Intel Group Equity Valuation

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Intel Group Equity Valuation

April 1, 2005

Paul Gilliam [email protected] Michael Fanuzzi [email protected] Yolanda Martinez [email protected] Brett Stratil [email protected] Josh Vickers [email protected]

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Intel

Valuation

Executive Summary

Nasdaq EPS Forecast

52 Week Range $19.64 - $29.01 FYE 12/25 2004A 2005E 2006E 2007E $1.17 $1.08 $1.18 $1.29 Revenue (2004) $34,209,000,000

Market Capitalization $141,040,000,000 Ratios Intel Avg of Competitors Shares Outstanding 6.4B Forward P/E 15.34 40.56

Forward PEG 1.30 5.68

Dividend Yield $0.16 M/B 3.72 2.37

3-Month Avg Daily Trading Volume 64.39M

Book Value Per Share $6.03 Actual Current Price $23.01 Return on Equity 19.48%

Return on Assets 15.61% Ratio Based Valuations

Est. 5 Year EPS Growth Rate 11.78% P/E Valuation $51.40

PEG Valuation $24.27

Cost of Capital Estimates M/B Valuation $18.60

Value Ke R-Squared Ford Epic Beta (5yrs) 2.336 7.05% 50.48%

Beta (3yrs) 2.024 7.43% 48.30% Intrinsic Valuations

Beta(2yrs) 1.990 7.75% 35.72% Discounted Dividends Valuation $8.38 Published 2.352 7.16% Discounted Cash Flows Valuation $37.04

Residual Income Valuation $16.97 Performance of Intel Abnormal Earnings Growth Valuation $17.39 Trailing 3 Months 6 Months 12 Months

Return on Intel -0.02% 10.36% -15.96% Return on S&P 500 -0.05% 6.15% 2.58%

Recommendation – Slightly Undervalued Security

We recommend Intel’s stock to be a hold security. The semiconductor industry is a highly competitive market and Intel leads the way being the largest (70% of market share) and most recognized company in this in this industry and having the broadest product line. With AMD and TXN lagging behind in the Industry we do not feel that Intel’s competition is much of a threat at all and it is promising that our recommendation will soon change for the better.

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Industry Demand Drivers

Growth in this industry relies heavily on new innovations. Intel’s biggest growth opportunity comes from their emergence into the wireless communication industry. It will be important for Intel to gain a significant market share in the cellular market now that it’s shifting to 3G, the new standard for all devices and with properpartnerships they can easily do so. Along with this emergence into the wireless industry, Intel recently introduced their Pentium Processor Extreme Edition in April of 2005. The new Pentium is like two processors in one which enables multiple programming at a faster speed. (Intel.com) With Intel’s past experience in being the first to innovate and wanting to stay ahead of the competition, we believe only great things will evolve from them.

Healthy Financials

Intel’s cash flows have been positive and we feel they will remain positive many years to come. The net profit margin for Intel in the year 2004 stands at 21.97%; far higher than the industry average of only 8.12 %. Revenues in the past have fluctuated slightly but in a consistently upward trend. The drop in revenues in 2001 and 2002 are a result of the terrorist attacks of 9/11 but quickly bounce back and grow in the years after. One of the more impressive characteristics of Intel when compared to their industry is their returns on equity and assets. In 2004 Intel had a ROE of 19.48% with an industry average of only 9.22%. ROA for the year 2004 for Intel stood at 15.61% with the industry lagging behind at 6.33%. Intel leads the industry in most all the financial performance measures. They appear to be a very stable corporation with the appropriate people in place looking out for the best interests of the business’s future success.

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Valuation

Based on the valuation models, Intel’s stock is slightly undervalued with their actual price per share at $23.01. Intel is primarily an equity financed

company. In fact, its stockholders equity section of the balance sheet is nearly 4 times the value of its liabilities. Intel’s lack of liabilities allows for it to maintain a low cost of debt which is .67%. Using a five year beta in the CAPM method, we calculated Intel’s cost of equity to be 7.05%. While we do recommend holding Intel’s stock, with the evolving technology we do expect the stock to become a buy in the near future.

Risks

The semiconductor industry is characterized by rapid advances in

technology and new product introductions and as a result, there is a lot of risk in this industry. This is an industry where quantity demanded by the consumers varies greatly at different times of the year and companies who wish to keep from losing their customers to the competition must be able to adjust output and costs to efficiently match the current market conditions.

As with any company in any industry, Intel’s future and success relies on being able to supply the demand of the modern consumer. This means consistently searching for new advances in technology and looking for or even creating new markets in which to sell their product to a new group of consumers. In the semiconductor industry, this means that tens of millions of dollars need to be set aside each year for research and development of new products.

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Business and Industry Analysis

Company Overview

Intel Corporation is one of the leading technology developers in the world. Starting with the creation of the world’s first microprocessor in 1971, Intel has developed many products that have aided the computer and internet revolution. Intel’s mission is to be the preeminent building block supplier to the Internet economy. Intel consists of three product line operations: Intel Architecture Business, Intel Communications Group and Wireless Communications Group. Their major products include: microprocessors, chipsets, boards, wired Ethernet, and wireless connectivity products. Major customers include Original Equipment Manufacturers (EOM’s) and retail and industrial distributors, who contributed to the rise in revenues for Intel, which rose 13 percent to 34.21 billion last year (2004). Net income also rose 33 percent to 7.53 billion (Intel’s 10K). The following pages take an in depth look at Intel’s competition (five forces model), KSF identification and analysis, and competitive strategy analysis to discover what keeps Intel ahead of the game.

Five Forces Model

Competitive Force 1: Rivalry among Existing Firms

Rivalry in the semiconductor industry is very high. Growth for Intel is at a rate of 12-13% as new technology is introduced to the semiconductor industry (Intel’s Annual Report). Sales continue to grow as companies in the industry expand and compete in all areas of the globe. As there is a high level of competition in the industry, a number of rival companies work together. For example, many of Intel’s key competitors are also their customers and even suppliers. They have made agreements with some businesses that license them to use each others patents. Differentiation and switching costs in the

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semiconductor industry are relatively high and low, respectively, as a number of products quickly become obsolete and are compatible with products of the competition. The main way in which they compete is through increased product performance, added features, and lower prices. Fixed costs remain high as a result of the large quantity of capital needed for research and development of new products. Intel has realized that as technology keeps advancing rapidly, the products they offer should also advance accordingly. This requires sources to large sums of capital and keeping a watchful eye on new and existing

competition. Since Intel is the world’s largest semiconductor chip maker, their ability to raise large amounts of capital surpasses that of all competition in the industry (Intel.com).

Competitive Force 2: Threat of New Entrants

Large economies of scale exist in the semiconductor industry. Smaller companies in the industry have trouble raising the capital needed for marketing there products to the public and research and development of new products. Intel has a well-earned, long standing reputation of having high quality products on the leading edge of technology. This shows a high level of brand recognition and customers who actively seek out their products. New entrants to the

semiconductor industry may have difficulty establishing distribution channels because larger companies such as Intel and their competitors control most of them. These smaller companies will have trouble acquiring raw material at a cheap price. The first mover advantage has given Intel a large consumer base as well as cost advantage and a wide range of distribution channels in which to promote their product. They have already set up networks with other companies to drive down costs even lower and make selling of their product easier. Legal barriers pose another problem. In such a big industry, it is difficult for new and smaller companies to get licenses and patents needed to effectively compete in the industry.

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Competitive Force 3: Threat of Substitute Products

There are many players in the semiconductor industry that make it a highly competitive market, however when it comes to the best, Intel is the market leader. Intel’s competitive advantage has some “cost leader” in it, but for the most part this company has a high degree of “differentiation” as their competitive advantage. Because of the high availability of substitute products, fairly low switching costs, and the fact that the products for the most part are very similar, you could say that there is a high level of rivalry and competition (as it would be in most cases) and it wouldn’t matter what product you choose. But if there was ever an exception to the rule, Intel would be it. Intel’s brand identification is like Nike, Wal-Mart, or Coca-Cola; their brand name is so big that it constrains rivalry. People want an Intel chip in their PC’s and the company knows this, thus giving them power to affect prices. It’s hard for other suppliers or products that are not well known to compete in this competitive market. However, the threat comes from smaller companies who have begun to create similar products at cheaper prices. This is the only way these less sophisticated companies can stay competitive. In response, Intel has to constantly work and stay ahead of the game by spending billions of dollars on R&D and the creation of better, smaller, faster chips to make customers upgrade their computing and electronic devices more often. Yes, there are many competitive players (like Texas Instruments, and Advanced Micro Devices), and the threat is there that their lower prices may induce buyers to switch to the substitute. Comparing Intel to its competitor is like comparing bottled water to tap water. Even though they serve similar functions, customers are still willing to pay more and not switch because of their name, reputation, and superior product quality and variety.

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Competitive Force 4: Bargaining Power of Buyers

In the past, due to Intel’s superior quality and practically one-of-a-kind products they possessed an enormous amount of power over the buyers of their product. Intel has been similar to Microsoft because they both are considered somewhat of a monopoly in their field. Intel’s microprocessors and chipsets are a necessity for companies such as Gateway and Dell and since Intel was the only manufacturer there was no room to argue for these companies. However, due to several strong rivals entering the market in recent years Intel’s dominance has somewhat decreased. They have also moved into new product lines with stiffer competition as they now market networking and communications processors, handheld and handset components and other various forms of software.

There are now several other companies that produce motherboards, microprocessors and chipsets therefore the power Intel once had is not as prevalent. Intel could still set a price above the norm and get away with it, but businesses, government and schools now will only pay a certain amount before they switch to a cheaper product from ABM or Texas Instruments two of Intel’s biggest rivals. Intel also has produced processors in the past that were only compatible for small servers and personal systems. Intel has recently decided to come out with processors that will be used in supercomputers and large servers. The switching cost for companies who decide not to do business with Intel is not real high but Intel’s reputation for superior products is why these companies stick with Intel.

Companies that resell Intel’s products such as Dell and Gateway also give Intel a tug of war when it comes to power. They both depend on each other even though it would seem Intel would have the power since they provide a product that pc’s have to have. However, since these companies are reselling Intel’s products which in turn markets for Intel and they are two of Intel’s biggest customers they hold a certain amount of power and receive a big discount on the products they buy.

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The craze of cutting cost across the board to lower prices and gain an edge on the competition has hit almost every business and industry in America. This has been especially true in the computer industry, where you can now buy pc’s way cheaper than you could ten years ago. Intel has had to meet the

demand in its business as well with the barriers to entry being enormously low in the pc market thus increasing competition amongst each other. Michael Dell started his business out of his dorm room at the University of Texas (dell.com). Computers are also practically a commodity now people used to have them at work only but now an enormous amount of people have a cpu in their home.

Even with the emergence of recent trends taking their toll on Intel’s power over its customers, Intel still wields more power in most of its relationships

because of its name recognition and superior product quality.

Competitive Force 5: Bargaining Power of Suppliers

Intel has a unique relationship with the software companies it deals with. Intel is both a supplier and a buyer with the software company. Intel knows that software is useless if they don’t provide the components that run them and software companies products are needed to boost the sales of Intel’s products. Both companies agree to make products compatible with each other so they can continue to run efficiently.

None of Intel’s other suppliers have any power over Intel. Manufacturing equipment and raw material suppliers have very little bargaining power since Intel is one of the few people that buy their product as well as other people in the semiconductor industry. Intel’s most integral supplier is probably

engineering schools which produce graduates who are the brain behind Intel’s operation. They have a pretty good relationship with these schools and they have several projects that they use to promote themselves among the schools students.

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Key Success Factor Identification and Analysis

One key success factor for Intel is their focus on research and development. They set aside millions of dollars each year for making new products and

exploring new technology. R&D also allows for them to differentiate their products from that of the competition, offering new and enhanced features that their customers want or feel they need.

Another key success factor for Intel is entering new market segments. This company is constantly looking to increase their number of customers by

introducing a new product to a new group of consumers, such as wireless communications, the 3G Standard, and the recently released Intel Pentium Processor Extreme Edition (intel.com).

Staying the low cost producer is a third key success factor for Intel. With such a large volume of consumers, Intel is able to produce more goods at a lower prices by purchasing raw material in larger quantities than that of their competition, or constructing the needed material themselves (intel.com). A final factor, and maybe the most important, is Intel’s image. Intel has a long-standing, well earned reputation of producing quality products that consumers seek out. Another benefit comes from their image: this positive reputation makes it easy for them to choose the best candidates from engineering schools throughout the country because after all, today’s graduates are tomorrow’s innovators of new technology.

Competitive Strategy Analysis

Intel is the world’s largest chip maker and leading manufacturer in computer products largely due to their product differentiation. Intel achieves and maintains its competitive advantage through intense research and

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development, spending on capital investments and focusing on e-Business to become worldwide.

In order to increase manufacturing capacity Intel spent $3.7 billion on capital investments which in turn increased efficiency and cut costs by 30

percent. In addition they spent $4.4 billion in research and development in order to overcome technical barriers and to sustain competitive advantage. Intel is an e-Corporation and therefore handles everything online, which helps in reaching people worldwide and also maximizes profitability. Combining all these factors Intel’s differentiation strategy is not only being achieved but is sustainable as well.

Overall Intel is a well managed company with a strong focus on success. They constantly explore new opportunities while keeping a sharp eye on their competition. They have made some costly mistakes (such as the failure of their Rambus Memory) but appear to learn greatly from them. They now use more caution before introducing their product to the public. Intel is the powerhouse of their industry and should stay that way well into the future.

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Accounting Analysis

Identify Key Accounting Policies

As stated already, the semiconductor industry is a very competitive market. Although many competitors such as “Texas Instruments” and

“Advanced Micro Devices” can offer similar products at competitive prices, Intel offers a great opportunity for differentiation of products at lower costs. Because of these lowered prices, the product variety, and quality, Intel hopes to maximize sales and increase revenues. Therefore, Intel has developed a list of critical accounting policies which it believes are key factors that help to determine the success of the company. They are as follows:

Intangible Assets

In an industry that competes so much in product quality and innovation, intangibles such as Research and Development (R&D), marketing, and

trademarks are more than huge for Intel. One might not realize that these are as important as other assets since they don’t show up on the balance sheet when in reality they are a big chunk of Intel’s assets. By looking at the income statement, you can see R&D and marketing are the biggest expenses. R&D rose 1 billion dollars from 2001 to 2004 equaling to $4.7 bill. and $4.6 billion in marketing (gen. & admin.). Compared to AMD at $1 billion and Texas

Instruments at $2 billion for R&D. Obviously Intel puts more money into this because they want to innovate and it pays off in their income and revenues which have been skyrocketing these past four years, unlike these competitors. Another interesting point is when you leave out intangible assets from the

balance sheet there is an inflated measure on the rates of return on capital such as ROA or ROE. This is definitely true for Intel who’s ROA of 19.48% and ROE of 15.61% is well above the industry average because of the large amount of R&D and marketing. One other point is that there is nothing in the books or numbers

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that can fairly judge or estimate Intel’s brand name or trademark and the amount of revenue it accounts for. Part of the reason Intel holds nearly 50% market share and controls the industry is partly due to they’re name and reputation.

Investments

Intel Capital, is the investment program that typically invests in non-marketable equity securities of private companies alongside high quality co-investors to help these companies grow from initial stages to successful Initial Public Offerings or acquisitions. About 40% of Intel Capital's new deals in 2004 were in early stage companies. Investments accounted for under the equity method is usually classified as “other assets” in the balance sheet. So even though “other assets” on the balance sheets have been declining in past years, it is most likely that this number will rise since there were so many early stage companies that will soon grow. Short term investments have grown every year now for the past four along with trading assets which is a sub category

investment. It is important to point out again that Intel invests a lot into R&D which allows them to come up with new technology and new innovations. This in-turn creates more capital for the company and allows them to keep investing more money elsewhere. Notice that R&D rises along with the Gains on

Investments and so does Net Income and Revenues.

Goodwill

This is one of the more difficult judgments for management to identify. Basically we are looking to see how our company is doing on an acquisition, and if we made the right choice or if we overpaid and whether there any warning signs. When looking at the Income Statement you can see that in 2002 and 2004 goodwill was not impaired and their acquisition was in excess of its carrying value. However, in 2003 there is a $617 million impairment when management went back to review. When we look back at notes from Intel’s 10k, we find that

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the flash memory products and cellular baseband chipsets were growing more slowly than projected and not accepted by the customers as Intel had hoped. This delayed their transition into next generation phone networks and lowered their growth expectations which caused this impairment on goodwill. Thus, since the carrying value exceeds the fair value, we see this $617 million impairment charge, which by the way was included in “all other” in the operating income.

Assessment of Degree of Potential Accounting Flexibility

After looking at different accounting policies we also see that there are different levels of flexibility. In the semiconductor industry the firms have a fairly equal amount of constraints; however, because the industry is so ever changing there are many differences when it comes to the choices each one makes and what all they want to disclose.

The first point of disclosure in which in which Intel has some flexibility is in their Inventory. Intel chooses to compute their inventory using FIFO which approximates actual cost on average and is a currently adjusted standard basis while stating their value at lower of cost or market (not valuing inventory in excess of saleable amounts). Possible methods to calculate inventory that firms could choose from are first-in-first-out (FIFO), last-in-last-out (LIFO), or the average cost method. Actually, most firms in this industry also calculate

adjusted standard basis. Inventories on hand in excess of forecasted demand of generally six months or less are not valued. Intel also writes-off inventories that are obsolete. Also, as stated in the annual report, “the estimates of future demand that we use in the valuation of inventory are the basis for our published revenue forecast, which is also consistent with our short term manufacturing plan. If our demand forecast for specific products is greater than actual demand and we fail to reduce manufacturing output accordingly, we could be required to

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record additional inventory reserves, which would have a negative impact on our gross margin.” 1

Another area in which firms have flexibility to choose their method of disclosure is in Property, Plant, and Equipment and how to treat depreciation. You can either use the straight line method or the accelerated method to record depreciation. According to Intel’s annual 10K from 2003, Intel stated PP&E at cost and they use the straight line method of depreciation, having an estimated useful life for machinery and equipment at 2-4 years and 4-40 years for

buildings. Intel chooses to write off fully depreciated assets against accumulated depreciation. One rival, AMD, also uses straight line depreciation and stated their PP&E at cost which is very conservative. A company like Intel or AMD might use straight line method because of the ease of calculation for a larger corporation, but a smaller firm in the industry might choose to use accelerated depreciation to get more in the asset’s earlier years of use and also maybe since there is such quick technological advancements in our industry, machines could become obsolete fairly quickly.

The Intel Corporation believes that its research and development is a key factor in enabling them to be a continued leader in the industry. Intel has spent $4.4 billion on R&D in 2003 and increasing every year and is disclosed on the Income Statement. Although the number of workers for Intel has stayed level, the number of R&D workers has increased to 23,000 in December of 2003 from 21,000 in 2002. According to Intel’s 10-k the corporation continues to work with hardware and software companies and industry groups to encourage the

development of product offerings designed to take advantage of our product features. Although a lot of our design and development is primarily done in the U.S, production development is increasing around the world.

Advertising is another important variable in the Intel Corporation. Intel reportedly spent $1.8 billion in 2003 for advertising and disclosed. According to

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the company’s 10-k cooperative advertising obligations are accrued and the cost is expensed at the same time the related revenue is recognized.

For post retirement benefits the Intel Corporation expensed $302 million for the qualifiers and non qualifiers of their profit sharing retirement plans. Amounts are contributed yearly into the funds and the distributions are ultimately determined by the CEO of the corporation. Intel’s contribution to retirement benefits are noted in the statement of retained earnings.

Evaluation of Accounting Strategy

A corporation’s accounting strategy is frequently influenced by top management; stock compensation and pressure from investors often provides management with an incentive to manipulate the reporting of financial

information in order to make a corporation appear more profitable than it really is. Upon first examination of Intel’s financial reports, one may be led to believe management is trying to hide financial information that may reflect poorly on its performance. This is because Intel presents investors with disaggregated financial statements, requiring additional research to find where Intel is getting its numbers. However, upon further review, it can be found that the accounting strategy used by Intel accurately represents the company’s financial activity and value. Rather than using the flexibility allowed by generally accepted accounting policies in the U.S. to overstate its’ financial condition, Intel uses a conservative approach to its accounting strategy. Intel’s conservative approach reflects

industry norms and can be identified through a number of its accounting policies, including estimates on impairment of goodwill, non-marketable equity securities, inventory, and long-lived assets.

After reviewing many of Intel’s leading competitors, including AMD and Texas Instruments, it can be established that Intel’s accounting strategies and practices are in-line with industry norms. All of the corporations apply the same

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policies for revenue recognition, expense recognition, and impairment of assets. Although there has been opposition to Intel’s policy of not claiming employee stock options as corporate expenses, this is an industry-wide practice. Many economists blame this accounting practice for the inflated high-tech stock prices of the late 1990s (http://www.portlandtribune.com/archview.cgi?id=19512); however, it does not indicate Intel is manipulating its financial statements to manage earnings. Management’s decision to not identify employee stock options as corporate expenses is simply a result of following industry norms.

Changes in accounting policies often indicate a corporation is attempting to manipulate its financial statements to hide losses or create false profits. However, in the case of Intel, the sole change in accounting policies as stated by Ernst and Young LLP, the firm responsible for auditing Intel and many of its competitors, came as a result of a change handed down by the Financial Accounting Standards Board. Released during fiscal year 2002, Statement of Financial Accounting Standard No. 142 allowed Intel, as well as its competitors, to altar its policies regarding accounting for goodwill and other various intangible assets. In fiscal year 2003, Intel, as well as its competitors, stopped amortizing goodwill and now test the remaining book value of goodwill for impairment annually. They also stopped amortizing goodwill recorded on their equity investments.

Management is often influenced to inflate a corporation’s earnings as a result of incentives through stock compensation. Upon evaluation of Intel’s stock distribution, it was found that insiders do not own a significant portion of Intel’s stock. In fact, insiders account for just 3% of Intel’s shares. Although Intel’s largest single shareholder is one of its Directors, he owns a very small

percentage of the shares as a whole. The majority of Intel’s stock ownership (52%) can be found in mutual funds (http://finance.yahoo.com/q/mh?s=INTC). These findings lead us to believe managers do not confront strong incentives to use accounting discretion to manage earnings.

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Evaluating the Quality of Disclosure

Intel’s financial statements over the last few years have been similar to others in there industry. While some of the numbers and accounting procedures are somewhat broad, this seems to be the industry norm. Intel really has

nothing to hide in there financial statements since they are the dominant force in their marketplace. They are the world’s largest producer of semiconductor chips and their revenue has increased substantially over the last two years along with their net income.

The letter to shareholders that is sent out along with the 10-k clearly states the condition of the industry, plans for the future and how their previous plans failed or succeeded. Intel is also quick to point out that they are the leader in the industry they serve.

Intel does a great job of explaining their numbers and accounting policies in the footnotes of the financial statements. They explain how they account for and report goodwill, intangible assets, warranties, revenue recognition,

advertising expenses, etc. Their policy is to report and accrue information as quickly as possible for example; their property plant and equipment may become obsolete due to the constant evolution of the high tech industry they belong to. Therefore, at the end of each year any equipment that is deemed useless is written off and depreciated off the books. Intel may report this more often than yearly if they deem necessary. They also explain changes in the accounting policy as they occur. For example, in 2002 they no longer amortized goodwill because it was diluting earnings per share this new policy was explained well in the footnotes.

There is plenty of discussion and explanation of the firm’ performance in the management discussion and analysis section. When the firm has performed poorly in certain areas or product lines management usually list several reason’s for this. Poor performance in their wireless communications and computing

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group segment was linked to lost business as a result of the pricing strategy on certain products.1 Intel also points out their plan to fix these problems in the future as well as comments on why they have performed well in certain areas. They do a great job of explaining their business in product and geographic segments. The company is broken down into three product segments while the architecture component usually compromises over 70% of Intel’s revenue. They also report the amount of revenue they bring in based on location of consumers. There is a chart that shows how much revenue was earned in America, Asia, Europe and Japan. Intel also devotes a section of the 10-k to its tax and legal proceedings. In this section, they explain the lawsuits: who won and lost and the amount of money that was required to settle them. They also explain there tax issues as most businesses of their size they are not always on the same page as the IRS and sometimes have to pay more tax’s than they see fit.

Overall Intel is very thorough and transparent in the way they disclose their financial information. Ever since the corporate scandals in recent years, companies are very careful to report accurate and honest information or else they may lose shareholders. They are also under a stronger restrictions and regulations. Intel has done a good job of adhering to the rules now in place.

Quantitative Measures and Indicators

In order to better analyze Intel’s performance in the last five years, we take a look at the sales manipulation diagnostics, core expense manipulation diagnostics as well as the percent changes.

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Sales Manipulation Diagnostics

2004 2003 2002 2001 2000

Net Sales/Cash from

Sales 7.57 11.24 49.29 -20.17 5.26

Net Sales/Net Accounts

Receivable 11.4 10.39 10.41 10.21 8.22

Net Sales/ Unearned

Revenue 57.8 47.6 56.3 63.5 50.0

Net Sales/Warranty

Liabilities NA NA NA NA NA

Net Sales/Inventory 13.05 11.97 11.76 11.78 15.05

Net sales decreased dramatically from 2000 to 2001 but what is

interesting is that Net Sales were very similar in 2001 and 2002 which shows us Cash from sales must have been much lower in 2002. The next two years show an increase in Net Sales and Cash from Sales. The ratios also show increase in sales over accounts receivable. The inventory ratios show the variability of our inventories through the years and how they stay somewhat consistent with Net Sales. You can also see that Intel does not have much in terms of Unearned Revenue from its ratio.

Core Expense Manipulation Diagnostics

2004 2003 2002 2001 2000 Sales/Assets 0.71 0.64 0.61 0.6 0.7 CFFO/OI 1.3 1.53 2.07 3.74 1.24 ∆CFFO/∆OI 0.62 0.76 0.16 0.50 0.43 CFFO/NOA 3.59 2.82 1.84 1.9 1.88 Total Accruals/∆Sales 1.01 1.06 13.26 (0.42) NA Pension Exp./SGA 0.08 0.08 NA NA NA Other Employment Expense/SGA NA NA NA NA NA

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Sales to assets have been increasing since 2001, which means with increasing sales we have increasing assets as well. The ratios also show an increase in the cash flow from operations but the reason the ratio has been declining is because Operating Income is increasing even faster. The change in CFFO over the change in OI has stayed somewhat consistent; however, the CFFO over NOA ratio is increasing because NOA is staying level while CFFO is rising. When looking at Total Accruals over change in Sales we find a negative 2001 ratio because Intel declined from 2000. And we also see a big jump from 2001 to 2002 because Sales stayed the same and Accruals increased. Intel has a Pension Plan set up but it doesn’t make a big mark in its ratios with SGA.

Percent Changes in Measures:

2004 2003 2002 2001

Net Sales/Cash from

Sales -48.45% -338.42% 140.91% -73.89% Net Sales/Net Accounts Receivable 9.72% -0.20% 1.96% 24.21% Net Sales/Inventory 9.04% 3.70% -3.57% -21.28% Sales/Assets 10.94% 4.92% 1.67% -14.29% CFFO/OI 129.51% 152.86% 208.33% 389.58%

Identification of Potential Red Flags:

Intel’s changes in their accounting policies have been clearly and

accurately described in their footnotes. Intel has some critics regarding their not claiming employee stock options as company expenses, but upon closer

investigation, we have discovered this to be a common practice in the industry. There has been a change in accounting policy regarding the allocation of

goodwill in 2002 under the provisions of the Statement of Financial Accounting Standards No. 142, but Intel clearly relates the results of the actions in under Goodwill in Footnote 16 of their financial statements.

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Intel is a well established company on the cutting edge of their industry. We have found no red flags and believe that Intel satisfactorily relates all

pertinent information regarding their day to day activities. If you were to just glance at the diagnostics above, some numbers might jump out at you that might be mistaken for a red flag, such as: Net Sales decreased dramatically from 2000 to 2001 but that was due in large part to 9/11. Another point that might raise a flag is why Total Accruals over change in sales is negative in 2001, jumps really high in 2002 to 13.26, and then drops back down to 1.06. The reason this is so different is because normally Intel increases their sales each year however from 2000 to 2001 they didn’t which caused a negative number. 2002 had a high ratio because its sales jump really high also. Then the change in sales from 2002 to 2003 is basically nothing, therefore causing another low number.

Undo Accounting Distortions

After analyzing the important financial information regarding Intel, we have come to the conclusion that the data in the company’s financial reports clearly and accurately reflects the financial position of the firm. We saw no indiscretions that would lead us to believe that Intel’s management was trying to misrepresent the figures in favor of the firm. Any changes in accounting were clearly backed up with good reason. Flexibility in accounting methods is

important for firms in this technological industry and Intel appears to be applying this method responsibly while backing their actions up in the footnotes. We feel that adjustments to the financial statements are unnecessary since we were unable to identify any accounting distortions.

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Ratio Analysis and Financial Forecasts

The financial statements of a company contain information that reveals the company’s position. This information can be manipulated by using various ratios to assess the company’s current financial position as well as form a prediction of their future position. This portion of the assignment is devoted to using the information in Intel’s financial statement as well as their competitors to see where Intel stands in comparison to their competitors and if their accounting procedure contains any hidden information. We will find an industry average by using the financial statements of AMD and Texas Instruments combined with Intel to see where Intel stands in comparison to the industry as a whole. We will also use these ratios from years past to try and predict their future income

statements. We feel that these ratios will bring Intel’s strengths and weaknesses to light. We performed three types of ratio analysis Liquidity, Profitability and Capital Structure.

Financial Ratio Analysis:

Liquidity Analysis

2000 2001 2002 2003 2004

Current Ratio 2.45 2.68 2.87 3.33 3.13

Quick Asset Ratio 2.19 2.34 2.52 2.96 2.80

Inventory Turnover 5.64 5.99 5.91 5.18 5.52

Days Supply of Inventory 64.72 60.93 61.76 70.46 66.12 Accounts Receivable Turnover 8.17 10.18 10.40 10.18 11.41 Days supply of Recievables 44.68 35.85 35.1 35.85 31.99

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The first four ratios we used were strictly to discover how liquid Intel is as a whole. Liquidity is the firm’s ability to repay its current liabilities at a given period in time. The first ratio used was current ratio which has been increasing every year from 2000-2003 and contained a slight decrease in 04. This is very good because the firm’s assets have been increasing while the company’s

liabilities have been decreasing when compared to each other. The firm’s quick

asset ratio was also encouraging as it was also increasing every year. The

quick asset ratio measures the firm’s ability to pay back liabilities immediately because it measures the firm’s quick assets such as cash and accounts

receivable. The positive outcome using the account’s receivable turnover showed us that Intel sells about ten accounts for every one accounts receivable so they are not reporting a bunch of sales that they haven’t received payment on. The inventory turnover for Intel has been around 5 for the last few years which mean the company has been investing about the same amount of money in inventory each year in comparison to what they sell. Overall Intel has passed the liquidity analysis test and generally has become more liquid as time goes on. To forecast future ratio’s we have taken the last five years and made an average of each and used that for our future forecast. We have also omitted any

numbers that were out of the ordinary or skewed due to special circumstances.

Profitability Analysis

2000 2001 2002 2003 2004

Gross Profit Margin 62.49% 49.18% 49.76% 56.71% 57.72% Operating Profit Margin 30.82% 8.50% 16.37% 24.99% 29.61% Net Profit Margin 31.24% 4.86% 11.65% 18.72% 21.97%

Asset Turnover 0.70 0.60 0.61 0.64 0.71

Return on Assets 21.97% 2.91% 7.05% 11.97% 15.61% Return on Equity 28.23% 3.60% 8.79% 14.91% 19.48%

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The first ratio we used to measure Intel’s profitability was the gross

profit margin which dropped over 10% in 2001 but has been on a steady

incline ever since and is almost back to where it was in 2000. This measure tells us how much money Intel is able to net for each sale they make and the amount has generally been about 55% which is good. The operating expense ratio for Intel has been one of the most erratic we have found and we believe that this is due to different amounts of money being spent on research and

development each year. The higher the percentage the less efficiently the company is running. We believe this number should be about 30% and the reason it dropped so low in 2000 is because we weren’t producing as much due to 9/11 and the economic recession that followed. So normally this ratio will be between 25 and 30 which means 30 cents of every sell goes to expenses. The

net profit margin tells us how much money the company is able to keep out of

what it earns from sales. The higher the number the better in this ratio because it means the company is efficient and not spending all of its money on cost etc. This number for Intel dropped dramatically in 2001 once again due to 9/11 but now is almost back to normal which is about 20%. Asset turnover measures a company’s productivity of its assets. This is measured by dividing sales by total assets and Intel has stayed right at about .65 which isn’t very good this means that for every dollar invested in assets Intel only generated .65 cents. This number seems low but there is a great amount of money spent on R&D in this industry so it isn’t as bad as it sounds. The return on assets for Intel has steadily increased since 2001 and should hold steady around 12%. Intel has an average of 15% for return on equity and should grow closer to 20% the reason it is only 15% is once again due to decreased profit in 2001. The fact that this number is growing is good because it means the company is not reinvesting everything they earn back into the company and the shareholders stand to gain money on their investment.

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Capital Structure Analysis

2000 2001 2002 2003 2004

Total Liabilities/Total Equity 0.28 0.24 0.25 0.25 0.25 Times Interest Earned 15.34 5.55 21.67 38.76 36.04 Debt Service Margin 5.37 4.97 5.92 6.94 6.75

The Capital Structure of Intel is very good and has been for the last five years. For every dollar of liability there are four dollars of owners equity which means the company is profitable and has very little debt. The debt equity

ratio has been consistent at this rate with an average of .25 over the last 5

years. The times interest earned ratio shows that Intel is earning more and more each year as the average now is 23% which is well above the industry average. The debt service margin also proves Intel is credit worthy because the average ratio for the last five years is 6 and it has grown every year since 2000. This means the company has plenty of cash on hand to pay any current liabilities that may arise. Having a sound capital structure is crucial because it shows your company is not in debt and there is no potential for bankruptcy.

Sustainable Growth Rate

The sustainable growth rate is the percentage growth in sales the

company is able to attain year in and year out. Considering the expansion into the international market as well as the expansion into new product lines we feel that Intel will continue to grow each and every year. Sales drastically decreased from 2000 to 2001 but since they have grown significantly. We forecast sales to continue growing at 15% for the next three years; we attained this from an analyst at www.yahoo.finance.com. We also feel that 15% is a little too high of a growth rate year in and year out so we forecast Intel to grow at a decreasing rate beginning with 12% in 2008 and 10% in 2011. We develop this theory of

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growth at a decreasing rate by recognizing the increase in competition Intel will face.

Sustainable Growth Rate

-40.00% -20.00% 0.00% 20.00% 40.00% 60.00% 80.00% 2000 2001 2002 2003 2004 Year Va lu

e Advanced Micro Devices

Texas Instruments Intel

Industry Average

Cross Sectional Analysis: Liquidity Ratios

Intel has been the dominant leader in the semiconductor industry for a good amount of years now and seeing that they are such an older and larger company they really don’t have any major competitors. However, I would say that AMD and Texas Instruments are their two biggest rivals. A complete cross analysis of the following ratios can be found in appendix A.

Over the past five years, Intel has better numbers when it comes to comparing liquidity ratios with the other two companies. Intel’s current ratio has gradually increased every year averaging about 3 which is better than AMD at 1.84 but less than TXN which is averaging almost 4. But when comparing the quick asset ratio, Intel was better by at least 1 each year than the other two (except TXN in 2004) and increased this ratio each year just like the current ratio. Inventory Turnover had little fluctuation with all three companies but over the past years has been pretty equal. However, Intel dominated the whole industry in Accounts Receivable Turnover, increasing every year again and averaging about 10, whereas the others were below 7. For the most part you can see that Intel’s ratios outperformed the competition which is consistent with the fact that they are larger and have a reputation of performing well

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Current Ratio 0.00 1.00 2.00 3.00 4.00 5.00 6.00 2000 2001 2002 2003 2004 Year Valu e

Advanced Micro Devices Texas Instruments Intel Industry Average Qu i c k A sse t R a t i o 0.00 1.00 2.00 3.00 4.00 5.00 2000 2001 2002 2003 2004 Y e a r

Advanced Mi cr o Devi ces Texas Instr uments Intel

Industr y Aver age

I n v e n t o r y T u r n o v e r 0.00 2.00 4.00 6.00 8.00 10.00 2000 2001 2002 2003 2004 Y e a r

Advanced Mi cr o Devi ces Texas Instr uments Intel

Industr y Aver age

Accounts Receivable Turnover

0.00 2.00 4.00 6.00 8.00 10.00 12.00 2000 2001 2002 2003 2004 Year Val u e

Advanced Micro Devices Texas Instruments Intel Industry Average

Working Capital Turnover

0.00 1.00 2.00 3.00 4.00 2000 2001 2002 2003 2004 Year Valu e

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Profitability Ratios

Once again, in the profitability analysis section of ratios, Intel was better with higher gross profit margin, net profit margin, return on assets, and return on equity. Intel is averaging about 8 ticks over the industry. This shows their incomes and profits are doing really well respectfully. All three were around the industry average of .72 in asset turnover.

Gross Profit Margin

0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 70.00% 2000 2001 2002 2003 2004 Year Va lu e

Operating Profit Margin

0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% 2000 2001 2002 2003 2004 Year Valu e

Net Profit Margin

-60.00% -40.00% -20.00% 0.00% 20.00% 40.00% 2000 2001 2002 2003 2004 Year Va lu e

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Asset Turnover 0.00 0.20 0.40 0.60 0.80 1.00 2000 2001 2002 2003 2004 Year Valu e

Advanced Micro Devices Texas Instruments Intel Industry Average Return on Assets -30.00% -20.00% - 10.00% 0.00% 10.00% 20.00% 30.00% 2000 2001 2002 2003 2004 Ye a r

Advanced Micro Devices Texas Inst rument s Int el Indust ry Aver age

Return on Equity -60.00% -40.00% -20.00% 0.00% 20.00% 40.00% 60.00% 2000 2001 2002 2003 2004 Year Va lu e

Capital Structure Ratios

Ratios in the capital structure analysis show that Intel has much larger return on equity and smaller debt to equity when compared to its rivals. In many cases larger companies such as Intel are more likely to issue debt than the smaller ones that have fewer employees and low profits but not necessarily in this case. Yes Intel has a decent amount of debt, but Intel’s higher return on equity is reflected more by its high net income. You know this because AMD and TXN have larger debt to equity ratios than Intel every year due to the fact they have more total liabilities. In Times Interest Earned, AMD is definitely the worst of the three averaging below 0. Both TXN and Intel are above the industry

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average, but Intel is high because of high operating income and TXN is high because of low interest expense. Also, Intel has a higher debt service margin; the other two are very low.

Total Liabilities/Total Equity

0.00 0.50 1.00 1.50 2.00 2000 2001 2002 2003 2004 Year Va lu e

Times Interest Earned

-40.00 -20.00 0.00 20.00 40.00 60.00 80.00 100.00 120.00 2000 2001 2002 2003 2004 Year Va lu e

Debt Service Margin

-2.00 0.00 2.00 4.00 6.00 8.00 2000 2001 2002 2003 2004 Year Va lu e

You can infer from this analysis that Intel is at the top of the industry and ahead of their biggest two rivals. Yes Intel is larger and the industry is young, but TXN and AMD are both good companies that are constantly learning and improving which at least gives Intel a good cross sectional analysis to look at.

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Financial Statement Forecasting Methodology Income Statement

In determining Intel’s 10 year forecast, we first look at the income

statement, which can be found along with forecasts in appendix B, to determine how much sales will grow and we decided to use the 5 year moving average model. Taking a look at our past sales growth, we decided to throw out 2001 and 2002’s percentages because of unusual circumstances including 9/11. We then looked at the remaining percentages and decided to increase the sales growth because we felt that the increase in technology would play a major part in our sales growth. Looking at the Yahoo! Finance the analysts predict that the growth rate would be 15% which is slightly lower than the industry prediction which was 15.11% (Yahoo Finance). Although the analysts predicted this

number for the next five years, we decided to use it for only the next three years because increasing 15% five years in a row is a bit unrealistic. We chose to increase the percentage to 15% sales growth for the next three years then drop it to 12% the following three years and finally have the percentage drop to 10% the remaining years. Because sales growth tends to be mean-reverting, we expect Intel’s growth to return to a normal level over time.

The weakness in using this model is that the average is only based on two years and is not an accurate measure of prior year sales growth. The strength comes from the fact of knowing that technology is evolving and sales will without a doubt increase for the next couple of years.

The next item we forecasted was gross margin. We found that the average percentage of sales from the last five years was 55.17%, which means out of 100% of sales we were able to keep 55% of it as profit. In the forecasts for the next 10 years we predicted that this percentage would stay constant and therefore our gross margin would increase every year due to growth in sales. In forecasting we took net revenues and multiplied the forecast assumption which

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was 55% to get our final number. In looking at the predictions we see that the jump in gross margin is a very realistic forecast.

The two most important forecasts on the income statement for Intel are Research & Development and Marketing. The average increase in the last five years is 13.87%; therefore we will predict that R&D will increase every year by at least 14%. Marketing is also another important expense and the average percentage for the last five years was 15%. Because new products are

constantly being developed, we feel Intel will increase their marketing yearly, but at the same time at a constant rate. We used our 15% average as a constant forecast for the next 10 years.

There were a few things on the income statement that we were not predictable. Impairment of goodwill, Amortization of goodwill, and amortization and impairment of acquisition-related intangibles and cost were some of the items that were non-forecastable. Because Intel had no percentages for goodwill we were unable to forecast for the next 10 years. Also because we are unable to determine whether or not we will acquire another company in the future, the acquisition-related intangibles and costs are impossible to forecast.

Balance Sheet

We constructed our forecasts for our Balance Sheet using the same

methods as that of our Income Statement. Our forecasts, which can be found in appendix B, extend out ten years and both the weighted growth rate and the moving average methods were used in computing the figures.

Intel’s asset forecasts were calculated using a combination of the weighted growth rate and the moving average. Under Current Assets, items such as trading assets and inventories did not appear to follow any particular trends so we resorted to the moving average method in making these forecasts. We also saw that marketable securities, intangibles, and other assets under the Non-current Assets section of the Balance Sheet seemed to have random

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fluctuations that called for use of the moving average method. All remaining asset forecasts, such as Property, Plant and Equipment, were calculated using the weighted growth rate. Here we figured PP&E will remain at about 36% of the total non-current assets with a projected growth next year of 13% and slowly falling to about 9% by 2014.

A variety of forecasting methods was also used calculating liabilities up to 2014. Short-term debt, accrued compensation and benefits, deferred income on shipments, accrued advertising, income taxes payable, and long-term debt all changed sporadically in the past and we feel this trend will continue as Intel pursues future business ventures. Here we felt that using a moving average was the appropriate method to use. Short-term debt is expected to fall while other liabilities such as accrued advertising and other accrued liabilities should rise. Income taxes payable were calculated at a constant 12% of Intel’s total current liabilities. The remaining liability forecasts were calculated under the weighted growth rate.

We figured the Shareholder’s Equity section of the Balance Sheet, Intel’s growth rate for 2005 is projected to be about 13.80% but fall to about 9.09% by 2014.

Our group feels that the weighted growth rate and moving average were the most appropriate models to use in making our forecasts for Intel’s Balance Sheet. Forecasting is a tricky job if not done carefully and it becomes very difficult to predict accurate forecasts beyond a couple of years in the future.

Statement of Cash Flows

After making forecasts for the balance sheet and the income statement, we then take our estimated information and predict future cash flows. These forecasts can be found in appendix B. The cash flow to capital is calculated by taking net operating profits after tax (NOPAT) minus increases in net working

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capital and net long-term assets; the cash flow to equity is cash flow to capital minus net interest after tax plus increase in net debt (Business Analysis and Valuation). In forecasting the last year we assume that there will be a growth in sales (as there has been), and ratios remain the same in 2015 in order to

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Valuation Analysis

In this section of our project we will be valuing Intel through a series of ratios which will compare Intel to its competitors. We will also use several other methods which involve forecasting and manipulation of numbers past and

present to try and put a value on the firm. The first method we will use is the method of comparables in which we will use 6 ratios based on industry averages to compare Intel with the rest of the industry. Then we will move to the intrinsic methods of valuing such as discounted dividends, discounted free cash flows, discounted residual income, abnormal earnings growth, and long run average residual income. Each of these methods will derive a price per share of the company and we can use these in comparison to the market value of the firm to decide whether the firm is over, under or fairly valued. It is important we

perform this valuation so we can make decisions for the future based on these assessments and know what our strengths and weaknesses are as a company. These calculations will also help investors make a more educated decision. The Discounted Dividends Model is the value of the firm’s equity expressed as the present value of forecasted dividends. To reach this prediction we must use dividends paid, market value, growth and ke (cost of equity).

Discounted Free Cash Flows are a by product of the discount dividend model

but the assumption is that the dividends can be switched to free cash flows back to the firm.

Discounted Residual Income is computed with the following equation:

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Abnormal Earnings Growth the book value of the firm’s equity is added to the

discounted forecast of abnormal earnings.

Long Run Average Residual Income is calculated by using a long run

average of ROE, K and SGR.

Kd Calculation

Intel is primarily an equity financed company. In fact, its stockholders equity section of the balance sheet is nearly 4 times the value of its liabilities. Intel’s lack of liabilities allows for it to maintain a low cost of debt. The following chart shows how we calculated Intel’s cost of debt at .67%.

Intel Corp 10-K 2004-12-25: Balance Sheet

2004/12/25 Percent of Total Liabilities Computed Interest Rate Value Weighted Rate Current liabilities: Short-term debt $178,000,000 1.86% 0.00% 0.00%

Long-term debt reclassified to short-term debt $33,000,000 2.12% 7.11% 0.15%

Accounts payable $1,943,000,000 20.32% 0.00% 0.00%

Accrued compensation and benefits $1,858,000,000 19.43% 0.00% 0.00% Deferred income on shipments to distributors $592,000,000 6.19% 0.00% 0.00%

Accrued advertising $894,000,000 9.35% 0.00% 0.00%

Other accrued liabilities $1,355,000,000 14.17% 0.00% 0.00% Income taxes payable $1,163,000,000 12.16% 0.00% 0.00%

Total current liabilities $8,006,000,000 83.71% 0.00%

Long-term debt $703,000,000 7.35% 7.11% 0.52%

Deferred tax liabilities $855,000,000 8.94% 0.00% 0.00%

Product Warranties $0 0.00% 0.00% 0.00%

Commitments and contingencies $0 0.00% 0.00% 0.00%

Total non-current liabilities $1,558,000,000 16.29% 0.00%

Total Liabilities $9,564,000,000 100.00% 14.22% 0.67%

Weighted Average cost of Debt 0.67%

Ke Calculation

To calculate Intel’s cost of equity, we used the CAPM method. A detailed view of the CAPM calculations can be found in appendix C. According to our calculated R-Squares, our five year beta calculation was our best option. Using this beta, our cost of equity calculation was as follows:

Average Risk Free Rate Estimated Beta Hisorical Market Price Premium Average Risk Free Rate Ke

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Method of Comparables

This section will give us values based on the industry average of Intel’s strongest competitors. We will compare Intel to its two chief competitors Texas Instruments and Amd.

In this portion of our valuation we have valued Intel’s stock price based on the industry average of numbers in the year 2004. We did this by using several price multiples beginning with the price/earnings ratio. According to our calculations there is much room to grow as our assumed price per share

according to the P/E ratio reaches $51.40. This number may be a bit skewed though as AMD has a rather high P/E ratio in comparison to the industry.

Price to Earnings Ratio

Company PPS EPS P/E Ratio Texas Instruments 24.96 1.08 23.11

Amd 16.19 0.25 64.76

Intel 23.01 1.17 19.67 Industry Average P/E Intel's Expected Share Price

43.94 $51.40

The expected share price found was $51.40. Intel's actual share price is $23.01, therefore Intel is undervalued according to this model.

The M/B ratio is much more symmetrical across the industry as all three competitors lie within 1.1 of each other and according to this ratio Intel has the most room to grow because they have the highest P/B multiple. This calculation also implies Intel is overvalued slightly as the price per share is only $18.60.

Market to Book Ratio

Company PPS BPS M/B Ratio Texas Instruments 24.96 7.52 3.32

Amd 16.19 6.22 2.60

Intel 23.01 6.28 3.66 Industry Average M/B Intel's Expected Share Price

2.96 $18.60

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The Dividend/Price ratio isn’t very accurate due to AMD not paying out dividends and TXI paying out less than Intel. The industry average is based on TXI alone and that causes this number to be distorted at a price per share of $44.37.

Dividend to Price Ratio

Company DPS PPS D/P Ratio Texas Instruments $0.09 $24.96 0.004

Amd N/A $16.19 N/A

Intel $0.16 $23.01 0.007 Industry Average D/P Intel's Expected Share Price

0.004 $44.37

The Price/Sales ratio indicates that Intel is way overvalued as it depicts the PPS to be only $12.33. This price is small because Intel has a significantly higher amount of shares outstanding than its competitors, which drives down the SPS number while increasing the Price/Sales ratio. Intel pays out significantly more than its competition.

Price to Sales Ratio

Company PPS SPS P/S Ratio

Texas Instruments $24.96 7.24 3.45

Amd $16.19 13.93 1.16

Intel $23.01 5.35 4.30

Industry Average P/S Intel's Expected Share Price

2.30 $12.33

The expected share price found was $12.33. Intel's actual share price is $23.01, therefore Intel is overvalued according to this model.

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In our Price Earnings Growth model we used a forward P/E ratio and divided that by our forecasted earnings per share growth to get the PEG ratio of each company. Once again we found out the industry average PEG then

multiplied that by our forecasted earnings per share growth to get an expected share price of $24.33. The share price this model gave us was the closest we have found to our actual market price, we feel that this was the most accurate multiple of the six methods we used.

Price Earnings Growth Ratio

Company P/E EPS Growth PEG Ratio Texas Instruments 21.24 14.45 1.47

Amd 59.87 18.27 3.28

Intel 15.34 11.78 1.30 Industry Average PEG Intel's Expected Share Price

2.37 $24.27

Discounted Dividend Model

When looking at the discounted dividend model (appendix D), our first step was to find the dividends per share. In looking at Yahoo! Finance we find that dividends are .32 per share. So for the first two years our dividends per share are .32, they grow every two years to .40, then to .48, to 56, to 64 and finally to.72 which we believe will be our terminal dividend per share. According to this model of valuation, Intel is currently overvalued at a value of $8.53. Although this is the not the only model presenting this conclusion, it is the lowest value compared to all the models which we feel is due mainly in part to Intel’s low dividend yield. In the sensitivity analysis we forecast what will happen if

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growth occurs and also if cost of equity increases. Looking at the sensitivity analysis we find that the blue shading is what our actual estimated value per share is and the yellow area is where we don’t want to be, which is below the actual value. If growth was to increase to 3% and/or the cost of equity was to also increase, our estimated values would all be below the actual values and would be undesirable. Sensitivity Analysis Ke 5.50% 7.05% 8.50% 10.00% Growth 0% $11.15 $8.38 $6.73 $5.54 3% $20.35 $12.21 $8.77 $6.73 5% N/A $20.98 $12.08 $8.32

Discounted Free Cash Flows

Under the Free Cash Flows model (appendix D), we expect to see Intel’s equity to more than double. We predict free cash flows into the firm to steadily increase and see this trend continuing into the future. Terminal value was calculated using our estimated free cash flows through 2014 and then dividing that number by the WACC of 5.74%. Taking the book value of equity of

$237,038 and dividing that figure by the number of shares outstanding for Intel we arrived at an expected value of $37.04 per share. Upon looking at the sensitivity analysis, it is not until the WACC reaches 9% with zero growth that Intel’s estimated stock price falls below its current price level.

Sensitivity Analysis WACC 4.50% 5.74% 8.00% 9.50% Growth 0% $48.92 $37.04 $25.05 $20.34 3% $124.80 $66.33 $34.57 $25.79 5% N/A $217.78 $51.49 $33.45

Intel Group Equity Valuation