0.84%Income (Loss) before Cumulative Effect of acct change -5.34% 0.63% 1.21%Cumulative Effect of Accounting Change, net of 0.00% 0.00% 0.00%income taxes and minority interest (Note 19)Net Income (Loss) -1.44% -7.98% -5.34% 0.63% 1.16% 1.36% 1.36% 1.36% 1.36% 1.36% 1.36% 1.36% 1.36% 1.36% 1.36%
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V. Cash Flow Statement
Actual Financial Statements Forecast Financial Statements2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Cash Flows from Operating Activities:Net Income (Loss) ($203,600,000) ($1,105,800,000) ($807,000,000) $115,000,000 $228,000,000 $289,198,349 $310,888,225 $334,204,842 $359,270,205 $386,215,471 $415,181,631 $446,320,253 $479,794,272 $515,778,843 $554,462,256
Adjustments to reconcile net income (loss) to cash flows from operating activities:
Depreciation and amortization $636,700,000 $602,800,000 $692,000,000 $629,000,000 $630,000,000 $631,008,000 $632,017,613 $633,028,841 $634,041,687 $635,056,154 $636,072,244 $637,089,959 $638,109,303 $639,130,278 $640,152,887 Amortization of debt issuance costs $62,000,000 $74,000,000 $76,000,000 $78,280,000 $80,628,400 $83,047,252 $85,538,670 $88,104,830 $90,747,975 $93,470,414 $96,274,526 $99,162,762 $102,137,645 Deferred tax provision (Note 13) ($252,000,000) $987,900,000 ($10,000,000) ($4,000,000) ($19,000,000) ($24,700,000) ($32,110,000) ($41,743,000) ($54,265,900) ($70,545,670) ($91,709,371) ($119,222,182) ($154,988,837) ($201,485,488) ($261,931,135) Net rationalization charges (Note 2) $158,300,000 $8,800,000 $267,000,000 $48,000,000 $5,000,000 Rationalization payments ($93,000,000) ($97,000,000) ($43,000,000) Net loss on asset sales (Note 3) ($30,800,000) ($22,000,000) $16,000,000 $8,000,000 $38,000,000 $45,328,450 $34,787,100 $38,265,600 $42,092,400 $46,301,400 $50,931,600 $56,024,700 $61,627,200 $67,790,100 $74,569,200 Net insurance settlement gains (Note 3) ($149,000,000) ($79,000,000) ($37,130,000) ($17,451,100) ($8,202,017) ($3,854,948) ($1,811,826) ($851,558) ($400,232) ($188,109) ($88,411) ($41,553) Insurance recoveries $20,000,000 $175,000,000 $228,000,000 $252,996,000 $278,296,800 $306,124,800 $336,739,200 $370,411,200 $407,452,800 $448,197,600 $493,017,600 $542,320,800 $596,553,600 Minority interest and equity earnings $54,000,000 $59,000,000 $91,000,000 Cumulative effect of accounting change $11,000,000 Proceeds from sales of accounts receivable (Note 4) $249,100,000 $34,800,000 ($840,000,000) ($118,000,000) $2,000,000 $78,007,100 $85,808,180 $94,388,480 $103,827,920 $114,210,120 $125,631,280 $138,194,260 $152,013,760 $167,215,580 $183,937,360 Pension contributions ($116,000,000) ($265,000,000) ($526,000,000) ($495,450,500) ($544,997,900) ($599,494,400) ($659,447,600) ($725,388,600) ($797,928,400) ($877,720,300) ($965,492,800) ($1,062,044,900) ($1,168,250,800)
Changes in operating assets and liabilities, net of asset acquisitions and dispositions:
Accounts and notes receivable $226,100,000 $60,200,000 ($9,000,000) ($277,000,000) ($16,000,000) $189,747,000 $208,722,600 $229,593,600 $252,554,400 $277,808,400 $305,589,600 $336,148,200 $369,763,200 $406,740,600 $447,415,200 Inventories $407,800,000 $84,900,000 $39,000,000 ($50,000,000) ($253,000,000) ($184,476,250) ($202,924,750) ($223,216,000) ($245,539,000) ($270,091,500) ($297,101,000) ($326,810,750) ($359,492,000) ($395,442,250) ($434,987,000) Accounts payable-trade ($77,900,000) $98,300,000 ($104,000,000) $153,000,000 $44,000,000 Compensation and benefits $387,000,000 $474,000,000 $439,000,000 $579,782,500 $637,763,500 $701,536,000 $771,694,000 $848,859,000 $933,746,000 $1,027,119,500 $1,129,832,000 $1,242,818,500 $1,367,102,000 Other current liabilities $70,000,000 $145,000,000 ($62,000,000) Other long term liabilities $115,000,000 ($149,000,000) ($34,000,000) Other assets and liabilities $119,600,000 ($73,500,000) ($12,000,000) $14,000,000 $125,000,000 $84,332,000 $92,765,600 $102,041,600 $112,246,400 $123,470,400 $135,817,600 $149,399,200 $164,339,200 $180,773,600 $198,851,200Total cash flows from operating activities $1,313,300,000 $676,400,000 ($269,000,000) $785,000,000 $885,000,000 1054150000.00 1159570000.00 1275520000.00 1403080000.00 1543380000.00 1697720000.00 1867490000.00 2054240000.00 2259670000.00 2485640000.00Total cash flows from investing activities -470400000 -542400000 ($290,000,000) ($651,000,000) ($440,000,000) (698380000.00) (768210000.00) (845030000.00) (929540000.00) (1022490000.00) (1124740000.00) (1237220000.00) (1360940000.00) (1497030000.00) (1646730000.00)Free cash flows to the firm $842,900,000 $134,000,000 ($559,000,000) $134,000,000 $445,000,000 $355,770,000 $391,360,000 $430,490,000 $473,540,000 $520,890,000 $572,980,000 $630,270,000 $693,300,000 $762,640,000 $838,910,000
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VI. ProForma Cash Flow Statement
Actual Financial Statements Forecast Financial Statements2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
2001/12/31 2002/12/31 2003/12/31 2004/12/31 2005/12/31Cash Flows from Operating Activities: Net Income (Loss) -15.50% -163.48% 300.00% 14.65% 25.76% 27.43% 26.81% 26.20% 25.61% 25.02% 24.46% 23.90% 23.36% 22.83% 22.31%
Adjustments to reconcile net income (loss) to cash flows from operating activities: 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Depreciation and amortization 48.48% 89.12% -257.25% 80.13% 71.19% 59.86% 54.50% 49.63% 45.19% 41.15% 37.47% 34.11% 31.06% 28.28% 25.75% Amortization of debt issuance costs 0.00% 0.00% -23.05% 9.43% 8.59% 7.43% 6.95% 6.51% 6.10% 5.71% 5.35% 5.01% 4.69% 4.39% 4.11% Deferred tax provision (Note 13) -19.19% 146.05% 3.72% -0.51% -2.15% -2.34% -2.77% -3.27% -3.87% -4.57% -5.40% -6.38% -7.54% -8.92% -10.54% Net rationalization charges (Note 2) 12.05% 1.30% -99.26% 6.11% 0.56% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Rationalization payments 0.00% 0.00% 34.57% -12.36% -4.86% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Net loss on asset sales (Note 3) -2.35% -3.25% -5.95% 1.02% 4.29% 4.30% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% Net insurance settlement gains (Note 3) 0.00% 0.00% 0.00% -18.98% -8.93% -3.52% -1.50% -0.64% -0.27% -0.12% -0.05% -0.02% -0.01% 0.00% 0.00% Insurance recoveries 0.00% 0.00% -7.43% 22.29% 25.76% 24.00% 24.00% 24.00% 24.00% 24.00% 24.00% 24.00% 24.00% 24.00% 24.00% Minority interest and equity earnings 0.00% 0.00% -20.07% 7.52% 10.28% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Cumulative effect of accounting change 0.00% 0.00% 0.00% 0.00% 1.24% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Proceeds from sales of accounts receivable (Note 4) 18.97% 5.14% 312.27% -15.03% 0.23% 7.40% 7.40% 7.40% 7.40% 7.40% 7.40% 7.40% 7.40% 7.40% 7.40% Pension contributions 0.00% 0.00% 43.12% -33.76% -59.44% -47.00% -47.00% -47.00% -47.00% -47.00% -47.00% -47.00% -47.00% -47.00% -47.00%
Changes in operating assets and liabilities, net of asset acquisitions and dispositions: 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Accounts and notes receivable 17.22% 8.90% 3.35% -35.29% -1.81% 18.00% 18.00% 18.00% 18.00% 18.00% 18.00% 18.00% 18.00% 18.00% 18.00% Inventories 31.05% 12.55% -14.50% -6.37% -28.59% -17.50% -17.50% -17.50% -17.50% -17.50% -17.50% -17.50% -17.50% -17.50% -17.50% Accounts payable-trade -5.93% 14.53% 38.66% 19.49% 4.97% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Compensation and benefits 0.00% 0.00% -143.87% 60.38% 49.60% 55.00% 55.00% 55.00% 55.00% 55.00% 55.00% 55.00% 55.00% 55.00% 55.00% Other current liabilities 0.00% 0.00% -26.02% 18.47% -7.01% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Other long term liabilities 0.00% 0.00% -42.75% -18.98% -3.84% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Other assets and liabilities 9.11% -10.87% 4.46% 1.78% 14.12% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% Total cash flows from operating activities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
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APPENDIX C- Cost of Capital
I. Capital Asset Pricing Model Data
Date Close dividendFirm's
Returns CloseS&P
Returnsmkt
premium Riskfree annualMonthly Risk Free
3-Oct-05 15.77 N/A 15.77 -0.055689 1226.7 0.00418307 0.0011 10/1/2005 3.7 0.00308 1-Apr-03 5.17 N/A 5.17 0.2671569 858.48 0.02835376 0.0274 4/1/2003 1.14 0.000951-Sep-05 16.7 N/A 16.7 -0.038018 1221.59 -0.01113854 -0.0140 9/1/2005 3.47 0.00289 3-Mar-03 4.08 N/A 4.08 -0.210832 834.81 -0.02965176 -0.0306 3/1/2003 1.13 0.000941-Aug-05 17.36 N/A 17.36 0.1481481 1235.35 0.03425036 0.0314 8/1/2005 3.45 0.00288 3-Feb-03 5.17 N/A 5.17 -0.263533 860.32 -0.05358459 -0.0546 2/1/2003 1.16 0.000971-Jul-05 15.12 N/A 15.12 0.0492713 1194.44 -0.00647136 -0.0091 7/1/2005 3.19 0.00266 2-Jan-03 7.02 N/A 7.02 -0.143902 909.03 -0.02728644 -0.0283 1/1/2003 1.2 0.00100
1-Jun-05 14.41 N/A 14.41 0.1840592 1202.22 0.0344703 0.0320 6/1/2005 2.97 0.00248 2-Dec-02 8.2 N/A 8.2 0.2041116 934.53 0.03726026 0.0363 12/1/2002 1.2 0.001002-May-05 12.17 N/A 12.17 -0.068147 1162.16 -0.00917369 -0.0116 5/1/2005 2.86 0.00238 1-Nov-02 6.81 N/A 6.81 -0.270878 900.96 0.0625656 0.0615 11/1/2002 1.31 0.001091-Apr-05 13.06 N/A 13.06 -0.102405 1172.92 -0.03097298 -0.0333 4/1/2005 2.78 0.00232 1-Oct-02 9.34 N/A 9.34 -0.259318 847.91 -0.03429307 -0.0356 10/1/2002 1.61 0.001341-Mar-05 14.55 N/A 14.55 -0.088346 1210.41 0.01765581 0.0154 3/1/2005 2.74 0.00228 3-Sep-02 12.61 N/A 12.61 -0.275287 878.02 -0.00750571 -0.0089 9/1/2002 1.63 0.001361-Feb-05 15.96 N/A 15.96 0.0711409 1189.41 -0.01054006 -0.0126 2/1/2005 2.53 0.00211 1-Aug-02 17.4 N/A 17.4 -0.04185 884.66 -0.08670831 -0.0881 8/1/2002 1.63 0.001363-Jan-05 14.9 N/A 14.9 0.1686275 1202.08 0.00898965 0.0071 1/1/2005 2.32 0.00193 1-Jul-02 18.16 N/A 18.16 -0.149016 968.65 -0.06921436 -0.0706 7/1/2002 1.68 0.001401-Dec-04 12.75 N/A 12.75 0.264881 1191.37 0.05383411 0.0520 12/1/2004 2.2 0.00183 3-Jun-02 21.34 N/A 21.34 -0.043478 1040.68 -0.04213685 -0.0436 6/1/2002 1.71 0.001431-Nov-04 10.08 N/A 10.08 -0.071823 1130.51 -0.00087494 -0.0026 11/1/2004 2.08 0.00173 1-May-02 22.31 N/A 22.31 -0.05865 1086.46 -0.05240114 -0.0539 5/1/2002 1.74 0.001451-Oct-04 10.86 N/A 10.86 -0.049037 1131.5 0.02313932 0.0217 10/1/2004 1.74 0.00145 1-Apr-02 23.7 N/A 23.7 -0.121897 1146.54 0.0130414 0.0116 4/1/2002 1.72 0.001431-Sep-04 11.42 N/A 11.42 0.0070547 1105.91 -0.00064159 -0.0020 9/1/2004 1.64 0.00137 1-Mar-02 26.99 N/A 26.99 0.1392993 1131.78 0.0085368 0.0070 3/1/2002 1.8 0.001502-Aug-04 11.34 N/A 11.34 0.2299349 1106.62 -0.01977076 -0.0210 8/1/2004 1.48 0.00123 1-Feb-02 23.69 N/A 23.69 -0.010443 1122.2 -0.02812059 -0.0296 2/1/2002 1.73 0.001441-Jul-04 9.22 N/A 9.22 0.0477273 1128.94 0.00690332 0.0058 7/1/2004 1.36 0.00113 2-Jan-02 23.94 N/A 23.94 0.0837483 1154.67 0.02192229 0.0206 1/1/2002 1.64 0.00137
1-Jun-04 8.8 N/A 8.8 0.0138249 1121.2 0.00331994 0.0023 6/1/2004 1.27 0.00106 3-Dec-01 22.09 N/A 22.09 -0.077277 1129.9 0.04224703 0.0408 12/1/2001 1.72 0.001433-May-04 8.68 N/A 8.68 -0.023622 1117.49 -0.01296625 -0.0138 5/1/2004 1.04 0.00087 1-Nov-01 23.94 N/A 23.94 0.0837483 1084.1 0.04385923 0.0423 11/1/2001 1.93 0.001611-Apr-04 8.89 N/A 8.89 0.0458824 1132.17 -0.02058877 -0.0214 4/1/2004 0.94 0.00078 1-Oct-01 22.09 N/A 22.09 0.1632438 1038.55 -0.08331421 -0.0852 10/1/2001 2.22 0.001851-Mar-04 8.5 N/A 8.5 -0.10808 1155.97 0.01824252 0.0175 3/1/2004 0.94 0.00078 4-Sep-01 18.99 N/A 18.99 0.0638655 1132.94 -0.06825228 -0.0706 9/1/2001 2.87 0.002392-Feb-04 9.53 N/A 9.53 0.2124682 1135.26 0.02415921 0.0234 2/1/2004 0.92 0.00077 1-Aug-01 17.85 N/A 17.85 -0.284282 1215.93 -0.0168106 -0.0196 8/1/2001 3.39 0.002832-Jan-04 7.86 N/A 7.86 0.154185 1108.48 0.03584645 0.0351 1/1/2004 0.89 0.00074 2-Jul-01 24.94 N/A 24.94 -0.121831 1236.72 -0.01899783 -0.0219 7/1/2001 3.54 0.002951-Dec-03 6.81 N/A 6.81 -0.027143 1070.12 0.01048139 0.0097 12/1/2003 0.9 0.00075 1-Jun-01 28.4 N/A 28.4 -0.008726 1260.67 -0.00455608 -0.0075 6/1/2001 3.51 0.002933-Nov-03 7 N/A 7 0.0670732 1059.02 0.04006993 0.0393 11/1/2003 0.94 0.00078 1-May-01 28.65 N/A 28.65 -0.048173 1266.44 0.10522136 0.1022 5/1/2001 3.68 0.003071-Oct-03 6.56 N/A 6.56 -0.143603 1018.22 -0.00368888 -0.0045 10/1/2003 0.93 0.00078 2-Apr-01 30.1 N/A 30.1 0.2176375 1145.87 -0.07682702 -0.0801 4/1/2001 3.92 0.003272-Sep-03 7.66 N/A 7.66 0.3533569 1021.99 0.04268734 0.0419 9/1/2003 0.95 0.00079 1-Mar-01 24.72 N/A 24.72 0.0321503 1241.23 -0.09628168 -0.1000 3/1/2001 4.5 0.003751-Aug-03 5.66 N/A 5.66 0.0679245 980.15 -0.00220906 -0.0030 8/1/2003 0.95 0.00079 1-Feb-01 23.95 N/A 23.95 -0.04008 1373.47 0.07028918 0.0662 2/1/2001 4.93 0.004111-Jul-03 5.3 N/A 5.3 -0.199396 982.32 0.01584281 0.0151 7/1/2003 0.89 0.00074 2-Jan-01 24.95 N/A 24.95 -0.038906 1283.27 -0.02429993 -0.0286 1/1/2001 5.21 0.00434
2-Jun-03 6.62 N/A 6.62 0.0729335 967 0.05533122 0.0545 6/1/2003 0.95 0.00079 1-Dec-00 25.96 N/A 25.96 0.1426056 1315.23 -0.07457677 -0.0795 12/1/2000 5.9 0.004921-May-03 6.17 N/A 6.17 0.1934236 916.3 0.0673516 0.0665 5/1/2003 1.08 0.00090 1-Nov-00 22.72 N/A 22.72 0.30126 1421.22 -0.01045097 -0.0156 11/1/2000 6.19 0.00516
2-Oct-00 17.46 N/A 17.46 #DIV/0! 1436.23 #DIV/0! #DIV/0! 10/1/2000 6.1 0.00508
http://finance.yahoo.com/
Rhpq=Rf+β(Rm-Rf)
67
II. Capital Asset Pricing Model Series
Y ahoo F in an ce 1 .6 0 .1 6 9Y ea rs C o s t o f E qu ity R f
1 0 Y r 0 .1 6 9 5 .6 9 %5 Y r 0 .1 7 1 5 .8 5 %1 Y r 0 .1 7 2 6 .0 0 %3 M o . 0 .0 1 6 9 5 .7 4 %
1 0 -Y ea r C on s ta n t M a tu r ity R isk F ree R a teM on th s B e ta R ^ 2 K e
6 0 0 .6 2 2 0 .0 1 2 0 .14 8 1 .6 3 5 0 .1 2 9 0 .1 7 1
3 6 2 .8 3 8 0 .2 4 1 0 .2 5 62 4 2 .4 4 2 0 .1 7 1 0 .2 2 8
5 -Y ea r C on s tan t M a tu r ity R isk F ree R a te
M on th s B e ta R ^ 2 K e6 0 0 .6 2 2 0 .0 1 2 0 .1 0 24 8 1 .6 3 5 0 .1 2 9 0 .1 7 3
3 6 2 .8 3 8 0 .2 4 1 0 .2 5 72 4 2 .4 4 2 0 .1 7 1 0 .2 2 9
Y ahoo F in an ce 1 .6 0 .1 7 11 -Y ea r C on s tan t M a tu r ity R isk F ree R a te
M on th s B e ta R ^ 2 K e6 0 0 .6 2 2 0 .0 1 2 0 .1 0 44 8 1 .6 3 5 0 .1 2 9 0 .1 7 43 6 2 .8 3 8 0 .2 4 1 0 .2 5 92 4 2 .4 4 2 0 .1 7 1 0 .2 3 1
Y ahoo F in an ce 1 .6 0 .1 7 23 -M on th C on s tan t M a tu r ity R isk F ree R a te
M on th s B e ta R ^ 2 K e6 0 0 .6 2 2 0 .0 1 2 0 .1 0 14 8 1 .6 3 5 0 .1 2 9 0 .1 7 23 6 2 .8 3 8 0 .2 4 1 0 .2 5 6
2 4 2 .4 4 2 0 .1 7 1 0 .2 2 8
Y ahoo F in an ce 1 .6 0 .1 6 9
68
SUMMARY OUTPUT SUMMARY OUTPUTRf 0.0569
Regression Statistics Regression StatisticsMultiple R 0.171731782 Multiple R 0.51277117R Square 0.029491805 R Square 0.26293427Adjusted R Square 0.012465346
III. Value Weighted Cost of Equity
Adjusted R Sq 0.24125586Standard Error 0.154501876 Standard Erro 0.14295929Observations 60 Observations 36
ANOVA ANOVA
df SS MS F Significance F df SS MS F Significance FRegression 1 0.041347049 0.041347049 1.732116119 0.193409216 Regression 1 0.247881818 0.24788182 12.1288574 0.0013854Residual 57 1.360637298 0.02387083 Residual 34 0.694870223 0.02043736Total 58 1.401984347 Total 35 0.942752041
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.013501289 0.020188115 0.668774163 0.506339136 -0.026924712 0.053927291 -0.026924712 0.053927291 Intercept -0.00248503 0.02476049 -0.10036286 0.92064574 -0.0528044 0.04783434 -0.0528044 0.04783434
0.00109974 0.622227869 0.472782026 1.316098826 0.193409216 -0.3245018 1.568957539 -0.3245018 1.568957539 0.00109974 2.83781514 0.814843411 3.48265091 0.0013854 1.18185411 4.49377618 1.18185411 4.49377618
SUMMARY OUTPUT
SUMMARY OUTPUT Regression StatisticsMultiple R 0.45475012
Regression Statistics R Square 0.20679767Multiple R 0.384205545 Adjusted R Sq 0.17074302R Square 0.147613901 Standard Erro 0.10761852Adjusted R Square 0.129083768 Observations 24
Standard Error 0.145374922Observations 48 ANOVA
df SS MS F Significance FANOVA Regression 1 0.066429098 0.0664291 5.73567259 0.02557343
df SS MS F Significance F Residual 22 0.254798391 0.01158175Regression 1 0.168355658 0.168355658 7.966154605 0.007017186 Total 23 0.321227489
Residual 46 0.97215792 0.021133868
Total 47 1.140513578 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.02442214 0.022833077 1.06959495 0.29639715 -0.02293076 0.07177505 -0.02293076 0.07177505
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% 0.00109974 2.44230427 1.019782587 2.39492643 0.02557343 0.32740463 4.5572039 0.32740463 4.5572039
Intercept 0.007948921 0.020988665 0.378724476 0.706634902 -0.03429907 0.050196912 -0.03429907 0.0501969120.00109974 1.634590134 0.579141262 2.822437706 0.007017186 0.468839256 2.800341013 0.468839256 2.800341013
69
Current ssets of discontinued operationsOther current assets $251,000,000 $299,200,000 $305,400,000 $453,700,000 $448,600,000 $259,900,000 $329,200,000 $354,900,000 $336,500,000 $306,300,000
TOTAL CURRENT ASSETS $8,680,000,000 $8,631,700,000 $6,959,600,000 $5,180,400,000 $5,264,200,000 $5,467,200,000 $5,379,900,000 $4,529,100,000 $4,163,900,000 $4,025,000,000
PROPERTY, PLANT, AND EQUIPMENT $5,179,000,000 $5,455,200,000 $5,205,200,000 $5,156,200,000 $5,166,000,000 $5,521,000,000 $5,761,000,000 $4,358,500,000 $4,149,700,000 $4,067,900,000GOODWILL $637,000,000 $720,300,000 $658,200,000 $602,600,000 $706,300,000 $588,400,000 $516,900,000 $257,400,000OTHER ASSETS $870,000,000 $78,300,000 $71,500,000 $253,000,000 $251,900,000 $183,800,000 $79,000,000 $99,500,000 $134,100,000 $163,000,000
LIABILITIES AND STOCKHOLDERS' EQUITY i-rate weightShort-term borrowings 0.0456 0Current maturities of long-term debt 0.07 0.02880288 0.0020162 $448,000,000 $1,010,000,000 $113,500,000 $369,800,000 $109,700,000 $395,600,000 $294,500,000 $1,186,500,000 $844,500,000 $1,132,200,000Trade accounts payable 0.0524 0.12504822 0.00655253 $1,945,000,000 $1,970,000,000 $1,562,800,000 $1,515,400,000 $1,359,200,000 $1,505,200,000 $1,417,500,000 $1,131,700,000 $1,177,800,000 $1,096,700,000Current liabilities of discontinued operationsOther current liabilities 0.054 0.04314003 0.00232956 $671,000,000 $718,000,000 $585,200,000 $512,300,000 $479,600,000 $395,600,000 $294,500,000 $351,900,000 $421,800,000 $300,400,000
TOTAL CURRENT LIABILITIES $4,811,000,000 $5,199,000,000 $3,666,500,000 $3,952,700,000 $3,448,400,000 $4,225,900,000 $3,959,900,000 $3,276,500,000 $3,251,000,000 $2,766,200,000
LONG-TERM DEBT 0.0641 0.30487334 0.01954238 $4,742,000,000 $4,443,000,000 $4,825,800,000 $2,989,800,000 $3,203,600,000 $2,349,600,000 $2,347,900,000 $1,186,500,000 $844,500,000 $1,132,200,000DEFERRED INCOME TAXES 0.0497 0.01954481 0.00097138 $304,000,000 $402,000,000 $380,600,000 $320,000,000 $309,300,000 $208,400,000 $249,000,000 $252,600,000 $362,000,000 $382,100,000POSTRETIREMENT BENEFITS 0.087 0.2880288 0.02505851 $4,480,000,000 $4,645,000,000 $4,541,700,000 $913,600,000 $897,200,000 $2,310,500,000 $2,137,400,000 $751,000,000 $782,700,000 $742,500,000OTHER LONG-TERM LIABILITIES 0.067 0.02738845 0.0018332 $426,000,000 $495,000,000 $464,700,000 $369,800,000 $109,700,000 $334,100,000 $149,100,000 $175,600,000 $224,500,000 $264,900,000
Total Non-Current Liabilities $9,952,000,000 $9,985,000,000 $11,066,800,000 $10,780,600,000 $7,471,000,000 $5,839,100,000 $5,525,600,000 $3,567,000,000 $3,270,900,000 $3,626,500,000Total Liabilities $15,554,000,000 $16,027,000,000 $14,733,300,000 $14,733,300,000 $10,919,400,000 $10,065,000,000 $9,485,500,000 $6,843,500,000 $6,521,900,000 $6,392,700,000
STOCKHOLDERS' EQUITYCommon stock (outstanding: December 31, $177,000,000 $176,000,000 $175,300,000 $175,300,000 $163,200,000 $157,600,000 $156,300,000 $155,900,000 $156,600,000 $156,100,0002005 77,357,370 shares; December 31, 2004 82,095,161 shares)Capital in excess of par value $1,398,000,000 $1,392,000,000 $1,390,200,000 $1,390,100,000 $1,245,400,000 $1,092,400,000 $1,029,600,000 $1,015,900,000 $1,061,600,000 $1,059,400,000Unearned restricted stock compensationRetained earnings $1,298,000,000 $1,070,000,000 $955,100,000 $1,782,500,000 $3,192,700,000 $3,558,800,000 $3,706,900,000 $3,477,800,000 $2,983,400,000 $2,603,000,000Accumulated other comprehensive income (Loss) ($2,800,000,000) ($2,564,000,000) ($2,552,800,000) ($3,092,500,000) ($1,737,300,000) ($1,305,800,000) ($1,100,200,000) ($903,800,000) ($806,100,000) ($539,400,000)
TOTAL STOCKHOLDERS' EQUITY $73,000,000 $74,000,000 ($32,200,000) $255,400,000 $2,864,000,000 $3,503,000,000 $3,792,600,000 $3,745,800,000 $3,395,500,000 $3,279,100,000
II. Value Weighted Debt a
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APPENDIX D - Valuation Models
I. Free Cash Flows
WACC(AT 0.0679 Kd 0.0631
0 1 2 3 4 5 6 7 8 9 102006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
EPS (Earnings Per Share) 1.74 1.86 1.98 2.12 2.27 2.42 2.59 2.77 2.96 3.16DPS (Dividends Per Share) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00BPS (Book Value Equity per Share) 0.99Cash From Operations 1124.06 1261.20 1415.06 1587.70 1781.40 1998.73 2242.57 2516.17 2823.14 3167.56Cash Investments 698.38 768.21 845.03 929.54 1022.49 1124.74 1237.22 1360.94 1497.03 1646.73Cash Flow to Firms Assets (Free Cash Flow) 425.68 492.99 570.03 658.16 758.91 873.99 1005.35 1155.23 1326.11 1520.83
PV Factor 0.9364 0.8769 0.8211 0.7689 0.7200 0.6742 0.6314 0.5912 0.5536 0.5184PV of Free Cash Flows 398.61 432.29 468.07 506.07 546.43 589.28 634.75 683.00 734.18Total PV of Annual Free Cash Flows 4,992.69Continuing (Terminal) Value Perpetuity 22398.1PV of Terminal Value Perpetuity 12,400.42 WACCValue of Firm 17,393.10 g 0.055 0.06 0.065 0.0679 0.07 0.075 0.08Book Value of Liabilities 15,792.00 0 37.44 24.93 14.41 9.05 5.45 -2.26 -8.97Estimated Market Value of Equity 1,601.10 0.01 58.88 41.88 28.05 21.15 16.58 6.93 -1.29Number of Shares 177.00 0.02 92.58 67.31 47.74 38.30 32.16 19.46 8.94Estimated Price per Share (end of 2006) 9.05 0.03 153.23 109.69 78.69 64.50 55.52 37.57 23.27
0.04 294.74 194.46 134.41 109.49 94.47 66.03 44.76Overvalued (< 90%) 16.1Undervalued (> 110%) 19.68
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II. Residual Income
Residual Income Valuation WACC(AT) 0.09 Kd 0.06 Ke 0.116
0 1 2 3 4 5 6 7 8 9 102006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
EPS (Earnings Per Share) 1.74 1.86 1.98 2.12 2.27 2.42 2.59 2.77 2.96 3.16DPS (Dividends Per Share) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00BPS (Book Value Equity per Share) 0.99 2.73 4.59 6.57 8.69 10.96 13.38 15.97 18.74 21.70 24.86Cash From OperationsCash Investments
PerpetuityEPS (Earnings Per Share) 1.74 1.86 1.98 2.12 2.27 2.42 2.59 2.77 2.96Normal Earnings (Notice "Lag") 0.11 0.32 0.53 0.76 1.01 1.27 1.55 1.85 2.17Residual Income 1.63 1.54 1.45 1.36 1.26 1.15 1.04 0.92 0.79PV Factor 0.8961 0.8029 0.7195 0.6447 0.5777 0.5176 0.4638 0.4156 0.3724PV of Residual Income 1.456 1.239 1.041 0.875 0.729 0.595 0.481 0.381 0.293 0.293Total PV of Annual Residual Income 7.091Continuing (Terminal) Value Perpetuity 2.523918PV of Terminal Value Perpetuity 0.940BPS (Book Value Equity per Share) 0.99 KeEstimated Price per Share (end of 2006) 9.02 g 0.06 0.07 0.08 0.09 0.1 0.11 0.116
0 23.56 18.77 15.42 12.99 11.16 9.73 9.02Logical Test for Growth in Perpetuity 0.01 25.83 20.01 16.13 13.40 11.39 9.87 9.12g 0 0.02 29.24 21.75 17.07 13.92 11.69 10.04 9.24
0.03 34.92 24.36 18.39 14.63 12.08 10.25 9.390.04 46.28 28.71 20.36 15.61 12.59 10.52 9.57
Initial Ke 0.116 0.05 80.37 37.40 23.65 17.08 13.30 10.89 9.82
Overvalued (< 90%) 16.10Undervalued (> 110%) 19.68
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III. Abnormal Earnings Growth
1 2 3 4 5 6 7 8 9 PerpForecast Years
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016EPS 1.62 1.74 1.86 1.98 2.12 2.27 2.42 2.59 2.77 2.96 3.16DPS 0 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00DPS invested at 11.6% (Drip) $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 0Cum-Dividend Earnings $1.86 $1.98 $2.12 $2.27 $2.42 $2.59 $2.77 $2.96 3.16Normal Earnings $1.94 $2.08 $2.21 $2.37 $2.53 $2.70 $2.89 $3.09 3.30336Abnormal Earning Growth (AEG) ($0.08) ($0.10) ($0.09) ($0.10) ($0.11) ($0.11) ($0.12) ($0.13) ($0.14) 0
PV Factor 0.896 0.803 0.719 0.645 0.578 0.518 0.464 0.416 0.372
PV of AEG ($0.07) ($0.08) ($0.06) ($0.06) ($0.07) ($0.06) ($0.06) ($0.05) ($0.05)
Core EPS $1.74Total PV of AEG ($0.56)Continuing (Terminal) Value 0PV of Terminal Value $0.00 KeTotal PV of AEG ($0.56) g 0.06 0.07 0.08 0.09 0.1 0.11 0.116Total Average EPS Perp (t+1) $1.18 0 31.17 24.55 19.76 16.17 13.40 11.23 10.14Capitalization Rate (perpetuity) 0.116 0.01 31.17 24.55 19.76 16.17 13.40 11.23 10.14
0.02 31.17 24.55 19.76 16.17 13.40 11.23 10.14Value Per Share end of 2006 $10.14 0.03 31.17 24.55 19.76 16.17 13.40 11.23 10.14
0.04 31.17 24.55 19.76 16.17 13.40 11.23 10.14Ke 0.116 0.05 31.17 24.55 19.76 16.17 13.40 11.23 10.14g 0
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Works Cited 1. “GOODYEAR TIRE & RUBBER C0MPANY 10-K”. PriceWaterhouseCoopers Technology Center. 31 Dec
2005. PriceWaterhouseCoopers. 10 Oct 2006. http://edgarscan.pwcglobal.com
2. “Goodyear Tire & Rubber Co. (GT)”. Yahoo Finance 2005. Goodyear Tire & Rubber Company. 2 Oct
2006. http://finance.yahoo.com/q?s=gt
3. “Investors and Analysts”. Michelin 2005. 1 Nov 2006.
http://www.michelin.com/corporate/front/templates/affich.jsp?codeRubrique=5&lang=EN 4. “Investor Relations”. Goodyear Tire & Rubber Company. 1 Oct 2006.
http://www.goodyear.com/investor/investor_reports.html