valuation of bmw

Bachelor Thesis Department of Business Studies

Århus, the 3rd

of May 2010

ASB

Aarhus School of Business

Valuation of BMW

- Financial & Strategic Analysis

Authors

Rasmus Ramshøj Pløen Mikkel Kronborg Olesen

Exam no. 282821 Exam no. 283755

BSc (B/IM) BSc (B)

Academic Advisor

Nicolai Borcher Hansen

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TABLE OF CONTENTS

1 PREFACE ................................................................................................................................................................ 4

1.1 EXECUTIVE SUMMARY ................................................................................................................................................ 5 1.2 BRIEF INTRODUCTION ................................................................................................................................................. 6 1.3 PROBLEM STATEMENT ................................................................................................................................................ 8 1.4 STRUCTURE .............................................................................................................................................................. 9 1.5 DELIMITATIONS AND ASSUMPTIONS ............................................................................................................................ 10 1.6 METHODS .............................................................................................................................................................. 12

2 HISTORICAL FINANCIAL ANALYSIS........................................................................................................... 13

2.1 REARRANGING THE BALANCE SHEET - ANALYZING INVESTED CAPITAL .................................................................................. 13 2.2 REARRANGING THE INCOME STATEMENT – ANALYZING NOPLAT ...................................................................................... 14 2.3 ANALYZING THE FREE CASH FLOW .............................................................................................................................. 15 2.4 REINVESTMENT RATIOS ............................................................................................................................................. 16 2.5 RETURN ON INVESTED CAPITAL (ROIC) ........................................................................................................................ 16 2.6 ANALYSIS OF REVENUE GROWTH ................................................................................................................................. 17 2.7 CAPITAL STRUCTURE – OPTIMAL CAPITAL STRUCTURE .................................................................................................... 18 2.8 PEER GROUP FINANCIAL RATIOS .................................................................................................................................. 20 2.9 CONCLUSION ON THE FINANCIAL ANALYSIS ................................................................................................................... 21

3 THE COST OF CAPITAL ................................................................................................................................... 21

3.1 ESTIMATING MARKET VALUE WEIGHTS & TAX .............................................................................................................. 21 3.2 ESTIMATING THE COST OF EQUITY .............................................................................................................................. 23 3.3 THE CAPM EQUATION ............................................................................................................................................. 24 3.4 ESTIMATING THE COST OF DEBT ................................................................................................................................. 28 3.5 CONCLUSION .......................................................................................................................................................... 29

4 EXTERNAL STRATEGIC ANALYSIS ............................................................................................................. 31

4.1 THE DEGREE OF TURBULENCE .................................................................................................................................... 31 4.2 PEST .................................................................................................................................................................... 32 4.3 PORTER ‘S 5 FORCES ................................................................................................................................................ 37

5 INTERNAL STRATEGIC ANALYSIS .............................................................................................................. 43

5.1 TANGIBLE ASSETS .................................................................................................................................................... 44 5.2 INTANGIBLE ASSETS .................................................................................................................................................. 44 5.3 ORGANIZATIONAL CAPABILITIES .................................................................................................................................. 45 5.4 MC KINSEY’S 7S MODEL ........................................................................................................................................... 46 5.5 EVALUATION OF INTERNAL RESOURCES ......................................................................................................................... 49

6 KEY FACTORS OF SUCCESS (KFS) ............................................................................................................... 51

7 SWOT ANALYSIS ............................................................................................................................................... 52

7.1 PRIORITIZING BMW’S STRATEGIC CHALLENGES ............................................................................................................. 52 7.2 CONCLUSION ON THE STRATEGIC ANALYSIS ................................................................................................................... 55

8 FORECASTING AND VALUATION................................................................................................................. 57

8.1 FORECAST DRIVERS .................................................................................................................................................. 57 8.2 SHORT TERM FORECAST FOR THE INCOME STATEMENT .................................................................................................... 58 8.3 SHORT-TERM FORECAST FOR THE BALANCE SHEET .......................................................................................................... 61 8.4 LONG TERM AND CONTINUING VALUE FORECAST DRIVERS ................................................................................................ 62 8.5 VALUATION ............................................................................................................................................................ 63 8.6 DIFFERENT STOCK CLASSES......................................................................................................................................... 64 8.7 SENSITIVITY ANALYSIS............................................................................................................................................... 66 8.8 PRELIMINARY CONCLUSION ........................................................................................................................................ 69

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9 CONCLUSION...................................................................................................................................................... 70

10 BIBLIOGRAPHY ................................................................................................................................................. 72

11 APPENDICES ....................................................................................................................................................... 76

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1 Preface

This report was written for an academic audience, where pre knowledge about basic economic

terms is assumed. Still economic terms will be written out, when the reader is introduced to them

for the first time.

In order to ease up the access to this report, the structure has been visualized in appendix one in the

back of the report. Along the report comes a CD with a copy of the report and all the relevant

spreadsheets, which have been used for the valuation. The spreadsheets have been created from

scratch instead of using a standardized spreadsheet, which can be bought from e.g. McKinsey. This

has been done in order to get comprehensive understanding of the company’s accounts and the

reorganization of financial statements.

Reading the report without having to look forth and back has been a major concern for the writers,

which made it a necessity to include a PowerPoint Slide Show consisting of the appendixes, which

can be used while reading. It is therefore recommended to keep the slideshow open on the computer

while reading.

The length of the report is within the limits given by the Aarhus School of Business for a Bachelor

project for two persons (Appendix 14).

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1.1 Executive summary

This report takes its starting point in the evaluation of the BMW Group through historical financial

analysis and strategic analysis. The outlook obtained from the evaluation is used to calculate a

market value for BMW’s equity and the two stock classes.

In the financial analysis the following measures were derived: Invested capital, NOPLAT, FCF,

ROIC and revenue growth. Moreover the consequences of the past were assessed for the future.

Despite the negative development in the above mentioned ratios, the fact that BMW has been able

to generate a positive net profit throughout the crisis, yields a positive outlook for the forecast

period. The development in the FCF was also positive. It increased to 4,859 mio. € in 2009. The

increase in FCF stems from a decrease in invested capital and has a positive impact on the

company, since it allows for flexibility in operations. The current WACC was estimated to be

6.69%.

The strategic analysis was divided into two parts: External and internal. The external analysis

started with outlining the current turbulence in the market. The market was evaluated to be

changing but still partly predictable. Afterwards the general environment was described in a PEST

analysis. The premium car market in particular was evaluated in Porter’s five forces. After the

external analysis was finished off, the internal resources were analyzed. These were analyzed

according to the 7S model and finally evaluated against the VRIO Framework. The underlying idea

behind performing a strategic analysis was to obtain quantified factors, which could help with the

estimation of forecast drivers, in order to get an as accurate forecast as possible.

In the external analysis the factors, which were found, have been quantified and put into a time

perspective. The quantification was chosen in order to make the strategic factors better comparable.

The division of the change in strategic factors between the past, the short- and the long run was

undertaken in order to make the strategic factors more usable in the actual forecasting.

The PEST analysis concluded that the general environment would have an almost unchanged

impact on BMW in the future. The composition of this impact would however have changed, since

on one hand socio-cutural factors would yield a more positive influence on the company, whereas

on the other economic factors would have a more negative impact.

With regards to the analysis of the premium car segment, Porter’s five forces lead to the conclusion

that BMW would be impacted more negatively in the future by factors directly attributable to the

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premium car industry. The negative impact was due to the threat from new potential entrant from

emerging markets.

The internal analysis concluded the sustainable competitive advantages to be: Branding, Innovative

capabilities and the experience with sustainable solutions.

In order to combine internal and external factors, key factors of success were looked at.

Finally in the strategic analysis, the factors from the internal and external analysis were brought

together in a SWOT analysis. The most important strategic factors were combined in order to

identify BMW’s strategic position. The critical SWOT analysis concluded that BMW was not in a

situation where changes were needed immediately.

After the SWOT analysis, the actual valuation was taken care of. First, forecast drivers were

estimated on the basis of the strategic and historical analysis. Second the forecast drivers were used

to establish values for free cash flows and economic profits. The result of the valuation was a

market value for equity of 31,968 mio. €.

The equity value was used in a valuation of the two different stock classes. Before the valuation of

the stock classes could be undertaken, the price differential between the stock classes was

explained. The valuation gave a preferred stock price of 35.70 € and a common stock price of 50.22

€.

In order to account for the change in variables, a sensitivity analysis was carried out. The

conclusion of the sensitivity analysis was that the equity value is highly sensitive to changes in

certain variables and that deviations from the expected values for these variables, would result in a

significantly different equity value and corresponding stock prices.

In total the result is that if all assumption throughout the report hold, both BMW’s stock classes are

undervalued. The preferred stock was undervalued with ca. 12 €, whereas the common stock was

undervalued with ca. 18 €.

1.2 Brief introduction

The BMW GmbH was founded in 1917 and its first line of business was the production of engines

for airplanes. One year later the company became a public corporation. First in the year 1923, when

the Versailles peace still prohibited Germany to produce airplane engines, the company launched

the production of their first motorcycle. Already in 1926, the company’s common stock was listed

on the stock exchange. In 1928, the company grew into a new market through the acquisition of

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“Eisenach car production” facilities. They started the development of their first small sized car.

During the 2nd

World War, BMW was heavily involved in the production of engines for airplanes

and other war activities. After the 2nd

World War the company BMW, how we know it today,

started to evolve. The first step was made by the German industrial Herbert Quandt, who bought the

stock majority of 60%. The capital injection made BMW able to develop their first middle class car

and thereby enter the broad market. In the following years things developed quickly and

automobiles were becoming the major part of BMW’s operations. For the first time BMW entered

the luxurious automobile segment in 1951, where they launched the BMW 501. In 1989, the BMW

Group issued preferred stock for the first time (www.bmweducation.co.uk, 2010). In 1994, BMW

realized that they could only succeed as a car producer if they could drag on the same economy of

scale as their competitors. The acquisition of the Rover Group was therefore a natural step in the

business development. Contrary to BMW’s expectations, the acquisition of the Rover Group proved

to be a big failure. The models were out fashioned and the expected sales figures were therefore

never reached. During the years after 1994 the British Pound increased by 25%, which made it

really costly to serve the loans, which were obtained in British Pounds. In 2000, BMW pulled the

emergency brake and partly sold the Rover Group. Land Rover was sold to Ford and Rover was

sold to a British investment group for the symbolic amount of 10 Pound Sterling (Guardian, 2009).

The only business unit which was kept was Mini. The BMW Group extended their brand portfolio

in 2003 through the acquisition of Rolls-Royce. Today BMW is a house of brands consisting of

BMW, Mini and Rolls-Royce.

Contrary to the beginning, the operations of the BMW Group are now no longer local, but

globalised and the strategy is no longer focused at production, but on branding.

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1.3 Problem statement

A major concern for the company still remains its funding of operations. The volatility of company

stocks is therefore an issue of interest. Due to the high volatility in stocks, which occurred during

the financial crisis, the concern is bigger than ever before. The following figure represents the

BMW stocks development since 2005 till 2009.

(BMW AR, 2009)

The figure above shows a high volatility of BMW’s stock prices over the last years. This volatility

makes it difficult for investors to judge whether the stock is at a turning point or has reached a

somehow stable level. The aim of this report is to come up with a market value assessment of the

BMW Group through the evaluation of strategic- and financial factors. Moreover, it is the aim to

explore the differences between preferred- and common stocks. Hence, the research question of this

report becomes:

What is the market value of BMW’s equity and its two stock types?

It is not the purpose of this report to calculate a market value, which is identical to the market price

on the cut off date. Instead this report establishes a market value, which is based on a reasonable

choice of factors and assumptions.

In order to answer the research question the following supportive questions will be answered:

Historical financial analysis

What has BMW’s net operating profit less adjusted taxes (NOPLAT) and invested capital

been over the last 5 years?

What return on invested capital (ROIC) does BMW earn on its operating activities?

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What is the company’s weighted average cost of capital (WACC)?

Strategic analysis

Which external threats does the company face, how serious are these and how should the

company cope with them?

How exploitable are BMW’s external opportunities and how should they make the best use

of them?

Which strengths does BMW possess and how can they be used most effectively?

How should BMW deal with its internal weaknesses?

Valuation

What is BMW’s market value and stock price?

How sensitive is BMW´s market value and stock price to changes in variables?

How can the price difference between common- and preferred stocks be explained?

1.4 Structure

The structure is outlined in order to help the reader to approach the report in the right way;

moreover the reader will be told why the given structure was chosen. The authors have chosen to

visualize the structure in Appendix 1, which can be found in the back of the report.

The report is divided into four parts; Introduction, historical analysis, strategic analysis and

valuation.

The reader has already been introduced to the company in the brief introduction. This was done in

order to familiarize the reader with the discussed company and provide the foundation for the rest of

the report. After the brief introduction, the reader was exposed to the problem statement, which is

structured with an overall research question and with several supporting sub questions.

When having read about the structure, the next chapter is about assumptions and delimitations.

The introduction ends with a part about the methods applied throughout this report and the

reasoning behind the choice of methods.

The historical analysis is performed in order to find the economic performance for BMW rather

than the accounting performance, which is given by the company statements. The rearranging of

financial statements, when performed correctly, makes the writer able to find invested capital,

NOPLAT, Free Cash Flow, ROIC, reinvestment ratios and revenue growth. Finally, BMW’s cost of

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capital is estimated. The cost of capital (WACC) will in the valuation part be used on a static

WACC basis and hence be very important for the calculation of BMW’s company value.

The environment and the industry are covered through an external analysis, whereas an internal

analysis is used for the evaluation of the company’s resources.

The strategic analysis will not only account for the past five years, but also make a forecast of the

future. This forecasting is divided into two periods. One being from 2009-2014 (short run), the

other ranging from 2015-2024 (medium/long run). The reason for dividing the analysis into three

time periods is applicability to the later valuation, which is divided into similar time periods.

Moreover, the analysis of the past five years gives a good idea about the strategic issues in the last

years and hence help to forecast and perspective the real impact of certain issues. The writers hope

to account more realistically for the impact of strategic issues on the company through the

comparison of certain issues in the past.

The strategic analysis is summed up in a critical SWOT analysis, where different factors are graded

and combined. The grading portrays the importance of a factor for the company and helps to

identify extremes or trends in strengths, weaknesses, opportunities and threats.

The combination of different factors, which are interconnected, enables an assessment of BMW’s

need to change. BMW’s need to change is divided into three categories: areas for the need of

change in the long-run, opportunities exploitable right away and serious threats.

Lastly, the actual valuation is performed. First forecast drivers are found and forecasted according

to the historical- and strategic analysis. Afterwards the forecast drivers are used to estimate the

company value both through the usage of a discounted cash flow (DCF) and an economic value

added (EVA) model. In order to account for the impact of changes in key variables, a sensitivity

analysis is undertaken. Finally, the difference between the two stock classes is evaluated from a

theoretical perspective.

1.5 Delimitations and assumptions

Delimitations and assumptions have been chosen to put a reasonable limit to the analysis and

prohibit illegitimate generalizations.

The methods are not all discussed in detail, because a certain level of beforehand knowledge is

assumed.

The financial data has mostly been obtained through BMW’s annual reports, Bloomberg and the

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program DataStream. These three sources are all assumed to be of high quality and hence no

adjustments have been undertaken concerning the data.

The cut-off date for gathering additional information was the 17th

of March 2010, which was the

date for BMW presentation of their 2009 annual report.

The historical financial analysis does only cover the most recent five years. This is of course not the

ideal case, because such short time estimates can lead to biased data, where trends and unusual data

cannot be filtered out and analyzed. The reasons for only choosing the period from 2005-2009 are

the major financial implications on the BMW Group incurred in 2004, where Rover was sold.

Moreover, the reporting period before 2005 changes many accounting principles, which makes it

hard to compare accounts and numbers between years. The uncertainty with regard to the content of

certain accounts was estimated to be too high and hence the authors have chosen to go more in

depth with other issues.

According to BMW’s annual report of 2009, BMW operates after a certain target Debt to company

value (D/V) ratio. This implies that the capital structure of BMW will not change significantly in

the future. For this reason a static WACC has been used throughout the valuation.

The BMW Group is analyzed with the main focus on their automobile business, because this is their

main revenue source with about 98%. The financial department almost totally is a product of the

automobile activities, where financing is needed.

The peer group has been analyzed under the same conditions, so the revenue and sales correspond

to the automobile segment.

An important assumption is BMW’s strategy to keep a target D/V ratio. This intention is stated in

all of their annual reports, but no exact D/V is mentioned. The target D/V ratio for the BMW Group

is assumed to be at 60%, because this is close to their D/V ratio in the years before the financial

crisis set in.

In the forecasting it is assumed that the past five years give a good and truthful starting point for the

estimation of the forecast drivers. The forecast drivers are assumed to depend on the period and

years before the actual forecast and hence no abnormal values are found among the value driver

forecasts. The stable state is assumingly reached in year 2025, where many markets worldwide are

mature and growth declining. A prerequisite for calculating the continuing value of BMW

operations is the assumption that BMW will live up to the going concern principle and continue

their operations indefinitely.

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A core assumption for this report is that the authors, based on the financial and strategic analysis,

are able to estimate forecast drivers, which correspond to the future.

A more general assumption is the efficiency of capital markets. This is an important assumption in

crisis and post crisis times, where investors might be lead by necessities. A necessity might for

example be an investor’s need for money, which can lead to a sale even though the investor is

aware that the share is sold below its actual fair value.

1.6 Methods

Methods from many different areas are used in this report. In the historical analysis, definitions

from finance are used in order to find the economic performance rather than the accounting

performance of the company. In the calculation of the WACC, regression analysis is used to

calculate a Beta value.

In the strategic analysis a degree of turbulence analysis was used to assess the environments

likelihood to change and the predictability of market outcomes. Afterwards, a PEST and a SWOT

analysis are used to find out something more concrete about the environment. More methods from

the area of strategic management, like those three just mentioned, are used in the internal analysis.

Here McKinsey’s 7s model and the VRIO Framework are used to find and evaluate internal

resources. The strategic analysis is finally summed up in a KFS and a SWOT analysis.

After the prerequisites for the forecasting have been dealt with in the strategic analysis, the

forecasting is carried out. The main driver in forecasting, which is revenue growth, is validated with

the help of statistical analysis. Finally, the valuation methods DCF and ECA methods are used to

calculate the equity value. The reasoning for the choice of certain methods in the different analysis

parts, will be given along the application of the respective methods. Hopefully, this will create a

better connection between methods, assumptions and the application if methods, than would

otherwise be obtained.

The literature used in this report is mainly taken from scientific books, newspaper articles, reliable

internet sources, annual reports and databases. The option of including qualitative data in the form

of interviews has been evaluated not to be necessary, because it would probably only slightly

contribute to a more precise market value. On the basis of only a small contribution of qualitative

research to the market value assessment of BMW, the writers chose not to include it.

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2 Historical Financial analysis

The following historical analysis will be based on the chapter “Analyzing historical performance”

from “Valuation” by Tim Koller. The purpose of analyzing the historical performance of the BMW

Group is to assess the company’s historical performance, its competitive position and its ability to

generate cash flows in the future (Koller, 2005).

In order to do so, the following measures will be derived through a reorganization of the financial

statements: Net operating profit less adjusted taxes (NOPLAT), return on invested capital (ROIC)

and finally the free cash flow (FCF). The overall idea behind the reorganization of the financial

statements is to reflect economic profit rather than accounting profit. In a financial statement issued

by the BMW Group operating and non operating performance will be mixed together and hence

confuse the picture of the BMW Group’s economic profitability. It is the purpose to identify the

operating items, so these can be analyzed. The operating items have to be independent of financial

leverage and hence reflect the operating performance of the company.

Before starting the analysis it is important to make sure that the numbers given in the financial

statements from the years 2005-2009 are comparable in terms of accounting standards, since a

deviation can cause misinterpretation.

The BMW Group has because of its international outlook and its interest in foreign investors been

reporting according to IFRS standards for several years. The first change, imposed by the IASB,

which changes BMW’s accounting visibly occurs in 2009. In 2009 BMW starts to treat R&D costs

as part of cost of goods sold instead of as a separate entry (BMW Annual report 2009). However the

change does not impact the size of R&D expenditure, so there is no need for retrospective

corrections of financial statements.

2.1 Rearranging the balance sheet - analyzing invested capital

There are two roads to invested capital. The operating way goes over operating liabilities, which are

subtracted from operating assets; the financing way equals debt plus equity. The operating way will

be used in this report.

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Table 2-1 - Invested capital

all numbers are given in mio. €

2005 2006 2007 2008 2009

Invested capital (excl. Goodwill)

38.180 41.017 47.167 52.953 51.683

Invested capital (incl. Goodwill)

42.773 46.329 52.837 58.594 57.062

(source: own calculations)

The figure above shows that BMW is increasing its investments until year 2009, where investments

decline. The decline in investments in year 2009 reflects the decline in revenue and overall

profitability. The area where most invested capital was saved from 2008 to 2009 was inventories.

In this area BMW managed to bring down there inventory holding and hence free some invested

capital.

2.2 Rearranging the income statement – analyzing NOPLAT

NOPLAT should reflect the income from all operations, which is available to all investors.

Moreover, there should be consistency between the calculation of invested capital and NOPLAT, so

the same entries are found both places. Below is given the NOPLAT numbers for 2005-2009 for the

BMW Group.

Table 2-2 - NOPLAT


2005 2006 2007 2008 2009

NOPLAT 3.717 3.915 4.381 2.129 1.253 (Source: Own Calculations)

The NOPLAT calculation gives a good overview of the historical profitability of the company.

BMW is at a current down, which is caused by the financial crisis. Consumers are demanding fewer

cars than previously and this is having a big impact on the whole industry. The crisis is having an

especially big impact on the car industry, because car purchases often can be postponed.

The NOPLAT of BMW topped in 2007 with a record breaking result of €4,381 million. The high

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NOPLAT in 2007 was due to record high revenue and an increase in deferred tax liabilities (Annual

report 2007).

In conclusion the NOPLAT is very dependent on the external economic conditions. The fact that

BMW made it through the very hard crisis years 2008 and 2009, must be seen as a positive thing

when evaluating BMW’s ability to grow its NOPLAT.

2.3 Analyzing the Free Cash Flow

The Free Cash flow (FCF) represents the amount of cash available to both equity owners and debt

holders. Through the calculations of NOPLAT and invested capital it is assured that the now found

FCF is neither affected by non-operating nor financing items.

In order to understand the FCF fully, one has to decompose it into gross cash flow and gross

investment.

The gross cash flow stands for the cash flow generated by the company’s operations. Moreover, it

represents the cash flow available for investments and for payout to investors. More capital for

investment and for payout to investors could of course be created by the selling of non-operating

assets or the raising of additional debt. This is however not part of the free cash flow.

Much of the current standing of the company is reflected within its gross investments, since these

represent the amount being spent on new investments.

Table 2-3 below, outlines BMW FCF development over the historical period. The numbers for 2007

and 2008 stick out, because in these years BMW has invested more than they actually earned on

their operations. In 2009 the BMW Group has been able to reverse by freeing invested capital and

thereby enhancing the free cash flow. The higher free cash flow enables BMW to gain a higher

flexibility when planning and arranging their operations.

Table 2-3 - Free Cash Flow


2006 2007 2008 2009

Gross Cash flow

6.228 6.852 4.504 3.513

Gross investment

-5.009 -7.262 -5.966 1.346

Free Cash Flow

1.219 -410 -1.462 4.859


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A key figure in connection to the free cash flow is the reinvestment ratio, which indicates if the

company is growing, how fast it is growing or if it is scaling down its operations.

2.4 Reinvestment ratios

The reinvestment ratio is obtained by dividing gross investments by the gross cash flow.

In 2007 and 2008 BMW was still riding on the wave of record braking sales, with big investments

in inventory and a big amount of outstanding receivables. In 2009 BMW for the first time got a

positive reinvestment ratio. This means that BMW has actually derived capital from earlier

operations. The capital is mainly derived from smaller investments in financial leases, but also from

disposals of property, plant and equipment.

Table 2-4- Reinvestment ratios

2006 2007 2008 2009

Reinvestment ratios

-80,42% -105,98% -132,46% 38,31%

(Source: own calculations)

2.5 Return on invested capital (ROIC)

ROIC is derived by finding the ratio of NOPLAT to invested capital. The NOPLAT numbers found

previously will be used, but the invested capital will be recalculated in order to reflect the average

usage of invested capital and not just the ending usage of capital during a specific year.

Other measures, which could have been used when looking at invested capital, are ROE and ROA.

Both measures are affected by the company’s capital structure and hence not so good indicators of

the company’s core performance (Koller, 2005).

It is important to find both ROIC including goodwill and excluding goodwill. The first will be

interesting for shareholders, who want to get their payoff from capital invested also in intangible

resources. This means that investors can compare the ROIC to the company’s WACC or their own

cost of capital and then decide whether the company’s operation adds any value. Only if the

company’s ROIC lies above or on its WACC, value is earned or added otherwise value will be

destroyed (Koller, 2005). Contrary, ROIC excluding goodwill is a good measure for comparing

companies’ internal performance, since it concentrates on the core operations of the company and

neglects intangible assets (Koller, 2005).

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Table 2-5 - ROIC

2006 2007 2008 2009

ROIC excl. Goodwill

9,55% 9,29% 4,02% 2,42%

ROIC incl. Goodwill

8,45% 8,29% 3,63% 2,20%

(Source: Own Calculations)

According to the figure above, the company is facing a hard time covering their invested capital.

Both ROIC including and excluding goodwill give the same picture; the company has a

significantly declining ROIC since 2007. This can be explained through the sharp decrease in

NOPLAT, whereas the invested capital has remained almost unchanged. BMW has been unable to

respond to the decline in sales caused by the financial crisis. Their cost og goods sold (COGS) are

almost identical throughout 2007 to 2009, whereas their sales have been declining by 3,000 mio. €

per year.

2.6 Analysis of revenue growth

During the recent two years BMW has not been able to sustain its earlier revenue growth. Revenue

for 2008 and 2009 is however still larger than 2006. Since 2007, where BMW’s revenue peaked

with 56,018 million €, revenue has been declining, in 2008 and 2009, with 5% and 4.7%,

respectively. The revenue generated by the company’s three divisions has changed in the last years.

Remarkably is the increasing importance of the financial division, which since 2005 has grown its

generation of total company revenue from 20% to 31.1% (BMW annual reports).Geographically

seen, revenue is also undergoing some changes; Asian markets are representing a continuously

increasing part of total company revenue.

Revenue can however be distorted by several things. The prime three things are: Currency changes,

mergers and acquisition and changes in accounting policies. During the analyzed historical period,

BMW has neither experienced any significant changes in accounting standards nor made any major

acquisitions. The change in accounting policies is assessed to be insignificant, since this is done so

by BMW in their annual reports (BMW AR, 2009). Currency risk is however an area, where BMW

has been exposed to operating, transaction and translation exposure (Moffett, 2009).

Transaction has in the past been the major concern for the BMW Group, since many cars were

produced in Europe and then exported to other markets, which meant that revenue was obtained in

one currency and expenditure in another. This is especially the case for the brands Mini and Rolls

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Royce, since these are only produced in Great Britain. The focus on bringing down transaction

exposure through the establishment of world-wide production facilities has however exposed BMW

to more translation and operating exposure. In order to assess the real revenue growth of the BMW

Group it is necessary to look at changes in exchange rates and their interest in different currencies.

Currency changes had the following impact on the BMW Group during the last five years:

Table 2-6 - exchange rate impact

numbers in mio. € 2009 2008 2007 2006 2005

Exchange rate impact -51 178 -46 82 66

(Source: BMW Annual Report)

In 2007 and 2009 exchange rates had a negative impact on the BMW Group, where 2005-2006 and

2008 had positive effects for the Group.

2.7 Capital Structure – Optimal Capital Structure

When valuing a company it is important to find out how invested capital was obtained. In order to

ensure a sustainable capital structure the company must strike a reasonable balance between debt

and equity financing. If the company would be solely equity financed, the company would forgo a

tax shield which could be obtained through the carriage of debt. Contrary, a company, which is

relying heavily on debt financing, will destroy value after a certain level of debt to the total

company value. This point, where a deviation would lead to value destruction is a desired target for

many companies. If a company carries more debt than the ideal debt level it incurs financial

distress, where investors will adjust their demand for return upwards and hence create a situation,

where the upward adjustment of demanded return will eat up the tax shield created by the additional

debt obtained by the company.

The credit health of the BMW Group will be analyzed by looking at the two factors: Liquidity and

leverage. Liquidity is defined as the company’s ability to meet short term obligations; contrary,

leverage represents the company’s ability to meet long term obligations in the future.

BMW’s liquidity can be measured by taking the ratio of current debt to current liabilities. It will

only be looked at this ratio in a historical perspective, because a peer group analysis is not

considered value adding in this context.

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Table 2-7 - BMW's Liquidity

in mio € 2005 2006 2007 2008 2009

current assets 27.010 28.543 32.378 38.670 39.944 current liabilities

17.838 17.656 22.493 29.887 26.934

Current assets/current liabilities

1,51 1,62 1,44 1,29 1,48

(Source: Own Calculations)

2.7.1 Financial Leverage

Leverage is in the wake of the financial crisis probably a better measure for the company’s credit

health. Liquidity is a good measure during times of crisis, where it is important to have a flexible

capital structure and be able to react immediately to market stimulus. However, in times of recovery

and more stable market growth, which is predicted for the coming years, the long-term perspective

of leverage might be a better measure.

The leverage is estimated by comparing BMW’s Debt to market value of equity over the analysis

period. Further BMW’s Debt to market value of its equity will be compared to its competitors.

Table 2-8 - BMW's Leverage

2005 2006 2007 2008 2009

Debt 34.668 36.456 43.921 60.384 61.325 Equity 24.776 28.464 27.389 13.733 21.281 Debt/Equity 139,93% 128,08% 160,36% 439,70% 288,17% Debt/Value 58,32% 56,16% 61,59% 81,47% 74,24%

(Source: own calculations)

BMW’s historical leverage has been suffering during the financial crisis, with an increased amount

of debt to equity. This however was characteristic for the overall market at the moment and should

not be seen as a sign of weakness.

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Table 2-9 - Peer Group leverage

year 2009 Debt Equity Debt/Equity Debt/Value

BMW 61.325 21.281 288,17% 74,24%

Mercedes 58.294 38.670 150,75% 60,12%

VW 77.599 12.375 627,09% 86,25%

Ford 132.441 44.020 300,86% 75,05%

Peer Group Average

341,72% 73,91%

(Source: Own calculations)

The peer group leverage average is distorted by the enormous debt to equity ratio of VW. BMW’s is

lying below the average leverage, which means that BMW with its current outlook has a good

position to service its long term obligations.

2.8 Peer group financial ratios

The peer group ratios should be seen as a starting point for the strategic analysis. It derives some of

the key financial ratios among BMW’s competitors in the automobile industry and hence gives a

good starting point for further analysis. The ratios below will be dealt with in more detail during the

strategic analysis.

Table 2-10 - Peer Group financial ratios

in mio. € BMW Mercedes VW Ford

Revenue 50.681 78.924 105.187 118.308 R&D 2.448 4.181 3.000 4.900 COGS -42.908 -65.567 -91.608 -100.016 Net profit 210 -2.644 911 2.717 cars sold 1.286.310 1.093.905 6.309.743 x R&D/revenue 4,83% 5,30% 2,85% 4,14% COGS/Revenue -84,66% -83,08% -87,09% -84,54% Net profit /Cars sold (Qty)

0,0001632577 -0,0024170289 0,0001443799 x

Working Cash / Revenue

15.33% 12.42% 18.12% 19.53%

Brands BMW, Mini, Rolls Royce

Daimler-Benz Mercedes, Smart,

Maybach

VW, Audi, Seat, Skoda,

Lamborghini, Bentley, Bugatti

Ford, Lincoln, Mercury

(Source: Own calculation based on annual reports from the respective companies) The x in the figure indicates that a number could not be obtained from the annual report of the corresponding company.

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2.9 Conclusion on the Financial Analysis

As shown in the financial analysis, BMW has been hit hard by the financial crisis. Especially with

regards to revenue which has dropped significantly during the crisis. Consequently, NOPLAT

dropped during the crisis and is now at a low level compared to the level before the crisis. This will

assumingly improve as the economy begins to stabilize in the future. Despite the negative

development in almost all key numbers, like ROIC, NOPLAT etc., the fact that BMW has been able

to generate a positive net profit throughout the crisis, yields a positive outlook for the forecast

period. The development in the FCF was also positive. It increased to 4,859 mio. € in 2009. The

increase in FCF stems from a decrease in invested capital and has a positive impact on the

company, since it allows for flexibility in operations. The fact that BMW made it through the crisis

without getting into any severe trouble with regards to liquidity and net profit, gives BMW a strong

position, when the market recovers fully.

3 The Cost of Capital

The valuation of BMW is based on discounting future free cash flows and economic profit.

However, these must be measured against something in order to ensure that the investment will be

better than investing in another asset with similar risk. The weighted average cost of capital or

WACC is a measure of this opportunity cost that investors face when investing in any asset. In its

most simple form the WACC looks like the following (Koller et.al., 2005, p. 292):

Where;

D/V, Ec/V & Ep/V = the weights of debt, common and preferred equity, respectively, to enterprise market value.

T = the company’s marginal income tax rate

kd, kec & kep = the cost of debt and equity respectively.

The following sections will be going through the steps of estimating the different measures needed

to calculate the WACC. In each section results will be presented and decisions will be reasoned for.

Finally the results are summed in a conclusion arriving at an appropriate WACC.

3.1 Estimating Market Value Weights & Tax

A critical component of the WACC is the weights which are given to the different funding sources

since they determine the impact of the different cost measures on the WACC. The weights should

be based on market values and not book values (Koller et. Al, 2005, p. 322). BMW is operating

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with a target debt to value ratio (BMW AR, 2009). They do however not disclose the exact target

debt to value ratio.

3.1.1 Market Value Weights

To determine the market value of BMW’s equity number of common shares is multiplied by their

respective market price and the same has been done for the preferred stock class. This is part of the

calculations in table 3-1. This table shows the portion that the entire equity represents of market

value. The equity weight has been further decomposed in order to obtain the weighting that is used

for the two different stock classes.

Table 3-1 shows the weights disclosed in the BMW financial report as well as estimations based on

the financial reports.

Table 3-1 - Market Value Weights

2004 2005 2006 2007 2008 2009 Average

Own Calculation based on market share prices of 30.3.2010

E/V 42% 42% 44% 38% 19% 25% 35%

D/V 58% 58% 56% 62% 81% 75% 65%

BMW disclosed figures:

E/V 35% 33% 34% 33% 25% 25% 31%

D/V 65% 67% 66% 67% 75% 75% 69%

(Source: BMW financial reports 2005-2009 and own calculations based on the reports)

The two stock classes are assumed to maintain their relative share of total equity throughout the

forecasting period. The weight of the two classes is based on the figures for the financial year

ending 31.12.2009. The historical development in the percentage that the two classes make of the

total equity can be seen from the below table.

3-2 - The composition of equity

Market value of Equity in Percentages

Year 2004 2005 2006 2007 2008 2009

Common 94,10% 93,05% 92,02% 93,08% 94,73% 94,05%

Preferred 5,90% 6,95% 7,98% 6,92% 5,27% 5,95%


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The weight of BMW’s debt is based on the book values, which is a breach of the assumption that

the weights should be based on market values. This is however not considered to be of significant

importance for the valuation as the book values of debt are considered as good approximation of

their current market value. Based on these values the capital structure of BMW is constructed and

presented in table 3-1.

Based on these results a capital structure for BMW AG of 40% equity to enterprise value was

assessed. This corresponds to the average of equity to company value before the financial crisis.

This value is chosen as it is expected to be closest to BMW’s target debt ratio. Multiplying the

percentages found in table 1.2 for 2009 with the 40% equity weight and the weights for the two

different stock classes are used in the market value calculation of equity.

This leads to market value weights of 60% for debt, 2.38% for preferred equity and 37.62% for

common equity. These values will be used when calculating the WACC at the end of this chapter.

3.1.2 Tax

The tax rate chosen is 30%. This is close to the statutory corporate tax rate in Germany of 30.2%.

The average effective tax rate for the company over the historical period is found to be 27.3% (own

calculations). The tax rate is set just below the statutory tax rate as the company also pays taxes in

other countries, where the tax rate is lower.

3.2 Estimating the Cost of Equity

In order to estimate the cost of equity, several different methods have been developed. The model

favored by practitioners is the capital asset pricing model (CAPM) (Robert F. Bruner et.al., 1998, p.

17). Other models have however also gained acceptance over the years. Some of the better known

are the Fama-French three-factor model and the arbitrage pricing theory (APT) (Koller et.al, 2005,

p. 294).

The Fama-French three factor model has been widely accepted due to its significant validity based

on empirical research. The authors of the model, Eugene Fama and Kenneth French, found that the

CAPM model was too imprecise in estimating the return on equity. They accuse the CAPM of

being insufficiently able to capture all factors with the beta value. They found that the CAPM had a

tendency of overestimating the average return on companies with a low market equity value and

underestimating the average return on companies with a high market equity value (Fama-French,

1992).

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The Fama-French three factor model is an attempt to remove this tendency by introducing further

two portfolios when estimating a company’s specific beta. The two additional factors are meant to

capture the excess return of small stocks over large stocks and the excess return for high book to

market stocks over small book to market stocks. This should increase the precision in the

calculation of return on equity. Even though the Fama-French three factor model is backed up by

empirical research it is still a young model and much has still to be researched on it. Even though it

is used increasingly in practice, there is still much doubt about how many data points should be

used when calculating the different portfolios (Koller et.al, 2005, p. 317).

The APT is a very theoretical model. It is constructed in such a way that all factors, which are

influencing a company’s required return on equity, are accounted for and afterwards added to the

risk free rate (Koller et.al, 2005, p.317). The main critique of the model is on the practicalities of it.

It has not been determined what the factors that influence the return on equity are. Furthermore any

deviations from the model will result in arbitrage.

The CAPM is chosen, because it is the preferred model among practitioners and furthermore has

withstood the test of time, which indicates that it is a strong model. It is noted that the CAPM might

be too simple to capture all factors influencing the calculation of return on equity, however it is

considered to be of minor importance for the valuation of BMW.

3.3 The CAPM Equation

Below is the CAPM equation presented (Koller et. al., 2005, p. 294). As can be seen, the model is

split into two. First, the rf, captures the investor’s time value of money. Second, βi[E(Rm) – rf],

captures the investor’s risk premium, what he expects to get in return for the risk that he is

accepting.

In the sections following the equation, the specific factors will be derived for BMW.

Where;

E(Rm) = the market’s expected return

rf = The risk free rate

βi = the stocks sensitivity to the market

E(Ri) = security i’s expected return

It should be noted that the procedure for calculating the required return for preferred and common

equity is based on the CAPM. The only difference in the used inputs for the two classes is the beta,

which will be specified later.

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3.3.1 Estimating the Risk Free Rate

When estimating the risk free rate most practitioners turn to government treasury bills or bonds

(Koller et. al., 2005, p. 296). There is a big difference between the practitioners and the scholars,

when estimating the risk free rate. 43% of scholars use a treasury bill as an approximation for the

risk free rate, while only 4% of the practitioners do (Robert F. Bruner et.al., 1998, p. 17). The

current yield on the 90-day German treasury bill is 0.12% (www.bloomberg.com, 2010). This is

extremely low and is caused by the financial crisis, which has forced the central banks to decrease

the interest rates in order to boost economy. We choose to use a 10-year government bond as it

matches the period of analysis better than a 90-day treasury bill.

Several different government bonds were considered. There was doubt about whether an US

government bond with a 10-year maturity or a German 10-year Government bond should be used.

Since there is very little difference in the two bonds liquidity the German 10 Year government bond

is chosen as BMW’s headquarter is located in Munich, Germany.

When calculating the risk free rate data was collected on the constant 10-year maturity German

Government bond from 1.1.1995 until 1.1.2005. The data was collected quarterly. The development

in the 10 year German government is presented in appendix 2. Three different time periods was

considered for calculating the risk free rate as the current yield on the 10-year German Government

bond is 3.06% (www.bloomberg.com, 2010), this is considered to be too low to be used for the

entire forecasting period. The period 1995-2006 was considered as it is believed to be a period of

stable market developments and it should give a good indication of the risk free rate in a normal

stable market. The time period of 2005-2009 was considered as it was identical to the period of our

historical analysis and thereby more closely connected with the historical returns of the company

and its performance. Lastly a time period using all data points was considered as was expected to

depict the development in the risk free rate in both unstable and stable market conditions.

The first period, 1995-2006, was chosen as it is expected that the future markets will be stabilizing

and return to a level seen prior to the financial crisis. This corresponds to a risk free rate of 4.97%,

which will be used in our future calculations.

3.3.2 Estimating the BMW’s sensitivity to the Market

In the following the calculations of the two BMW betas will be presented. Several different simple

regression analyses where conducted in order to get a better picture of the betas in connection with

different market portfolios. The full regression analysis and calculation on DAX30 for the common

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stock is presented in appendix 3. The procedure for calculating all the betas is outlined in that

appendix. It should, however be noted that the calculation on the other indices where conducted in a

similar way. Data was gathered on the development of the BMW common share as well as the

development on the different stock indices. These figures were then regressed against each other in

a simple regression model, which is introduced in the following. In the estimation of the company’s

sensitivity to the market or beta (β) the market model was used (Koller et. al., 2005, p. 306):

where;

Ri = the % change in BMW’s share price

Rm = the % change in the DAX30 index

The model is: (Appendix 3)

Ri = -0.0053 + 1.0038Rm + ε

This means that the estimated beta of BMW on DAX30 Performance. The high-end car segment is

probably significantly more affected by macro factors, such as fluctuations in the economy, than

company specific factors, such as operating risks, which explains why the beta values are so close

to 1.

Table 3-3 - Beta values

Index Beta Value

MSCI – Own Calculation 0.9555

S&P500 – Own Calculation 0.9702

DAX30 Performance – Own Calculation 1.0038

Bloomberg.com – DAX30 1.044

Frankfurt Boerse – DAX30 1.09

(Source: Public Betas from Bloomberg and Frankfurt Boerse, 23-4-2010 and own calculations based on data from DATASTREAM)

The Beta calculated on the basis of DAX30 is chosen as a fair estimator, although it seems to be

slightly less than those offered by professional services.

The same steps were used for the preferred stock class and it yielded a beta equal to 1.07.

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3.3.3 Estimating the Risk Premium on Stocks

The risk premium on stocks, defined as the difference between the return on the market portfolio

and the risk free rate, is one of the most debated topics in finance (Koller et. al. 2005, p. 297). The

risk premium is the same for all equities. It captures the shocks that all companies are exposed to by

being in the market. These shocks normally come from the macro economic factors.

Koller et. al. mentions 3 broad categories of estimating risk premium on stocks (Koller et.al, 2005,

p. 298). These are:

1. Estimating by measuring historical market excess return

Extrapolating the development in government bond vs. stocks

2. Using current market variables to estimate the current market premium

Aggregate dividend-to-price ratio which projects the expected market premium

3. Reverse engineer the market premium by means of

DCF valuation, based on estimates of Return On Investments and growth

The problem associated with using a historical market premium is its dependence on the past.

Hence, there is no guarantee that the risk premium of the past will be identical to the risk premium

of the future.

When using market variables the advantage is that they are grounded in the present and reflect

future expectations. It is possible to predict future market premiums by means of regression analysis

on dividend yields (Koller et.al., 2005, p. 304). However they have an undesirable possibility of

being negative.

It is chosen to use an outside source for the risk premium, because estimations are not expected to

be more precise. Furthermore no one has yet been able to establish any long-term trend in the

market premiums (Koller. et.al., 2005, p. 303), suggesting that the regression of market premiums

might not be any more precise than average historical market premiums.

Koller suggests a market premium between 4.5% and 5.5% whereas the majority of practitioners

use a market premium between 4% and 6% (Bruner et.al., 1998, p. 18), which is very much in line

with the estimated values by Koller.

These values are based on markets, which are in a stable development and not characterized by

great uncertainty. Due to the financial crisis, a 6% risk premium seems reasonable and will

therefore be used in the calculations.

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3.3.4 Conclusion of the CAPM

The risk premium, which are given in table 3-4 are evaluated to be the most appropriate values for

the return on equity, which could be obtained. The values are therefore used in finding the WACC.

Table 3-4 - Calculating Cost of Equity

CAPM:

Preferred Common Rf 4.97% 4.97% Βi 1.07 1.0038 Rm 8 8 E(Ri) 11.40% 13.00%


3.4 Estimating the Cost of Debt

BMW is operating with several different types of debt. The majority of this debt comes from

corporate bond issues, making up roughly 40% of the company’s total debt. BMW is rated by

Moody and Standard & Poor’s rating services. BMW is rated in the investment grade category,

which makes it possible to obtain favorable interest rates when issuing corporate bonds. In order for

the WACC to achieve its theoretical right value it should have included a weight and cost for each

of the different types of debt that BMW makes use of. However, as many of these types of liabilities

are not publicly traded or otherwise identifiable as to estimating their cost, the liabilities are treated

if they were bonds. This is chosen as the expected gain of treating the debt types individually is

expected to have an insignificant impact on the company valuation.

Two different ways of estimating BMW’s cost of debt have been utilized. First the information

enclosed in the financial statements of BMW was reviewed and second a simple method taken from

Koller et. al., 2005, which is based on a spread over the risk free rate.

Enclosed in the financial report of 2009 is a comprehensive review of the bond issues, their average

maturity and average effective interest rate. After reviewing these bond issues the average interest

payment on these loans is calculated to be 4.35%. The cost of debt is expected to increase during

the forecasting period, meaning that the found interest rate is probably too low. This is based on two

reasons. First, there has been a positive development in the interest rates. They are at their lowest

for many years due to the financial crisis, which have forced the central banks to lower the interest

rates in order to boost the general economy. Second, the current credit rating of BMW has a

negative outlook, meaning that the company is in risk of being downgraded. If the company gets a

downgrading it would all other things equal mean that the cost of debt would increase.

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Another method that could be used is the yield spread over US treasuries. These spreads are

calculated by Bloomberg and presented in Koller et. al. on page 320. It has not been possible to

obtain spreads, which were more up to date than in the book. The procedure is quite simple though.

In order to estimate the company’s cost of debt one takes the risk free rate and adds the spread

corresponding to the company’s credit rating. The spread used is the one corresponding to the

current credit rating of BMW. This is not corrected though there is a change of further downgrading

of the company.

With a maturity of 10 years and a credit rating A2/A, the spread is 48 basis points. When this is

combined with risk free rate the cost of debt becomes: 4.97% + 48 basis points = 5.45%.

Table 3-5 – Cost of Debt Rates Compare to Risk Free Rate

Source Interest rate After Tax Rate

BMW 4.35% 3.045%

Koller et. al/Bloomberg 5.45% 3.815%

Corporate Bond 4.23% 2.961%

Risk Free rate 4.97%

(Source: Own calculations based on data from Datastream, BMW, Koller et.al & Bloomberg)

Table 3-5 gives an overview of the different interest rates that were considered as estimators for the

cost of debt. The corporate bond is a corporate bond index calculated by JP Morgan for companies

rated A, as BMW is currently. It was included to indicate that the current cost of debt according to

the financial statement of 2009 for BMW is not much higher than for other similar companies.

The chosen cost of debt, to be used in the calculation of BMW’s WACC, is the interest rate from

Koller et. al./Bloomberg. This is chosen as it is considered to fit expectations best possibly in the

years to come. This means that the cost of debt becomes 5.45%.

3.5 Conclusion

The WACC can be calculated and it will be presented in the following table.

Table 3-6 - Calculating the WACC

WACC

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D/V 60%

Ec/V 37.62%

Ep/V 2.38%

kd 5.45%

T 30%

Kec 13.00%

Kep 11.40%

WACC 6.69476%


As can be seen from the table 3-6, the WACC is calculated to be 6.69476%. This WACC is

evaluated to represent BMW’s current cost of capital most precisely and hence it will be used in the

valuation to discount back cash flows and economic profit.

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4 External Strategic analysis

The following pages will deal with the environment of BMW. The more general environment will

be analyzed according to the PEST model. In order to capture how the environment is changing the

Degree of Turbulence (DOT) model will be used. The concrete industry will be analyzed by using

Porter’s Five Forces analysis.

4.1 The Degree of Turbulence

For the strategic analysis of the environment it is crucial to find out how turbulent the industry at

the moment is. This is especially important, when considering whether the company should follow

an emergent or prescriptive approach in terms of strategy choice. The result of this analysis is

quantified on a scale from 1 to 5; 1 being least turbulent and 5 – being very turbulent (Appendix 4).

The two central factors determining the turbulence in the environment are changeability and

predictability (Ansoff, 1990).

The changeability is defined through the likelihood of the environment to change. It is further

composed into two factors: “Complexity” and “Novelty”. “Complexity” represent the impact of

factors such as political, technological and social complications. With regards to complexity, the

BMW Group is affected to a “global economic” extent, since they have world-wide operations and

world GDP, commodity prices and the change in technology will have a big impact on their

success. “Novelty” determines how often the environment yields new situations for the company.

The BMW Group is assessed to be somewhere between “extrapolable” and “discontinuous familiar”

with events. On one hand BMW is in a high technology industry, where innovations can turn the

market up side down, but on the other hand, all businesses within the industry know how important

technology is.

The predictability defines to which degree the changes, which were presented above, can be

determined. Predictability can be decomposed into the “rapidity of change”, which ranges from fast

to slow and the “visibility of the future”, which relates to the availability and quality of the

information used to predict the future. The “rapidity of change” is evaluated to be between “slower

than response” and “comparable to response”, because changes in e.g. GDP of a country will most

likely lead to a change in the amount of premium cars demanded. However, BMW’s position as a

price taker in the acquisition of commodities can easily affect their profit margin on cars and hence

their bottom line result. With respect to the “visibility of the future”, the future is assessed to be

“forecastable”. Changes in the factors, which are important to BMW are “forecastable”, i.e. BMW

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is able to act accordingly. The industry participants all know that the trend is going towards

environmental friendly cars, which implies that it is forecastable to say where the market is going.

According to the DOT analysis, the environment obtains a score of 3. Consequently, the

environment is “changing” and there is a need for continuous adjustments to the preliminary

strategy by the BMW Group. Accordingly, the following strategic analysis will focus on the

prescriptive approach, but also emphasize that there might be some changes in factors.

4.2 PEST

A PEST analysis stands for: Political-, economic-, socio-cultural- and technological factors. These

areas are listed, analyzed and related to the BMW Group. The purpose of this is to get an

impression of how the environment is going to change in the future (Lynch 2009). However, it must

be kept in mind that a PEST analysis first and foremost builds on historical data. As previously

mentioned in the degree of turbulence analysis, the environment gets a rating of 3, which means it

is likely to change. Hence, it becomes more difficult to predict the future from past events. Further

it must be acknowledged that the results from the PEST analysis are not directly transferable to the

future. For this reason, the factors in the PEST analysis will be divided into three time periods. The

first being an analysis of past events (the last 5 years), corresponding to the historical financial

analysis. The last two time periods deal with the future. In order to predict the future accurately, the

analysis is divided into the short run and the long run. Lastly, the factors will be quantified on a

scale from 1 to 5 (1 being the most favorable for BMW). This should simplify the comparison

between factors and further make past and future events comparable (Appendix 5).

When applying too many factors, a PEST analysis can easily become confusing and irrelevant. The

purpose of the following analysis is therefore to focus on the most relevant factors and describe

them in detail.

4.2.1 Political factors

In the past one political factor has lead to several obstacles for BMW. This namely is the

enforcement of new laws. The areas, which at the moment are debated the most, are the emission

of CO2 and the end-of-life vehicles directive (www.environment-agency.gov.uk, 2010).

Tighter emission standards are on the agenda all over the globe, especially in OECD countries. It is

not just a matter of national legislation; also some city areas are restricting CO2 emission

(www.umwelt-plakette.de, 2010). Europe, which accounts for 50% of BMW’s total revenue, has

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had similar standards for several years. The current standard, the EURO 5, was enforced on the 1st

of September 2009. It prescribes the car manufacturers to follow certain norms and further makes

the manufacturers liable for the performance of the car for 5 years or the first 100.000 km

(www.ec.europa.eu, 2010) Also BMW’s second largest market, the US, is enforcing emission

regulations in certain areas. The emission restrictions can easily increase costs in the areas of

development, testing and manufacturing for BMW.

Another hot issue, where the EU is the forerunner, are ELV directives, which dictate how the end-

of-life vehicles (ELV) should be recycled. Further the directives state that the car manufacturer is

obliged to take back components as: airbags, shredder residue and fluorocarbon. The directive poses

additional costs on BMW, since they will have to take the recyclability of the car components into

account and the cost of scraping the components they receive after ended life of the car (EU

directive). BMW has reacted on this directive and is now manufacturing cars, which are at least

85% recyclable and at least up to 95% recoverable (Group Management report 2008, p. 32). Even

though BMW has been able to cope with the new directives in the past, newer and more stringent

directives remain a threat to the company in the future. BMW should however come easier about

the more stringent directives than competitors, since they continually try to beat the industry in

terms of sustainability (www.sustainabilityindex.com , 2010).

The last, but not less important political factor, is the political (in)stability in emerging markets.

This area is of great importance to BMW, since these markets take up a larger part of total revenue

(Group Management Report, p. 15). Moreover, these markets represent the future growth prospects

for BMW. Emerging markets currently deliver about 13% of total revenue. (Own calculations of p.

15 – Annual report) Political instability can lead to very different outcomes, but common for them

is the negative impact on BMW’s bottom line. In the future the operations of BMW in emerging

markets will increase, hence a increase in the dependency on political stability will occur.

4.2.2 Economic factors

The world GDP growth has been fluctuating a lot in the past years. In 2008 the market contracted

with a decline in GDP of 2.6%. In 2009 however, world GDP grew by 1.6%. The projections for

2010 is a growth in GDP of 2.5% (IMF, 2009).This leads to the suggestion that the world economy

is about to recover from the financial crisis. Projections for the years from 2011-2025 predict world

GDP to increase steadily by 3.5%. For BMW’s operations it seems relevant to distinguish

between the growth in emerging markets like China and India and the growth in Western economies

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like Europe and the US. The prospects for China and India are a GDP growth of 4.7% and 6.2%

respectively, whereas the US and Europe grow by 2.2% and 1.8% respectively (Duval 2010).

In the wake of the financial crisis there is a huge awareness for the credit risk associated with

especially debt financing. BMW therefore finances its activities by matching the maturities of bonds

to their activities. They further rely on derivatives to hedge for the interest rate risk (BMW AR,

2008). Even though interest rates are historically low at the moment they are expected to rise in the

future (www.bluechip.com, 2009).

BMW has two ways of reducing its currency risk exposure. One way is by natural hedging; BMW

has production facilities in its major markets. Having production facilities located in the countries

where revenue is generated means that BMW is able to spend the revenue in the same currency,

hence reducing their currency risk. However these production facilities are specialized, so not every

car model is produced everywhere. This means that BMW will not be able to perfectly match its

revenue with its costs. At the moment BMW is exposed to the biggest currency risk from US dollar,

British Pound, Japanese Yen and Chinese Renminbi. They in total account for 65% of BMW’s total

currency exposure. When BMW settles a deal in a foreign currency, they immediately conclude a

exchange rate hedge to eliminate the risk (BMW AR, 2008). The main hedging takes place between

Euro and US Dollar, since BMW has a large revenue from its US operations, but not

correspondingly high costs. The current weak Euro makes the exchange rates to a major concern for

BMW.

Due to BMW’s continuous globalization , currency risk exposure will remain an important topic for

the BMW Group in the future.

BMW’s cost of manufacturing are to a very big extent determined through the cost of raw

materials, which are used for the production of cars and motorcycles. The most used raw materials

are by far steel and aluminum. These fluctuate a lot in price, which means that BMW has

difficulties in predicting the future prices and therefore has the risk of under pricing their products

and earning less than desired on their products or maybe even incurring losses (BMW AR, 2008).

The prices on aluminum and steel have risen over the last years (www.metalprices.com , 2010) and

for April 2010 experts expect the price of steel to increase by further 10-15%

(www.economictimes.com, 2010).In order to counteract the volatility in raw material prices, BMW

hedges. They have further centralized their purchases of raw materials, so they now can rely on the

synergies created by mutual acquisitions (BMW AR, 2008). Due to the limited access to raw

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materials and the increasing demand by emerging economies, the price of raw materials is expected

to rise in the future.

The price of crude oil is another major determinant for the economic outlook of the BMW Group.

The price of crude oil is both reflected in the price of manufacturing and in the demand for

products. An increase in the price of crude oil will therefore have a double negative effect. Just as

with the price of raw materials, the price of crude oil must be expected to rise in the future, due to

the increased demand from emerging markets.

4.2.3 Socio-cultural factors

The demographics of the emerging markets are yielding new opportunities to BMW. The middle-

class in countries like India and China is growing continuously and hence new big target

segments evolve (www.euromonitor.com, 2010).

In BMW’s existing markets, concern for the environment plays a more and more important role.

Especially consumers in the US and Europe demand “green” products, which live up to emission

standards and environmental directives. BMW’s reaction to their customers’ change in preferences,

becomes evident, in BMW’s increased focus on hybrid cars, dual fuel engines and in general more

fuel efficient cars. BMW has also produced 500 hydrogen cars, which have been handed over to the

customer on a trial basis (BMW AR, 2008). At the Climate Conference in Copenhagen BMW

sponsored several vehicles with low CO2 emission (www.pressebox.com, 2010). Through its focus

on green driving, the BMW Group achieved to be the market leader on the Dow Jones sustainability

index (www.sustainabilityindex.com, 2010). In the long run BMW is expected to remain at the

forefront of sustainability by providing innovative solutions to environmental issues.

4.2.4 Technological factors

A recent survey of top managers in the automobile industry revealed what they considered the top

issues for the future. 85% of respondents answered that technology is the top priority

(Automotivenews, 2010). This leads to the conclusion that technology is an area where it is difficult

to gain a competitive advantage. Even though competition is fierce, BMW managed to get an

advantage in the production of engines, which lead them to win several “engine of the year awards”

(BMW AR, 2009). The increased focus on environmental issues is creating possibilities for the

development of environmental friendly solutions within the area of transportation. As already

mentioned BMW has a good position, because BMW has researched in this area for years, by

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researching dual fuel engines, hybrid electric cars and hydrogen driven cars. When talking about

technology and R&D it is not just important to be innovative and have the “best” technology, it is

just as essential to be perceived by customers as the most innovative. This point was emphasized by

Thomas Weber (Daimler’s head of development), when he acknowledged that Daimler is beginning

to catch up on BMW in terms of technology, but is still lacking behind in terms of public perception

(www.chinadaily.cn, 2010).

In the short run BMW will as a response to the current situation cut costs in research and

development, but in the long run they are expected to expand their activities within R&D and keep

their focus on technology (www.bmwgroup.com, 2010).

4.2.5 Conclusion of the PEST analysis

The PEST analysis suggest that there is a continuous improvement for BMW in terms of external

impact on the organization. The relevancy of each factor for the future was considered equal across

the four external factors. This might however be doubtful, since the economic factors will have the

most direct effect on BMW’s performance. The enforcement of new laws and the political

instability in emerging markets are the main political factors. Several economic factors are

identified, because they are assessed to have the most direct effect on BMW profitability. The

biggest threats are interest rate risk, currency risk and increasing raw material prices. Contrary, the

predicted increase in GDP is an opportunity, which could help BMW to increase its revenue. The

most important socio-cultural factors for BMW are the growing middle class in emerging

economies and the increasing demand for “green” products. Within technologies, innovation in the

area of sustainable solutions, is evaluated to be the most important issue for BMW.

There are of course other factors, which have not been specified in the PEST analysis. These have

been left out in order to focus on the most relevant factors impacting the development of the

company. Consequently, the PEST analysis should only be seen as a guideline for the future

development; not an concise description of all factors.

According to table 4-1, BMW is facing an overall importance of general environmental factor in the

future. The composition does however change. In the future socio-cultural factors are more positive

for BMW, whereas economic factors have a negative impact on the company. The positive outlook

in terms of socio-cultural factors can be explained to the expected increased demand for “green”

products in the future. The negative economic outlook is associated with the increase in raw

material prices.

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Table 4-1 - PEST summary

PEST overview Past Short run Long run

Political factors 2.5 2.5 2.5

Economic factors 2.4 3 3.4

Socio-cultural factors 3 2 1.5

Technological factors 2 2 2

Grand average 2.475 2.375 2.35

4.3 Porter ‘s 5 forces

The Porter’s 5 Forces is often used as a model for describing an industry. The model is very useful

in describing the relation between the company in focus, its competitors and its suppliers. The 5

forces of the model are: Potential entrants, buyers, suppliers, substitute products and industry

rivalry. The model works by assessing each of these categories and their relative power in relation

to the focal company. For each of the 5 forces, opportunities and threats have been quantified

(Appendix 6). This has been done by a scale ranging from 1-5, where 1 is a favorable position and 5

is unfavorable. Furthermore the quantification has been divided into 3 categories; the past, the

short-run and the long-run. This has been done in order to make the model less static and ease up

the development of forecast drivers.

The turbulence of the environment in which BMW operates quantified at a level of 3 in the degree

of turbulence analysis. This means that the market is changing but it is possible to forecast most

changes. This can, however be a problem when using Porter’s 5 Forces Model, since it is criticized

for being very static. Due to its static nature it is not capable of depicting the changes in the market

structure. Still the model was chosen, because it is common tool for describing the competitive

environment of company.

4.3.1 Industry Rivalry

The industry rivalry will be evaluated by looking at some key areas.

Marketing and Branding

The industry of premium cars is characterized by fierce competition. The name of the game is

branding. No other industry is so focused on the usage of catchphrases. Take for instance BMW,

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that uses the following catchphrase: The Ultimate Driving Machine (www.bmwgroup.com, 2010).

The branding and brand awareness is something the car manufacturers are investing heavily in.

Examples of BMW’s engagement in sponsorships are: Sport events and events with the focus on

sustainability. BMW’s does obviously make sure that the events they sponsor are in line with the

image, which BMW has. BMW e.g. sponsors golf tournaments (Golf Today, 2010), America’s Cup

sailing (www.bmworacleracing.com, 2010) and Olympia 2012 in London (www.auto-motor-und-

sport.de, 2010).

Leasing Financing

In recent years, there has been a significant increase in the financing activities of BMW and their

competitors. All larger car manufacturers in the world have financing as a separate business unit,

performing leasing services, financing and even banking to their customers (Datamonitor,

2009a,b,c,). This suggests that the companies are trying to boost their sales by offering their

customers ways of financing their purchase. This has opened up all new market opportunities for

branding, marketing and it has increased competition. This is substantiated by the increase in

demand for leased products (www.automotivenews.com, 2010a).

Static Industry

There has been very little change in the world top 10 largest manufacturers of cars in the period

2003-2008, the two recent years, however, have seen 1 new company in top 10 each year (OICA,

2010). This fact, in combination with several mergers starting in the late 1990’s (Automotive news,

2003), suggests that this is a well-consolidated market. It seems to be obvious that competition is

working fine and companies are investing in large production facilities in order to achieve

economies of scale. The ten biggest companies have been successful in this endeavor, since there

are no other indicators pointing in the direction of less competition. The concentration ratio among

the top four producers is at 41.62% (OICA, 2010) with an even distribution among the four, which

does not indicate any problems with the competition.

Financial Crisis and M&A

The financial crisis, which hit the world with all its fury in the second half of 2008, has brought

several of the major car manufacturers to their knees. This seems to be especially true for the

American manufacturers: GM, Chrysler and Ford, which received state funded financial support in

order to stay in business (Ingeniøren, 2008). This could mean that the future would hold even more

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mergers and acquisitions, because some companies might find cheap struggling companies that

could fit into their portfolio.

The industry rivalry is considered to be very fierce in the premium automobile segment. This is

seen on the basis of the high marketing and branding efforts that the companies engage in.

Furthermore the rivalry is expected to increase even further in the future. This is based on the

possibility of new entrants to the market.

4.3.2 Entry Barriers

The premium car manufacturing industry is characterized by heavy marketing expenditures

allowing the companies to charge a premium for their products. The products in this segment are

considered to be more luxurious and of better quality than the competitors in the more ordinary

classes, such as Toyota, Ford, Nissan, Suzuki and Mazda. Heavy marketing expenditures, as well as

inputs of higher quality, ensure the companies in the premium car segment, their mark-up.

Customers are willing to pay a price premium for the image of premium brands. They want to make

a statement with their purchase of a premium car and it is this statement that the heavy marketing

expenditures ensure. Potential entrants to this segment will have to spend a lot of money on

branding their products in such a way that the consumers see their products as being of equal

quality and technological standard.

R&D Investments

Investing in marketing is not everything. In order to secure a foothold in the premium segment the

intruding company must also focus on continued development of the cars. Design, production and

quality-management are just a few areas. BMW has an advantage in terms of R&D investments,

because they have a base to build on and do not have to start from scratch, like new entrants to the

market, would usually have to.

Emerging Countries

There is a growing export potential in the developing economies, with China in the lead. This

export potential can lead to a significant threat to BMW if a Chinese competitor enters into the

premium segment market, with a product as good as BMW’s. These emerging countries are

characterized by low cost production and they are constantly increasing their scale (Peridy &

Abedini, 2008, p. 1). In 2006, China was the third largest car manufacturing country; in 2008 they

came in second just after Japan (OICA, 2010). This can be a threat to BMW, because BMW does

not have the same home market to gain an equal economies of scale as Chinese producers.

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Distribution Network

Today, BMW has a large extensive network of distributors. BMW is present in more than 150

countries worldwide and distributes its products either through company owned showrooms,

independent dealers, subsidiaries or importers (Datamonitor, 2009b, p. 5). This is a very extensive

and large network but it is needed in order to secure BMW’s quality requirements. A potential

entrant must acquire or build a distribution network. This can be a very expensive and difficult

investment but necessary if the company wants to control the vital service level, which is the basis

for creating a loyal customer base.

4.3.3 Bargaining power of buyers

When thinking about the potential buyers in a Porter’s 5 forces model, backward integration and

switching costs come to mind. Backward integration meaning the possibility that costumers of the

car industry are starting to produce their own cars is considered very small. The Switching costs of

the general car industry is however very low. It means that it is very easy for the costumers to

switch to another car brand if they are not happy with their current one. This gives customers

bargaining power over the car manufacturers. For the premium automobile market the situation is a

bit different. Customers in this segment have a reason for spending more than necessary for a car.

Customer do often have high expectations when they buy a premium cars. This increases the need

for the companies of the premium segment to deliver a service and a product, which is a bit out of

the ordinary. If the customers are not happy they will either not come back the next time they are

purchasing a new car or they will cause the company a lot of trouble. Both scenarios are costly for

premium producer and both scenarios damage the company’s image. These factors clearly give the

buyers bargaining power over the company. This fact has also increased the awareness in BMW of

maintaining a good relationship with the buyers and the company has developed a customer

relationship management program (CRM) (www.allbusiness.com, 2010). The implementation of

CRM and BMW distinctive brand contributes to customers being more loyal and it therefore

decreases the bargaining power of the buyer.

Leasing and Costumer Relationships

Leasing of new cars has become a more and more important part of financing new cars. For BMW

this is also true. Leasing agreements generated roughly 10% of their revenues in 2008 (BMW AR,

2008). Leasing can help the company to maintain a good relationship with buyers, since they are

receiving payments from them each month and hence stay in continuous contact. Furthermore the

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customers have to return the car at the end of the leasing agreement, which creates an ideal

opportunity to inquire the customer about the car and gives the possibility of setting up a new

agreement. This suggests that the bargaining power of buyers is of less importance.

All in all, customers bargaining power is assessed to be of minor importance for BMW.

4.3.4 Substitute Products

The threat from substitute products comes from the fact that they are able to perform the basic task

of the car e.g. transportation from point A to B. This could include alternatives such as trains,

busses, bicycles or even walking. However in the case of BMW substituting products as the above

mentioned might not be relevant to examine, since a BMW is meant to be much more than just a

mean of transportation (www.bmwgroup.com, 2010). A buyer, who considers whether to buy a car

or simply just commute by means of public transport would not buy a BMW, since such a buyer

might be looking for the cheapest alternative and that is not BMW. The threat of such substitute

products is therefore considered to be very low.

Other car manufacturers

Instead of looking at the alternative means of transport for substituting products it might be more

relevant to actually look at other car manufacturers as substitute products. The substitute product

could come from a car manufacturer who is not currently present in the premium segment. This

could be car manufacturer such as Kia, Suzuki and Hyundai. These are car manufacturers who are

operating the segment of low prices. They are competing on the best prices and their margins are

considerably lower than BMW’s (Automotivenews, 2008). This could increase the threat from these

substitutes as they might venture into the premium segment trying to increase their profit margins.

However this comes at a cost, since they must invest heavily in creating an image of quality, which

the competitors in the premium segment already have.

New Technologies

The car manufacturing industry is continually moving towards more and more sustainable products.

Several companies are researching hybrid cars and the first prototypes of hydrogen powered cars

have already been produced. BMW has delivered 100 7-series cars for VIPs around the world, in

order to promote the new hydrogen car (BMW AR, 2008). GM is expecting to launch mass

produced hydrogen models by the middle of this decade (www.beyondfosilfuels.com, 2010). The

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future threat of these different types of fuel cell cars is considered to be manageable, since BMW is

already investing in this field.

All in all the threat of substituting products is considered to be small in the short-run and medium in

the long-run, since new technologies influence the car industry.

4.3.5 Bargaining power of suppliers

Market Prices

BMW operates an extensive production facility network all over the world, with car production, as

well as spare parts production, at several different locations worldwide (www.bmwgroup.com,

2010). The major suppliers of BMW are producers of components such as aluminum, steel, plastics

and cables. The market for these products is characterized by many suppliers and many buyers,

making the market operate under near perfect competition. This has a significant influence on

BMW, since they have plenty of suppliers to choose from. In general BMW’s with regard to

suppliers bargaining power is expected to be positive. Hence, BMW has a good position when

negotiating prices. Production Network

The extensive production network that BMW possesses does have some important advantages. It

gives the company the possibility of making the most of transfer pricing, moving expenditures to

countries where it is beneficial. Furthermore BMW has won several awards for their production

network and their relations to suppliers (Automotivenews, 2008). By increasing the collaboration

between BMW and their suppliers they are able to achieve more beneficial prices, a better product

development and co-operation in research and development (BMW AR, 2009). However the

increased cooperation between BMW and its suppliers comes at a price. It can be very difficult for

BMW to maintain full control as more and more is outsourced. This is always something that a

company must consider before entering a co-operation.

Dependency between suppliers and producers

A close cooperation between suppliers and manufacturers in the automotive industry is common

(BMW AR, 2008). When the financial crisis was on its top, BMW’s suppliers were struggling with

financing their operations. This problem was solved by BMW, who helped providing the needed

funds. Consequently, the BMW Group was able to handle the situation without significant

disturbances to production. This has shown the large risk that is involved when choosing suppliers.

BMW does therefore not enter into a supply relation without thoroughly investigating the other

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party. Furthermore there has been a consolidation in the supplier market due to the financial distress

of the financial crisis (BMW AR 2009). This coupled with the greater dependence between BMW

and its suppliers have increased the bargaining power of the suppliers.

4.3.6 Conclusion on the 5 forces Analysis

As can be seen from table 4-2 below, the car industry is assessed to become even more competitive

in the future. This puts pressure on BMW to continually improve in order to stay ahead of the

competition. The overall influence of factors in the premium car segment predicts a continuously

worsening situation for BMW. The most significant factors in this connection is risk of new

entrants to the market. Especially, car producers from emerging markets, which could drag on

economies of scale from a huge home market, were considered a big threat in the future.

In general BMW’s position in the premium market it not assessed to be under threat. The strong

brand and BMW’s experience in R&D will help BMW to remain competitive in the future. BMW

should however expect to lose market share, if new brand make their entrance to the market.

Table 4-2 - Porter's 5 forces summary

Past Short Run Long Run

Industry Rivalry 3.8 4 4.2

Potential entrants 1 1.67 3

Buyers 2 1.67 1.67

Substitute Products 2 1.67 2

Suppliers 4 4 3.67

Gand total 2.16 2.602 2.908

5 Internal Strategic Analysis

It is very difficult and probably impossible to obtain a true and fair picture of the company’s

internal resources without insider knowledge. The internal strategic analysis is therefore limited in

its scope and will only be a minor part of the overall strategic analysis. For the presentation and

analysis two models are chosen. The first divides the internal resources into three groups: intangible

resources, tangible resources and organizational capabilities.

The second, Mc Kinsey’s 7S model, will try to catch the more difficult accessible areas, as for

instance strategy and systems (Lægaard, 2003). Finally, the resources will be evaluated against the

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VRIO framework, which indicates the factors which are most likely to be competitive resources for

the BMW Group (Appendix 7).

5.1 Tangible assets

BMW currently operates 17 production facilities in six countries. More than half of the production

facilities are located in Germany and Great Britain (www.bmwgroup.com, 2010). These

manufacturing sites are mostly owned. The two US production facilities, Oxford and Hams Hall,

are however leased. The financial lease agreement gives BMW the right to purchase the two plants

in 2028. (BMW AR, 2009)

The innovation does however not only take place within Great Britain and Germany. The eleven

innovative sites are mainly located in the US and in Munich, Germany. Thereby keeping a close

connection between the BMW Group and qualified employees (Trendence, 2008). When BMW

decided to locate a lot of the innovation around Munich it was not a choice of convenience.

Moreover it was a conscious choice making the BMW Group able to monitor closely the products

and patents, thereby ensuring that these are safeguarded. Consequently, the geographical location of

the innovative sites can be seen as a two-fold advantage. The assembly has been outsourced and

does now take place in low wage countries as Indonesia, Thailand, India or Egypt. With regards to

assembly, BMW is not liable for any facilities, which makes them very flexible in this point, since

they do not have the problem of fixed costs, if demand is falling.

BMW has a weakness in the production of the two brands Mini and Rolls Royce, since these are

solely produced in Great Britain. The production in Great Britain on one hand ensures good access

to qualified employees, but on the other hand it exposes the exported Mini and Rolls Royce cars to

currency risk. Hence a change in exchange rates can easily eat up the profit margin on products or

products must be set to unreasonably high prices abroad.

Another valuable asset for the BMW Group is its financial department, which helps to finance

BMW’s activities and finances customers’ car purchases.

5.2 Intangible assets

The brand portfolio of BMW has been extended several times, thereby always keeping in mind how

the brands are perceived by customers. It has always been in the BMW Groups spirit to have brands

of high value with premium status in their respective markets (www.bmwgroup.com, 2010).

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The possession of three premium brands creates a disadvantage in terms production compared to

premium brand, which also have a volume brand associated. The BMW Group is not able to obtain

the same economies of scale as its competitors, which can cover fixed costs like R&D costs more

easily. A good example is Bentley, which underlies the mother company VW. Fixed costs of VW

are spread out on the production of 6,309,743 cars and BMW can only spread its fixed costs on

1,286,310 cars in 2009 (Table 2-10).

One of the cornerstones of BMW’s success is its ability to create the new and unexpected. They

have acquired their skills in research and development over several years, now making them able to

drag on valuable knowledge for future developments. Consequently, the expenditure on R&D has

increased over the period from 2003-2008 by 33% (BMW AR, 2003 & 2008). Valuable is also

BMW’s acquired knowledge about customers and their preferences, which makes BMW able to

anticipate and respond to the market.

Other intangible resources, which have been previously mentioned, are the highly skilled employees

working in the R&D departments. They have been able to establish a close connection between the

BMW brand, design and technological inventions.

Lastly, it is worth mentioning that BMW has quite a few important strategic alliances. They have a

strategic alliance with the Italian car manufacturer Fiat. Their agreement is about the mutual

exchange and usage of parts within the brands of Mini and Alfa Romeo. The common development,

manufacturing and usage of components makes both manufacturers able to gain economies of scale

and thereby decrease their costs. The alliance is important in these times, where the global

automobile industry is continuously consolidating and only very few independent brands exist. The

alliance does however not only create a valuable resource for BMW it does also create a threat,

since Fiat is producing the car model Alfa MiTo, which is a direct rival to the Mini

(www.pistonheads.com, 2010).

5.3 Organizational capabilities

BMW’s unique stock owner structure, where 46.7% of shares are controlled by the family Quandt,

gives the company both advantages and disadvantages (www.bmwgroup.com, 2010). One

advantage is the group’s ability to focus on the long-term. The BMW Group is not as many other

car manufacturers dependent on delivering astonishing quarter year statements, but can focus on the

long-term and thereby not compromise the value of the company for short term benefits (Welt,

2007). In 2004 BMW demonstrated their ability to focus on the long run by pulling the emergency

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brake and selling Rover and Land Rover. The possession of Rover was about to ruin BMW as a

business, because sales figured did not materialize as they were anticipated. The selling off of

Rover was an immediate loss, because BMW only sold Rover for 10 Pound Sterling, but in the long

run BMW has been able to increase their profit and turn Mini into profitability.

BMW’s leadership of the Dow Jones sustainability index is another good indicator for its future

oriented way of doing business. Not only is BMW a leader in the category for automobiles and

parts, they are also the overall leader of the sustainability index. Sustainability is becoming a more

and more important factor in doing business, which can be seen at several places. The big attention,

which was devoted to the climate conference in Copenhagen, reflects the time spirit, where people

are more aware of their environment than ever before. This change in consumer preferences leads to

a change in demand for automobiles, which perfectly fits the automobiles BMW supplies.

A disadvantage of BMW equity structure might however be that some investors can find the

overwhelming number of shares controlled by the Quandt family threatening, because the Quandt

family can almost solely control the company and other investors have difficulties in influencing on

the company.

In conclusion, BMW’s organizational capabilities must be seen as a real advantage compared to

competitors.

5.4 Mc Kinsey’s 7S model

Mc Kinsey’s 7S model is used as a checklist to highlight the different areas impacting the internal

strategic options and decisions. The model can be decomposed into three hard elements, which are

concrete and accessible: Strategy, structure and system. The last four elements are hence of a softer

nature and it will therefore not be so easy to give a fair and realistic view of them. For that reason

they will only be dealt with briefly (Waterman, 1980). The four soft elements are: Shared values,

skills, style and staff.

5.4.1 Strategy

The overall strategy of the BMW Group is called strategy number one. The strategy was introduced

right before the financial crisis appeared, in 2007. It is a strategy, which does not only focus on key

numbers, but also on soft issues, as ensuring employee satisfaction and sustainability along the

value chain (www.bmwgroup.com, 2010). The strategy number one has set up the ambitious target

of achieving a return on capital employed (ROCE) of 26% and a profit margin of about 8-10% in

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year 2012. The ROCE for 2009 is 3.3% (BMW AR, 2009), being at its highest in 2006, with a

ROCE of 16.7%. BMW’s main competitor Daimler incurred a negative ROCE of 4.8% in 2009

coming down from a positive ROCE of 8.7% in 2008 (own calculations – based on Daimler’s 2009

annual report).

The BMW Group wants to bring down material costs with 3% annually. This would mean a cost

reduction of about 750 mio €. Another cost reduction of about 500 mio. € is targeted in the area of

human resources, where workers will be laid off. Additional cost reductions will be achieved

through the use of standard components, benefitting from the economies of scale. R&D will still be

a key area of the BMW Group, however the expenditure in this area will be brought slightly down.

The strategy set out to reduce R&D expenditure in relation to revenue from 6.1% in 2006 to 5-5.5%

in 2012. This goal is achieved and the R&D expenditure in relation to sales is at 4.8% (own

calculations).

In conclusion, the BMW Group is trying to bring down costs in many areas in order to achieve a

higher return rate on invested capital.

5.4.2 Structure

BMW has a typical corporate structure and is comparable to its competitors in many ways. They

have several boards and of those the most important is the management and the advisory board. The

management board takes care of the daily operations and the strategic development of the

organization. It consists of 10 persons, with each their area of responsibility. The advisory board is

there to support the decision making in the management board. The advisory board consists of 20

persons, whereof 10 are employee representatives and 10 are shareholder representatives. It shows

that corporate governance is a major issue for the BMW Group (BMW AR, 2009). Even though the

head quarter in Munich is the center of power, the subsidiaries, placed all over the world, are taking

care of e.g. purchasing and marketing. Disadvantages of decentralizing the power with regards to

acquisition and marketing are that the organization may not be streamlined and a diffuse picture of

values can be the result. BMW tries to prevent the decentralization from escalating by hosting

several obligatory courses for managers in brand awareness and core principles. Another

disadvantage is the forgone economies of scale effect, which could be achieved by centralizing

operations, using a divisional structure. The advantages by having a regional structure are e.g. the

close contact to the market and a decreased currency risk exposure.

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Due to BMW’s focus on streamlining the organization their company structure must be regarded as

an advantage compared to companies, which solely operate their business from the headquarters.

5.4.3 Systems

The systems of an organization can be divided into three: technical-, social- and administrative

system (Lægaard, 2003). The division makes it easier to grasp all aspects and infer how the systems

are interconnected.

The technical system deals with production processes and production facilities. BMW, as a

premium brand manufacturer, has high demands to the quality standards in the production process.

Consequently, BMW demands its suppliers to live up to the high ISO/TS 16949:2002 standard

(www.iso.org, 2010). ISO standards are quality requirements, which make sure that a production

facility, which lives up to a ISO standard also lives up to a high quality standard. This enables the

company to produce with a very small amount of defects. The results are satisfied customers and

few costly call-backs of cars.

In recent years there has not been any major damage caused to the organization from bankruptcy by

suppliers, neither has there been damage caused by suppliers not able to fulfill their contracts.

During the last few years, BMW has undergone a natural restructuring process caused by the

increase in production efficiency. The restructuring means that jobs are cut in the area of production

and partly transferred to other areas of the organization. The aim is to follow strategy number 1,

which was presented above, in order to bring down costs with regards to employees.

The social system composes the attitudes and norms established between employees, departments

and geographical distinct subsidiaries. An analysis in this area should normally be founded on

qualitative interviews conducted at all corporate levels. Since this was not possible and not the

intention in this report, the social system will not be discussed any further.

The administrative system ensures that the technical- and social systems are working fine and

living up to the targets set by the organization. The decision making within the BMW Group is

hardly accessible for an outstanding person, so this area cannot be analyzed further. The role of the

payment scheme however is accessible, since it is specified in the Annual Reports. The regular

employee has a base salary and an option to buy 35 preferred shares at a discount rate. Contrary, the

management receives a base salary and a bonus, which is based on the yearly dividend payment.

The bonus payment going hand in hand with the dividend payment is posing some risk for the

company and its investors. Especially in year 2009 a doubtful situation arose, when the

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management decided to payout the same amount of dividend/share as in the previous year, even

though net profit had declined by more than 37%. The problem is that management might be

tempted to keep dividends at a high level even though the company’s performance does not allow

this. The result is a management, which compromises the long-term prosperity of the company.

The bonus scheme must be regarded as a weakness and it does not correspond to the understanding

presented in the German Corporate Governance codex’s (German Corp. Gov. Codex, 2009).

According to the corporate governance principles, the investor should be protected against

managers working for their own sake instead of for the company.

5.4.4 Shared values, skills, style and staff

The shared values, which should be part of every employees consciousness within the BMW Group

are: High quality standards, customer focus, continuous improvements and sustainability

(www.bmweducation.co.uk, 2010). The skills of employees were under the intangible resources

identified as valuable. The condition of staff and style is assumingly good, with competent,

motivated and committed employees coaching and motivating newly arrived employees. This

assumption builds on the outline given by the BMW Group, stating in their strategy number one

that the employees are their most valuable asset and therefore a major priority

(www.bmweducation.co.uk, 2010). Moreover, the employees, which are working at BMW are

highly skilled and some of the best in their respective areas. The high motivation and satisfaction of

employees is ensured through continuous employee satisfaction surveys. Consequently, the BMW

Group ranks as a favorite choice for students graduating from universities throughout Germany

(BMW AR, 2009).

5.5 Evaluation of internal resources

Internal resources are evaluated by the VRIO Framework (Appendix 7). The resources which were

found throughout the internal analysis are now evaluated in order to see whether they are capable of

providing BMW with a sustainable competitive advantage.

A resource is placed in one out of four categories, ranging from a competitive parity to a sustainable

competitive advantage. The framework is structured around some questions, which have to be

answered with yes in order for the resource to qualify as a potential sustainable competitive

advantage (Barney, 2002).

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BMW’s access to and good reputation among highly educated persons is evaluated to be a

temporary competitive advantage. It is both valuable and rare to rank at the top, when university

students are asked about their preference for future employment (BMW AR, 2009). If BMW is able

to retain this resource they will have an advantage to some of their competitors.

Further does BMW’s partnership with Fiat create a temporary competitive advantage. The

partnership is valuable, because BMW can obtain some of the benefits from being a volume

producer. It is rare because Fiat will not engage in several partnerships, because these are often

bound by contract and the idea behind a partnership would shrink if too many companies were

involved. The partnership could even be classified as a sustainable competitive advantage, because

the partnership one could argue, is so difficult to imitate. Only few car producers are so specialized

in the production of small cars as Fiat is. Finding an adequate partner with as much market

knowledge and where the same economies of scale are created would be almost impossible. It

would hence be costly for a competitor to create a similar partnership where the benefits would be

comparable.

Sustainable competitive advantages are found in the areas of: Branding, innovative capabilities and

the focus on sustainable solutions.

BMW with its possession of three premium brands is of course in an unique position with respect to

its image. This position can hardly be imitated, it is at least not possible for competitors to totally

imitate the brand. Competitors may however want to approach it, if BMW’s brand remains as

profitable as it has been until now. To create brands with the same wide spread premium reputation

would however be extremely costly for competitors, so BMW’s brands are definitely core

resources.

BMW’s good reputation is created through several things, but one thing, which is prominently

mentioned is their ability to be innovative. An indicator for their innovative capability, which was

previously mentioned was their winning of “the engine of the year award” for several years.

Possessing a workforce and a work environment, which creates so many innovative solutions is not

only valuable, it is also rare and costly for competitors to imitate.

Lastly, BMW’s focus on sustainable solutions must be highlighted. This point can be seen as an

extension to both their brand and their innovative capabilities, because the sustainable solutions are

created through the excellent innovative capabilities in order to shape the brand for the future.

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In conclusion; if they build further on branding, innovative capabilities and focus on innovative

solutions they will be well equipped to meet competition and retain or increase their market share in

the future.

6 Key factors of success (KFS)

Key factors of success are those parameters a company has to live up to in order to succeed in a

certain industry. Key factors for success combines internal analysis with external analysis and

consequently the key factors of success are dealt with after the respective analyses. Below will be

dealt with the key factors of success for the automobile industry and a short comment on BMW’s

position according to each factor. The factors will be derived by an analysis guided by the division

into the three Cs: customers, corporation and competitors (Ohmae, 1983).

The customer base is ranging from private customers and companies to governments. BMW has

until recently not been able to strike any deals with governments, because their cars are relatively

expensive and therefore are not used as e.g. police cars. However, BMW has just won a contract,

stating that they will be supplying engines to the American government for a value of 1.35 billion

(www.bloomberg.com, 2010). This does not only ensure BMW a revenue source for the following

years, but also a economies of scale guarantee.

In this particular case, BMW got the contract, because they were able to offer an engine that won

the engine of the year award. And exactly these innovative skills and technical capabilities, which

make BMW able to produce such engines, are key factors for success in the industry.

According to BMW they place all their cars in the premium segment (www.bmwgroup.com, 2010).

In this segment it is essential to stand out from the crowd, because otherwise they will not be able to

charge a premium price on their products. The differentiation comes in different forms and ideally it

should be part of every managers consideration, when he thinks about the value chain and the

internal resources. The prime resource in this area is branding. When branding is carried out in the

right way, the brand will stand out as a distinct brand and appeal to the consumers’ preferences.

In the last few years, especially during the financial crisis, the corporation has been focusing on

liquidity. There are several reasons for this, the most prominent being the threat of takeovers and

bankruptcy. BMW has expanded its cash and equivalents and succeeds in keeping resources liquid.

With respect to competition, the BMW is seeing itself in a situation, where it can often not follow

volume producers in terms of cost. These volume producers have maybe one or two brands, which

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are in direct competition to BMW’s premium brands. The volume producers can drag on the

resources from the volume production to safe in all business areas. An example of a volume

producer using this strategy is Ford, by having the brand Lexus and letting it share resources with

its volume brand Ford. Volume producers or those, which according to Porter are pursuing a cost

leadership strategy, will have larger economies of scale and hence have an advantage, when talking

about costs. The BMW group however is standing out, as mentioned before, by using a

differentiation strategy and since they have no volume car brands under their roof, they do not risk

that their luxurious brands are compromised in terms of their image. Despite the volume producers’

advantage in terms of costs, BMW has been able to cut cost substantially in different areas.

In conclusion, the BMW Group’s most important factor of success is assessed to be branding. They

further have to excel in the areas of cost, innovation and liquidity to stay competitive.

7 SWOT analysis

The SWOT analysis is a sum up of the external and internal analysis. Moreover, the SWOT analysis

will be used to manipulate the strategic findings in order to identify which areas are of particular

interest for the BMW Group. This covers both the identification of the best opportunities and the

biggest threats to the organization. The SWOT analysis will put things into perspective by

identifying, which threats and opportunities should be dealt with right now and which should be a

concern for the organization in the future.

7.1 Prioritizing BMW’s strategic challenges

The factors will be prioritized using the following guidelines:

A mix of opportunities with strengths yields opportunities which are exploitable right away. A

strength can be matched with a opportunity to create a directly exploitable opportunity.

Areas, which pose threats to the organization and corresponding weaknesses should be areas of

major concern for the company. It will take time for them to align their resources to deal with the

threats in these areas, so there is no time to be lost. The threats could, if not countered by an internal

strength, turn real and cause severe damage to the company.

The match of threats with strengths or opportunities with weaknesses gives a situation, which is

neither favorable nor unfavorable. Both combinations should not be a major priority to work on

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right away, rather BMW should keep these combinations in mind for the future, where they have

dealt with the immediate exploitable opportunities and the most serious threats.

7.1.1 Areas with the need for change in the long run (threats/strengths &

opportunities/weaknesses)

Firstly, external threats are connected with the company’s corresponding strength. The main issue

for BMW here, is to use its strength against the threats effectively.

Secondly, the external opportunities will be related to the corresponding weaknesses. This

connection obliges the company to improve on its weaknesses and create a more favorable

situation, where the opportunity can be explored.

Threats and Strengths

New legislations as e.g. ELV directives or increased emissions standards are a major threat

to the company’s profitability. However, BMW can easily turn this into an advantage

against its competitors, since they possess significant innovative capabilities within the area

of “green” driving.

The price of raw materials is very volatile and is therefore not predictable for the company,

but with the company’s in-house financing division they should be able to handle the threat

by focusing their efforts on reasonable hedging.

The emerging economies are creating huge markets not only for established manufacturers

as BMW, but also for new entrants. At the moment the biggest threat in this area stems from

the Chinese market, where several producers are grasping the benefits of economies of

scale. However, BMW, as an established company has the advantage of having good market

knowledge and distribution channels.

Interest rate risk is a major threat to the company, since the interest rate is historically low at

the moment and is likely to increase in the future. Moreover the company is threatened by

the current high amount of debt, corresponding to a D/V ratio of 74.24%. Further BMW’s

downgrading by Standard and Poors reflects negatively on their ability to obtain cheap

loans. Standard and Poors even give BMW a negative outlook for the future, hence there is a

risk of BMW being downgraded even more.

In such a globalized company as BMW, currency risk is a major concern. BMW has

however established several initiatives to bring it down. One way was through natural

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hedging another is by financial hedging. BMW’s strength in this connection is their

expertise in the area of financing through their in-house financial department.

7.1.2 The combination of opportunities with weaknesses

As discussed previously, BMW has the opportunity to enter emerging markets, where

growth prospects are good. However, BMW has a weakness, when talking about two of its

brands; Mini and Rolls Royce. These two brands are exclusively produced in Great Britain,

i.e. BMW has to incur high shipping cost, when supplying emerging markets in e.g. Asia. A

strategic choice might be to establish a production facility in Asia, which is followed

closely by the division in Great Britain. The close contact will ensure that cars produced at

this facility live up to Mini and Rolls Royce standards and further create the possibility for a

close market contact.

BMW’s favorable standing in the eyes of consumers, through its valuable brands, poses a

great opportunity for charging premium prices on their cars and thereby earning a higher

margin than e.g. on volume produced cars. However, since BMW is only involved in the

premium segment of automobiles they are not able to obtain the same economies of scale as

volume producers are. BMW therefore has the weakness of having relatively higher cost

associated with each of their cars. One of the biggest issues in this connection is R&D costs,

which for producers like BMW represent a significant amount of cost.

7.1.3 Opportunities exploitable right away (opportunities/strengths)

The demand for “greener” technology is increasing at the moment, posing an especially big

opportunity to BMW, since they are on the forefront of “green” solutions through their

leadership of the Dow Jones sustainability index.

The fact that China is now the biggest single market for automobiles is a big opportunity for

the BMW Group. Through the utilization of their strong brand image and their strategic

alliances with Chinese partners, they should be well equipped to benefit from the

opportunity.

Moreover, does the demographic change in emerging markets lead to a growing middle

class which is a core market segment for BMW. They can explore this opportunity by

drawing on their strong brand image and their market knowledge.

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The increased demand for leasing agreements and other activities performed by the

financing department is creating a possibility for BMW to increase its activities in this area

and further diversify their operations. BMW should be able to grow their financing

department through their good connection to qualified employees and their strong cash flow

position. (Trendence, 2008)

7.1.4 Serious threats (threats/weaknesses)

A return of the economic recession in Europe and the US is threatening the BMW Group.

The company is very dependent on these two markets, since they stand for about 80% of the

company’s revenue. A solution to this problem might be the differentiation into emerging

economies, where growth prospects are good.

The recent copyright infringements by some Asian car manufacturers poses a big threat for

BMW, since it undermines their growth prospects in emerging economies. There is no

obvious way to solve this problem, since suing for copyright infringements will only yield to

a satisfactory result in countries, which enforce laws against copyright infringements.

Political instability in some emerging economies is a threat to the company’s operations.

BMW can however not leave out the chance to grow in emerging economies, since these

through their size will represent a future core market to the company. When entering

emerging economies it will be a good idea for BMW to establish a connection to a local

supplier in order to ensure the close customer contact and a legal secure basis.

7.2 Conclusion on the strategic analysis

In conclusion, the situation for BMW looks more positive than negative. This can however quickly

change as determined in the degree of turbulence analysis. Market conditions are not just changing

slowly and predictably, so BMW has to focus correctly and change according to market conditions.

In order to do so and especially keeping in mind that BMW has so many areas to focus on, the

SWOT analysis was used to highlight the company’s need to change and the recommended time for

change. At the moment BMW is in a situation, where changes are not needed immediately, which

does however not mean that they cannot change. BMW has the ability to take advantage of several

opportunities and the internal strength to deal with the most serious threats. The best opportunities

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for BMW at the moment are the opportunity of exploring their “green” image further, growing in

emerging markets and extending their leasing activities. The most serious threats are the possibility

of a reoccurring recession, political instability in emerging markets and copyright infringements.

Even though the just mentioned factors are graded as serious threats, they are not evaluated to

require an immediate response by BMW, because they seem very uncertain. In total the need for

reaction on threats must be evaluated as low, but the potential for the exploration of opportunities,

as high.

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8 Forecasting and Valuation

The two methods, which will be used for valuation are the discounted cash flow method (DCF) and

the economic value method (EVA). Both methods rely on forecasts, which will be detailed below.

The two methods differ significantly in their approach to valuation. The DCF method, which is the

most commonly used, is grounded in the free cash flow of the organization. Hence, it measures

whether a company is able to generate a positive cash flow in a specific year. The DCF has the

advantage of relying on the Cash flow and not on the earnings presented in the usual accounting. A

general criticism of the DCF method is its lack of acknowledging the creation of value. An example

is: If a company for instance is investing heavily in growth in a specific year and the year end result

therefore is a negative cash flow, this will give a wrong picture. The EVA method is better in such a

situation, because it shows if the company is earning its cost of capital in a specific year. Thus the

EVA method is included in the report to supplement the DCF method and give additional

information.

For the valuation a static WACC instead of a dynamic WACC was chosen. Fully aware that a

dynamic WACC would yield a more accurate market value for BMW, it was left out, because the

change in the WACC seems uncertain and a forecast would be pure guessing.

In order to account for the uncertainty in forecast drivers, a sensitivity analysis on some key

variables has been carried out. Another way of approach the uncertainty in forecast drivers would

be a scenario analysis where e.g. a best and a worst case could be detailed. It was not chosen to do a

scenario analysis, because the uncertainty in forecast drivers is evaluated to be caught in the

sensitivity analysis.

8.1 Forecast drivers

The performance of BMW will be forecasted for a period of 15 years. The short term, which is the

first 5 years (2010-2014), will be forecasted with a detailed set of forecast drivers. The medium to

long run, which is 10 years (2014-2024), will only be estimated on the basis of few key ratios,

which are used as forecast drivers. Finally the continuing value from 2025 and onwards will be

calculated solely on the basis of the free cash flow (FCF).

Mutual for all three periods, is the underlying strategic analysis, which was presented in this report.

It is assumed that the strategic analysis gives enough background in order to give a fair indication of

certain variables in the future. However, this can only be assumed, since the market is changing a

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lot at the moment and BMW’s strategic choices are not predictable. In the short term forecasting,

the values of forecast drivers and the corresponding historical financial numbers are held close to

each other. Frequent approaches were either to set the historical average equal to the forecast driver

value or to give the forecast driver the value of the last financial period.

The medium to long run is forecasted through ratios, which are almost all held up against revenue.

For this reason the forecasting of revenue has a very high priority and its accuracy determines

almost all other numbers.

8.2 Short term forecast for the income statement

8.2.1 Revenue growth

Revenue is as previously mentioned a core item of forecasting, because many things are held up

against it to forecast value drivers. Two different approaches to forecasting revenue are a top-down

approach and a bottom-up approach. For BMW a top-down approach was chosen, because general

economic factors according to the strategic analysis seem to have a big influence. A bottom up

approach would have been better if BMW was driven by for example the pure production of cars or

the number of BMW retailers.

GDP is found to be a good indicator for the total car production worldwide with an R2

of 0.95.

Moreover, GDP was identified to reflect BMW’s revenue growth to a high degree with a R2

of 0.8

(Appendix 8). Another factor, which according to the strategic analysis was expected to inversely

correlate with BMW’s revenue growth, was the price on crude oil. This was however not

confirmed, when a regression analysis was conducted.

In order to forecast organic revenue, which stands for the revenue growth internally created, actual

revenue growth was composed into revenue growth caused by: organic growth, price increases and

mix changes, acquisitions, currency changes and accounting changes. Both acquisitions and

changes of accounting policies had no impact in the respective period. Organic growth has risen

steadily until 2008, where organic revenue decreased by 5.09%. BMW’s ability to improve on its

prices and mix of products has, since 2006, had a positive impact on the actual revenue of the BMW

Group. Currency changes had a fluctuating impact on BMW’s revenue during the respective period.

Due to the high volatility of the factors composing the actual revenue growth, the authors have

assessed the actual future revenue growth to be solely based on estimates obtained through a

regression analysis of world GDP to BMW’s revenue.

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The regression analysis provides an immediate revenue growth of 14.09% in year 2010. This

number was assessed to be unrealistically high and hence the growth coefficient was adjusted to

reflect revenue growth more reasonably. The original regression line and BMW’s revenue for 2009

were used to obtain a second regression line. This line goes from the actual revenue level in 2009 to

the predicted revenue in 2014. The correction seems in line with world GDP growth and it reflects

BMW’s current potential in the market place. For the remaining period from 2015 and onwards the

growth numbers correspond to the world GDP growth. For the prediction of world GDP the report

builds on numbers from the OECD economic department published in the start of 2010. (Duval,

2010)

The only adjustment has been to reduce BMW’s revenue growth by 2% for the long run. This is

done in order to stabilize BMW’s revenue growth. Moreover, it reflects the future market situation

better, because the automobile market is going to mature more and more, when the developing

countries are explored. When no more unexplored markets exist, BMW Group has to get its revenue

growth through increasing its market share or moving into other markets.

Table 8-1 - World GDP Growth and BMW revenue growth

2010 2011 2012 2013 2014 2015-25 2025-

GDP

growth 5.3% 5.0% 4.8% 4.5% 4.3% 3.6% 3.4%

BMW

Growth 5.3% 5.0% 4.8% 4.5% 4.3% 3.6% 2%

Source: OECD 2009

8.2.2 Cost of goods sold

The average of cogs to revenue in the period from 2005-2010 has been around 78%. However,

before the crisis, the cost of goods sold was lower. On one hand the increase in raw material prices

of metals and oil will increase and thereby increase costs for the company. On the other hand

BMW’s recent focus on cost reduction and the fact that fixed costs will not increase proportionally

to revenue growth, because there is excess capacity at the moment, will contribute to a decreased

cost to revenue ratio.

Assumingly, the cost of goods sold will stay at a level of decline to a level of 77%.

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8.2.3 Sales and administrative cost

Cost for sales and administration have been around 10% of revenue for several years and since no

significant changes to sales and administration were identified in the strategic analysis, this is used

as an indicator for the future.

8.2.4 R&D expenditure

R&D expenditure is historically low for BMW at the moment with 4.83% of revenue. Due to R&D

importance in the industry, which was previously found in the KFS analysis, BMW is assessed to

focus more resources at R&D, when their revenue normalizes and profits allow for increased

investments. The average R&D expenditure to revenue ratio has been 5.2% from 2005-2009 and is

for the future predicted to be a little higher at around 5.3% of revenue.

8.2.5 Other operating income and expenses

Historically, operating income and expenses have nearly equaled out. Over the period from 2005-

2009 operating income had a low volatility. It averaged 1.8% of revenue and operating expenses

averaged 1,4% of revenue. Hence, net operating income is set equal to its historical average.

8.2.6 Equity investments

Equity investments account for BMW’s interest in a Joint Venture with BMW Brilliance

Automotive Ltd., Shenyang. The operations in emerging markets, like this one is, was in the

strategic analysis found to be a good opportunity for future growth. It is therefore expected that

equity investments will increase slightly in the short run.

8.2.7 Interest estimates

Interest expenses and income are expected to stabilize in the long run. They might however increase

slowly in the short run, since interest rates according to the strategic analysis are at historical low

and BMW is about to get downgraded by financial bureaus (BMW AR, 2009).

8.2.8 Other financial results

Other financial results have been set to zero, because this is not only the historical average, but also

the expected outcome derived from the strategic analysis, where increased natural hedging would

contribute to bring down the use of derivative instruments. Derivative hedging will still be used by

the BMW Group, but it is assumed that derivative hedging is solely used to hedge and hence there

will assumingly be no profit or loss from these activities.

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8.2.9 Income taxes

In 2008, BMW used a lot of their deferred tax assets, to gain a higher profit. This is an explanation

for the fluctuation in the income taxes to EBT ratio. The historical revenue obtained from 2005-

2009 will therefore underestimate BMW’s tax expenses. The tax expense is therefore adjusted

upwards to give a more realistic picture of taxes expected for the future. Taxes are predicted to take

up 30% of revenue in the short run. This is a bit over the historical average, but below the statuary

tax rate in Germany. It is set below the German statutory tax rate, because BMW had income in

other countries, where tax rates are lower.

8.3 Short-term Forecast for the Balance sheet

8.3.1 Working capital

8.3.1.1 Operating Cash to revenue

The industry average for cash and cash equivalents is at a very high level of revenue compared to

previous years. Cash and cash equivalents have risen significantly during the financial crisis; for

BMW in particular they have risen from around 3% of revenue to more than 15% of revenue. This

increase is due to the enhanced awareness about liquidity caused by the financial crisis and its

demand for flexible financing. BMW’s competitors are keeping higher amounts of cash and cash

equivalents than BMW, with the exception of Mercedes. The appropriate amount of working cash

was set to 3.5%, which seems reasonable according to the historical average before the crisis.

8.3.2 Receivables from sales financing

Was set at its 2009 level. This reflects the expectations of increased demand for leases in the

coming years.

Other working capital entries were set at their historical averages.

8.3.3 Fixed assets

Assumingly fixed assets will stay at their 2009 level, since they have constantly stayed around the

value for 2009.

8.3.4 Other assets

Accounts in other assets are held at their historical averages for the future, because this seems most

reasonable.

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8.3.5 Liabilities

Most other liabilities were predicted to stay at their 2009 level for the future. The increase in equity

value, but constant debt tries to catch the fact that BMW’s equity started at a very low level and for

the future is expected to catch up with liabilities and hit the target debt to company value ratio of

60%. Another reason for keeping debt constant is BMW’s ability to fund investments through the

usage of cash and cash equivalents, which are brought down under the forecast period.

In order to reconcile BMW’s forecasted balance sheet, excess cash has been used as a “plug

account” where differences between assets and liabilities are balanced out.

8.4 Long term and continuing value forecast drivers

The long term and continuing value period are uncertain in their nature, so an equally detailed level

as in the short term analysis would not contribute to accuracy. Hence, the long term and the

continuing value forecast will only be based on a few overall operating ratios.

The following forecast drivers are used in determining the long term and continuing value of

operations: revenue growth, growth in invested capital, NOPLAT growth, depreciation and

investment in goodwill & intangible assets.

8.4.1 Revenue growth

Revenue growth was outlined in the short term forecast and values are kept at their previously

predicted rates. 3,6% for the long run and 2% for the continuing value period.

8.4.2 Growth in invested capital

The growth in invested capital is assumed to increase with 5% per anno, which is in line with the

historical average and the intention of BMW to grow its operations.

8.4.3 NOPLAT growth

NOPLAT growth is assumed to stay at a level equal to revenue growth, because NOPLAT is a

direct function of revenue.

8.4.4 Depreciation

For the long run and the continuing period, depreciation on fixed assets is equal to 20% of Property

Plant and Equipment (PP&E). PP&E has been forecasted to grow at a rate, which is equal to its

historical average. This is in line with the company’s intention to grow its business.

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8.4.5 Investment in goodwill & intangible assets

The new investments in goodwill & intangible assets are assumed to grow proportionally with

revenue. Historical evidence indicates that 2% of revenue is a fair estimate for the future

investments in goodwill & intangibles.

8.5 Valuation

This sub chapter handles the real valuation of BMW. The valuation enables an assessment of the

market value of the BMW Group. The market value will be a result of conclusions drawn upon

from the historical- and financial analysis. Finally, the market value, will be split up in equity

belonging to the owners of preferred- and common stocks, respectively. The result should be a final

estimation of stock prices for both preferred- and common stock.

8.5.1 Summary of valuation

First, BMW’s operating value was calculated to be 65,698 mio. €, which was further adjusted by a

factor of 1.033 in order to adjust for the generation of FCF throughout the year. Before the

adjustment factor was applied, the generation of free cash flows were seen as only taking place in

the very end of the year. This was of course not correct and was therefore altered. The final value

for BMW’s equity value became: 67,862 mio. €. This value was both established through the DCF-

and the EVA method.

A problem with regards to the valuation of the company’s operating value is the high amount of

value generated in the continuing value period. The continuing value period takes up 49.55% of

total operating value creation. The high value of the continuing period and the high uncertainty

connected to predicting events, which are so far out, once more acknowledges the uncertainty in the

valuation.

When talking about the EVA and DCF calculations in detail it must be mentioned that no values are

negative. This is probably not realistic, but since modest values, which stem from historical

averages, have been used throughout the valuation, future peaks and down will simply be smoothed

out. Hence, the valuation numbers should not be seen on a year to year basis, but rather as a big

picture where the averages over the forecast period are as close as possible to the expected

averages.

To illustrate the difference between the EVA- and the DCF principle, the years 2019 and 2020,

which are reverse in terms of EVA and DCF, will be looked at. Even though it is expected that 2020

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generates a higher free cash flow than 2019, the economic value added is expected to be higher in

2019. This is due to investments in capital, which are higher in year 2020 than in 2019.

The market value of BMW’s equity value is estimated to be 31,968 mio. € (Appendix 9).

8.6 Different stock classes

BMW issues two different types of shares. One type is called common stock, the other is called

preferred stock. The two stock types differ significantly in their characteristics, which is also why

they are not traded at the same market price. Both stock classes have a par value of 1 €

(www.bmwgroup.com, 2010).

The price differential between the two stock classes will be discussed by comparing the two stock

classes rather than estimating one class and dedicating the rest of equity to the other, which is a

frequently used approach (Miller, 2007). The theory in this area does however treat preferred stock

as if it was debt and this is not in line with BMW preferred stocks, which are not yielding a fixed

dividend. The dividend yield for BMW’s two stock classes is determined by the board of

management (BMW AR, 2009).

The common stock has the advantage of having voting rights associated to it. This in general

implies that a company can only be taken over, when more than 50% of common stocks agree to

sell their stocks to the buyer. For BMW the takeover threat is not only limited buy several hurdles,

which are e.g. related to the refinancing of debt after a takeover, but also through the fact that a

single family possesses 46,3% of common shares (www.bmwgroup.com, 2010). The fact that the

Quandt family, which assumingly is acting as one investor, does not possess 50% of shares gives

the remaining shareholders, through the acquisition of a common share, the possibility of

influencing directly in the decision making.

Preferred shares are non-voting shares, which means that stock holders of preferred shares are not

entitled to vote at annual meetings, when for example members for the company boards are elected.

The implication of this is that owners of preferred stocks are not able to influence on the

organizations operations, which is a clear drawback. This drawback for investors has been explored

very recently by the BMW Group, when creating 469,200 new non-voting shares (BMW AR,

2009). The share issuance was part of employees payments and was underlying the restriction that

shares could not be sold within the first four years after issuance. This solution to paying

employees, was a way of keeping money within the organization for four years and hence having

more capital to work with.

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A clear advantage of preferred shares is that they are entitled to receive more dividend per year than

common stock owners. A preferred stock yields 0.02 € more per share than a common stock. When

only looking at the dividend yield and discounting it back, preferred stocks should be worth more

than common stock.

Another factor that usually counts towards a higher value for preferred stocks is the smaller credit

risk associated to it (Horner, 1988). However, in the case of BMW, the owners of preferred stocks

will not be paid before common stock owners in case of bankruptcy.

The underlying strategic principle of issuing preferred shares is the creation of additional working

capital through a equity issuance. In conclusion, two different stock classes enable a company

separate cash flows from control of the organization (Bebchuk, Lucian et al., 2000).

A lot of research in the area concerning the price differential between stock classes, centers around

the voting right difference. Research has shown that voting power has a significant impact on the

price of a stock (Barcley and Holderness, 1992). A German research, which also concerned BMW

gave a result of 26% price premium on shares with an associated voting right compared to the

corresponding non-voting shares (Hoffmann-Buchardi, 1999). Contrary to these finding, other

research has focused on the liquidity of different shares as a driving factor in the price difference

(Neuman, 2003). No quantitative results were made available about the exact impact of liquidity on

the stock price, which makes it difficult to use this factor in valuing the different stock classes. It is

however assumed that liquidity will have some kind of impact in favor of BMW’s common stock,

since common stock is traded in a much higher volume (BMW AR, 2009).

In order to clarify the above mentioned factors, these will be placed in context. Two different

scenarios will be outlined in order to explain the factors in more detail.

The first scenario is: BMW’s dividend payout is ensured and the company is able to satisfy its

investors by living up to the required return on invested capital. The investors will be confident in

the company’s operations.

In the second scenario the company is struggling. It can hardly make the dividend payments and

general market conditions are uncertain. The investors react either by selling the stocks or else they

want to engage more in the company and hence contribute to the company’s well being.

In the first scenario, which corresponds to BMW’s and the markets situation before the financial

crisis set in, the investors want to get as much out of their investment as possible in terms of

monetary refunding. The conclusion of this is that more and more investors want to buy preferred

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shares rather than common shares. The increasing demand for BMW’s preferred shares increases its

price and hence makes it approach the common stock in terms of its market price. Another way of

saying it could be: Investors see that the company is doing well, so there is no need to intervene

through the usage of voting power. The focus is shifted from the voting power and liquidity, to the

pure dividend yield. Exactly the same as just described, happened in 2007, when the market and

company had a positive outlook and investors thought everything was going well.

The opposite is seen in the second scenario, which corresponds to their current standing. The

market prices of the two stock classes are no longer close to each other and the common stock is at

the moment worth ca. 30% more than the preferred stock (Appendix 10).

In conclusion, the relationship between the prices of common stock and preferred stock must be

regarded as difficult to assess and dependent on many factors. The voting right, liquidity and

dividend yield are found to be the most important factors for explaining the price differential. These

factors must however always be seen in their economic context, which both encompasses the

environment and the company.

The relationship between the two stock classes has obviously not been constant over the past, but

due to the indication that BMW’s current outlook might have a big impact on the relationship

between stock classes, the relationship on the 17th

of March 2010 is taken as an estimator for the

relationship between BMW’s stock classes. The establishment of a market value for the two stock

types will hence be based on the relationship between the preferred and common stock price on the

17th

of March 2010. The price differential of ca. 30% at the moment seems in line with the

identified factors.

8.6.1 Valuation of different stock classes

The price of the two stock classes was calculated to be 35.70 € for preferred shares and 50.22 € for

common shares (Appendix 11). Both values lie over their respective market prices. Several sources,

which could have lead to a wrong estimation of BMW’s value have been identified throughout this

report. The prime source of error is the subjectivity, which is an inbound part of estimating forecast

drivers.

8.7 Sensitivity Analysis

A sensitivity analysis will be conducted on the results from the valuation of BMW. This is done in

order to see the influence of different variables upon the equity value of the company. The

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sensitivity analysis will be conducted on the variables weighted average cost of capital (WACC),

cost of goods sold (COGS), long term revenue growth and continued value growth. The variables

are chosen on the basis that they are very important for the development in the equity value.

The sensitivity analysis is create, so that it can partly substitute scenario analysis. This was done by

making data tables, two dimensional, so that two variable were allowed to change at the same time.

In the following the results of the sensitivity analyses will be presented. Each variable’s influence

will be evaluated on a “ceteris paribus” basis. For the combined effects of e.g. the WACC and

COGS on equity value see appendix 11.

On the basis of a equity value of €31,968,453,605, the variables are evaluated. From the table below

it can be seen how the equity value changes, when WACC is varied by one percentage point at a

time.

Table 8-1 - Changes in common share price by WACC

WACC values

3,69% 4,69% 5,69% 6,69% 7,69% 8,69% 9,69%

359% 150% 55% 0% -36% -61% -79%

(Source: Own Calculation)

From the table it can be seen that the WACC has a major influence on the equity value of the

company. In the span of the 6 percentage points the equity value changes by more than 400

percentage points, which is an enormous change.

The cost of goods sold is the single largest cost of the company. This makes it an interesting

variable to investigate further. From the table below the equity value based on different cost levels

for the company is presented.

Table 8-2 - Changes in common share price by COGS

COGS values

74% 75% 76% 77% 78% 79% 80%

93% 62% 31% 0% -31% -62% -93%


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The percentages of the COGS are of company revenue. Again the variable is changed by ±3

percentage points. The 6 percentage point span results in an equity value span of 186 percentage

points. The development in the equity value is linear in its relation to the share price, with an

increase/decrease of 93% in both directions. This shows that the company’s equity value is

significantly influenced by changes in the COGS level.

The following two variables determine the expected growth in value. These variables are very

interesting to examine since much of the value of the company is based on these estimates, so the

sensitivity of company value on these variables is very interesting as it tells something about the

robustness of the model.

Table 8-3 - Changes in common share price by revenue growth

Long term revenue growth

0,6% 1,6% 2,6% 3,6% 4,6% 5,6% 6,6%

-80% -56% -29% 0% 31% 65% 102%

Continued value revenue growth

0,5% 1,0% 1,5% 2,0% 2,5% 3,0% 3,5%

-25% -18% -10% 0% 13% 28% 49%

(source: own calculation)

It should be noted that the two lines are separately calculated. A value of e.g. 1% in continued value

growth is based on a long term growth rate of 3.6%. The long term revenue growth is changed by ±

3 percentage points whereas the continued value growth is only changed by ± 0.5 percentage points.

There is a slight dissymmetry in the value of the equity. This means that the equity value increases

more if revenue is growing than if revenue is falling. This is caused by the discounting of free cash

flows. As revenue falls more and more of the company value is derived from the current operations

e.g. the percentage that the continued value makes of the company value will be smaller and

smaller.

In conclusion the equity value is found to be significantly influenced by the change of the variables.

Especially the WACC proved to be very influential, which is consistent with the valuation

technique of discounting cash flows by the WACC.

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8.8 Preliminary conclusion

Forecast drivers were derived on the basis of previous strategic- and financial analysis. The forecast

drivers were almost exclusively held up against revenue growth. Therefore special attention has

been paid to establishing a reasonable revenue growth. The best predictions for BMW’s future

revenue growth were obtained through a regressions analysis against world GDP growth.

Afterwards the forecast drivers were used in both an EVA and a DCF valuation of BMW.

The estimated equity value was the base for the pricing of two stock classes. The proportionality

between the two stock classes was obtained through a theoretical discussion about price

differentials between preferred and common stock.

Finally, a connection between key variables and the estimated equity value was established in a

sensitivity analysis. The sensitivity analysis highlights the uncertainty of the estimated equity value.

Special attention is dedicated to the WACC and COGS, which both impact the value significantly.

Both calculated values for the two stocks do however lie within their corresponding ranges of 5-

year low and high of stock prices (Appendix 10). Therefore the stock prices do not seem

unreasonably and are taken as the best possible estimates with the information at hand, at the

moment. The market value assessment of the stock classes means that both stocks are undervalued.

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9 Conclusion

The purpose of this report was to estimate the market value of BMW’s equity. Moreover, the

market value of the two stock types should be found. The values were found using a DCF- and an

EVA method. These methods built on forecasts, which were grounded in both a financial and a

strategic analysis.

The report started out with reorganizing the financial statements. Invested capital, NOPLAT, FCF,

ROIC and revenue growth were found and their implications for the company’s future were

assessed. Despite the negative development in the above mentioned ratios, the fact that BMW has

been able to generate a positive net profit throughout the crisis, yields a positive outlook for the

forecast period. The development in the FCF was also positive. It increased to 4,859 mio. € in 2009.

The increase in FCF stems from a decrease in invested capital and has a positive impact on the

company, since it allows for flexibility in operations. The current WACC was estimated to be

6.69%.

The strategic analysis was divided into two parts: External and internal. The external analysis

started with outlining the turbulence in the market at the moment. The market was evaluated to be

changing but still partly predictable. Afterwards the general environment was described in a PEST

analysis. The overall impact of the general environment was evaluated to be almost unchanged in

the future. There were however changes in the areas of socio-cultural and economic factors. Due to

an expected increase in the demand for green products, socio-cultural factors were assessed to have

a more positive impact in the future. Contrary, the economic factors were due to higher raw material

prices evaluated to have a more negative impact on the organization in the future.

The premium car market in particular was evaluated in Porter’s five forces. The conclusion was

that BMW would face a bigger threat from factors, directly related to the premium segment, in the

future. The increased threat is derived from the assumption that car producers from emerging

markets might enter the premium segment in the future and due to their large economies of scale

they will have an advantage in terms of costs compared to BMW. The strong brand and BMW’s

R&D experience are however assessed to keep BMW competitive in the market.

After the external analysis was finished off, the internal resources were analyzed. These were

analyzed according to the 7S model and finally evaluated in a VRIO Framework. Branding,

innovative capabilities and the experience with sustainable solutions were found to yield sustainable

competitive advantages for BMW.

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In order to combine internal and external factors, key factors of success were looked at. The prime

factor for success in the premium automobile segment was found to be branding. Other factors,

which are determinants of success are: Innovative skills & technical capabilities, low costs in

production and liquidity.

Finally, the factors from the internal and external analysis were brought together in a SWOT

analysis. The most important strategic factors were combined in order to identify BMW’s strategic

position. Important opportunities in the SWOT analysis were the focus on a “green image”, growing

emerging markets and an increased need for leases. The biggest threats were identified to be: A

reoccurring recession, political instability in emerging markets and copyright infringements.

The critical SWOT analysis concluded that BMW was not in a situation where changes were

needed immediately.

After the SWOT analysis, the actual valuation was taken care of. First forecast drivers were

estimated on the basis of the strategic and historical analysis, second the forecast drivers were used

to establish values for free cash flows and economic profits. The result of the valuation was a

market value for equity of 31,968 mio. €.

The equity value was used in a valuation of the two different stock classes. Before the valuation of

the stock classes could be undertaken, the price differential between the stock classes was

explained. The price difference was found to be highly influenced by voting rights, liquidity and

dividend yield. These factors lead to the usage of the current relationship between the market price

of the two stock classes, as an estimator. The valuation gave a preferred stock price of 35.70 € and a

common stock price of 50.22 €.

In order to account for the change in variables, a sensitivity analysis was carried out. The three

factors, which had the biggest influence on the equity value were COGS, revenue growth and

WACC. The conclusion was therefore that the equity value is highly sensitive to changes in certain

variables and that deviations from the expected values for these variables, would result in a

significantly different equity value and corresponding stock prices.

In total the result is that if all assumption throughout the report hold, both BMW’s stock classes are

undervalued. The preferred stock was undervalued with ca. 12 €, whereas the common stock was

undervalued with ca. 18 €.

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11 Appendices

Appendix 1 – Structure

Appendix 2 – 10-year German Government Bond

Appendix 3 – Regression analysis of Beta

Appendix 4 – Degree of Turbulence (DOT)

Appendix 5 – Quantification of PEST analysis

Appendix 6 – Quantification of the five forces analysis

Appendix 7 – The VRIO Framework

Appendix 8 – Regression analysis of revenue growth

Appendix 9 – DCF and EVA approaches to valuation

Appendix 10 – Historical overview of stock prices

Appendix 11 – Calculating stock prices

Appendix 12 – Sensitivity analysis

Appendix 13 – SWOT overview

Appendix 14 – Word count

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Appendix 1 – Structure

Introduction

• Preface

• Executive summary

• Brief introduction

• Problem statement

• Structure

• methods

• Assumptions and Delimitations

Historical analysis

• Analysing invested capital

• Analysing NOPLAT

• Analysing the free cash flow

• reinvestment ratios

• Return on invested capital

• Analysis of revenue growth

• Capital Structure

• Peer Group financial ratios

Strategic analysis

• External analysis

• The degree of turbulence

• PEST

• Porters five forces

• Internal analysis

• Key factors of success

• Critical SWOT

Valuation

• Forecast drivers

• Valuation

• Different stock classes

• Sensitivity analysis

• Conclusion

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Appendix 2 – 10-year German Government Bond

Appendix 3 – Regression analysis of Beta

It is examined whether there is a linear relationship between the DAX30 Performance Index and the

BMW AG share price in order to estimate BMW’s beta against the DAX30 Performance Index.

From the following figure it seems okay to believe that there could be a linear relationship between

the two.

Figure 1 – DAX30 and BMW Share price development

Model-formulation:

. where n = 75

µi = β0 + β1 * X1 + ε this can be translated into the market model:

0

1

2

3

4

5

6

7

8

9

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

10-Year German Gov. Bond

10-Year German Gov. Bond

-30,00%

-20,00%

-10,00%

0,00%

10,00%

20,00%

30,00%

-20,00% -10,00% 0,00% 10,00% 20,00%

X:DAX & Y: BMW

DAX on BMW

Source: Own Calculations on DataStream data

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where,

Y is the monthly share price development for BMW AG in % month on month

X1 is the monthly development of the DAX30 Performance Index in % month on month

Before we start testing whether DAX30 is useable in predicting the share price of BMW, we have to

make sure the assumptions for the test are valid.

Assumptions:

1: The error-terms are normally distributed – ε ~ Normally Distributed

Figure 2 - Normal Probability Plot

This assumption is assumed fulfilled as the standard residuals roughly follow the trend line with

equal amounts of observations above and below the line, especially if we disregard the few outliers

in both ends.

2: E(ε) = 0, i.e. E(Y) = β0+β1*X1 – Linearity of the model

This states that the relationship described by the model, has to be linear.

If we plot the %-change in BMW share price against the standardised residuals, then we get the

following output:

Figure 3 - BMW Plotted Against Standardised Residuals

This shows a linear development between the two and the assumptions is therefore assumed to be

fulfilled.

-0,4

-0,2

0

0,2

0,4

0 20 40 60 80 100 120BM

W%

Sample Percentile

Normal Probability Plot

-4

-2

0

2

4

6

-30,00% -20,00% -10,00% 0,00% 10,00% 20,00% 30,00%

BMW %-change in Share price

BMW %-change in Share price

Source: Own Calculations

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3:

The variation in the error components must be constant and independent of the explanatory variable

DAX30 Performance Index in % month on month.

Figur 4 - Variation in the Error Components

When plotting the Standardised residuals against the predicted values, as done above, we see that

there is no pattern forming in the cluster. This suggests that there is no problem with

heteroskedasticity and the assumption is therefore assumed to be fulfilled.

4: Cov(εi,εj) = 0 for i ≠ j ~ Independent error components

The assumption assumes that there is no connection/pattern between the individual error terms that

they are independent of each other.

Plotting the standardised residuals along the x-axis gives the following picture.

Figure 5 - Independent Error Components

There does not seem to be any particular pattern in the error terms and the assumptions is therefore

assumed to be fulfilled.

The regression’s output from excel:

Tabel 4 - Regression Output

SUMMARY OUTPUT

Regression Statistics

Multiple R 0,733545782

R Square 0,538089414

Adjusted R Square

0,531761872

Standard Error 0,054780327

Observations 75

ANOVA

-6

-1

4

-0,2 -0,15 -0,1 -0,05 0 0,05 0,1 0,15 0,2

Stan

dar

dis

ed

R

esi

du

als

Predicted Values

-6

-1

4


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df SS MS F Significance F

Regression 1 0,25519293 0,25519293 85,039 0,00

Residual 73 0,21906455 0,003000884

Total 74 0,47425748

Coefficients Standard Error

t Stat P-value Lower 95% Upper 95%

Intercept -0,0053 0,006381804 -0,828324478 0,41 -0,01800512 0,007432712

DAX 30% 1,0038 0,10885744 9,221672542 0,00 0,786895101 1,220800224


From the output we are able to define the model in the following way:

Y = -0.0009 + 0.9555*Xi + ε

We want to test whether slope in the model is significant, in other words whether we can use the

beta value of 0.9555 for BMW on the DAX30 Performance Index.

Hypothesis testing:

1: Formulation of Hypothesis:

H0: β1 = 0, the line is not useable

H1: β1 ≠ 0, the line is useable

2: Significance level:

α = 5% or 0.05

3: Choice of Test Statistic:

4: Test Statistic:

The test statistic is given in table 1 and is: t = 9.2217

5: Critical Value:

tobs = 9.2217 < t75-1-1, α/2 = 9.2217 < t73, 0.25 = 9.2217 < 1.994 False! We reject H0!

6: P-Value:

Again using the table we can see that the p-value is practically 0, which means that it is a strong

rejection of the H0 hypothesis indicating that the line is useable.

7: Conclusion:

We reject H0 and continues to use DAX30 Performance Index as explaining the development in the

share price of BMW.

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Appendix 4 – Degree of Turbulence (DOT)

Repetitive Expanding Changing Discontinuous Surprising

Ch

ange

abili

ty Complexity National National Regional

Technological Regional

Socio-Political Global

Economic

Familiarity of events

Familiar Extrapolable Discontinuous Familiar

Discontinuous Novel

Pre

dic

tab

ility

Rapidity of change

Slower than

response

Comparable to response

Faster than response

Visibility of future

Recurring Forecastable Predictable Partially predictable

Unpredictable surprises

Turbulence level

1 (low) 2 3 4 5 (high)

Grading average: (5+3+2+2)/4 =3

Appendix 5 – Quantification of PEST analysis

Political factors Past Short run Long run

Enforcement of new laws 3 2 2

Political (in)stability 2 3 3

Total average 2.5 2.5 2.5

Economic factors

GDP increase 5 4 2

Interest rate risk 1 2 3

Currency risk 2 3 4

Cost of raw materials 2 3 4

Cost of crude oil 2 3 4

Total average 2.4 3 3.4

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Socio-cultural factors

Growing middle class 3 2 1

Demand for green products 3 2 2

Total average 3 2 1.5

Technological factors

position 2 2 2

Environmental friendly solutions 2 2 2

Total average 2 2 2

Grand average 2.475 2.375 2.35

Appendix 6 – Quantification of the five forces analysis

Past Short Run Long Run

Industry Rivalry

Marketing & Branding 4 4 5

Leasing Financing 3 4 5

Static Industry 4 4 4

Financial Crisis 5 5 3

Mergers & Acquisitions 3 3 4

Total Average 3.8 4 4.2

Potential Entrants

Entry Barriers(Marketing) 1 2 3

R&D Investments 1 2 3

Emerging Countries 1 1 3

Distribution Network 1 1 2

Total Average 1 1.5 2.75

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Buyers

Backward Integration of Costumers 1 1 1

Switching Costs 2 2 2

Leasing Agreements 3 2 2

Total Average 2 1.67 1.67

Substitute Products

Bicycles etc. 1 1 1

Other Car manufacturers 4 3 3

New Technology 1 1 2

Total Average 2 1.67 2

Suppliers

Market Prices 5 5 5

Production Network 3 3 3

Dependency 4 4 3

Total Average 4 4 3.67

Grand Average 2.16 2.602 2.908

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Appendix 7 – The VRIO Framework

Valuable? Rare? Costly/

difficult to imitate?

Exploitable by the firm?

Competitive implications

Expected competitive economic performanc

e

Resource

NO - - NO Competitive disadvantage

Below normal

-

YES NO YES/NO Competitive parity

normal Headquarters in Munich

Good distribution channels

Market knowledge

Partly decentralized company structure

Close contact with qualified suppliers

Worldwide production facilities

In house financial department

YES YES NO YES/NO Temporary competitive advantage

Above normal

Access to highly educated employees

Partnership with Fiat

YES YES YES YES Sustainable competitive advantage

Above normal

Brand portfolio

Strong brands

Innovative capabilities

Focus on sustainable solutions

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Appendix 8 – Regression analysis of revenue growth

It is examined whether there is a linear relationship between the World GDP and the revenue of

BMW in order to estimate BMW’s future revenue growth.

From the following figure it seems reasonable that there is a linear relationship between the two.

Model-formulation:

. where n = 75

µi = β0 + β1 * X1 + ε

where,

Y is the yearly revenue of BMW in million Euros

X1 is the World GDP in US billions

Before we start testing whether World GDP is useable in predicting the revenue of BMW, we have

to make sure the assumptions for the test are valid.

Assumptions:

1: The error-terms are normally distributed – ε ~ Normally Distributed

This assumption is assumed fulfilled as the standard residuals roughly follow the trend line with

equal amounts of observations above and below the line.

2: E(ε) = 0, i.e. E(Y) = β0+β1*X1 – Linearity of the model

This states that the relationship described by the model, has to be linear.

If we plot the BMW revenue against the standardised residuals, then we get the following output:

-

20.000

40.000

60.000

0 20.000.000 40.000.000 60.000.000 80.000.000

X: World GDP Y: BMW Revenue

0

50000

100000

0 20 40 60 80 100 120

BM

W R

eve

nu

e /

Mio

€

Sample Percentile

Normal Probability Plot

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This shows a linear development between the two and the assumptions is therefore assumed to be

fulfilled.

3:

The variation in the error components must be constant and independent of the explanatory variable

DAX30 Performance Index in % month on month.

When plotting the Standardised residuals against the predicted values, as done above, we see that

there is no pattern forming in the cluster. This suggests that there is no problem with

heteroskedasticity and the assumption is therefore assumed to be fulfilled.

4: Cov(εi,εj) = 0 for i ≠ j ~ Independent error components

The assumption assumes that there is no connection/pattern between the individual error terms that

they are independent of each other.

Plotting the standardised residuals along the x-axis gives the following picture.

There does not seem to be any particular pattern in the error terms and the assumptions is therefore

assumed to be fulfilled.

The assumptions are assumed to be fulfilled. It should be noted, however, that the number of

observations is very low, which could influence the estimated numbers. This is assumed not to be

the case and the number of data points is assumed to be satisfactory in giving an accurate picture of

the future.

-3

-2

-1

0

1

2

- 10.000 20.000 30.000 40.000 50.000 60.000

-3

-2

-1

0

1

2

0 10000 20000 30000 40000 50000 60000

-5

0

5

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The regression’s output from excel:

Regression Statistics

Multiple R 0,895441993

R Square 0,801816362

Adjusted R Square 0,785301059

Standard Error 4104,156724

Observations 14

Coefficients Standard Error

t Stat P-value

Intercept 14541,78648 4047,75 3,592563521 0,00

World GDP, Current Prices US millions

0,000664523 0,00 6,967776024 0,00

From the output we are able to define the model in the following way:

Y = 14,541.79 + 0.000664523*Xi + ε

The model was found to overestimate the value of the 2010 revenue growth, an increase in growth

of more than 14%. This was found to be too positive based on the current development in the

market. The other years were found to be reasonable estimates. On the basis of the 2014 expected

revenue and the 2009 revenue a linear slope was developed. This resulted in an annual increase in

revenue of 2,667. This lead to the following expected revenue numbers for the years 2010-2014:

Year Expected Revenue

2010 53.348

2011 56.015

2012 58.682

2013 61.349

2014 64.016

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Appendix 9 – DCF and EVA approaches to valuation

DCF approach to the value of operations Year Free Cash Flow / mio. € Discount factor PV of FCF / mio. €

2010 4.168 0,9373 3.907

2011 2.822 0,8785 2.479

2012 3.098 0,8234 2.551

2013 3.375 0,7718 2.605

2014 3.651 0,7234 2.641

2015 3.393 0,6780 2.300

2016 3.466 0,6355 2.203

2017 3.539 0,5957 2.108

2018 3.613 0,5583 2.017

2019 3.686 0,5233 1.929

2020 3.759 0,4905 1.844

2021 3.832 0,4597 1.762

2022 3.905 0,4309 1.683

2023 3.976 0,4039 1.606

2024 4.047 0,3786 1.532

continuing value 86.297 0,3786 32.669

Total operating value 65.837

continuing value % of operating value

49,62%

mid-year adjustmenf factor 1,033

Adjusted operating value 68.004

EVA approach to the value of operations Year Economic profit/ mio. € Discount factor PV of EP / mio. €

2010 524 0,9373 491

2011 643 0,8785 565

2012 653 0,8234 538

2013 663 0,7718 512

2014 674 0,7234 487

2015 655 0,6780 444

2016 614 0,6355 390

2017 568 0,5957 338

2018 516 0,5583 288

2019 460 0,5233 241

2020 397 0,4905 195

2021 328 0,4597 151

2022 253 0,4309 109

2023 170 0,4039 69

2024 80 0,3786 30

continuing value 1704 0,3786 645

Total operating value 5.493

Invested Capital incl. Goodwill 60.344

Operating value 65.837

Mid Year Adjustment 1,033

Adjusted value of Operations 68.003

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Appendix 10 – Historical overview of stock prices

Appendix 11 – Calculating stock prices

Calculating the equity value and stock prices:

Stock prices:

preferred common

EqV 1.880.068.977 30.229.661.176

stock price 35,70 € 50,22 € Ratio pref./common

71,09%

0

10.000

20.000

30.000

40.000

50.000

60.000

preferred stock

common stock

Value of Equity

Value of Operations 68.003

Non-operating Assets 31.122

Enterprise Value 99.125

Value of Debt - 61.325

Retirement Liabilities - 5.678

Minority Interests - 13

Equity Value 32.109

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Appendix 12 – Sensitivity analysis

% change in equity value by percentage point changes in variables

Equity value WACC values

€ 31.968.453.605 -3,00% -2,00% -1,00% 0,00% 1,00% 2,00% 3,00%

CO

GS

Val

ues

-3% 621% 314% 173% 93% 41% 4% -23%

-2% 533% 259% 134% 62% 15% -18% -42%

-1% 446% 205% 94% 31% -10% -39% -61%

0% 359% 150% 55% 0% -36% -61% -79%

1% 272% 96% 15% -31% -61% -82% -98%

2% 184% 41% -24% -62% -86% -104% -117%

3% 97% -13% -64% -93% -112% -125% -135%


€ 31.968.453.605 3,69% 4,69% 5,69% 6,69% 7,69% 8,69% 9,69%

Lon

g te

rm R

even

ue

Gro

wth

-3,0% 73% -15% -56% -80% -97% -109% -118%

-2,0% 160% 36% -22% -56% -78% -94% -106%

-1,0% 255% 91% 15% -29% -58% -78% -93%

0,0% 359% 150% 55% 0% -36% -61% -79%

1,0% 471% 215% 98% 31% -12% -42% -64%

2,0% 594% 286% 145% 65% 14% -22% -48%

3,0% 727% 362% 196% 102% 42% 0% -31%


€ 31.968.453.605 3,69% 4,69% 5,69% 6,69% 7,69% 8,69% 9,69%

Co

nti

nu

ed V

alu

e R

eve

nu

e G

row

th

-1,5% 151% 64% 11% -25% -51% -71% -86%

-1,0% 195% 85% 22% -18% -47% -68% -84%

-0,5% 258% 113% 37% -10% -42% -65% -82%

0,0% 359% 150% 55% 0% -36% -61% -79%

0,5% 544% 205% 79% 13% -28% -56% -76%

1,0% 998% 293% 112% 28% -20% -51% -73%

1,5% 3842% 454% 160% 49% -9% -44% -69%

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Appendix 13 – SWOT overview

SWOT overview Internal

Strengths Weaknesses

Innovative capabilities, the company is using significant amounts on R&D

In house financing capabilities, the financing division of the company provides very valuable services for the company

Good distribution network/channels, the large production and distributions network makes it difficult for other companies to enter the markets of BMW

Minimising risks by different means of hedging; Natural & Financial hedging

Leader on the Dow Jones Sustainability Index

Joint venture with company in China

Strong Brand and effective marketing by BMW, the strong brand of the company allows it to charge a premium

Strategic Alliances with other car manufacturers e.g. Fiat on the exchange of parts between the Mini and Alfa Romeo

Significant efforts to lower the production costs for the company, will give them a strength when the markets turn around

The corporate structure, with several different management boards to assist general management in strategy development

High production standards to ensure a good quality of the products produced by the company

Employees are considered the company’s most valuable asset as they are dependent on Human capital/knowledge

Winner of the engine of the year award showing their significant skills within innovation and technology

Only Mini and Rolls-Royce production in the UK, which gives the company high costs of delivery and a mix of currencies. Costs in Pound and income in other currencies.

A lack of economies of scale as the company is a niche producer within the premium car manufacturing segment

Very dependent on the European and American markets

Cannot afford to stay out of the emerging markets, though they posses both opportunities and threats

BMW is currently operating with a high D/V ratio, which puts them at risk from increasing interest rates

Loss of management control as an effect of decentralisation of power in the structure of the company

Management bonus schemes, which are dependent on the ratio of dividend paid each year, this could lead management to pay out dividend even in years where it is not financially sound to do so

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External Opportunities Threats

Emerging markets and the possibility of high growth in these markets

Favourable standing in the consumers eyes due to their branding and marketing

Focus on the environment and green technology, a continued focus on the environment in the car production, will give BMW the opportunity of increasing their sales as their cars becomes more environmentally friendly

China the worlds largest car manufacturing market

Positive demographic development for BMW. A growing middle aged population, which have the financial means to buy their products

Increasing leasing opportunities, which gives them a possibility of diversification

New ELV directive from the European union, which sets higher demand on the produced cars

Price of raw materials such as the metals going into the body work of their cars. These prices are determined by the market

The threat of new competitors from emerging markets a Chinese company has just bought Volvo, which is a close competitor to BMW

Currency risks. The threats from uncontrollable interest rates, which the company is trying to minimise by hedging

A returning recession. A returning recession would seriously hit the demand and thereby the revenue of the company

Copyright infringement from Asian companies

Political instability in emerging countries, makes it difficult to evaluate the possible gains of these markets

The demographic development of the western countries means that the production workforce of the company will become older and older, which can reduce labour productivity in the company

Consolidation in the supplier market, leading to increase dependency between the companies

Appendix 14 – Word count

The allowed number of pages are 70 for a group

of 1-2 bachelor students. A page should not

consist of more than 2,200 characters excl. spaces.

The maximum limit of 154,000 characters excl

spaces is therefore respected.

valuation of bmw

Documents

01x1 linearity

free cash

sou rceoverview

free cash

risk free

gross cash

current credit

temporary