Deere and Co. Valuation - Texas Tech Universitymmoore.ba.ttu.edu/ValuationReports/JohnDeerel.pdf · Deere and Co. Valuation April 1, 2005 ... Current Financial Position Deere and

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Deere and Co. Valuation April 1, 2005

Edward Benton ([email protected]) Stefanie Calhoun ([email protected] Kevin Hinton ([email protected]) Brian Kendall ([email protected]) Justin Looney ([email protected])

Executive Summary

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Table of Contents Executive Summary ...................................................................................................................... 3 Business and Industry Analysis ................................................................................................... 6

Five Forces Model ...................................................................................................................... 6 Key Success Factors ................................................................................................................... 7 Competitive Strategy Analysis ................................................................................................... 8

Accounting Analysis ................................................................................................................... 10 Step 1: Identifying Key Accounting Policies............................................................................ 10 Step 2: Assess Accounting Flexibility ...................................................................................... 11 Step 3: Account Strategy .......................................................................................................... 12 Step 4: Quality of Disclosure Evaluation.................................................................................. 13 Step 5: Potential Red Flags ....................................................................................................... 14 Step 6: Undo Accounting Distortions ....................................................................................... 15

Ratio Analysis and Forecast Financials .................................................................................... 16 Financial Ratio Analysis ........................................................................................................... 16

Trend (Time Series) Analysis ............................................................................................... 16 Cross Section (Benchmark) Analysis ................................................................................... 18

Financial Statement Forecasting Methodology ........................................................................ 27 SGR....................................................................................................................................... 27 Income Statement.................................................................................................................. 28 Forecasting the Balance Sheet .............................................................................................. 30 Forecasting the Statement of Cash Flows............................................................................. 30

Valuation and Analysis............................................................................................................... 31 Valuations ................................................................................................................................. 31

Method of Comparables........................................................................................................ 31 Cost of Capital Estimation .................................................................................................... 32 Discounted Dividends Model ............................................................................................... 33 Discounted Free Cash Flows ................................................................................................ 34 Discounted Residual Income ................................................................................................ 35 Abnormal Earnings Growth.................................................................................................. 36 Lon Run Residual Income .................................................................................................... 36

Conclusion ................................................................................................................................ 37

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Executive Summary

Analysis of Deere and Co. _

Investment Recommendation: Sell or Short the security

P/E 11.5 Market Cap 15.93 BilEarnings/Share 5.77 Total Shares 246.5 MilCurrent/Div Yeild 1.9 Exchange NYSEPrice/Cash Flow 11.45 ROE 27.03Price/Revenue 0.81 Total Debt/Equity 2.3ROA 5.35 NI (est 2005) 873.9 Mil

Last 66.24 Change -1.37% Change -2.00Volume 1.952 MilAvg Daily Volume 2.046 MilDay's High 67.76Day's Low 65.87Open 67.61Previous Clos 67.13Instit. Ownership 80.40%52 Week High 74.9352 Week Low 56.72Book Value/Share ($) 26.36Cash Per Share ($) 11.36Div/Yield% 1.88Div Amount ($) 0.31Price/Bok 2.51Beta 0.615

Dicounted Div 43.01$ Discounte FCF 194.41$ AEG 26.54$ Risidual Income 80.00$ Long Run Ri 91.05$ Dividend Yield 64.87$ Price to Sales 58.18$ Price to Book 54.87$ Forward P/E 48.81$ Trailing P/E 84.65$ EPIC 104.79$

Valuations

Deere and Co. and S&P 500 5 year returns

Deere and Co vs. CAT, KUB, & CNH

Executive Summary

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Firm Strategy Deere and Co. maintains its competitive advantages primarily through product differentiation, brand recognition, and superior customer service. This firm has established its immense presence through over 165 years of service in the industry, it and remains the largest manufacturer of farm equipment in the world. Deere and Co. has capitalized on the fact that its brand well known, and they have used this brand image to be successful in other areas of equipment manufacturing including, but not limited to, construction, forestry, lawn and garden equipment. In addition to these ventures into other manufacturing arenas, Deere and Co. also has many growth opportunities arising from emerging markets located primarily in Brazil, Australia, and Mexico. Deere and Co. has been very successful in initiating this strategy, and continues to be a formidable competitor. While this analysis recognizes Deere and Co.’s strengths, we cannot, however, ignore the many risks that are prevalent throughout the agricultural industry. These risks, which will be discussed later in greater detail, along with certain indications derived from our valuation models are what have led us to recommend a no buy on Deere and Co.’s common stock. Current Financial Position Deere and Co.’s has made some significant changes to its capital structure over the last five years. In an attempt to take advantage growth opportunities that have resulted from historically low interest rates, Deere and Co. has vastly expanded its financing division. These expansive financing practices have greatly increased sales revenues and have aided the company in penetrating emerging foreign markets. While this venture has been quite profitable for the company, the FOMC’s upward pressure on the low end of the yield curve will most likely put a damper on farmers’ ability to finance new equipment. Aside from this expansive financing, Deere and Co. has maintained its financial position in a consistent and stable manner. The company has $3.040 billion in total debt outstanding $601 million of which is due in five years. Deere and Co. is considered a large cap stock with a current market capitalization of $17.3 billion and has 246,859,131 common shares outstanding. Forecasts of Future Financial Performance Prior to forecasting Deere and Co.’s financial statements for the next ten years, Common Size Balance Sheets, Income Statements, and Cash Flow Statements were created in an attempt to capture any constant trends in Deere and Co.’s numbers. The years 2001 through 2004 illustrate an extremely important change in Deere and Co.’s overall business model, especially with regards to the company’s sales. As mentioned above, during the past five years the company expanded its consumer financing division. This has greatly increased the amount of equipment sold on credit and consequently increased the company’s overall sales. This expansion explains the company’s astronomical sales growth, from 2002 to 2004. According to Deere and Co.’s financials, the company grew sales 11.38 percent from 2002 to 2003, and 28.66

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percent from 2003 to 2004. We believe that while this boom in financing is slowing down, Deere and Co. will be able to use this method of growth into 2006 which should be after the farming sector recovers from this trough in the agricultural cycle. While it is understandable that the company will not be able to sustain sales growth of 28.66 percent over the next ten years, we feel a sales growth estimate of 11 percent is not unreasonable. Estimate of Equity Value On average our valuation models suggest that Deere and Co.’s shares are currently overvalued, and we would therefore recommend shorting the stock or engaging in some options trading. While Deere and Co. is a well run company and continues to be a strong force in the machinery manufacturing industry, our analysis suggests that certain downside risk is currently being priced into the stock. The valuation models suggest that on average Deere and Co.’s shares’ true intrinsic valuation should be approximately $50 to $55. These indications from our models, as well as certain other economic and internal risks, are what cause us to be skeptical about investing in this company. Economic Factors and Risks Underlying the Valuation In addition to the valuation models, there are three main risks that support our analysis of Deere and Co. The first would be the approaching trough of the agricultural cycle. Our analysis suggests that due to increased commodities prices, rising interest rates, and decreases in farmers’ discretionary income, Deere and Co.’s sales will see an immediate but impermanent decrease. This decrease will be most prominent in the last three quarters of 2005. The next threat would be from the impending danger of the Asian Rust fungus. This fungus, which blew in with Hurricane Ivan, has already affected Deere and Co.’s sales by making farmers nervous about crop yields. This has caused them to buy chemicals and sprayers instead of new equipment. The final and most serious risk that Deere and Co. faces is internal in nature. In addition to producing machinery, Deere and Co. also provides managed healthcare plans to its employees. As of right now these, healthcare and life insurance plans are 90% unfunded to the tune of $5 billion in obligations that they do not have the assets to meet. While Deere and Co. has made tremendous progress with its pension obligations, raising this plan’s status to 77 percent funded within the last year, it has been unable to do the same with its managed healthcare. Although it has been able to make generous voluntary contributions within the last year, given its favorable sales environment, this will not likely continue given the expected growth decrease in sales. This situation, by far, poses the most immediate and serious threat to Deere’s financial health.

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Business and Industry Analysis Deere and Co. is the largest manufacturer of farm equipment in the world. While focusing mainly on selling its products to the agricultural industry, Deere and Co. also manufactures a wide range of industrial, construction, and forestry equipment that it sells in over 10 countries abroad as well as in the United States. To facilitate the sale of its products, Deere and Co. offers lines of revolving credit at its stores and in-house financing. The analysis that follows uses the Five Forces Model to determine how Deere and Co. maintains its competitive advantage in the highly cyclical farm equipment industry. In addition, this section analyzes Deere and Co.’s Key Success Factors in comparison to its competitors and its business environment.

Five Forces Model Rivalry among Existing Firms The rivalry among existing firms in the equity market of construction and agriculture machinery is high. The market for such specialized equipment used on construction sites and on agricultural land is a very small niche market. Thus, there is high product differentiation. The main competing firms within the United States consist of Caterpillar, Case, and Kubota; as well as many other firms existing primarily in foreign markets. Threat of New Entrants The threat of new entrants into the construction and agriculture machinery industry is very low. Such an industry has high entry barriers and high exit barriers. The barriers that exist are in the form of the high amount of capital needed to produce the large pieces of machinery. Once a firm is settled in such an industry, leaving it is hard due to the amount of money tied up in the production machinery needed to produce specialized components for the large pieces of equipment. Threat of Substitute Products The threat of substitute products in the construction/forestry and agriculture industry is relatively low. Buyers in the same industry as Deere and Co. mainly buy based on brand loyalty. The buyers’ perception of value is formed over many years of experience with the company. This positive experience is expected to drive Deere and Co.’s sales in 2005. However, the industry is becoming more competitive and some companies are merging and forming alliances and partnerships. With a more competitive market, the threat of substitute products will increase. The construction/forestry and agriculture industry is less competitive than the commercial and consumer industry. A buyer will be more inclined to switch in the commercial and consumer industry. In the near future, the construction industry may look to robots for help. This will eliminate the need for some equipment that Deere and Co. has to offer. 2005 should be a year where not many substitutes emerge. Deere and Co.’s reputation and brand loyalty should help

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drive the company sales in the years to come. As the industry consolidates and robots take over equipment, the threat for substitutes will increase. The Bargaining Power of Buyers The amount of bargaining power the buyers have over the company is relatively low due to the limited number of firms in the industry. However, the limited amount of bargaining power the buyer has depends upon the quality of the product. Deere and Co.’s customers are generally going to choose products based on quality. Since the expenditure for agricultural and construction equipment is rather larger, consumers will choose the product that offers the most features and has the best quality. Thus, if Deere and Co. doesn’t invest money to develop more efficient and effective products, then the customers will choose other suppliers The Bargaining Power of Suppliers The bargaining power of suppliers is high because there is not a huge amount of companies that offer the same products and services that Deere and Co. does. It also works in their favor that there are not a lot of reasonable product substitutes. The buyer could switch brands if they chose, but the only alternative for farm machinery is using animals, human labor, or nothing at all. These are not practical alternatives for any farming operation that expects to make money. So, this aspect also increases the bargaining power of the supplier.

Rivalry HighThreat of New Entrants LowThre of Substitute Products LowBargaining Power of Buyers LowBargaining Power of Suppliers High

Five Forces Model

Due to the limited amount of competitors in this industry, John Deere must take certain measures to differentiate itself from its competitors. These measures would manifest themselves as certain strategic decisions made by management to ensure that consumers bought a tractor from John Deere, as opposed to one of Deere’s competitors. For this reason we believe that Deere uses a product differentiation competitive strategy.

Key Success Factors Superior Product Quality The industry that Deere and Co. operates in is one that has few players but high competition. John Deere must therefore do what it can to portray that its product is of the highest quality. It is important that Deere and Co. recognize who their customers are, and what it is their customers are looking for from them. If they can then understand how to use that information to their advantage, Deere and Co. will remain a leader in the industry. By maintain its large presence over the last 160 years, it is

Executive Summary

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obvious that Deere has distinguished its product and has been successful labeling itself as the premier brand in the agricultural machinery industry. Investment in Brand Image Deere has learned to capitalize on a few of their competitive strengths. One of those is the Brand Name that they have established. The John Deere Brand has been doing business in the United States for over 165 years. During that timeframe, they have built a name that most people are familiar with. Their brand name and logo give them a competitive advantage over their competitors. Investment in Research and Development The company is also excelled by investing in their research and development department. Deere and Co. allocates a larger percentage of their sales towards research and development than any of their main competitors. For example, in 2003, Deere and Co. allocated 5.3 percent while Caterpillar and CNH only allocated 3 percent towards research and development. In addition, Deere and Co. offers a very strong product line which is stimulated by high research and development. In their Construction and Forestry division, Deere and Co. was named Manufacturer of the year by Peter Kiewit and Sons, Inc Superior Customer Service Deere and Co. is dedicated to maintaining a good corporate structure. Deere and Co. is composed of three divisions that correlate with their customer types: Agricultural Equipment, Construction and Forestry Equipment, and Commercial and Consumer Equipment. Each division focuses on product development and distribution for customers in that particular segment of the industry. International Expansion 25 percent of Deere and Co.’s sales come from outside the U.S. and Canada. During the 1st quarter of 2005, Deere and Co. made a big investment in Asia by allocating funds to build an agricultural equipment distribution facility. Also, Deere and Co.’s increased international demand leaves plenty of opportunity for the company to do well. Considering that Deere and Co.’s businesses abroad make up 28 percent of their total revenues and that the company has offices or affiliates in over 10 countries, an investor can expect that the current weak dollar will spur exports to most, if not all, of those countries.

Competitive Strategy Analysis The farm equipment industry is not as competitive as other market segments. Deere and Co. is a key player in manufacturing agricultural, commercial, and forestry equipment. Deere and Co. also boasts a large market share in the manufacturing of agricultural equipment. They are fortunate that there is not much threat from substitute products because there are not any reasonable products that could achieve the same amount of work. The only alternative for farmers would be to switch brands. Depending

Executive Summary

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on the situation, this could help or hurt the company. In most situations, forcing customers to switch brands is strong competitive advantages for Deere and Co. Deere and Co. has two customer types: potential/new and repeat. Potential/new customers tend to do a lot of price shopping on their first purchase whereas repeat customers, who make up a large percentage of Deere and Co.’s customer base, are going to be loyal in their purchase decisions. There are two reasons customers are loyal to the John Deere brand. First, the John Deere brand has a very positive reputation for creating quality products and providing excellent customer service. Second, if a person already owns John Deere equipment, they are likely to stick with the brand because the parts are more compatible with each other compared to other brands. However, their customers are somewhat price sensitive. Deere and Co. offset this sensitivity by offering competitive product financing options. This competitive advantage helps grow Deere and Co. to grow a loyal customer base in a market where products are not very differentiated. Finally, Deere and Co. has a very low cost of goods sold ratio compared to its competitors. Deere and Co.’s ratio is approximately 79 percent, while some of the other businesses in the industry are in the upper 80s in cost of goods sold/sales ratio. This is good sign that the company is efficient in manufacturing its products.

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Accounting Analysis

Step 1: Identifying Key Accounting Policies Deere and Co. has to identify its key success factors in order to assess their accounting policies. Deere and Co. competes on brand name and financial services. The threat of substitute products is very low. Since the farm industry has specialized equipment, the only way a customer can leave Deere and Co. is to switch brands. This is why Deere and Co. focuses on their brand name. The threat of new entrants is very low in the farm industry, and this keeps Deere and Co. focusing on a cost leadership strategy. Not only are Deere and Co.’s prices low, they offer very good financial services to their customers. Deere and Co. has financial investments in and control over a number of companies. Its investments in unconsolidated affiliated companies is recorded as net assets of that company as related equity, and companies with less investment are recorded as costs. Special purpose entities (SPE) are treated as special cases and are not consolidated because Deere and Co. does not have the majority of control. Deere and Co. recognizes that there might be some discrepancies in their calculations for these investments due to numerous estimations made by the management. However, the company feels these estimations are necessary in order to comply with generally accepted accounting principles (GAAP). The way that Deere and Co. recognizes revenue on its sale of products in the United States is by recording the sale after the title and risk of ownership of the product is transferred to an independent dealer. It is important to note that the rules differ slightly between countries for these transactions. Deere and Co. recognizes its revenue on financing by recording the revenue after a customer has purchased the product. The income realized from operating leases is recorded on a straight-line basis, and financing revenue is done over a period of time with the interest method. Long-lived assets and goodwill are evaluated after considering the particulars of specific situations when it is felt to be necessary. Property, plant and equipment are depreciated over the useful life of the asset by using the straight-line method. When equipment or other assets require general maintenance, Deere and Co. expenses the maintenance costs. One item that stood out in Deere and Co.’s accounting policies was how they delt with changes in accounting standards that are either ‘to be adopted’ or ‘adopted’. In reference to standard that are ‘to be adopted,’ there is a lot of speculation of how these required changes will affect future earnings. For example, the FASB issued a statement that requires Deere and Co. to recognize the cost of employee services. These changes will take place at the beginning of the fourth fiscal quarter in 2005. However, Deere and Co. has not yet determined how these changes will effect future financial statements. As for accounting standards that have been adopted, management has a better assessment of the outcome of these changes. One new accounting standard

Accounting Analysis

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that has been adopted is in reference to the consolidation standards that were discussed earlier paragraphs. These standards are for variable interest entities (VIE) that are not making enough money to cover their own costs or are not invested in by reliable sources. Under the newly adopted accounting standards, these VIEs must be consolidated if Deere and Co. is the primary beneficiary.

Step 2: Assess Accounting Flexibility The FASB allows managers to be flexible with their accounting, but not all firms and industries are allowed equal flexibility. Accounting data will likely be less informative if managers have little flexibility in accounting policies related to key success factors. Vice versa, accounting data likely will be more informative if managers are allowed more flexibility. All firms, however, have the flexibility to choose depreciation policy, inventory policy, policy for amortization of goodwill, and policies regarding the estimation of pension and other post-employment benefits. Deere and Co. depreciates their assets using a straight line method by depreciating the assets over their estimated useful life. All other competitors in the industry use straight line depreciation. Most inventories of Deere and Co. are valued at cost using the LIFO (Last in, First Out) method. In 2004, Deere and Co. recognized 61 percent of their inventory with the LIFO method. In 2003, 67 percent of their inventory was recognized using LIFO. The rest of Deere and Co.’s inventory was valued lower than cost using FIFO (First In, First Out) method. The FIFO method accounted for 39 percent and 33 percent of Deere and Co.’s inventory in 2004 and 2003 respectively. Under FASB statement No. 142, at the beginning of fiscal year 2003, goodwill will no longer be amortized and will only be written down due to impairments. All other intangible assets, excluding pension, will be amortized in 17 years or less. These assets, which are stated at cost less accumulated amortization, will use the straight line method. Deere and Co. adopted FASB Statement No. 132 in 2004, Employers Disclosures about Pensions and Other Postretirement Benefits. This statement is how Deere and Co. operates pensions, and is an amendment to Statements No. 87, 88, and 106. Pension will be remeasured and adjusted annually. These will be measured every October 31. Pension decreased significantly following 2003 because of a decrease in the minimum pension liability due to voluntary company contributions to the pension plan and the return on assets. The minimum pension liability in 2003 and 2004 was $1,964 million and $106 million respectively. The average annual return of Deere and Co.’s US pension fund during the past 10 years has been 11 percent. This rate of return reflects management’s expectations of long term average rates of return on funds invested to provide for benefits included in the projected benefit obligations. Deere and Co. expects to contribute $130 million to the pension fund in 2005.

Accounting Analysis

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FASB statement No. 123, Share Based Payment, will be implemented in the fourth fiscal quarter in 2005. This statement will eliminate the alternative for accounting for share-based compensation. Other accounting standards adopted in 2004 include FASB interpretation No. 46, Consolidation of Variable Interest Entities, and FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities

Step 3: Account Strategy Just like most publicly traded companies, the main accounting strategy of Deere and Co. is to provide the stakeholders with transparent financial statements and disclosures to ensure a true picture of the company. Comparing Deere and Co.’s financial statements to others in the agricultural machinery and equipment industry, Deere and Co.’s appears, at a glance, to have the most complete and detailed coverage. Upon a more in depth review, the accounting practices in the disclosures also show that they follow most of the same principles and structure as others in their industry. A few of the main areas that could cast a cloud over the true financial positions are those of depreciation, depletion of goodwill, inventories, warranty recognition, accounts receivable, and foreign currency translation. In the disclosure of depreciation, Deere and Co. depreciates on a straight line basis like all others in the industry, but goes the extra step and actually breaks down the categories being depreciated and shows the years that they are depreciated over and the amounts for the current year and previous years. However, others in the industry only confirm the usage of straight line and leave out the details of over what time periods the depreciation is occurring. In the case of depletion of goodwill, all the top competitors in the industry have changed their accounting policy to follow FASB No. 142, which states that goodwill should now be tested from time to time to find impairment for write-down. This differs from the previous method used by the industry where goodwill was amortized. Inventories are one of the main areas that companies can create distortions in their financial statements by the choice of what method of recording inventories they use. In comparing Deere and Co. to their main competitor Caterpillar, Deere and Co. records 67 percent of their inventories by the Last in First out (LIFO) method while Caterpillar records 80 percent of their inventories with LIFO. The difference in amounts recorded with the LIFO method results in a larger amount being recorded with First in First out (FIFO) method in Deere and Co.’s financials. This results in more of the oldest and cheapest expenses reaching the income statement with the accompanying revenues leaving a higher income. This could possibly lead to higher income being recorded in comparison to others in the industry such as Caterpillar. In an industry such as agricultural equipment, warranties are a big part of their business, and recording warranty expenses correctly is a big part of the picture. All the

Accounting Analysis

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main competitors in the industry record warranty expenses on historical claims. This should result in a respective level of warranties in all of the companies. Accounts receivable is an area of the financials where false revenues can be hidden. In comparison to other competitors, Deere and Co. has a very low accounts receivable turnover resulting in longer days to collect. A large portion of this has to do with their large credit operations which make them one of the largest equipment finance companies in the United States. This is an undertaking that many of the others in the industry don’t carry out on such a large scale and therefore don’t affect their accounts receivable as much as it does on Deere’s financials. So the ratios and numbers on the accounts may seem large, but it is really normal in the overall scale of their operations. All of the main competitors in this industry deal a great deal in foreign business. Therefore, proper foreign currency translation is required to properly represent their business deals abroad. Deere and Co. translates their foreign currency on a weighted average. However, some of the others in the industry translate their interests abroad on just an average. Using a weighted average allows Deere and Co. to record their foreign currency on a more accurate scale and not mislead users in their financials. According to many of the main disclosures, such as some of those discussed in the preceding paragraphs, Deere and Co.’s has a transparent accounting strategy that follows many of their top competitors in the industry and results in a relatively clear presentation of their company.

Step 4: Quality of Disclosure Evaluation In Deere and Co.’s Management’s Discussion and Analysis, an adequate amount of Information is provided in reference to the company’s current performance and future goals. Deere and Co. accurately contributes a large portion of their 28.6 percent spike in net sales to strong market conditions. Management discusses how record crop production and low interest rates were a contributing factor to their sales success. As for future performance, Management’s Discussion and Analysis adequately forecasts future sales and gives a realistic projection of 2 to 5 percent growth due to strong economic conditions. In addition, the Chairman’s Message outlines how the company plans to expand by growing a broader customer base through various products and contracts and by expanding globally. Deere and Co.’s Notes to Consolidated Financial Statements adequately explains their accounting policies and assumptions. In the footnotes, Deere and Co. discusses policies ranging from revenue recognition to how sales incentive costs are accounted for. Deere and Co. also discusses which accounting statements govern their accounting practices. However, one concern is that Deere and Co. doesn’t explain their logic behind certain accounting practices. Several methods of their allocation of costs require estimating, and Deere and Co. typically doesn’t outline the reasons for using heavy cost estimation. Interestingly, with all of the cost estimations, Deere and Co. fails

Accounting Analysis

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to include cost estimations of Stock Options as a result of changes to FASB Statement No. 123. A strong point to Deere and Co.’s disclosures is the fact that they effectively illustrate their financial data geographically and by segment. This makes it easy to determine that a large portion of their sales comes from agricultural equipment sales in the United States and Canada. In addition, the segment statements provide readers with enough information to adequately assess Deere and Co.’s performance and efficiency in each segment. Deere and Co. had strong financial success in 2004. Yet, in business, everything is not always “rosy.” In their 2004 financial statements, Deere and Co. doesn’t provide enough, if any, information pertaining to potential or current obstacles and challenges. Even during strong financial years, companies still have concerns. Yet, Deere and Co. does little to address these concerns. Being too optimistic can lead investors to questions the accuracy of the financial data provided. Deere and Co. has a solid investor relations program. Deere and Co. allows investors to purchase their stock directly from the company. However, unlike a lot of corporations, there is no charge for purchasing stock directly. In addition to providing annual reports, Deer and Co. also supplies fact sheets in various file formats. This makes it easy for investors and analysts to analyze Deere and Co.’s performance over a longer time period (10 years), and the fact sheet makes it easier for analysts to compute financial ratios based off of Deere and Co.’s financial statements.

Step 5: Potential Red Flags After conducting a ratio analysis over five years using Deere and Co.’s 2000 through 2004 financial statements, several identifiable trends stand out as definite potential red flags. The aspects of Deere and Co.’s business which we feel merit some further investigation have to do with the company’s inventory turnover, accounts receivable turnover and the corresponding days in accounts receivable, as well as their gross margin. While some of the ratios themselves maintain consistent trends that do not differ materially from either their competitors or the industry, the underlying fundamentals making up the ratios show cause for concern. When examining this company’s inventory turnover, the first item that grabs analysts’ attention would be the relatively low number in 2000 (5.75) followed by modest increases up to 2003. Upon further investigation, Deere and Co.’s cost of sales showed significant increases in all five of the years reviewed. While the inventory amounts fluctuated up and down throughout all of these years, these movements were not enough to offset the rather large increases in the ratio’s numerator. This increase could be the result of inefficient operations. It is important to ask, “has the company grown larger and become unable to distribute its products in manner that tightly controls costs?” Or, “could the production process itself be inefficient and therefore more expensive?” After referencing the corporation’s footnotes to the 10K report, it is

Accounting Analysis

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discovered that Deere and Co. primarily uses the LIFO accounting method for expensing inventory costs. While being characteristic of other competing firms in the industry (for example Caterpillar), this could be a possible explanation for the increase in cost of sales throughout those years. Whatever the reason, this will be the first order of business when doing further analysis of the company. The next item that deserves attention is Deere and Co.’s large days in accounts receivable ratio. This number has close to twice that of Deere’s competitors as well as the industry. The reason this number is so large is because Deere and Co.’s account’s receivable turnover number is close to, and sometimes less than, one, in all of the years under review. This draws attention to Deere’s large accounts receivable balances. The first question one asks is whether or not these sales are legitimate? It is very common in corporate America for a company to book large amounts of receivables in an effort to artificially increase the bottom line. While this issue will be investigated more closely throughout this analysis, the most probable reason for these large balances would be Deere’s enormous finance department. This business finance’s a large portion of Deere and Co.’s sales on account (revolving lines of credit), as well as the sale of its equipment to dealerships and the final consumer. Finally, taking into account the large increase in both sales and cost of sales, one would need to consider what effect this has on the company’s gross profit margin. While the large sales numbers are more than likely legitimate further analysis needs to be done to verify this fact. Also, the increasing cost of sales is definitely suspect and warrants further investigation. Seeing as how these are the two numbers making up gross margin, large misrepresentation here would have an effect on that ratio. Upon completion of this preliminary accounting analysis these are the factors that will initially be under investigation. While we expect legitimate reasoning behind some of the numbers, they still appear to be potential red flags

Step 6: Undo Accounting Distortions Deere and Co.’s financial statements appear to be transparent and represent their unique combination of consumer services and production needs. Therefore, we feel that no accounting distortions exist that need to be reversed.

Ratio Analysis and Forecast Financials

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Ratio Analysis and Forecast Financials The purpose of this section is to perform a financial ratio analysis of Deere and Co.’s liquidity, profitability, and capital structure, and this section will forecast the company’s Balance Sheet, Income Statement, and Statement of Cash Flows for the next 10 years. The financial ratios computed will be compared to three of their competitors, CNH Global, Kubota, and Caterpillar, and the industry average. This comparison will determine where Deere and Co. ranks in their industry in terms of financial performance. The forecast financials section will map out future growth for Deere and Co. This will give a visual of Deere and Co.’s future growth and performance.

Financial Ratio Analysis The ratio analysis section will discuss the trend among Deere and Co.’s financial ratios, and it will benchmark these ratios with their competitors and industry average. This will help evaluate Deere and Co.’s performance in comparison to their industry average and top competitors. .

Trend (Time Series) Analysis The trend analysis section will discuss the liquidity, profitability, and capital structure of Deere and Co. The analysis is based on 12 highly used ratios using data from the Balance Sheet, Income Statement, and Statement of Cash Flows. The actual ratio computations can be found in Appendix A of this report.

Deere and Co.’s Liquidity With the exception of working capital turnover, all of Deere and Co.’s liquidity ratios showed favorable signs. Thus, Deere and Co.’s overall liquidity is favorable. Their current ratio and quick asset ratio improved due to a combined increase in cash and decrease in short-term borrowings form 2000 to 2004. Deere and Co.’s inventory turnover improved 1.04 from 2000 to 2005 which reduced the days their products stayed in inventory. In addition, Deere and Co. improved their accounts receivables turnover which resulted in Deere and Co. reducing their collection process by over 50 days. Finally, Deere and Co.’s working capital turnover dropped 35 percent from 2000 to 2004. The reason for the drop in working capital turnover is Deere and Co.’’s cash increased at a greater rate than net income. This spike in cash increased working capital which led to the decrease in working capital turnover.

EvaluationFavorableFavorableFavorableFavorableNegativeFavorable

Working Capital Turnover

Liquidity RatiosCurrent RatioQuick Asset RatioInventory TurnoverAccounts Receivable Turnover

Overall Assessment


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Deere and Co.’s Profitability Overall, Deere and Co.’s profitability during the past five years has improved and, based on the following profitability ratio analysis, is favorable. Operating efficiency is measured by evaluating the gross profit margin, operating expense ratio, and net profit margin. The gross profit margin (gross profit on sales) was virtually unchanged. This illustrates that Deere and Co. didn’t increase their costs to produce products nor did they reduce their costs to produce their products. The operating expense ratio showed favorable results by dropping 1 percent. This shows that Deere and Co. is managing their operating expenses more effectively. Finally, the ratio that produced the most favorable results was the net income ratio. Deere and Co.’s net income increased 83 percent when compared to sales. There are two reasons for the spike in the net profit margin: first, Deere and Co. managed their operating costs more effectively, and second, Deere and Co had record sales in 2004 (32 percent increase in sales). As a result of their record sales, Deere and Co.’s gross profit from sales was allocated more towards net income than operating expenses. For a detailed breakdown of Deere and Co.’s operating efficiency, refer to the Common Size Income Statement in Appendix B. Deere & Co.’s asset turnover ratio increased 9 percent from 0.64 in 2000 to 0.70 (positive). The increase was due largely to Deere & Co.’s net income increasing at a greater rate than their assets. Even with the acquisition of additional assets, Deere & Co. was able to increase their return on assets (positive). Deere & Co. also experienced an increase in their return on equity from 2000 to 2004 (positive). Increases in both return on assets and return on equity are the result of large increases in net income.

EvaluationUnchangedFavorableFavorableFavorableFavorableFavorableFavorable

Profitability RatiosGross Profit MarginOperating Expense RatioNet Profit Margin

Return on AssetsReturn on EquityOverall Assessment

Asset Turnover

Deere and Co.’s Capital Structure Deere and Co.’s capital structure has improved during the last five years and overall is favorable. Deere and Co.’s debt to equity remained unchanged but illustrates that they are highly leveraged. It did spike during 2002 and 2003 as a result of additional long-term borrowings. However, the increase in liabilities was offset in 2004 by an increase in retained earnings and additional financing from common stocks. Deere and Co.’s time interest earned ratio increased (positive) from 2000 to 2004 as a result of higher earnings before interest and taxes (NIBIT). This shows that Deere and Co. has the ability to take on more debt than in prior years. Finally, Deere and Co.’s debt service margin increased 33 percent. This increase was a result of lower current installments on long-term borrowings.


Page 18

EvaluationUnchangedFavorableFavorableFavorableOverall Assessment

Capital Structure RatiosDebt to EquityTimes Interest EarnedDebt Service Margin

Cross Section (Benchmark) Analysis This section will compare Deere and Co.’s liquidity, profitability, and capital structure ratios with the industry average, Kubota, Caterpillar, and CNH Global. This comparison will help determine where Deere and Co.’s stands with respect to their top competitors.

Industry’s Liquidity

2000 2001 2002 2003 2004Deere & Co 1.58 1.64 2.16 2.46 2.60Kubota 1.47 1.36 1.44 1.44 1.48Caterpillar 1.44 1.30 1.24 1.34 1.29CNH Global 0.81 0.82 1.01 1.00 1.36Industry Avg 1.32 1.28 1.46 1.56 1.68

Current Ratio

Current Ratio

0.00

0.50

1.00

1.50

2.00

2.50

3.00

2000 2001 2002 2003 2004

Year

Valu

e

Deere & CoKubotaCaterpillarCNH GlobalIndustry Avg

Deere and Co dominate their industry in terms of their current ratio. This is comforting to lenders because it shows that Deere and Co. more likely to meet their short-term obligations compared to their competitors.

2000 2001 2002 2003 2004Deere & Co 1.41 1.48 1.98 2.28 2.35Kubota 0.31 0.30 1.04 0.85 0.97Caterpiller 0.98 0.86 0.83 0.92 0.90CNH Global 0.48 0.49 0.64 0.62 0.89Industry Avg 0.79 0.78 1.12 1.17 1.28

Quick Asset Ratio


Page 19

Quick Asset Ratio

0.00

0.50

1.00

1.50

2.00

2.50

2000 2001 2002 2003 2004

Year

Valu

eDeere & CoKubotaCaterpillerCNH GlobalIndustry Avg

Like their current ratio, Deere and Co. has a strong quick ratio. Once again, Deere and Co. is more likely to meet their short-term obligations compared to their competitors.


Inventory Turnover

Inventory Turnover

0.001.002.003.004.005.006.007.008.009.00

2000 2001 2002 2003 2004

Year

Valu

es

Deere & CoKubotaCaterpillerCNH GlobalIndustry Avg

Deere and Co. consistently has one of the highest inventory turnover ratios in their industry. This shows that Deere & Co is keeping their products in inventory for a shorter period of time than their competitors.


Page 20


Accounts Receivable Turnover

Accounts Receivable Turnover

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

2000 2001 2002 2003 2004

Year

Valu

es


With a low accounts receivable turnover ratio, Deere and Co. is taking more time to collect on their sales than their competitors. This negates any advantage Deere and Co. could have had by balancing out the total days in sales and inventory.

2000 2001 2002 2003 2004Deere & Co 2.17 1.82 1.29 1.17 1.40Kubota 3.36 4.90 4.36 4.34 4.65Caterpiller 4.91 6.09 7.32 5.41 6.51CNH Global -3.39 -6.14 NA NA 4.55Industry Avg 1.76 1.67 4.32 3.64 4.28



-8.00

-6.00

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

2000 2001 2002 2003 2004

Year

Valu

es

Deere & Co

Kubota

Caterpiller

CNH Global

Industry Avg


Page 21

Deere and Co. lag behind their competitors and the industry in working capital turnover. This shows that Deere Co. isn’t effectively using the current assets they have to generate sales. Overall, Deere & Co.’s liquidity is strong relative to their competitors. Deere and Co. has a better cash reserve than their competitors and turns their inventory better than any of their competitors. The only concerns are that Deere and Co.’s receivables take longer to collect, and they aren’t using the current assets as effectively as those in their industry.

Industry’s Profitability


Gross Profit Margin

Gross Profit Margin

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

2000 2001 2002 2003 2004

Year

Valu

es


Deere and Co. has the best gross profit margin compared to their competitors. It shows that Deere and Co. has more efficient operations than their competitors.


Operating Expense Ratio


Page 22

Operating Expense Ratio

0.00

0.05

0.10

0.15

0.20

0.25

2000 2001 2002 2003 2004

Year

Valu

esDeere & CoKubotaCaterpillerCNH GlobalIndustry Avg

Deere and Co. has one of the lowest operating expense ratios in their industry. Once again, this shows that they have more efficient operations.

2000 2001 2002 2003 2004Deere & Co 0.04 0.00 0.02 0.04 0.07Kubota 0.02 0.10 0.01 -0.01 0.01Caterpiller 0.06 0.04 0.04 0.05 0.07CNH Global 0.02 -0.04 -0.03 -0.04 -0.01Industry Avg 0.03 0.02 0.01 0.01 0.03

Net Profit Margin

Net Profit Margin

-0.06

-0.04

-0.02

0.00

0.02

0.04

0.06

0.08

0.10

0.12

2000 2001 2002 2003 2004

Year

Valu

es


Deere and Co. improved their net profit margin from 2001 to 2002 and is now the leader among their competitors.


Page 23


Asset Turnover

Asset Turnover

0.000.100.200.300.400.500.600.700.800.90

2000 2001 2002 2003 2004

Years

Valu

es


Deere and Company was indifferent when compared to their competitors and the industry average in terms of Asset Turnover.

2000 2001 2002 2003 2004Deere & Co 0.02 0.00 0.01 0.02 0.05Kubota 0.01 0.01 0.01 -0.01 0.01Caterpiller 0.04 0.03 0.02 0.03 0.05CNH Global -0.01 -0.03 -0.02 -0.02 0.01Industry Avg 0.02 0.00 0.01 0.01 0.03

Return on Assets


Page 24

Return On Assets

-0.03

-0.02

-0.01

0.00

0.01

0.02

0.03

0.04

0.05

0.06

2000 2001 2002 2003 2004

Years

Valu

es

Deere & Co

Kubota

Caterpiller

CNH Global

Industry Avg

Deere and Co.’s return on asset high compared to their competitors and industry. This shows that Deere and Co. is effectively using their assets to generate profits.

2000 2001 2002 2003 2004Deere & Co 0.11 -0.02 0.10 0.16 0.22Kubota 0.04 0.02 0.02 -0.03 0.03Caterpiller 0.19 0.15 0.15 0.18 0.27CNH Global -0.03 -0.15 -0.17 -0.15 0.09Industry Avg 0.08 0.00 0.02 0.04 0.15

Return on Equity

Return on Equity

-0.20-0.15

-0.10-0.05

0.000.050.10

0.150.20

0.250.30

2000 2001 2002 2003 2004

Years

Valu

es

Deere & Co

Kubota

Caterpiller

CNH Global

Industry Avg

Like return on assets, Deere and Co.’s return on equity is one of the highest in the industry. They are more effective at using their equity to generate profits compared to others in their industry.


Page 25

Overall, Deere and Co.’s profitability ratios are favorable compared to their competitors. Their efficient operations allow them generate better results than their competitors. The above analysis shows that Deere and Co. can charge lower prices for their products and still be profitable. Deere and Co. has a competitive advantage in reference to their ability to control their operations, and they could exploit their competitors’ weaknesses if they choose to do so.

Industry’s Capital Structure


Debt to Equity

Debt to Equity

0.001.002.003.004.005.006.007.008.009.00

10.00

2000 2001 2002 2003 2004

Years

Valu

es

Deere & Co

Kubota

Caterpiller

CNH Global

Industry Avg

As reflected in their debt to equity ratio, Deere & Co use more debt to finance their operations than most of their competitors. With a debt to equity ratio slight above the industry average, Deere and Co. is more leveraged than most of their competitors.


Times Interest Earned


Page 26

Times Interest Earned

0.001.00

2.003.004.00

5.006.007.00

8.009.00

2000 2001 2002 2003 2004

Years

Valu

esDeere & Co

Kubota

Caterpiller

CNH Global

Industry Avg

As a result higher debt financing, Deere and Co. has a lower times interest earned ratio. In other words, they have less room for debt financing than their competitors.

2000 2001 2002 2003 2004Deere & Co 0.57 0.40 0.76 0.72 0.76Kubota 1.25 0.64 1.81 1.71 2.14Caterpiller 10.58 9.93 -16.67 -22.00 -16.76CNH Global 0.08 0.54 -0.12 0.79 0.45Industry Avg 3.12 2.88 -3.56 -4.70 -3.35

Debt Service Margin

Debt Service Margin

-25.00

-20.00

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

2000 2001 2002 2003 2004

Years

Valu

es

Deere & Co

Kubota

Caterpiller

CNH Global

Industry Avg

If you throw out Caterpillar’s debt service margin, Deere & Co.’s is inline with the rest of the industry in terms of meeting short-term obligations with operating cash. However, the industry overall is relatively low compared to other industries such as refinery.


Page 27

Overall, Deere and Co. is inline with the rest of the industry in terms of capital structure. There is not one particular area that Deere and Co. is highly leveraged when being compared to others in their industry. However, if Deere and Co. can reduce their debt during the upcoming years, this will give them more leverage in terms of debt and equity financing.

Financial Statement Forecasting Methodology

SGR Prior to forecasting Deere and Co.’s financial statements for the next ten years, common size balance sheets, income statements, and cash flow statements were created in an attempt to capture any constant trends in Deere and Co.’s numbers. More specifically, past sales trends were examined in order to identify any constant percentage growth in total revenue. The years 2001 through 2004 illustrate an extremely important change in Deere’s overall business model, especially with regards to the company’s sales. During 2003 and 2004 in particular the company expanded its consumer finance division, greatly increasing the amount of equipment sold on credit and consequently increasing the company’s overall sales. This expansion explains the company’s astronomical sales growth, from 2002 to 2004. According to Deere and Co.’s financials, the company grew sales 11.38 percent from 2002 to 2003, and 28.66 percent from 2003 to 2004. We believe that by using consumer financing, this company will be able to sustain double digit sales growth, at least into the foreseeable future. The Common Size Balance Sheet, Income Statement, and Statement of Cash Flows can be found in Appendix C, B, and D, respectively. To begin discussion of the sales estimates used, we first turn our attention to Deere and Co.’s sustainable growth rate (SGR). While the company has declared dividends in all of the years examined, the actual amount of dividends is immaterial in proportion to the organization’s net income. This effectively causes Deere and Co.’s plowback ratio to be equal to one, making the SGR equal to ROE. Taking an average of the company’s actual ROE over the last four years (2001’s ROE was incalculable due to the incurrence of a net loss) one finds that Deere and Co. has an average ROE, and therefore an average SGR, of 14.75 percent. When considering that this company has grown its sales by an average of 20 percent from 2002 to 2004, Deere and Co.’s most probable growth rate would be in excess of its sustainable growth rate. While it is understandable that the company will not be able to sustain sales growth of 20 percent over the next ten years, we feel that due to the aggressive expansion of Deere and Co.’s financing division, and the company’s track record of almost 100 percent plowback, a sales growth estimate of 11 percent is not unreasonable. While this projected growth rate is not in excess of the SGR, Deere and Co. has still made considerable changes to its capital structure in order to achieve this growth. Our analysis suggests that although Deere and Co. is making significant changes to its capital structure through the use of revolving debt, this does not necessarily have a negative impact on the company as a whole. It is true that currently the financial sector is at best questionable due to the uncertainty of future interest rates. It is also true that many companies who are lending long term at fixed rates are exposed to a


Page 28

considerable amount of interest rate risk. We feel that because the interest rates that Deere and Co. charges are variable in nature, the changes that have been made to the company’s capital structure in order to sustain this growth do not reflect negatively on the company as a whole. More plainly, since Deere and Co. is able to increase or decrease its interest rate in reaction market rates, the leverage that it has taken on is less risky. Given these circumstances, a projected sales growth rate of 11 percent was used as the basis for our forecasted income statements. This percentage increase is reflected in total revenue, which serves as a starting point for the rest of the numbers that appear in the forecasted income statements. For more information on SGR, refer to Appendix E.

Income Statement After evaluating the SGR, we continued through the Income Statement to the Cost of Sales. Using five years of data, our team compiled a Common Size Income Statement and used it to recognize trends in the calculations. From this information, we were able to accurately compute an average, which was then used as our primary tool for our ten year forecast. Each percentage represented in the Common Size Income Statement is shown as a percentage of sales. The five year data and the overall average are reported as follows:

2000 2001 2002 2003 200468.02% 70.54% 68.78% 69.22% 67.88%

Cost of Sales

Average cost of sales: 68.89% As mentioned earlier, the average is the number we used to make the forecast. For example, these figures show us that we predict the average cost of sales to be between 68 and 69 percent of our sales for the next ten years. Therefore; regardless of how our sales information may change, we still expect the cost of sales to be around 69 percent of that number. The next line item, Research and Development, was not calculated as an average. Instead, the figure is an estimate of what seemed like a reasonable figure, considering new business ventures that Deere and Co. is involved in. The Research and Development costs have been decreasing as a percentage of sales over the past five years, from 4.13 percent to 3.06 percent. However, we feel that while Deere and Co. is taking on new business growth with the addition of financing options for customers, it is better to overestimate this item slightly incase of unforeseen action by the company. The average is actually 3.8 percent for the past five years, but to stay on the safe side, we have estimated 4 percent. The Selling, General and Administrative (SG&A) expense was noted to have a few figures that were inconsistent with the other data. Excluding these outliers, the average of the three consistent years is 11.5 percent of sales. When compared with the total average of all five years, the result is slightly different at 11.6 percent. To exclude the


Page 29

years that may have been inaccurate, we decided to forecast using 11.5 percent, which was derived from the years that seemed the most accurate. The value we used to forecast the Interest expense was decided upon after analyzing the historical data. This figure is shrinking as a percentage of sales, and experienced a drastic drop between 2003 and 2004. We cannot be sure that this is a direct indicator of Interest Expense in the future because it is so different from the previous information. As an alternative, we looked to the four years prior to the drop in 2004, and decided that Interest Expense has (although it is decreasing) is traditionally about 4 percent of sales. Once again, the information from the Common Size Income Statement seemed to have one percentage that was not in line with the rest. The Health Care Claims and Costs data is represented as follows:

2000 2001 2002 2003 20042.90% 3.58% 3.72% 3.45% 3.25%

Health Care Claims and Costs

Total Average: 3.38% Average excluding outlier: 3.5% Clearly, the year 2000 is not an accurate estimation of Health Care Claims and Costs in Sales. This number is an outlier, and after being thrown out, the new average is 3.5 percent. The ‘Other’ Operating Expense account is also currently decreasing. We assume that this is correct because the data shows that the percentage of Other Operating Expense of sales has gone down for the past three consecutive years. It also shows that there was an increase between the years of 2000 and 2001. Assuming it is normal for this value to fluctuate, we took an average to get a good idea of where the number usually falls. The average of these values is approximately 2.5 percent. Deere and Co. is currently experiencing a change in accounting policies that has to do with the income of consolidated entities. To forecast the expected percentage Income for Consolidated Groups of sales, we once more took the average of the past five years of data. This value was 5.5 percent. Because this section of the company is changing right now, we felt that it was appropriate to be a little more aggressive with that value. We forecasted the next ten years using 6.5% percent for this item. Since Deer and Co. is such a large corporation, it is taxed in the highest tax bracket which is 35 percent. To derive our taxes value, our team took the Income Before taxes and multiplied it by the 35 percent required by the tax bracket. After finding the taxes, we subtracted the Income Before taxes from that value to obtain the Net Income amount. A copy of the forecasted income statement can be found in appendix F.


Page 30

Forecasting the Balance Sheet The Balance Sheet was forecasted using a weighted average method. We found the average from the previous five years and used that average to forecast the following ten years. We found the average for all the accounts on the Balance Sheet from the past five years. For the most part, the average follows a trend. We feel that this trend will help in forecasting the future of the firm. The asset accounts are computed as a 100 percent of total assets, liability accounts as a 100 percent of total liabilities, and equity accounts as a 100 percent of equity. Half of Deere and Co.’s assets are cash and cash equivalents and net financing receivables. Liabilities and Equity were also calculated using a weighted average. The biggest components to liabilities are the short and long term borrowing accounts. The equity section is the only section to report a negative growth rate in certain categories. Treasury stock and unamortized restricted stock compensation reported negative growth rates. The figures under total add up to be more than 100 percent. The reason for this is because of adjustments. Because Deere and Co. operates overseas, they have currency adjustments. To make the Balance Sheet more transparent, we added the adjustments to reach the bottom line total stockholders equity. Using the weighted average method was an efficient way to measure future growth because the trends were very close to the averages. Also, in cases that a trend could not be established, the weighted average provided a means to calculate future numbers. A copy of the forecasted balance sheet can be found in Appendix G.

Forecasting the Statement of Cash Flows Like the Balance Sheet, the Statement of Cash Flows was also calculated using a weighted average method. The Statement of Cash Flows is divided up into investing activities, financing activities, and operating activities. All three categories are based on 100 percent of their respected categories. Net Income is found in the operating activity section. The investing activities contained some real extreme numbers. Cost of receivables acquired was 1191.06 percent of investing activities. Some extreme negative numbers are collections of receivables and proceeds from sales of financing receivables, which came up as -867.27 percent and -280.15 percent respectively. Proceeds from long term borrowing were the number one component of the financing section. A copy of the forecasted cash flows can be found in appendix H.

Page 31

Valuations Analysis The main purpose of the valuation section is to use the information we have accumulated so far, as well as additional data, to arrive at a fair value for Deere and Co.’s common stock. Using these two resources we will estimate the company’s cost of equity and debt, along with a weighted average cost of capital for the entire firm. Then we will apply this information to six different valuation models (the method of comparables, discounted dividends, discounted free cash flows, discounted residual income, abnormal earnings growth, and the long run average residual income perpetuity based on the price – to – book ratio) ultimately arriving at an estimate fair value for Deere and Co.’s common share price. This analysis will enable us to determine whether Deere and Co. is overvalued, undervalued, or fairly valued. The analysis and logic that underlies our assumptions will be discussed, along with our confidence in the final result.

Valuations Before we can use our forecasted financial statements as inputs into our valuation models, it is necessary that we calculate Deere and Co.’s cost of equity, cost of debt, and weighted average cost of capital. In doing this, we will establish the discount rates that will be employed in our various valuation models. These different rates will then be used as inputs into the appropriate models to discount dividends, cash flows, earnings etc., ultimately arriving at Deere and Co.’s estimated share price. While the method used to calculate Deere and Co.’s different discounts rates will be explained later in greater detail, it is important now to note what these rates will be used for and why they are important. The only method of valuation which does not require the use of any calculated discount rate is the method of comparables, which will be discussed first.

Method of Comparables The method of comparables required that we take Deere and Co.’s most obvious direct competitors (Kubota, Caterpillar and CNH Global) and calculate certain multiples. These multiples were based on; a trailing and a forward earnings per share (EPS), book value per share, dividends per share, price per share, growth in EPS, and sales per share. These per share values were then divided or multiplied by the share price to come up with multiples for each individual competitor. For instance, Kubota’s trailing PE multiple of 7.11 was calculated by dividing Kubota’s price per share of $27.09 by their trailing EPS of 3.81. The price to book, dividend yield, price to sales, and price to earnings growth were calculated in this same fashion. The competitor’s multiples were then averaged, excluding the Deere and Co.’s information, to get an average industry multiple. This average industry multiple was then multiplied by the appropriate number to arrive at an estimated share price. More information on our calculations for the Method of Comparables can be found in Appendix I.

Valuations Analysis

Page 32

Trailing P/E 84.65$ Forward P/E 48.81$ P/B 54.87$ D/B 64.87$ P/S 58.18$ PEG 14.64$

Multiples

In terms of quality and relevance the price to earnings growth will be immediately thrown out of our analysis due to the fact that it yielded a negative share price. This negative share price is a result of negative growth in EPS during the years examined. Some of the other multiple valuations however, appear to be more useful. Given our April 1 closing price of $66.24 the dividend yield valuation appears to be the most accurate. This valuation of $64.87 suggests that Deere and Co. shares are currently overvalued and would lead the analyst to recommend a no buy. Given forward PE, price to book, and price to sales valuations of $40.82, $57.47, and $51.52 respectively almost all of the multiples valuations seem to suggest that the shares are overvalued as well. Only the trailing EPS multiple suggests that Deere and Co.’s shares are undervalued with a valuation of $84.77. This valuation is due to the large trailing EPS number of $5.70 which is not in line with other EPS estimations which could in turn cause the trailing EPS number to be treated like an outlier and thrown out as well. While the method of comparables can be a reliable way of valuing a firm, and has the potential to produce correct intrinsic valuations, its major flaw is that it assumes that the competitors used are relevant to the firm at hand. While we stand by the assumption that the companies chosen directly compete with Deere and Co. and therefore can be potentially relevant in this valuation, there is the possibility that the pricing of these firms is not applicable to Deere and Co. For this reason we feel that the next five valuation models give a more realistic picture of Deere and Co.

Cost of Capital Estimation The four valuation methods used are based on either Deere & COs cost of equity (ke) or weighted average cost of capital (WACC). In order to determine Deere & COs WACC, we had to first determine their cost of debt and cost of equity. We used a weighted average cost of debt to determine Deere & COs total cost of debt. Supporting calculations are provided in Appendix J. Deere & COs cost of equity was derived using the capital asset pricing model (CAPM).

)( fmfe rrrr −+= β

re – the firm’s cost of equity, 7.79% rf – the risk free rate, 4.01% β – the firm’s beta, .6068 rm – the market rate, 6.24% The risk free rate was obtained by calculating the average 60 month gain/loss of a 5 year treasury bill. The market rate was derived by taking the average 60 month

Valuations Analysis

Page 33

gain/loss of the S&P 500. Finally, the firm’s beta was calculated by taking the slope of the risk free rate and the market premium over the past 60 months. Supporting calculations are provided in Appendix J. Upon calculating the Deere & Co.s cost of debt and cost of equity, we then completed their WACC. Deere & Co.’s WACC is

ede

ed

ed

d kVV

Vk

VVV

WAAC+

++

=

WACC – 3.40% Vd – the market value of the firm’s debt, $22,361.2 million Ve – the market value of the firm’s equity, 246.7 million shares X $66.24 per share, $16,352 million kd – the firm’s cost of debt, 2.38% ke – the firm’s cost of equity, 7.79% The market value of the firm’s debt was taken directly from Deere & Co.’s 2004 Balance Sheet. The market value of the firm’s equity was computed taking Deere and Co.’s stock price on April 1, 2005 multiplied by the number of shares of common stock outstanding. With Deere and Co.’s WACC and ke, we now have enough information to run all of the valuation models.

Discounted Dividends Model

∑∞

=

+

+=

1

1

)1()(

tt

e

tt k

dEPPS

or (in perpetuity)

grdE

PPS tt −= + )( 1

The discounted dividends model requires forecasted dividends per share to be discounted to the current year using Deere and Co.’s ke of 7.79%. Then, the model requires that the sum of those discounted dividends be added to the present value of the terminal value of the company using Deere and Co.’s ke minus the projected dividend growth rate. This summation provides us with Deere and Co.’s price using the discounted dividends model. There are several assumptions that were made to forecast Deere & Co.’s dividends. We looked at Deere & Co.’s recent trends in dividends payout. From 2003 to 2005, Deere has increased their dividend payout rate by an annual percentage of 18 percent on average. We do not anticipate that this rate will be sustained for a long period of time; however, we do predict that, with Deere & Co.’s recent success domestically and plans to expand internationally, their dividend growth rate will level out at 11 percent for

Valuations Analysis

Page 34

the next 10 years. After that, Deere & Co. will return to a moderate dividend growth rate of 2 percent. With these assumptions in place, we forecasted Deere & Co.’s price to be $43.01 as of April 1, 2005. Based on this model, Deere & Co.’s current price of $66.24 is overvalued. Supporting Calculations are found in Appendix K.

Sensitivity Analysis Growth

1% 1.50% 2% 2.50% 3% 5% $ 59.21 $ 77.23 $ 87.24 $ 101.26 $ 122.28 6% $ 48.11 $ 58.74 $ 64.05 $ 70.88 $ 79.98 7% $ 40.26 $ 47.04 $ 50.20 $ 54.07 $ 58.91 8% $ 34.42 $ 39.00 $ 41.03 $ 43.43 $ 46.32

Ke

9% $ 29.93 $ 33.15 $ 34.53 $ 36.11 $ 37.97 Based on the sensitivity analysis for discounted dividends, either an increase in the growth rate or a decrease in the cost of equity will cause the price to rise. In addition, growth rates between of 2 percent with the cost of equity between 6 and 7 percent bring the value closer to the actual stock price. It is also important to know that Deere & Co.’s price under the discounted dividends model is more sensitive to changes in the growth rate than changes in the cost of equity.

Discounted Free Cash Flows

∑∞

=

+

+=

0

1, )1(

)(t e

tttE k

FCFEV

Several steps are required to determine the value of Deere &Co.’s using the discounted free cash flows model. First, we subtract forecasted cash flows from investments from cash flows from operations to get cash flows provided to the firm. Next, we take the summation of 10 years of discounted cash flows to the firm using the WACC. Then, we took the continuing value, the perpetuity of year 11 discounted to the present value, and added it to the present value of the cash flows to come up with the value of the firm. Finally, we took the value of the firm minus the book value of the debt obtained from the balance sheet to get the value of the Deere & Co.’s equity. Dividing Deere & Co.’s equity by the number of common stock shares outstanding gave us a price $194.91. Based on this model, Deere & Co.’s current price of $66.24 is undervalued. Supporting calculations are provided in Appendix L.


1.50% 2% 2.50% 3% 4% $ 71.27 $ 105.12 $ 161.53 $ 274.36 5% $ 22.96 $ 36.94 $ 57.45 $ 88.21 6% $ (4.77) $ 3.00 $ 12.99 $ 26.32 7% $ (21.88) $ (17.25) $ (11.59) $ (4.51)

Ke

8% $ 3.17 $ 8.01 $ 13.53 $ 19.91

Valuations Analysis

Page 35

The sensitivity analysis of the discounted free cash flows shows that the price is more sensitive to changes in growth when the cost of equity is low. In addition, the valued price is close to the actual price when the cost of equity is between 4 and 5 percent. However, small fluctuations both the cost of equity and growth rate can have large impacts on Deere & Co.’s valued stock prince using this model.

Discounted Residual Income

∑∞

=+

+

+−

+=0

11

, )1()()((

Tt

e

tettttE k

BVEkNIEBVEV

The discounted residual income model derives a share price by first taking the book value of equity (BVE) per share in the initial year of the valuation, and assuming that the firm will at least earn the cost of equity on that amount. This rate of return on the BVE is termed “normal income”. The previous year’s ending BVE then becomes the current year’s beginning BVE. The current year’s EPS is added to that year’s beginning BVE and whatever dividends per share were paid, or are forecasted to be paid, are subtracted from that amount. This calculation then arrives at ending BVE for that current year. By subtracting the normal income number from the current year’s EPS you arrive at the firm’s forecasted residual income for that year. Deere and Co.’s residual income was forecasted in this manner and then discounted back to today’s dollars using the appropriate present value factor. Next a terminal value is assumed in order to account for the fact that residual income is expected to continue infinitely. In our analysis we chose to use the last year’s residual income as the terminal value and assumed a moderate growth rate of two percent perpetually. This terminal value was discounted back to today’s dollars in the same way as the residual income. Summing the terminal value with the total of present values of each individual year’s residual income together with the initial years ending BVE yields a stock price of $80.00 on April 1, 2005. This indicates that Deere and Co.’s shares are undervalued at $66.24, which would lead the analyst to believe that the shares should be purchased. Supporting calculations are provided in Appendix M.


1% 1.50% 2% 2.50% 3% 6% $ 110.60 $ 117.25 $ 125.56 $ 136.25 $ 150.50 7% $ 87.42 $ 91.11 $ 95.54 $ 100.96 $ 107.73 8% $ 71.21 $ 73.36 $ 75.87 $ 78.84 $ 82.40 9% $ 59.31 $ 60.60 $ 62.08 $ 63.78 $ 65.76

Ke

10% $ 50.28 $ 51.06 $ 51.94 $ 52.94 $ 54.08 After examining the sensitivity analysis that corresponds to this model one can see that values closest to the actual share price are attained at a cost of equity of about nine percent, and growth rates of about two to three percent. This would lead on to believe that our calculated cost of equity (approximately 8 percent) could be a little low, but the assumed growth rate (2 percent) seems to be accurate.

Valuations Analysis

Page 36

Abnormal Earnings Growth The Abnormal Earnings Growth (AEG) model takes into account the growth possibilities of the distributed dividends assuming that a reasonable investor would reinvest these distributions at the cost of equity capital. What this means is that the previous year’s dividends were assumed to earn the cost of equity for the entire year and that this amount was added to the current years EPS to arrive at cumulative dividend earnings. Normal earnings, which consists of the previous year’s EPS grown at the cost of equity capital, is then subtracted from this cumulative dividend earnings number to arrive at abnormal earnings. For John Deere this number was negative for every year forecasted. We then discounted all AEG at the appropriate present value factor. A terminal value was then determined by taking the tenth year’s AEG and discounting at the cost of equity. A share value as of April 1, 2005, of $26.54 was obtained by taking the core EPS and subtracting out the present value of the AEG the present value of the continuing value and then capitalizing this number at the cost of equity. Details for AEG are provided in Appendix N.


0% 1% 6% $ 15.75 $ 0.43 7% $ 32.24 $ 23.62 8% $ 40.86 $ 35.65 9% $ 45.29 $ 41.98

10% $ 47.37 $ 45.17 11% $ 48.07 $ 46.56 12% $ 47.94 $ 46.88 13% $ 47.32 $ 46.56 14% $ 46.41 $ 45.85

Ke

15% $ 45.32 $ 44.90 The AEG model shows that increases in the growth rate cause the price to fall. In addition increases in the cost of equity up to 11 percent cause the price to increase. Cost of equity above 11 percent causes the price to drop. Since the highest price generated by this model is around $48.07 we are unable to conclude any real meaning from the model. That is to say that it probably does the worst job of estimating the actual price of the stock.

Lon Run Residual Income

⎟⎟⎠

⎞⎜⎜⎝

⎛−−

+= de

etE gk

kROEBVEBVEV *,

This valuation model is yet another used to compute the estimated price of a stock. The computation of this model begins with the return on equity (ROE) minus the cost of equity (Ke) which is divided by the cost of equity minus the growth rate (G). This

Valuations Analysis

Page 37

number is then multiplied by the book value of equity (BVE) which is then added to the book value of equity. Finally this number is divided by the total common shares outstanding. The final number calculated is the estimated value of the firm’s stock price. For this model the cost of equity is derived from the CAPM which was also used to evaluate the other models in this valuation. The growth rate is a rate that we believe is a good representation of the firm’s future potential, and the book value of equity is derived directly from the firm’s balance sheet along with the total number of common shares outstanding. The price that this model gives is $91.07 which is well over the stock price as of April 1st of $66.24. Therefore, the valuation of this model is that the stock price is undervalued. Supporting calculations are provided in Appendix O.


1% 1.50% 2% 2.50% 3% 7% $ 90.62 $ 96.50 $ 103.56 $ 112.19 $ 122.98 8% $ 77.67 $ 81.65 $ 86.30 $ 91.79 $ 98.38 9% $ 67.96 $ 70.77 $ 73.97 $ 77.67 $ 81.98

10% $ 60.41 $ 62.44 $ 64.73 $ 67.31 $ 70.27

Ke

11% $ 54.37 $ 55.87 $ 57.53 $ 59.39 $ 61.49

Based on the sensitivity analysis for long run residual income model, the price is more sensitive to changes in the growth rate than changes in the cost of equity. According to his model, a cost of equity between 9 and 10 percent will bring the value closer to the actual stock price.

Conclusion

Trailing P/E 84.65$ UndervaluedForward P/E 48.81$ OvervaluedP/B 54.87$ OvervaluedD/B 64.87$ OvervaluedP/S 58.18$ OvervaluedPEG 14.64$ Overvalued

Discounted Dividends 43.01$ OvervaluedDiscounted Cash Flows 194.41$ UndervaluedResidual Income 80.00$ UndervaluedAbnormal Earnings Growth 26.54$ OvervaluedLong Run Average Residual Income 91.05$ Undervalued

Intrinsic Value Models

Multiples

The valuations that do the best job of estimating our current stock price are the discounted dividend model, the dividend yield, and the price to sales multiple. On

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Page 38

average the valuations state that our company’s shares are overvalued, and we would therefore recommend to short the stock or to engage in some options trading. On average the valuation models suggest that our stock should be intrinsically valued at around $45 to $50 dollars. Some of the main weakness of our valuations could come from miscalculations of forecasts, since all of the models in one way or another derive there values from estimates in cash flows, dividends, earnings etc. Some pieces of information that could prove to be very useful in performing valuations in the future would be expert opinions on growth rates in terminal values or other estimations that we made. We feel that some expert direction in this regard could make the terminal values used in our models more precise and meaningful.

Page 39

References 1. http://www.forbes.com/ (stock prices, comparisons with industry, valuation measures, charts and graphs) 2. http://www.cat.com/cda/layout?x=7 (Cat financials) 3. http://www.deere.com/en_US/deerecom/usa_canada.html (Deere financials) 4. http://www.cnh.com/ (CNH financials) 5. http://www.fortune.com/fortune/ (stock prices, comparisons with industry, valuation measures, charts and graphs) 6. http://online.wsj.com/public/us (industry news and analysis) 7. http://finance.yahoo.com/ (stock prices, comparisons with industry, valuation measures, charts and graphs) 8. http://edgarscan.pwcglobal.com/servlets/edgarscan (10k and other financials about Caterpillar, Deere, Kubota, CNH) 9. http://www.sec.gov/ (10k and other financials about Caterpillar, Deere, Kubota, CNH) 10. Palepu, K.G., Healy, P.M., Bernard, V.L. (2004). Business Analysis and

Valuation: Using Financial Statements. Mason: South-Western.

http://www.forbes.com/

http://www.cat.com/cda/layout?x=7

http://www.deere.com/en_US/deerecom/usa_canada.html

http://www.cnh.com/

http://www.fortune.com/fortune/

http://online.wsj.com/public/us

http://finance.yahoo.com/

http://edgarscan.pwcglobal.com/servlets/edgarscan

http://www.sec.gov/

Page 40

Appendix A

Trend (Time Series) Analysis 2000 2001 2002 2003 2004 Current Ratio 1.58 1.64 2.16 2.46 2.60 Quick Asset Ratio 1.41 1.48 1.98 2.28 2.35 Inventory turnover 5.75 6.23 6.99 7.87 6.79 Days Supply 63.43 58.61 52.19 46.37 53.78 Accounts Receivable Turnover 1.11 1.06 1.14 1.19 1.32 Days to Collect 328.97 343.51 320.00 305.96 275.81 Working Capital Turnover 2.17 1.82 1.29 1.17 1.40 Gross Profit Margin 0.32 0.29 0.31 0.31 0.32 Operating Expense Ratio 0.12 0.13 0.12 0.11 0.11 Net Profit Margin 0.04 0.00 0.02 0.04 0.07 Asset Turnover 0.64 0.59 0.59 0.59 0.70 Return on Assets 0.02 0.00 0.01 0.02 0.05 Return on Equity 0.11 -0.02 0.10 0.16 0.22 Debt to Equity Ratio 3.76 4.68 6.51 5.56 3.50 Times Interest Earned 1.15 -0.03 0.95 1.55 3.57 Debt Service Margin 0.57 0.40 0.76 0.72 0.76

Page 41

Appendix B

Common Size Income Statement 2000 2001 2002 2003 2004

Net Sales and RevenuesNet sales 85.02% 83.33% 83.91% 85.93% 88.43%Finance and interest income 10.06% 10.87% 9.60% 8.21% 5.98%Health care premiums and fees 3.61% 4.40% 4.56% 4.28% 3.83%Other income 1.18% 1.31% 1.93% 1.58% 1.76%Total 100.00% 100.00% 100.00% 100.00% 100.00%

Costs and ExpensesCost of sales 68.02% 70.54% 68.78% 69.22% 67.88%Research and development expenses 4.13% 4.44% 3.78% 3.72% 3.06%SGA 11.46% 12.92% 11.88% 11.23% 10.59%Interest expense 5.15% 5.76% 4.57% 4.05% 2.96%Health care claims and costs 2.90% 3.58% 3.72% 3.45% 3.25%Other operating expenses 2.43% 2.95% 2.94% 2.09% 1.67%Total 94.08% 100.19% 95.68% 93.75% 89.42%

Income of Consolidated Group before Income 5.92% -0.19% 4.32% 6.25% 10.58%

TaxesProvision for income taxes 2.24% 0.13% 1.85% 2.17% 3.54%

Net Income 3.70% -0.48% 2.29% 4.14% 7.04%

Dividends declared 0.00670% 0.00662% 0.00631% 0.00566% 0.00530%

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Appendix C

Common Size Balance Sheet ASSETS 2000 2001 2002 2003 2004 AverageCash and cash equivalents 1.43% 4.54% 11.84% 16.70% 11.06% 9.11%Marketable securities 0.62% 0.78% 0.80% 0.88% 0.86% 0.79%Receivables from unconsolidated affiliates 1.13% 1.40% 1.12% 1.15% 0.06% 0.97%Trade accounts and notes receivable - net 15.48% 12.90% 11.50% 9.98% 11.15% 12.20%Financing receivables - net 40.43% 40.59% 38.15% 37.99% 39.06% 39.24%Other receivables 1.93% 1.72% 1.79% 1.63% 2.31% 1.88%Equipment on operating leases - net 9.55% 8.56% 6.77% 5.26% 4.51% 6.93%Inventories 7.59% 6.64% 5.77% 5.20% 6.95% 6.43%Property and equipment - net 9.34% 9.06% 8.41% 7.90% 7.52% 8.45%Investments in unconsolidated affiliates 0.93% 0.88% 0.76% 0.74% 0.37% 0.74%Goodwill 0.00% 0.00% 0.00% 3.32% 3.39% 1.34%Other intangible assets - net 3.19% 3.86% 3.77% 0.96% 0.08% 2.37%Prepaid pension costs 3.10% 2.88% 0.21% 0.24% 8.67% 3.02%Other assets 1.25% 1.86% 2.45% 2.03% 1.79% 1.88%Deferred income taxes 3.62% 3.90% 6.27% 5.62% 1.84% 4.25%Deferred charges 0.41% 0.46% 0.40% 0.38% 0.38% 0.41%Total Assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

LIABILITIES AND STOCKHOLDERS EQUITYLIABILITIES 2000 2001 2002 2003 2004 AverageShort-term borrowings 35.62% 33.20% 21.54% 19.53% 15.46% 25.07%Payables to unconsolidated affiliates 0.20% 0.09% 0.31% 0.39% 0.64% 0.33%Accounts payable and accrued expenses 18.41% 16.59% 15.25% 13.95% 17.77% 16.39%Health care claims and reserves 0.39% 0.54% 0.45% 0.42% 0.61% 0.48%Accrued taxes 0.36% 0.24% 0.42% 1.02% 0.80% 0.57%Deferred income taxes 0.46% 0.07% 0.12% 0.14% 0.28% 0.21%Long-term borrowings 29.47% 35.14% 43.44% 46.75% 49.60% 40.88%Retirement benefit accruals and other liabilities 15.09% 14.14% 18.47% 17.79% 14.85% 16.07%Total liabilities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%STOCKHOLDERS EQUITYCommon Stock 43.34% 48.81% 61.87% 49.67% 31.97% 47.13%Treasury Stock -33.45% -35.21% -41.80% -28.52% -16.27% -31.05%Unamortized restricted stock compensation -0.25% -0.42% -0.56% -0.14% -0.20% -0.32%Retained earnings 95.71% 96.06% 123.69% 108.18% 85.18% 101.76%Total 105.34% 109.24% 143.20% 129.18% 100.67% 117.53%other adjustments -10.68% -18.48% -86.39% -58.37% -1.34% -35.05%Total stockholders equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

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Appendix D

Common Size Statement of Cash Flows 2000 2001 2002 2003 2004 Average

Cash Flows from Operating ActivitiesNet income 44.95% -5.75% 16.99% 41.88% 120.95% 43.81%Adjustments to reconcile net income to net cash provided by operating activities:Provision for doubtful receivables 6.94% 10.15% 8.56% 6.95% 4.42% 7.41%Provision for depreciation and amortization 59.99% 64.51% 38.61% 41.11% 53.42% 51.53%Undistributed earnings of unconsolidated affiliates -0.11% 1.75% 1.21% -0.36% 1.78% 0.85%Provision (credit) for deferred income taxes -12.31% -20.68% -0.06% 2.16% 33.12% 0.44%Receivables -4.98% 28.46% 8.42% 11.87% -41.10% 0.53%Inventories -17.04% 12.26% 4.57% 5.48% -25.26% -4.00%Accounts payable and accrued expenses 50.00% 3.66% 7.67% -12.04% 75.07% 24.87%Other* -27.45% 5.64% 14.03% 2.95% -122.40% -25.45%Net cash provided by operating activities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Cash Flows from Investing ActivitiesCollections of receivables -213.97% -294.57% -2225.16% -1013.01% -589.66% -867.27%Proceeds from sales of financing receivables -31.45% -73.07% -945.16% -216.61% -134.46% -280.15%Proceeds from maturities and sales of marketable securities -7.97% -1.37% -24.01% -8.53% -3.84% -9.14%Proceeds from sales of equipment on operating leases -10.76% -16.56% -157.71% -57.42% -25.61% -53.61%Proceeds from sales of businesses 0.00% 0.00% -17.04% -2.51% -5.22% -4.95%Cost of receivables acquired 293.43% 414.21% 3170.48% 1291.91% 785.26% 1191.06%Purchases of marketable securities 1.99% 3.20% 27.96% 13.19% 4.59% 10.19%Purchases of property and equipment 13.72% 20.76% 114.24% 34.55% 20.96% 40.85%Cost of operating leases acquired 30.22% 32.78% 155.38% 52.86% 32.91% 60.83%Acquisitions of businesses, net of cash acquired 20.68% 13.33% 6.05% 1.18% 11.11% 10.47%Decrease (increase) in receivables from unconsolidated affiliates 4.35% 4.74% -4.71% 0.76% 3.96% 1.82%Other -0.24% -3.45% -0.32% 3.62% 0.01% -0.08%Net cash used for investing activities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Cash Flows from Financing ActivitiesIncrease (decrease) in short-term borrowings 87.95% -25.32% -625.59% 14.77% 53.25% -98.99%Proceeds from long-term borrowings 138.59% 240.87% 2024.66% 385.71% -327.52% 492.46%Principle payments on long-term borrowings -117.09% -105.90% -1226.65% -296.04% 345.95% -279.95%Proceeds from issuance of common stock 0.78% 0.89% 21.25% 20.32% -37.52% 1.14%Repurchases of common stock -0.03% -0.06% -0.53% -0.05% 28.89% 5.64%Dividends paid -10.15% -10.32% -92.47% -24.51% 36.89% -20.11%Other -0.06% -0.14% -0.66% -0.21% 0.06% -0.20%Net cash provided by (used for) financing activities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

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Appendix E

Sustainable Growth Rate (SGR) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Net Sales and RevenuesNet sales -0.82% 5.65% 14.07% 32.39% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00%Finance and interest income 9.38% -7.33% -4.75% -6.26% -5.00% -5.00% -5.00% -5.00% -5.00% -5.00% -5.00% -5.00% -5.00% -5.00%Health care premiums and fees 23.50% 8.72% 4.48% 15.30% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00%Other income 12.23% 55.04% -8.77% 43.11% 22.00% 22.00% 22.00% 22.00% 22.00% 22.00% 22.00% 22.00% 22.00% 22.00%Total 1.19% 4.92% 11.38% 28.66% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00% 11.00%

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Appendix F

Tradition and Forecast Income Statement 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Net Sales and RevenuesNet sales 11168.60 11077.40 11702.80 13349.10 17673.00 19440.30 21384.33 23522.76 25875.04 28462.54 31308.80 34439.68 37883.65 41672.01 45839.21Finance and interest income 1321.30 1445.20 1339.20 1275.60 1195.70 1135.92 1079.12 1025.16 973.91 925.21 878.95 835.00 793.25 753.59 715.91Health care premiums and fees 473.70 585.00 636.00 664.50 766.20 842.82 927.10 1019.81 1121.79 1233.97 1357.37 1493.11 1642.42 1806.66 1987.33Other income 154.60 173.50 269.00 245.40 351.20 428.46 522.73 637.73 778.03 949.19 1158.01 1412.78 1723.59 2102.78 2565.39Total 13136.80 13292.90 13947.00 15534.60 19986.10 21847.50 23913.28 26205.46 28748.76 31570.92 34703.13 38180.56 42042.90 46335.03 51107.83

Costs and ExpensesCost of sales 8936.10 9376.40 9593.40 10752.70 13567.50 14856.30 16261.03 17819.72 19549.16 21468.22 23598.13 25962.78 28589.17 31507.82 34753.33Research and development expenses 542.10 590.10 527.80 577.30 611.60 873.90 956.53 1048.22 1149.95 1262.84 1388.13 1527.22 1681.72 1853.40 2044.31Selling, administrative and general 1504.90 1716.80 1657.30 1744.20 2117.40 2512.46 2750.03 3013.63 3306.11 3630.66 3990.86 4390.76 4834.93 5328.53 5877.40Interest expense 676.50 765.70 637.10 628.50 592.10 873.90 956.53 1048.22 1149.95 1262.84 1388.13 1527.22 1681.72 1853.40 2044.31Health care claims and costs 380.50 476.00 518.40 536.10 650.30 764.66 836.96 917.19 1006.21 1104.98 1214.61 1336.32 1471.50 1621.73 1788.77Other operating expenses 319.20 392.70 410.30 324.50 333.50 546.19 597.83 655.14 718.72 789.27 867.58 954.51 1051.07 1158.38 1277.70Total 12359.30 13317.70 13344.30 14563.30 17872.40 20427.41 22358.91 24502.11 26880.09 29518.81 32447.43 35698.83 39310.11 43323.26 47785.82

Income Before Taxes 777.50 (24.80) 602.70 971.30 2113.70 1420.09 1554.36 1703.36 1868.67 2052.11 2255.70 2481.74 2732.79 3011.78 3322.01Taxes 293.80 17.70 258.30 336.90 708.50 497.03 544.03 596.17 654.03 718.24 789.50 868.61 956.48 1054.12 1162.70Income of Consolidated Group 483.70 (42.50) 344.40 634.40 1405.20

Income (Loss) of Unconsolidated Affiliates 1.80 (21.50) (25.20) 8.70 0.90Net Income 485.50 (64.00) 319.20 643.10 1406.10 923.06 1010.34 1107.18 1214.64 1333.87 1466.21 1613.13 1776.31 1957.66 2159.31

Per Share Data Dividends declared 0.88 0.88 0.88 0.88 1.06 1.46 1.60 1.76 1.93 2.12 2.33 2.56 2.82 3.10 3.42

Page 46

Appendix G

Balance Sheet and Forecast Balance Sheet ASSETS 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014Cash and cash equivalents $291.7 $1,030.0 $2,814.9 $4,384.5 $3,181.1 $3,211.9 $3,515.6 $3,852.5 $4,226.4 $4,641.3 $5,101.8 $5,613.0 $6,180.9 $6,811.9 $7,513.5Marketable securities $127.4 $176.2 $189.2 $231.8 $246.7 $277.4 $303.7 $332.8 $365.1 $400.9 $440.7 $484.8 $533.9 $588.4 $649.0Receivables from unconsolidated affiliates $230.9 $316.6 $265.8 $303.2 $17.6 $342.5 $374.8 $410.8 $450.6 $494.9 $544.0 $598.5 $659.0 $726.3 $801.1Trade accounts and notes receivable - net $3,169.2 $2,922.5 $2,733.6 $2,619.3 $3,206.9 $4,299.5 $4,706.1 $5,157.2 $5,657.7 $6,213.1 $6,829.5 $7,513.9 $8,274.0 $9,118.6 $10,057.9Financing receivables - net $8,275.7 $9,198.9 $9,067.5 $9,974.2 $11,232.6 $13,828.7 $15,136.3 $16,587.2 $18,197.0 $19,983.3 $21,965.9 $24,167.0 $26,611.7 $29,328.5 $32,349.5Other receivables $395.3 $388.9 $426.4 $428.3 $663.0 $660.9 $723.4 $792.8 $869.7 $955.1 $1,049.8 $1,155.0 $1,271.9 $1,401.7 $1,546.1Equipment on operating leases - net $1,954.4 $1,939.3 $1,609.2 $1,381.9 $1,296.9 $2,441.9 $2,672.8 $2,929.0 $3,213.2 $3,528.7 $3,878.8 $4,267.4 $4,699.1 $5,178.8 $5,712.3Inventories $1,552.9 $1,505.7 $1,371.8 $1,366.1 $1,999.1 $2,266.3 $2,480.6 $2,718.3 $2,982.2 $3,274.9 $3,599.8 $3,960.5 $4,361.2 $4,806.4 $5,301.5Property and equipment - net $1,912.4 $2,052.3 $1,998.3 $2,075.6 $2,161.6 $2,976.1 $3,257.5 $3,569.7 $3,916.2 $4,300.6 $4,727.3 $5,200.9 $5,727.1 $6,311.7 $6,961.9Investments in unconsolidated affiliates $190.7 $198.4 $180.6 $195.5 $106.9 $259.6 $284.1 $311.4 $341.6 $375.1 $412.3 $453.6 $499.5 $550.5 $607.2Goodwill $0.0 $0.0 $0.0 $872.1 $973.6 $472.7 $517.4 $567.0 $622.0 $683.1 $750.8 $826.1 $909.7 $1,002.5 $1,105.8Other intangible assets - net $652.2 $874.0 $894.9 $252.9 $21.7 $834.9 $913.8 $1,001.4 $1,098.6 $1,206.5 $1,326.2 $1,459.0 $1,606.6 $1,770.7 $1,953.1Prepaid pension costs $635.3 $652.0 $49.6 $62.6 $2,493.1 $1,064.1 $1,164.7 $1,276.3 $1,400.2 $1,537.6 $1,690.2 $1,859.5 $2,047.6 $2,256.7 $2,489.1Other assets $256.8 $420.8 $582.1 $534.3 $515.4 $661.6 $724.2 $793.6 $870.6 $956.1 $1,050.9 $1,156.2 $1,273.2 $1,403.2 $1,547.7Deferred income taxes $740.4 $883.1 $1,490.1 $1,476.1 $528.1 $1,497.0 $1,638.5 $1,795.6 $1,969.9 $2,163.2 $2,377.9 $2,616.1 $2,880.8 $3,174.9 $3,501.9Deferred charges $84.1 $104.4 $94.0 $99.6 $109.7 $142.9 $156.4 $171.4 $188.1 $206.5 $227.0 $249.8 $275.0 $303.1 $334.3Total Assets $20,469.4 $22,663.1 $23,768.0 $26,258.0 $28,754.0 $35,237.9 $38,569.8 $42,266.9 $46,369.0 $50,920.8 $55,972.8 $61,581.6 $67,811.1 $74,733.9 $82,432.0

LIABILITIES AND STOCKHOLDERS EQUITYLIABILITIESShort-term borrowings $5,758.5 $6,198.5 $4,437.3 $4,347.2 $3,457.5 $7,182.0 $7,861.1 $8,614.6 $9,450.7 $10,378.5 $11,408.1 $12,551.3 $13,821.0 $15,231.9 $16,800.9Payables to unconsolidated affiliates $32.7 $16.6 $64.0 $87.8 $142.3 $93.5 $102.4 $112.2 $123.1 $135.2 $148.6 $163.5 $180.0 $198.4 $218.8Accounts payable and accrued expenses $2,976.4 $3,097.1 $3,142.2 $3,105.5 $3,973.6 $4,696.7 $5,140.8 $5,633.6 $6,180.4 $6,787.1 $7,460.4 $8,208.0 $9,038.3 $9,961.0 $10,987.1Health care claims and reserves $63.4 $100.3 $92.8 $94.1 $135.9 $138.1 $151.2 $165.7 $181.7 $199.6 $219.4 $241.3 $265.8 $292.9 $323.1Accrued taxes $57.5 $44.1 $87.4 $226.5 $179.2 $162.4 $177.8 $194.8 $213.8 $234.7 $258.0 $283.9 $312.6 $344.5 $380.0Deferred income taxes $74.6 $12.9 $24.5 $30.7 $62.6 $61.2 $66.9 $73.4 $80.5 $88.4 $97.1 $106.9 $117.7 $129.7 $143.1Long-term borrowings $4,764.5 $6,560.7 $8,950.4 $10,404.2 $11,090.4 $11,711.1 $12,818.4 $14,047.1 $15,410.4 $16,923.2 $18,602.2 $20,466.2 $22,536.6 $24,837.3 $27,395.7Retirement benefit accruals and other liabilities $2,440.1 $2,640.7 $3,806.2 $3,959.9 $3,319.7 $4,603.7 $5,039.0 $5,522.0 $6,057.9 $6,652.6 $7,312.6 $8,045.3 $8,859.2 $9,763.6 $10,769.3Total liabilities $16,167.5 $18,670.9 $20,604.8 $22,255.9 $22,361.2 $28,648.7 $31,357.6 $34,363.3 $37,698.4 $41,399.1 $45,506.3 $50,066.3 $55,131.0 $60,759.3 $67,017.9STOCKHOLDERS EQUITYCommon Stock $1,864.4 $1,948.6 $1,957.0 $1,987.8 $2,043.5 $3,105.5 $3,399.1 $3,725.0 $4,086.5 $4,487.6 $4,932.9 $5,427.2 $5,976.2 $6,586.3 $7,264.7Treasury Stock $1,439.0 $1,405.5 $1,322.2 $1,141.4 $1,040.4 $2,046.0 $2,239.4 $2,454.1 $2,692.2 $2,956.5 $3,249.8 $3,575.5 $3,937.2 $4,339.1 $4,786.1Unamortized restricted stock compensation $10.9 $16.8 $17.8 $5.8 $12.7 $20.8 $22.8 $25.0 $27.4 $30.1 $33.1 $36.4 $40.1 $44.2 $48.7Retained earnings $4,117.2 $3,834.8 $3,912.6 $4,329.5 $5,445.1 $6,705.3 $7,339.3 $8,042.8 $8,823.4 $9,689.6 $10,650.9 $11,718.2 $12,903.6 $14,220.9 $15,685.7Total $4,531.7 $0.0 $4,529.6 $5,170.1 $6,435.5 $7,744.0 $8,476.3 $9,288.8 $10,190.3 $11,190.6 $12,300.8 $13,533.5 $14,902.5 $16,423.9 $18,115.6Adjustments $229.8 $3,992.2 $1,366.4 $1,168.0 $42.7Total stockholders equity $4,301.9 $3,992.2 $3,163.2 $4,002.1 $6,392.8 $6,589.2 $7,212.2 $7,903.6 $8,670.6 $9,521.8 $10,466.5 $11,515.2 $12,680.1 $13,974.6 $15,414.1Total Liabilities and Stockholders Equity $20,469.4 $22,663.1 $23,768.0 $26,258.0 $28,754.0 $35,237.9 $38,569.8 $42,266.9 $46,369.0 $50,920.8 $55,972.8 $61,581.6 $67,811.1 $74,733.9 $82,432.0

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Appendix H

Statement of Cash Flows and Forecast Statement of Cash Flows 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Cash Flows from Operating ActivitiesNet income $485.5 ($64.0) $319.2 $643.1 $1,406.1 $923.1 $1,010.3 $1,107.2 $1,214.6 $1,333.9 $1,466.2 $1,613.1 $1,776.3 $1,957.7 $2,159.3Adjustments to reconcile net income to net cash provided by operating activities:Provision for doubtful receivables $75.0 $113.0 $160.7 $106.8 $51.4 $97.7 $107.0 $117.2 $128.6 $141.2 $155.3 $170.8 $188.1 $207.3 $228.7Provision for depreciation and amortization $647.9 $718.3 $725.3 $631.4 $621.0 $680.2 $744.5 $815.9 $895.1 $982.9 $1,080.4 $1,188.7 $1,308.9 $1,442.6 $1,591.2Undistributed earnings of unconsolidated affiliates ($1.2) $19.5 $22.7 ($5.5) $20.7 $11.3 $12.3 $13.5 $14.8 $16.3 $17.9 $19.7 $21.7 $23.9 $26.4Provision (credit) for deferred income taxes ($132.9) ($230.3) ($1.2) $33.1 $385.0 $5.9 $6.4 $7.0 $7.7 $8.5 $9.3 $10.2 $11.3 $12.4 $13.7Receivables ($53.8) $316.9 $158.2 $182.3 ($477.8) $7.1 $7.7 $8.5 $9.3 $10.2 $11.2 $12.3 $13.6 $15.0 $16.5Inventories ($184.0) $136.5 $85.8 $84.1 ($293.7) ($52.8) ($57.8) ($63.3) ($69.5) ($76.3) ($83.9) ($92.3) ($101.6) ($112.0) ($123.5)Accounts payable and accrued expenses $540.0 $40.7 $144.0 ($184.9) $872.7 $328.3 $359.3 $393.8 $432.0 $474.4 $521.5 $573.7 $631.7 $696.2 $768.0Other* ($296.5) $62.8 $263.6 $45.3 ($1,422.9) ($335.9) ($367.6) ($402.9) ($442.0) ($485.4) ($533.5) ($587.0) ($646.4) ($712.3) ($785.7)Net cash provided by operating activities $1,080.0 $1,113.4 $1,878.3 $1,535.7 $1,162.5 $1,320.0 $1,444.8 $1,583.3 $1,736.9 $1,907.4 $2,096.7 $2,306.8 $2,540.1 $2,799.4 $3,087.8

Cash Flows from Investing ActivitiesCollections of receivables $6,655.1 $6,966.3 $6,987.0 $9,077.6 $10,233.6 $6,868.7 $7,518.1 $8,238.8 $9,038.4 $9,925.6 $10,910.4 $12,003.6 $13,217.9 $14,567.3 $16,067.9Proceeds from sales of financing receivables $978.3 $1,728.0 $2,967.8 $1,941.0 $2,333.6 $2,218.7 $2,428.5 $2,661.3 $2,919.6 $3,206.2 $3,524.3 $3,877.5 $4,269.7 $4,705.6 $5,190.3Proceeds from maturities and sales of marketable securities $247.8 $32.4 $75.4 $76.4 $66.7 $72.4 $79.3 $86.9 $95.3 $104.6 $115.0 $126.6 $139.4 $153.6 $169.4Proceeds from sales of equipment on operating leases $334.6 $391.7 $495.2 $514.5 $444.4 $424.6 $464.7 $509.3 $558.7 $613.5 $674.4 $742.0 $817.1 $900.5 $993.2Proceeds from sales of businesses $0.0 $0.0 $53.5 $22.5 $90.6 $39.2 $42.9 $47.1 $51.6 $56.7 $62.3 $68.6 $75.5 $83.2 $91.8Cost of receivables acquired ($9,126.5) ($9,795.7) ($9,955.3) ($11,576.8) ($13,628.2) ($9,433.0) ($10,324.9) ($11,314.6) ($12,412.7) ($13,631.2) ($14,983.6) ($16,485.0) ($18,152.6) ($20,005.8) ($22,066.5)Purchases of marketable securities ($61.9) ($75.7) ($87.8) ($118.2) ($79.6) ($80.7) ($88.3) ($96.8) ($106.2) ($116.6) ($128.1) ($141.0) ($155.2) ($171.1) ($188.7)Purchases of property and equipment ($426.7) ($491.0) ($358.7) ($309.6) ($363.8) ($323.5) ($354.1) ($388.0) ($425.7) ($467.5) ($513.8) ($565.3) ($622.5) ($686.1) ($756.7)Cost of operating leases acquired ($939.9) ($775.2) ($487.9) ($473.7) ($571.1) ($481.8) ($527.3) ($577.9) ($633.9) ($696.2) ($765.2) ($841.9) ($927.1) ($1,021.7) ($1,127.0)Acquisitions of businesses, net of cash acquired ($643.3) ($315.2) ($19.0) ($10.6) ($192.9) ($82.9) ($90.8) ($99.5) ($109.1) ($119.8) ($131.7) ($144.9) ($159.6) ($175.9) ($194.0)Decrease (increase) in receivables from unconsolidated affiliates ($135.2) ($112.0) $14.8 ($6.8) ($68.7) ($14.4) ($15.8) ($17.3) ($18.9) ($20.8) ($22.9) ($25.2) ($27.7) ($30.5) ($33.7)Other $7.4 $81.5 $1.0 ($32.4) ($0.1) $0.6 $0.7 $0.7 $0.8 $0.9 $1.0 $1.1 $1.2 $1.3 $1.4Net cash used for investing activities ($3,110.3) ($2,364.9) ($314.0) ($896.1) ($1,735.5) ($792.0) ($866.9) ($950.0) ($1,042.2) ($1,144.5) ($1,258.0) ($1,384.1) ($1,524.1) ($1,679.7) ($1,852.7)

Cash Flows from Financing ActivitiesIncrease (decrease) in short-term borrowings $1,785.8 ($506.6) ($1,413.2) $126.9 ($356.0) ($1,071.4) ($1,172.7) ($1,285.1) ($1,409.8) ($1,548.2) ($1,701.8) ($1,872.4) ($2,061.8) ($2,272.3) ($2,506.3)Proceeds from long-term borrowings $2,814.0 $4,818.3 $4,573.7 $3,312.9 $2,189.5 $5,330.3 $5,834.3 $6,393.5 $7,014.0 $7,702.6 $8,466.8 $9,315.2 $10,257.5 $11,304.7 $12,469.1Principal payments on long-term borrowings ($2,377.4) ($2,118.5) ($2,771.0) ($2,542.7) ($2,312.7) ($3,030.1) ($3,316.6) ($3,634.5) ($3,987.2) ($4,378.6) ($4,813.0) ($5,295.3) ($5,831.0) ($6,426.3) ($7,088.2)Proceeds from issuance of common stock $15.9 $17.8 $48.0 $174.5 $250.8 $12.4 $13.6 $14.9 $16.3 $17.9 $19.7 $21.6 $23.8 $26.3 $29.0Repurchases of common stock ($0.6) ($1.3) ($1.2) ($0.4) ($193.1) $61.1 $66.8 $73.3 $80.4 $88.3 $97.0 $106.7 $117.5 $129.5 $142.9Dividends paid ($206.0) ($206.5) ($208.9) ($210.5) ($246.6) ($217.7) ($238.3) ($261.1) ($286.5) ($314.6) ($345.8) ($380.4) ($418.9) ($461.7) ($509.3)Other ($1.3) ($2.8) ($1.5) ($1.8) ($0.4) ($2.2) ($2.4) ($2.6) ($2.9) ($3.2) ($3.5) ($3.9) ($4.2) ($4.7) ($5.2)Net cash provided by (used for) financing activities $2,030.4 $2,000.4 $225.9 $858.9 ($668.5) $1,082.4 $1,184.7 $1,298.3 $1,424.3 $1,564.1 $1,719.3 $1,891.6 $2,082.9 $2,295.5 $2,532.0

Effect of Exchange Rate Changes on Cash ($3.9) ($10.6) ($5.3) $71.1 $38.1 $46.2 $50.5 $55.4 $60.7 $66.7 $73.3 $80.7 $88.8 $97.9 $108.0

Net Increase (Decrease) in Cash and Cash equivalents ($3.8) $738.3 $1,784.9 $1,569.6 ($1,203.4) $1,656.5 $1,813.1 $1,986.9 $2,179.8 $2,393.8 $2,631.3 $2,894.9 $3,187.8 $3,513.2 $3,875.1

Cash and Cash Equivalents at Beginning of Year $295.5 $291.7 $1,030.0 $2,814.9 $4,384.5 $3,211.9 $3,515.6 $3,852.5 $4,226.4 $4,641.3 $5,101.8 $5,613.0 $6,180.9 $6,811.9 $7,513.5

Cash and Cash Equivalents at End of Year $291.7 $1,030.0 $2,814.9 $4,384.5 $3,181.1 $4,868.4 $5,328.7 $5,839.5 $6,406.2 $7,035.1 $7,733.1 $8,508.0 $9,368.6 $10,325.1 $11,388.6

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Appendix I

Multiples Valuation Symbol Company Name EPS Trailing EPS Forward BPS DPS PPS EPS Growth Sales Trailing P/E Forward P/E P/B D/P P/S PEGKUB Kubota 3.81$ 4.18$ 15.98$ 0.47$ 27.09$ 9.71% 31.74$ 7.11$ 6.48$ 1.70$ 0.02$ 0.85$ 66.74$ CNH CNH Global 0.85$ 0.91$ 37.11$ 0.25$ 18.40$ 7.06% 77.09$ 21.65$ 20.22$ 0.50$ 0.01$ 0.24$ 286.45$ CAT Caterpillar 5.73$ 7.28$ 21.77$ 1.64$ 90.69$ 27.05% 85.25$ 15.83$ 12.46$ 4.17$ 0.02$ 1.06$ 46.05$ DE Deere & Co. 5.70$ 3.74$ 25.90$ 1.06$ 66.24$ 11.00% 80.96$ 11.63$ 17.71$ 2.56$ 0.02$ 0.82$ 161.05$

Industry Averages (excluding DE) 14.86$ 13.05$ 2.12$ 0.02$ 0.72$ 133.08$Estimated DE Price 84.65$ 48.81$ 54.87$ 64.87$ 58.18$ 14.64$

Page 49

Appendix J

Weighted Average Cost of Capital (WACC) and Capital Asset Pricing Model (CAPM)

Total Liabilities Rate Aount % of Debt AverageShort-term borrowings (given) 2.8% 3,458.00$ Long-term borrowings:Equipment OperationsMedium-term notes due 2006 9.2% 20.00$ 0.19% 0.02%5-7/8% U.S. dollar notes due 2006 3.1% 250.00$ 2.39% 0.07%7.85% debentures due 2010 7.85% 500.00$ 4.78% 0.38%6.95% notes due 2014 3.1% 700.00$ 6.69% 0.21%8.95% debentures due 2019 8.95% 200.00$ 1.91% 0.17%8-1/2% debentures due 2022 8.5% 200.00$ 1.91% 0.16%6.55% debentures due 2028 6.55% 200.00$ 1.91% 0.13%8.10 debentures due 2030 8.1% 250.00$ 2.39% 0.19%7.125% notes due 2031 7.125% 300.00$ 2.87% 0.20%Financial servicesMedium term notes due 2005-2009 3.9% 3,443.00$ 32.91% 1.28%5.125% debentures due 2006 2.7% 600.00$ 5.73% 0.15%4.5% notes due 2007 2.4% 500.00$ 4.78% 0.11%3.90% notes due 2008 2.6% 850.00$ 8.12% 0.21%6% notes due 2009 1.9% 300.00$ 2.87% 0.05%7% notes due 2012 2.9% 1,500.00$ 14.34% 0.42%5.10% notes due 2.7% 650.00$ 6.21% 0.17%Total Liabilities 10,463.00$ 3.93%

Weigthed Average Cost of Loans

Total Liabilities Amount Rate % of Debt AverageShort-term borrowings 3,457.50$ 2.80% 15.46% 0.43%Payables to unconsolidated affiliates 142.30$ 0.00% 0.64% 0.00%Accounts payable and accrued expenses 3,973.60$ 0.00% 17.77% 0.00%Health care claims and reservies 135.90$ 0.00% 0.61% 0.00%Accrued taxes 179.20$ 0.00% 0.80% 0.00%Deferred income taxes 62.60$ 0.00% 0.28% 0.00%Long-term borrowings 11,090.40$ 3.93% 49.60% 1.95%Retirement benefit accruals and other liabilities 3,319.70$ 0.00% 14.85% 0.00%Total Liabilities 22,361.20$ 2.38%

Weighted Average Cost of Debt

Page 50

Appendix J (Continued)

Date Close Dividend Return Date Close Return Date Return MonthlyMar-00 38.00 0.22 Mar-00 1498.58 Apr-00 0.0626 0.0052Apr-00 40.37 0.0682 Apr-00 1452.43 -0.0308 May-00 0.0669 0.0056May-00 41.56 0.0295 May-00 1420.60 -0.0219 Jun-00 0.0630 0.0053Jun-00 37.00 0.22 -0.1097 Jun-00 1454.60 0.0239 Jul-00 0.0618 0.0052Jul-00 38.56 0.0481 Jul-00 1430.83 -0.0163 Aug-00 0.0606 0.0051Aug-00 32.94 -0.1457 Aug-00 1517.68 0.0607 Sep-00 0.0593 0.0049Sep-00 33.25 0.22 0.0094 Sep-00 1436.51 -0.0535 Oct-00 0.0578 0.0048Oct-00 36.81 0.1137 Oct-00 1429.40 -0.0049 Nov-00 0.0570 0.0048Nov-00 40.69 0.1054 Nov-00 1314.95 -0.0801 Dec-00 0.0517 0.0043Dec-00 45.81 0.22 0.1258 Dec-00 1320.28 0.0041 Jan-01 0.0486 0.0041Jan-01 42.92 -0.0583 Jan-01 1366.01 0.0346 Feb-01 0.0489 0.0041Feb-01 40.70 -0.0517 Feb-01 1239.94 -0.0923 Mar-01 0.0464 0.0039Mar-01 36.34 0.22 -0.1071 Mar-01 1160.33 -0.0642 Apr-01 0.0476 0.0040Apr-01 40.83 0.1296 Apr-01 1249.46 0.0768 May-01 0.0493 0.0041May-01 37.36 -0.0850 May-01 1255.82 0.0051 Jun-01 0.0481 0.0040Jun-01 37.85 0.22 0.0131 Jun-01 1224.42 -0.0250 Jul-01 0.0476 0.0040Jul-01 41.95 0.1141 Jul-01 1211.23 -0.0108 Aug-01 0.0457 0.0038Aug-01 43.17 0.0291 Aug-01 1133.58 -0.0641 Sep-01 0.0412 0.0034Sep-01 37.61 0.22 -0.1288 Sep-01 1040.94 -0.0817 Oct-01 0.0391 0.0033Oct-01 36.99 -0.0106 Oct-01 1059.01 0.0174 Nov-01 0.0397 0.0033Nov-01 39.99 0.0811 Nov-01 1139.45 0.0760 Dec-01 0.0439 0.0037Dec-01 43.66 0.22 0.0918 Dec-01 1148.08 0.0076 Jan-02 0.0434 0.0036Jan-02 43.97 0.0121 Jan-02 1130.20 -0.0156 Feb-02 0.0430 0.0036Feb-02 47.93 0.0901 Feb-02 1106.73 -0.0208 Mar-02 0.0474 0.0040Mar-02 45.55 0.22 -0.0497 Mar-02 1147.39 0.0367 Apr-02 0.0465 0.0039Apr-02 44.76 -0.0125 Apr-02 1076.64 -0.0617 May-02 0.0449 0.0037May-02 47.00 0.0500 May-02 1067.14 -0.0088 Jun-02 0.0419 0.0035Jun-02 47.90 0.22 0.0191 Jun-02 989.81 -0.0725 Jul-02 0.0381 0.0032Jul-02 42.02 -0.1182 Jul-02 911.62 -0.0790 Aug-02 0.0329 0.0027Aug-02 45.92 0.0928 Aug-02 916.07 0.0049 Sep-02 0.0294 0.0025Sep-02 45.45 0.22 -0.0102 Sep-02 815.29 -0.1100 Oct-02 0.0295 0.0025Oct-02 46.39 0.0255 Oct-02 885.77 0.0864 Nov-02 0.0305 0.0025Nov-02 51.15 0.1026 Nov-02 936.31 0.0571 Dec-02 0.0303 0.0025Dec-02 45.85 0.22 -0.1036 Dec-02 879.82 -0.0603 Jan-03 0.0305 0.0025Jan-03 42.20 -0.0748 Jan-03 855.70 -0.0274 Feb-03 0.0290 0.0024Feb-03 41.38 -0.0194 Feb-03 841.15 -0.0170 Mar-03 0.0278 0.0023Mar-03 39.26 0.22 -0.0512 Mar-03 848.18 0.0084 Apr-03 0.0293 0.0024Apr-03 44.03 0.1271 Apr-03 916.92 0.0810 May-03 0.0252 0.0021May-03 43.67 -0.0082 May-03 963.59 0.0509 Jun-03 0.0227 0.0019Jun-03 45.70 0.22 0.0465 Jun-03 974.51 0.0113 Jul-03 0.0287 0.0024Jul-03 50.78 0.1160 Jul-03 990.31 0.0162 Aug-03 0.0337 0.0028Aug-03 56.51 0.1128 Aug-03 1008.01 0.0179 Sep-03 0.0318 0.0027Sep-03 53.31 0.22 -0.0566 Sep-03 995.97 -0.0119 Oct-03 0.0319 0.0027Oct-03 60.62 0.1412 Oct-03 1050.71 0.0550 Nov-03 0.0329 0.0027Nov-03 61.23 0.0101 Nov-03 1058.20 0.0071 Dec-03 0.0327 0.0027Dec-03 65.05 0.22 0.0624 Dec-03 1111.92 0.0508 Jan-04 0.0312 0.0026Jan-04 62.60 -0.0343 Jan-04 1131.13 0.0173 Feb-04 0.0307 0.0026Feb-04 64.23 0.0260 Feb-04 1144.94 0.0122 Mar-04 0.0279 0.0023Mar-04 69.31 0.22 0.0791 Mar-04 1126.21 -0.0164 Apr-04 0.0339 0.0028Apr-04 68.04 -0.0151 Apr-04 1107.30 -0.0168 May-04 0.0385 0.0032May-04 65.70 -0.0344 May-04 1120.68 0.0121 Jun-04 0.0393 0.0033Jun-04 70.14 0.28 0.0676 Jun-04 1140.84 0.0180 Jul-04 0.0369 0.0031Jul-04 62.81 -0.1005 Jul-04 1101.72 -0.0343 Aug-04 0.0347 0.0029Aug-04 63.27 0.0073 Aug-04 1104.24 0.0023 Sep-04 0.0336 0.0028Sep-04 64.55 0.28 0.0202 Sep-04 1114.58 0.0094 Oct-04 0.0335 0.0028Oct-04 59.78 -0.0696 Oct-04 1130.20 0.0140 Nov-04 0.0353 0.0029Nov-04 71.73 0.1999 Nov-04 1173.82 0.0386 Dec-04 0.0360 0.0030Dec-04 74.40 0.28 0.0372 Dec-04 1211.92 0.0325 Jan-05 0.0371 0.0031Jan-05 69.43 -0.0630 Jan-05 1181.27 -0.0253 Feb-05 0.0377 0.0031Feb-05 71.11 0.0242 Feb-05 1203.60 0.0189Mar-05 67.13 0.31 -0.0560 Mar-05 1174.28 -0.0244

Stock Price (DE) Market Price (S&P 500) Risk Free (5 Year T-Bill)CAPM Data

Page 51

Appendix J (Continued)

Date Firm's Return S&P 500 Return Risk Free Rate Market Risk Prm Beta R-Squared Average Risk Published Beta Avg. MRPMar-00 0.606856174 0.1196817 0.0401 0.6 0.0624Apr-00 0.0682 -0.0308 0.0056 -0.0364May-00 0.0295 -0.0219 0.0053 -0.0272 Cost of debt 2.38%Jun-00 -0.1097 0.0239 0.0052 0.0188 Cost of equity 7.79%Jul-00 0.0481 -0.0163 0.0051 -0.0214 WACC 3.40%Aug-00 -0.1457 0.0607 0.0049 0.0558Sep-00 0.0094 -0.0535 0.0048 -0.0583 Short horizonOct-00 0.1137 -0.0049 0.0048 -0.0097Nov-00 0.1054 -0.0801 0.0043 -0.0844 Beta R-SquaredDec-00 0.1258 0.0041 0.0041 0.0000 1.771955266 0.375406704Jan-01 -0.0583 0.0346 0.0041 0.0306Feb-01 -0.0517 -0.0923 0.0039 -0.0962 Cost of debt 2.38%Mar-01 -0.1071 -0.0642 0.0040 -0.0682 Cost of equity 15.06%Apr-01 0.1296 0.0768 0.0041 0.0727May-01 -0.0850 0.0051 0.0040 0.0011Jun-01 0.0131 -0.0250 0.0040 -0.0290Jul-01 0.1141 -0.0108 0.0038 -0.0146Aug-01 0.0291 -0.0641 0.0034 -0.0675Sep-01 -0.1288 -0.0817 0.0033 -0.0850Oct-01 -0.0106 0.0174 0.0033 0.0141Nov-01 0.0811 0.0760 0.0037 0.0723Dec-01 0.0918 0.0076 0.0036 0.0040Jan-02 0.0121 -0.0156 0.0036 -0.0192Feb-02 0.0901 -0.0208 0.0040 -0.0247Mar-02 -0.0497 0.0367 0.0039 0.0329Apr-02 -0.0125 -0.0617 0.0037 -0.0654May-02 0.0500 -0.0088 0.0035 -0.0123Jun-02 0.0191 -0.0725 0.0032 -0.0756Jul-02 -0.1182 -0.0790 0.0027 -0.0817Aug-02 0.0928 0.0049 0.0025 0.0024Sep-02 -0.0102 -0.1100 0.0025 -0.1125Oct-02 0.0255 0.0864 0.0025 0.0839Nov-02 0.1026 0.0571 0.0025 0.0545Dec-02 -0.1036 -0.0603 0.0025 -0.0629Jan-03 -0.0748 -0.0274 0.0024 -0.0298Feb-03 -0.0194 -0.0170 0.0023 -0.0193Mar-03 -0.0512 0.0084 0.0024 0.0059Apr-03 0.1271 0.0810 0.0021 0.0789May-03 -0.0082 0.0509 0.0019 0.0490Jun-03 0.0465 0.0113 0.0024 0.0089Jul-03 0.1160 0.0162 0.0028 0.0134Aug-03 0.1128 0.0179 0.0027 0.0152Sep-03 -0.0566 -0.0119 0.0027 -0.0146Oct-03 0.1412 0.0550 0.0027 0.0522Nov-03 0.0101 0.0071 0.0027 0.0044Dec-03 0.0624 0.0508 0.0026 0.0482Jan-04 -0.0343 0.0173 0.0026 0.0147Feb-04 0.0260 0.0122 0.0023 0.0099Mar-04 0.0791 -0.0164 0.0028 -0.0192Apr-04 -0.0151 -0.0168 0.0032 -0.0200May-04 -0.0344 0.0121 0.0033 0.0088Jun-04 0.0676 0.0180 0.0031 0.0149Jul-04 -0.1005 -0.0343 0.0029 -0.0372Aug-04 0.0073 0.0023 0.0028 -0.0005Sep-04 0.0202 0.0094 0.0028 0.0066Oct-04 -0.0696 0.0140 0.0029 0.0111Nov-04 0.1999 0.0386 0.0030 0.0356Dec-04 0.0372 0.0325 0.0031 0.0294Jan-05 -0.0630 -0.0253 0.0031 -0.0284Feb-05 0.0242 0.0189Mar-05 -0.0560 -0.0244

CAPM

Page 52

Appendix K

Discounted Dividends Model 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

DPS 1.46$ 1.60$ 1.76$ 1.93$ 2.12$ 2.33$ 2.56$ 2.82$ 3.10$ 3.42$ 59.09$ PV factor 0.93 0.86 0.80 0.74 0.69 0.64 0.59 0.55 0.51 0.47PV of Div 1.36$ 1.38$ 1.40$ 1.43$ 1.45$ 1.48$ 1.51$ 1.55$ 1.58$ 1.62$ Sum of Divs 14.75$ Terminal Value 59.09$ PV of Terminal Value 27.90$ Estimated Share Price 42.65$ Estimated Share Price (04/01/05) 43.01$

1% 1.50% 2% 2.50% 3%5% 59.21$ 77.23$ 87.24$ 101.26$ 122.28$ 6% 48.11$ 58.74$ 64.05$ 70.88$ 79.98$ 7% 40.26$ 47.04$ 50.20$ 54.07$ 58.91$ 8% 34.42$ 39.00$ 41.03$ 43.43$ 46.32$ 9% 29.93$ 33.15$ 34.53$ 36.11$ 37.97$

Forecasted Years

Ke

GrowthSensitivity Analysis

Page 53

Appendix L

Discounted Free Cash Flows

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015CFFO 1,319.97$ 1,444.78$ 1,583.27$ 1,736.93$ 1,907.44$ 2,096.68$ 2,306.77$ 2,540.13$ 2,799.45$ 3,087.81$ CFFI (791.98)$ (866.87)$ (949.96)$ (1,042.16)$ (1,144.46)$ (1,258.01)$ (1,384.06)$ (1,524.08)$ (1,679.67)$ (1,852.68)$ FCF 527.99$ 577.91$ 633.31$ 694.77$ 762.97$ 838.67$ 922.71$ 1,016.05$ 1,119.78$ 1,235.12$ 1,235.12$ PV Factor 0.97 0.94 0.90 0.87 0.85 0.82 0.79 0.77 0.74 0.72PV of FCF 510.63$ 540.54$ 572.87$ 607.81$ 645.53$ 686.24$ 730.18$ 777.61$ 828.82$ 884.14$ 884.14$

Tot PV of cash flows 6,784.37$ PV of CV 63,169.63$ Value of firm 69,954.00$ BV of Debt 22,361.20$ Value of Equity 47,592.80$ Est. Value/Share 192.79$ Value at 04/01/05 194.41$ 1.50% 2% 2.50% 3%

4% 71.27$ 105.12$ 161.53$ 274.36$ 5% 22.96$ 36.94$ 57.45$ 88.21$ 6% (4.77)$ 3.00$ 12.99$ 26.32$ 7% (21.88)$ (17.25)$ (11.59)$ (4.51)$ 8% 3.17$ 8.01$ 13.53$ 19.91$

Ke

Forecasted Years

Sensitivity AnalysisGrowth

Page 54

Appendix M

Residual Income Model

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015Beg BV of Equity 25.90$ 28.17$ 30.66$ 33.39$ 36.39$ 39.67$ 43.29$ 47.27$ 51.64$ 56.47$ EPS 3.74$ 4.09$ 4.49$ 4.92$ 5.40$ 5.94$ 6.53$ 7.20$ 7.93$ 8.75$ DPS 1.46$ 1.60$ 1.76$ 1.93$ 2.12$ 2.33$ 2.56$ 2.82$ 3.10$ 3.42$ End BV of Equity 25.90$ 28.17$ 30.66$ 33.39$ 36.39$ 39.67$ 43.29$ 47.27$ 51.64$ 56.47$ 61.79$ ke 7.79%Normal EPS 2.02$ 2.20$ 2.39$ 2.60$ 2.84$ 3.09$ 3.37$ 3.68$ 4.03$ 4.40$ Residual Income 1.72$ 1.90$ 2.10$ 2.32$ 2.57$ 2.85$ 3.16$ 3.51$ 3.90$ 4.35$ 4.35$

74.99$ PV of RI 1.60$ 1.63$ 1.67$ 1.72$ 1.76$ 1.81$ 1.87$ 1.93$ 1.99$ 2.05$ 35.40$

BV of Equity 25.90$ Tot PV of RI 18.03$ PV of CV 35.40$ Est Val/Share 79.33$ Value on (04/01/05) 80.00$ 1% 1.50% 2% 2.50% 3%

6% 110.60$ 117.25$ 125.56$ 136.25$ 150.50$ 7% 87.42$ 91.11$ 95.54$ 100.96$ 107.73$ 8% 71.21$ 73.36$ 75.87$ 78.84$ 82.40$ 9% 59.31$ 60.60$ 62.08$ 63.78$ 65.76$

10% 50.28$ 51.06$ 51.94$ 52.94$ 54.08$

Sensitivity Analysis

Ke

Growth

Forecasted Years

Page 55

Appendix N

Abnormal Earnings Growth Model

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015EPS 5.70$ 3.74$ 4.10$ 4.49$ 4.93$ 5.41$ 5.95$ 6.54$ 7.21$ 7.94$ 8.76$ DPS 1.46$ 1.60$ 1.76$ 1.93$ 2.12$ 2.33$ 2.56$ 2.82$ 3.10$ 3.42$ DPS invested 0.11$ 0.12$ 0.14$ 0.15$ 0.16$ 0.18$ 0.20$ 0.22$ 0.24$ 0.27$ Cum-Dividend Earnings 3.86$ 4.22$ 4.63$ 5.08$ 5.58$ 6.13$ 6.74$ 7.43$ 8.18$ 9.03$ Normal Earnings 6.15$ 4.04$ 4.42$ 4.84$ 5.31$ 5.83$ 6.41$ 7.05$ 7.77$ 8.56$ AEG 2.29$ (0.19)$ (0.21)$ (0.24)$ (0.26)$ (0.30)$ (0.33)$ (0.37)$ (0.42)$ (0.47)$ (8.04)$

PV Factor 0.93 0.86 0.80 0.74 0.69 0.64 0.59 0.55 0.51 0.47PV of AEG 2.12$ (0.16)$ (0.17)$ (0.17)$ (0.18)$ (0.19)$ (0.20)$ (0.20)$ (0.21)$ (0.22)$

EPS 5.70$ Tot PV of AEG 0.42$ CV (8.04)$ PV of CV (4.09)$ Tot PV of AEG 2.03$ Capitalization Rate 7.79% 0% 1%G 0.02 6% 15.75$ 0.43$ Value/Share 26.04$ 7% 32.24$ 23.62$ Value (04/01/05) 26.54$ 8% 40.86$ 35.65$

9% 45.29$ 41.98$ 10% 47.37$ 45.17$ 11% 48.07$ 46.56$ 12% 47.94$ 46.88$ 13% 47.32$ 46.56$ 14% 46.41$ 45.85$ 15% 45.32$ 44.90$

Forecasted Years

Ke

GrowthSensitivity Analysis

Page 56

Appendix O

Long Run Average Residual Income Perpetuity Book Value of Equity 6,392.80$ ROE 0.22Ke 7.79% 1% 1.50% 2% 2.50% 3%g 0.02 7% 90.62$ 96.50$ 103.56$ 112.19$ 122.98$ Price 89.36$ 8% 77.67$ 81.65$ 86.30$ 91.79$ 98.38$ April 1, 2005 Price 91.05$ 9% 67.96$ 70.77$ 73.97$ 77.67$ 81.98$

10% 60.41$ 62.44$ 64.73$ 67.31$ 70.27$ 11% 54.37$ 55.87$ 57.53$ 59.39$ 61.49$

Growth

Ke

Sensitivity Analysis

Documents

Deere and Co. Valuation - Texas Tech Universitymmoore.ba.ttu.edu/ValuationReports/JohnDeerel.pdf · Deere and Co. Valuation April 1, 2005 ... Current Financial Position Deere and