Best Buy

Group 5

Brian HuiChia C. Li

George H. LohEva Shen

James Trisna

FINA 4332

Table of Contents

Best Buy: Our Brands Make Life Fun and Easy 1

Goals 2

History 3

Company Leaders 4

Business Segments 7

Industry Pie Chart 11

Financial Ratios 12

Share Price 18

Trading Volume 18

Market Capitalization 19

Holding Period of Return 19

Free Cash Flow and the Cost of Equity 20

Discounted Cash Flow 21

Market Efficiency 22

Risk Analysis 24

Cost of Capital and Optimal Capital Structure 25

Conclusion 27

1

Best Buy,

“Our Brands Make Life Fun and Easy.”

Best Buy Co., Inc. is an innovative Fortune 100 growth company that continually strives to create superior customer experiences. Through more than 820 retail stores across the United States and in Canada, our employees connect customers with technology and entertainment products and services that make life easier and more fun. We sell consumer electronics, home-office products, entertainment software, appliances and related services. A Minneapolis-based company, our operations include: Best Buy (BestBuy.com), Future Shop (FutureShop.ca), Geek Squad (GeekSquad.com) and Magnolia Audio Video (Magnoliaav.com). We support our communities through employee volunteerism and grants from The Best Buy Children's Foundation.Source: http://phx.corporate-ir.net

2

  Our Goal: 

“To transform into a

talent-powered, customer-driven

enterprise focused on enhancing our

customers’ enjoyment of technology.”

Fiscal 2005 Goals

o To increase revenue by 11 to 13 percent by opening 70 new stores.o To increase diluted earnings per share by 15 to 20 percent.o Implement customer centricity in up to 110 additional stores.o To emphasize more customer service through the supply chain and

customer contact centers.o Expand value in the Geek Squad through rapid response.o To upgrade and renovate existing stores to a more competitive level.

3

Era 1: Humbling BeginningsMilestone: “The Journey Begins”

In 1966, Richard Schultz and a business partner opened the ‘Sound of Music’ store in St. Paul, Minnesota. In the first year of business, Sound of Music grossed $173,000 in sales. Sound of Music began issuing its stock in 1969 and compensated employees with the first employee stock option plan. The first $1 million annual revenue was hit in 1970.

Era 2: Growth and ChallengeMilestone: “The Tornado Sale”

Sound of Music moves its headquarters to Bloomington, Minnesota. In 1978, Sound of Music has a total of nine stores in the Minnesota area. It began to sell video products instead of just music products. In 1981, a tornado hits Roseville, Minnesota and Sound of Music responds with a “Tornado Sale” introducing low prices for quality electronics.

Era 3: Forging New PathsMilestone: “Enter the Superstore, What’s in a Name?”

In 1983, Sound of Music’s board of directors changes the company name to Best Buy Co., Inc. and opens the first superstore in Burnsville, Minnesota. Major expansions occur with 12 more opening and Best Buy debuts on the NYSE as BBY.

Era 4: Unprecedented GrowthMilestone: “A Novel Concept”

In 1990, Richard Schultz in named “Retailer of the Year” by Consumer Electronics Magazine. Best Buy begins to enter other major cities such as Texas and Chicago. In 1994, Best Buy Children’s Foundation is established in a way to make a difference in the community.

Era 5: Reaching New HeightsMilestone: ‘”Forbes, ‘Company of the Year’”

In 2000, Best Buy penetrates online shopping through Bestbuy.com. Fortune Magazine names Best Buy as one of the top 10 performing stocks since 1990. Best Buy acquires Magnolia Hi-Fi in the same year and enters the International market in 2001 through the acquisition of Future Shop in Canada and opening a Best Buy in Canada. In 2004, Forbes names Best Buy “Company of the Year.”

Executive Officers:

Age Salary Shares Yrs w/company

Richard M.Schulze 63 $1.01M 46,961,302 38 yrs.

Founder of Best Buy. Officer and director from 1966 and currently is

Chairman of the Board. Relinquished the duties of Chief Executive Officer,

and office he had held since Feb. 1983. A trustee of the University of St. Thomas, chairman of

its Executive and Institutional Advancement Committee, and chairman of the board of governors of the University of St. Thomas Business School.

4

Bradbury H. Anderson 54 $3.18M 1,232,355 31 yrs.

Allen U. Lenzmeier 60 $1.79M 1,1671744 20 yrs. Director since February 2001. Currently the President and Chief Operating Officer. Prior to his promotion to his current position, he served as President of Best Buy

Retail Stores from 2001 to 2002 and as Executive Vice President and Chief Financial Officer from 1991 to 2001.

Michael P. Keskey 49 -- -- 16 yrs. Joined Best Buy in 1988. Named President – U.S. Retail Stores in April 2004. Previously served as President – Best Buy Retail Stores since March 2002. Served as Executive Vice President – Retail Sales from 2001-2002 and as Senior

Vice president – Retail Sales from 1997-2001.

Age Salary Shares Yrs w/company

Darren R. Jackson 39 $3.09M -- 4 yrs. Named Executive Vice President – Finance and Chief Financial Officer in April

2002. Joined Best Buy in 2000 as Senior Vice President – Finance and Treasurer and

was promoted to Chief Financial Officer in 2001. Prior to his current position, he served as chief financial officer of the Full-Line

Store Division at Nordstrom, Inc. from 1998-2000 and as chief financial officer of Carson Pirie Scott & Co. Inc.

Brian J. Dunn 43 -- -- 19 yrs. Named Executive Vice President – Retail Sales in March 2002. Joined Best Buy in 1985 and has held positions as Senior Vice President,

Regional Vice President, regional manager, district manager and store manager.

Director since August 1986. Currently the Vice Chairman and Chief Executive

Officer. Serves on the board of trustees of Minnesota Public

Radio.

5

5%/Insider Ownership:

OWNERSHIP INFORMATION

Shares Outstanding 328.00 Mil

Institutional Ownership (%) 71.1

Top 10 Institutions (%) 30.24

Mutual Fund Ownership (%) 31.76

5%/Insider Ownership (%) 18.68

Float (%) 81.32

Source: History Information: http://bestbuymedia.tekgroup.comBoard of Directors and Officers: Fiscal 2004 Annual Report

Best Buy’s 5%/Insider Ownership is 18.68%. It is considerably high for a corporation of Best Buy’s magnitude. If an inside owner were to suffer from death, bankruptcy, etc. this could adversely effect the company.

Can the company board be improved?

The top officers for Best Buy Co., Inc. are Bradbury H. Anderson, Richard

Schulze, Allen Lenzimeier, Brian Dunn and Darren Jackson.

Susan S. Hoff (Senior VP and Chief Communications Officer) and Richard

Schulze (Founder and Chairman of the Board) are the only relatives in the company.

Mr. Bradbury H. Anderson is the current CEO. He was the former COO and

President of the company. He is the member of mostly communication specialized

association and committees. Mr. Richard Schulze is the founder of the company. He is

currently the Chairman of Best Buy. He was formerly the CEO but stepped down from

his position. Schulze is involved with leadership and management associations. Allen

Lenzmeier is the current COO. He was the former President for retailing. He is involved

with mostly religious groups. Darren Jackson is the current CFO of Best Buy. He has a

strong financial background. He was former CFO of Nordstrom. He also has 15 years

retail experience. Brian Dunn is the Executive VP of retail and sales. His former

experiences with Best Buy Co. involves mostly managerial positions with the region,

district and store.

The problem that Best Buy was having with its false inflated stock prices points

can be assumed that the there was a lack of knowledge in the area of financial

management. Darren Jackson, being the only officer with the experience in Best Buy’s

finances has put the company on dangerous grounds under the law. All other board

members have interests or specialize in either communications, retail or management.

There is no other member of the board with a financial background other than Darren

Jackson. It would be a recommendation that they place a few more people with more

knowledge of retail finance on the board to prevent issues like artificially inflated stock

prices from happening again and causing the company to have irregularities in financial

trends due to non-market forces.

BUSINESS SEGMENTS

Best Buy Domestic revenue increased 15% since fiscal 2003. Slightly more than half of the revenue increase for fiscal 2004 was due to new stores added in the past two years. The remainder of revenue increase was attributable to the 7.4% comparable store sales gain that was driven by an improved economic environment, including increased consumer confidence; demand for, and increased affordability of, digital products; and effective advertising and promotional.

Best Buy International revenue increased 41% since fiscal 2003. The effect of changes in foreign currency exchange rates accounted for approximately half of the revenue increase for the fiscal year.

DOMESTIC SEGMENT:

U.S. Best Buy (608 Stores)

U.S. Best Buy stores offer merchandise in four product categories: consumer electronics, home office, entertainment software and appliances.

Consumer electronics, the largest product category for fiscal 2004 based on revenue, consists of video and audio products. Video products include: televisions, digital cameras, DVD players, digital camcorders and digital broadcast satellite systems. Audio products include: car stereos, shelf systems and speakers, home theater audio systems, portable audio equipment, audio components and mobile electronics.

Home office category includes desktop and notebook computers and related peripheral equipment, telephones, cellular phones and MP3 players.

Entertainment software products include DVD movies, video game hardware and software, compact discs and computer software.

Appliance category includes major appliances as well as vacuums, small electric and houseware.

Magnolia Audio Video (22 Stores)

Magnolia Audio Video was founded 50 years ago and became a part of the Best Buy company in 2000. It has been named “Retailer of the Year” by Audio Video International for 22 consecutive years. Magnolia Audio Video stores are typically managed by a store manager, and audio/video sales manager and, if the store contains

mobile products, a mobile electronics sales manager. For fiscal 2004, Magnolia Audio Video retail stores generated average revenue of approximately $6.5 million per store.

Magnolia Audio Video stores offer merchandise in two product categories: consumer electronics and home office. Consumer electronics was the largest product category for fiscal 2004 based on revenue.

INTERNATIONAL SEGMENT:

International segment consists of two sectors: Best Buy Canada and Future Shop. Home office was the largest product category for fiscal 2004 based on revenue.

Best Buy Canada (19 Stores)

Best Buy in Canada is a subsidiary of Best Buy Co., Inc. It specializes in electronics, computers, and entertainment software in Alberta, Manitoba, and Ontario.

Future Shop (108 Stores)

Future Shop has over 100 stores across Canada and grows continuously in retailing and e-retailing of electronics. It employs more than 8,500 associates in its stores as they offer a wide line of products such as televisions, computers, appliances, entertainment software, and audio.

INDUSTRY PIE CHART:

Industry pie chart shows the top 8 industries in Service Retail (technology) sector. Best Buy generated most sales at 53%, and followed by Circuit City at 23%.

Ticker Name TTM Sales $

3 Yr. Sales Growth Rate%

5 Yr. Sales Growth Rate%

BBY Best Buy Co., Inc. 23,681.000 17.35 19.52

CC Circuit City Stores, Inc. 10,154.004 -1.92 .84

CONN Conn's Inc. 548.392 15.12 16.10

ELBO Electronics Boutique Holdings Corp. 1,851.935 25.66 21.73

GME GameStop Corp. 1,759.447 27.78 27.69

RSH RadioShack Corporation 4,841.200 .46 3.25

TWTR Tweeter Home Entertainment Group Inc. 789.433 12.95 22.72

ULTEQ Ultimate Electronics, Inc. 705.708 13.74 16.73

FINANCIAL RATIOS

Growth Rates(%) Company Industry S&P 500

Sales (MRQ) vs Qtr. 1 Yr. Ago 10.18 10.34 16.82

Sales (TTM) vs TTM 1 Yr. Ago 14.03 11.72 15.49

Sales - 5 Yr. Growth Rate 19.52 14.68 9.66

EPS (MRQ) vs Qtr. 1 Yr. Ago 20.87 16.97 22.14

EPS (TTM) vs TTM 1 Yr. Ago 30.76 27.84 27.64

EPS - 5 Yr. Growth Rate 28.77 23.63 13.44

Capital Spending - 5 Yr. Growth Rate 26.84 21.54 -18.55

Sales GrowthAt a first glance, Best Buy appears to be following the industry very closely in relation to sales growth (MRQ vs Qtr. 1 Yr. Ago). Furthermore, this short term measure might lead one to believe the company’s sales are deficient when compared to the S&P 500. However, TTM sales growth for Best Buy is well above the industry by about 2.3% and much closer to the market average than its MRQ sales growth. Also, according to five-year historical data, the sales growth rate (5 Yr. Growth Rate) for the company is roughly 5% higher than the industry average and double that of the S&P 500. This may indicate that Best Buy has had a relatively weak sales quarter, but its overall sales growth health remains quite healthy (Good).

EPS GrowthSimilarly, the company maintains fairly solid EPS growth (TTM) by staying about 3% ahead of both the industry average and the S&P 500. Its five-year growth is even more impressive with EPS being ahead by roughly 5% of the industry and more than double the S&P. Although its recent quarter’s EPS growth is slightly

lower than the market average by 1.3% (but still above the industry by 4%), this limited measure seems inconsequential when compared to Best Buy’s strong annual and past five-year growth, which results in it having an overall EPS growth that is Good.

*According to this in-depth analysis of Sales Growth and EPS Growth, it appears that Best Buy has relatively healthy growth rates and the potential for higher growth rates in future periods. OVERALL GROWTH RATES GOOD

Price Ratios Company Industry S&P 500

P/E Ratio (TTM) 32.43 29.35 22.08

P/E High - Last 5 Yrs. NA 47.80 41.96

P/E Low – Last 5 Yrs. NA 13.27 15.71

Price to Sales (TTM) 0.72 0.71 3.05

Price to Book (MRQ) 4.28 4.17 4.04

Price to Cash Flow (TTM) 18.16 15.68 16.54

P/E RatioSince companies’ Price/Earnings ratios vary enormously across industries, it is considered inappropriate to compare the P/E of a single company to the market average (S&P 500). Thus, we must compare this ratio to a suitable benchmark—the respective industry average. Best Buy’s P/E ratio is slightly higher than the industry average, but this should not bear too much significance. It seems as though Best Buy’s value in terms of price over earnings is only marginally more costly than a typical company within the industry. Consequently, the company’s P/E ratio should be rated Fair.

P/S RatioFurthermore, although Best Buy’s Price/Sales ratio is significantly less than the S&P 500’s 3.1 (which could be considered very good to the investor), it is virtually identical to the industry average at 0.7. This P/S ratio is a limited measure anyway, as it doesn’t take either expenses or debt into consideration. When appropriately compared to the industry (as P/E ratio was), P/S ratio is considered Fair.

*According to this in-depth analysis of P/E Ratio and P/S Ratio, it appears that Best Buy has relatively fair price valuations and is not a significantly overvalued company. OVERALL PRICE RATIOS FAIR

Profit Margins (%) Company Industry S&P 500

Gross Margin (TTM) 25.17 29.63 46.45

Gross Margin - 5 Yr. Avg. 22.10 27.36 45.41

Pre-Tax Margin (TTM) 3.59 4.73 18.15

Pre-Tax Margin - 5 Yr. Avg. 4.83 5.14 17.06

Net Profit Margin (TTM) 2.22 2.94 14.11

Net Profit Margin - 5 Yr. Avg. 2.97 3.14 11.37

Gross MarginBoth current and historical five-year gross margins for Best Buy lie a bit below that of the industry’s mean gross margins. Current gross margins are approximately 4.5% less for Best Buy when compared to the industry. Although the current and historical gross margins of the S&P 500 are about two times that of both Best Buy and the industry, this simply indicates that the retail (technology) industry is most likely not as profitable as the general market. When appropriately compared to its specific industry, Best Buy’s gross margin is relatively Weak.

Pre-tax and Net Profit MarginsIn a similar method of relative measurement, pre-tax margins and net profit margins for the company have generally lagged behind the industry’s standard for the past five years and even more so in the past twelve months. Summarily, pre-tax and net profit margins remain Weak.

*According to this in-depth analysis of Gross, Pre-tax, and Net Profit Margins, it appears that Best Buy has relatively weak profit margins and must rely more on factors such as higher asset turnover to achieve higher sales. OVERALL PROFIT MARGINS WEAK

Investment Returns (%) Company Industry S&P 500

Return On Assets (TTM) 9.17 8.89 7.41

Return On Assets - 5 Yr. Avg. 9.50 8.61 6.67

Return On Investment (TTM) 19.46 17.19 11.19

Return On Investment - 5 Yr. Avg. 19.98 16.97 10.54

Return On Equity (TTM) 23.33 21.88 19.33

Return On Equity - 5 Yr. Avg. 25.43 24.01 18.76

Return on InvestmentEvidently, the company’s return on investment nearly doubles the S&P’s average showing a greater comparative profit on its investment transactions. Relative to the industry, ROI is still attractive as it remains a good 2.3% higher. Overall, return on investment is Very Good.

Return on EquityIt seems as though Best Buy’s return on equity has outpaced both the industry and market for the past five years. More specifically, in the recent twelve months, the company’s ROE is about 1.5% above the industry average, and exactly 4% above the S&P 500. This indicates that Best Buy has been able to consecutively yield investors a higher return on their contributed equity to the firm. Best Buy’s return on equity is Good.

*According to this in-depth analysis of Return on Investment and Return on Equity, it appears that Best Buy has above average investment returns and remains an attractive investment for potential stockholders seeking higher ROEs. OVERALL INVESTMENT RETURNS VERY GOOD

Financial Condition Company Industry S&P 500

Quick Ratio (MRQ) 0.47 0.49 1.19

Current Ratio (MRQ) 1.21 1.41 1.71

LT Debt to Equity (MRQ) 0.12 0.22 0.52

Total Debt to Equity (MRQ) 0.12 0.26 0.76

Interest Coverage (TTM) 35.13 30.57 12.63

Total Debt to Equity/LT Debt to EquityTotal debt to equity of 0.12 is less than half that of the industry average of 0.26 for Best Buy. This figure is less than one sixth the S&P average. Moreover, the company’s LT debt to equity exhibits almost identical results. Evidently, Best Buy relies on debt to a much lesser extent than either the industry or market. In essence, this fact allows Best Buy to maintain lower levels of debt-related expenses and liquidity risks. It seems as though the company’s significantly lower total debt to equity ratio (and LT debt/equity) should be considered EXCELLENT.

Current Ratio/Quick RatioAlthough the company’s current ratio is somewhat lower than the industry average, they should easily be able to meet the demands of current liabilities with current assets as it is well-above 1.0. In addition, quick ratio is virtually the same as the industry average at 0.5, but much lower than the S&P’s 1.2. This simply means that Best Buy (and its respective industry) tends to maintain higher inventories than the overall market. This is necessary for firms such as Best Buy. Furthermore, for a firm as large as Best Buy, this ratio doesn’t seem to bear much weight as the company should not be in danger of needlessly liquidating its inventory. Thus, current and quick ratios, when taken in the proper context, are relatively FAIR.

*According to this in-depth analysis of Total Debt to Equity/LT Debt to Equity and Current Ratio/Quick Ratio, it appears that Best Buy is in relatively good financial condition. OVERALL FINANCIAL CONDITION GOOD

Management Efficiency Company Industry S&P 500

Revenue/Employee (TTM) 236,810 230,243 714,102

Net Income/Employee (TTM) 5,260 6,168 96,111

Receivable Turnover (TTM) 52.92 47.21 10.15

Inventory Turnover (TTM) 5.32 4.69 12.18

Asset Turnover (TTM) 2.53 2.46 0.93

Receivable Turnover

Best Buy maintains a receivable turnover that is approximately 12% higher than the industry average and over five times the S&P 500 benchmark. This indicates that the company is very efficient at collecting debts from extended credit. Consequently, this firm deserves a receivable turnover rating of Very Good.

Inventory TurnoverInventory turnover remains favorable when compared to the industry, with a marginal lead of about 0.6. However, inventory turnover is less than half of the S&P 500, indicating that Best Buy holds their inventory twice as long as a typical market firm. Since inventory turnover should be compared to only the industry average, it is not fair to say that inventory turnover is weak for Best Buy. Thus, in light of the aforementioned fact, Best Buy’s inventory turnover is Fair.

Asset TurnoverThe company’s asset turnover is only slightly higher than the industry, but over two and a half times as large as the market average. Compared to the market, it would appear that Best Buy uses its assets much more efficiently to generate revenues. However, the reason why asset turnover is so high in comparison to the market is because its profit margins are so much lower. Taking this into consideration, Best Buy’s asset turnover is Very Good.

*According to this in-depth analysis of Receivable Turnover, Inventory Turnover, and Asset Turnover, it appears that Best Buy has relatively very good management efficiency with strong receivable and asset turnover. OVERALL MANAGEMENT EFFICIENCY VERY GOOD

***According to this analysis of the multiple facets of Best Buy’s financial position, the company should be considered in OVERALL GOOD financial health with very good investment returns and management efficiency, good growth rates and financial condition, fair price valuation ratios, and somewhat weaker profit margins which can be offset with its higher volume of sales due to factors such as higher asset turnover.

SHARE PRICE:

As of the end February 2005, the share price of Best Buy was $51.69. This face value alone does not provide much insight into the value of the stock, however, and further comparison is necessary. In order to provide a more useful reference, we could compare Best Buy’s share price appreciation/depreciation to the price fluctuations of the S&P 500 index.

TRADING VOLUME:

Evidently, Best Buy’s stock price has remained well above the S&P 500 index for the better part of the last five years. Currently, Best Buy’s stock price is outpacing the S&P by an average of about 50-60%. Furthermore, current trading volume is 2,868,600 while average trading volume for the past three months is 3,267,454. This stock seems relatively liquid according to the steady trading volume for the past five years.

MARKET CAPITALIZATION:TOP RETAIL (TECHNOLOGY) COMPANIES BY MARKET CAP

Company Symbol Price Change Market Cap P/E

Best BUY Co Inc BBY 51.69 +0.56% 16.96B 32.43

Radioshack Corp RSH 29.70 +0.78% 4.70B 14.27

Circuit City Stores Inc CC 15.72 +1.22% 3.01B 46.10

Gamestop Corp GME 19.23 +3.39% 975.67M 17.20

Electronics Boutique Holdings Corp ELBO 37.61 +2.34% 901.29M 17.50

Conns Inc CONN 16.63 +2.46% 385.95M 13.Chart source at: http://finance.yahoo.com/q/in?s=BBY

Best Buy is the undisputed market leader in terms of market capitalization. It is four times larger than its closest competitor, Radioshack, in this aspect. However, taking P/E ratio into account, Radioshack is actually “cheaper” at half the relative cost (P/E of 14.27 vs 32.43).

BACKGROUND ANALYSIS:

FINA4332--Corporate Finance BBY (Best Buy)    2005 (12/31) 2004 2003 2002

1.Background Analysis:

. HPR = Ending Price – Beginning Price + Distributions 0.8455 -0.5687 Beginning Price

Earnings growth rate estimate (2005) 0.2740Dividend 0.80 0.4 0 0Price 66.95 53.25 29.07 67.4HPR 0.27230.8455 -0.5687

(expected)

In 2005 the Holding Period of Return decreased from 84.55% to 27.33%. Best Buy didn’t pay dividend in the years prior to 2004. Holding period return for 2004 increased so much because the growth rate from 2003 to 2004 stock price increased tremendously.

Free cash Flow and Cost of Equity 2002~2004 2005 2004 2003 2002 2001

NI $705 $99 $570 $396(+) depreciation 385 310 242 164(-) capital Expenditures 541 656 556 626(-) Change in working capital 27 290 667(+) Change in long-term debt -346 20 627FCFE 224 .224 176 - 517 216

(Mil) (Mil) (Mil) (Mil)

Note:Capital Expenditures 541 656 556 626Additions to porperty, plant, and equipment 545 725 581 657(-) Disposition of property and equipment 4 69 25 31

Change in working capital=[(CA 03)- (CA 02)] - [(CL 03) - (CL 02)] 27 290 667CA 5724 4989 4611 2929CL 4501 3793 3730 2715

Change in long-term debt=LTD 03- LTD 02 -346 20 627LTD 482 828 808 181

The cash flows of a company signify imperative facts about the company while the free cash flow reveals the sum of money that the company has left over after all capital expenditures are accounted for. In Best Buy Co. Inc., the cash flow between 2003 and 2004 had a big improvement from negative 517 million to positive 176 million. We use the formula [FCFE (2005) = FCFE(2004) * (1+G)] to expect in the 2005 the cash flow will increase to more than 224 million.

Ke(Discounted cash flow (DCF) model):

2005 2004 2003 2002

P0=(FCFE1/Shares0)/(Ke0-G1) FCFE 12/31/2005 224,224,000 176,000,000 -517,000,000 216,000,000

ke0=[(FCFE1/shares0)/P0]+G1 shares outstanding 328,080,000 324,648,000 321,966,000 319,130,000

G1=(FCFE1-FCFE0)/FCFE0 G 12/31/2005 0.2740 1.3404 -3.3935

P 2/26/2005 51.69 53.25 29.07 67.40

Ke 0.2872 0.2870 1.3592 -3.4176

.ke(Constant dividend growth model)

Po=D1/(ke-G)=>Ke=(D1/Po) +G 1.0150 0.0000 0.0000

EX: Ke2001=(D2002/P2001)+g2002; D2002=D2001(1+g2002); g2002=(D2002 - D2001)/D2001

In 2005, the stock has a return of 28.72%.

The backed out estimate of the discount rates are unrealistic. In 2003 Best Buy Co., Inc. was hit with a lawsuit stating that the stock prices were artificially inflated. Best Buy was convicted and had to repurchase a large sum of its own stock. The drastic decrease in the NI along with the negative FCFE give evidence of Best Buy repurchasing its own stock. However in relation with the discount rates, a useful estimate of the discount rates cannot be determined by using the current method due to sudden drop in the FCFE by a force that was not market related.

We cannot use the Ke from dividend growth model in later calculations because Best Buy did not pay any dividend prior to 2004.

MARKET EFFICIENCY:COMPANY SPECIFIC EFFECTS

Maytag Posts 4th-Quarter Loss of $14.1MFriday January 28, 4:45 pm ET By David Pitt, Associated Press Writer

Maytag Reports Fourth-Quarter Loss of $14.1 Million on Charges, Lower Hoover Sales and Margins

DES MOINES, Iowa (AP) -- Maytag Corp. swung to a fourth quarter loss of $14.1 million, amid reduced sales of its Hoover floor care equipment, higher steel and energy prices and restructuring costs, the company said Friday.

The appliance manufacturer's loss, equivalent to 18 cents a share, compares with a profit of $23.9 million, or 30 cents a share, a year ago. Sales for the quarter fell 8.4 percent to $1.16 billion, compared with $1.27 billion for the same period last year.

Excluding one time charges for restructuring, the closing of a refrigerator plant and the costs of settling a lawsuit related to early models of the Neptune front-load washer, the company would have reported a profit of 8 cents a share. On that basis, analysts surveyed by Thomson First Call expected fourth quarter earnings of 17 cents a share. The company also lowered its earnings guidance for 2005 to $1.10 to $1.30 per share, including about 5 cents for restructuring charges. Previous guidance was between $1.50 and $1.60 including restructuring. The lower expectations were due to lower revenue generation in the fourth quarter and an end to sales of major appliances through Best Buy Co. retail stores, which was announced earlier this month.

SYNOPSIS: The drop in stock price of Best Buy from 01/26 – 01/31 is due to the discontinuation of Maytag appliances being sold at all Best Buy outlets. This announcement was made on January 28, 2005. We can see a WEAK FORM in market structure for Best Buy during the time of 01/26 – 01/31. Insider traders quickly react during the price decrease before the announcement date and normal traders react after the announcement of the news.

NON-COMPANY SPECIFIC EFFECTS

Unocal deal underscores changes at Chevron By Sheila McNulty in Houston Published: April 13 2005 23:05 | Last updated: April 13 2005 23:05

Despite all the froth over Chinese rivalry for Unocal, the market took a dim view of ChevronTexaco's $18bn trump last week. The immediate 5 per cent fall in share price reflected more than the usual technical trade exacted on an acquirer.

Investors saw the impact of the deal as initially neutral to earnings and diluting return on capital employed (roce). In addition, it fails to expand Chevron's portfolio into new growth areas, such as liquefied natural gas or oil sands. As a result, they questioned the price being paid.

SYNOPSIS: From this chart you can see that Best Buy’s stock price was negatively affected by the ChevronTexaco’s acquisition of Unocal. The time of the graph between 4/12 – 4/15 takes on a WEAK FORM structure. The announcement date of April 13, 2005 reflects inside traders ability to adjust and react quicker than normal traders.

RISK ANALYSIS:

2005 2004 2003 2002 2001Beta BBY 2.1528 2.1495 2.2766 2.2602 2.2276Beta=COV(R BBY, R S&P

500) /VAR (R S&P 500)2004 2003 2002 2001

Unlevered Beta[Equity/(Equity +((1-T)Debt))]* BetaEquity=Beta_unlevered

0.1870 0.4360 0.2791 1.5310

Equity 3422 2730 2521 1822Debt 5230 4933 4854 3018Income from Continuing operations before income taxes

1296 1014 926 649

Provision for income tax 496 392 356 248

Tax rate (T) 0.3827 0.3866 0.3844 0.3821

EBIT*T=TAX2005 (4/7)

2004 2003 2002 2001

Rf 0.0219 0.0119 0.0102 0.0163 0.0386Rm-Rf 0.019 0.1182 0.3206 -0.2261 -0.1497

Beta 2.1528 2.1495 2.2766 2.2602 2.2276

Ke(required return on equity) 0.0628 0.2660 0.7401 -0.4947 -0.2949 .Ke(CAPM)Ke=Rf+Beta(Rm-Rf)

Currently the market only requires a 6.28% return on the stock and as we can see the price is under priced because Ke (DCF model) > Ke (CAPM) ; 0.2872 > 0.0628

COST OF CAPITAL AND OPTIMAL CAPITAL STRUCTURE:

5. Cost of Capital and Optimal Capital Structure: 2004 2003 2002We= Equity/(Equity+Debt+Preferred Stock) 0.3955 0.3563 0.3418Wd=Debt/(Equity+Debt+Preferred Stock) 0.6045 0.6437 0.6582Wp=Preferrd stock/(Equity+Debt+Preferred Stock) 0.0000 0.0000 0.0000Ke 0.2870 1.3592 0.3000*Kd 0.0298 0.0293 0.0285

Kp 0.0000 0.0000 0.0000WACC=We*Ke + Wd*kd*(1-T)+ Wp*Kp WACC   0.1246 0.4958 0.0457

For the determination of Best Buy’s Weighted Average Cost of Capital(WACC), hypothesized return on equities(Ke) had to be used for 2002 (30%). To estimate Ke for 2002, we compared the Wd for 2002 and 2004. The reason for this is that in 2002 the company produced a negative return, which is unacceptable for a WACC calculation, and we can’t use the dividend growth model because Best Buy didn’t pay any dividend prior to 2004.

Best Buy’s capital structure remained relatively stable within three years. Its Weighted Debt to Equity ratio has little variation in the past three years.

From the M & M Proposition graph above, Best Buy follows Model 3 of the MM model, which is the approach with tax, agency costs, and finance distress costs. The max firm value is at 49.58%. At year 2002 to 2003 Best Buy’s WACC rises and falls from 2003 to 2004. Therefore, the value of the firm follows the opposite pattern.

CONCLUSION:

Strengths and Weaknesses

In the U.S. Best Buy is the undisputed industry leader in the retail technology industry in terms of market capitalization and total sales revenue. No other competitor comes close in these regards. For instance, in terms of market capitalization, Best Buy maintains an impressive $16.96 billion standing, while its closest competitor (market cap-wise) Radioshack only has about one fourth of that. Furthermore, Best Buy maintains annual sales of $23.681 billion while its closest sales competitor Circuit City generates less than half of this. Another growing strength of Best Buy’s is the fact that they are using a portion of their current cash flows to pay off large amounts of debt and refraining from issuing significant amounts of new debt therefore improving their capital structure. This is evidenced by the fact that current Total Debt/Equity ratio is a mere 0.12 (check financial ratios) compared to the hefty debts of the past three years which averaged about 60% of total assets. The aforementioned EPS growth (check financial ratios) of Best Buy continues to take the lead over industry and market averages, and as a large growth firm, will most likely continue to do so into the next year. Also, currently improving/increasing FCFE is a good indicator of growth for stockholders. Weaknesses include the fact that at a Beta of 2.15, Best Buy incurs over two times the systematic risk of the market, and is a bit higher than the industry average of 1.9. As most investors are risk adverse, this high volatility may not be a good thing. Also, the company heavily relies on higher sales volume than the typical market firm because its profit margins are considerably lower (check financial ratios). However, this may not be too much of a concern if it keeps its asset turnover rate higher than the market (indicating it does have the capacity to generate higher-than-market sales). Also, a concern about corporate governance and its competency in financial matters is present. Darren Jackson, current CFO, is the only board member who has a background in finance while the other board members specialize in communications, retail or management. It would serve Best Buy well to gain acquire more financial expertise to improve their balance sheet and cash flows and to avoid inflated stock prices or react quickly to them (see company leaders section).

Best Buy Co., Inc.: Analyst Ratings

 Recommendations  Current  1 Month Ago  2 Months Ago  3 Months Ago

 Strong Buy 9 11 11 11

 Moderate Buy 4 4 4 4

 Hold 7 6 6 6

 Moderate Sell 0 0 0 0

 Strong Sell 2 1 1 1

 Mean Rec.  2.18  1.91  1.91  1.91

Mean Recommendation Conversion TableStrong Buy: 1.0Moderate Buy: 1.1 – 2.0Hold: 2.1 – 3.0Moderate Sell: 3.1 – 4.0Strong Sell: 4.1 – 5.0

The Mean Recommendation Average suggests that shareholders should Hold their stocks, and the majority of the Analysts recommend Strong Buy to Moderate Buy. These recommendations imply that the value of the stocks will increase in the future.

Group Recommendation

In lieu of the strengths/weaknesses analysis and analyst ratings, it is our group’s

recommendation to BUY Best Buy’s stock (BBY). Our decision is influenced by a careful understanding that although the near future short term seems highly volatile and uncertain, the long term potential of BBY as an investment remains promising (much due to its industry dominance). At a current P/E of 32, Best Buy is closely priced relative to the industry at a P/E of 29 making it a fair value. Also, with improving FCFE and EPS, Best Buy seems concerned about building shareholders’ value and increasing its stock price for the long run. Moreover, our 28.72% Ke (DCF) > 6.28% Ke (CAPM), indicating that this stock at its current price is actually under priced and should be bought.

Our group’s recommendation is also influenced by what the professional financial analysts are currently recommending. As can be seen in the above analysts’ ratings table, 9 of 22 analysts recommend a STRONG BUY, 4 recommend BUY, 7 HOLD, and only 2 say to STRONG SELL. We believe our recommendation is relatively conservative as we issue a regular BUY rating for the long hold (NOT for short term profit taking).