Valuation of Dillard's Company

You have been hired as new analyst at Kash Financial Services and have been asked to demonstrate your finance skills that you learned in the college. You have been assigned to James Thomas who is one of the top portfolio managers of the company. Your first assignment is to analysis Dillard's department stores and recommend a buy/or sell price to Thomas.

You have taken courses in your program which have dealt with investment and corporate finance.

To value the company, you decided to use the two widely valuation models that you learned in your classes- discounted free cash flows and relative valuation based on comparable companies. However, you remembered that your instructor had told the class that these two valuation methods would result in widely different prices.

In your program you remembered you had taken some courses in finance from professor Kashefi at the local state university.Professor Kashefi teaches in corporate finance and investment area and is recognized for his specialization in valuations of the companies.Upon contacting him for some help, he recommended that you take the followings:

Go to http://finance.yahoo.com. Under "Market Summary," you will find the yield-to-maturity for ten-year

Treasury bonds listed as "10 Yr Bond (%)." Collect this number as your risk-free rate.

In the box next to the "Get Quotes" button, type Dillard's ticker symbol (DDS) and press enter. Once you see the summary information for Dillard's, find and click "Statistics" on the right side of the screen. From the key statistics, collect Dillard's market capitalization (its market value of equity) and all relevant information such as enterprise value (market-value equity + net debt), cash, beta, and relative values.

Under "Financial" get the most recent three years of the three financial statements and copy and paste (or export) them to an excel file.

Section 1-Discounted Cash flow Valuation

To value the stock using discounted cash flow model estimate the last three-year averages of the following ratios:

EBIT/Sales

Tax Rate

Property and Equipment

Depreciation as a percent of property and equipment

Net Working Capital

Click on Analysis and gather the most recent long-term growth rate for the next five years. Forecast future sales for the next five years. Using the forecasted sales estimate, the ratios of section-1 for the next five years.

Section 2-Cost of Capital

Cost of Debt

To get Dillard's cost of debt and the market value of its long-term debt, you will need the price and yield to

1.maturity on the firm's existing long-term bonds. Go to http://www.finra.org or http://finra-markets.morningstar.com/BondCenter/Default.jsp

on the front page scroll down "market data center" click on bonds. Under "Bond Search," click "Corporate" and type Dillard's ticker symbol. A list of Dillard's outstanding bond issues will appear. Assume that Dillard's policy is to use the expected return on non-callable ten-year obligations as its cost of debt.

Find the non-callable bond issue that is as close to 10 years from maturity as possible. (Hint: You will see a column titled "Callable"; make sure the issue you choose has "No" in this column.) Find the yield to maturity for your chosen bond issue (it is in the column titled "Yield").

Now you now have the yield and price for each bond issue, but you need to know the size of the issue.

Click on each issue name and find "Bond Elements" amount outstanding, and yield to maturity. Noting that this amount is quoted in thousands of dollars (e.g., $60,000 means $60 million =$60,000,000), record the issue amount in the appropriate row of your spreadsheet. Repeat this step for all the bond issues.

The price for each bond issue in your spreadsheet is reported as a percentage of the bond's par value. For

example, 104.50 mean that the bond issue is trading at 104.5% of its par value. You can calculate the market value of each bond issue by multiplying the amount outstanding by (Price 100). Do so for each issue and then calculate the total of all the bond issues. This is the market value of Dillard's debt.

Section 3- Cost of Equity

The cost of equity should be based on CAPM. To estimate it you need to come up with beta.

There are two different ways to betas: Top down which is based on running a regression

of returns on Dillard's stock against returns on a market index, preferably using monthly data and 5 years of observations or bottom up which is based on comparable companies.

Step 1: Collect a group of publicly traded comparable firms, preferably in the same line of business of Dillard's.

Step 2: Estimate the average beta for the comparable firms.

Step 3: Estimate the average market value of debt-equity ratio of these comparable firms and calculate the unlevered beta for the business.

b_unlevered = b_levered / (1 + (1 - tax rate) (Debt/Equity))

Re-leverage the unlevered beta based on debt-equity ratio of Dillard's.

Calculate Dillard's cost of equity capital using the CAPM, the risk-free rate you collected in Step 1, and a market risk premium of 5%.

Compute the weights for Dillard's equity and debt based on the market value of equity and Dillard's market value of debt.

If Dillard's has a tax rate of 21%, calculate its effective cost of debt capital and the cost of capital.

4. Valuation

What is the value of this firm, based upon a discounted cash flow model?

How much of this value comes from the expected growth?

How sensitive is this value to changes in the different assumptions?

Value relative to comparable

Make a list of "comparable" companies' relative values such as P/E, P/B, Enterprise Value/Revenue and Enterprise Value/EBITDA and their corresponding industry average. Based on the relative values what is the price.

.

Compare the stock prices produced by the two methods to actual stock price. What recommendation can you make as to whether the company should buy or sell to your boss James Thomas?

Useful Websites

www.reuters.comwww.morningstar.com

www.financeyahoo.comwww.bloomberg.comwww.finra.org