The Equity Valuation Process & DDM Valuation

The Equity Valuation Process & DDM Valuation (Answer the following two questions) Everett Spitzer, a newly minted CFA charterholder and an analyst for the Special Entities Fund, discovers that the General Cable Company’s (GCC) common stock currently trades at $4.01. Everett calculates the stock’s intrinsic value and forecasts that the share price will rise to $5.25 during the next 12 months. This compares to a required return of 6% for the company’s shares. Given the earnings projections, the analyst also believes the company will declare a $0.25 per share dividend by the end of the coming year. At the end of the 12-month period, General Cable’s shares trade at $4.05 an d the company has paid a dividend of $0.10 per share. As a benchmark, companies with similar risk to General Cable have returned 12% during the same period. (1) GCC’s ex-ante alpha is closet to: a. -6.0% b. 31.2% c. 37.2% (2) GCC’s ex-post alpha is closet to: a. -8.5% b. 3.5% c. 12.0%

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Question L2-01347

Randall McNamara, CFA, of the Altero Development Fund wishes to determine whether the portfolio's manager, Anita Reed, has captured risk-adjusted returns over a broader market index appropriate for the fund. Randall observes the following table of expected and actual data over a one-year holding period:

Investment's estimated CAPM required return 12% At time = 0

Manager's estimated holding period return 14% At time = 0

Holding period return after one year 6% At time = 1

Return for securities with similar characteristics 9% At time = 1 (3) The ex ante alpha for the Altero Development Fund is closest to: a. -3%b. -2%c. 2% (4) The ex post alpha for the Altero Development Fund is closest to: a. -3%b. -2%c. 2% (5) Which of the following statements is correct with regard to alpha within the context of portfolio management and valuation? a. Ex ante alpha measures expected holding period return based on expected capital appreciation and expected income during the holding period, relative to the end-of-period price.b. Ex post alpha measures the excess of actual holding period return over the contemporaneous required return for the period.c. Alpha is a measure of the total return that a portfolio manager is able to achieve in any given period.

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Question L2-01594 (Gordon growth model equity risk premium)

(6) Kevin Antonio and Joe Bales are analysts with Northridge Investments. Both have recently taken the Level II CFA exam and want to apply what they have learned. They agree that cash flow valuation is the best way to determine a firm's value. Antonio, based on his studies, believes that dividends are the most appropriate cash flows to use, while Bales believes free cash flow to either the firm or equity is better.Not only do they disagree on the appropriate cash flow measure, they also are arguing over which approach to use in estimating the required return on equity. Antonio states that the capital asset pricing model (CAPM) is best, while Bales prefers to use the bond yield plus risk premium approach.The firm is considering investing in Sykes Gambling Technologies Corporation (SGTC). SGTC is a small-capitalization, non-dividend paying stock that is experiencing high growth. Sykes is investing heavily in new technology and capital equipment to fund future growth.Antonio and Bales are arguing the relative merits of each issue with respect to how they apply to SGTC.The firm's research director believes that a weakness to the CAPM approach is the reliance on historical data to generate the market risk premium. She believes a better approach is to use expectations to generate a prospective equity risk premium estimate. She gathers the following data:

Sykes Gambling TechnologiesS&P 500 Index Corporation (SGTC)

Current price 1,094 $22.00Current dividend (annualized) $17.60 $0.00Next year's forecasted dividends $18.30 $0.20Consensus long-term earnings

growth rate 6% 12%Beta 1.00 1.35

Current long-term government bond yield = 4%Current yield on SGTC's long-term debt = 10%

She uses the above information to calculate the Gordon growth model equity risk premium. Which of the following is closest to the calculated value?

a. 2.91%b. 3.61%c. 3.67%

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Using the information in the table to answer the next three questions:

0.00-----Value beta

-0.14-----Size beta

1.111.07Beta

4.30%-----Value premium

2.00%-----Size premium

6.00%6.00%Market (equity) risk premium

2.25%2.25%Risk-free rate

FFM Data and EstimatesCAPM Data and Estimates

MegaCorp Inc. (MG)

0.00-----Value beta

-0.14-----Size beta

1.111.07Beta

4.30%-----Value premium

2.00%-----Size premium

6.00%6.00%Market (equity) risk premium

2.25%2.25%Risk-free rate

FFM Data and EstimatesCAPM Data and Estimates

MegaCorp Inc. (MG)

(7) The required return on equity for MegaCorp using the Capital Asset Pricing Model (CAPM) is closest to: a. 8.41% b. 8.67% c. 8.83% (8) The required return on equity for MegaCorp using the Fama-French model (FFM) is closest: a. 8.39% b. 8.63% c. 9.19% (9) The most accurate interpretation of MegaCorp’s value beta is: a. The market capitalization factor of MegaCorp is the same as the overall market. b. MegaCorp stock has neither a value nor growth bias. c. There will be a significant value risk premium effect on MegaCorp’s required return.

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(10) A common stock has the following characteristics: Market beta: 1.3 Size beta: 0.17 Value beta: -0.49 Liquidity: 0.25 The style of a company with the following stock characteristics is most likely to be: a. Larg-cap growth. b. Small-cap value. c. Small-cap growth. ________________________________________________________________________ Use the following date to answer the next 3 questions: Hans frank, a Germ an investor, believes because of the rece nt decline in th e U.S. dollar, there are many good short-term investment opportunities in the united states. So Fra nk decides to buy 1,000 shares of Zade American Basketballs (ZAB) at $30 per share. At the time, the exchange rate was $1. 30/€. The co mpany pays an annul dividend of $0.30 per share, which Frank receives just before selling his shares. When Frank sold the shares of ZAB at $33.00, he was disa ppointed to find that the U.S. dollar had conti nued to deteriorate agai nst the euro. He closed his currency position at $1.326/€. The United States withh olds taxe s o n dividend s paid at a 10% rate an d i t has a treat y with Germany to avoid dou ble taxation. The treaty allo ws citizens to take a tax credit for any taxes paid/withheld in the oth er country. Assume Frank has a 40% income tax rate and a 25% capital gains tax rate. The capital gains tax applies to all capital gain s, without co nsideration of the holding period. On the day F rank sold hi s shares of ZAB, he made the decision at 3:00 pm March 8 Fra nkfurt local time, based on the current price of $32.50. Frank’s trader was on break when he placed the order. By the time the trad er returned, a larger institutional American pension plan had started to build a position in ZAB a nd in the process bid up the price by $0.50. As a result, Frank’s shares were sold for $33.00. Although Frank was impressed by the performance of his tra de, he is concerned about adverse consequences of execution co sts on the perfo rmance of futu re trade s an d is consi dering alternatives to dire ct inve stment in i nternational e quities. Fr ank’s st rategic g oal is t o maximize diversification within the co untries he invests. Ho wever, from a tactical pe rspective, Frank wants to ensure th at he can li quidate any positio n qui ckly to ta ke advantag e of intra-day price movements.

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(11) Frank’s after-tax return is closest to: a. 9.76% b. 8.82% c. 6.47% (12) Which of the following execution cost components best describes the $0.50 price increase from Frank’s standpoint? a. Commissions. b. Oppoetunity cost. c. Market impact cost. (13) Given Frank’s investment goals and strategy, which of the following alternatives to direct investment in the equities of U.S.- based companies is most appropriate? a. Closed-end funds that buy stocks of U.S.-based companies and trade on German

exchanges. b. ADRs trading on U.S. exchanges and representing shares of U.S.-based companies c. Exchange Traded Funds (ETFs) that mimic a U.S.-based index, like the S&P 500.

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International Equity Analysis (14) In evaluating Alden Corp’ s common stock, Andrea has calculated an intrinsic P/E of 10. For the same stock, Tom has calculated an intrinsic P/E of 20. Both have assumed a retention rate of 40%. Which of the following best describes the potential discrepancy in their estimates? a. Both estimate a growth rate of 6%, but Andrea has a required return of 9% versus Tom’s

required return of 12% b. Both estimate a required return of 11%, but Tom has a growth rate of 5% versus Andrea’s

growth rate of 8%. c. They have identical ROE estimates, but Tom’s required return estimate is lower than

Andrea’s (15) Coulder Co. stock has a Return on Equity of 12%, a Dividend Payout Ratio of 60%, and a Required Return of 8.8%. Calculate Coulder’s Intrinsic P/E and Franchise P/E

Intrinsic P/E Franchise P/E a. 15.0x 13.64x b. 15.0x 3.64x c. 25.0x 3.64x

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Question L2-01381

(16) Ryback Manufacturing produces high quality precision parts for use in other manufacturing processes. The following information appeared on Ryback's income statement and balance sheet.

Sales $1,100,000EBIT 800,000EBT 130,000Net Income 78,000Equity 600,000Assets 8,900,000

Ryback retains 70 percent of earnings for reinvestment and paying down debt. The market required rate of return is 11%.The franchise factor for Ryback is closest to:

a. 0.7b. 1.4c. 9.1

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Question L2-01382



Ryback retains 70 percent of earnings for reinvestment and paying down debt. The market required rate of return is 11%.The growth factor for Ryback, within the franchise factor context, is closest to:

a. 20.8 percent.b. 2.3 times.c. 4.8 times.

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Question L2-01383



Ryback retains 70 percent of earnings for reinvestment and paying down debt. The market required rate of return is 11%.The forward P/E ratio for Ryback, calculated using the franchise factor framework, is closest to:

a. 17.5b. 15.8c. 12.7

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Use the following data to answer the next 3 questions Bill Richards, CFA has recently joined a new firm, All Asset Management, LLC. The investment firm buys small positions in a large number of companies throughout the world. He has brought a free cash flow valuation model with him. This model was developed in college and is based on discounting a firm’s free cash flows (FCF). In addition, Bill believes that the CAPM should be used to determine the discount rate. Bill’s boss, Linda Adams, informs him that the firm uses a dividend discount model (DDM) and that the discount rate is found using bond yield plus risk premium. She states that the DDM and the firm’s discount rate calculation are preferable to what bill learned in college. Bill and Linda decide to compare the different discount rates that would be calculated for a company depending on whether the CAPM or bond yield plus risk premium is used. All Asset Management is looking into a flip-flop manufacturer, Flom’s Flops. Bill and Linda have gathered the following data:

1.35Average beta for all shoe manufacturers

4.1%Average shoe manufacturer’s equality risk premium over the average long-term debt YTM

2.1%FFF’s equality risk premium over its long-term debt

4.5%Market risk premium

7.2%Average yield-to-maturity on all shoe manufacturers corporate long-term debt

12.5%Yield-to-maturity on FFF’s long-term debt

4.3%Risk-free rate

1.65Beta for FFF

Flom’s Flops, Inc. (FFF)

1.35Average beta for all shoe manufacturers

4.1%Average shoe manufacturer’s equality risk premium over the average long-term debt YTM

2.1%FFF’s equality risk premium over its long-term debt

4.5%Market risk premium

7.2%Average yield-to-maturity on all shoe manufacturers corporate long-term debt

12.5%Yield-to-maturity on FFF’s long-term debt

4.3%Risk-free rate

1.65Beta for FFF

Flom’s Flops, Inc. (FFF)

(18) In their discussion, Linda lists reasons why dividends are preferable to free cash flows. Choose the following statement made by Linda that is most correct: a. Dividends are less volatile, with the result being more stable model values than is the case

with other discounted cash flow models. b. Dividends are predictable for all companies, as payout ratios are stable. c. No shareholder can influence the timing and size of a firm’s payment of cash flows, thus

dividends are the most appropriate cash flow measure. The firm would be at a competitive disadvantage if it did not use a model that incorporated the cash flows most appropriate for all shareholders.

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(19) Bill, in responding to Linda, states that it is more suitable to use his free cash flow (FCF) model. He lists examples of where a FCF model would be preferable to a DDM. Choose the example below that is not a valid reason to prefer an FCF model to a DDM. a. FCF models are preferable for valuing firms that do not pay dividends. b. FCF models are preferable for valuing firms whose dividends are not suitable. c. FCF models are preferable for valuing firms where a non-control perspective is being taken. (20) Based on the data in the table, Bill and Linda estimate the required return on equity for FFF using the CAPM and bond yield plus risk premium approaches. Which of the following most closely matches the results they should have calculated? Bond yield + CAPM risk premium a. 4.6% 6.4% b. 11.7% 14.6% c. 11.4% 16.6%

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Bill Richards, CFA, is a nalyzing Flom’s Flops, Inc. (FFF, $87.25). He is planning to value the company b y using a discou nted div idend approa ch, p rimarily the Gordon gr owth model. He has read FFF’ s financial statements a nd noted that the firm’s current pe r share earnings an d div idend are $3.60 and $1.20, resp ectively. He believ es that the firm can achieve a long-term su stainable g rowth o f 4.1 %. In addition , he has mo dified th e b ond yield plus risk premium approach to generate an estimated cost of equity of 8.2% (21) Using the Gordon growth model, the share value that Bill will calculate for Flom’s Flops will be closest to: a. $29.27 b. $30.49 c. $87.80 (22) Bill’s boss asks that he include an analysis of the growth potential for Flom’s Flops (FFF). Bill develops a detailed growth analysis and also decides to find the present value of growth opportunities (PVGO) for FFF. Which of the following is closest to the PVGO that bill should calculate? a. $41.55 b. $43.35 c. $72.01 (23) Bill believes that P/E ratios are helpful, as market participants use them extensively. He decides to find the justified leading P/E for Flom’s Flops. Using the data provided, the justified leading P/E ratio that Bill should include in his report is closest to: a. 23.3 b. 8.5 c. 8.1

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(24) Robert wants to use a two-stage dividend discount model (DDM) to value BPT. He knows that he must estimate dividends during the period of high growth. The amount of dividends to be expected during the high growth is closest to: 20x6 20x7 a. $1.03 $1.06 b. $1.02 $1.10 c. $1.08 $1.17 (25) Robert wants to use a two-stage dividend discount model (DMM) to value BPT. Is next step is to estimate the terminal value for the firm. His firm’s policy requires that all terminal values be determined using the Gordon growth model approach. In addition, he has done some detailed modeling and now estimates that BPT’s 20X7 dividend will be $1.14. His long-term growth rate assumption remains unchanged. The correct terminal value that Robert will calculate is closest to: a. $9.50 at the end of 20X7. b. $9.79 at the end of 20X7. c. $9.79 at the end of 20X8. (26) Robert has changed several of his assumptions/projections and has generated the following revised data: Current dividends: 20X5 (actual) $1.00 Estimated dividends during high growth: 20X6 $1.10 20X7 $1.20Terminal value (based on projected P/E) $12.00 He is still assuming two years of high growth. Which of the following best estimates the per share value using a two-stage divined discount model (DDM) valuation? a. $9.75 b. $10.94 c. $11.12 (27) Robert wants to examine the reasonableness of the growth rates he has estimated. He decides to calculate BPT’s sustainable growth rate, based on the historical results. Using average shareholders’ equity for 20X4 and 20X5, the firm’s sustainable growth rate for 20X5 is closest to: a. 4.4% b. 6.7% c. 9.7%

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Question L2-01726

Rio National Corp. is a U.S. based company and the largest competitor in its industry. Exhibits 5-1 through 5-4 present the financial statements, which are prepared according to U.S. Generally Accepted Accounting Principles (U.S. GAAP), and related information for the company. Exhibit 5-5 presents relevant industry and market data.

Exhibit 5-1Rio National Corp.

Summary Balance SheetsAs of 31 December

(U.S. $ millions)20X2 20X1

Cash $ 13.00 $ 5.87Accounts Receivable 30.00 27.00Inventory 209.06 189.06

Current Assets 252.06 221.93Property, Plant & Equipment (net) 320.30 319.47

Total Assets $572.36 $541.40

Accounts Payable $ 25.05 $ 26.05Current Portion of Long-term Debt 0.00 0.00

Current Liabilities 25.05 26.05Long-term Debt 240.00 245.00

Total Liabilities 265.05 271.05Common Equity 160.00 150.00Retained Earnings 147.31 120.35

Total Shareholders' Equity 307.31 270.35Total Liab. and Shareholder's Equity $572.36 $541.40


Summary Income Statementfor the Year Ended 31 December 20X2

(U.S. $ millions)Revenue $300.80Total Operating Expenses (173.74)

Operating Profit 127.06Gain on Sale 4.00

EBITDA 131.06Depreciation and Amortization (71.17)

EBIT 59.89Interest (16.80)Income Tax Expense (12.93)

Net Income $ 30.16


Supplemental Notes for 20X2Note 1: Capital expenditures for the year totaled $75 million.

Note 2: A piece of equipment that was originally purchased for $10 million was sold for $7 million at year-end, when it had a net book value of $3 million. Equipment sales are unusual for Rio National.

Note 3: The company made a $5 million unscheduled principal repayment; there was no new borrowing during the year.

Note 4: On 1 January 20X2, the company received cash from issuing 400,000 shares of common equity at a price of $25.00 per share.

Note 5: A new appraisal during the year increased the estimated market value of land held for future

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development by $2 million, which was not recognized in 20X2 income.


Common Equity Data for 20X2Dividends Paid (U.S. $ millions) $3.20Weighted Average Shares Outstanding during 20X2 16,000,000Dividend per Share $0.20Earnings per Share $1.89Current Market Price $25.00Beta 1.80

Note: The dividend payout ratio is expected to be constant.

Exhibit 5-5Industry and Market Data

31 December 20X2Risk-free Rate of Return 4.00%Expected Rate of Return on Market Index 9.00%Median Industry Price/Earnings (P/E) Ratio 19.90Expected Industry Earnings Growth Rate 12.00%

Rio National Corp. management has signed a new marketing agreement that will allow the company to sell its products in Southeast Asia. Sophie Delourme, an analyst at Euro-International Co., is analyzing the effect of this announcement on her estimate of Rio National's stock value. She uses the H-model in her valuation process and has identified the following inputs:

● Rio National's earnings growth rate is expected to be 30.0 percent in 20X3, declining over a five-year period to a constant growth rate of 12.0 percent in 20X8 and thereafter.

● Because of the change in risk, the required rate of return (cost of equity) for Rio National is expected to be 13.5 percent.

● The dividend per share for 20X2 was $0.20.

● The dividend payout ratio is expected to be constant.

The estimated value of a share of Rio National's equity on 31 December 20X2, using the H-model is closest to:

a. $17.33b. $20.93c. $26.93

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120100806448

3224201612

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Percentsharestraded

1284

Target Price Range2012 2013 2014

MCDONALD’S CORP. NYSE-MCD 58.84 15.5 15.917.0 1.04 3.5%

TIMELINESS 2 Lowered 6/5/09

SAFETY 1 New 7/27/90

TECHNICAL 3 Lowered 5/1/09BETA .70 (1.00 = Market)

2012-14 PROJECTIONSAnn’l Total

Price Gain ReturnHigh 95 (+60%) 15%Low 75 (+25%) 10%Insider Decisions

J A S O N D J F Mto Buy 0 0 0 1 0 0 0 0 0Options 0 2 1 1 1 0 0 2 2to Sell 0 2 2 1 1 2 0 2 1Institutional Decisions

2Q2008 3Q2008 4Q2008to Buy 461 420 505to Sell 482 542 541Hld’s(000) 840859 834673 833419

High: 39.8 49.6 43.6 35.1 30.7 27.0 33.0 35.7 44.7 63.7 67.0 64.5Low: 22.3 35.9 26.4 24.8 15.2 12.1 24.5 27.4 31.7 42.3 45.8 50.4

% TOT. RETURN 4/09THIS VL ARITH.

STOCK INDEX1 yr. -7.8 -25.83 yr. 68.2 -24.75 yr. 121.8 2.8

CAPITAL STRUCTURE as of 3/31/09Total Debt $10439.1 mill. Due in 5 Yrs $4130 mill.LT Debt $10420.1 mill. LT Interest $700.0 mill.(LT interest earned: 14.1x; total interestcoverage: 12.5x) (45% of Cap’l)Leases, Uncapitalized Annual rentals $1046 mill.

No Defined Benefit Pension PlanPfd Stock None

Common Stock 1,103,243,371 shs.(Options exercisable: 9.0%)

MARKET CAP: $64.9 billion (Large Cap)CURRENT POSITION 2007 2008 3/31/09

($MILL.)Cash Assets 1981.3 2063.4 1978.7Receivables 1053.8 931.2 903.4Inventory (FIFO) 125.3 111.5 99.2Other 421.5 411.5 469.1Current Assets 3581.9 3517.6 3450.4Accts Payable 624.1 620.4 488.8Debt Due 1991.1 31.8 19.0Other 1883.3 1885.7 1705.1Current Liab. 4498.5 2537.9 2212.9

ANNUAL RATES Past Past Est’d ’06-’08of change (per sh) 10 Yrs. 5 Yrs. to ’12-’14Revenues 9.0% 9.5% 6.0%‘‘Cash Flow’’ 8.5% 13.0% 8.0%Earnings 9.5% 16.5% 9.0%Dividends 24.0% 36.5% 13.0%Book Value 7.0% 8.5% 6.5%

Cal- Fullendar Year

QUARTERLY REVENUES ($ mill.)Mar.31 Jun.30 Sep.30 Dec.31

2006 4914 5367 5672 5633 215862007 5293 5839 5901 5754 227872008 5615 6075 6267 5565 235222009 5077 5700 6000 5623 224002010 5300 5750 6050 5900 23000Cal- Full

endar YearEARNINGS PER SHARE A

Mar.31 Jun.30 Sep.30 Dec.312006 .49 .56 .64 .61 2.302007 .63 .72 .83 .73 2.912008 .81 .94 1.05 .87 3.672009 .83 .95 1.08 .94 3.802010 .92 1.08 1.17 1.03 4.20Cal- Full

endar YearQUARTERLY DIVIDENDS PAID B ■

Mar.31 Jun.30 Sep.30 Dec.312005 - - - - - - .67 .672006 - - - - - - 1.00 1.002007 - - - - - - 1.50 1.502008 .375 .375 .375 .50 1.632009 .50

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 20065.24 6.00 7.00 7.69 8.32 9.16 9.82 10.92 11.61 12.15 13.58 15.01 16.20 17.931.13 1.30 1.49 1.63 1.76 1.95 2.15 2.29 2.23 2.16 2.36 2.88 2.98 3.43

.73 .84 .99 1.11 1.15 1.26 1.39 1.46 1.36 1.32 1.43 1.93 1.97 2.30

.11 .12 .13 .15 .16 .18 .20 .22 .23 .24 .40 .55 .67 1.00

.93 1.11 1.47 1.71 1.54 1.39 1.38 1.49 1.49 1.58 1.04 1.12 1.27 1.453.96 4.48 5.36 6.02 6.45 6.98 7.14 7.05 7.41 8.11 9.50 11.18 11.99 12.84

1414.8 1387.4 1399.4 1389.2 1371.4 1356.2 1350.8 1304.9 1280.7 1268.2 1261.9 1269.9 1263.2 1203.717.9 17.1 19.0 21.5 21.0 24.7 30.4 22.9 20.9 18.3 14.1 14.4 16.2 16.01.06 1.12 1.27 1.35 1.21 1.28 1.73 1.49 1.07 1.00 .80 .76 .86 .86.8% .8% .7% .6% .7% .6% .5% .7% .8% 1.0% 2.0% 2.0% 2.1% 2.7%

13259 14243 14870 15406 17141 19065 20460 2158631.3% 29.1% 27.2% 26.1% 25.6% 26.3% 26.2% 26.4%956.3 1010.7 1086.3 1050.8 1148.2 1201.0 1249.5 1249.9

1947.9 1977.3 1772.6 1692.0 1831.4 2458.6 2509.8 2873.032.5% 31.4% 29.9% 32.7% 33.5% 28.3% 31.5% 31.0%14.7% 13.9% 11.9% 11.0% 10.7% 12.9% 12.3% 13.3%d1702 d698.5 d429.0 d706.9 d600.4 d662.7 1813.4 617.25632.4 7843.9 8555.5 9703.6 9342.5 8357.3 8937.4 8416.59639.1 9204.4 9488.4 10281 11982 14202 15146 1545813.9% 12.8% 11.1% 9.4% 9.5% 11.6% 11.1% 12.8%20.2% 21.5% 18.7% 16.5% 15.3% 17.3% 16.6% 18.6%17.5% 18.4% 15.6% 13.6% 11.1% 12.4% 11.0% 10.7%

14% 14% 16% 18% 27% 28% 34% 42%

2007 2008 2009 2010 © VALUE LINE PUB., INC. 12-1419.55 21.09 20.85 21.70 Revenues per sh 27.60

4.06 4.85 5.10 5.55 ‘‘Cash Flow’’ per sh 6.452.91 3.67 3.80 4.20 Earnings per sh A 4.951.50 1.63 2.05 2.25 Div’ds Decl’d per sh B■ 2.851.67 1.91 1.95 2.05 Cap’l Spending per sh 2.15

13.11 12.00 12.55 14.15 Book Value per sh C 18.251165.3 1115.3 1075.0 1060.0 Common Shs Outst’g D 1015.0

17.6 15.8 Bold figures areValue Lineestimates

Avg Ann’l P/E Ratio 17.0.93 .98 Relative P/E Ratio 1.15

2.9% 2.8% Avg Ann’l Div’d Yield 3.4%

22787 23522 22400 23000 Revenues ($mill) 2800022.3% 32.5% 32.0% 32.5% Operating Margin 30.0%1214.1 1207.8 1300 1350 Depreciation ($mill) 15253522.6 4201.1 4180 4555 Net Profit ($mill) 5025

NMF 31.8% 30.0% 30.0% Income Tax Rate 31.0%15.5% 17.9% 18.7% 19.8% Net Profit Margin 18.0%d916.6 979.7 1200 1300 Working Cap’l ($mill) 6507310.0 10186 10000 9000 Long-Term Debt ($mill) 700015280 13383 13500 15000 Shr. Equity ($mill) 1850016.4% 18.8% 18.0% 19.0% Return on Total Cap’l 19.5%23.1% 31.4% 31.0% 30.5% Return on Shr. Equity 27.0%11.5% 17.8% 14.5% 14.0% Retained to Com Eq 11.5%

50% 43% 54% 54% All Div’ds to Net Prof 58%

Company’s Financial Strength A++Stock’s Price Stability 100Price Growth Persistence 45Earnings Predictability 95

(A) Based on avg. shares through ’96; dilutedafter. Excl. nonrecur. gain/(loss): ’95, (1¢); ’98,(8¢); ’01, (11¢); ’02, (55¢); ’03, (25¢); ’04, (6¢);’05, 3¢; ’06, 53¢; ’07, (93¢); ’08, 9¢; ’09, 4¢.

Excl. cum. effect of accting change: ’02, (7¢);’03, (3¢); ’04, (8¢). Incl. tax benefit: ’04, 7¢.Excl. tax benefit ’05, 4¢. Next egs. rpt. lateJuly. (B) Beginning 3/08 div’ds expected to be

paid mid Mar., Jun., Sep., Dec. ■ Div’d. rein-vestment plan available. (C) Incl. intang. At12/31/08: $2,237.4 mill. $2.00/share. (D) Inmill., adj. for splits.

BUSINESS: McDonald’s Corporation operates or licenses nearly32,000 fast-food restaurants in the United States, Canada, andoverseas, mostly under the McDonald’s banner (12/08). About 80%are operated by franchisees, with the remainder under the controlof the company or affiliates. Foreign operations contribute around65% of systemwide sales and about 53% of consolidated operating

profits. Sold stake in Pret A Manger in 2008. Spun off ChipotleMexican Grill in 2006 and Boston Market in 2007. Has about400,000 employees. Officers/directors own less than 1% of com-mon stock (4/09 Proxy). President & CEO: Jim Skinner. Inc.: DE.Addr.: One McDonald’s Plaza, Oak Brook, Illinois 60523. Tele-phone: 630-623-3000. Internet: www.mcdonalds.com.

McDonald’s Corporation posted re-spectable first-quarter results. Shareearnings were $0.83, excluding a $0.04gain from the sale of the company’s minor-ity stake in Redbox Automated Retail,LLC. The figure was a few pennies belowour estimate, primarily due to an $0.08-per-share unfavorable currency transla-tion, which also contributed to the 10%year-over-year revenue decline. Nonethe-less, earnings were slightly higher thanthe year-earlier tally, and comparable-restaurant sales increased 4.3% in the in-terim. Moreover,We think that the rest of the year willbe solid, but currency headwinds willprobably persist. Breakfast, chicken,and beverages will likely drive results atthe ‘‘hamburger’’ chain, and the company’svalue and convenience should continue toresonate with consumers. Comparable-store sales were up 6.9% in April, butoverall sales fell 1.0% because of exchangerate moves. The resurgent United Statesdollar is making McDonald’s vast overseassales and earnings worth less when con-verted into greenbacks. On the bright side,the foreign currency handicap has shown

signs of moderating of late, and shouldease somewhat (though remain negative)as 2009 progresses.The company is making a big pushinto the specialty coffee market. Itrecently rolled out its new McCafe on a na-tional scale, and is in the midst of an ag-gressive marketing campaign to push thedrinks and lure coffee drinkers away fromhigher-priced rivals, such as Starbucks.Although the move is somewhat risky(pushing high-end coffee drinks whenMCD’s customers are looking to stretchtheir dollars), we think that the strategywill pay off down the road. People have de-veloped a taste for these beverages, andgiven the company’s strong position in thebreakfast market, McDonald’s coffeedrinks should take off eventually.We continue to view these timelyshares in a favorable light. The corebusiness is doing very well, and foreigncurrency headwinds are one of the fewblemishes we see. Additionally, the stockgarners excellent scores for FinancialStrength and Safety. The well-covered div-idend sweetens the pot.Matthew E. Spencer June 5, 2009

LEGENDS12.0 x ″Cash Flow″ p sh. . . . Relative Price Strength

2-for-1 split 3/99Options: YesShaded area: prior recession

Latest recession began 12/07

© 2009, Value Line Publishing, Inc. All rights reserved. Factual material is obtained from sources believed to be reliable and is provided without warranties of any kind.THE PUBLISHER IS NOT RESPONSIBLE FOR ANY ERRORS OR OMISSIONS HEREIN. This publication is strictly for subscriber’s own, non-commercial, internal use. No partof it may be reproduced, resold, stored or transmitted in any printed, electronic or other form, or used for generating or marketing any printed or electronic publication, service or product.

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