Target Corp. is the second-largest discount retailer in the U.S. Target sells many basics but also differentiates itself by selling stylish products at reasonable prices, relying on partnerships with a changing set of designers. At the end of fiscal year 2023 (FY23) (Target's fiscal year ends on the Saturday closest to January 31 and is referred to by the year in which it ends. So, for example, the year from Feb. 2022 through Jan. 2023 is referred to as "fiscal year 2023" (FY23)) , Target had 1,948 stores in the U.S. Most of Target's stores are large, averaging more than 125,000 square feet. The company also has asignificant e-commerce presence, representing 18.6% of sales in FY23 (vs. about 8.8% pre-pandemic). From Jan 1 through Mar 31, 2023, TGT stock price rose 9.16%, compared to +7.46% for S&P 500 and +2.68% for Walmart. Target's earnings announcement of $1.89 per share for Q4 beat the consensus analyst forecast of $1.40, while Chief Executive Brian Cornell said it "continues to be a very challenging environment" with strong sales in food, beauty, and household essentials offsetting weaker consumer spending in other categories. At time of writing, the majority of analysts predict that Target will outperform the market (2 As of March 31, 2023, 8 analysts rate TGT as a "buy", 12 rate it as "outperform", and 17 rate it as "hold", with no "underperform" or "sell" recommendations. Source: Financial Times, markets.ft.com. ). Among the positives, Target has announced plans to implement drive-up returns across its stores. Drive-up returns have the potential to cut mail-in return expenses as well as delivering convenience to customers through expanded omnichannel capability (e.g., in-store purchasing, click-and-collect, delivery, and ship to home). Target's store network is well-developed, and their small-store format unlocks markets that cannot support traditional large stores, such as college campuses and urban areas. However, Target faces serious headwinds including the lack of switching costs and intense competition in retail. Much-larger rivals such as Walmart and Amazon can drive down prices and define the retail landscape in ways that Target cannot. Whether Target's recent outperformance means its stock is now over- or undervalued is an open question. The key to answering that question is whether Target's future outlook for generating free cash flows and growth, and the risk, more than justify its current valuation. Your valuation of Target should incorporate careful analysis of Target's fundamental cash flow generating potential as well as its valuation relative to other companies.

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Question :

a) Wrap-up DCF Valuation . In this final step of DCF valuation, compute the enterprise value, total firm value, and equity value of Target by estimating the terminal value and discounting free cash flows to the firm using the WACC.

a) Estimate the terminal value that captures the present value of FCFFs from FY 2029 and onward following the instructions below.

i) State and justify your choice for the terminal growth rate (g).

ii) State and justify your choice for the terminal return on invested capital (ROIC).

iii) Compute your steady-state reinvestment rate (b) using the relation we discussed in our third class (i.e., b = g/ROIC). Does the implied reinvestment rate (b) make sense? Please discuss.

iv) Calculate the terminal value using the "value driver" formula based on NOPAT, g, and ROIC, which we derived in our third class as: TVT = NOPAT(T+1) (1-g/ROIC) / WACC - g

b) Compute Target's enterprise value by discounting projected FCFF and TVT using the estimated WACC. Then compute firm value by adding any excess cash to the enterprise value. (Excess cash is defined as the cash, cash equivalents, and short-term investments on the balance sheet, from the latest 10-K or 10-Q, less operating cash.) Finally, compute Target's equity value by subtracting the market value of debt (computed in Question 4) from total firm value.