Valuation Report

For the course Business Analysis and Valuation

Under the guidance of Prof. Ritika Jaiswal

GAIL(India) Limited

Name: Sharnam Singhwal

ID Number: 2018A4PS0067G

Branch: Mechanical Engineering

Gail (India) Limited
About the company
Gail (India) Ltd. was incorporated 36 years back on 16th August 1984 under the Ministry of Petroleum
and natural gas. As the years passed the company was commissioned for a number of projects, a few of
them being the Vijaypur propane recovery plant and the HVJ natural gas pipeline. The company went
public in 1996 and was granted the Navratna status by the government of India in 1997-98. In the
subsequent years, GAIL undertook projects in different states for natural gas supply for domestic and
industrial purposes, some in collaboration with companies such as ONGC, IOC, and Gazprom. At present,
the company has business segments in liquid hydrocarbon, natural gas, liquified petroleum gas
transmission, petrochemical, city gas distribution, exploration and production. The company has a
market cap of Rs. 386.97B with 4.51B shares outstanding.

Qualitative Analysis

Competitive Strategy Analysis

Mission: Critical Success Factor:

Quality of life: To transform the lives of people by Increase the supply of power harnessed from
providing environment friendly products at sustainable resources to the less privileged parts
optimal cost. of the country at optimal cost.

Clean Energy and beyond: Use of environment Research and develop methods of using the
friendly and efficient sustainable resources for producing energy.

Stakeholders: Deliver superior results and create a Optimizing production and transportation to
sustainable value of the company and economic reduce cost and increase company value. Start
opportunities for deprived sections of the society. operations in different locations to enhance
economic opportunities and company growth.

Environment Responsibility: Promote operational Developing optimum waste disposal systems for
safety, employee health and cleaner environment. the byproducts of the production process. Provide
healthcare facilities and insurance to employees.

Cost Leadership Strategy:

● GAIL is the largest state owned Indian company with a business in processing and distribution of
gas and gas fuels such as natural gas and liquid hydrocarbons for domestic and industrial use.
● Despite having a high market share GAIL faces competition from companies like Oil India, HOCL,
Duke Offshore, etc. To tackle this competition GAIL follows a competitive pricing strategy
undertaking city distribution to direct customers which reduces interim costs and helps the
company to reduce profit margin with increasing revenue.
● Since the industry requires high principal investment there exists high exit barriers because of
which companies have to reduce prices to sustain market share. Same is incorporated by GAIL.
 The prices of crude oil have been falling globally which pushes the companies to tighten rivalry
in terms of relative prices.

Porter’s Five Force Model

Threat of New Threat of Substitutes Bargaining Bargaining Competitive Rivalry
Entrants power of power of
customers suppliers

The industry Since the operations Since the prices Most of the The competition among
requires a huge require huge investment are a factor of company companies is high. Since
investment the number of availability of projects depend with development and
before the substitutes reduces. natural resources, on government movement towards
operation. However, the state research and state exploring different
The projects are contracts that are developments approval and for resources, companies
not short decided by the and macro- access to the have been focusing on
spanned and government have high economic factors country’s expanding their scope. A
may last for chances of substitution such as foreign natural step towards this was
years before after the contract trades and resources. The expansion of GAIL with
they start expires. This depends on inflation, the company wind energy in 2009. The
yielding a number of factors such bargaining power becomes bound high investment in
revenue. as the company’s of customers is to the research and high fixed
This reduces policies toward the low. regulations and cost poses exit barriers
the threat of environment and the conditions for which increases the
new entrants price and cost business given incentive for companies
and makes effectiveness. by the state. to outdo one another in
GAIL’s position Substitutes are the This increases terms of prices and
in the industry similar big companies of the supplier’s services. Few major
strong. the market such as power in case of competitors for GAIL in
ONGC. Substitution by GAIL(India) the industry are ONGC,
other sources of energy Limited. Reliance and Indian Oil.
such as nuclear energy This leads to highly
weakens the strength of competitive rivalry in the
GAIL(India) Ltd. The large industry.
capital investments
make it difficult to exit
the industry.

Corporate Strategy
● GAIL(India) Ltd. focuses on meeting energy needs through sustainable resources and keeping in
check with the environmental consequences.
● Being India’s one of the most vertically integrated companies it incorporates all the components
on the natural gas value chain ranging from exploration and production to processing and
transmission.
● Cutting down on intermediary costs and directly supplying to consumers and industries.
● Promoting employee safety and health benefits which in turn persuades them to work more
efficiently for the company.
● With the advancement of technology and need for better resources the company has expanded
 its scope to harness other forms of energy such as wind energy.
● Large investments in R&D to bring better and more optimized methods of resource
consumption
● Integration with competitors such as in 2000 when GAIL was awarded 2 blocks under NELP I,
one in Orissa offshore with ONGC and one in offshore Bengal with Gazprom.

Quantitative Analysis

Performance Analysis using ROE decomposition

Company Financials (in crore ₹):

Financials GAIL Reliance Industries

Sales: 71870.96 365421

Assets: 68533.63 968912

Net Income: 6620.63 30903

Equity: 43871.10 425584

Traditional Approach for ROE Decomposition:

Ratio Formula Calculation Value Calculation Value
(GAIL) (GAIL) (Reliance (Reliance
Industries) Industries)

Net Profit Net 6620.63/71870. 9.211% 30903/365421 8.4568%

Margin(ROS) Income/Sales 96

Asset Turnover Sales/Assets 71870.96/68533 1.048696239 365421/968912 0.377

.63

Return on ROS*Asset (6620.63/71870. 9.6604% (30903/365421) 3.189%

Asset(ROA) Turnover 96)*(71870.96/ *(365421/96891
68533.63) 2)

Financial Assets/Sharehol 68533.63/43971 1.558606221 968912/425584 2.27666

Leverage der’s Equity .10

Return on ROA*Financial ((6620.63/7187 15.056% ((30903/365421 7.260%

Equity Leverage 0.96)*(71870.96 )*(365421/9689
/68533.63))*(68 12))*(968912/4
533.63/43971.1 25584)
0)
Even though the net profit margins of the 2 companies are almost equal there is a significant difference
in the ROE. This can be attributed to the remarkable difference in the value of assets for the companies.
The high asset turnover and ROA reflects better utilization of the capital employed which in turn
increases the ROE for GAIL(India) Limited. The high asset turnover ratio for GAIL can also be attributed
to the relatively lower amount of asset value in comparison to reliance industries.

Alternative Approach for ROE Decomposition:

Financials according to GAIL 2019-20 Balance sheet (in ₹ crores):
NOPAT: 3552.36 Current Asset:11114
Cash and Marketable securities:548 Total long term Assets: 33644.98
Non interest-bearing long-term liabilities:8758.54 Interest expense:108.95
Interest Income: 311.2 Tax Rate:17%
Net Debt: 3668 Equity: 43971
Current liabilities excluding short term debt and current portion of long term debt: 9492.89
Formula Calculation Values

Net Long term Total Long Term Asset- Non 33644.98-8758.54 24886.58
Asset Interest bearing Long term
Liabilities

Operating Working (Current Asset - Cash and 11114 - 548 - 9492.89 1073.11
Capital Marketable Securities)-
(Current Liabilities - Short
term debt and current
portion of long term
liabilities )

Net Asset Operating Working Capital 1073.11+24886.58 25959.69

+ Net Long term Assets

Operating ROA NOPAT/Net Asset 3552.36/25959.69 0.1368

Effective Interest Net Interest expense after (108.95-311.2)/3668 -0.055139

Rate after tax tax/Net Debt

Spread Operating ROA - Effective 0.1368-(-0.055139) 0.1919

Interest Rate after Tax

Net Financial Net Debt/Net Equity 3668/43971 0.0834

Leverage

ROE Operating ROA + 0.1368+(0.1919*0.0834) 0.152

Spread*Net Financial Or
Leverage 15.2%

The low financial leverage and High operating ROA shows that the company has been successfully
utilizing the capital to generate profits and has reduced its dependency on debt. The high value of
spread shows that the small amount of debt that the company took has greatly benefited the company
and its growth.
Firm Valuation

Cost of equity
● Risk free rate: Govt. 10 year bond yield - Country default Spread
India has BBB- rating according to Stand and Poor’s which gives a default spread of 1.79%
Govt. 10 year bond yield: 5.916%
Therefore, the risk free rate is 5.916-1.79 = 4.126%
● Risk Premium:
Taking Market Risk Premium for mature market as 5.23%
This mature market risk premium is taken from a paper link to which is attached in the
references section.
Default spread of India is 1.79%
Risk Premium = 5.23+1.79=7.02%
● Beta:

Company Regression Beta D/E Tax Rate(%) Unlevered Beta

ONGC 0.92 0.07 25.168% 0.87420

Indian Oil 1.27 0.55 26.168% 0.89970

Reliance 1.08 0.28 21.12 0.88461

Industries

Exxon Mobil 1.06 0.39 26.34 0.823445

Chevron Corp. 1.21 0.253 48.61 1.070780

Average Unlevered Beta= 0.910551

Taking this average unlevered beta as the unlevered beta for GAIL(India) limited.
For GAIL

Unlevered Beta D/E Tax Rate(%) Levered Beta

0.910551 0.09 16.8 0.978

This approach uses the regression data of various competitors of the market and the present
statistics for GAIL. This helps in reducing the standard error for GAIL and reflects the company’s
current statistics and not just the past information by taking into account the current D/E ratio
and tax rate.

● Cost of equity: Rf + Beta*Risk Premium

= 4.126+(0.978*7.02)
= 11%
Growth Rate
ROE=15.056%
Payout ratio=0.5955
Retention ratio = 1-payout ratio = 1-0.5955
=0.4045
Growth Rate=ROE*(retention ratio)
=15.056*(0.4045) =6.090152%
Industry growth rate for
Indian Renewable energy = 17.33%
Petrochemical Industry=10%
Fuel RO=17.5%

Therefore, growth rate for GAIL< Growth rate for industry

Therefore, GAIL is in stable growth rate period

Dividend Payments for GAIL in the last 5 years have been highly irregular with dividend yield ranging
from 9% to 76%. A link for the same has been provided in the references section of the report.
Therefore, we cannot use the dividend discount model for valuation and we’ll be using the FCFE
Approach for valuation of the company.

GAIL(India) Ltd. Financials According to the Annual Report 2019-20 (in ₹ crores)
Cost of equity: 11% New debt issues: 4649.70

Net income: 6620.63 Repayments:130.10

Debt Ratio:(3957.39/68533.63)=0.0577 Number of shares used for EPS calculation:451.01

Book value of equity: 43971 EPS: 14.68

Cash and Marketable Security: 548

after tax income from cash and marketable securities:

397.55

Net capex : 6114 Capital Expenditures per share: 13.55

Change in Working Capital: 307.26 Change in Working Capital/share:0.68127

Depreciation: 1835.99 Depreciation per share:4.0708

Expected Growth Rate for FCFE valuation

Equity (Net capex + Change in working ((6114+307.26)- 30.55%

reinvestment rate capital –(New debt issues – (4649.70-130.10))/
Repayments) )/( Net Income-after (6620.63-397.55)
tax income from cash and
marketable securities)

Noncash ROE (Net income – after tax income (6620.63-397.55)/( 0.1439

 from cash and marketable 43971-548)
securities)/ (Book value of equity-
cash and marketable securities)

Expected growth in Equity reinvestment rate * Noncash 36.2753*0.1439 4.37%

FCFE ROE

Since the growth rate is less than industry growth rate therefore the firm is in a stable period. Therefore,
using FCFE approach for valuation in stable period:

The single stage FCFE approach for GAIL(India) Limited is valid because of the following reasons:
● The firm is in steady state with company growth rate less than the industry growth rate.
● The beta of the stock is close to one or less than one. Beta in case of GAIL(India) Limited is 0.978
● The firm has FCFE which are significantly different from dividends, or dividends are not relevant.
The firm FCFE per share comes out to be 10 which is almost 3 times the average annual dividend
paid by GAIL(India) Limited.
● The leverage is stable. The past 4 years have shown a stable leverage for GAIL with its average
D/E ratio being close to 0.085.

Firm valuation:

Value of equity in operating assets:

(Net Income-after tax income from cash and marketable securities) (1+growth rate) (1-reinvestment
rate)/(cost of equity-growth rate)
=(6620.63-397.55)*(1.0437)*(1-.3055)/(0.11-0.0437)
=73458.317
Value of Equity: Value of equity in operating assets + Cash
=73458.317+548
=74006.317
Number of shares: 451.01
Share Price: 74013.317/451.01
=₹164.11

Therefore, the fair value for GAIL(India) Limited is ₹164 per share.
Current Market Price per share for GAIL(India) Ltd. = ₹92

Therefore, the firm is undervalued and the right decision would be to buy the share.
The reason for undervaluation of the company can be the COVID-19 crisis which has significantly
lowered the stock prices however the company business hasn’t seen a similar decline. The firm is in its
stable period and would be a great fundamental investment.

A similar valuation done by “Simply wall street” shows the company to be undervalued with fair price as
₹189 with a margin of 20% giving the fair price a range from ₹151 to ₹226 which matches our analysis of
fair value of ₹164. Link of a screenshot from the website of simply wall street stating the fair value is
attached in the references section of the report.
References

● Gail(India) Limited Annual report 2019-20

● ONGC Annual Report 2019-2020
● Indian Oil Annual Report 2019-20
● Reliance Industries Annual Report 2019-20
● Exxon Mobil 2019 Summary Annual Report
● Chevron Annual Report 2019-20
● Industry Returns
● Sector CAGR
● GAIL(India) Limited past year dividends
● Nifty returns
● Country risk premium and default spreads
● Indian government bond yield and credit rating
● Simply Wall Street
Business Analysis & Valuation
Report
Starbucks’ Corporation
November 21, 2020

Prepared by:
Kartik Tarsolia
(2018A8PS0500G)
I. Qualitative Analysis
In this we will cover 3 Analytical techniques:
1) Industry Analysis:
We will do industry analysis using the following steps:
Step 1. Defining the industry and indentifying the business:
Starbucks primarily operates & competes in the retail coffee and snacks store industry, as the world's
biggest coffeehouse chain, Starbuck’s Corporation is seen to be the main representation of the United
States' 2nd wave of coffee culture. As of 2020, the company operates over 30,000 locations worldwide in
more than 70 countries.
Step 2. Measuring the operating profitability with Market share:
This industry is in a relatively mature stage with a medium level concentration. Starbuck’s maintains a
massive 40% market share in the U.S. coffee shop market. It is followed by Dunkin that has 26% market
share
Step 3. Industry Profitability Drivers and Demand Determinants:
The industry’s demand for premium coffee and snack products are driven by a number of factors which
includes disposable income, per capita coffee consumption, attitudes towards health, world pricing of
coffee and demographics. As coffee beans are the primary input in the value chain of its industry
participants the volatile prices of coffee beans determines the market costs and profitability margins.
Step 4. Using Porters Five Forces Analysis of the Retail Coffee and Snacks Industry:
1. Threat of New Entrants: Moderate
 As the barriers to entry are not high enough to effectively discourage new competitors to enter the
market there is a moderate threat of new entrants into the industry.
 At a localized level, small coffee shops can compete with the likes of Starbucks because there are
no switching costs for the consumers. But a relatively easy entry into the market is usually
countered by large brands identities like Starbucks who have achieved economies of scale by
lowering cost, improved efficiency with a large market share.
2. Threat of Substitutes: High
 There are reasonable substitute beverages to coffee, such as tea, fruit juices, water, sodas, energy
drinks etc.
 As there are no switching costs for the consumers for switching to substitutes makes the threat high.
 But it’s should be noted that industry leaders like Starbucks are currently trying to counter this threat
by selling coffee machines, premium coffee packs in grocery stores but this threat still puts pressure
on their the margins.
3. Bargaining Power of Buyers: Moderately Low
 As Starbucks offers vertically differentiated products with a diverse consumer base, which make
relatively low volume purchases and erodes the buyer’s power. Due to competitive rivalry industry
leaders like Starbucks prices its product mix in relation to competitors with prevailing market price
elasticity and competitive premium pricing.
 As consumers pay a premium for higher quality product, they have a moderate sensitivity in
premium coffee retailing, but are watchful of excessive premium in relation product quality.
4. Bargaining Power of Suppliers: Moderately Low
 Its main inputs into the value chain is coffee beans and premium Arabica coffee grown in some regions
which are of average inputs, which makes the cost of switching between substitute suppliers, moderately
low.
 Starbucks also forms a highly important part of the suppliers business, due its scope and size, which makes
the power of the suppliers lower. Given these factors, suppliers have a moderately low bargaining power.
5. Intensity of Competitive Rivalry: Moderately High
 Beverages industry has a monopolistic competition, with Starbucks dominating the largest markets share
and its closest competitors also having a significant market share, creating notable pressure on Starbucks.
 Consumers do have any switching cost to other competitors, which crates high intensity in rivalry
Looking at the Porters five forces analysis, we can get successfully deduce that the strength of forces and
profitability in the retail coffee and snacks industry for Starbucks are Moderate.

2) Competitive Strategy Analysis:

 Critical Success Factor: The core competency of Starbucks has been its ability to efficiently leveraging their
cornerstone product differentiation strategies through offering a premium product mix of top notch quality
beverages and snacks. Its brand equity is built on offering the finest quality coffee and related products, and by
providing each customer a unique “Starbucks Experience”, which comprises of clean and well-maintained
stores, supreme customer service, that reflect the culture of the communities in which they operate.
 Starbucks Key Strategies: One of the primary key strategy that Starbucks stuck to since its inception is that of
product differentiation offering differentiators such as premium product mix, coffee beverages reputation,
locations and supreme customer service that translated to establishing a premium valued brand which is very
costly to imitate for competitors. Starbucks has also been following a shrewd strategy (of strategic alliance and
making smart acquisitions) and expanding strategy. Starbucks has made some notable acquisitions such as Bay
Breads (premium bread products), Evolution Fresh (fresh juice products), Teavana (Tea products), etc. to use the
product diversification strategy, and expanding its business to 70 countries. All these strategies have derived
considerable competitive advantage for Starbucks over its competitors.
3) Corporate Strategy Analysis:
We will do Corporate Strategy analysis using BCG Growth Share Matrix.

STAR: Contributing more than 18% to the company’s total revenue, Starbuck’s food business vertical has
surely been the STAR for the company. Its hot sandwiches for breakfast complemented the brand’s signature
coffee offerings so well. The company has been successfully able to create its own niche in the industry catering
to a specific customer group.
CASH COWS: Without a doubt its beverage business accounting 60% of the total revenue is CASH COW for
Starbuck’s. Despite facing competition from the likes of Cafe coffee day, Costa Coffee, Barista, etc. the
company has been successfully able to create its own set of loyal customers.
QUESTION MARK: Packaged coffee products and single-serve coffees portray a positive growth trend,
however only made up about 8% percent of total sales in 2019. Sales in this category are expected to go up as
Starbucks VIA instant coffee and K-cups.
DOGS: Starbucks merchandise is operating in a low growth market and holds a low market share. The
unpredictability that this business vertical holds in the future is the prime reason it is considered as a Dogs for
the company.
 II. Quantitative Analysis
Quantitative Analysis will be done using ROE decomposition.
Exhibit 1(This table will be used for future references also)
Average Sep 27, Sep 29, Sep 30, Oct 1, Oct 2, Sep 27,
2020 2019 2018 2017 2016 2015
Selected Financial Data (US$)
Cash dividends declared 14,36,600 18,01,600 17,60,500 15,15,900 12,46,200 10,16,20
0
Net earnings attributable to 9,28,300 35,99,200 45,18,300 28,84,700 28,17,700 27,57,40
Starbucks 0
Net revenues 2,35,18,00 2,65,08,60 2,47,19,50 2,23,86,80 2,13,15,9 1,91,62,
0 0 0 0 00 700
Total assets 2,93,74,50 1,92,19,60 2,41,56,40 1,43,65,60 1,43,29,5 1,24,46,
0 0 0 0 00 100
Shareholders’ equity (deficit) (78,05,100 (62,32,200 11,69,500 54,50,100 58,84,000 58,18,00
) ) 0
Additions to property, plant and (14,83,600 (18,06,600 (19,76,400 (15,19,40 (14,40,30 (13,03,7
equipment(CapEx) ) ) ) 0) 0) 00)
Effective income tax rate (t) 20.60% 19.50% 19.00% 33.20% 32.90% 29.30%
EBIT(1 – t) 12,75,278 38,65,655 46,56,243 29,46,490 28,72,252 28,07,24
4
Change in Working Capital -26,76,400 16,48,700 69,13,700 89,700 3,53,000
Total capital 81,04,400 49,34,800 1,06,09,60 93,82,700 94,86,200 81,65,50
0 0
Net Cash Provided by 15,97,800 50,47,000 1,19,37,80 41,74,300 45,75,100 37,49,10
Operating Activities 0 0
Net Cash used for Investing 17,11,500 10,10,800 23,61,500 8,50,000 22,22,900 15,20,30
Activities 0
Net Cash used for by Financing 17,13,300 1,00,56,90 32,42,800 30,01,600 17,50,000 22,56,50
Activities 0 0

Free Cash Flow(FCFF) 1,14,200 32,40,400 99,61,400 26,54,900 31,34,800 24,45,40

0
Financial Ratios
Return on capital (ROC) 15.74% 78.33% 43.89% 31.40% 30.28% 34.38%
Reinvestment rate -0.40 0.47 0.59 0.46 0.55 0.62
Profit margin 3.95% 13.58% 18.28% 12.89% 13.22% 14.39%
Asset turnover 0.80 1.38 1.02 1.56 1.49 1.54
Financial leverage -3.77 -3.09 20.66 2.64 2.44 2.14
Averages
Reinvestment rate 0.54
Profit margin 14.47%
Asset turnover 1.30
Financial leverage 6.97
Average effective income tax rate 25.75
*P.T.O for Calculations
Calculations:

Share Holders Equity = Common Stock + Retained Earnings + Accumulates other Comprehensive Income
= 1200 + (-7,815,600) + (-364,600) = -7,805,100
Profit margin = 100 × Net earnings attributable to Starbucks ÷ Net revenues
= 100 × 928,300 ÷ 23,518,000 = 3.95%
Asset turnover = Net revenues ÷ Total assets
= 23,518,000 ÷ 29,374,500 = 0.80
Financial leverage = Total assets ÷ Shareholders’ equity (deficit)
= 29,374,500 ÷ -7,805,100 = -3.77
Average effective income tax rate = (20.60% + 19.50% + 19.00% + 33.20% + 32.90% + 29.30%) ÷ 6
= 25.75%

Net Profit Financial

Date ROE = × Asset Turnover ×
Margin Leverage

Sep 27, 2020 -11.92% 3.95% 0.80 -3.77

Sep 29, 2019 -57.91 13.58% 1.38 -3.09

Sep 30, 2018 386.34% 18.28% 1.02 20.66

Oct 1, 2017 52.93% 12.89% 1.56 2.64

Oct 2, 2016 47.89% 13.22% 1.49 2.44

Sep 27, 2015 47.39% 14.39% 1.54 2.14

Return on equity (ROE) is measured as net income divided by shareholders' equity.

When a company incurs a loss, hence no net income, return on equity is negative. A
negative ROE is not necessarily bad, mainly when costs are a result of improving the
business, such as through restructuring, as seen FY 2019 and FY 2020 due to pandemic
situation ROE comes out to be negative and is expected to improve in the coming years.
In case of negative ROE a better idea of the company’s financial situation can be given
by free cash flow (DCF analysis). Hence in this case no conclusion can be drawn based
on ROE decomposition.
III. Valuation
To value Starbucks Corporation, we utilized the approaches of Discounted Cash Flow
Analysis using FCFF method. We used FCFF method as the D/E ratio of Starbucks is non
stagnant which means debt has a major impact on its valuation.

Discounted Cash Flow Approach (FCFF)

The parameters required for DCF Approach are:

I. Discount rate:
As we are using FCFF approach we will use Discount rate as Cost of Capital which is calculated
by WACC method.

Cost of Equity

It is calculated by adding the risk free rate to the product of a company’s beta and the market risk
premium using CAPM model (r SBUX = RF + βSBUX [RM – RF]).

1) Risk Free Rate(Rf):

Risk free rate is taken as the 20yr treasury rate which is 1.42%.
2) Beta(β ):
SBUX

First we will find market beta using data available online by the formula below.
Variance(SBUX) 36.30
Variance(S&P 500) 17.30
Covariance(SBUX, S&P 500) 13.32
β(SBUX) 0.77

βSBUX = CovarianceSBUX, S&P 500 ÷ VarianceS&P 500

= 13.32 ÷ 17.30 = 0.77
This gave us historical beta. This historical beta is taken same as levered beta. Ideally for calculation of
beta we have to find weighted average of unlevered beta for each business of the company (using the
formula below) and lever that out, but in this case Starbucks is a single type of business organization and
we need not do the same.
Levered Beta = Average Unlevered Beta * (1+ (1- Effective Tax Rate) * Debt/Equity)
 3) Market Risk Premium(R M – RF):

For this we used the market portfolio dividend growth rate and dividend yield.
Market portfolio dividend growth rate = Retention rate × Profit margin × Asset turnover × Financial leverage
= 0.53 × 10.55% × 0.68 × 2.83 = 10.93%

Market portfolio dividend growth rate 10.93%

Add: Market portfolio dividend yield 1.55%
Expected rate of return on market (Rm) 12.48%
Finally using the CAPM formula above, we will calculate the COE for Starbucks.
Risk free Rate( R )
F 1.42%
Beta( βSBUX ) 0.77
Return on Market Portfolio( R ) M 12.48%

Cost of Equity (Ke) 9.93%

Cost of Debt

1) Risk Free Rate(Rf):

2) Risk free rate is taken as the 20yr treasury rate which is 1.42%.
3) Default Spread:
For this we have to find the rating of Starbucks given by top rating agencies and the typical
default spread associated with it. Currently Starbucks have a moody’s rating of Baa1 and the
default spread associated with the same is 1.87%. This gives a pretax cost of Debt to be 3.29%.
Risk free Rate( R )
F 1.42%
Default Spread 1.87%
Estimated (average) effective income tax rate 25.75%
After tax Cost of Debt 2.442%

Weighted Average Cost of Capital:

Starbucks have equity of value $114,916,967 and Debt of value $17,938,800.

Cost of Debt (Kd) 2.442%

Weight of Debt (Wd) 14%
Cost of Equity (Ke) 9.93%
Weight of Equity (We) 86%
WACC= Kd*Wd + Ke*We 8.89%

II. Free Cash Flow:

Using the below formula we have found out the Free Cash Flow required (refer Exhibit 1):
Free Cash Flow (FCFF) = Cash Flow from Operations + Net Debt Issued (Repaid)– CapEx,
which comes out to be $429,339 FY 2020.
 III. Growth Rate:
Due to the current pandemic situation we have to assume that for the next 5 years it will have a high
growth period and then it will attain a stable growth rate.

1) Growth Rate of FY2021 (hereafter referred g1) will be calculated by using Sustainable growth
rate(SGR) model. SGR = ROC*Reinvestment Rate. Where ROC = 100 × EBIT(1 – t)÷ Total capital
and Reinvestment rate = (Net Capx+ Change in WC)/ EBIT(1-t) (refer Exhibit 1 for values), which
gives average ROC(for last 5 years) as 31.14% & Reinvestment Rate as 0.54. Therefore Expected
Growth rate is 16.75%.
2) Now using single stage model we will calculate g5(refer Exhibit 1 for values).
g = 100 × (Total capital × WACC – FCFF) ÷ (Total capital + FCFF)
= 100 × (132,855,767 × 8.89% – 429,339) ÷ (132,855,767 + 429,339) = 8.56%
3) Now using linear interpolation between g1 and g5 will be g2, g3, g4 calculated.
g2 = g1 + (g5 – g1) × (2 – 1) ÷ (5 – 1)
= 16.75% + (8.56% – 16.75%) × (2 – 1) ÷ (5 – 1) = 14.70%
g3 = g1 + (g5 – g1) × (3 – 1) ÷ (5 – 1)
= 16.75% + (8.56% – 16.75%) × (3 – 1) ÷ (5 – 1) = 12.65%
g4 = g1 + (g5 – g1) × (4 – 1) ÷ (5 – 1)
= 16.75% + (8.56% – 16.75%) × (4 – 1) ÷ (5 – 1) = 10.61%

Year Value g(t)

1 g(1) 16.75%
2 g(2) 14.70%
3 g(3) 12.65%
4 g(4) 10.61%
5 and thereafter g(5) 8.56%

IV. Final Enterprise Value (DCF Analysis):

Now using the above growth rates and Free Cash Flow of the current year we will compound the same for
the subsequent years and discount it with the Discount Rate calculated above to get the future cash
flow (FCFF) forecast. TV is calculated by the formula: Terminal value = FCFF6 / (Cost of Capital - g)

Year Value FCFF(t) or TV(t)(USD) Calculation Present value at

8.89%(USD)
0 FCFF(0) 4,29,339
1 FCFF(1) 5,01,239 >> 429,339 × (1 + 16.75%) 4,60,230
2 FCFF(2) 5,74,921 >> 501,239 × (1 + 14.70%) 4,84,694
3 FCFF(3) 6,47,668 >> 574,921 × (1 + 12.65%) 5,01,351
4 FCFF(4) 7,16,363 >> 647,668 × (1 + 10.61%) 5,09,158
5 FCFF(5) 7,77,683 >> 716,363 × (1 + 8.56%) 5,07,518
5 TV(5) 24,06,48,354 >> 777,683 × (1 + 8.56%) ÷ (8.89% – 8.56%) 15,70,47,670
Intrinsic value of Starbucks Corp.’s capital 15,95,10,620
Less: Debt (fair value) 1,79,38,800
Intrinsic value of Starbucks Corp.’s common stock 14,15,71,820
Common outstanding Shares 11,73,701
Intrinsic value of Starbucks Corp.’s common stock (per share) $120.62
Current share price $97.80

Conclusion: As the current share price of Starbucks Corporation is less than its intrinsic value, it’s a good
time to invest in the company.
 References and Bibliography

https://www.sec.gov/Archives/edgar/data/829224/000082922415000038/sbux-
9272015x10k.htm

https://www.sec.gov/Archives/edgar/data/829224/000082922416000083/sbux-
1022016x10xk.htm

https://www.sec.gov/Archives/edgar/data/829224/000082922417000049/sbux-
1012017x10xk.htm

https://www.sec.gov/Archives/edgar/data/829224/000082922418000052/sbux-
9302018x10xk.htm

https://www.sec.gov/Archives/edgar/data/829224/000082922419000051/sbux-
9292019x10xk.htm

https://www.sec.gov/Archives/edgar/data/829224/000082922420000078/sbux-20200927.htm

https://en.wikipedia.org/wiki/Starbucks

https://in.finance.yahoo.com/quote/SBUX/cash-flow?p=SBUX

https://in.finance.yahoo.com/quote/SBUX/balance-sheet?p=SBUX

https://businessquant.com/starbucks-revenue-by-product

https://www.marketwatch.com/investing/stock/sbux/financials/cash-flow

https://tradingeconomics.com/usgg20y:ind

https://dailycoffeenews.com/2019/10/25/nearly-four-of-every-five-us-coffee-shops-are-now-
starbucks-dunkin-or-jab-brands/

https://www.gurufocus.com/term/ChangeInWorkingCapital/SBUX/Change%252BIn%252
BWorking%252BCapital/Starbucks%2BCorp
 Business Analysis &
ValuationReport
The Coca-Cola Company

Prepared by:
Yuvam Sharma
(2017B3A80309G)
I) Qualitative Analysis
1)Industry Analysis
Threat of New Entrants/Potential Competitors: Medium Pressure
• There are almost no entry barrier present in the beverage industry.
• There is no switching cost for the consumer and the capital requirement is also low
• Loyalty of the customers and the goodwill earned by the company over the years adds
to its strengths even though there is an increase in the number of brand and products
in the market .

Threat of Substitute Products: Medium to High pressure

• There are many similar products (Soda/lime/carbonated drinks) present in the market.
• It is very hard or almost impossible to differentiate between a Cola and a Pepsi in
terms of taste .

The Bargaining Power of Buyers: Low pressure

• There is no individual buyer power presence for Coca – Cola .
• Some big retailers such as Walmart , Big Bazaar have a bit of bargaining power as
they order in large quantities.

The Bargaining Power of Suppliers: Low pressure

• The main ingredient for a soft drink includes sweeteners, carbonated water ,caffeine
etc. Coca Cola can be considered as on of the largest buyer of these supplies hence
diluting any pressure from the suppliers .

Rivalry among Existing Firms: High Pressure

• The main competitor and the other largest manufacturer of carbonated beverages is
PepsiCo which also has it’s wide range of products in the market.
• Some other local country wise beverage companies have tried to compete with them
but have failed miserably and shut down.
• Parle is trying to enter and excel in the beverage market which is dominated by
Coca- cola and Pepsico

Corporate strategy Analysis –

Star: Bottled water brand Kinley (in Asia ) or Dasani (in UK and US ) is the star performer as
the amount of water is directly proportional to the population which is on arise and hence is
the rise in the demand of water . The other star performer of Coca – Cola is the thumbs Up
and the mango fruit drink Maaza .
Cash Cow : The Coca - cola acts as the cash cow for the company as the name suggests and is
being sold in over 200 countries and has been the original and one of the most popular drinks
of coca – cola . The other brand being Limca which is quite old and has seen quite low sale
because of the growing competition from other brands such as Sprite etc.
Dogs: The coca cola Life being launched to target the audience which was conscious about
the health the Diet coke being the special one in this respect. Even after a lot of marketing it
has not been able to rise in the market as expected by the brand.
Question Mark : Minute maid is the biggest brand under this category being popular in some
states while not being able to generate desirable revenue in the others . It faces quite a big
competition from other companies who sell juice and similar products.

Competitive Strategy analysis:-

• The Coca-Cola Company supports the current recommendations of several leading health
authorities, hence is promoting the diet coke which limits the intake of sugar in the body to
around 10% as recommended by the WHO guidelines. that people should limit their intake of
added sugar to no more than 10 percent of their total daily calorie/energy intake.
• It tends to be the most consumer friendly as it became the first company to put their calory
readings on the bottle hence showing the consumer what they are actually consuming .
• Coca Cola is also known for its great marketing capabilities. For generations, it has served great
marketing campaigns that have helped it engage with its customers better. Being it from
Sachin to the latest Virat Kohli they have enticed the consumer with their amazing and
indulging campaigns
• Coca Cola’s large product bench is one of its key strengths. 20 of it’s brands are generating
more than a billion revenue with 16 of them available in the low calorie or the diet variant
Hence targeting the health conscious section of the consumers as well
 II) Quantitative Analysis

Quantitative analysis will be done using ROE Decomposition.

Retention rate = (Net income attributable to shareowners of The Coca - Cola Company –
Dividends) ÷ Net income attributable to shareowners of The Coca - Cola Company
= (8,920 – 6,845) ÷ 8,920 = 0.23

Profit margin = 100 × Net income attributable to shareowners of The Coca-Cola Company ÷ Net
operating revenues
= 100 × 8,920 ÷ 37,266 = 23.94%

Asset turnover = Net operating revenues ÷ Total assets

= 37,266 ÷ 86,381 = 0.43

Financial leverage = Total assets ÷ Equity attributable to shareowners of The Coca - Cola
Company
= 86,381 ÷ 18,981 = 4.55
Quantitative Analysis
Discounted Cash Flow Analysis

I have used the Free cash flow to equity (FCFE) method . There are 3 major calculations in this
method: -

1. Discount Rate
2. Free Cash Flow
3. Growth Rate

I) Discount Cash Flow: - As we are using FCFE we will be using cost of equity as the discount
rate.

Cost of Equity

Cost of equity is calculated by using the formula

rKO = RF + βKO [E(RM) – RF]

where Rf is the risk-free rate and Rm being the expected return on market portfolio.

1 Risk Free rate (Rf) :-

We got the risk-free rate by taking the 20 yr treasury rate which is 1.34
2 Expected Rate of Return on market E (Rm) :-
We calculate the following financial ratios and taking out their averages for past 5 years we
get the table as follows: -

Market portfolio dividend growth rate = Retention rate × Profit margin × Asset turnover ×
Financial leverage
Market portfolio dividend yield = Next year expected market portfolio dividends ÷ Current
market portfolio price
3 Beta(βKO) :- We will find the Beta using the following formula and the data available
βKO = Covariance KO S&P500 / VarianceS&P500
βKO =0.42
Now using the above PRAT model formula we get
II) Free Cash Flow :- Using the formula given below we will calculate the Free cash flow for
Coca-Cola company

Free Cash Flow (FCFE) = Cash Flow from Operations + Tax Adjusted Interest Expense
– CapEx

= 7554 Million USD

III) Growth Rate :- There has been a downfall in the growth of the company because of the
decline in the use of aerated drinks by the people as it is considered harmful for the body
Hence we can see that the retention rate is negative .

i) Now we will calculate the growth rate of the FY20(referred as g5 ) by using the
PRAT/SGR model
g = Retention rate × Profit margin × Asset turnover × Financial leverage
= -21.87%

ii) Now using the Single stage model we will calculate g1

g = 100 × ( r x Equity market value0 – FCFE0) ÷ ( FCFE0 + Equity market value0 )

= 100 × (226,346 × 6.00% – 7,554) ÷ (226,346 + 7,554) = 2.57%
iii) Now using linear interpolation between g1 and g5 we will calculate g2 , g3 , g4

IV) Final Enterprise value (DCF analysis ) :-

Now we will use the above calculated growth rates and free cash flow of the current year to
calculate it for the subsequent year and then discount it with the Discount rate calculated
above as well to finally get the future cash.
Terminal value = FCFE6/ (Cost of capital – g)
Conclusion – Since the current price of Coca-Cola company is more than the intrinsic value
Therefore one should pertain to invest in it .

References and Bibliography

https://en.wikipedia.org/wiki/Coca-Cola
https://www.sec.gov/Archives/edgar/data/21344/000002134416000050/a2015123110-
k.htm
https://www.sec.gov/Archives/edgar/data/21344/000002134417000009/a2016123110-
k.htm
https://www.sec.gov/Archives/edgar/data/21344/000002134418000008/a2017123110-
k.htm
https://www.sec.gov/Archives/edgar/data/21344/000002134419000014/a2018123110-
k.htm
https://www.sec.gov/Archives/edgar/data/21344/000002134420000006/a2019123110-
k.htm
https://in.finance.yahoo.com/quote/KO/cash-flow?p=KO&.tsrc=fin-srch
 TESLA
VALUATION

20/11/2020 MOHIT SAWANE 2018A4PS0632G

TESLA VALUATION BAAV ECON 355 PROJECT REPORT

TESLA VALUATION
MOH IT SAWA N E 2018A4PS0632G

BUSINESS OVERVIEW | QUALITATIVE ANALYSIS

Tesla began as an extravagance vehicle specialty differentiator and is currently driving down the market with
a wide differentiation methodology. The organization utilizes its acquired media and online deals sites to
arrange its marketing effort, while automation, provider relations, and research separate their items. Their
SolarCity securing was a huge move, considering their development into different business sectors, which are
additionally eco-accommodating. Compelling HR and TQM strategies have given the organization an inventive,
persevering society that drives their presentation in the particular business sectors and fields. As financial
achievement furnishes the organization with positive incomes and enormous force, Tesla keeps on pursuing its
central goal: “accelerate the world to sustainable energy.”

Industr y Analysis | Por ter’s 5 Force Model

Tesla Inc's. prosperity as an inventive maker of electric vehicles is mostly founded on its methodologies that
tackle the outside elements in the car business climate, energy storage arrangements market. This Five Forces
Analysis (Porter's model) shows that Tesla competitive rivalry as the most prominent of the powers in its
worldwide business climate. Weights from substitutes, providers and buyers are likewise considered here.

Competitive Rivalry (Strong Force )

Tesla, Inc. works in a highly competitive marketplace. This aspect of the Five Forces Analysis outlines the
influence of competition on the automotive and energy solutions industry environment. –

 Small number of firms (weak force)

 High aggressiveness of firms (strong force)
 Low switching costs (strong force

Bargaining Power of Tesla’s Customers/Buyers (Moderate Force)

The influence of customers on firms and the automotive, battery, and solar panel industry environment is
accounted for in this aspect of the Five Forces Analysis. Tesla’s customers are a direct factor that determines the
company’s sales revenues. The following external factors and their intensities maintain the moderate force of
the bargaining power of customers on the company:
 Low switching costs (strong force)
 Moderate substitute availability (moderate force)
 Low volume of purchases (weak force)

Bargaining Power of Tesla’s Suppliers (Moderate Force)

Tesla Inc.’s suppliers have a low level of forward integration. This external factor refers to suppliers’ limited
control in the distribution and sale of their products.
Page 1
TESLA VALUATION
 Moderate substitute availability (moderate force)

 Low volume of purchases (weak force)

Threat of Substitutes or Substitution (Moderate Force)

Tesla, Inc. experiences the impact of substitutes on the automotive and energy solutions industry environment. In
this aspect of the Five Forces Analysis, the intensities of the external factors that lead to the moderate force of
the threat of substitution against the company are considered, as follows:
 Low switching costs (strong force)
 Moderate substitute availability (moderate force)
 Moderate performance of substitutes (moderate force)

Threat of New Entrants or New Entry (Weak Force)

New entrants are new firms, which impact the industry environment and determine the performance of companies
like Tesla Inc. This aspect of the Five Forces analysis identifies the intensities of the external factors that create
the weak force of the threat of new entry, as follows:
 High cost of brand development (weak force)
 High cost of doing business (weak force)
 High economies of scale (weak force)

Competitive Strategy Analysis

Tesla's competitive strategy is an expansive differentiation to target the two fragments by focusing on premium
purchasers and low-value purchasers in the car business. In view of that conventional technique, Tesla separates
itself among the contenders by expanding and creating venture each year to build up a profoundly inventive
exceptional environment for increasing its returns to an economical scale.

Tesla is perceived to be a high-end disruptor, which means they produce innovations that are difficult to quickly
imitate. Tesla is more selective regarding the markets they choose to compete in than most companies.

Corporate Strategy Analysis

Human resources are utilized to fulfill their strategies for production effectiveness and efficiency through hiring
the people who carry the same vision of the company, having a fast-paced, long hour work environment, intense
recruitment and training process and their continuous expansion worldwide to meet their business objectives.

Maybe no organization on the planet has the view of its image being attached to one individual more than
Tesla Inc. (Tesla) and its CEO and now previous administrator of the board, Elon Musk. As in any event one
writer stated it, "Elon Musk is Tesla. Tesla is Elon Musk." And Musk isn't only the substance of Tesla, however a
prime supporter of PayPal and Solar City, the author and current CEO of SpaceX and organizer of its auxiliary,
The Boring Company. He has created a "genuine Iron Man" persona, including all the unpredictability, and is
without a doubt one of the most unmistakable and polarizing CEOs on the planet.

Page 2
TESLA VALUATION BAAV ECON 355 PROJECT REPORT
PERFORMANCE ANALYSIS | ROE DECOMPOSITION
The investigation of a company’s performance is initiated with the assessment of its Return on Equity (ROE) .
ROE gives a sign of how well directors are utilizing the assets contributed by the association's investors to
create returns. Since quite a while ago run, the estimation of the equity value is controlled by the connection
between its ROE and its cost of equity capital. A correlation of ROE with the cost of capital is helpful not just
for breaking down the estimation of the firm yet in addition in thinking about the way of forward productivity.

ROE Decomposition | Traditional Approach

A company’s ROE is affected by return on assets (ROA) and a measure of financial leverage. ROA indicates
that how profitably firm employs its assets while financial leverage shows that how big the firm’s asset base is
relative to shareholder’ investment.

ROE = ROA * Financial Leverage = (𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 / 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟 ′𝐸𝑞𝑢𝑖𝑡y)

The ROA itself can be decomposed into:

ROA = ROS * Asset Turnover = (𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒/𝑆𝑎𝑙𝑒𝑠) *(𝑆𝑎𝑙𝑒𝑠/ 𝐴𝑠𝑠𝑒𝑡𝑠)
ROE = ROS * Asset turnover * Financial leverage
Where,
Financial Leverage = Total Assets / Shareholders Equity
Asset Turnover Ratio = Sales / Total Assets
ROS = Net Income / Sales

2020 2019 2018 2017

6.27% 0.33% -1.18% -14%
ROS
82.12% 82.64% 74.89% 51.88%
Asset Turnover
Ratio
5.18 6.04 6.76 4.77
Financial
Leverage
ROE 26.68% 1.62% -5.97% -34.34%

 ROE has been steadily increasing since the past few years, indicating that the firm is successful
at using the shareholder’s equity to generate profits at a very high growth rate.
 The Asset turnover ratio is increasing too, signaling increased productivity and sales.
 The firm’s capital structure is though dominated by equity shareholders, it has a good leverage
ratio.

Page 3
TESLA VALUATION

DCF VALUATION | FREE CASH FLOW APPROACH

We use Discounted cash flow valuation to get the intrinsic value, which we get by discounting the expected cash
flows, with either the cash flows or the discount rate adjusted to reflect the risk. Since we are interested in
valuing the firm and also after having a look at the financial leverage of Tesla we notice that the Debt Ratio
was quite high during beginning but as the firm started to raise more equity, the debts leverage has fallen
significantly and this pushes us to use the FCFF ( Free
Cash Flow to Firm) approach.

Since Tesla is young and growing at a very high rate

(> Overall growth rate + 10%) and has significant
barriers to entry into the business with characteristics
that are very different from the normal. We use the 3-
stage model, having a high growth, transition and a
stable growth period.

We make an estimate of the free cash flows to the firm,

by getting the operating income or EBIT from the income statement FY 2020 (TTM) and adjusting it for Tax
Expenses, Capital Expenditure, Depreciation & Amortization and changes in non-cash working capital.

FCFF = EBIT(1-t) – (capital expenditures – depreciation) – (change in noncash working capital)

Average Marginal Tax rate for the Auto-Tech Industry we assume as 25%.
Also we need to adjust After Tax Operating Income for capitalizing R&D Expenses and adjusting for its
amortization this year, in the process we get a tax-benefit = (Current Year R&D Expense- Amortized Research
Asset) * Tax Rate. Thus the adjusted after tax operating income becomes = (Operating earnings+ Current
Year R&D Expense- Amortized Research Asset)*(1-Tax Rate) + R&D Tax Benefit.
Current Year’s R&D Expenses = $1,343.00

Year R&D Unamortized Value Amortization

Expense portion this year Year R& D
Current 1343.00 1.00 1343.00 Expenses
-1.00 1460.40 0.80 1168.32 292.08 -1 1460.40
-2.00 1378.10 0.60 826.86 275.62 -2 1378.10
-3.00 834.40 0.40 333.76 166.88 -3 834.40
-4.00 717.90 0.20 143.58 143.58 -4 717.90
-5.00 464.70 0.00 0.00 92.94 -5 464.70
Value of Research Asset 3815.52 971.10
Amortization of asset for current year = 971.10
Adjustment to Operating Income = $371.90
Tax Benefit of R&D Expensing = $93

We calculate the Reinvestment rate which is the ratio of retained earnings to that of current earnings as -
Reinvestment rate = {(capital expenditures – depreciation) +(change in noncash working capital)} ÷ {EBIT(1-
t)}

The Return on Invested Capital is calculated as Net Earnings by the Total Book Value of Debt plus Equity.
Page 4
TESLA VALUATION BAAV ECON 355 PROJECT REPORT
ROC = {EBIT(1-t)} ÷ {BV of debt + BV of equity}

The rate at which the earnings or the firm is growing currently is given by –
Current Growth Rate in EBIT = Reinvestment rate* ROC

Figures in million USD* Base Year

2019 2018 2017 2016 2015
Revenues $ $ $ $ $
24,578.00 21,461.27 11,758.75 7,000.13 4,046.03
EBIT(Operating $ $ $ $ $
Income) (69.00) (388.07) (1,632.09) (667.34) (716.63)
Adjusted Operating $ $ $ $ $
Income* 302.90 (388.07) (1,632.09) (667.34) (716.63)
Marginal Tax Rate* $ $ $ $ $
0.25 0.25 0.25 0.25 0.25
EBIT(1-t) + RnD Tax $ $ $ $ $
Benefit 320.18 (291.05) (1,224.07) (500.51) (537.47)
Capital Expenditures $ $ $ $ $
1,437.00 2,319.52 (4,081.35) (1,440.47) (1,634.85)
Depreciation $ $ $ $ $
2,154.00 1,901.05 1,636.00 947.10 422.59
Non-cash items $ $ $ $ $
1,375.00 1,201.38 1,040.52 395.98 434.86
Change in Net working $ $ $ $ $
Capital (349.00) 57.95 (496.60) (693.86) (493.29)

Free Cash Flow to $ $ $ $ $

Firm 2,761.18 433.91 6,030.40 2,976.91 2,448.12

Reinvestment rate 97% 249% 593% 695% 555%

Total Long-Term Debt $ $ $ $ $

11,634.00 9,403.67 9,418.39 5,978.28 2,068.38
BV of Equity $ $ $ $ $
6,618.00 4,923.24 4,237.24 4,752.91 1,083.70
ROC 1.75%
Current Growth Rate 1.69%

Cost of Equity = R.f.r + Beta*(ERP) R.fr = 1.75% , ERP = 5.33% (US Market Risk Premium), CAPM

Using a bottom up multi-business beta approach we get the weighted average unlevered beta of the firm.

Business Revenues EV/Sales Estimated Value Unlevered Beta

Auto & Truck $ 4,217.00 0.9044 $ 3,813.87 0.8541
Green & Renewable Energy $ 325.00 6.7575 $ 2,196.19 0.5867
Firm $ 4,542.00 $ 6,010.07 0.7564

Page 5
 TESLA VALUATION

Levered Beta of firm = Unlevered Beta*(1+(1-t)*(D/E)) = 0.84 D/E = 1.5, t = 0.25

C.O.E = 1.75% + 0.84*5.33% = 6.23%
Actual Rating of Tesla is BB by S&P Moody’s, therefore After-Tax Cost of Debt = 4.15%*(1-0.25) = 3.11%
We use WACC (Weighted average Cost of Capital), as the constant discounting rate for our free cash flows
to the firm. WACC = We*Ke + Wd*Kd(*1-t)

Equity Debt Preferred Capital

Stock
Market Value $ $ $ $
102,837.00 15,062.20 - 117,899.20
Weight in Cost of Capital 87.22% 12.78% 0.00% 100.00%
Cost of Component 6.23% 3.11% 7.14% 5.83%

Therefore the WACC is 5.83% , which we use as the discounting rate, for all 3 periods.
Now that we have the free cash flow for the base year we project it for the high growth & transition period
using corresponding projected after tax adjusted operating income, reinvestment rates calculated from
expected growth rates and ROC for each year.
The Automobile industry average ROC is around 18%, which we assume Tesla to achieve in the next 5
years from the current ROC of 1.75%, after which remains at 18% at perpetuity.
At the same time, since the profitability as well as the revenues of the firm will increase over the next 5 years,
due to the continuous economies of scale and brand, growth in E-V Market, environmental policy benefits over
cleaner automobiles, Tesla’s early moves and expansion plans, we would expect the Growth Rate in operating
income to increase as a result, till it reaches a 12% at the end of 5 years, and 2% at perpetuity for a stable
firm. Years 5-10 are the transition period years.
Using the below relation, we calculate the required projected reinvestment rates-
Expected growth rate = ROCtarget * Reinvestment rate + [(RoC target / RoC current) ^1/n -1]
Figures in 1million 0 1 2 3 4 5 6 7 8 9 10
USD*
Projected ROC 1.75 5.00 8.25 11.5 14.7 18.0 18% 18% 18% 18% 18%
% % % 0% 5% 0%
Expected Growth 1.69 3.75 5.81 7.88 9.94 12.0 10% 8% 6% 4% 2%
Rate % % % % % 0%
Reinvestment 97% 75.0 70.4 68.4 67.3 66.6 55.6 44.4 33.3 22.2 11.1%
Rate 4% 7% 9% 8% 7% % % % %
EBIT(1-T) + RnD 320. 332. 371. 466. 682. 1202 1322 1402 1431 1406 1327.171
Tax benefit 175 188 9377 9224 0811 .06 .266 .083 .673 .24
FCFF 2761 82.9 109. 147. 222. 400. 587. 778. 954. 1093 1179.708
.175 1412 823 1414 5203 6866 6737 9348 4484 .742
WACC 5.83 5.83 5.83 5.83 5.83 5.83 5.83 5.83 5.83 5.83 5.83%
% % % % % % % % % %

PV of FCFF 2761 78.3 98.0 124. 177. 301. 418. 523. 606. 656. 669.5217
.175 4793 5992 1458 4049 8561 341 9553 659 9105
Total 6416.377

Page 6
TESLA VALUATION BAAV ECON 355 PROJECT REPORT
Stable Growth Period
Stabe Equity Reinvestment rate 10.00%
Stable Expected growth rate 2.00%
WACC 5.83%

Expected Operating Income in 11th year 1353.715

T.V @ t = 10 31810.53
PV of TV 18050.24

Value of Equity $24466.61 this is Value of Equity in operating

assets
-Debt 11634
+Cash & Marketable securities 6514
Value of Equity 19346.61
Outstanding Shares 177
Value of Equity per share traded $109.3029 Value of equity per share

The stock price has rallied since the beginning of FY 2020, starting around $85. Since our valuation is based
on FY 2019 as the base year and suggests the Value of equity per share as $109 then. Therefore we conclude
that Tesla was undervalued at the beginning of FY 2020, but since then the stock price has rallied up to $500
per share suggesting that the company is doing really well with all the positive sentiments and a dominating
future ahead.

References.
https://finance.yahoo.com/quote/TSLA/balance-sheet?p=TSLA
https://in.investing.com/equities/tesla-motors-cash-flow
https://in.investing.com/equities/tesla-motors-income-statement
http://www.investorsgrow.com/
https://www.fastcompany.com/90435100/elon-musks-chaotic-business-strategy-for-tesla-is-actually-brilliant
https://ir.tesla.com/contact-us#item-does-tesla-pay-a-div-control
https://www.duffandphelps.com/insights/publications/cost-of-capital/us-equity-risk-premium-increased-
march-25-2020

“Valuation Approaches and Metrics: A Survey of the Theory and Evidence”, Aswath Damodaran
NYU. (n.d.). NYU-Stern. From http://people.stern.nyu.edu/adamodar/pdfiles/ovhds
NYU. (n.d.). NYU-Stern. - http://pages.stern.nyu.edu/~adamodar/pdfiles/eqnotes/dcfall2pgOld.pdf

Page 7
TESLA VALUATION

Page 8