Financial Analysis: Home Depot

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Company Report:

Home Depot Inc.

I. Investment Policy

A) Qualitative Analysis:

The Home Depot currently has 2,193 retail stores in all 50 states, the District of Columbia, Puerto Rico, U.S. Virgin Islands, 10 Canadian provinces and Mexico. The Home Depot Inc also owns and operates Expo Design Center stores, THD Design Center stores and Yardbird stores (

The Home Depot made a very important acquisition in 2006 when they signed a definitive agreement to acquire The Home Way, China’s first home improvement retailer. The terms of the deal were not disclosed, but it was estimated that buying control of the retailer would cost $100 million. (IHT Online) The Home Way provides Home Depot with an immediate retail presence in China with 12 stores in six cities, including Beijing. The Chinese home improvement market was valued at nearly $50 billion and had been growing at a compounded annual rate of 20% when the deal was made. Approximately 70%of home improvement spending in China is for the completion of interior space in new homes.  This is a solid growth opportunity given Home Depot's strength in merchandise and services geared to finishing out a home. Big-box stores make up only about 4% of the home-improvement business in China. The rest consists of smaller independent vendors who specialize.

Expansion in China is an important area of growth and helps establish a foothold in the global market for Home Depot. (Home Depot Online) Home Depot has proven in the past that they can flourish outside the United States and the opportunity in China is something that the world’s largest home improvement specialty retailer should be able to capitalize on.  Ultimately, we believe that this project is value enhancing because China represents a $1 trillion market opportunity and expanded 10.2% in 2005 creating higher wages and increased purchasing power for consumers. (IHT Online)

In recent years, Home Depot has seen its customer service levels fall and with them the price of the average transaction. However, in 2008 same store sales should be positively affected because of their recent investment in customer service.  This investment included the hiring of more than 2,500 licensed Master Trade Specialists in the plumbing and electrical departments. (Yahoo Finance Online) We believe that this investment project will be value enhancing because these specialists will provide both increased service to customers and training for associates which will increase sales.

B) Quantitative Analysis:

        We determined that Home Depot’s investment in The Home Way was the most significant recent investment.  However, there was not sufficient information to provide a valuation of the specific investment plan because the terms of the deal were not enclosed in the acquisition.  Therefore, our group decided to provide a valuation of the entire firm of Home Depot.

WACC Model:

        In order to determine the WACC we first needed to decide on the appropriate Beta to use.  These three websites provided an estimate of Beta as:

We determined that the Beta estimate from Value Line seems to be the most applicable of the three estimates listed above. Because the Home Depot is such a large company and its business is tied so closely to the housing sector, which is a leading economic indicator, its Beta would follow the market over the long term. In other words, the Home Depot closely follows the economy as a whole. The beta given by Yahoo, which is obviously an outlier, is probably the result of a short term beta measurement. Large swings in the S&P in recent months, coupled with the low volatility of The Home Depot are probably to blame. The beta estimate of one reflects the moderate systematic risk of The Home Depot and the fact that it has a great deal of exposure to the domestic economy, because the majority of its revenues come from the U.S. This beta is similar to those seen throughout the home improvement industry, of which The Home Depot is the dominant force.

        The rest of the numbers required for the calculation did not require a decision between different statistics or estimates for the same category. We calculated the Weighted Average Cost of Capital for The Home Depot to be 8.294 %( refer to Exhibit 1).

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Discounted Cash Flow Model:

        We used the historical information in The Home Depot’s income statements and balance sheets for the time period from 2005-2007 to formulate our DCF Model (refer to Exhibit 3). With this data we were able to make projections seven years out to 2015. The calculation for sales growth was extremely tough, as we felt that we could not use one constant rate for the seven year forecast. This is due to the current downturn in the macroeconomic environment and the effect that it has had on Home Depot. Current expectations of sales growth for Home Depot’s ...

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