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Dell, Inc.

Cade Carpenter – cade.carpenter@ttu.edu

Chris Fink – chris.fink@ttu.edu

Peyton Harris – peyton.harris@ttu.edu

Josh Jacobsen – joshua.jacobsen@ttu.edu

Carly Moore – carly.moore@ttu.edu

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Table of Contents

Executive Summary 1

Overview of Firm 6

Business and Industry Analysis 8

Industry Overview 8

The Five Forces Model 8

Rivalry among Existing Firms 9

Industry Growth Rate 10

Concentration and Balance of Competitors 11

Degree of Differentiation 12

Switching Costs 13

Scale of Economies 13

Ratio of Fixed to Variable Costs 13

Excess Capacity 14

Exit Barriers 15

Threat of New Entrants 15

Economies of Scale 16

First Mover Advantage 17

Access to Channels of Distribution 18

Legal Barriers 19

Threat of Substitute Products 20

Relative Price & Performance 20

Buyer’s Willingness to Switch 21

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Bargaining Power of Customers 23

Price Sensitivity 23

Relative Bargaining Power 24

Bargaining Power of Suppliers 24

Value Creation Analysis 26

Economies of Scale 26

Superior Product Quality & Product Variety 27

Research & Development 27

Brand Image 27

Competitive Advantages of the Firm 29

Formal Accounting Analysis 32

Key Accounting Policies 32

Revenue Recognition 33

Cost Control 33

Operating & Capital Leases 34

Research & Development 35

Accounting Flexibility 36

Research & Development 37

Operating & Capital Leases 37

Revenue Recognition 38

Pension Plans 39

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Accounting Strategy 40

Research & Development 40

Operating & Capital Leases 41

Pension Plans 42

Cost Control 43

Evaluating Quality of Disclosure 44

Quantitative Disclosure 44

Problems & How They Solve Them 45

Investor Relations 46

Business Strategy Disclosure 47

Explanation of Trends in Revenue & Expenses 47

Qualitative Disclosure 48

Core Sales Manipulation Diagnostics 49

Core Expenses Diagnostics Manipulation 52

Potential Red Flags and Undoing Distortions 55

Financial Analysis, Forecasts, Cost of Capital Estimation 56

Liquidity Analysis 56

Current Ratio 57

Quick Asset Ratio 58

Accounts Receivable Turnover 59

Days’ Supply of Receivables 60

Inventory Turnover 61

Day’s Supply of Inventory 62

Cash-to-Cash Cycle 63

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Profitability Ratio Analysis 64

Gross Profit Margin 64

Net Profit Margin 65

Asset Turnover 66

Return on Assets and Equity 67

Capital Structure Analysis 69

Growth Rate Analysis 71

Financial Statement Forecasting 72

Income Statement 73

Balance Sheet 77

Statement of Cash Flow 81

Cost of Capital Estimation 81

Cost of Equity 81

Cost of Debt 84

Weighted Average Cost of Capital 85

Valuation Analysis 87

Method of Comparables 87

Residual Income 92

Long Run Residual Income 92

Abnormal Earning Growth 95

Free Cash Flow 97 Appendices 99

References 116

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Executive Summary

Overvalued, Sell April 1, 2008 DELL- NASDAQ (Apr.1,2008) $20.33 Altman's Z-Score

52 Week Range: $18.87- $30.77 2003 2004 2005 2006 2007

Revenue: 61.13B 5.66 5.21 5.05 5.26 4.84 Market Capitalization: 45.19B Shares Outstanding: 2.22B Valuation Estimates Percent Institutional Ownership: 74.70% Actual Price (Apr.1, 2008) $20.33 Book Value per Share: 1.83 ROE: 68.09% Financial Based Estimates ROA: 11.50% Trailing P/E: $21.67 Forward P/E: $22.11 Cost of Capital Estimate: R^2 Beta Ke PEG: $9.32 3 month 32.96% 1.84 13.51% P/B: $8.32 6 month 33.02% 1.84 13.68% P/EBITDA: $39.13 2 year 33.02% 1.83 13.71% P/FCF: $48.14 5 year 32.96% 1.82 14.50% Enterprise Value/EBITDA: $41.91 10 year 32.94% 1.82 15.47% Intrinsic Valuations Published Beta: 1.53 Dividend Discount: N/A Kd: 3.99% Free Cash Flow: $16.57 WACC BT: 10.28% Residual Income: $4.51

WACC AT: 9.95% Long Run Return on Equity: $5.24

Abnormal Earnings Growth: $0.64

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Industry Analysis

Dell is a technology company that produces personal and professional computer

systems utilizing an unrivaled direct to consumer business model. Dell’s main

competitors vary in size and business objectives. Competitors include Apple, Hewlett-

Packard, and International Business Machines (IBM). Dell competes in different sectors

with all of these companies from mp3 players to large business servers. These

companies compete on economies of scale, product quality and variety, brand image,

and research and development to become the industry leaders. There is constant

change and innovation in the technology sector forcing companies to invest largely in

research and development. In 2007 alone, these four companies invested over $11

billion dollars into R&D. Economies of scale is also a huge factor in the technology

sector. Large companies like Dell have developed relationships with suppliers and

distributors that allow them to dictate price and delivery options due to such mass

ordering. This also produces a problem for new entrants into the market due to the

large amount of capital required for start up. Firms also compete largely on product

superiority and functionality, the public demands constant innovations in technology

and products. A company’s products and technologies set them apart from their

competitors and help control their market share. Finally brand image is an important

part of any company. In recent years this has become increasingly important with

global trading and the demand for more eco-friendly production facilities.

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Accounting Analysis

In performing an accounting analysis we examined Dell and its main competitor’s

annual 10-k financial reports to compare the different companies. Company’s 10-k

information is based on their yearly or quarterly accounting information. There are

degrees of accounting flexibility allowing companies to report conservatively or

aggressively altering the value of the firm. When valuing a firm it is important to take

accounting procedures into account when truly valuing a firm. Companies accounting

policies should reinforce its key success factors. Dell’s key accounting polices include

cost control, accounting for operating and capital leases, calculation of pension plans,

and recording research and development (R&D) costs.

When analyzing accounting flexibility analysts and companies have to follow law

determined by generally accepted accounting procedures or GAAP. GAAP offers no

flexibility in the recording of R&D; it must be expensed as incurred. GAAP does allow

firms to estimate their own pension plan and discount rates which if overstated can

cause an understated pension expense and vise versa. For operating/capital leases and

pension plans GAAP allows much more flexibility compared to R&D and other expenses.

After analyzing Dell and its competitors we can conclude that all the companies

have different methods and intentions for annual reporting. Dell puts a larger emphasis

on cost control and R&D than other key accounting policies. These sections of their

financial reports were more detailed and conclusive compared to lease and pension

plans sections. IBM and HP are much larger companies than Apple causing there to be

distortions between those companies’ financials. When we started to analyze these four

companies we thought they were each others main competitors in the technology

sector. After analyzing Dell, Apple, IBM and HP we can conclude that these companies

are really nothing alike. They all operate business in different ways changing them

drastically in comparative models, Apple in particular.

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Financial Analysis, Forecasting, and Cost of Capital

When valuing a firm one must look at the ratio’s calculated and used by analysts

to understand a company inside and out. These ratios consist of liquidity, profitability,

and capital structure. The second step in valuing a company is forecasting financial

statements out a significant amount of years or 10 years in our case. By running theses

ratios and forecasts we are able to take current conditions and forecast values

accurately into the future. The forecasts and ratios are also used in valuations of Dell’s

stock price determining whether it is fairly, under or overvalued. Cost of equity, cost of

debt, and weighted average cost of capital are also used in intrinsic valuations.

After calculating the ratios for all four companies we noticed that the companies

were similar in some areas and in some cases extremely different. Most of the major

differences resulted from Apple; they are a completely different and much smaller

company compared to IBM, HP and Dell. This hurt when it came to comparing some of

the ratios, Apple numbers would have to be taken out to make reasonable assumptions.

We then forecasted the financial statements for the next ten years in order to

provide statistical data for intrinsic valuations. There are several forecasts that provide

analysts necessary information to value a company. We forecasted out net income,

CFFI, CFFO, book value of equity, and retained earnings. These ratios are considered

the future cash flows to the firms which will then be discounted back in time to

calculate the net present value. Discount rates are calculated by calculating cost of

debt, cost of equity, and weighted average cost of capital. Once these figures are

calculates they are used as the discount rate to find the present value factors. Using

proven analytic techniques consisting of weighted averages and linear regressions we

were able to estimate accurate comparative values for Dell as of April, 1 2008.

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Valuations Analysis

Financial valuations are the most important and significant part of the equity

analysis. Utilizing the method of comparables and intrinsic valuation models we are able

to very accurately value Dell and its competitors. These valuation numbers truly portray

whether a company is fairly, over or undervalued. Valuations main point is to provide

information to analysts and the public to make well educated investment decisions.

The methods of comparables are tools based on financial ratios that value the

firm based on 7 different aspects. Using these methods we found that the value of the

firm could not be appropriately estimated using these ratios due to such differing

numbers. We calculated trailing price to earnings, forward price to earnings, price to

book, P.E.G., price over EBITDA, price over free cash flows, and enterprise value over

EBITDA. When calculating these values we found that trailing and forward price to

earnings gave Dell a fair value while price to book and the P.E.G ratios undervalued

Dell. All other valuations calculated Dell as overvalued.

Intrinsic valuations are normally a better valuation model compared to the

method of comparables. Intrinsic values include free cash flow, residual income,

abnormal earning growth and, long run residual income. When using these evaluations

we were able to get much more reliable values. When using intrinsic values all values

proved Dell to be overvalued. Given our research and proven values Dell is overvalued

and should be sold.

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Overview of Firm

Dell, Inc. is one of the leading technology companies in the world. It was

founded in 1984 and is headquartered in Round Rock, Texas. Dell boasts the largest

market share within the United States in the personal computing industry and the

second largest share worldwide. In an industry dependant on innovation and constant

consumer feedback, Dell strives to attain a more personal customer relationship than its

competitors. This is achieved through its direct business model, which provides its

customers a way to interact directly with Dell to tailor each computer to their needs.

Although historically Dell has sold most of its PCs directly to the customer through its

online customization and over-the-phone ordering, Dell has explored new outlets for its

products, most recently placing its products for sale in retail outlets such as Best Buy

and Wal-Mart. A large portion of Dell’s computer sales come from customization of

business and educational institution orders. Dell focuses on selling laptops, desktops,

servers, storage, networking, printers, televisions, software, and accessories. In

addition to these products, Dell provides services such as information technology

management and software support.

In fiscal year ending February 2, 2007 Dell reported sales of $57.4 billion.

Although net income experienced a slight decline from 2006 to 2007, gross revenue

was up 3% on increased sales and an industry record 39.1 million shipments in the

2006 calendar year.1 Dell has experienced an incredible 62.2% increase in revenue up

from $35.4 billion in 2003. The market capitalization of the firms within the industry

vary from Dell, whose market cap is $45.78 billion, to IBM which holds a $146.85 billion

market cap.1 Over the last five years Dell’s stock price has generally moved in

accordance with the firm’s performance. The stock has varied in price from $21.61 to

$42.57 over the last five years.2 Also; the total assets of Dell have increased

tremendously over the last five years ranging from $15.4 billion in 2003 to $25.6 billion

in 2007.

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2003 2004 2005 2006 2007 Total Sales (mil) $35,404.00 $41,444.00 $49,121.00 $55,788.00 $57,420.00

Total Assets (mil) $15,470.00 $19,311.00 $23,215.00 $23,252.00 $25,635.00 Market

Capitalization $61,534.94 $85,472.64 $102,034.10 $68,175.80 $45,780.00 This is a snapshot of Dell’s total sales, total assets, and market capitalizations for the

past five years.

www.moneycentral.msn.com

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Business and Industry Analysis

Industry Overview

The technology industry, specifically personal computers, has experienced

exponential growth over the last 30 years. The berth of the technology industry came

when computers were primarily used for business database storage. Initially, few

technology firms dominated the industry because it was so expensive to compete in.

Over time the technology became more affordable to produce allowing new firms to

enter the industry. These firms brought new ideas to the industry that transformed the

computer from the enormous primitive mainframe into the mobile personal computer

we know today.

The Five Forces Model

According to Michael Porter, there are five forces which classify and analyze the

industry in which a company competes. He created a diagram to illustrate this, simply

named The Five Forces Model. This mechanism gives a comprehensive analysis of an

industry and the competitiveness of the firms within it. The five forces model is

comprised of factors that determine the ability of a firm to get a better understanding

of the industry they compete in and their ability to make a profit. The model is divided

into two sections: the degree of actual and potential competition and the bargaining

power in input and output markets. The former consists of rivalry among existing firms,

threat of new entrants, and threat of substitute products. The latter consists of

bargaining power of customers and bargaining power of suppliers. A large portion of

competition in the technology industry is base on Hewlett-Packard, Dell, IBM, and

Apple. These four firms attempt to gain as much market share as possible each year.

Most of these firms thrive on coming out with new innovative products that excite

customers. A great example of this is when Apple has come out with all of their

different “i” products, starting with the iPod. IBM has continued to maintain their

expertise in the computer mainframe industry while HP continues to contain a small

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portion of each product in the technology industry. Dell competes on the basis of

customization along with customer service. Dell allows customers to order and select

exactly which computer they want along with the accessories. Overall, each of these

companies’ goals are to follow their business strategy as close as possible and continue

to grow their market share each year.

Five Forces Level Of Competition Rivalry Among Existing Firms Moderate

Threat of New Entrants Low Threat of Substitute Products Moderate Bargaining Power of Buyers Moderate

Bargaining Power of Suppliers Moderate OVERALL Moderate

Rivalry Among Existing Firms

Rivalry within the personal computer industry is becoming more and more

competitive as time passes and the consumer becomes more aware of their technology

needs. One of the most obvious competitive factors within the industry is price.

Technology firms are well aware of their market’s purchasing power; that being the

case, they strive to manufacture a product that will meet the value standards which the

consumer holds while maintaining a pricing structure that is affordable. It is important

that firms find a way to stand out in the industry and make themselves different. If

they want to have a successful firm they have to hold on to the market share they

currently have and continue to find a way to gain new market share. If the industry is

growing then firms can each take the new consumers in the market; however, if the

market is not growing firms are forced to steal from each other in order to grow.

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Industry Growth Rate

The industry growth rate will assist in determining if a firm can expect to grow in

the market. One of the most important factors to a firm’s growth rate is trying to retain

all of the current customers that you have. If a firm is able to effectively retain current

customers then they can have a goal to attain a portion of the new market and/or

existing customers of other clients. During a tight market, taking care of customers

could be vital in retaining and attaining customers.

Growth in the technology industry has continued to increase over the last few

years. The percentages in the graph are based on total revenues of the industry.

When referring to industry, this refers to IBM, Apple, Hp, and Dell. As the graph

shows, there was a decline in the industry growth from 2003 until 2005. Since then the

industry has grown from 6.62% in 2005 to 10.19% in 2007. However, analysts are

predicting that these growths will slow down in 2008. If these predictions turn out to

be true then this will cause little room for firms to enter the industry; therefore,

increasing competition among existing firms which makes new and innovative ideas

vital to the success of individual firms.

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Concentration and Balance of Competitors

While IBM has been the cornerstone for the technology industry over the past

thirty years, the dynamic changes in the industry have caused a shift in power. The

globalization of the personal computer industry has required a new way of competitive

thinking. This has led to the decentralization of the past technology leaders allowing

firms like Dell, HP Compaq, and Apple to fill in the gaps left by the firms structured for

the consumer of the past. Dell’s innovative customer-first thinking has allowed it to

evolve into the leading market share holder of firms in North America; this is according

to research by Forrester.1 More recently the industry has been marked by a balance of

competition between the top firms. If you refer to the chart above you will see that IBM

led for most years but HP, Dell, and Apple took some of the market share each year.

All of the industry’s firms have done a great job of maintaining a moderate competition

level and competing for market share in the industry. This balance of competition is

proving to be beneficial to both the firms and the consumers. Because there are only a

handful of firms which produce the type of product which are in high demand it allows

them to avoid large destructive price competition.3 Similar to the unspoken agreement

between companies like Coca-Cola and Pepsi whom maintain a certain competition level

without entering into a price-war with each other.

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Concentration of the industry can be calculated by the number of firms in an

industry and their relative sizes. There is an index called the Herfindahl-Hirschman

Index (HHI) that is used by the U.S. Department of Justice and the Federal Trade

Commission to measure an industry’s concentration.3 The concentration is calculated by

summing the squares of the individual market shares of all the participants. According

to the Department of Justice, a market that has an HHI of 1,800 or above is considered

to be highly concentrated. When comparing Dell, HP Compaq, IBM, and Apple the HHI

comes out to 3,028.4 According to the HHI Index, the industry is highly concentrated

and there is moderate competition among firms.

Degree of Differentiation

It is important to set yourself apart from other firms in the industry by

differentiating yourself in a unique way. In the personal computer industry switching

costs are low and make price competition a regular occurrence. Each firm has to figure

out how they can set themselves apart from others. Dell competes on the fact that they

will custom-build your computer and have it at your doorstep in ten days or less.

(dell.com) By cutting out the middleman they are able to sell their product at a cheaper

price to the consumer. An example of a way that firms like to differentiate themselves

is by coming out with a new innovative product. A great example of this is the Apple

iPod. Apple branded their product very well and set themselves apart in the music

player industry. Apple found features that consumers wanted and continued to improve

them and keep their customers happy. In order to survive in a market as competitive

as it is today, it is important to tweak your business strategy around your special skills

and knowledge. By having a diverse employee base for specialization in separate

areas, this will help companies ensure that they set themselves apart from the pack and

continue to be different than their competitors. With that being said, the technology

industry has a highly competitive market as far as differentiation goes. Customers want

that new, hot item or the product that performs better.

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Switching Costs

It is important to estimate how much it would cost; as well as, if a firm would be

able to do something else. This is referred to as switching costs. Companies in the

technology industry would have a difficult time attempting to do something else. Most

firms have the warehouse and buildings that would allow them to do something

different; however, they have a large amount of machinery that is worth lots of money.

The amount of money these firms have invested makes it tough for them to decide one

day to pack it up. Switching costs are high also due to Research and Development.

Firms invest a large sum of money each year into R&D in order to try to keep an edge

in the future. Overall, the technology industry has moderate competition due to the

fact that there are high switching costs.

Scale of Economies

The economies of scale in the technology industry are very large because these

firms have to constantly spend money to be innovative in the industry. Research and

development for all firms in the personal computer industry is a very high cost due to

the fact that they must have an advantage on what the next product in the market will

be. It is important to be constantly making current products and future products more

efficient. The consumers are always looking for the firm that comes out with the new

innovative product.

Ratio of Fixed to Variable Costs

Dell has low fixed to variable costs because they outsource most of their

products. Therefore, you don’t have to lower your price if sales decrease. Research and

development is the main way that firms are able to achieve these goals. If you refer to

the chart below you will see the large amounts of money that these firms spend on

Research and Development each year. This shows just how important this category is

to firms. R&D is tough for some to justify, however, R&D is what gets you into the next

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innovative product. R&D is what helps these firms to compete on a moderate level and

stay successful.

Excess Capacity

When the capacity of an industry becomes larger than the demand of the

customers, firms are forced to cut prices to attempt to fill the capacity. So far, the

technology industry has been fairly successful at keeping from getting an excess

capacity. Everyone from families to businesses have continued to become more and

more reliable on computers and products from this industry. The main time that they

have a problem with capacity is when a new product comes out and customers decide

to switch to the new one, leaving a large supply of inventory from the older product.

One benefit to the computer and electronics industry is that most firms outsource their

products and do not have to worry about excess capacity. They, for the most part, can

prevent themselves from becoming stuck with lots of inventory. Many of them are very

cautious when ordering inventory to make sure that they are not stuck with an obsolete

product. Therefore, management is keeping a close eye on the industry and market to

make sure they know when the capacity and demand are off balance.

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Exit Barriers

Exit barriers are high in this industry as it is tough for firms to pack up and

switch industries. Many firms have a lot of money invested in Research and

Development that will help them over the next few years. As said before, most firms

have the property and warehouse space available to switch industries, but they have

too much invested in their large machinery and equipment. It would be hard to justify

leaving this information behind and switching products.

Conclusion: Rivalry Among Existing Firms

The rivalry among the firms in this industry represents moderate competition.

When considering Research and Development economies of scale are very high.

Switching costs are also high due to Research and Development. In correlation to the

fact that firms outsource a lot of their products excess capacity is not much of a

problem. There are not many new entrants to the market due to the fact that it is

tough to establish yourself in this industry. This industry is also highly concentrated

creating a moderate competition. Overall, the rivalry among existing firms section has

a moderate competition level.

Threat of new entrants

Within the personal computer market there are only a few very established

companies that consume a large part of the market share. These companies are: Dell,

HP Compaq, and Gateway. These companies have a large economies of scale in the

personal computer market, which limits new entrants. The large economies of scale

make it almost impossible for any new start-up companies to gain any type of market

share. A new company would need to have an incredible amount of capital and

financial backing in order to try and compete with the well-established market leaders.

In the computer market there are basically three main operating systems offered on

computers: Microsoft’s Windows, Apple’s Mac OS X and Oracle; although Oracle is

mainly only used in the business world. A new company would have to create

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competitive software that is a step ahead of the ever changing technological world

within the computer software market. Aside from all those problems a new company

would have numerous legal hurdles to pass in the form of patents. The market leaders

have hundreds, if not thousands, of patients on their products and technologies. New

start up companies would have to create and develop new and unique technologies to

be able to compete; which again means that new companies would need substantial

capital to start up.

Economies of Scale

The technology industry is dominated by large companies that have substantial

capital backing, extensive research, development, and established production facilities.

Economies of scale are a huge benefit to these large companies and a giant road block

for smaller companies. Small companies wanting to enter the technology industry face

many different problems. The biggest decision for new companies is deciding on the

amount of initial capital needed to compete. Too much or too little capital could lead to

the downfall of a company. They would also have to get companies to invest in the

area where most companies spend a large part of their budget, technology.

Companies are always looking to decrease spending so a new company would have to

be on the leading front of innovation and price. Given all this, the technology industry

is one of the most impenetrable industries to date.

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First Mover advantage

Some companies exercise a first mover advantage in order to keep them on the

cutting edge. One important factor is attempting to be the biggest computer supplier in

the world by thriving on exceptional customer service and some of the lowest prices in

the industry as a couple of examples.

One of the biggest reasons that a business model can be successful is by having

a complex network of distribution centers and shipping points. This system allows

customization of every computer ordered and the ability to deliver them with the fastest

turnaround in the industry. Dell turns over inventory every six days on average,

keeping related costs low. No other business or company has been able to replicate

Dell’s network of shipping points or customization options.

All these reasons have allowed companies to be constantly increasing their

worldwide market share in the technology sector. Another first mover advantage most

of the technology industry has on its side is patents. Almost every product that is

produced has a patent or copy write of some kind.

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Companies also spend huge amounts of money on research and development.

The Technology sector spent several hundred billion dollars on research and

development in fiscal year 2007. This investment allows companies to stay at the top of

new developments and technologies keeping them atop of their technology sectors.

Dell spent nearly half a billion dollars on R&D last year. The investment in R&D is

necessary for any company involved in technology. There is new innovations everyday

and developing the newest technology and software can make or break a companies

cash flows.

Access to Channels of Distribution and Relationships

Companies’ ability to get their raw materials and ship finished products is crucial

in making a profitable company. Many companies get parts and products from all over

the world to make their products. Almost all companies utilize some kind of just-in-time

or JIT inventories. Using JIT inventories requires having a successful and strong

relationship with suppliers and distributors. Using a just-in-time inventory system keeps

inventory and raw material costs at a minimum adding profit to the entire company.

This would not be possible without the participation of its thousands of strategic

shipping and distribution points through out the world. These different shipping points

rely on data from Dell research and their own forecasts to estimate how much product

to have on hand or in transit to again, keep costs down and still get orders out

efficiently. Dell has applied this to single consumer and large industry orders alike. The

direct business model also eliminates retailers and middlemen reducing costs which Dell

has been passing on to its customers for years and continues to be a low cost leader.

Another reason for most companies success is their strong partnerships with

some of the largest technology companies in the business including. Having partners

who are the leaders of different sectors in the technology world, benefit companies

tremendously. Microsoft and Intel are two of the biggest worldwide technology

companies with production facilities located in many different countries. Most of these

companies have world wide facilities allowing for easier shipping of components on a

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global scale. Many of these suppliers actually change how and where they supply

products because large companies like Dell and HP are their biggest customers. Many

of these crucial partnerships in the technology industry have been around for years

giving the companies bargaining power. With those relationships bargaining power top

companies get the lowest price available, once again reducing cost and saving

customers money.

Legal Barriers

The technology industry has become a worldwide business and doing business

internationally can be very complicated. Laws change dramatically from country to

country. Government agencies have placed limitations on business between countries.

Companies trying to enter the market would have difficulties knowing the current

policies in place since they are ever changing. Also companies have patents on almost

everything they produce stopping any business trying to copy their products.

Companies dealing largely with US government agencies are restricted from dealing

with countries supporting terrorism. The US also has historically had trade problems

with different countries, stopping new companies in the US from trading worldwide.

Many of the industry leaders have found gotten around this by opening production

facilities around the world.

Conclusion: Threat of New Entrants

The low amount of competition in the technology industry makes it difficult for

new companies to enter the market and be successful. There are many barriers

stopping these new companies including economies of scale, first mover advantages,

access to channels of distribution and relationships, as well as legal barriers. The

Technology industry adds to these barriers by spending billions of dollars or research

and development to stay on the cutting edge of technology. New companies

production abilities would not be able to compete on the large scale of current

companies, forcing them to try and compete in different sectors or regions. Established

companies also have long term relationships with their suppliers allowing them the best

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prices. Even with the low amount of competitors in technology there is still competition

to be the low price leader; adding to need of strong supplier relations. Legal barriers

are the final road block for new companies; not meeting the necessary regulations can

cause serious legal problems with sever repercussions. Aside from the barriers listed

above the industry leaders have the capital and resources to stop any new company if

they so wanted to. Overall the threat of new entrants affecting the technology market

is minimal.

Threat of Substitute Products

The threat of substitute products greatly impacts the computer and electronics

industry on several levels. The products these firms produce complete the same task

and fulfill a general technology need for the consumer. For example, a laptop with the

same components, regardless of its manufacturer, should theoretically have similar

capabilities and functionality. Therefore, firms consistently compete on more than just

price. The consumer bases purchasing decisions on a combination of need, price,

quality, and ultimately value.

Relative Price & Performance

Consumers more and more are looking to the computer and electronics industry

for products used on a daily basis. Whether it is a desktop or laptop computer a family

uses to send and receive emails or a data base server used to support the entire IT

division of a fortune 500 company consumers rely on these products everyday. This

emergence of technology into the day-to-day life of almost every person on the globe

has led to the standardization of pricing structure in the computer and electronics retail

markets.

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Figure T.1

Manufacturer Standard Laptop Price

Dell Inspiron $699.99 HP Compaq Presario $699.99 Apple MacBook $1,499.99 Toshiba Satelite Laptop $749.99

However, the increasing competition of late is driving computer manufacturers to

think outside-of-the-box for new innovative and customer focused products; products

that will demand a slightly higher price in comparison with their competitors.

Manufacturing, marketing, and designing costs are not flexible enough to adjust to

compensate for lost profit margin due to price standardization. Therefore, competing

firms in the industry must seek different avenues to differentiate themselves from

competition.

Design innovation leaders Sony and Apple are a perfect example of firms

differentiating themselves through customer-friendly stylish designing. Apple is gaining

market share at a rapid pace over the last three years. This market share growth can

be attributed mostly to their sleek younger looking iBooks and iMacs, products which

are extremely aesthetically pleasing and moderately easier to use. As seen in Figure

T.1 above, this product differentiation allows Apple to charge a premium for its product

relative to the remaining competitors.

Buyer’s Willingness to Switch

Technology is an industry which experiences rapid change and innovation in both

capability and pricing. In the 30 year history of the industry there has been ups and

downs for firms that manufacture PCs and their components. Consumers, both

enterprise and personal, realize the fast-passed growth and strive to stay up to date on

the latest, faster, bigger computer; granted they can afford the purchase of such

products. This is leading to a 3-5 year replacement life of the average PC. When

27

making a purchasing decision on the next PC for the organization or home there are

many things that consumers consider.

The first is Operating system. Microsoft’s Windows has been the behemoth of the

20th century when it comes to operating systems. An operating system is a platform or

base for which all software and hardware come together and synergize. In addition to

Microsoft’s Windows OS, there is Apple’s Leopard and IBM’s Lenox. Being that Windows

OS has been the mainstream platform for PC users for so many years consumers have

become familiar with and, for the most part, enjoyed its capabilities. A switch to

Leopard or Lenox would take a relearning of applications and software uses that for

most seem foreign ultimately leading to unwillingness to switch.

The second thing a consumer considers when making a purchasing decision is

primary use. This includes mobility, capability, and size. One must decide whether to

purchase a notebook PC or a desktop PC, and consider the tradeoff one will give over

the other. Apple’s PCs are becoming more and more known for their fast processing

speeds and stable computing experiences. However, many software applications for

both business and personal uses are designed to run only on Windows or Leopard; for

the most part, not both. In addition, consumers rarely “downgrade” to a PC that has

fewer capabilities than their previous PC. This is mostly due to the decreasing cost of

better technology. You can purchase a better computer today for the same money you

would have paid three years ago. Data storage is becoming weightier when making a

purchasing decision. The increase in use of video and other media files, which require

large memory usage, has lead the consumer to seek a PC that can store more of such

files. These tradeoffs can lead a consumer who is used to Windows to not even

consider purchasing a Mac.

Conclusion

Because the industry is so competitive and the consumer is provided many

choices there is a moderate level of willingness to switch. The rate at which technology

changes leads the consumer or organization to constantly consider their next PC

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purchase. This high turnover combined with a competitive pricing structure cultivates

an industry in which the consumer considers every option and is moderately willing to

switch from one firm’s product to another. Keep in mind the variance from this

conclusion that applies to the purchasing a computer with a different operating system

than what is currently used by each purchaser.

Bargaining Power of Customers

Price sensitivity and relative bargaining power are two factors that determine the

bargaining power of customers. Bargaining power in an industry determines the actual

profits of a firm. Price sensitivity determines the degree that buyers are willing to

bargain on price and relative bargaining power determines the degree that buyers will

succeed in lowering the price. In the most recent years, customers have gained more

and more bargaining power in the industry.

Price Sensitivity

One of the most important decisions when purchasing a product is the price.

When the product is less differentiated and switching costs are kept to a minimum then

the customers are more price sensitive. Computer electronics are all very similar in

nature. As a result of this lack of differentiation, one factor that attracts customers to a

certain product over another will be the cost. Because competitors products are closely

related in this industry, switching costs are low. These minimal switching costs allow

customers to select the product of their choice based primarily on price.

Price sensitivity also depends on how relevant the product is to the customer.

Increasingly, personal computers are viewed as a commodity in the eyes of consumers.

This means that price is the main determinant of which product they will buy. More

recently, customers are focusing on price and are not becoming influenced by the brand

name of a product. Computers are very valuable to consumers, which means that they

will shop around to find the best product at a reasonable price. This provides firms with

an idea of how the consumers will react to the price of a certain product. If we are

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basing our evaluation of bargaining power of customers on price sensitivity, then

customers have a relatively high bargaining power.

Relative Bargaining Power

In order to maintain a lower price, customers have to achieve a relatively strong

bargaining position in the industry they are focusing on. There are several determinants

of bargaining power of customers including the number of buyers in relation to

suppliers, volume of purchases, number of alternative products, and the costs of

switching from one product to another.3 Because of the relatively low number of

computer manufacturers, customers have a moderate amount of bargaining power.

They are capable of going to another supplier for the same product; however, their

choices are limited. As previously stated, low switching costs give the consumer the

ability to shop for the best price in the market. This allows them to achieve a relatively

high amount of bargaining power. Another determinant of relative bargaining power in

the industry is the customer’s volume of purchases. Obviously, this factor depends on

the specific type of buyer. For example, a corporate buyer will purchase a large amount

of units at one time, giving them an extremely high amount of bargaining power. On

the other hand, a household consumer will typically purchase one, on occasion two,

computers or related peripherals. This single purchaser will not achieve nearly as much

bargaining power as the corporate consumer would. Overall, the relative bargaining

power of the consumer is moderate in relation to the bargaining power of customers as

a whole.

Bargaining Power of Suppliers

The bargaining power of suppliers is the amount of power that the suppliers

have over their customer, the firm. The analysis of the bargaining power of suppliers is

exactly the same as an analysis of the bargaining power of customers in a specific

industry. In addition to the bargaining power of customers, the bargaining power of

suppliers influences the actual profits that a firm can make in its industry. When there

are few substitutes available to customers, suppliers have more power over them.

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They also have more power when the businesses of their buyers depend heavily on the

supplier’s product or service.

In this industry, the suppliers have a varying amount of power over their buyers.

Microsoft and Intel are two suppliers that have a considerable amount of bargaining

power. One reason for this is because both of them dominate their sector of the

industry. If they, for some reason, decided to quit supplying companies with their

operating systems and microprocessors we would have a very limited selection of

replacement suppliers to choose from. For this reason, Microsoft and Intel’s bargaining

power is significantly increased. On the other end of the spectrum, the suppliers of

various other raw materials including, but not limited to, the casing, keyboard keys,

screen, and speakers have little bargaining power. The reason for this is because all of

these products are not differentiated. Companies have the choice to choose the supplier

with the least cost to them for these products. Because customers can get these

products from virtually anyone, these suppliers have very little bargaining power.

Conclusion: Bargaining Power of Customers/Suppliers

The bargaining power of customers and suppliers is very important to a firm. A

company does not want to allow either of these parties to have too much power

otherwise they will have a hard time making any profits. As consumers in the

electronics and computer industry, buyers tend to have a relatively moderate bargaining

power, as they can choose from various products from a number of suppliers. An

electronics supplier would like everyone to buy their products, but in order to

accomplish this, the company needs to compete on various levels of the business

sector. In this particular industry, suppliers on average have a moderate amount of

bargaining power. The software and microprocessor suppliers have a high amount of

bargaining power; however, the hardware suppliers have low bargaining power.

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Value Creation Analysis

In the industry of personal computers, there are several factors that determine

the profitability of a firm. In order for a firm to be able to make a profit, they must try

to achieve a competitive advantage in the industry in which they compete. Two such

strategies include cost leadership and product differentiation. Cost leadership is the

ability of a firm to supply a product or service at a lower price than competitors. There

are several ways for a business to achieve cost leadership, including economies of scale

and scope, efficient production, simpler product designs, better sourcing and lower

input costs, and efficient organizational processes.3 If a firm can properly apply these

ideas to their cost leadership strategy, they will be able to turn a respectable profit.

Differentiation is the ability of a firm to provide a unique product or service that is in

some way important to the customer. Firms can focus on a variety of strategies to

compete on differentiation which include superior product quality and variety, superior

customer service, and investment in brand image and research and development. Once

a firm can create a unique product or service, they must still attempt to offer it at a

reasonable price to the end user. In order for a business to create and sustain value in

a specific industry, they need to strive to compete on either cost leadership or

differentiation, or a combination of both.

Economies of Scale

Producing low cost products requires companies to have strong relationships

with its suppliers. These relationships allow companies to drive down the purchase

price of components in their products which then allows them to pass those benefits

onto their customers. In the current technology driven world, corporations and

individuals are searching for the best value they can find. Another way to increase

efficiency and drive down the prices is to outsource manufacturing. This allows a

company to focus on other areas of the company and reduce other relative costs.

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Superior Product Quality and Product Variety

Customers in today’s economy demand the highest quality products when

making a significant investment for their company or home. Quality depends on many

different aspects including production, innovation, research and service. Service is ever

becoming one of the biggest parts of the technology industry, with new innovations

everyday. Consumers demand to be on the leading edge and need to constantly be

taught and updated. Variety is just as important as quality for many companies trying

to cover the entire market. A superior variety allows companies to move production

needs to different sectors when demand changes enabling them to maximize profit.

Research and Development

In the technology industry research and development is one of the biggest

assets of most companies. Technology is the fastest growing and innovative industries

in the world. The leading firms spend billions of dollars every year on research and

development to keep them and their customers on the leading edge. Companies are

creating technology that most people thought could never happen. Products are

competing on size, price, and functionality. Many firms spend hundreds of millions of

dollars on research and development each year. These outstanding numbers show the

dedication of companies to their products and development. These numbers also help

stop new entrants from entering the market because they cannot compete with the

innovations and new developments of the market leaders.

Brand Image

In today’s world brand names dominate most markets. Logos and brand image

have a significant impact on many consumers spending habits. Often people will only

buy certain brands or spend more money to get a certain brand. Companies invest

millions of dollars on advertising to get their names all over the market place.

Advertising is most companies largest source of new business, allowing them to

showcase their new products and innovations in the computer industry.

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Conclusion

In an industry with just a few major competitors businesses are spending more

and more money to be the innovative, price, and compatibility leaders. Companies do

this with economies of scale, research and development, brand imaging and creating

superior or unique products. Using those key business methods companies differentiate

themselves from competing firms in the industry and create customer loyalty.

Companies in the technology industry that have succeeded in these different areas of

business have become the dominate forces leading the way in the technology

dominated world.

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Competitive Advantages of the Firm

Dell has dedicated large amounts of resources to achieving and maintaining a

high level of competitive advantage within the personal computing industry. Dell not

only provides its customers with the hardware that they need, it interacts with the

customer on a one-on-one basis in order to customize a system that meets their

specific needs. This includes everything from the computer hardware and software to

the deployment of the information technology system for the customer to the service

and support. This direct customer interaction is one of Dell’s key success factors. Dell’s

customers, as well as perspective customers, are valuing the dedication to customer

service and support more and more as technology needs continue to increase.

For most of the nineties and the first few years of the twenty-first century Dell’s

growth rate exceeded that of the average within the industry. This success can be

attributed to the dedication of the firm’s leadership to its direct business model. From

the conception of Dell in 1984 until now Dell has sought new and innovative ways to

bring its product to market. Though there have been changes to the method of

customer interaction, the intimate relationship Dell has with its customers has been

steadfast. Changes in technology and customer’s needs modified the direct model as

time passed. In the late eighties and early nineties, most of Dell’s sales were made over

the phone and through catalog sales. However, the recent convenience and efficiencies

provided by the internet has directed most of Dell’s sales to that avenue. Dell has been

able to successfully acquire contracts with suppliers that allow them to compete with

others in the industry on pricing. As a result of Dell’s direct business model, which

allows the company to receive payment for product before it has been manufactured,

the firm has been able to leverage its pricing positions against other firms in the

industry.

We have shown how Dell has been extremely successful in a very competitive

industry thus far. However, recent trends in the global technology industry have led to

slumping revenues for the firm. Dell’s market share has seen declines over the last few

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years. This seems to be due to the increasing innovation of companies like Apple and

Hewlett-Packard. Most of Dell’s customers are reluctant to switch to Apple’s products

because of both hardware and software differences, though there are some that will be

willing to learn and adapt to this different technology. To battle the competition Dell is

furthering previous talks with certain retail outlets about selling its computers in their

stores. These talks have led to selective product placements in Best Buy and Wal-Mart

stores around the nation.1 Talks are still ongoing with international retailers for product

placement. In addition to placing its products in retail stores, Dell has beefed up its

design team in efforts to make their products more aesthetically pleasing to its

customers.1 Apple seems to be the forerunner when it comes to design, and a recent

trend in mobile computing is making the look, color, and feel of the PC much more

important to the consumer. The notebook computer is becoming more and more a

status symbol amongst users rather than just a business tool.

The successful implementation of new products and marketing strategies is vital

to the future success of Dell. This firm has seemed to have what it takes to beat out

competition in the past. It looks like Dell’s leadership has realized that the firm may be

falling behind the curve, and is deploying new plans and strategies that aim to

circumvent the further decline in market share within the computing industry. Dell may

have slipped a little; however, this firm will make a comeback. A comeback of this

nature can only be achieved by a firm that knows what its customers want; and there is

no better company in the industry at customer relations than Dell. The constant transfer

of information between Dell and its customers will springboard this firm back into the

leadership position of the industry within a few years. There are, however, a few things

that could detour Dell’s comeback. Economic recession, which is a current fear around

the globe, could lead to consumers tightening their budgets; meaning less spending on

personal computers and other peripherals. Other risks the firm faces include supplier

contractual agreements, intellectual property lawsuits, government levies and taxes. A

few of the international markets in which Dell sells its products have governments

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which can, at any given time, without any notice, implement new laws that will make

Dell’s success in their countries difficult if not impossible.

The fast-paced computer industry is extremely competitive. Dell is striving to

once more set itself apart in the eyes of consumers. This will be accomplished through

Dell’s design initiative and continuing strategies to cut costs and reach more markets

with their products. Though there are few firms that are able to compete in the

computer industry there is still a great deal of competition between firms. The industry

has been marked, of late, by pricing pressures from consumers and institutions on tight

budgets of their own. Dell will continue to be successful if they continue to keep their

sights positioned on the competition, while maintaining the same innovative state of

mind that has made Dell a world-wide leader in the computer industry.

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Formal Accounting Analysis

To truly understand the value of a firm, one must consider the art behind

financial reporting. To do this you must examine the principles behind the methods

used in a firm’s accounting. Generally Accepted Accounting Principles (GAAP) is the

guidelines and standards used in corporate record keeping. These principles are the

basis of the financial reports compiled by each individual firm. Potential investors, credit

analysts, and others wishing to understand a firm’s dynamics read these reports. There

are six steps to effectively analyze the accounting principles of a specific firm. The steps

in performing an accounting analysis are identifying principle accounting policies, assess

accounting flexibility, evaluate accounting strategy, evaluate the quality of disclosure,

identify potential red flags, and undo accounting distortions. These steps are important

because they identify potential accounting discrepancies that may distort the financial

position of a firm. Recognizing and understanding these discrepancies is important to

be able to accurately determine a firm’s value. Discrepancies are due to varying levels

of disclosure in financial reporting.

Key Accounting Policies

A company’s key accounting policies are directly correlated to their key success

factors that were discussed in the business analysis. Firms are either very transparent

and disclose a lot of information or they disclose the bare minimum putting a cloud over

their accounting financials. Some firms believe that they have nothing to lose and are

very open to anyone looking at their accounting procedures. On the other hand, many

firms are afraid that if they disclose too much information it will give firms competing in

and entering the industry an advantage. Disclosing lots of information would show

firms how to structure their accounting department and inventory costs.

As stated previously in the business analysis, Dell’s key success factors are direct

customer interaction, cost control, and research and development. The accounting

procedures that affect the key success factors are revenue recognition, cost control,

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accounting for operating or capital leases, and recording research and development

(R&D). The preparation of all financial statements is stated in accordance with

Generally Accepted Accounting Principles (GAAP). All firms in the industry must abide

by the rules set by the SEC, who governs GAAP. How these policies are utilized help to

determine the value of a firm. GAAP can either be beneficial, or just the opposite.

GAAP allows flexibility in some categories and is much stricter in others. For example in

categories such as R&D, GAAP requires that firms show this as an expense instead of

an asset.

Revenue Recognition

According to the 10-k, revenue recognition is an important accounting policy.

Dell claims that they frequently enter into sales contracts that have many different

stipulations such as hardware, software, and peripherals. So that they can comply with

GAAP, Dell has to report certain earnings at the appropriate time such as immediately

or at a future date when services occur. An example would be an item such as

extended warranty or a service contract. These revenues are recorded as deferred

revenue and are recognized over the term of the contract. Industry wide firms have to

make decisions on when to recognize revenues. The toughest and most frequent

category that has a gray area of when to recognize is the extended warranty section.

Cost Control

Cost control is a crucial segment of any companies’ business strategy and

accounting procedures. In the technology industry there are multiple items that could

affect accounting statements. One of the main elements is accounting for warranty

expenditures. It is impossible to know the exact amount that will be spent and

obviously every firm would like to keep this item to a minimum. Most companies

reevaluate warranty expenses each quarter and make adjustments accordingly.

Another sector of cost control is income taxes. It is important for a firm to budget for

future tax consequences. According to Dell’s 10-k, the differences between anticipated

39

and actual outcomes of future tax consequences could have a material impact on the

results of operations as well as financial position. Dell uses the asset and liability

method to calculate income taxes. Under this method deferred tax assets and liabilities

are recognized by looking at the differences between tax and accounting purposes.

The other key cost control measures for most companies are pension and retirement

plans. Full time employees are given the option of contributing to a 401k plan.

Companies are willing to match up to 4-6% of each participant’s annual compensation.

It is important for Dell and each firm in the industry to recognize these costs each year

and adjust accordingly. Controlling these costs is vital when looking at financial

statements of firms.

Operating and Capital Leases

Leases have always been a questionable topic when it comes to trying to find the

value of a company. This is a category which can easily change an investor’s outlook

on the firm by switching the accounting procedure. A company using capital leases

when operating leases should be employed assets would be overvalued and vice versa.

Choosing between capital or operating leases can drastically change a firms balance

sheet. Dell leases property and equipment, manufacturing facilities, and office space

under non-cancelable leases. Some of these leases obligate them to pay taxes,

maintenance fees, and repair costs. All of their leases are allocated as operating leases.

This means they are expensed each year and do not show up on the balance sheet.

However, some firms in the industry prefer to show their leases as capital leases.

Capital leases are accounted for as an asset on the balance sheet. Lots of firms decide

which way to account for their leases by looking at different financial ratios and seeing

which one makes the firm’s image look best.

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Research and Development

Research and Development is an easy accounting policy because GAAP requires

that each firm capitalize these costs and can not record them as an asset. In the

technology industry R&D plays a significant role in future success. Each firm is always

looking for the next innovative product or how to tweak their current products to make

them more efficient. The technology industry as a whole spends billions of dollars

every year investing in the future. Many firms argue that R&D should be an asset since

it has future economic benefits. However, the SEC believes that you can not put an

exact figure on how much, if any, economic benefits will come from R&D. Most

investors will look at R&D as an asset in their mind when deciding the value of a firm.

Therefore, even though GAAP will not allow firms to disclose R&D as an asset on the

balance sheet, investors normally look at R&D as an asset. Below is a chart that shows

R&D expenses for Dell, IBM, HP, and Apple over the last 5 years so that you can see

how much money goes into this sector of business each year.

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Conclusion

As stated previously, the accounting procedures that affect the key success

factors are revenue recognition, cost control, accounting for operating or capital leases,

and recording research and development. The way these sections are recorded has a

huge impact on the value of a firm. Many of these policies affect the financial standing

of firms industry wide. By making each company abide by GAAP it helps to keep the

industry on a fair playing field. Since each firm has to follow the same rules, it partially

helps investors when looking at multiple firms in the industry. Overall, each firm’s

executives must look at the accounting policies and decide which procedures are most

beneficial for their firm.

Accounting Flexibility

Accounting flexibility is the degree to which a firm can have control over

choosing their accounting policies and estimates for reporting purposes. Some firms

have more flexibility than others regarding this topic which depends on the type of

industry that they compete in. The degree of flexibility for firms determines the quality

of information that will be available for investors to analyze and decide what financial

position the company is actually in. The more flexibility a manager has, there is more

potential for accounting numbers to look favorable. These policies are closely regulated

and monitored by the Financial Accounting Standards Board (FASB) which has

delegated authority from the SEC. Further, the guidelines for accounting are established

by Generally Accepted Accounting Principles (GAAP) which expresses the standards,

rules, and procedures set forth by the FASB. Certain accounting policies are more

regulated than others, which gives managers a different degree of flexibility depending

on the type of policy they are evaluating. For example, managers have no flexibility on

the way that research and development is expensed. According to GAAP, this activity

must be expensed as it is incurred and there is no flexibility in doing so. However, in

regards to other policies such as inventory costing methods, pension plans, and lease

arrangements, managers have some control over how to record such activities as to

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relate them to the business environment they compete in. The choice that managers

make in conducting accounting policies is very important to the firm, and the way these

are carried out greatly affect the overall position of the company in the economy.

Research and Development

Research and development is a very important accounting policy that firms

conduct in order to increase their economic position. In the industry that Dell competes

in, each firm spends a great amount of money in order to conduct research and

development. According to the 10-K, during fiscal year 2007 Dell spent $ 498 million on

R & D. Firms invest in this activity to stay ahead of competition by finding new

innovations that could potentially increase profits in the future. When it comes to

accounting, this investment that firms undertake is required by GAAP to be expensed as

it is incurred. Even though investment in research and development adds value to a

firm, it must be recorded on the income statement as an expense. Part of the reason

for this is that it is often too difficult to estimate the benefits of research and

development because certain new technologies and products might not ever make it to

the market.

Operating and Capital Leases

When it comes to accounting for lease arrangements, managers of firms have a

much greater degree of flexibility. There are two types of leases that a firm can choose

to report, operating and capital, each with its own set of characteristics that cause a

manager to choose one over the other. If the firm wants to treat a lease as a rental

contract, then they will record it as an operating lease. In this circumstance, the

transaction does not affect the balance sheet because the lease is not recorded as an

asset. The owner of the asset leases it to a firm for a specified time period and expects

to receive it back with value still left on the asset. This transaction will include rent

expense on the income statement for the lessee. On the other hand, if the firm chooses

to use a capital lease, it is considered equivalent to a purchase and therefore written

down as an asset on the books with a corresponding lease liability. This type of lease

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gives the lessee direct ownership of the asset they are using. Dell leases property and

equipment, manufacturing facilities, and office space under non-cancelable operating

leases as well as other capital arrangements. In large corporations like Dell and its

competitors leases are in the million’s of dollars every year. Firm’s managers will choose

which type of lease they want to use depending on how they want their assets to look

or when they want to recognize expenses when it comes to reporting.

Revenue Recognition

When it comes to recognizing revenue and calculating allowances for doubtful

accounts, there is also some degree of flexibility. Determining when to record revenues

is an important decision for a manager of a firm. When it comes to certain things like

warranties and sales contracts, revenues might need to be recorded as deferred and

should be recognized over a set time period. In Dell’s case, they offer extended

warranty and service contracts to customers which obligates them to perform other

services. Revenue from these practices is recorded as deferred revenues and is

subsequently recognized over the life of the contract or when the service is complete.

The only time that these revenues are not deferred is when a third party sells extended

warranty and service contracts that Dell is not obligated to perform. When these sales

occur, the revenue is recognized at the time of sale on a net basis. When warranties are

sold, Dell records a warranty liability at the time of sale for the amount of cost they

estimate that might be incurred under the specified terms of the warranty. There are

factors that a firm looks at to determine how much liability to record which include

historical claim rates, number of units currently under warranty, and the cost per claim

on a warranty. Estimates that impact the recognition of revenues include returns on

sales as well as allowance for doubtful accounts. Firms have a choice in determining

how to make such estimates. When it comes to estimating returns on sales, Dell bases

them on estimated returns and the number of units that have been shipped that still

have the right to be returned. Historical experience also plays a big factor in estimates

for both returns and allowances. In the decision for allowances for doubtful accounts,

firms including Dell will include factors such as previous customer default rates and they

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make anticipations on how much they think will default in the accounting period at

hand. The effect on the accounting books is a contra- asset allowance account and also

a Bad Debt expense.

Pension Plans

Another policy that firms must consider when making accounting choices is

determining costs associated with pension plans. Firms have a choice in deciding which

type of plan to offer their employees which include either a defined benefit or a defined

contribution plan. Under a defined benefit plan, an employee receives a set monthly

amount as determined by the employer for a specific time period. On the other hand, a

defined contribution which includes the 401 K and 403 B plans, is where an employer

promises to make contributions to an employees account. The contributions can vary

greatly between firms. For instance, Dell has a defined contribution plan which offers a

4% contribution to its employees according to the 10-K. It is an important decision for

managers to determine what type of plan the firm will have as well as the discount rate

associated with it. Firms are required to make estimates for pension costs based on the

present value of future cash obligations. Firms have a choice in determining what

discount rate to use for the present value but if this rate is too high, the present value

will be too low which will provide an understatement of liabilities on the books. In

practice, doing this would increase the perceived value of the firm because the liabilities

on the balance sheet would not be high enough. Conversely, if they use too low a

discount rate, the present value will be overstated as well as the ensuing liabilities. With

this said, even though there is flexibility on this subject, managers need to be careful in

determining rates for their pension plans.

Conclusion

The degree of accounting flexibility varies widely throughout firms as well as the

industry that a company competes in. Some accounting policies offer firms a choice on

how to report them while others are highly regulated by standards and principles. If a

manager has a choice in accounting, they might be able to manipulate numbers to

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provide a higher perceived value to potential investors and financial analysts. Otherwise

they have to go by the book even if doing so will decrease the value of the firm or

make it look like they are struggling financially.

Accounting Strategy

Companies have extensive control over how, what, and when they report their

financial statements. Companies, or more so managers, attempt to alter financial

statements in several ways including aggressively recording revenues, hiding expenses,

or diluting liabilities in the short term. Management manipulation is the main concern

of most executives concerning accounting strategies within firms. Financial manager’s

job is to maximize their specific sectors performance. Altering financial statements is

easy and tempting if a sector is underperforming. This construes data sent to

shareholders and other significant readers of a company’s financial reports. Managers

are allowed to be creative in their accounting policies to a certain extent according to

GAAP and other accounting laws. Accounting strategies in the technology industry

consist of research and development, pension plans, cost control, and recognition of

leases have on the financial statements and the overall value of the firm. Depending on

the extent of these financial discrepancies firms will either portray a transparent picture

into the firm’s activities or create a cloud in communicating particular financials to

investors and competitors. Dell is somewhat conservative in reporting when it comes to

certain financial numbers. On the other hand their business strategies and management

decisions are very conclusive. Limited disclosure makes it difficult to determine just

how much these strategies will affect the value of Dell and its competitors.

Research and Development

In the technology industry, research and development is a key accounting

principle due to extremely high investments and the necessity to stay on the cutting

edge. Most of the industries research and development investment is spent purely on

creating innovation and new product creation including Dell. Constant innovation has

actually become a problem in the technology industry from the view of accounting

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principles. GAAP requires firms to immediately expense any research and development

when recognized. When managers of a company have accounting flexibility, there is

always a chance that a firms’ true economic performance could be slightly manipulated.

To get an accurate value, a large amount of research and development should be

adjusted to the asset account which would allow a firm to recognize the benefits of

their time and effort.

When companies make huge adjustments in research and development it causes

expenses to be overstated conversely causing net income to be understated. When net

income is understated and moves into retained earnings, owner’s equity is also

understated. However, there are balance sheets and protocols in place to ensure

assets are either financed by liabilities or part of owner’s equity. So, if or when owner’s

equity is understated, assets are adjusted or financed to also be understated. This

method is almost exclusively used only in the technology industry.

In most of today’s industries, GAAP regulations work and allow companies to

accurately record their research and development as an expense. However, in an

industry requiring technology innovation each year, GAAP fails to allow firms to

accurately value their company. Most of the technology industry invests a huge

percentage of their company into research and development which can be devastating

to a company’s financial statement after adjustments. Managers under constant

pressure often try to write off high research and development expenses to other areas,

which will again alter financial statements.

Operating and Capital Leases

In large industries such as the technology industry most companies have millions

of dollars invested in leases every year. Most leases are reported as operating leases

and are expensed when incurred. However, some companies report capital leases

which are transferred into an asset account. Companies can change accounting policies

and significantly change their appearance to consumers. Operating leasing decreases

the current ratio while capital leasing increases it. Also, it gives a more realistic picture

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of the company’s situation. As stated above, Dell states almost all leases as operating

leases even if it does hurt some financial ratios. Dell also owns more property in square

footage than it leases.

Companies face problems here sometimes when managers change reporting

methods to improve their financials. The biggest problem occurs when both the lessee

and leasor report operating leases. One company has to record the lease as an asset

and the other as a liability according to normal lease agreements. Dell has been

consistent for years with its leasing policies and continues to do the same.

Pension Plans

Pensions are one of, if not the biggest, employee incurred expenses for

companies. Pensions can consist of several different expenses like health care and

retirement plans. Retirement is the most volatile of these expenses because they have

to be constantly estimated using different discount and growth rates keeping on track

with changing inflation rates. Again, this is another way for managers to change

financials to satisfy their quotas and ratios. Pension plans are huge assets to a

company’s employees, these quality retirement and health care plans keep employees

loyal. Since Dell’s beginning they have always taken pride in their employees. They

have an excellent benefit package in place for their employees keeping their turnover

ratio down. Having quality pension plans are both good and bad for companies. They

are also very costly to the company and its investors. Discount rates are used to

forecast the present value of future payments. Normally, discount rates are very similar

across industries; rates will vary slightly due to economic outlooks when calculating the

forecast.

Discount rates are the rates that are calculated by projecting profits or in this

case payments in the future and discounting them back in time to calculate their

current net present value. So when discount rates are off, the value of future cash

payments is also off, which either under or overstates current liabilities and expenses.

This is normally done accidentally although managers have the ability to manipulate

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figures. Companies are trying to impress potential investors and maximize shareholders

wealth. That pressure is often enough to make managers alter their financials, leading

to some companies downfalls.

Cost Control

Cost control is an integral part of any company. Dell is no exception, cost control

is its highest priority and one of the main reasons they have been so successful. Dell’s

direct business model is a huge part of this, they have managed to cut out almost all of

the middlemen and use just-in-time inventory to further reduce costs. Aside from

general everyday cost control measures, companies in the technology industry have to

account for warranty expenses, pension plans and income taxes. Just like pension

plans, warranty expenses and income taxes are forecasted from year to year. It is

inevitable for the forecasts to be off at one time or another. Warranty expenses and

income taxes are recalculated every quarter to accurately record expenses. Cost

control discrepancies normally do not affect financial statements as much as some other

accounting errors or manipulations.

Conclusion

Accounting strategies are a crucial part of all companies’ financial responsibilities.

The ability of managers and companies to manipulate these financial statements can

allow an untrue picture of the companies to the public. Managers do this when

tremendous pressure comes from executives to constantly perform better. There will

always be the possibility for managers to alter numbers. This paints an untrue picture

for investors and consumer’s alike, creating doubt and mistrust. Companies have the

knowledge and abilities to report accurate financials. Companies know all accounting

laws and their severe repercussions.

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Evaluating the Quality of Disclosure

Every year companies are required to publish reports of their previous fiscal year.

These reports are very important to investors and the public. Every year the SEC audits

these reports for any errors or discrepancies. There are laws that outline the minimum

amount of information that must be published. Companies vary in the amount and

quality of reports. The better and more conclusive companies reports are, allows for

much more accurate and reliable analysts measurements.

Quantitative Disclosure

Dell’s revenue is generated from various segments of its operations. This

segmentation of its products can produce a distorted view of revenue sources if not

properly disclosed. However, Dell outlines the revenue generated from each one of its

product segments in the Management Discussion and Analysis. Dell presents net

revenue by product category in both absolute and relative terms. Being able to look

revenue data in the disaggregated format allows us to see the growth in different

segments and shows us in which product segments Dell really succeeds and where we

should expect growth to

continue.

2-Feb-07 3-Feb-06 28-Jan-05

Dollars% of Revenue Dollars

% of Revenue Dollars

Desktop PCs 19,815.00$ 34% 21,568.00$ 39% 21,141.00$ Mobility 15,480.00$ 27% 14,372.00$ 25% 12,001.00$ Software and peripherals 9,001.00$ 16% 8,329.00$ 15% 6,626.00$ Servers and networking 5,805.00$ 10% 5,449.00$ 10% 4,880.00$ Enhanced Services 5,063.00$ 9% 4,207.00$ 8% 3,121.00$ Storage 2,256.00$ 4% 1,863.00$ 3% 1,352.00$

Net Revenue 57,420.00$ 100% 55,788.00$ 100% 49,121.00$

Fiscal Year Ended:

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Problems: How to solve them

The Securities and Exchange Commission (SEC) contacted Dell in August of 2005

requesting information about certain aspects of their accounting and financial reporting

methods. While compiling the requested information for the SEC, management was

notified of important matters involving the accounting and financial reporting. Items of

particular concern were whether certain balance sheet items had been properly

adjusted and reported. Management, after careful review and consulting with an

independent auditor, decided that the attention raising issues demanded an internal

investigation into Dell’s accounting and financial reporting standards.

The audit committee of Dell’s Board of Directors, upon the recommendation of

management, approved an internal investigation. Dell hired KPMG, an external

accounting firm, to conduct the investigation. KPMG used several different methods for

determining where errors or adjustments may have been made. Concurrently with

KPMG’s investigation, Dell also initiated an internal investigation into accounting and

financial reporting principles of the firm. The results of these investigations led to the

discovery of several intentional adjustments by Dell employees in order to attain certain

term goals. These adjustments and misstatements were material, significant to the

financial standing of the firm, and intentional. However, some of the reporting errors

that were found were unintentional. In KPMG’s report they stated that several of the

adjustments were in amounts ranging from several hundred thousand to several million

dollars. This type of distortion is extremely significant to a firm with the financial

position of Dell or any firm for that matter.

Dell acknowledges these errors and adjustments and has devised a corrective

plan for the remediation of its deficiencies in accounting and financial reporting. They

have outlined a plan in The Notes to Consolidated Financial Statements of their 10-K for

fiscal year ended 2007. As part of the remediation efforts, Michael S. Dell re-assumed

the position of Chief Executive Officer and Donald J. Carty assumed the role of Chief

Financial Officer. Under this new leadership team and other management members,

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Dell will be set on a new path dedicated to financial reporting integrity, high ethical

standards, and an increased control environment. The focus of management and all

employees will be shifted from achieving short-term operating goals to that of

increasing shareholder value on a more long-term basis. Reprimands, terminations, and

reassignments of other employees have and will continue to take place as Dell

continues to coordinate the remediation of their past deficiencies. In addition, Dell has

taken steps to segregate the accounting and financial reporting responsibilities from the

planning and forecasting responsibilities to achieve a greater level of integrity amongst

its finance department. These and other processes and procedures are being

implemented to remediate Dell’s acknowledged shortcomings.

Investor relations

Companies make data available to investors in many different ways depending

on the sensitivity of the information. Many post through their website, conference calls,

press releases, and Security and Exchange Commission filings. Investor relations are an

extremely important attribute of a firm’s financial disclosure quality. It is through this

avenue that current and potential investors get all information to base their investment

decisions. The quality of communication that the firm provides through these avenues

must be read and interpreted very carefully. One must understand the intentions of

those responsible for the reporting. This is another example of the Principle-Agent

problem which involves the tendency of members of management to distort information

in a favorable light for their own benefit.

Dell, however, has a very informative investor relations website with excellent

disclosure methods. Since the return of Michael Dell to the Chief Executive Officer

Position in January 2007, Dell has recognized and acknowledged certain shortcomings

in disclosure. In addition, Dell has a renewed dedication to informing its owners and

potential investors of how they will be remediating these, and other, issues.

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Business strategy disclosure

The business strategy of a firm is important to investors. It tells investors the

manor in which the firm chooses to compete in the industry in which its products and

services are located. Company’s strategies are disclosed in the Management Discussion

and Analysis portion of its annual report. Often business strategies have to evolve as

they continuously adjust to changing market and economic conditions to expand in the

most profitable areas. Expanding relevant technologies and solutions, and developing

more efficient manufacturing and logistics to increase the value added by the core

infrastructure can add tremendous value to a company.

Dell’s core values incorporate simplifying information technology for customers,

offering a large customizable selection of products, and a commitment to environmental

responsibility in all aspects of the business. By providing high-quality products, relevant

technology, and customizable solutions to its customers Dell has acquired a competitive

advantage that will allow the firm to continue its market share growth experienced for

the past few years. In their annual report Dell is very descriptive and informative about

the status of the firm’s business strategy now as well as the direction of future

strategies that leadership plans to implement. This high quality disclosure of business

strategies makes Dell attractive to potential investors and current shareholders.

Explanation of trends in revenue and expenses

In the quarterly and annual reports Dell has filed with the SEC they explain

trends in revenue and expenses in the footnotes and the Notes to Consolidated

Financial Statements. This disclosure describes why Dell has experienced a decline in

revenues from fiscal year 2006 to fiscal year 2007. A descriptive analysis is provided for

investors to decide for themselves the effects of the business decisions made by Dell

leadership.

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In addition to explaining revenue and expense trends Dell evaluates its exposure

to certain market risks, interest rate risks, and industry conditions. Some of the risks

the firm is exposed to are beyond their control. However, the management of

controllable risk is important to the success of the firm. Dell explains the strategy used

to hedge against fluctuations in foreign currency rates, debt interest rates, and

investment activities. This is yet another example of Dell’s high quality disclosure in

financial reporting.

Conclusion

We have found that Dell’s quality of disclosure is high. They do an excellent job

of describing operational activities as well as business strategy. They disclose

information on where they have made mistakes and they discuss how they are taking

action to correct these mistakes. Quality of disclosure is an important factor to consider

when choosing a firm for an investor, and it is clear that Dell would be an excellent

choice for an investor seeking a firm with high quality disclosure.

Quantitative Disclosure

When analyzing the quantitative disclosure of a firm you examine the core sales

manipulation ratios along with the core expense manipulation ratios in comparison to

those in the same industry. We use these ratios based upon accounting numbers

retrieved from the financial statements to search for inconsistencies in trends. If

inconsistencies are discovered, we must investigate for motive. Management may have

manipulated some methods used in sales and expense accounting.

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Core Sales Manipulation Diagnostics

Using the sales manipulation ratios allows us to investigate trends in sales

accounting methods used by each firm. We will examine the sales to cash from sales,

sales to receivables, and sales to inventory ratios. These ratios will help us see how the

firm specific trends differ from those of the industry. If there is a drastic difference in

firm specific results relative to industry results we must identify the potential accounting

distortions leading to these differences.

The net sales to cash ratio show us the relationship between total sales and the

cash that was received for sales in the year shown. This ratio tells stockholders how

much of sales is collected in cash every year. We see here that there was a decrease in

the cash collected in fiscal 2006 for Apple. This is most likely due to an increase in sales

to enterprise whom are given a grace period for payment of purchases as opposed to a

consumer who purchases a product and must submit payment at the time the order is

placed. This ratio is desired by investors and managers to be low and consistent.

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The ratio used to create the chart above is the net sales to net account

receivables ratio. This allows us to see what amount of the net sales within a period

were credit transactions. It is important to see the relationship of sales to receivables

because it is a good indicator of the firm’s ability to generate cash from sales. The

higher the ratio the less the amount of sales that were sold on account, and vise versa.

As we see here Dell has been able to maintain a relatively higher ratio than its

competitors due to the fact that a large portion of their business is directly with the

public keeping accounts receivable low. Investors and companies alike want liability

accounts kept as low as possible.

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The net sales to inventory ratio displayed in chart form above is an indicator of

inventory costs and unit sales. As we can see Dell has maintained an above industry

average ratio for the past five years. This is due in most part to the customer direct

business model Dell employs. This is another ratio that is desired to be higher, the

lower the inventories are the less liabilities and overhead amount to. Keeping costs

down in all areas of business is curtail to successful companies.

Conclusion

We have reviewed the sales manipulation ratios and have determined that there

are no firm specific inconsistencies that require further investigation. Dell’s ratios do

differ from those of the rest of the industry competitors. However, this is a reflection of

the methods employed on a consistent basis due to Dell’s direct business model.

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Core Expense Diagnostics Manipulation

The core expense diagnostics manipulation examines the expense accounting of

the firm relative to that of the industry. It allows us to determine if there is a possibility

of manipulation of expense accounting.

The asset turnover ratio shows the relationship between net sales to the net

value of assets. This is important because this ratio is an indicator of a firm’s ability to

generate revenue from its assets. As we see in the chart above Dell has a much higher

asset turnover ratio than its competitors. This is, again, a reflection of the business

model Dell incorporates. Even though there is a variance from the industry norm, there

does not appear to be any material distortion of expense accounting using the asset

turnover ratio.

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This ratio shows relationship of the change in cash flow from operations to the

operating income. This trend analysis allows us to see if the firm maintains a consistent

ratio. If there is a high variance in the trend it may have been derived from a

manipulation of expenses and accruals in order to achieve period earning targets.

Looking at Dell it seems that there is consistency in the relationship. This is a strong

indicator that there has not been any attempt to manipulate earnings figures. Investors

are interested in this information because it allows them to see if a company’s core

businesses are profiting.

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The chart above shows the relationship of the change in cash flow from

operations to the value of net operating assets. This relationship tells us about the

firm’s ability to utilize its plants, properties, and equipment. A higher ratio would

indicate that a company is maximizing the use of its assets. Maximizing productivity is

major concern with any company in any business. This being the case, a higher ratio is

always preferred. Variations may be an indicator of manipulated earnings numbers due

to adjustments made to accrual and expense accounts.

Conclusion

Using the manipulation diagnostic tool set gives us a quantitative understanding

of the consistencies and inconsistencies within a firm. This is an important aspect to a

valuation because it is a strong indicator of earnings management if there seems to be

a deviation from the trends set in place. Dell over the past five years appears to have a

consistent set of ratios. This consistency shows an ability to disclose information

without manipulation.

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Potential Red Flags

By analyzing the 10-K’s and diagnostic ratios of a company, an analyst can

determine if the figures have been manipulated. This manipulation of company data

poses as a “red flag” to a reader and distorts their perception of the financial position of

the firm. After doing a thorough examination of all aspects of Dell, we noticed one area

that needed to be discussed. This potential red flag was the way that they accounted

for their leases. Although this area caught our attention, we feel that Dell has properly

and accurately disclosed all other information. Therefore, there are no other potential

red flags.

Undoing Accounting Distortions

If any “red flags” are found after analyzing a firm, the analyst will have to undo these

red flags to accurately show the financial position of that firm. Red flags can be a

variety of distortions that can alter a company’s financial reports to make them look

better than they actually are. When analyzing Dell, we found one particular red flag that

we thought needed attention. The way Dell records leases could be more accurately

reported. They automatically expense these leases as a rent expense. We feel that

these leases should be capitalized instead of expensed. As a result of expensing these

leases, assets and liabilities are overstated on the balance sheet, misrepresenting actual

figures of the company. Aside from this, we feel that Dell is a high disclosure company

reporting reliable and consistent data to investors and the public.

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Financial Analysis, Forecast Financials, and Cost of Capital

Estimation

Throughout this section we will go over the financial ratio analysis, financial

statement forecasting methodology, and cost of capital estimation for Dell and the

industry in which Dell competes. The best way to analyze the financials of these firms

is through ratios. Liquidity, profitability, and capital structure ratios are the most

commonly used by analysts to assess the value of a company. All of these ratios help

in monitoring how well a firm is performing. After these ratios are computed, they will

help to forecast the expectations of these firms in the future. Finally, to close out the

financial analysis section we will calculate the cost of capital estimation to see how

expensive it is for these firms to raise capital for use in their future business operations.

Liquidity Analysis

Liquidity ratios measure the ability of a company turn their assets into cash. One

of the main reasons that investors look at this ratio is to see if in case a firm were to

get into debt, what amount would they be able to pay? Most often these ratios are

used to derive the credit risk of a company. There are numerous ratios calculated to

help investors and creditors formulate an analysis of a specific firm. Creditors also use

these ratios to create covenants within their contracts requiring firms to maintain

certain levels of leverage and liquidity. The most commonly used ratios are the current

ratio, quick asset ratio, accounts receivable, days in accounts receivable, inventory

turnover, days in inventory, and cash-to-cash cycle.

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Current Ratio

The current ratio is calculated by dividing current assets by current liabilities.

This ratio shows the firms’ ability to cover the current assets with the current liabilities.

It is desirable to have a high current ratio. The higher it is, the more capable the

company is to pay off its short-term debt by liquidating most of its current assets. Dell’s

current ratio is lower than most of its competitors because they have been aiming

towards having zero working capital which creates lower cash requirements. As you can

see from referencing the graph above, Apple currently has the highest current ratio and

has been at the top of the industry average over the past 5 years. A reduction in cash

requirements leads to a reduction in the current ratio over time.

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Quick Asset Ratio

The quick asset ratio is calculated by dividing the “quick” assets by current

liabilities. These quick assets are cash and cash equivalents, securities, and accounts

receivable. This is another ratio calculated to show investors and companies how fast a

company can pay off short-term debt. This breaks it down to only the most liquid of

assets; accounts that can be turned into cash in a very short period of time, normally a

few days. A ratio of close to one or more is desired by most companies. The higher the

ratio the quicker a company can pay back debt even in a sudden financial crisis. Dell

has been hovering around one consistently for the past few years, which is fairly close

to that of its competitors. This is caused by Dell’s consistent low amount of cash on

hand. Apple, once again led the industry in this category. Although, Dell has continued

to stay with other competitors in the industry.

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Accounts Receivable Turnover

Accounts recievable (A/R) turnover is calculated by dividing sales by accounts

receivable. This allows an analyst to determine how productively the accounts

recievable portion of working capital is being used. Again this ratio is desired to be

high, this actually measures the amout of times a company turns over its accounts

recievables every year. Dell has been keeping a turnover rate of around twelve for the

past few years. Dell has been able to keep this up because it deals with short collection

periods from most of its public customers. There are few places to get Dell products in

stores, when ordered via the web consumers must pay then or create a short term

payment plan. As most of these ratios have turned out, Apple again leads the industry.

Apple has a business plan which was implemented to focus strictly on beating many of

these statistics in the industry.

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Days Supply Of Receivables

Days supply of receivables is the amount of days it takes a firm or company to

collect its accounts recievables. Calculated by dividing 365 by the accounts recievable

turnover. This is a simple ratio that shows how quickly a company can collect its

money. Dell has an A/R turnover that remains consistenlty around thirty days. This is

close to the market average which shows that Dell is a financially sound company and

that they have the ability to collect recievables in a timely manner. The more efficient a

firm can be at collecting their receivables, the better off they will be. Some investors

look at this statistic as a key principle of the business strategy that is implemented. It

is very important to have a quick turn around of cash in hand. The longer firms allow

customers to wait before paying them, the less cash they have on hand. Many people

invest by the philosophy that money today is worth more than money tomorrow.

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Inventory Turnover

Inventory turnover is similar to A/R turnover except inventory turnover is the

measure of how many times a company turns over their inventories evey year as

opposed to accounts receivable. This is calculated by dividing cost of goods sold by

inventory. It is desirable for this ratio to be high. The more times the firm has to re-

order and stock their inventory, the higher their sales will be to a certain extent. Some

could also look at a high ratio as the fact that a company does not keep a very large

inventory. Obviously a firm that keeps an inventory of half the size of another

competitor in the industry but has the same amount of sales would have a higher A/R

turnover. Dell has been a consistent leader in this category through the years. The

reason for this is Dell’s unmatched direct model and just-in-time invertory system.

Because they have not been matched, they have a higher inventory turnover than their

competitors.

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Days Supply Of Inventory

Days supply of inventory is a simple ratio to understand. It is desirable to be low

because it tells how many days it takes a company to turnover its inventories. The more

times you turnover your inventory per year then the lower the days supply of inventory

will be. This is derived by dividing 365 days by inventory turnover. Dell is again a

consistent leader in this category because it utilizes the direct model and just-in-time

inventory systems. Dell has been constantly around 5 to 6 days, its only true competitor

in this aspect is Apple. HP along with IBM both have larger ratios and as of last year

began a downward trend to try and get closer to the industry average.

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Cash-to-Cash Cycle

The cash-to-cash cycle is calculated by adding days supply of accounts

recievable and days supply of inventory. This ratio shows analysts how long it takes to

convert inventories and labor costs into cash. Basically, it is the amount of time it takes

the company to complete one cash cycle. Starting with the inventories through

accounts recievables and finally when they are collected. Dell averages around 30 days

which leads the industry. Dell and Apple once again have the best ratio in this industry.

It seems that since they have a newer business strategy than HP or IBM, they have

focused on implementing different techniques than the previous firms in the indsutry.

Being able to have a great ratio comes from the extremly fast inventory turnover rates.

Conclusion

After analyzing Dell using various liquidity analysis ratios, we have concluded

that they are performing within the overall average of the market or industry. This

means that Dell is able to pay off its debt in a timely manner. They over-performed in

the areas of inventory turnover, days supply of inventory, and the cash-to-cash cycle.

However, they under-performed on the basis of current ratio and days supply of

receivables. With this said, it brings them closer to the overall average performance of

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their competitors in the industry. From an investor’s standpoint, a firm that has ratios

around or above the industry average is very appealing.

Profitability Ratio Analysis

The basis for profitability ratios is to determine how efficient a company is in

creating profit. All profitability ratios are divided by sales, which is the basis to

performance of a sales driven company. The more efficient a company is the more

profitable they become, thus attracting investors and debtors. There are five basic

profitability ratios; gross profit margin, net profit margin, asset turnover, and return on

assets, and return on equity.

Gross Profit Margin

Gross proft margin is gross profit divided by sales. Gross profit is calculated by

subtracting cost of goods sold from sales. This ratio is used to analyze how well a

company can cover the costs incurred when purchasing its inventories or anything that

goes into cost of goods sold. “Gross profit margin is affected by two factors, the first is

the price premium that a firms product or service command in the marketplace and

second is the efficiency of the firms procurement and production process.” (Palepu &

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Healy) Dell is constantly lower than the industry average of almost 31%. This is

because Dell uses its direct model and has been a constant price leader.

Net Profit Margin

Net profit margin is calculated by dividing net income by sales. This is the most

commonly used profitability ratio, where once again bigger is better. This is valuable to

investors because it shows the bottom line profitabliity of a company. This ratio tells

investors how much of every income dollar will be transferred in retained earnings,

possible dividends, or invested into owners equity. Again Dell is lower than most of the

industry. This has to do with Dell’s low prices and direct-to-consumer model. Dell has

been consistent for most of the past years until recently. This has been the result of the

recent economic downturn.

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Asset Turnover

Asset turnover is calculated by dividing sales by total assets producing a ratio

that shows analysts how many times a company’s assets produce sales every year. This

ratio shows how much money every dollar invested in assets produces in sales dollars.

For example in 2005 Dell’s asset turnover was close to 2.50, this means that $2.50 of

sales was produced for every $1.00 invested in assets. Even though this number may

sometimes be low, it is a good ratio for analysts to use. When numbers are low one

needs to see how much money was invested. Sometimes investing for the future can

decrease this ratio. Dell is the leader here again because it has a high amount of sales

and a consistantly low amount of total assets.

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Return On Assets

Return on assets (ROA) is calculated by dividing the current year’s net income by

the previous years ending total assets. The previous years assets are used in this

equation because the assets that are already owned are the ones that were used to add

profit to the firm. ROA is a fairly volitale ratio because there are many different

accounts that go into net income and total assets. One or more of those accounts can

dramatically change during a years time. Dell has been fairly consistent for the past few

years. However, as of recent they have dropped due to changes in the company and

the economy as a whole.

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Return On Equity

Return on equity is calculated by dividing net income by ending owners equity

from the previous year. This is a very similar ratio to return on assets. This ratio shows

investors the overall profitability of a company. “ROE provides an indication of how well

managers are employing the funds invested by the firms shareholders to generate

returns.” (Palepu & Healy) As you can see Dell is a very profitable company, currently

over 70% of every dollar invested is returned in profits. This is relatively high compared

to their competitors.

Conclusion

After analyzing the profitability ratios we have determined that Dell’s overall

performance is average compared to the industry. The profitability ratios tell how

efficient a company is at creating profit. In the areas of return on equity and asset

turnover Dell over-performed compared to its competitors. However, they under-

performed on the basis of gross profit margin.

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Capital Structure Analysis

The capital structure of a company is the way a company choses to finance their

assets. Assets can be financed by either debt or equity. Financing using debt is done by

borrowing money from a bank or other lender. Equity financing is done by selling

shares of stock to raise equity. Analyzing the capital structure allows investors and

debtors to analyze how efficiently a company is managing its debt and income.

Debt To Equity Ratio

The debt to equity ratio is calculated by dividing total liabilities by owners equity.

This ratio shows how much of a company is financed by debt compared to overall

equity. Dell currently has a ratio of five-to-one, meaning that dell has five dollars of

debt for every every dollar of equity. Dell is higher than the indusry average because of

recent investments. They also depend less on owners investments than do other

companies.

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Debt Service Margin

Debt service margin (DSM) is calculated by dividing current operating cash flows

by the previous years ending current maturities of long term debt. The previous years

debt is used here because it is the debt that is currently being paid for. DSM is a margin

that analysts perfer to be higher. Dell is currently under-performng the industry due to

its lower profit margin. Also, Dell is less pressured to use operating cash flows to pay

for long term debt. This allows Dell to generate more profit with invested dollars as

seen in return on equity.

Conclusion

After analyzing the capital structure of Dell, we came to the conclusion that they

under-performed compared to the industry. They are not very effective at managing

their debt and equity compared to their competitors.

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Internal Growth Rate

The internal growth rate is calculated by multiplying return on assets by one

minus the dividend payout ratio. The dividend payout ratio is dividends paid divided by

net income. IGR shows analysts how well a company will perform and grow in the more

distant future without the help of outside investors. This is done by calculating how

much of net income will be used in the future before being added to retained earnings.

Dell has a fairly constant IGR and is above the industry average. Again proving to

analysts how profitable and reliable Dell is as a company.

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Sustainable Growth Rate

Sustainable growth rate (SGR) is calculated by multiplying the internal growth

rate by one plus the debt to equity ratio. This measures how much a company can

grow their internal growth rate without increasing debt leverage. This estimates how

much a company can grow when they reinvest in retained earnings also allowing for

additional outside investments. It is calculated using a company’s current debt leverage

ratio.

Forecast Financials

The goal of the financial statement forecasting methodology is to determine

future values of a firm using ratio trends and benchmarks, industry averages, and the

firm’s financial statements. These sectors will help to produce the future income

statements, balance sheets, and cash flow statements. We feel that it is important to

take a diverse portfolio of ratios and statements so that we can try to have as accurate

as possible forecasts. We believe that it is important to forecast 10 years of financials.

With that being said, we also understand that the farther out in years that you forecast,

the harder it is to be accurate with your numbers. During this section we will look at

multiple aspects of ratios and financials to get as accurate predictions as possible.

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Income Statement

To begin our forecasting section, we started with the income statement. We

created a common size income statement which looked at the income statement in

comparison to sales. Creating a common size income statement will help for us to look

at past results and see the different trends in the financials. We will look at these

trends for the firm and compute a five year average of their financials. Along with

Dell’s average over the last five years, we will also look at the industry wide average to

help compute as accurate as possible predictions.

We started off by forecasting Dell’s future sales and sales growth. In order to

come up with the rate to forecast Dell’s sales, we took an industry wide average and

compared it to Dell’s growth average over the past five years. We came up with an

industry weighted average growth rate of 9.6% and Dell’s previous five years growth

rate came to 13.1%. Although, Dell’s 2007 growth rate was 2.9%, we feel that Dell will

grow at a rate of 3.00% over the next 10 years. This rate was figured by looking at

competitor’s trends and Dell’s trend. Dell has recently implemented new sales

strategies by opening new stores and planning to grow their sales numbers in new

ways. Therefore, we feel that although Dell has experienced a reduction in sales over

the last couple of years, now they will rebound starting in 2008 with the new strategies

that have been implemented as well as the industry growth rate.

Ideally, Dell would prefer to keep their gross profit ratio at least at the same rate

if not better than previous years. Therefore, when calculating the cost of goods sold

over the next 10 years we came to the conclusion that cost of goods sold should grow

at the percentage rate of sales. These rates are figured by taking the average over the

last five years divided by sales. The rate of cost of goods sold divided by sales is

81.99%. By achieving this rate they will keep their gross profit margin at a rate that

will keep profits at the same rate as they have been in years past. Dell’s expectations,

like most corporations, are to improve each year. We feel that in order for this to be

possible they must keep this ratio increasing at this rate.

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Research and development (R&D) is a vital part of the technology industry. This

department is crucial in keeping the company innovative and on top of the newest,

hottest items on the market. Over the last 5 years, Dell has increased R&D by an

average rate of 2.4%. We feel that with the market as tight as it is at this point, R&D is

a very important aspect of the technology industry. We chose a rate of .96% of sales

for R&D to increase over the next 10 years. We believe it will take that much allocation

of funds in order to continue to grow and compete at a high level in this industry.

As the goal of Dell is to grow, obviously it is necessary to expect new plants, new

employees, new equipment, and larger facilities. We feel that they will increase these

operating expenses at a rate of 10.83% of sales each year. This will help them to

gradually use funds to continue to grow. Allocating this percentage over 10 years will

help them offset these costs over that period of time and to continue to grow at a rate

expected. By increasing all of these categories, this will also help to increase the

operating income that Dell will receive in each of the next years. By looking at different

trends in both Dell and the industry, we have forecasted the operating income to

increase at a rate of 7.18% of sales over the next 10 years.

By increasing sales strategies and corporate structure, we are expecting Dell’s

net income to increase at a rate of 5.65% of sales over the next 10 years. They will be

able to do this by utilizing the different strategies discussed on the income statement

previously. Sections such as R&D making sure they utilize their funds to increase the

innovation and efficiency of the company. Becoming cost effective and taking

advantage of sales programs and growth will help Dell get to the level they are

expecting.

The different rates for these items on the income statement were calculated by

looking at the industry average, Dell’s average, Dell’s trends, and the different

benchmarks and trends in the industry. By considering these different strategies, we

were able to use a weighted average to come up with the forecasts of the next 10

years.

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Balance Sheet

To forecast the next 10 years of Dell’s assets, liabilities, and owners equity we

first had to link the forecasts from the income statement to the balance sheet. We did

this by employing the total asset turnover ratio. This ratio shows the relationship

between sales for one year and the assets of the firm. We wanted to estimate a growth

rate for this relationship. We felt that sales would level off over the next 10 years while

assets maintained a fairly steady growth rate. This led us to use a slightly lower total

asset turnover than had been the average for the past 5 years of 2.45. This allowed us

to maintain a constant relationship between the balance sheet and the income

statement through sales.

To begin, the current assets grew at the rate of current assets/total assets for

the last five years. The total assets were forecasted by looking back at the income

statement and connecting sales to the total asset turnover. This helped to check our

figures and ensure that our forecasts are as accurate as possible. As liabilities plus

stockholders equity have to equal assets, it is important that these figures all coexist

with each other. The current liabilities are forecasted using the current ratio. This ratio

is the current assets divided by the current liabilities. Therefore, you calculate current

liabilities by dividing the current assets over the current ratio. The stockholders equity

of the firm is equal to last year’s stockholder equity, plus net income, minus dividends.

Since Dell is a non dividend paying company, you leave the dividend part out. To check

your figures you may then add total liabilities to total stockholders equity and see if that

equals total assets. If these figures check to be the same, you have done the correct

calculations.

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Statement of Cash Flow

The statement of cash flow looks at the amounts of cash that are provided from

various activities in the company. Looking at Dell’s financial averages over the past

year was the way we were able to come up with our forecasting for the cash flow

statement. We looked at our predictions for sales, growth, and income and compared

those statistics to Dell’s average over the last few years to give us the best estimate of

where Dell is expected to be in the next 10 years.

Conclusion

When forecasting Dell’s income statement, balance sheet, and statement of cash

flows for the next 10 years, the most accurate way to attain these numbers is by using

a weighted average method. We were able to look at not just Dell’s numbers, but, the

industry as a whole. By calculating the different firms that compete with Dell and

creating a ratio of how large their sales volume is, we were able to come up with the

most accurate predictions for Dell’s financials. Investors look at most forecasts as a

percentage of sales. They look at previous years sales data and use their figures as a

percentage of sales. We implemented this procedure as well to look at Dell’s figures.

Cost of Capital Estimation

Cost of equity

The cost of equity for any firm is the amount of interest paid to shareholders for

owning stock in that particular firm. As a common stock investor, one would demand a

greater return than that of an investment with less risk. Because stockholders are the

last to be repaid in the event of bankruptcy this type of investment is high risk. The

difference in the return expected of a risk free investment, such as a US Treasury Bill,

and that of a riskier investment is the risk premium paid to the investor. We use a

model called the Capital Asset Pricing Model (CAPM) to calculate the cost of equity for

the firm. This model uses the β (which measures the systematic risk of the firm) of the

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firms stock, the risk free rate, and the market risk premium to calculate the cost of

equity.

To calculate the cost of equity we needed to gather information on the monthly

return of Dell’s stock, monthly Treasury returns for the 3 month, 6 month, 2 year, 5

year, and 10 year rates, as well as the monthly return for the S&P 500 index (which is

the market return) for the past 7 years. Using this data we ran regressions comparing

the return provided by Dell’s stock to the market risk premium for holding periods of 24,

36, 48, 60, and 72 months. Running 25 regressions enabled us to compare betas and

adjusted R2 for all of the observations and to obtain the appropriate beta for our cost of

equity. The adjusted R2 value tells us the percentage of beta that is explained by Dell’s

stock return and the market risk premium. The appropriate value for beta was

determined by finding the highest adjusted R2 value within all 25 regression outputs

and using the corresponding beta value. We found the highest adjusted R2 in the

regression output using the 2 year treasury yield with 36 month holding period and a

corresponding beta of 1.83. The risk free rate used was the 2 year treasury yield of

1.646% and the market risk premium we used was the average 7% observed in the

S&P 500 adjusted using the size adjusting factor for firms with a market capital similar

to that of Dell’s which resulted in a market risk premium of 6.6%. We used this

information to compute our cost of equity to be 13.71% as indicated by the highlighted

chart below. The following charts display the results of the 25 regressions we ran along

with the CAPM calculations of the cost of equity using the current risk free rates.

3 Month Rate

Months Beta Risk Free Rate

Adjusted R Squared Cost of Equity

72 1.15 1.367% 0.29841 8.97%

60 1.42 1.367% 0.29452 10.76%

48 1.68 1.367% 0.30096 12.45%

36 1.83 1.367% 0.32904 13.41%

24 1.84 1.367% 0.32961 13.51%

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6 Month Rate

Months Beta Risk Free Rate

Adjusted R Squared Cost of Equity

72 1.15 1.522% 0.29888 9.13%

60 1.42 1.522% 0.29486 10.91%

48 1.68 1.522% 0.30154 12.62%

36 1.83 1.522% 0.32983 13.59%

24 1.84 1.522% 0.33018 13.68%

2 Year Rate

Months Beta Risk Free Rate

Adjusted R Squared Cost of Equity

72 1.15 1.646% 0.29698 9.22%

60 1.42 1.646% 0.29414 11.04%

48 1.68 1.646% 0.29934 12.70%

36 1.83 1.646% 0.33020 13.71%

24 1.84 1.646% 0.33006 13.79%

5 Year Rate

Months Beta Risk Free Rate

Adjusted R Squared Cost of Equity

72 1.14 2.497% 0.29431 10.04%

60 1.42 2.497% 0.29267 11.90%

48 1.66 2.497% 0.29585 13.46%

36 1.82 2.497% 0.32963 14.50%

24 1.83 2.497% 0.32958 14.58%

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10 Year Rate

Months Beta Risk Free Rate

Adjusted R Squared Cost of Equity

72 1.14 3.443% 0.29267 10.96%

60 1.42 3.443% 0.29141 12.83%

48 1.65 3.443% 0.29338 14.33%

36 1.81 3.443% 0.32915 15.40%

24 1.82 3.443% 0.32940 15.47%

Cost of Debt

The cost of debt for any given company is the interest rate that the company

pays on its liabilities, or the amount it pays on its borrowings. In using a weighted

average cost of debt, we gave a weight to each liability in relation to total liabilities and

multiplied it by the corresponding interest rate. The sum of these multiplications gave

us the effective interest rate for all debt held by the company. The interest rates, all

found in the 10-K, varied from 5.25 % to 5.9% depending on the type of debt issued.

The interest rate used on accounts payable was taken from the St. Louis Fed using the

3 month, non-financial commercial paper rate of 2.35%. The following table displays

the debts and interest rates used in calculating the total cost of debt. We found Dell’s

cost of debt to be 3.99%, using the formula for weighted average cost of debt.

Liabilities Debt Weight Interest Rate WACD

Short-term borrowings $225 0.01 5.30% 0.05%

Accounts payable 11,492 0.48 2.35% 1.44%

Accrued and other 6,809 0.29 5.25% 1.51%

Long-term debt 362 0.02 5.90% 0.09%

Other non-current liabilities 4,844 0.20 5.90% 1.20%

Total liabilities 23,732 1.00 3.99%

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Weighted Average Cost of Capital

The weighted average cost of capital for a firm is an average of the total cost of

equity and debt. It computes an average interest rate that the firm pays to finance its

total assets. The formula for WACC involves the use of the firms market value of equity

(market cap), value of assets and liabilities, and the percentage costs of debt and

equity; WACC = (MVe/ MVa)* ke + (MVl/MVa)* kd. There are also two ways to look at

this cost of capital, before and after taxes. We calculated Dell’s WACC BT to be 10.28%

and WACC AT to be 9.95%. The effective tax rate used by Dell in 2007 was 23%,

according to the 10-K. The following table summarizes this information and shows the

calculations used to arrive at this conclusion.

Weighted Average Cost of Capital

(Mve/Mva)

Cost of Equity

(MVl/Mva) Cost of Debt

tax rate

WACC

WACC BT

(43510/43510+23732) 0.1371 (23732/43510+23732) 0.0399 0 10.28%

WACC AT

(43510/43510+23732) 0.1371 (23732/43510+23732) 0.0399 (1-.23) 9.95%

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Credit Risk

In order to determine the bankruptcy risk of Dell and its competitors, we used Altman’s

Z-Score. The higher the score, the lower is the risk of bankruptcy. A score of 1.8 or

below is considered to have a high risk of bankruptcy and a score of 3.0 or higher is

considered to have a low risk of bankruptcy. (www.spireframe.com) The Altman’s Z-

Score is calculated by combining these five ratios:

3.3 x (EBIT/Total Assets)

1.0 x (Net Sales/Total Assets)

0.6 x (Market Value of Equity/Total Liabilities)

1.2 x (Working Capital/Total Assets)

+ 1.4 x (Retained Earnings/Total Assets)

Altman’s Z-Score

Altman's Z-Score 2003 2004 2005 2006 2007Dell 5.66 5.21 5.05 5.26 4.84

Apple 3.82 6.58 11.35 8.55 12.13

HP 16.06 12.51 16.05 12.39 11.09

IBM 2.90 2.48 3.04 3.27 3.01

Dell’s Z-Score is the lowest it has been in 5 years. This is likely due to an increase in

debt and a decreasing market cap. A recent decline in sales is also a contributing factor

to the declining Z-Score. This change in capital structure has led to a slightly higher risk

of bankruptcy according to Altman’s Z-Score. However, Dell still remains a highly

unlikely bankruptcy candidate. The asset turnover ratios, which is net sales divided by

total assets, has also seen a recent decline. This is evidence that the firm’s assets are

producing fewer sales dollars per 1 dollar of assets. Overall, Dell has a very low risk of

bankruptcy.

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Valuation Analysis

Intrinsic Valuation Models

The most accurate and reliable valuation methods are those derived from

intrinsic analysis. These analysis are called intrinsic valuation models and include the

dividends discount model, the residual income model, abnormal earnings growth model,

and free cash flow models. These models give us a more realistic idea of the value of a

firms equity based on forecast earnings numbers. Using the book value of equity is the

starting point for these models. Then we forecast out numbers for the firm for ten

years. These forecasted numbers must be discounted back to present time numbers. To

do this we use the discount rates provided by the weighted average cost of capital and

the cost of equity. The aggregate of these numbers along with any terminal value

perpetuity is what builds the basis for valuation. Analysis of these numbers is very

important as they are a sound valuation process for any firm.

Method of Comparables

Price to Earnings Trailing

Price to Earnings Trailing

PPS EPS P/E Trailing Industry Average Expected PPS

Dell 20.33 1.33 15.29 16.29 21.67 Apple 149.53 3.93 38.05 Don’t Use HP 47.59 2.93 16.24 IBM 116.49 7.13 16.34

Price to earnings trailing is calculated by dividing the price per share by the

earnings per share. For the trailing you use the current earnings per share number.

When you look at the industry average there is an outlier. What this means is there is

a firm which throws off the industry average. The example of this is the fact that

Apple’s P/E Trailing is 38.05, while the other competitors are 16.24, 16.34, and 17.83.

Therefore you throw that figure out. After you throw out any outliers, you compute the

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industry average and multiply it by the firm you are valuing earnings per share. After

this number was computed the figure came back that Dell’s price per share is valued at

$18.57. This would say that Dell’s stock is fairly valued; the actual price per share at

that time was $20.33.

Price to Earnings Forward

PPS EPS 1 Year Out P/E Forward Industry Average Expected PPS

Dell 20.33 1.60 12.71 13.82 22.11 Apple 149.53 5.13 29.15 Don’t Use HP 47.59 3.52 13.52 IBM 116.49 8.25 14.12

The price to earnings forward is almost identical to the price to earnings trailing

model. The only difference is that with this model you divide the price per share by the

earnings per share 1 year out. As done in the previous model, Apple’s figure was

thrown out. They are an outlier since they are not within $15 of the closest competitor.

After running this model, Dell’s price per share is valued at $20.73. This would mean

that Dell’s current stock price is fairly valued. When looking at this model the advice

would be to buy this stock. This means that the stock price is predicted to be worth

more than it is currently and will go up in value in the near future.

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Price to Book PPS BPS P/B Industry Average Expected PPS Dell 20.33 1.68 12.10 5.55 9.32 Apple 149.53 19.13 7.82 HP 47.59 15.09 3.15 IBM 116.49 20.55 5.67

For the most part, the comparables models are a lot alike. The price to book

model is calculated by dividing the price per share by the book value per share. There

was not an outlier when using this model so we were able to use all of the competitors

to calculate the industry average. After running the model, Dell’s price per share came

back valued at $10.15. Therefore, this model suggests that Dell’s stock is overvalued

and would advise stockholders to sell their stock.

PEG Company PE EGR (t+1) P.E.G. Industry Average Expected PPS Dell 15.34 5.75 2.67 1.45 8.31 Apple 38.05 22.96 1.66 HP 16.24 14.59 1.11 IBM 16.34 10.44 1.57

The price to earnings growth rate is a unique model. This model takes your

price per share over earnings per share and then divides that figure again by your

earnings growth rate of (t+1) which means the next year. There are no outliers in this

section either, as all of the competitor’s averages are close together. After computing

the model it generates the price per share of $8.31 which leaves Dell’s stock again

overvalued.

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Price over EBITDA In Billions

Market Cap EBITDA P/EBITDA Industry Average Expected PPS

Dell 45.19 4.51 10.02 8.68 39.13 Apple 134.54 5.56 24.20 Don’t Use HP 114.39 12.25 9.34 IBM 160.25 19.99 8.02

The price over EBITDA is the price over earnings before income taxes,

depreciation, and amortization. This calculation is determined by dividing the market

cap by the EBITDA. When using this model, it was determined that Apple is an outlier

in the industry. The same structure is used to determine the expected price per share

however. Dell’s expected price per share comes out to $39.13, which again shows that

Dell is undervalued.

Price over Free Cash Flows In Billions Market Cap FCF P/FCF Industry Average Expected PPS Dell 45.19 2.19 20.63 21.98 48.14 Apple 134.54 2.90 46.39 Don't Use HP 114.39 6.02 19.00 IBM 160.25 6.42 24.96

The price over free cash flows model is calculated by dividing, once again, the

market cap by the free cash flows. Your free cash flows are calculated by cash flow

from operations plus or minus cash flow from investments. Apple again is an outlier

when calculating the industry average. After calculating the model it computes a stock

price of $48.14 per share. This model also says that Dell is undervalued.

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Enterprise Value/EBITDA

Company EV ($bill.) EBITDA ($BILL.) EV/EBITDA

Industry Average

Expected PPS

Dell 76.89 4.51 17.05 9.29 41.91 Apple 116.09 5.56 20.88 Don’t Use HP 117.72 12.25 9.61 IBM 179.38 19.99 8.97

In the enterprise value to EBITDA model the enterprise value is first computed

by adding the market value of equity, plus the book value of liabilities, plus cash, plus

the investments. After computing that number, you divide that by EBITDA. Apple

again was an outlier in the industry and was thrown out in order to computer the

industry average. The expected price per share for Dell’s stock was $41.91 using this

model. This model says that Dell’s stock is undervalued.

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Residual Income

The residual income model is considered one of the most reliable models used to

estimate the value of a firm. This is true because this model is not as sensitive to

terminal value growth rates and assumptions as the other models put into place. The RI

model relies primarily on the present value of residual income and book value of equity

rather than perpetuities.

The residual income is the actual value created or destroyed by the firm. When

the RI is negative, this means that the firm is destroying value to the shareholders. The

residual income of a firm is calculated by taking the difference between the firm’s actual

earnings and a calculated normal, or benchmark, income. This benchmark is calculated

by multiplying the previous year’s book value of equity by the cost of equity. Once the

difference, residual income, is calculated, the present value of each year is taken by

using the following formula: 1/ (1+ke)t. The total present value of residual income is

calculated by adding the present values of each year, which came out to $ 8592 million.

The next step is to determine the value of the perpetuity and discount it back using the

present value factor of year ten with the following formula:

Perpetuity2017= RI2018/ (ke-g).

Using a cost of equity of 13.71% and the appropriate zero growth rate, this value came

out to be $ (2641) million. Once these calculations are complete, the next step is to add

the present value of residual income, present value of the perpetuity, and the initial

book value of equity. This determines our appropriate market value of equity and that

value is then divided by the number of shares outstanding to determine the estimated

share price at the beginning of 2008. To determine the time consistent share price at

April 1, 2008, the beginning 2008 price is given a future value of 3 months later which

gives us an estimated share price at our valuation date, April 1 2008, of $ 4.50.

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Growth Rates

0.0% -10.0% -20.0% -30.0% -40.0% -50.0%

10.00% $ 8.52 $ 8.21

$ 8.11 $ 8.06

$ 8.03

$ 8.01

Cost 11.00% $ 7.09 $ 7.16

$ 7.19 $ 7.20

$ 7.21

$ 7.22

of 12.00% $ 5.96 $ 6.27

$ 6.38 $ 6.44

$ 6.48

$ 6.51

Equity 13.71% $ 4.50 $ 5.02

$ 5.23 $ 5.34

$ 5.41

$ 5.46

15.00% $ 3.69 $ 4.26

$ 4.51 $ 4.65

$ 4.74

$ 4.80

16.00% $ 3.18 $ 3.77

$ 4.03 $ 4.18

$ 4.28

$ 4.34

Overvalued <

$17.28 Fairly Valued ($17.28-$23.38) Undervalued > $23.38

When looking at the sensitivity analysis of this model, one can see that Dell is

overvalued no matter what growth rate or cost of equity is used. The cost of equities

used ranged from 10% to 16% and we used negative growth rates up to -50%.

Negative growth rates are used in this model because in effect the residual income

should over time converge to zero. Looking at this sensitivity analysis, it is obvious that

this firm is consistently overvalued no matter what cost of equity and growth rate was

used. This summarizes the fact that the residual income model is not very sensitive to

the changes made.

Long Run Residual Income

The long run RI model is based on such factors as residual income, long run return on

equity, and the growth rate of return on equity. The growth rates stem from the forecasted

financial statements such as the change in equity from the balance sheet. To begin this

valuation model, we took an average of the return on equity in the long run, and this number

came out to be 30%. We also used a growth rate of the return on equity of 5.65%. These two

numbers along with our cost of equity of 13.71% and the book value of equity will be used in

calculating the value of the Long Run Residual Income. The formula for this valuation is as

follows:

Estimated Market Cap= Book value of Equity ( 1 + ((ROE –Ke)/(Ke-g))).

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In using this formula we arrived at an estimated market cap of $ 11284 million. After

calculating this value, we divided that number by the number of shares outstanding of 2223

million to find an estimated share price of $ 5.08. Once this value is achieved, a time consistent

price of $ 5.24 was calculated by going ahead 3 months to arrive at the valuation date of April

1, 2008.

Long Run Residual Income Sensitivity Analysis Return on Equity

10.00% 20.00% 30.00% 40.00% 50.00%

Cost 11.00% $ 1.40 $

4.63 $

7.85 $ 11.07 $ 14.30

of 12.00% $ 1.18 $

3.91 $

6.63 $ 9.35 $ 12.07

Equity 13.71% $ 0.94 $

3.09 $

5.24 $ 7.39 $ 9.55

15.00% $ 0.81 $

2.67 $

4.53 $ 6.39 $ 8.25

16.00% $ 0.73 $

2.42 $

4.10 $ 5.79 $ 7.47

Growth Rate is held Constant at 5.65% Overvalued < $17.28 Fairly Valued ($17.28-$23.38) Undervalued > $23.38

Long Run Residual Income Sensitivity Analysis Return On Equity

10.00% 20.00% 30.00% 40.00% 50.00%

-5.00% $ 1.39 $

2.32 $

3.25 $ 4.17 $ 5.10

0.00% $ 1.27 $

2.53 $

3.80 $ 5.06 $ 6.33

Growth 5.65% $ 0.94 $

3.09 $

5.24 $ 7.39 $ 9.55

Rates 10.00% N/A $

4.68 $

9.35 $

14.03 $

18.71 15.00% $ 6.72 N/A N/A N/A N/A

Cost of Equity is held Constant at 13.71% Overvalued < $17.28 Fairly Valued ($17.28-$23.38) Undervalued > $23.38

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Long Run Residual Income Sensitivity Analysis Growth Rates

-5.00% 0.00% 5.65% 10.00% 15.00%Cost 11.00% $ 3.77 $ 4.70 $ 7.85 $ 34.49 N/A

of 12.00% $ 3.56 $ 4.32 $ 6.63 $ 17.28 N/A Equity 13.71% $ 3.25 $ 3.80 $ 5.24 $ 9.35 N/A

15.00% $ 3.04 $ 3.48 $ 4.53 $ 6.96 N/A 16.00% $ 2.91 $ 3.27 $ 4.10 $ 5.81 $ 26.16

Return on Equity is constant at 30% Overvalued < $17.28 Fairly Valued ($17.28-$23.38) Undervalued > $23.38

When conducting sensitivity analysis on this model, several variables are taken

into account including cost of equity, growth rates, and the return on equity. Looking at

the sensitivity analysis, one can see that there is a wide variety of outputs depending

on what variables are taken into account. Overall the estimated prices from these

outputs show the firm to be overvalued.

Abnormal Earnings Growth

When it comes to using different models to value a firm, the abnormal earnings

growth model is one of the most difficult to calculate. To calculate the AEG, the net

income is added to the DRIP income or dividend reinvestment and then the normal

income is subtracted from that number. This figure is your abnormal earnings. For a

firm like Dell, this is just simply the net income minus the normal income. Dell does not

pay dividends; therefore, they have no DRIP income. The normal income is computed

by the net income in the year past times one plus the cost of equity. While first

thought would be that this model is not important or capable of valuing a firm that does

not pay dividends, it actually is. This model works for firms that pay dividends, as well

as, firms that do not pay dividends.

To value the equity of Dell, we first had to use our forecasted net income in the

model. To calculate the normal income we took the net income from the previous year

times one plus our cost of equity which is 13.71%. The best part of this model is the

101

fact that there is a check figure built into the model. The change in the residual income

is the same as the abnormal earnings growth. Therefore, you can compare the residual

income model to the abnormal earnings growth model to make sure you have the most

accurate statistics. When computing this model we come up with a time consistent

price of $.64. Therefore, this model says that Dell’s stock is overvalued.

Growth Rates -10.0% -20.0% -30.0% -40.0% -50.0%

10.00% $ 3.07

$ 4.13

$ 4.66

$ 4.98

$ 5.19

Cost 11.00% $ 2.14

$ 3.08

$ 3.56

$ 3.85

$ 4.05

of 12.00% $ 1.45

$ 2.28

$ 2.71

$ 2.98

$ 3.16

Equity 13.71% $ 0.64

$ 1.30

$ 1.66

$ 1.89

$ 2.04

15.00% $ 0.23

$ 0.79

$ 1.10

$ 1.30

$ 1.44

16.00% N/A $ 0.49

$ 0.77

$ 0.95

$ 1.07

Overvalued < $17.28

Fairly Valued ($17.28-$23.38)

Undervalued > $23.38

When looking at the chart above, you will see that all but one price is

overvalued. We took into consideration different growth rates as well as cost of equity

to get a value of the firm. Using this model it would be apparent that Dell’s stock is

extremely overvalued since stock prices go as low as $.23 and only as high as $5.19.

When comparing this price to the April 1, 2008 price there is a large difference and

according to these values, Dell is extremely overvalued.

102

Free Cash Flow

The valuation model we used to determine the intrinsic value for Dell based on

cash flow was the free cash flow model. This model examines the future expected free

cash flows of the firm to debt and equity. We first forecasted out ten years worth of

cash flows for the firm including cash flow from operations and cash flow from

investment activities. To calculate the free cash flow to equity for one year we must use

the following equation:

Free Cash Flow to Equity = Cash Flow from Operations – Cash outlays for

Capital Investments

After determining the free cash flow for each of the forecasted years we

discounted them back to present value using the weighted average cost of capital rate.

For Dell the weighted average cost of capital (WACC) is 10.28%. In addition to

forecasting ten years of cash flows we also calculated a terminal value for cash flows.

The terminal value is the last forecasted number we use; beyond that we use a

perpetuity growth rate to determine cash flows beyond the foreseeable future. Using

the present value formula PV= FV/(1+KWACC)t and the present value of a perpetuity

PVp=[FV/(KWACC-G)]/(1+KWACC)t-1 we calculated the total free cash flows in the future in

2008 dollars.

We calculated the value of Dell to be $60,076 and since we know that the book

value of liabilities is $23,732 we subtracted the liabilities from the total value of the

firm. What we were left with is the intrinsic market value of equity (MVE) which was

$36,344. This number, however, is the value of equity as of January 1st 2008. To get

the MVE we then multiplied the beginning year price by one plus KWACC raised to 3/12

power then divide the MVE by the shares outstanding of 2,223,000,000 to get the time

consistent share price of $16.57. This discounted free cash flow valuation model shows

that at the current observed stock price per share of $20.33 Dell is overvalued.

103

0.00% 2.00% 4.00% 5.51% 7.00%4.00% 40.50$ 79.74$ N/A N/A N/A

W 6.00% 21.79$ 32.65$ 65.24$ 266.03$ N/AA 8.00% 12.61$ 17.13$ 26.18$ 42.64$ 107.63$ C 10.28% 6.64$ 8.71$ 12.11$ 16.57$ 25.00$ C 12.00% 3.70$ 4.96$ 6.85$ 9.06$ 12.55$

(BT) 14.00% 1.25$ 2.00$ 3.05$ 4.18$ 5.78$

Growth Rates

* N/A represents irrelevant negative share pricesOvervalued < $17.27 $17.27 < Fairly Valued > $23.38 Undervalued > $23.38

The chart shown above is the sensitivity analysis of the discounted free cash flow

valuation model for Dell. By substituting different WACC and Growth rates for the model

we can see that the stock price fluctuates greatly. You can see that at most growth

rates and WACCs Dell is overvalued.

Conclusion

After analyzing all of the intrinsic valuations, it is determined that Dell is

consistently overvalued in the market. The intrinsic models including Residual Income,

Long Run ROE RI, and AEG all prove Dell to be severely overvalued. On the other hand,

the Free Cash Flow model showed the company to be only slightly overvalued

depending on the rates used in the valuations. This is a result of the sensitivity involved

with the different models. The least sensitive being the Residual Income and the most

sensitive to growth rates is the Free Cash Flow Model. With this being said the data

provided by each of these intrinsic valuation models suggests that Dell is overvalued at

April 1 2008, and therefore we set our recommendation to sell.

104

Appendices

Inventory Turnover 2003 2004 2005 2006 2007

Dell 103.25 87.37 78.06 72.58 41.92

Apple 80.34 59.60 59.93 50.80 45.81

HP 8.93 8.57 9.63 8.93 9.78

IBM 28.95 27.88 30.77 18.45 21.42

Days Supply of Inventory 2003 2004 2005 2006 2007

Dell 3.53 4.18 4.68 5.03 8.71

Apple 4.54 6.12 6.09 7.18 7.97

HP 40.85 42.57 37.90 40.89 37.30

IBM 12.61 13.09 11.86 19.78 17.04

Working Capital Turnover 2003 2004 2005 2006 2007

Dell -157.14 17.79 34.42 26.73

Apple 1.71 1.89 1.44 2.39 1.90

HP 4.72 5.58 7.30 7.38 12.81

IBM -146.90 -29.97 8.67 20.01 11.14

Profitability Analysis

Gross Profit Margin 2003 2004 2005 2006 2007

Dell 18.30% 18.36% 17.73% 16.57% 19.09%

Apple 27.52% 27.29% 29.01% 28.98% 33.97%

HP 25.84% 24.13% 23.61% 24.53% 24.63%

IBM 4.62% 3.98% 4.07% 43.30% 42.24%

Operating Profit Margin 2003 2004 2005 2006 2007

Dell 8.53% 8.56% 7.85% 5.35%

Apple -0.02% 3.94% 11.79% 12.70% 18.37%

HP 3.96% 5.29% 4.01% 7.16% 8.36%

IBM 1845% 1450.10% 715.03% 357.48% 901.99%

Net Profit Margin 2003 2004 2005 2006 2007

Dell 6.35% 6.14% 6.46% 4.50% 4.82%

Apple 1.11% 3.33% 9.53% 10.30% 14.56%

HP 3.48% 4.38% 2.77% 6.76% 6.97%

IBM 6.13% 4.91% 5.17% 5.11% 3.72%

Asset Turnover 2004 2005 2006 2007

Dell 2.54 2.40 2.47 2.38

105

Apple 1.21 1.73 1.68 1.40

HP 1.07 1.14 1.19 1.27

IBM 0.92 0.82 0.86 0.96

Return on Assets 2004 2005 2006 2007

Dell 15.63% 15.52% 11.11% 11.50%

Apple 4.05% 16.50% 17.27% 20.32%

HP 4.68% 3.15% 8.02% 8.86%

IBM 7.16% 7.15% 8.98% 10.10%

Return on Equity 2004 2005 2006 2007

Dell 48.06% 55.54% 63.83% 68.09%

Apple 6.54% 26.16% 26.78% 35.02%

HP 9.26% 6.38% 16.68% 19.04%

IBM 26.84% 25.04% 28.68% 36.55%

Capital Structure Analysis

Debt to Equity Ratio 2003 2004 2005 2006 2007

Dell 2.08 2.58 4.75 4.90 6.35

Apple 0.61 0.59 0.55 0.72 0.74

HP 0.98 1.03 1.08 1.15 1.30

IBM 2.75 2.50 2.19 2.62 3.23

Times Interest Earned 2003 2004 2005 2006 2007

Dell 3.42 3.18 4.58 4.39

HP 137.90 120.77 41.84 10.83 19.64

IBM 3.33 3.36 2.89 3.41 3.56

Current Ratio 2003 2004 2005 2006 2007

Dell 0.98 1.20 1.10 1.12 1.07

Apple 2.50 2.63 2.95 2.25 2.36

HP 1.61 1.50 1.38 1.35 1.21

IBM 0.98 0.92 1.30 1.11 1.20

Quick Asset Ratio 2003 2004 2005 2006 2007

Dell 0.81 1.01 0.81 0.84 0.75

Apple 2.26 2.33 2.63 1.76 1.83

HP 0.92 0.81 0.76 0.76 0.63

IBM 0.47 0.53 0.66 0.53 0.62

Accounts Receivable Turnover 2003 2004 2005 2006 2007

106

Dell 11.37 11.13 13.67 12.42 10.26

Apple 8.10 10.70 15.57 15.43 14.66

HP 8.19 7.81 8.75 8.43 7.77

IBM 8.91 9.15 9.55 8.47 8.64

Days Supply of Receivables 2003 2004 2005 2006 2007

Dell 32.10 32.80 26.71 29.38 35.59

Apple 45.04 34.12 23.45 23.66 24.89

HP 44.57 46.71 41.69 43.30 46.97

IBM 40.97 39.88 38.21 43.07 42.23

Cash to Cash Ratio 2003 2004 2005 2006 2007

Dell 35.64 36.98 31.38 34.41 44.30

Apple 49.59 40.25 29.54 30.84 32.86

HP 85.42 89.29 79.60 84.19 84.27

IBM 53.58 52.97 50.07 62.86 59.27

Revenue Manipulation Diagnostics DELL 2003 2004 2005 2006 2007Net Sales/Cash from Sales 0.991 0.975 0.982 0.984 0.988 Net Sales/Net Accounts Rec 13.636 11.369 11.128 13.667 12.423 Net Sales/Inventory 115.235 126.382 107.017 94.878 87.000 Net Sales/Unearned Revenues N/A* N/A* 16.915 15.049 13.603 Net Sales/Warranty Liabilities N/A* N/A* 68.035 58.662 59.937

Price to Earnings Trailing

PPS EPS P/E Trailing

Industry Average

Expected PPS

Dell 20.33 1.14 17.83 16.29 18.57 Apple 149.53 3.93 38.05 Do Not Use HP 47.59 2.93 16.24 IBM 116.49 7.13 16.34

Price to Earnings Forward

PPS EPS 1 Year Out

P/E Forward

Industry Average

Expected PPS

Dell 20.33 1.50 13.55 13.82 20.73 Apple 149.53 5.13 29.15 Don't Use HP 47.59 3.52 13.52 IBM 116.49 8.25 14.12

107

Price to Book

PPS BPS P/B Industry Average

Expected PPS

Dell 20.33 1.83 11.11 5.55 10.15 Apple 149.53 19.13 7.82 HP 47.59 15.09 3.15 IBM 116.49 20.55 5.67

PEG

Company PE EGR (t+1) P.E.G. Industry Average

Expected PPS

Dell 17.83 5.75 3.10 1.45 8.31 Apple 38.05 22.96 1.66 HP 16.24 14.59 1.11 IBM 16.34 10.44 1.57

Price over EBITDA

In Billions Market Cap EBITDA P/EBITDA

Industry Average

Expected PPS

Dell 39.89 4.51 8.84 8.68 39.13 Apple 134.54 5.56 24.20 Don't Use HP 114.39 12.25 9.34 IBM 160.25 19.99 8.02

Price over Free Cash Flows

In Billions Market Cap FCF P/FCF

Industry Average

Expected PPS

Dell 39.89 2.19 18.21 21.98 48.14 Apple 134.54 2.90 46.39 Don't Use HP 114.39 6.02 19.00 IBM 160.25 6.42 24.96

Enterprise Value/EBITDA

Company EV ($bill.) EBITDA ($BILL.) EV/EBITDA

Industry Average

Expected PPS

Dell 71.59 4.51 15.87 9.29 41.91 Apple 116.09 5.56 20.88 Don't Use HP 117.72 12.25 9.61 IBM 179.38 19.99 8.97

108

109

Z-Score

3.3 x (EBIT/Total Assets)

1.0 x (Net Sales/Total Assets)

110

0.6 x (Market Value of Equity/Total Liabilities)

1.2 x (Working Capital/Total Assets)

+ 1.4 x (Retained Earnings/Total Assets)

Altman’s Z-Score

Altman's Z-Score 2003 2004 2005 2006 2007Dell 5.66 5.21 5.05 5.26 4.84

Apple 3.82 6.58 11.35 8.55 12.13

HP 16.06 12.51 16.05 12.39 11.09

IBM 2.90 2.48 3.04 3.27 3.01

Liabilities Debt Weight Interest Rate WACD

Short-term borrowings $225 0.01 5.30% 0.05%

Accounts payable 11,492 0.48 2.35% 1.44%

Accrued and other 6,809 0.29 5.25% 1.51%

Long-term debt 362 0.02 5.90% 0.09%

Other non-current liabilities 4,844 0.20 5.90% 1.20%

Total liabilities 23,732 1.00 3.99%

Weighted Average Cost of Capital

(Mve/Mva)

Cost of Equity

(MVl/Mva) Cost of Debt

tax rate

WACC

WACC BT

(43510/43510+23732) 0.1371 (23732/43510+23732) 0.0399 0 10.28%

WACC AT

(43510/43510+23732) 0.1371 (23732/43510+23732) 0.0399 (1-.23) 9.95%

111

Five Forces Level Of Competition Rivalry Among Existing Firms Moderate

Threat of New Entrants Low Threat of Substitute Products Moderate Bargaining Power of Buyers Moderate

Bargaining Power of Suppliers Moderate OVERALL Moderate

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.598961224

R Square 0.358754547

Adjusted R Square 0.329607027

Standard Error 0.068076164

Observations 24

ANOVA

df SS MS F Significance F

Regression 1 0.057040845 0.057040845 12.30823549 0.001984141

Residual 22 0.101956012 0.004634364

Total 23 0.158996857

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.008790052 0.013927573 -

0.631125909 0.534460953 -0.037674071 0.020093967 -

0.037674071 0.020093967

X Variable 1 1.839797582 0.524411426 3.508309492 0.001984141 0.752234855 2.927360309 0.752234855 2.927360309

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.5900915

R Square 0.348207978

Adjusted R Square 0.329037624

Standard Error 0.063430313

Observations 36

ANOVA

df SS MS F Significance F

Regression 1 0.073080633 0.073080633 18.16387874 0.000151924

Residual 34 0.136795756 0.004023405

Total 35 0.20987639

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

112

Intercept -

0.015561745 0.01057296 -

1.471843674 0.150259624 -0.037048586 0.005925096 -

0.037048586 0.005925096

X Variable 1 1.825320871 0.42828703 4.261910222 0.000151924 0.954936911 2.69570483 0.954936911 2.69570483

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.561990543

R Square 0.31583337

Adjusted R Square 0.300960183

Standard Error 0.060705485

Observations 48

ANOVA

df SS MS F Significance F

Regression 1 0.07825459 0.07825459 21.23508279 3.2312E-05

Residual 46 0.169517169 0.003685156

Total 47 0.247771759

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.008409746 0.008763793 -

0.959601198 0.342272884 -0.026050345 0.009230853 -

0.026050345 0.009230853

X Variable 1 1.67963997 0.364493025 4.608153946 3.2312E-05 0.945953576 2.413326364 0.945953576 2.413326364

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.553600482

R Square 0.306473493

Adjusted R Square 0.29451614

Standard Error 0.057303827

Observations 60

ANOVA

df SS MS F Significance F

Regression 1 0.084163755 0.084163755 25.6305454 4.47593E-06

Residual 58 0.19045626 0.003283729

Total 59 0.274620015

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.010502261 0.007556681 -1.38979806 0.169901874 -0.025628602 0.00462408 -

0.025628602 0.00462408

X Variable 1 1.422463752 0.280971509 5.062661888 4.47593E-06 0.860038174 1.984889331 0.860038174 1.984889331

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.555237009

R Square 0.308288136

113

Adjusted R Square 0.298406538

Standard Error 0.06125106

Observations 72

ANOVA

df SS MS F Significance F

Regression 1 0.117046073 0.117046073 31.19820638 4.15057E-07

Residual 70 0.262618467 0.003751692

Total 71 0.37966454

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.001330376 0.007220691 -

0.184244974 0.854353995 -0.015731589 0.013070837 -

0.015731589 0.013070837

X Variable 1 1.151451991 0.2061489 5.58553546 4.15057E-07 0.74030098 1.562603003 0.74030098 1.562603003

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.599419411

R Square 0.35930363

Adjusted R Square 0.330181068

Standard Error 0.068047012

Observations 24

ANOVA

df SS MS F Significance F

Regression 1 0.057128148 0.057128148 12.33763796 0.001964296

Residual 22 0.101868709 0.004630396

Total 23 0.158996857

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.008594689 0.013925412 -

0.617194596 0.543442062 -0.037474226 0.020284848 -

0.037474226 0.020284848

X Variable 1 1.841762721 0.524345647 3.512497397 0.001964296 0.75433641 2.929189032 0.75433641 2.929189032

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.590743751

R Square 0.34897818

Adjusted R Square 0.329830479

Standard Error 0.063392825

Observations 36

ANOVA

df SS MS F Significance F

Regression 1 0.07324228 0.07324228 18.22559204 0.000148758

114

Residual 34 0.136634109 0.00401865

Total 35 0.20987639

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.015300597 0.010567822 -

1.447847653 0.156818786 -0.036776996 0.006175802 -

0.036776996 0.006175802

X Variable 1 1.827804846 0.428143152 4.269144181 0.000148758 0.957713281 2.697896411 0.957713281 2.697896411

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.562491763

R Square 0.316396983

Adjusted R Square 0.301536048

Standard Error 0.060680475

Observations 48

ANOVA

df SS MS F Significance F

Regression 1 0.078394237 0.078394237 21.29051638 3.16801E-05

Residual 46 0.169377522 0.00368212

Total 47 0.247771759

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.008143288 0.008759229 -

0.929680916 0.357389597 -0.025774703 0.009488126 -

0.025774703 0.009488126

X Variable 1 1.681702826 0.364465275 4.614164754 3.16801E-05 0.94807229 2.415333363 0.94807229 2.415333363

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.553907993

R Square 0.306814064

Adjusted R Square 0.294862583

Standard Error 0.057289755

Observations 60

ANOVA

df SS MS F Significance F

Regression 1 0.084257283 0.084257283 25.67163414 4.4104E-06

Residual 58 0.190362732 0.003282116

Total 59 0.274620015

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -0.01030867 0.007546957 -1.36593731 0.177232027 -0.025415545 0.004798205 -

0.025415545 0.004798205

X Variable 1 1.422615566 0.280776528 5.066718281 4.4104E-06 0.860580286 1.984650847 0.860580286 1.984650847

115

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.555657064

R Square 0.308754772

Adjusted R Square 0.29887984

Standard Error 0.061230396

Observations 72

ANOVA

df SS MS F Significance F

Regression 1 0.117223239 0.117223239 31.26652192 4.05086E-07

Residual 70 0.262441301 0.003749161

Total 71 0.37966454

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.001188712 0.007217673 -0.16469456 0.869659067 -0.015583907 0.013206484 -

0.015583907 0.013206484

X Variable 1 1.152357091 0.206085432 5.591647514 4.05086E-07 0.741332664 1.563381519 0.741332664 1.563381519

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.55326472

R Square 0.30610185

Adjusted R Square 0.294138089

Standard Error 0.057319179

Observations 60

ANOVA

df SS MS F Significance F

Regression 1 0.084061695 0.084061695 25.58575391 4.54851E-06

Residual 58 0.190558321 0.003285488

Total 59 0.274620015

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.010042005 0.007540857 -

1.331679617 0.188175477 -0.02513667 0.005052659 -0.02513667 0.005052659

X Variable 1 1.423818275 0.281485128 5.058236245 4.54851E-06 0.860364578 1.987271972 0.860364578 1.987271972

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.553965643

R Square 0.306877933

Adjusted R Square 0.296976189

116

Standard Error 0.061313465

Observations 72

ANOVA

df SS MS F Significance F

Regression 1 0.116510669 0.116510669 30.99231197 4.46665E-07

Residual 70 0.263153871 0.003759341

Total 71 0.37966454

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.000874685 0.007226503 -

0.121038435 0.904007363 -0.01528749 0.013538121 -0.01528749 0.013538121

X Variable 1 1.147939339 0.206201562 5.567073915 4.46665E-07 0.736683296 1.559195382 0.736683296 1.559195382

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.598936964

R Square 0.358725487

Adjusted R Square 0.329576646

Standard Error 0.068077707

Observations 24

ANOVA

df SS MS F Significance F

Regression 1 0.057036225 0.057036225 12.30668079 0.001985196

Residual 22 0.101960632 0.004634574

Total 23 0.158996857

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.008874236 0.013926297 -

0.637228703 0.530552028 -0.037755608 0.020007136 -

0.037755608 0.020007136

X Variable 1 1.830754142 0.521866666 3.50808791 0.001985196 0.748468923 2.913039361 0.748468923 2.913039361

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.590576654

R Square 0.348780785

Adjusted R Square 0.329627278

Standard Error 0.063402435

Observations 36

ANOVA

df SS MS F Significance F

Regression 1 0.073200852 0.073200852 18.20976164 0.000149564

Residual 34 0.136675538 0.004019869

117

Total 35 0.20987639

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.015293253 0.010569462 -

1.446928172 0.157074563 -0.036772984 0.006186479 -

0.036772984 0.006186479

X Variable 1 1.819263646 0.42632766 4.26728973 0.000149564 0.952861604 2.685665687 0.952861604 2.685665687

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.55752553

R Square 0.310834716

Adjusted R Square 0.295852862

Standard Error 0.060926844

Observations 48

ANOVA

df SS MS F Significance F

Regression 1 0.077016064 0.077016064 20.74741328 3.84733E-05

Residual 46 0.170755694 0.00371208

Total 47 0.247771759

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.007564046 0.008794039 -

0.860133386 0.394176368 -0.025265528 0.010137435 -

0.025265528 0.010137435

X Variable 1 1.661022468 0.364664535 4.554932852 3.84733E-05 0.926990843 2.395054093 0.926990843 2.395054093

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.551959694

R Square 0.304659504

Adjusted R Square 0.292670875

Standard Error 0.05737872

Observations 60

ANOVA

df SS MS F Significance F

Regression 1 0.083665598 0.083665598 25.41237187 4.84118E-06

Residual 58 0.190954418 0.003292318

Total 59 0.274620015

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.009462091 0.007528007 -

1.256918406 0.213821489 -0.024531034 0.005606853 -

0.024531034 0.005606853

X Variable 1 1.424171236 0.282513762 5.041068525 4.84118E-06 0.858658502 1.989683969 0.858658502 1.989683969

118

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.551592445

R Square 0.304254225

Adjusted R Square 0.294315

Standard Error 0.061429402

Observations 72

ANOVA

df SS MS F Significance F

Regression 1 0.11551454 0.11551454 30.61146259 5.11833E-07

Residual 70 0.264149999 0.003773571

Total 71 0.37966454

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.000296407 0.007239528 -

0.040942867 0.967457999 -0.014735191 0.014142377 -

0.014735191 0.014142377

X Variable 1 1.142252175 0.206452408 5.532762655 5.11833E-07 0.730495835 1.554008514 0.730495835 1.554008514

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.598799798

R Square 0.358561198

Adjusted R Square 0.329404889

Standard Error 0.068086427

Observations 24

ANOVA

df SS MS F Significance F

Regression 1 0.057010104 0.057010104 12.29789395 0.001991173

Residual 22 0.101986754 0.004635762

Total 23 0.158996857

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.008593912 0.013933567 -

0.616777558 0.543712147 -0.037490361 0.020302538 -

0.037490361 0.020302538

X Variable 1 1.822438431 0.519681783 3.506835318 0.001991173 0.744684382 2.90019248 0.744684382 2.90019248

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.590180168

R Square 0.348312631

Adjusted R Square 0.329145355

Standard Error 0.063425221

119

Observations 36

ANOVA

df SS MS F Significance F

Regression 1 0.073102597 0.073102597 18.17225559 0.00015149

Residual 34 0.136773792 0.004022759

Total 35 0.20987639

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.015014268 0.010574859 -

1.419807912 0.164768282 -0.036504967 0.00647643 -

0.036504967 0.00647643

X Variable 1 1.811544275 0.424956557 4.262892866 0.00015149 0.947928651 2.6751599 0.947928651 2.6751599

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.555349051

R Square 0.308412569

Adjusted R Square 0.293378059

Standard Error 0.061033817

Observations 48

ANOVA

df SS MS F Significance F

Regression 1 0.076415925 0.076415925 20.51364372 4.18517E-05

Residual 46 0.171355834 0.003725127

Total 47 0.247771759

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.007113049 0.008810161 -

0.807368734 0.423609308 -0.024846983 0.010620885 -

0.024846983 0.010620885

X Variable 1 1.649525471 0.364198055 4.529199015 4.18517E-05 0.916432821 2.38261812 0.916432821 2.38261812

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.550836161

R Square 0.303420476

Adjusted R Square 0.291410484

Standard Error 0.057429819

Observations 60

ANOVA

df SS MS F Significance F

Regression 1 0.083325336 0.083325336 25.2640036 5.10711E-06

Residual 58 0.19129468 0.003298184

Total 59 0.274620015

120

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept -

0.008896002 0.007515911 -

1.183622623 0.241391002 -0.023940732 0.006148728 -

0.023940732 0.006148728

X Variable 1 1.42299445 0.283107985 5.026331028 5.10711E-06 0.856292251 1.989696649 0.856292251 1.989696649

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.550121069

R Square 0.302633191

Adjusted R Square 0.292670808

Standard Error 0.061500923

Observations 72

ANOVA

df SS MS F Significance F

Regression 1 0.114899091 0.114899091 30.37759048 5.56634E-07

Residual 70 0.264765449 0.003782364

Total 71 0.37966454

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 0.000212252 0.007248642 0.02928162 0.976723311 -0.014244709 0.014669212 -

0.014244709 0.014669212

X Variable 1 1.13883458 0.206625532 5.51158693 5.56634E-07 0.726732957 1.550936203 0.726732957 1.550936203

121

References

1. Wall Street Journal www.wsj.com

2. Standard & Poor Stock Report

3. Business Analysis & Valuation, Using Financial Statements (Palepu & Healy)

4. www.unclaw.com/chin/teaching/antitrust/herfindahl.htm

5. Dell, Inc. www.dell.com

www.moneycentral.msn.com

Dell, Inc. 10-K

IBM 10-K

HP 10-K

Apple 10-K

Google Finance finance.google.com

Yahoo! Finance finance.yahoo.com

Associated Press-Brian Bergstein

www.spireframe.com