Valuation Project

1

• Valuation Project
• BAFI 403
• 12/08/2007
• Johannes Albrecht
• Ryan Arlia
• Jim Reese
• Siddharth Sharma
• Peter Zale

2
Executive Summary

• Goodyear Tire and Rubber Company has gone through
  great change in the last ten years, barely
  skirting bankruptcy as it dealt with recession,
  labor difficulties and changing demand in the
  tire market. Avoiding default by mere days, it
  has rebounded to become a buy in most analysts
  portfolios.
• Goodyear began its transformation by realizing
  the growth market for tires was moving away from
  the commodity-based low margin tires it had
  featured to higher margin differentiated tires
  for targeted markets. The strategy requires
  Goodyear be less leveraged and more equity
  financed as the risk of selling differentiated
  tires is greater than that of cheaper commodity
  tires. Goodyears excessive level of debt could
  not allow for any more risk.
• Goodyear is changing from being a highly
  leveraged high dividend producing company to
  being a no to low dividend growth company,
  featuring differentiated tires given value by
  Goodyears superior RD capability and its
  worldwide brand equity.
• Based on our assessment of Goodyears current
  financial and market structure, have set a price
  target of 40 for Goodyears common stock.

3
Summary Slide

• Company Background
• Executive Summary
• Industry Information
• Goodyear Positioning
• Goodyear Strategy
• Competitive Analysis
• Financial Analysis
• Cash Flow Analysis
• Valuation Analysis
• 3 Economic Scenarios and Assumptions
• Best Estimates
• Appendix

4
Company Background

• The Goodyear Tire and Rubber Company was founded
  in 1898 by F. A. Seiberling in Akron, OH.
  Goodyear specializes in the design, manufacture
  and distribution of tires for automotive and
  industrial applications. They operate 60 plants
  in 26 countries for distribution to 185 countries
  around the globe. Revenues are generated through
  five operating units based on geographic regions
  North America, Latin America, European Union,
  Asia Pacific, and Eastern Europe (which includes
  the Middle East and Africa).
• Goodyear had 2006 revenues of 20.3 billion on
  the sale of 215 million tire units.
• In 2007, Goodyear sold off its Engineered
  Products division, which accounted for
  approximately 1.5 billion in sales for 2006

5
Industry Information

• The tire industry sells through two basic
  channels
• Original Equipment auto manufacturers (OE)
• Replacement
• The original equipment market has traditionally
  been an outlet where manufacturers could sell
  many units of guaranteed business while
  minimizing SKUs. In addition, the fitments on
  popular vehicles would result in replacement sets
  of the same brand when the originals wore out.
• Today, with the popularity of leases and higher
  vehicle turnover, this logic no longer holds
  true. The OE business is still a good source of
  high volume but most fitments are either provided
  at a financial loss or a very small margin.
• The replacement market has become a much more
  profitable segment for tire makers. The
  popularity of large diameter aftermarket wheels
  has created a sweet spot in the industry for
  manufacturers who can produce large bead diameter
  tires margins on these units can be well over
  100 per tire.

6
Goodyear Positioning

• In 2003 Goodyear was on the brink of bankruptcy.
  They were overloaded with debt and suffering from
  years of mis-management. In 1998 Goodyear had
  net income of nearly 700 million, by 2002, they
  were loosing nearly 1 billion per year.
• Goodyear had sought a growth strategy that
  involved acquiring businesses to grow market
  share. Many smaller tire companies were
  purchased around the globe. This strategy
  culminated in the purchase of 75 of Dunlop Tires
  from SRI in 1999 for 125 billion. All of this
  consolidation activity put Goodyear deep in debt.
  The weak economy that followed combined with
  Goodyears failure to capitalize on the newly
  acquired brands lead to a string of financial
  losses for the years 2001-2003.
• Goodyear is now in the 4th year of their
  turnaround plan. Much attention has been put on
  improvement in leadership, products, quality,
  cost and finances. Steady improvement has been
  achieved and the Goodyear management team
  believes that they have turned the corner and are
  gaining momentum towards profitability.

7
Goodyear Strategy

• Goodyear has stated the following strategies to
  achieve their long and short term goals
• Improved Product Mix
• De-leveraging of the firm
• Cost Saving

8
Goodyear Strategy

• Improved Product Mix
• Revitalize brand image and position brands for
  greater market differentiation
• Goodyear, Dunlop, and Kelly brands
• Focus development on premium branded products
• Recent activity includes launches of highly
  successful ICON products including Assurance,
  Wrangler, Fortera, and Eagle products
• Reduce unit volume on value-line tires that have
  low profitability
• Exited 8 million units of private brand tires in
  2006
• Invest in capacity for larger rim diameter tires

Source Goodyear 3Q2007 Earnings Presentation,
Goodyear.com
9
Goodyear Strategy

• Cost Saving
• Continuous improvement/USWA union contract
• Footprint reduction
• Asia sourcing
• SAG reduction
• VEBA Insurance Deal

Gross Anticipated Savings 1.8 - 2.0 Billion
Over 4 Years
Source Goodyear 3Q2007 Earnings Presentation,
Goodyear.com
10
Goodyear Strategy

• De-leveraging/Improved Balance Sheet
• Reduce long term debt
• 2006 sold Farm Business Unit
• 2007 sold Engineered Products Unit (1.4 billion)
• 2007 equity offering (833 million)

Reduced LT debt from 7.2B in Dec 06 to 5.0B
in Sept. 07
Source Goodyear 3Q2007 Earnings Presentation,
Goodyear.com
11
Competitive and Financial Analyses
12
Competitive Analysis

• Business Analysis
• In the first part of this section, current
  industry conditions as well as historical
  developments in the industry are described in
  order to establish a qualitative framework for
  the subsequent financial analysis.
• Industry Analysis
• The following Porter analysis provides insights
  into each major tire industry players profit
  potential within the industry, given each firms
  intentions to compete and their specific aims to
  exploit synergies across the range of businesses
  in which they operate.

13
Competitive Analysis

• 5 forces Analysis
• The above table shows that each of the major tire
  companies faces pretty much the same competitive
  landscape and industry pressures.
• Also the table shows that, from a Porter
  perspective, the tire industry is relatively
  unattractive with three areas scoring High.
• Raw material suppliers can exercise high pressure
  on the prices for their input materials in tire
  manufacturing due to strong competition in a
  rather commoditized market.
• Buyers can exercise high power which keeps prices
  low.
• Threat of substitutes is low which is favorable
  for the existing players.
• Threat of new entry is low since new entrants are
  rather not attracted due to the commodity nature
  of the environment. Also initial costs of entry
  (creating a manufacturing capability) are high.
• However, new competition is seen in growing
  markets such as China, which already has impacted
  the threat of the new entrants-pressure
  structure.
• That said, each of the major players
  differentiates itself from its competitors in
  unique ways relating to diversification
  (Continental), footprint (Bridgestone), premium
  brand (Michelin) and overall reputation and
  reputation for new product development (Goodyear).

14
Competitive Analysis

• SWOT Analysis
• Competitor Analysis Goodyear (USA), Michelin
  (FR), Bridgestone (JP), Continental Tire (GE).
• In the SWOT analysis we begin to see some of the
  differentiation occurring between the major
  players in the tire industry. We also see the
  similar threats faced more or less by all of
  them.

15
Competitive Analysis

• Market, Segment and Products
• Over the last ten years, Goodyear, Bridgestone,
  Michelin and Continental have all faced
  challenges presented by rising raw material costs
  and a global excess in manufacturing capacity.
• Petroleum, steel, and natural rubber are the
  primary materials used in tires and prices rose
  greatly over the last few years.
• Stagnating markets in North America and the
  European Union, along with the expansion of
  manufacturing capacities in Asia means that more
  tires can be made than can be sold.

16
Competitive Analysis

• Market, Segment and Products (Cont.)
• To counteract these conditions, each company has
  adopted a different strategy and focused on
  different segments.
• Until 2003 Goodyear focused its strategy on high
  volume, low value tires while it grew its top
  line.
• Michelin focused on high end-premium tires and
  followed a strict branding hierarchy.
• Continental is a much more diversified company
  (a good of its business being in automobile
  electronics) and deals in both high and low end
  tires.
• Bridgestone focused on a rounded product
  portfolio and leveraged its vertical integration
  mainly its large stake in rubber raw material
  production.

17
Competitive Analysis

• Market, Segment and Products (Cont.)
• Currently, Goodyear is well positioned for future
  success.
• The brand is strong and well positioned in the
  market.
• Its perceived as a quality brand with a good
  pipeline of new products.
• It is widely recognizable around the world and is
  consistently voted as one of the top and most
  admired companies.
• Recent product introductions followed by industry
  accolades are helping Goodyear move towards a
  higher margin product mix and are driving top
  line growth.
• This growth, coupled with aggressive cost cutting
  measures and landmark labor agreements have set
  the stage for financial success moving forward.

18
Competitor Analysis Michelin
18
BAFI 403 Goodyear Tire Rubber Company Valuation
19
Competitor Analysis Bridgestone
19
BAFI 403 Goodyear Tire Rubber Company Valuation
20
Financial Analysis

• This section assesses Goodyears current and past
  performance as well as its expected future
  financial prospects.
• First, the product market performance is
  considered using ratio-analysis.
• Second, cash-flow analysis is used to determine
  the firms liquidity and financial flexibility
  and discusses business risk.

21
Financial Analysis

• Goodyear 10 year historical strategy
  performance
• The years from 1997 to 2007 can be divided off
  into two sections to tell an effective story
  about Goodyear.
• 2001-2002 should be considered the turning point
  for the company.
• At this point, the previous strategic direction
  the firm had adopted nearly put them into
  bankruptcy.
• This was avoided by days and now the firm is on
  what should be considered a sounder footing and
  direction.

22
Financial Analysis

• Goodyear 10 year historical strategy
  performance
• The new President and CEO Robert J. Keegan took
  over the office at Goodyear in 2002 and announced
  the future begins now with a solid turnaround
  strategy of restoring profitability and growth
  for the troubled company.
• The period from 1997-2002 was dominated by a more
  commodity based sales strategy, as Goodyear
  strove to grow its market share selling OE and
  private branded value tires to please its
  shareholders with average dividend payouts of 30
  of cash flow provided by operating activities.
• The companys stock grew impressively during this
  time reaching a height of 75 per share.
• Likewise during this time Goodyear leveraged
  itself quite aggressively. In fact, we noticed
  that there was very possibly a strategy being
  employed by the shareholders to, in effect,
  milk the company as its increased leverage led
  to an escalating stock price and returns for
  shareholders.

23
Financial Analysis

• Goodyear 10 year historical strategy
  performance (Cont.)
• In 2000, when the stock market fell, the company
  began a slide towards financial distress.
• In 2002, enforced by a non-cash charge of 1.2
  billion in tax provisions, the firm reported a
  net loss of 1.22 billion.
• The troubles culminated in the firm facing
  bankruptcy in early 2003 when it issued 1.3
  billion long-term debt securities.
• The company however was supported by its
  continued strong RD capability, focus on
  innovation, leadership, and brand building which
  allowed it to launch several successful new
  products just at the right time to help it skirt
  the most severe financial troubles and buoy it
  for restructuring which continues to the present.

24
Financial Analysis

• Goodyear 10 year historical strategy
  performance (Cont.)
• The focus in 2004 and 2005 was on higher margin
  products and increased market and customer focus
  which successfully drove sales.
• In 2006, Goodyear announced that it would exit
  about half of its private branded value-line
  business, reducing it by approximately 8 MM
  units. Also, it has begun outsourcing some of the
  remaining value-line production to Chinese
  suppliers.
• This strategy allowed Goodyear to close down high
  cost plants in North America and lower the costs
  associated with producing low margin products.
• The strategy involves some risk however as the
  manufacturers sourcing the product are outfitted
  to produce higher value added products (the
  various sized tires spoken of earlier).
• These suppliers could be tempted to leave the
  partnership with Goodyear if another suitor,
  more closely aligned with their best
  capabilities, approached them for tire supply.

25
Financial Analysis

• Goodyear 10 year historical strategy
  performance (Cont.)
• In addition to product mix, Goodyear also is
  expanding capacity in Asia and Eastern Europe to
  serve those growing markets.
• Investment in its own facilities in countries
  like China presents a risk in that the Chinese
  government cannot be completely trusted to not
  nationalize foreign industry.
• Similar threats have been carried out in
  Venezuela.
• We dont consider this a high or even medium
  threat presently, but the regime in China is such
  that we cannot completely dismiss this
  possibility, particularly with the nations
  extraordinarily rapid growth and what could well
  be concomitant social, economic and environmental
  turbulence.

26
Financial Analysis

• Goodyear 10 year historical strategy
  performance (Cont.)
• In 2007, Goodyear extended an equity offering of
  23 million shares of common stock, earning the
  company about 850 million.
• This is being put towards refitting its
  manufacturing capability so that it may address
  the changing needs of the tire market which now
  requires a wide variety of different sized tires
  (13-22) for various standard cars and light
  and heavy trucks. Also Goodyear is interested in
  the growing airline tire market.
• Also, Goodyear recently sold its Engineered
  Products Division for roughly 1.4 billion and
  used the money to restructure its debt.

27
Financial Analysis

• 10-year overview of net sales, gross profit and
  net income

28
Financial Analysis

• The margins
• It is interesting to observe that between 2003
  and 2006, sales increased about 30 from 15
  billion to 20 billion dollars per year
  indicating that the turnaround efforts were
  gaining momentum from a sales volume perspective.
  
• At the same time though gross-profit declined
  which indicates that Goodyears ability to turn
  sales dollars into profits was impaired.
• This stems from increasingly more expensive raw
  materials such as rubber, oil, and steel.
• The price for natural rubber had doubled during
  2006 and remains at high level. According to the
  2006 annual report, overall a 17 increase in all
  raw materials was pressuring on Goodyears
  margins.
• In addition, Goodyear appears to have had
  difficulties passing along price increases
  through sales to customers, which could be
  related to strong competition in a rather
  commoditized product market, where low cost is an
  important driver of overall performance.

29
Financial Analysis

• Current Profitability and comparison with
  Competition
• Goodyear vs. Michelin
• Looking at Michelins asset management, Michelin
  consistently reports a lower Inventory Turnover
  Ratio than Goodyear due to maintaining higher
  levels of inventory.
• Goodyear is also performing better in regards to
  managing its accounts receivable, beating out
  Michelin by 30 days in 2006 in its Accounts
  Receivable Days Ratio.
• This of course reflects Goodyears value tire
  strategy of greater sales of less expensive
  tires.
• One might almost consider this a Wal-mart like
  strategy of beating the competition with quicker
  turnover leading to faster sales, smaller
  inventory and handling costs and buyer power with
  suppliers from whom you can possibly command
  smaller charges because you are paying them
  faster and thus lessening their own need to
  finance.
• Goodyear also maintains higher liquidity ratios
  than its competitor Michelin.

30
Financial Analysis

• Current Profitability and comparison with
  Competition (Cont.)
• Goodyear vs. Michelin
• In the past four years, Goodyear has kept its
  Quick Ratio above a 1.0, whereas Michelin has
  failed reach this level of liquidity in the past
  five.
• Decision makers should also note that Michelins
  liquidity level has been on the decline year
  after year, while Goodyear has shown improved
  liquidity over the same given time frame.
• Overall Goodyear is showing good working capital
  management along with a stable cash flow position
  as illustrated in Figure 5.
• Turning to profitability performance, Michelin
  seems to be operating more efficiently in
  relation to Goodyear, reporting a higher
  Operating Profit Margin for the past three years.
  
• Michelins ROA and Gross Profit Margin have also
  been higher than Goodyears in the past five
  years.
• Goodyears poor profitability performance seems
  to be attributable to the companys higher costs
  directly related to costs of goods sold as seen
  in Figure 3.

31
Financial Analysis

• Current Profitability and comparison with
  Competition (Cont.)
• Bridgestone Analysis
• Bridgestones Inventory Ratio falls just short of
  Goodyears figures every year for the past five
  years.
• Bridgestones Asset Turnover ratio has decreased
  every year for the past five years.
• On the other hand, Bridgestones asset management
  earns high marks for gradually reducing its
  Accounts Receivable Days Ratio 14 over the last
  five years.
• However, this ratio still does not compare to the
  low levels of Goodyears receivables.

32
Financial Analysis

• Current Profitability and comparison with
  Competition (Cont.)
• Taking a look at Bridgestones financial
  management ratios, one can see significant
  decreases in company liquidity.
• Bridgestones Current Ratio declines every year
  for the past four years for a combined 28 drop,
  while Bridgestones Quick Ratio declines every
  year for the past four years as well for a
  combined 38 drop.
• Despite these apparent changes in company
  liquidity, there is little need for concern as
  the current level of these ratios remains
  relatively safe.
• Approaching 2006, Bridgestone, and the entire
  tire industry, appear to be slowly losing profit
  margins.
• However, Bridgestone has still managed to
  consistently produce higher Gross Profit Margins
  and Operating Profit Margins than Goodyear over
  the past five years.
• The resulting depressed profitability figures for
  Goodyear resonates in the companys high cost of
  goods sold (see Figure 3).

33
Financial Analysis

• Gross-Profit Margin Comparison

Figure 2 Gross-Profit Margin comparison
34
Financial Analysis

• Operating Profit Margin Comparison

Figure 3 Operating Profit Margi
35
Financial Analysis

• Net Profit Margin Comparison

Figure 4 Net Profit Margin
36
Financial Analysis

• Current Profitability and comparison with
  Competition (Cont.)
• The overall lower operating profit margin of
  Goodyear compared to Bridgestone could indicate
  that the firm pursued a differentiation strategy
  which requires overall higher SGA costs, more
  RD, more frequent new product introductions,
  high-end products, branding activities, support
  and full service activities.
• However, the overall lower gross-margins
  contradict the differentiation strategy and
  suggest rather a low-cost approach.

37
Financial Analysis

• Current Profitability and comparison with
  Competition (Cont.)
• Michelin has been able to improve its operating
  management between 2003 and 2005 significantly
  and outperformed both Goodyear as well as
  Bridgestone in 2005 and 2006.
• What business activities cause Goodyear to under
  perform at the operating margin? Goodyears
  strategy through the 1990s focused on
  high-volume, value-line tires with small margins.
  Michelin has focused on the premium, high-margin
  segment. As raw material prices have increased,
  the margins on the value-line products have been
  reduced by a higher percentage. This has resulted
  in much lower operating margin for Goodyear when
  compared to Michelin and even Bridgestone.
• Goodyears strategy moving forward is to focus on
  reducing their share of the value-line business
  and increasing their share of the premium,
  high-margin business. They are also aggressively
  pursuing cost reductions in materials,
  manufacturing and other operations. These
  strategies should help Goodyear command more
  dollars per tire in price and reduce the cost per
  tire to manufacture. The coupling of these
  strategies will result in higher operating
  margins and more flexibility to compete for shelf
  space with competitors.

38
Cash Flow Analysis

• Cash Flows
• Despite a 300 million loss in 2006, Goodyear was
  able to generate positive cash flow from
  operating activities during the year.
• Overall, the firm has had positive cash flow from
  operating activities throughout all ten years
  with exception of 2003.
• Cash flows from operating activities appear to be
  quite volatile though.
• Significant investments in property plant and
  equipment have been made in 1999 and 1998 and at
  a smaller scale continuously throughout the
  remaining years.
• Three major financing events occurred.
• In 1999, the firm increased borrowings by 1.4
  billion.
• In 2003 it added 1.4 billion in debt.
• In 2006, the firm issued 1.7 billion debt.

39
Cash Flow Analysis

• Cash Flows
• As discussed earlier the 2003 debt issuance had
  to do with the turnaround and refinancing
  activities in the face of distress.
• The fact, that the company yet again issued
  significant portion of debt in 2006, indicates
  that it still faces significant difficulties.
• The 2006 annual report discloses that Goodyear
  has sold off several non-core businesses and
  continuous with this divestment strategy.
• Change in cash has been positive and increasing
  the strongest peak being in 2006, when the firm
  was able to increase cash by 80 compared to the
  beginning of the year.
• Net income and net cash from operations are
  moving closely together, particularly in the last
  3 years. This indicates no unusual events for
  Goodyears accounting policies or practices. The
  Cash flow from operations to sales ratio declined
  in 2006 to 30 which indicates that the firm
  struggles increasingly to translate sales dollars
  into cash compared to 2005 and 2004, when 40 of
  sales manifested in cash flow from operations.

40
Cash Flow Analysis

• Cash Flows

Figure 5 Cash Flows
41
Cash Flow Analysis

• Income and CFO

Figure 6 Income and CFO
42
Cash Flow Analysis

• Future prospects, growth potential, and business
  risk for Goodyear
• Goodyears results of operations, financial
  position and liquidity could be adversely
  affected in future periods by loss of market
  share or lower demand in the replacement market
  or the OE industry, which would result in lower
  levels of plant utilization and an increase in
  unit costs.
• Also, the firm could experience higher raw
  material and energy costs in future periods.
• These costs, if incurred, may not be recoverable
  due to pricing pressures present in todays
  highly competitive market and Goodyear may not be
  able to continue improving its product mix.
• Future results of operations are also dependent
  on the firms ability to successfully implement
  cost reduction programs and address increasing
  competition from low-cost manufacturers.

43
Cash Flow Analysis

• Future prospects, growth potential, and business
  risk for Goodyear (Cont.)
• With this, the major drivers of ROE are strongly
  limited as asset turnover is expected to remain
  stable or otherwise decrease if demand slows down
  and utilization decreases, profit margins will be
  crucial.
• However, the firm has had as discussed earlier
  much lower margins than its competitors Michelin
  and Bridgestone and will struggle with these due
  to environmental cost conditions pertaining to
  raw materials and consumer unwillingness and
  inability to pay premium prices.
• The currently extreme high leverage most likely
  must be reduced in the future and recent equity
  offerings confirm this trend, which in return
  will impact ROE negatively.
• The overall growth rate is expected to align with
  averages in the US due to the effect of mean
  reverting.
• Industry structure and competitive environment
  will also constitute limitations to ROE.
• As a matter of fact, Goodyear has achieved high
  ROEs solely due to financial leverage and as
  this must decline in the future, ROE is expected
  to be lower.

44
Cash Flow Analysis

• Key Data

45
Cash Flow Analysis

• Future prospects, growth potential, and business
  risk for Goodyear (Cont.)
• Comparing Goodyear to its competitors in a couple
  of key margins provides insight into the future
  business risk which must be considered highest
  among the three compared companies.
• The key drivers of ROE indicate various
  strategies toward return generation.
• While Goodyear shows low margins compared to the
  competitors, it has higher asset turnover.
• In an environment with dominating market share
  and stable demand for products, this position of
  Goodyear might be sustainable.
• However, industry structure and future expected
  developments as described, indicate that weak
  margins cannot be compensated which results in an
  overall low return on assets for Goodyear versus
  Bridgestone and Michelin.

46
Cash Flow Analysis

• Future prospects, growth potential, and business
  risk for Goodyear (Cont.)
• The other key driver for ROE is financial
  leverage and it is obvious that Goodyear, in
  contrast to its competitors, is pursuing a
  different financial policy with a highly levered
  balance sheet.
• This can result in excessive shareholder returns
  during stable business environments, however, in
  unstable environments it can pose a major
  business risk.
• The high beta for Goodyear of 2.6 indicates that
  investors internalize these circumstances as they
  reflect a higher volatility of stock prices
  compared to the market.
• Bridgestone has the lowest beta of 0.9 followed
  by Michelin with beta of 1.59, and 1.78 for the
  industry benchmark.

47
Valuation Analysis
48
Purpose

• Based on preceding
• Business and Industry Analysis of Goodyear
• Historical and Financial Analysis
• Competitor Comparison in the industry
• Future economic prospect for the firm and the
  industry
• Conducting Valuation Analysis of Goodyear Rubber
  Tire
• Over a 10 year time frame
• With the goal to determine ultimately the best
  estimate of current stock price per share
• Based on 3 economic scenarios

49
Methodology for Valuation (DCF-Analysis)

• Using the Discounted Cash Flow Valuation
  Technique
• Forecast essential financial statements
• Income Statement
• Balance Sheet
• Cash Flows
• Based on
• Percentage of Sales method
• And Assumptions about
• Operational future performance of the firm
• Expected capital structure policy changes
• Expected cost of capital
• 3 General economic scenarios

50
Objectives

• Establish best estimate of Present Value
• Of the Firm
• The Value of the Firm is obtained by discounting
  expected cash-flows to the firm
• Cash flow to firm the residual cash-flows after
  meeting all operating expenses and taxes, but
  prior to debt payments and without the benefit of
  tax-shelter
• Discount rate weighted average cost of capital
  (WACC)
• Of Common Equity
• The Value of Equity is obtained by discounting
  expected cash-flows to equity
• Cash flow to equity the residual cash-flows
  after meeting expensed, meeting all tax
  obligations and interest and principal payments
• Discount rate rate of required return by equity
  investors (CAPM)
• Determine stock-price per share

51
Variable Forecasting Control Parameters

• Incremental Sales Growth Rate for each year
• Gross-Profit Margin
• Indicating the companys ability to charge
  premium prices
• Lowering their costs of goods sold
• Operating-Profit Margin
• Operational efficiencies and ability to manage
  firm effectively
• Total Asset-Turnover
• Proxy for the ability of the firm to utilize
  assets and their infrastructure. The need for
  further investment in property, plant and
  equipment
• Debt / Equity
• How much leverage will the firm use in the
  future? What capital structure policy changes
  might influence the return of the firm?

52
Variable Forecasting Control Parameters (cont.)

• Current Ratio
• Coverage of short term liabilities with cash and
  equivalents
• The Cost of Debt
• Depending on economic scenario, inflation,
  company bond rating
• The After Tax Cost of Debt
• The Cost of Equity
• Depending on risk premium, beta for the firm, and
  country risk premium
• Beta for the Firm
• Based on historical movement of Goodyears stock
  vs. market

53
Fixed Firm-Specific Parameters

• The corporate tax rate for Goodyear assumed to be
  35
• Depreciation on PPE assumed to be 53
• Estimated using historic average percentage of
  PPE
• Depreciation Expense per fiscal year assumed to
  be 4
• Estimated using historic average percentage of
  Sales
• Current Liabilities portion assumed to be 24
• Approximated using historic average of Sales

54
Fixed External Parameters

• Based on Financial-Market Research
• Risk Free Rate assumed to be 4.5
• Computed based on 10 year average (1997-2007) of
  10 Year Government T-Bonds
• Expected Market Return assumed to be 8.3
• Historical arithmetic average of SP 500 since
  1928 (80 years).
• Market Risk Premium assumed to be 3.8
• 20-year arithmetic Average

55
3 Economic Scenarios and Assumptions
56
Recession

• Sales are going to decrease
• Margins are decreasing due to price pressure
• Leverage going up due to need for borrowing to
  cover liquidity issues having low cf
• Beta estimated to be high due to bond grading,
  due to leverage, due to risk
• Cost of debt is high at 9
• Cost of equity is about 15

57
Recession

• The market and economy are stagnate or in
  recession. GT struggles to grow sales revenue
  but maintains levels based on execution of their
  product mix and cost cutting strategy. Low
  margins result in the inability to de-leverage
  any further but the bad economy keeps interest
  rates low.
• The soft economy keeps raw material cost
  increases lower than in previous years. GT
  profit margin is flat via management execution of
  strategic plan.
• The cyclical nature of markets see improvements
  by 2011

58
Recession (cont.)

• Cost of Equity 15.9 (including 2 country
  related risk)
• WACC for the 10 years forecasting period (to
  2017)
• Beta 2.47

RECESSION
2007
Value of Equity
5,386

Stock Price
25.51

Value of Firm
12,629
59
Flat

• Sales increase initially a little due to positive
  effect of product mix and restructuring
• But then remain stable without much growth
• Decline slightly at the bottom of the period and
  will slight come back
• Margins decline slightly as the effect of
  products towards higher margin products do not
  materialize fully
• Leverage will remain lower as the strategy and
  policy changes manifest
• Yet borrowing will become necessary again mid of
  period in order to support lacking revenue
  streams
• Beta of 1.7 as rating improves due to
  restructuring then stable due to un-levered
  balance sheet
• Then increasing to 1.9 mid term to reflect the
  new borrowings

60
Flat

• The market and economy are estimated to be
  relatively flat. GT maintains a low growth in
  sales revenue based on execution of their product
  mix strategy.
• The soft economy keeps raw material cost
  increases lower than in previous years. GT
  profit margin increases slowly via management
  execution of strategic plan

61
Flat (cont.)

• Cost of Equity 13 (including 2 country
  related risk)
• WACC for the 10 years forecasting period (to
  2017)
• Beta 1.7

FLAT
2007
Value of Equity
7,762

Stock Price
36.76

Value of Firm
18,002
62
Boom

• 20 B to 28 B B Net Sales is a reasonable
  assumption based on
• History steady increase rate in sales
• Increased prices due to higher raw materials ?
  higher margins
• Product mix and strategy objectives fully
  materializing
• Larger customer base
• Emerging markets, more infrastructure
• More international business
• Approaching competitor margins due to high margin
  products
• Un-levering the firm pays off and debt to equity
  is improved
• Mid term new expansion and borrowings in order to
  benefit tax-shelter again and increase ROE
• Cost of debt decreases as bond rating will
  improve
• Beta at the 10-years historic price fluctuations

63
Boom

• The market and economy continue to grow. GT
  increases sales revenue based on execution of
  their product mix strategy and strong global
  presence.
• The growing economy sees raw material costs
  continue to increase but they are offset by price
  increases and product mix. GT profit margin
  increases rapidly via management execution of
  strategic plan

64
Boom (cont.)

• Cost of Equity 12 (including 2 country
  related risk)
• WACC for the 10 years forecasting period (to
  2017)
• Beta 1.45

BOOM
2007
Value of Equity
14,249

Stock Price
67.48

Value of Firm
41,377
65
3 Sales Revenue Projections
66
3 Different Stock Prices
Future Economic Outlook 10 years Future Economic Outlook 10 years Future Economic Outlook 10 years Future Economic Outlook 10 years Future Economic Outlook 10 years
RECESSION FLAT BOOM
2007 2007 2007
Value of Equity Value of Equity Value of Equity
5,386 7,762 14,249

Stock Price Stock Price Stock Price
25.51 36.76 67.48

Value of Firm Value of Firm Value of Firm
12,629 18,002 41,377
67
Best Estimate based on Probability
Best Estimate
2007
Value of Equity
8,346

Stock Price
40

Value of Firm
21,065
Probabilities Boom 20 Flat 50 Recession
30
68
Best Estimates

• Conclusion
• Goodyear Tire and Rubber Company is well
  positioned to grow in profitability in the next
  ten years in either a boom, flat or bust
  scenario. This is because Goodyear has taken
  steps to align its corporate strategy with the
  changing competitive landscape for its products
  and has adjusted its financial strategy to fit
  this direction.
• Goodyear is changing from being essentially a
  highly leveraged mass low margin cheaper tire
  seller paying high dividends to shareholders to a
  more equity financed higher margin targeted
  seller of quality, differentiated tires. They
  will grow with this strategy because there is
  potential in the high margin differentiated
  market in the otherwise flat North American and
  European markets which comprise 75 of Goodyears
  sales. Goodyear can capture the growth in this
  market by leveraging both its brand and its
  superior RD capability.
• Goodyear is supplementing this with a lower risk
  maintenance of low margin tire selling to
  emerging markets in Eastern Europe, Asia and
  Latin America. Odds are these markets will grow
  to become enamored of Goodyears higher margin
  tires over time.
• While there are risks due to increasing costs of
  raw materials and ever increasing competition
  from rivals, we feel Goodyear is a good buy for
  investors looking for a stable growth stock
  paying less dividends in the next ten years.

69
Appendix
70
Country Risk

• To estimate country risk, find country rating
  (www.moody.com) and estimate default spread for
  rating over a default free government bond rate.
• Basis Traded country bonds.
• This becomes the added risk for the country and
  is added to historical risk premium for a mature
  equity market (U.S.) to get total risk premium.
• Multiply default spread by relative equity market
  volatility (STD DEV. in country equity
  market/STD DEV. in country bond.)
• Emerging market average 1.5 (emerging equity
  markets approx. 1.5 X more volatile than bond
  markets.)
• Estimate of country Risk Premium.
• Add this to U.S. Historical Risk Premium of 3.8
  to get the total risk premium.

71
Country Risk

• Making Lambdas
• Company has exposure to country risk different
  from exposure to all other market risk.
• Call this Lambda and, like Beta, scale around 1
  (gt1 greater country risk lt1 less country
  risk)
• The cost of equity for a firm in this market is
  written asExpected Return Rf Beta (Mature
  Market Risk) ? (County Risk)

72
Country Risk

• Lambdas
• Companys risk exposure to country risk reflects
  revenues it derives from the country.
• Goodyear can have exposure to country risk
  because it has revenues from and production
  facilities within these markets.
• Estimate Lambdas by revenues.
• A company getting a smaller of its revenues
  from a market should be less exposed to country
  risk than one with a larger .
• To get Lambda, scale of revenue company gets
  from a country, dividing it by of revenues all
  companies in the market get from the country,
  i.e. its local GDP.
• For example Goodyear did approximately 0.018
  (1.8) of its business in Brazil compared to .92
  (92) for the average company (8 of Brazils GDP
  was in exports and 92 local), so we measure
  Lambda as 0.018 / 0.92 0.02 and we multiply
  this by the country risk premium (0.0486) 4.86
  which is the difference between the mature equity
  risk premium of 0.038 (3.8) and country premium
  of 0.0866 (8.66).
• 0.0486 x .02 0.00097 and this is then added to
  the cost of capital. The process is repeated for
  each country Goodyear does business in that has
  risk beyond the mature market equity premium.

73
Country Risk for Goodyear

• Estimate business done in each country out of
  approx. 18.5 billion in net revenues.
• N.America 10 billion US 6 billion
  30 Canada 2 billion 10 Mexico 2
  billion 10
• European Union 5 billion in sales Average
  across 7 countries .71 billion EA 24.5
  (3.5 EA)
• Eastern Europe, Mideast, Africa 1.6
  billion Average across all 3
  countries .53 billion EA 7.2 (2.6 EA)
• Latin America 1.8 billion Average across all
  5 countries .36 billion EA 9 (1.8 EA)
• Asia Pacific 1.6 billion Average across all
  11 countries .145 billion EA 8 (.72
  EA.)

74
Country Risk
(2.1)