FORD MOTOR CORPORATION

Corporate Valuation

Juan Cabrera 12/18/14

Robert Schaefer Sarah Garas

Michael Mikhail

BB Ticker: F US Equity Date: December 18, 2014 Price: $14.70 Recommendation: Conviction Buy Target Price: $19.45 Upside: 32.31% Key Stock Statistics Prev Close: 14.45 Open: 14.70 Bid: 14.56 x 13500 Ask: 14.57 x 16600 1y Target Est: 17.21 Beta: 0.85 Next Earnings Date: 29-Jan-15

Day's Range: 14.51 - 14.77 52wk Range: 13.26 - 18.12 Volume: 10,131,161 Avg Vol (3m): 35,608,300 Market Cap: 56.00B P/E (ttm): 9.52 EPS (ttm): 1.53 Div & Yield: 0.50 (3.30%)

Ford Motor Corporation

Business Description Ford Motor Company is engaged in developing, manufacturing, servicing, and distributing vehicles and vehicle parts nationwide. Ford is committed to providing great vehicles for great drivers everywhere. By doing this they are increasing their capacity in the United States by adding new plants all around the world. Ford Motors is continuously funding their on-going “Go Further” brand to help solve global challenges linked to economic development. The company has two operating sectors, the automotive and financial sector. Founded in 1903, the automotive division of the company offers vehicles under the Ford and Lincoln brand names. It sells these cars primarily through markets and distributors in North America, South America, Europe, Turkey, Russia, and the Asia Pacific region. Each region is engaged in the sales of vehicles, vehicle parts and accessories for that region specifically. This sector also offers trucks, accessories and service parts through dealers. The Automotive division also engaged in sales for commercial fleet customers and daily rental car companies. It provides these products with the commitment of quality, safety, sustainability, and innovation of the market. The Financial Services division operates through two segments, Ford Credit and Other Financial Services. Ford Credit offers various automotive financing products such as, financing, leasing, and insurance of vehicles. This includes retail installment sale contracts and lease contract agreements for new and used vehicles. Ford Credit also offers loans to dealers to finance the purchase of vehicles and inventory, rentals car companies, and government entities. The Other Financial Services segment deals with holding companies and real estate purchases for new dealerships.

Year-to-Date Comparison vs. S&P 500

Ford Vs. Competitors

Ford 0.88 114,688,000$ 60,560,500$ 189% 40.0%Competitors Company Beta M. Debt M. Equity D/E Tax Rate(Financial) Bank of America 1.59 364,981,000$ 179,260,800$ 204% 40.0%

Wells Fargo 0.86 53,883,000$ 282,751,200$ 19% 40.0%CitiGroup 1.94 592,334,000$ 163,529,100$ 362% 40.0%

JP Morgan 1.93 672,638,000$ 224,998,400$ 299% 40.0%Average 1.58 221% 40.0% 1.58/[1+(1-.4)2.21] = 0.6793 Financial Beta-UAverage

Ford 0.88 114,688,000$ 60,560,500$ 189% 40.0% .6793*[1+(1-.4)1.89] = 1.4496262 Ford Beta- L

We initiate our coverage of Ford Motor Co. with a fair value of $19.45 per share using a conservative weighted average cost of capital valuation method. A combination of strong earnings, a low cost of capital, and steady growth prospects under an iconic American brand name cumulatively justify the significant upside potential. The stock is trading at $14.70(open 12/18/14), 20.25% off of its 52 week highs of $18.12, and 32.31% from its target price. Cost of Capital The first area of valuation examined was Ford’s cost of capital. The weighted average cost of capital was constructed using a ground up, fundamental beta approach. Beginning with the cost of equity the firm was broken into its two segments, automotive and financial services weighted 95% and 5% respectively, based on proportions of total revenue. They were then unlevered, and re-levered in line with peers for new adjusted fundamental betas. - The automotive division adjusted beta was 1.4178 based on four peers.

- The financial services division adjusted beta was 1.4496 based on four peers.

Auto Rev $ 139,369 95% Financial Service Rev $ 7,548 5%

Competitors Company Beta M. Debt M. Equity D/E Tax Rate(Auto) GM 1.25 7,137,000$ 53,822,300$ 13% 40.0%

Toyota 0.78 166,751,000$ 195,776,700$ 85% 35.6%Honda 1.09 57,148,000$ 54,576,000$ 105% 35.6%Nissan 0.90 47,889,998$ 39,081,000$ 123% 35.6%

Average 1.005 81% 36.7% 1.005/[1+(1-.367).81] = 0.6644 Auto Beta-U

Ford 0.88 114,688,000$ 60,560,500$ 189% 40.0% .6644*[1+(1-.4)1.89] = 1.4178296 Ford Beta- L

The two were combined into a weighted average for the final weighted firm beta. This beta was then used in the capital asset pricing model using US 30 Year Treasuries as the risk free rate, and assuming a 5.5% historical average market risk premium. This yielded a final cost of equity of 10.8068% WEIGHTED FIRM BETA = 1.41941943

30 YEAR TREASURY RATE (NOV. AVERAGE) = 3.00%

RISK PREMIUM = 5.50%

KE = 10.8068%

Next the cost of debt was considered. This was initially calculated using the implied rate spread of a given times interest earned ratio, however a Morning Star analyst rating was used given its wider range of considerations and more comprehensive solvency analysis. Ford received a BBB- debt rating implying a 2.04% rate spread over the risk-free rate of 3.00% for a pretax cost of debt of 5.04%. Using Fords marginal tax rate of 40% the after tax cost of debt fell to 3.0240%

Finally the weighted average cost of capital was calculated using market value weight of equity and book value weight of debt (due to lack of information and an assumed similarity to current market values).Ford has no preferred stock, and no operating leases to consider.

EBIT 7,380,000$ Interest Coverage Ratio > 8.5 Interest Expense 829,000$ TIER Rate Spread: 0.40% (as of Jan 2014)Int Coverage Ratio 8.90 Morning Star Rating: BBB-

Rueters Implied BBB- Spread: 2.04%Pre-Tax Cost of Debt = 5.04%

Marginal Tax Rate = 40% Rate Spread: 2.04%After Tax Kd = 3.0240% 30 Year Treasury Rate 3.00%

MW Equity = 3.85 B * $15.73 = 60,560,500,000$ = 34.56%MW Debt = 114,688,000,000$ = 65.44%

WACC = 5.7135%

Adjusting Earnings The next consideration in the valuation process was to adjust earnings. There are three main concerns regarding adjustments. The first is to reclassify certain expenses to account for their cash flow generating nature, by capitalizing them and then amortizing them as assets. The next concern is to smooth lumpy unusual expenses. The final concern is to disregard minority holdings as they are not relevant to the production value of the business itself. First we addressed Fords research and development expenses. These obviously are expected to generate future cash flows given the R&D intense nature or auto production and design. As such, we treat them like an asset and capitalize them over their useful lifespan which is estimated at 5 years for the auto industry.

Using this information; an adjustment will be made to the income statement as we remove the cost of 6.4 billion, and add the cost of 5.175 billion to account for total amortization of R&D this year. Secondarily an addition of 14.425 billion we be made to the firm’s assets on the balance sheet. There are no operating leases to consider, which would be treated similarly. Second we address the highly variable nature of the firm’s unusual expenses. The way this is achieved is by taking a simple average of current and previous years unusual earnings and using this figure to replace the current year unusual

Year R&D Expense Unammortized Portion Ammorization This YearCurrent $6.40 100% 6.400$ -$

-1 $5.50 75% 4.125$ 1.375$ -2 $5.30 50% 2.650$ 1.325$ -3 $5.00 25% 1.250$ 1.250$ -4 $4.90 0% -$ 1.225$

14.425$ 5.175$ Value R&D Asset Am. R&D This Year

Year 2013 2012 2011 2010 2009 (Millions)Unusual Exp 520 560 220 910 -4470Average '10-'13 552.5 ~ ~ ~ ~

expense. In the case of Ford it is easy to pick out a particularly large expense in 2009. This was not factored into the average as it is not expected in the future course of the Ford Motor Company. This cost was largely related to post recessionary restructuring costs which were incurred across the board by all three large US auto manufacturers. This leaves us with a resulting smoothed unusual expense of 552.5 million as opposed to 520. Finally addressing the last concern, we disregard the income of 1.04 B attributable to minority holdings. At the conclusion of this final step we are left with the final adjusted EBIT of $7.933 B. Cash Flows As investors we are less concerned about raw earning more and more concerned with the free cash flow to the firm’s stock holders. In this section we examine taxes, and the amount of earnings firms decide to retain and reinvest. Starting with adjusted earning of & 7.933 B we will tax this income at the firm’s marginal tax rate of 40%. Marginal tax rate is used because the firm’s effective tax rate has been relevantly volatile over recent years and we want to value the firm based on expected future figures which are the marginal tax rates in this case. Deferred tax figures switched signs between positive and negative on a yearly basis (implying both tax benefits and liabilities) and are relatively insignificantly small considering the offsets. As a result these figures will be ignored. Next capital expenditures and change in working capital, or money the firm chooses to reinvest back into itself, is addressed. Considered here are capital expenditures, depreciation which partially offsets these expenditures, R&D expense, and R&D amortization. These four components make up the adjusted net capex figure.

CapEx(Normalized): 6.9180 R&D Expense: 6.4000 Adjusted CapEx: 13.3180Depreciation: 6.5000 R&D Amm: 5.1750 Adjusted Depereciation: 11.6750

No Acquisitions: ~Adjusted Net Capex: 1.6430

Next the change in working capital is calculated by finding the total working capital, considering it as a percentage value of revenues, and then using historically projected changes in revenue to estimate the change in working capital. Working capital which is found by taking current assets, minus current liabilities, minus cash, minus current interest bearing debt factored out to be 4.93 B or 3.356% of current year revenue. Using a simple average of change in revenues over the past 4 years we anticipate an increase in revenue of $7.14 B. This gives us an estimate of a $239.5 M change in working capital. Using this and the previously calculated net capex, we can calculate the free cash flow to the firm using this formula. One of the final component calculations before the actual valuation is estimating growth.

Growth One of the last components before the actual valuation is the growth rate. The growth rate is calculated by multiplying the firms return on capital by the firms reinvestment rate. Return on capital is calculated using the firms current year after tax EBIT, and dividing that figure by sum of book value of equity, plus book value of debt, minus cash from the end of the previous year. Intuitively this helps decipher what sort of return we can expect from further investments in the firm. Reinvestment rate is calculated by adding net capex and change in working capital, and dividing this term by after tax EBIT. Intuitively this is helping us decipher how much profit the firm is kicking back into working investments. The equation follows below:

EBIT EBIT(1-t) ( Adj Net Capex) (chWC) FCFF7.993 B 4.7958$ 1.643$ 0.2395$ 2.913$

EBIT(1-T) 4.7958$

Reinvest Rate: Net capex chWC418,000,000$ 295,000,000$ 0.7130$ 14.87%

4.7958$

ROC: BVd Be Cash 4.7958$ 5.22%66.3 40 14.47 91.83$

ROC * Reinvest Rate 0.776% Growth

Firm/Equity Valuation The final step in the valuation process is to value the firm based on the calculated free cash flows, WACC, and growth rates. Typically the first step is a rather qualitative one, in which you attempt to gauge how long the current growth rate of a given firm is sustainable. Whatever time period that may be, that becomes your high growth stage, after which the terminal stage follows at a much lower growth rate, resulting in a multi-stage valuation model. In this case that would be unnecessary in that Ford is already a mature, stable growth company after a few years of reestablishment following their restructuring. At this point we can assume a single stage valuation model treating the company as if it is already in the terminal stage, and value it as a single perpetuity. Some rational behind assuming the stable growth model for Ford: the firm is one of the largest in the market and has many competitors yet no distinct competitive advantages, has a relatively high debt to equity ratio even when compared to other large auto firms and a low cost of debt, has relatively lower excess returns and reinvestment rates, the firm is well diversified across the industry, has a very low historical beta of 0.81, and finally the growth rate is less than that of the growth of the economy as a whole. - Combing all of the values, we can estimate the value of the firm below: The last step to finding the estimated fair value share price is to isolate what value of the firm is attributable to equity, and then divide this by the number of common stock shares outstanding. We subtract debt from firm value, add cash, near cash investments, and other non-operating assets like accumulated depreciation which is much like a deferred tax asset.

Value of Operating Assets 2.913 B (1.00776) 59.4565$ Billion5.7134% - 0.776%

After taking the resulting equity value of 68.2 billion and dividing by the 3.5 billion shares outstanding, we arrive at our final recommendation price of $19.49, using relativity conservative growth estimates. Our professional recommendation is Conviction Buy.

Firm Value = 59.4565 B

Cash and ST Inv. 36.57 BAccumulated Dep 34.61 BOther Invesments 3.87 B

Debt -66.3 B

Value of Equity 68.2065 BShares Outstanding 3.5 BShare Price: 19.49$