Dell Computer:
Sample Midterm Exam -- Solution
• ACC 411
• Financial Statement Analysis
• Simon School
• Professor Wasley
Professor Charles E. Wasley 1
Instructions (Read Carefully)
• 1) This is a closed book, closed notes exam.
– You may use ONE SINGLE-sided 8½” x 11” cheat-sheet, but your cheat-sheet must be handwritten.
– Nothing can be taped or pasted onto it like output from Excel or Word.
– You may NOT use your original copy of the Dell case A clean and unmarked copy is . provided with the exam.
• 2) Answer all questions in your “blue” book, clearly label your response to each question, use a pencil and you may use a calculator.
You have 3 hours to complete the exam
Professor Charles E. Wasley 2
– .
Instructions (Read Carefully)
• 3) The questions are based on the
original case and some additional
information and analysis that I’ve
provided with the exam .
– Always be sure to clearly state any
assumptions and to show all of your work
to potentially receive partial credit .
• 4) The exam is worth a total of 175
points and each question’s point
allocation is clearly shown.
Professor Charles E. Wasley 3
Instructions (Read Carefully)
• 5) Questions 1-10 are required and total 145 points . From (optional) questions 11-16 you must answer those totaling another 30 points to produce 175 total exam points.
– Questions 11 and 13 are each worth 30 points so answering just ONE of them is an option.
– The remaining questions, 12, 14-16 are each worth 15 points so answering TWO of them is another option.
• 6) It is your responsibility to ensure you answer questions totaling 175 points (no more and no less).
– If you answer questions in excess of 175 points, your answers will be graded in the order they appear in your “blue” book .
– You may answer the questions in any order you wish.
– Just clearly label each answer in your “blue” book.
– Write the number of the optional questions you answer on the cover of your “blue” book.
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Instructions (Read Carefully)
7) Ch k i ht t h ll 38• ec r g now o ensure you ave a slides of the exam.
– I recommend you disassemble (i.e., tear apart) the exam.
– When you are finished, all you need to hand in is your “blue” book and your CHEAT-SHEET.
– Your exam will not be graded unless your CHEAT-SHEET is handed in.
• 8) Rather than providing suggested time allocations for each question, I offer the following (obvious) advice .
– Questions worth more points require more time.
– Don’t get bogged down on any one question and try to recognize when you have hit diminishing returns to your investment in a question
Professor Charles E. Wasley 5
.
Instructions (Read Carefully)
• 9) ON ALL QUESTIONS, THINK MORE AND
WRITE LESS .
– Use the first 15 minutes of the exam time to
review the questions and to decide which ones
you want to answer and in what order. This will
help you better organize your time.
– Develop a strategy before you start answering
questions.
• 10) In my opinion, questions 9, 10 and 7 are
likely to take the most time.
– Beyond that, don’t over-invest time in 5 and 10
point questions, they are designed with a
relatively short answer in mind.
Professor Charles E. Wasley 6
Question 1: Required
• Identify the 5 key aspects of
Dell’s direct distribution model
for PCs, and for each describe
how it would be reflected in the
firm’s financial statements. Be
very specific, but not overly
wordy. (10 points)
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Question 1: Required -- Answer
1) The direct distribution eliminates the•
need for dealers/resellers.
– F/S effects:
• 1) On the plus side this will yield higher
selling prices (higher Sales) because there
is no need for Dell to reduce selling prices
to accommodate a reseller’s or a retailer’s
markup (i.e., no reseller’s gross profit).
– See exhibit 7 of the case for details .
• 2) On the minus side, direct distribution
entails higher operating expenses due to
the extra costs of customization
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.
– Again see exhibit 7 of the case for details.
Question 1: Required -- Answer
2) Th di t di t ib ti• e rec s r u on
eliminates the need for finished
d i t d th i littlgoo s nven ory an ere s e
work-in-process and raw
t i l i tma er a s nven ory.
– F/S effect:
1) P d hi h i t t• ro uces g er nven ory urnover
rates, paving the way for higher ROA
and ROE.
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Question 1: Required -- Answer
3) The direct distribution easily•
accommodates component price
declines (endemic to the industry) and
allows price declines to easily and
quickly be passed on to customers.
– F/S effects:
• 1) Reduces risks associated with finished
goods in a rapidly changing environment ,
thus fewer inventory write-offs/charge-offs
leading to lower CGS and higher gross
margins.
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• 2) Less variable profits and profit margins.
Question 1: Required -- Answer
• 4) Items like monitors never pass through
Dell’s hands.
– F/S effect:
• 1) Lower required investment in inventory ,
produces greater liquidity and reduces operating
costs (e.g., inventory storage handling costs).
• 5) The direct distribution allows systems to be
completely customized to customer needs and
fpre erences.
– F/S effect:
• 1) Potentially higher selling prices for customized
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systems and related higher gross margins.
Question 1: Required -- Answer
G di• ra ng:
– 1 point each for the reasons listed
abo e and 1 point for thev
corresponding correct financial
statement effect.
– Other reasons, if economically
sensible, ½ point each and ½ point
for the corresponding correct
financial statement effect.
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Question 2: Required
“The Evolution of the PC industry ”• .
– Over the time period covered by the case,
the fast-growing PC industry, with
compelling customer demand, came to
suffer from low profitability.
Identify 2 reasons why one would view the–
PC industry (in general) as structurally
unattractive in the late 1990s. (5 points)
Professor Charles E. Wasley 14
Q ti 2 R i d Aues on : equ re -- nswer
• 1) Vigorous price competition.
– Bargaining power of end users is high and they can switch among PC brands easily.
“Wi t l” t d d th i littl t– n e s an ar s mean ere s e o distinguish among the PCs of leading companies except price which leads to vigorous price competition.
• 2) Low switching costs for customers.
– End users are growing more confident and becoming less brand loyal and are less in need of assistance as the portion of first-time buyers declines (see pg. 4 of the case).
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Q ti 2 R i d Aues on : equ re -- nswer
3) PC fi f “h ld ” bl f• rms ace severe o -up pro ems rom
Intel and Microsoft.
– Suppliers Microsoft and Intel are positioned to
extract the profits (rents) from the industry.
– Microsoft and Intel encourage competition among PC companies by selling “equally” to all PC companies and thereby treating them similarly.
• 4) Modest barriers to entry.
– Capital costs of manufacturing facility very low (see pg. 3 of the case).
– “Wintel” standards mean there is limited opportunity t diff ti t d to eren a e pro uc s.
– Absolute cost advantages are hard to maintain since most inputs are available at fixed prices.
• Note from Exhibit 5 that there is very little of the cost structure that can be influenced by the PC maker .
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Q ti 2 R i d Aues on : equ re -- nswer
• Grading:
– 2½ points each for up to 2 reasons
from the list above.
– Other reasons, if economically
sensible, 1½ points each.
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Question 3: Required
In view of the prior question• ,
identify 2 reasons why Dell has
been able to do so well in a
tough industry. (5 points)
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Question 3: Required -- Answer
• 1) Dell achieves low costs without sacrificing a great deal of the buyer’s willingness to pay.
– Exhibit 11 shows that Dell achieves higher average selling prices than its rivals do and focuses much more on corporate and institutional customers.
• 2) Dell avoids the low end price spectrum (sub $1000 PCs) and instead focuses on stable product lines.
– Corporate customers spending $8,000 - $12,000 per year supporting PCs (page 4 of the case) are willing to pay (substantial) premiums for easy-to-maintain PCs.
• 3) Geographic dimension:
– Dell is more focused in the US than all rivals but Gateway (see Exhibit 11).
– Focuses on the US market because high-end users are concentrated in the US .
• Grading:
– 2½ points each for up to 2 reasons from the list above.
– Other reasons, if economically sensible, 1½ points each.
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Question 4: Required
Identify 2 reasons why it has•
been so hard for Dell’s rivals to
match its success (5 points) .
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Question 4: Required -- Answer
• 1) The other firms (except Gateway) are trying to implement two strategies at once.
– It is difficult to occupy two strategic positions at once -- it is hard to sell direct and via resellers.
• Not only are the capabilities and activities required to do each distinct, but external players like resellers penalize those who fail to commit fully to one position or the other.
– As a result, firms like IBM, Compaq, and HP face three options.
• They can “reposition” entirely to the direct model, abandoning the channel that currently provides most of their revenue (Exhibit 11).
• They can “straddle” that is, try to sell both direct and via resellers, despite the inconsistencies (diseconomies) in doing so.
• Or they can remain entirely indirect and try to recreate the advantages of direct selling through hybrids like channel assembly, but such hybrids suffer from inflexibility and inefficiency.
– None of these is especially appealing.
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Question 4: Required -- Answer
• 2) Matching Dell's position is especially difficult because Dell is already successful and entrenched in its position (first mover advantage).
– Hence even Gateway which doesn't face , many of the trade-offs encountered by IBM, Compaq and HP, still encounters problems as it tries to serve (steal) Dell's corporate customers .
• The ability to “knock on the doors of big corporate clients" (pg. 13 of the case) entails a large investment.”
And Dell seems certain to fight Gateway’s– incursion, making it unlikely the investment will bear fruit.
• Accordingly, Gateway quickly abandoned its corporate efforts
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.
Question 4: Required -- Answer
• 3) Organizational resistance to change.
This is evidence in the case that Dell’s rivals are– unwilling to make difficult choices between competing ways to do business and between customer segments with very different needs.
• For instance, Eckhard Pfeiffer, Compaq’s CEO, declares, “We want to do it all, and we want to do it now.”
• Michael Dell offers a sharp contrast to Pfeiffer's desire to “be all things to all people.”
He emphasizes that from its founding Dell looked– , for a way of doing business that was distinctive from that of other competitors: “It was too late to challenge the technical standard and the dealer network had been done already.”
• Grading:
– 2½ points each for up to 2 reasons from the list above.
O h if i ll ibl 1½
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– t er reasons, econom ca y sens e, points each.
Question 5: Required
• “Dell’s Retail Fiasco.”
– If Dell (was) is such a great company,
why did it fail so miserably when it
tried to sell PCs through the retail
channel? (5 points)
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Question 5: Required -- Answer
• This can basically be attributed to two mismatches:
– 1) First, as we know, Dell’s manufacturing operation is configured to deliver customized PCs efficiently, that is, at low cost compared to other modes of customization.
• In contrast, conventional retail channels are designed to move a limited array of standardized products.
• If one straps together Dell’s manufacturing system and the retail channel, Dell bears the extra fixed costs associated with the ability to customize, but gets none of the benefit (i e higher selling prices) . ., based on customers’ willingness-to-pay for customization (Dell’s current model which it exploits well).
• The retail channel is far better paired with a manufacturing system that produces standard
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PCs in bulk (which is not Dell).
Question 5: Required -- Answer
• Exhibit 7 makes the point .
– From the numbers in the exhibit we
can see that in exchange for 4 extra
percentage points of operating
expenses associated with
customization Dell gets 12 extra,
percentage points of customers’
willingness to pay for customized
PCs.
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Question 5: Required -- Answer
2) A d i t h i l th• secon m sma c nvo ves e customer base.
– Dell is configured to serve educated customers who know what they need and want high-end PCs.
• In contrast, Topfer himself says, “Consumers at retail don’t know what they are looking for, other than price” (pg 7 of the case) . .
• Grading:
5 points for one of the mismatches noted– above.
– Another reason, if economically sensible, 3½ points.
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Question 5: Required -- Answer
If th i t h b i h• ese m sma c es are so o v ous, w y
did Dell dive into retail channel?
– Intriguingly, even Dell, one of the best run
d t di i li d i lik lan mos sc p ne compan es we are e y
to see in the class, could not resist the pull of
growth and convention.
• The quote from Michael Dell on pg. 7 of the
case suggests the prospect of growth lured
Dell into the retail channel.
– In other reflections, Michael Dell suggests the
presence of Compaq and others in stores drew
the company into retail.
– Either way, the retail fiasco provides an
interesting illustration of how difficult it is for
even companies not to do bad things (at least,
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occasionally).
Question 6: Required
I l i D ll i d i• c a m concerns e s engage n
earnings management during the time
period covered by the case are
unfounded.
– Even though the case does not provide
much information about Dell’s accounting
policies, use whatever information there is,
along with your economic intuition to cite 5
pieces of evidence to support (or refute) my
assertion. (15 points)
• Appendix A includes two pages from Dell’s
1997 annual report which discuss some of
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its accounting policies.
Question 6: Required -- Answer
• “Refute” evidence:
– 1) With the exception of fiscal years 1991,
1992 and 1995 (i.e., “earlier years”) Operating
cash flow consistently exceeds net income
(when earnings are managed the opposite
tends to be true).
– 2) With Dell’s direct order model, stuffing the
distribution channel in order to generate
revenue is not possible, therefore, premature
revenue recognition is unlikely to be a problem.
– 3) No sign of “Capitalized Computer Software
Development Costs” on Dell’s balance sheet or
in the supplemental balance sheet information
included with the case. So no evidence of
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aggressive cost capitalization.
Question 6: Required -- Answer
• “Refute” evidence:
– 4) Based on the supplemental
balance sheet information included
with the case it doesn’t appear that
Dell is aggressively “deferring”
revenue.
• The ratio of “deferred revenue to
revenue” for fiscal years 1997 and
1996 is the same. 1.6%.
– 1997: $193 / $12,327 = 1.6%.
– 1996: $126 / $7,759 = 1.6%.
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Question 6: Required -- Answer
• “Confirm” evidence: (#1 is stronger than #2 or #3 in fact #2 and #3 aren’t really serious, concerns in my mind):
– 1) Dell chooses to report the cost of stock ti i th f t t th th i thop ons n e oo no es ra er an n e income statement. One could argue Dell’s income is overstated because it could record on the cost as an expense on the income statement if it wanted to .
– 2) Provision for doubtful accounts:
• The ratio of “allowance for doubtful accounts to gross A/R” fell from 3 3% for fiscal 1996 to 1 9% . . for fiscal 1997.
• If Dell had keep the ratio the same in both years, pretax income and net income in fiscal 1997 would have been lower.
1997 $28 / $1 514 1 9%
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– : , = . .
– 1996: $31 / $934 = 3.3%.
Question 6: Required -- Answer
• “Confirm” evidence …
– 3) Accrued warranty costs:
• The ratio of “accrued warranty costs to Sales” fell from 1.4% for fiscal 1996 to 1.1% for fiscal 1997.
• If Dell had keep the ratio the same in both years, pretax income and net income in fiscal 1997 would have been lower.
– 1997: $139 / $12,327 = 1.1%.
– 1996: $111/ $7,759 = 1.4%.
• Grading:
– 3 points each for up to 5 reasons from eitherlist above.
– Other reasons, if economically sensible, 1½ points each, BUT they have to apply to Dell’s b d t b l i
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num ers an no e genera earn ngs management themes.
Question 7: Required
• “Quantifying ONE part of Dell’s competitive advantages ” .
– Use data from 1996 (before Dell’s rivals started to react to what Dell was doing) to quantity in dollar terms Dell’s overall competitive advantage over COMPAQ.
– Specifically, use information provided in the case about Dell’s Compaq’s and the , industry’s pricing and cost structures to estimate Dell’s overall competitive advantage over Compaq. (30 points)
– Hint to get you started:
• Exhibit 10b of the case shows Dell priced a PC at an average price of $2,313 in 1996.
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Question 7: Required -- Answer
• Focus on a state-of-the-art PC
configured for the business market – i.e.,
a typical Dell sale.
– As noted in the question, Exhibit 10b shows
that Dell priced such a PC at $2,313 in 1996.
– Dell’s gross margin during 1996 was 21.5%,
implying a cost of goods sold of $1,816 (see
exhibit 6).
• Now consider the extra costs incurred by
Compaq which uses resellers for sales
and distribution of its PCs…
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Question 7: Required -- Answer
• Such an approach incurs 4 extra costs:
– First, because component costs are declining rapidly and the “Compaq/reseller model” moves its inventory more slowly than Dell, the “Compaq/reseller model” incurs a higher CGS.
(I 1996) th “C / ll d l” h hl 65• n e ompaq rese er mo e as roug y days of inventory (pg. 11 of the case) while Dell has 15 days of inventory.
– Thus, to deliver a computer on July 1, Dell must purchase inputs on June 16 while the “Compaq/ reseller model” t h i t t th d f A ilmus purc ase npu s a e en o pr .
• Because component prices decline by roughly 0.6% per week (data from the case), this difference translates into $80 on the benchmark PC.***
– ***A 0.6% weekly decline translates into a 100% -99.4%^52 = 270% annual decline (per pg. 5 of the case).
– I am assuming Dell and Compaq buy components at identical prices, a good assumption in this industry.
– As a result, cost differences are assumed to result purely from differences in inventory throughput.
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Question 7: Required -- Answer
• Second, Dell incurs a carrying cost of
inventory of 65 – 15 = 50 less days than
the “Compaq/reseller model.”
– At an annual cost of capital of 20%, this
implies $50 savings.
• Third, Dell does not have to spend
money, as Compaq does, advertising to
channel partners funding market ,
development activities and managing
product returns from resellers.
– From page 5 of the case we know that this
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,
consumes 2.5% of revenue, or $58.
Question 7: Required -- Answer
• Fourth (and last), we must also address the channel’s markup of 5-7% (see pg. 5 of the case).
– Some portion of this reflects true, extra costs involved in delivery via the channel. The rest is profit pocketed by the channel (i.e., resellers).
– Given the competitive and brow-beaten nature of the channel, I assume all of the markup reflects extra costs.
This adds 7% * $1 816 = $127 to the total– , costs incurred by the “Compaq/reseller model” versus Dell’s model.
• I use 7% (the upper end of the 5-7% range) because margins are reported to have
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declined to that range by 1998.
Question 7: Required -- Answer
• BOTTOM LINE:
– These extra costs sum up to $315, or
13.6% of Dell’s per unit PC revenue
of $2,313.
– This is a measure of the dollar
amount of the overall (per unit)
competitive advantage produced by
D ll’ b i d l ( t l te s us ness mo e a eas versus
Compaq’s model).
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Question 7: Required -- Answer
B t h t b t ti f• … u , w a a ou accoun ng or
SG&A and R&D cost differences
reported in Exhibits 6 and 13?
– Were you tempted to account for
them in your analysis???
• If we are comparing marginal costs it ,
makes little sense to examine R&D
differences.
• However, it is easier to justify the inclusion
of SG&A differences since they truly are
marginal SG&A costs associated with
each sale.
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– But, …for 1996, SG&A was 10.6% of
revenue for both Dell and Compaq.
Question 7: Required – Answer --
Summary
M hi PC i d f t t• ac ne: equ ppe or a corpora e cus omer.
• Customer: Corporation.
• Competitor: “Compaq/reseller model.”
• Dell price: $2 313 (average of quarterly figures for , 1996 in Exhibit 10b).
• Dell gross margin in 1996: 21.5% (Exhibit 6).
• Rate of decline of component prices: 0.6% per week (25 30% per year pg 5 of the case) - , . .
• Annual cost of capital: 20.0% (assumed).
• Dell days inventory: 15.0 = ($251/($7,759-$1,666)*365 with data from Exhibit 6).
• Competitor days of inventory: 65 (30 + 35, from pg. 11 of the case).
• Channel markup: 7% (high end of range on pg. 5 of the case).
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Question 7: Required -- Answer
• The calculations:
– Dell's cost of goods sold for one PC: $1,816 = ( $2,313 * (1 - 21.5%)).
– Competitor's COGS, higher due to slower inventory turnover: $1 896 (= $1 816/ , , 0.994^((65-15)/7)).
– Dell advantage due to...
• Inputs purchased later: $80 (= $1,896 -$1 816), .
• Lower inventory carrying costs: $50 (= $1,816 * (65 -15) /365 * 20%).
• No channel-related costs: $58 (= $2,313 * 2.5%).
• No channel markup: $127 (= $1,816 * 7%).
– Total Dell advantage: $315.
– Dell advantage as a percent of per unit PC
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revenue: 13.6%.
Question 7: Required -- Answer
• Grading:
– 10 points for doing a reasonable job of setting up the analysis and the remaining 20 points as follows…with partial credit for minor mistakes or math errors…
– Dell's cost of goods sold for one PC: $1,816 = ( $2,313 * (1 - 21.5%)).
– Competitor's COGS, higher due to slower inventory t $1 896 ( $1 816/ 0 994^((65 15)/7))urnover: , = , . - .
– Dell advantage due to...
• 5 points -- Inputs purchased later: $80 (= $1,896 -$1,816).
• 5 points -- Lower inventory carrying costs: $50 (= $1,816 * (65 -15) /365 * 20%).
• 5 points -- No channel-related costs: $58 (= $2,313 * 2.5%).
• 5 points -- No channel markup: $127 (= $1,816 * 7%).
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– Total Dell advantage: $315.
Question 8: Required
O f f• Dell’s R E or iscal year 1998
was 80.8% (see the ratio
analysis in Appendix B) .
– Operating ROA is -331.1% while
the financial leverage effect is
411.9%.
• Briefly, but clearly and succinctly,
explain why these two ROE
components take on such “odd”
values. (10 points)
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Question 8: Required -- Answer
• At a superficial level, Dell’s operating ROA is negative ( 331 1%) because Dell has a negative, - . value for net operating assets (which is actually phenomenal).
• Also at a superficial level Dell’s financial leverage , effect is hugely positive, 411.9%, because Dell has negative net debt and no interest expense which means the “spread” is equal to Operating ROA, which as just noted is negative.
– So Dell’s negative net financial leverage times the negative value for Operating ROA produce a large positive number for the financial leverage effect.
• While the above two points are on target, you have to drill deeper to get full credit on the question….
– If all you do is (clearly) state each of the above, you earn 4 points (2 points for each item)…
T th i i 6 i t t d ill
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– o earn e rema n ng po n s you mus r deeper…
Question 8: Required -- Answer
• Drilling down Operating ROA of , … -331.1%:
– The driving force is that operating working capital asset balances like A/R and inventory are dwarfed by the balances in the operating liability accounts A/P and Accrued expenses.
• More specifically average operating , working capital is -$583,000 while average net long-term assets is $142,000, producing a average net operating assets of -$441,000.
• With NOPAT of $1,460,000, Operating ROA is off the scale at $1,460,000 / -$441,000 = -331.1%
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Question 8: Required -- Answer
• Drilling down, … Financial Leverage Effect of
411 9%:.
– There are two driving forces.
• The first is that Dell reports no interest expense or
interest income so the net interest rate after tax is
0%.
– Since Spread = (Operating ROA – Net Interest Rate
After Tax)… “Spread” is equal to operating ROA of
-331%
• The second is Dell has a negative net debt position .
– (Average) Net debt = (Average) Interest-Bearing
Liabilities – (Cash + Marketable Securities).
– Since Dell has little interest-bearing debt and a large
amount of (Cash + Marketable Securities), its
t d bt i $ 2 248 000average ne e s - , , .
– Average Net debt divided by average stockholders’
equity is (average) net financial leverage…
– And the (Average) net financial leverage is -124.4%
– This times the spread produces the financial leverage
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effect of 411.9 (-124.4% * -331% = 411.9%).
Question 8: Required -- Answer
G• rading:
– The remaining 6 points are earned
for drilling down and providing the
details that appear on the prior two
slides.
• 3 additional points for the in-depth
analysis on each of the two distinct
effects as discussed on the prior two
lids es.
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Question 9: Required
• Assume Dell’s management is quoted
as saying they intend to increase
Sales for the upcoming year (fiscal
year ending 1/31/2000) by 35%.
– Assuming no changes in profitability and
no changes in efficiency, what is your ex
ante estimate of the predictable operating
cash flow effect of the plan, that is, what is
your estimate of the operating cash flow
surplus or shortfall? (30 points)
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Q9: Preliminary Income Statement
A t A l iccoun na ys s
DELL
PRELIMINARY ANALYSIS
INCOME STATEMENT: 1/31/1999 1/31/2000 (DECREASE)
SALES $18,243,000 $24,628,050 $6,385,050
CGS $14,137,000 $19,577,511 $5,440,511
GROSS PROFIT $4,106,000 $5,050,539 $944,539
SALES PER DAY (SALES / 360) $50,675.000 $68,411.250 $17,736.250
CGS PER DAY (CGS / 360) $39 269 444 $54 381 975 $15 112 531 , . , . , .
GROSS MARGIN 22.507% 20.507% -2.000%
TOTAL SG&A $2,060,000 $3,027,281 $967,281
SG&A AS A % OF SALES 11 292% 12 292% 1 00% . . .
NON-CASH EXPENSES INCLUDED IN SG&A $103,000 $139,050 $36,050
NON-CASH SG&A AS A % OF SALES 0.565% 0.565% 0.000%
CASH SG&A $1 957 000 $2 888 231 $931 231
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, , , , ,
CASH SG&A AS A % OF SALES 10.727% 11.727% 1.000%
Q9: Preliminary Balance Sheet Account
A l ina ys s
ACTUAL FORECASTED
BALANCE SHEET: 1/31/1999 1/31/2000 (DECREASE)
A/R BALANCE (GIVEN IN MOST RECENT YEAR. IN FORECAST YEAR
EQUAL TO SALES PER DAY TIMES A/R DAYS) $2 094 000 $2 963 723 $869 723 , , , , ,
A/R DAYS (IN MOST RECENT YEAR, A/R DIVIDED BY SALES PER DAY, IN
FORECAST YEAR, PRIOR YEAR VALUE ADJUSTED FOR THE FORECASTED
CHANGE FROM ABOVE) 41.322 43.322 2.0
INVENTORY BALANCE (GIVEN IN MOST RECENT YEAR IN FORECAST .
YEAR EQUAL TO CGS PER DAY TIMES INVENTORY DAYS) $273,000 $323,680 $50,680
INVENTORY DAYS (IN MOST RECENT YEAR, INVENTORY DIVIDED BY CGS
PER DAY, IN FORECAST YEAR, PRIOR YEAR VALUE ADJUSTED FOR THE
FORECASTED CHANGE FROM ABOVE) 6.952 5.952 -1.0
A/P BALANCE (GIVEN IN MOST RECENT YEAR IN FORECAST YEAR .
EQUAL TO CGS PER DAY TIMES A/P DAYS) $2,397,000 $3,210,702 $813,702
A/P DAYS (IN MOST RECENT YEAR, A/P DIVIDED BY CGS PER DAY, IN
FORECAST YEAR, PRIOR YEAR VALUE ADJUSTED FOR THE FORECASTED
CHANGE FROM ABOVE) 61.040 59.040 -2.0
ACCRUED EXPENSES BALANCE (GIVEN IN MOST RECENT YEAR. IN
FORECAST YEAR EQUAL TO FORECASTED SALES TIMES THE
FORECASTED RATIO OF ACCRUED EXPENSES TO SALES FROM ABOVE) $1,298,000 $1,506,020 $208,020
ACCRUED EXPENSES AS A % OF SALES (IN THE MOST RECENT YEAR,
Professor Charles E. Wasley 51
ACTUAL ACCRUED EXPENSES DIVIDED BY SALES. IN THE FORECAST
YEAR, EQUALS PRIOR YEAR RATIO ADJUSTED FOR THE FORECASTED
CHANGE FROM ABOVE). 7.115% 6.115% -1.000%
Q9: Cash Flow Effects of Growth Per Se ,
DELL ACTUAL FORECASTED INCREASE %
CASH FLOW EFFECTS OF SALES GROWTH, PER SE, NO CHANGES IN
PROFITABILITY OF EFFICIENCY 1/31/1999 1/31/2000 (DECREASE) CHANGE
SALES $18,243,000 $24,628,050 $6,385,050 35.000%
CGS $14,137,000 $19,084,950 $4,947,950 35.000%
GROSS PROFIT $4,106,000 $5,543,100 $1,437,100 35.000%
SALES PER DAY $50,675.000 $68,411.250 $17,736.250 35.000%
CGS PER DAY $39,269.444 $53,013.750 $13,744.306 35.000%
GROSS MARGIN 22.507% 22.507% 0.000% 0.000%
SG&A (CASH SG&A) $1,957,000 $2,641,950 $684,950 35.000%
SGA (CASH) % 10.727% 10.727% 0.000% 0.000%
A/R $2,094,000 $2,826,900 $732,900 35.000%
A/R DAYS 41.322 41.322 0.000 0.000%
INVENTORY $273,000 $368,550 $95,550 35.000%
INVENTORY DAYS 6.952 6.952 0.000 0.000%
A/P $2,397,000 $3,235,950 $838,950 35.000%
A/P DAYS 61.040 61.040 0.000 0.000%
Professor Charles E. Wasley 52
ACCRUED EXPENSES $1,298,000 $1,752,300 $454,300 35.000%
ACCRUED EXPENSES AS A % OF SALES 7.115% 7.115% 0.000% 0.000%
Q9: Cash Flow Effects of Growth, Per Se:
Looks Good So Far!
DELL
CASH FLOW EFFECTS OF SALES GROWTH PER SE: ,
CASH FLOW DETERMINANT AFFECTED BY SALES GROWTH, PER SE $ AMOUNT
% OR DAYS
MEASURE
SOURCE (USE)
OF CASH
A) INCREASE IN SALES IMPACT ON GROSS PROFIT $6,385,050 22.507% $1,437,100
B) INCREASE IN SALES IMPACT ON SG&A $6,385,050 10.727% ($684,950)
C) INCREASE IN SALES PER DAY IMPACT ON A/R $17,736.250 41.322 ($732,900)
D) INCREASE IN CGS PER DAY IMPACT ON INVENTORY $13,744.306 6.952 ($95,550)
E) INCREASE IN CGS PER DAY IMPACT ON A/P $13,744.306 61.040 $838,950
F) INCREASE IN SALES IMPACT ON ACCRUED EXPENSES $6,385,050 7.115% $454,300
TOTAL CASH FLOW EFFECTS OF GROWTH, PER SE $1,216,950
EXPLANATION FOR THE AMOUNTS ABOVE:
A) PRIOR YEAR GROSS MARGIN RATE TIMES THE INCREASE IN SALES
B) PRIOR YEAR SG&A AS A % OF SALES TIMES THE INCREASE IN SALES
C) PRIOR YEAR A/R DAYS TIMES THE INCREASE IN SALES PER DAY
D) PRIOR YEAR INVENTORY DAYS TIMES IN INCREASE IN CGS PER DAY
E) PRIOR YEAR A/P DAYS TIMES IN INCRASE IN CGS PER DAY
Professor Charles E. Wasley 53

F) PRIOR YEAR ACCRUED EXPENSES AS A % OF SALES TIMES THE
INCREASE IN SALES
Question 9: Required -- Answer
• Grading:
– 5 points each for (A) – (F) on the
prior slide.
• Correct set-ups, but answers with
minor errors on the exact underlying
calculations lose a point or two.
• BUT, you must have the correction for
the non-cash amount of depreciation
and amortization expense imbedded in
SG&A i i ll t d D ll’ as or g na y repor e on e s
income statement.
Professor Charles E. Wasley 54
Question 10: Required
• Assume the same Sales growth projection as in
question 9 and in addition that:
– Gross margin declines by 2 percentage points.
– SG&A as a percent of Sales increases by 1 percentage point.
A/R d d t i t b 2 d– ays e er ora es y ays.
– Inventory days improves by 1 day.
– A/P days decreases by 2 days.
– The Accrued Expenses account will be 1 percentage point
lower as a percent of Sales for the year ending 1/31/2000 when
compared to the year ending 1/31/1999.
• Will these changes in profitability and efficiency be an
additional source or drain of operating cash flow and
by how much? (30 points)
Professor Charles E. Wasley 55
Q10: Cash Flow Effects of Growth, With
Changes in Profitability and Efficiency
DE ACTUA FORECASTED INCREASE %LL L
CASH FLOW EFFECTS CHANGES IN PROFITABILITY OF EFFICIENCY 1/31/99 1/31/00 (DECREASE) CHANGE
SALES $18,243,000 $24,628,050 $6,385,050 35.000%
CGS $14 137 000 $19 577 511 $5 440 511 38 484%, , , , , , .
GROSS PROFIT $4,106,000 $5,050,539 $944,539 23.004%
SALES PER DAY $50,675.000 $68,411.25 $17,736.250 35.000%
CGS PER DAY $39,269.444 $54,381.98 $15,112.531 38.484%
GROSS MARGIN 22.507% 20.507% -2.000% -8.886%
SG&A (CASH SG&A) $1,957,000 $2,888,231 $931,231 47.585%
SGA (CASH) % 10.727% 11.727% 1.000% 9.322%

A/R $2,094,000 2,963,723 $869,723 41.534%
A/R DAYS 41 322 43 322 2 000 4 840% . . . .
INVENTORY $273,000 323,680 $50,680 18.564%
INVENTORY DAYS 6.952 5.952 -1.000 -14.384%
A/P $2,397,000 3,210,702 $813,702 33.947%
A/P DAYS 61.040 59.040 -2.000 -3.277%
Professor Charles E. Wasley 56

ACCRUED EXPENSES 1,298,000 1,506,020 $208,020 16.026%
ACCRUED EXPENSES AS A % OF SALES 7.115% 6.115% -1.000% -14.055%
Q10: Cash Flow Effects of Growth, With
Changes in Profitability and Efficiency: OUCH!!!
DELL
CASH FLOW EFFECTS OF CHANGES IN PROFITABILITY AND EFFICIENCY
CASH FLOW DETERMINANT AFFECTED BY CHANGES IN PROFITABILITY
AND EFFICIENCY $ AMOUNT
% OR DAYS
MEASURE
SOURCE (USE)
OF CASH
A) CHANGE IN GROSS MARGIN RATE IMPACT ON GROSS PROFIT $24,628,050 -2.000% ($492,561)
B) CHANGE IN SG&A% IMPACT ON SG&A $24 628 050 1 000% ($246 281) , , . ,
C) CHANGE IN A/R DAYS IMPACT ON A/R $68,411.250 2.000 ($136,823)
D) CHANGE IN INVENTORY DAYS IMPACT ON INVENTORY $54,381.975 -1.000 $54,382
E) CHANGE IN A/P DAYS IMPACT ON A/P $54,381.975 -2.000 ($108,764)
F) CHANGE IN ACCRUED EXPENSES AS A % OF SALES IMPACT ON
ACCRUED EXPENSES $24,628,050 -1.000% ($246,281)
TOTAL CASH FLOW EFFECTS OF CHANGES IN PROFITABILITY AND
EFFICIENCY ($1,176,326)
EXPLANATION FOR THE AMOUNTS ABOVE:
A) CHANGE IN GROSS MARGIN RATE TIMES FORECASTED SALES
B) CHANGE IN SGA% TIMES FORECASTED SALES
C) CHANGE IN A/R DAYS TIMES FORECASTED SALES PER DAY
D) CHANGE IN INVENTORY DAYS TIMES FORECASTED CGS PER DAY
E) CHANGE IN A/P DAYS TIMES FORECASTED CGS PER DAY
Professor Charles E. Wasley 57

F) CHANGE IN ACCRUED EXPENSES AS A % OF SALES TIMES
FORECASTED SALES
Q10: Summary
SUMMARY OF THE ANALYSIS:
TOTAL CASH FLOW EFFECTS OF GROWTH, PER SE $1,216,950
TOTAL CASH FLOW EFFECTS OF CHANGES IN PROFITABILITY AND
EFFICIENCY ($1,176,326)
ADJUSTMENT FOR THE DUAL EFFECTS OF SALES GROWTH PER SE AND
CHANGES IN PROFITABILITY ON THE INVENTORY ACCOUNT ($9,512)
ADJUSTMENT FOR THE DUAL EFFECTS OF SALES GROWTH PER SE AND
CHANGES IN PROFITABILITY ON THE ACCOUNTS PAYABLE ACCOUNT $83,516
(NET) OPERATING CASH FLOW EFFECTS OF GROWTH $114,628
IF < 0, GROWTH CREATES AN OPERATING CASH FLOW SHORTFALL
Professor Charles E. Wasley 58
IF > 0, GROWTH CREATES AN OPERATING CASH FLOW SURPLUS
Q10: Summary Answer --
• If all goes as forecasted, the net
effect would be an operating
cash flow surplus of about
$114,628,000.
– While this main seem large, as a
t f t t l S l it i l 0 5%percen o o a a es s on y .
(=$114,628,000 / 24,648,050,000).
– In other words the margin for error
is only about ½ of 1% of Sales.
Professor Charles E. Wasley 59
Q10: Summary Answer --
• Grading:
– 5 points each for (A) – (F) on the
slide 57.
• Correct set-ups, but answers with
minor errors on the exact underlying
calculations lose a point or two.
Professor Charles E. Wasley 60
Question 11: Optional
• As the starting point, assume the forecasted
changes in profitability and efficiency noted in
question 10 are achieved, BUT THAT…
Dell wanted to generate enough operating cash–
flow to repurchase $2 billion worth of common
stock in the open market and to increase its
marketable securities portfolio by $500 million.
– How would the profitability and efficiency
enhancements noted in question 10 had to
have changed in order for Dell do accomplish
the two objectives above? (25 points)
– Do the changes required seem feasible given
the competitive nature of the industry? (5
Professor Charles E. Wasley 61
points)
Question 11: Optional -- Answer
From earlier analysis we know the•
forecasted changes in profitability and
efficiency will produce about
$134,000,000 of operating cash flow.
– To repurchase $2 billion worth of common
t k d i k t bl itis oc an ncrease mar e a e secur es
by $500 million we need improvements in
operating profitability and efficiency that
$will produce about 2.4 billion of surplus
operating cash flow.
Professor Charles E. Wasley 62
Question 11: Optional -- Answer
• From a big picture view we’re talking about
improvements in the Dell’s cash cycle (A/R
days + Inventory days – A/P days) and
improvements in Dell’s operating margin
(gross margin – SGA as % of sales).
– Obviously there are an infinite number of
i l b il i llnumer ca , ut not necessar y econom ca y
feasible possibilities that produce an operating
cash flow surplus of $2.4 billion.
Th f ll i lid tli h t f– e o ow ng s es ou ne one suc se o
forecasted improvements.
Professor Charles E. Wasley 63
Q11: Profitability and Efficiency Changes to Produce
Surplus Operating Cash Flow of about $2.4B
CHANGE IN PROFITABILITY PARAMETERS:
INCREASE IN GROSS MARGIN IN PERCENTAGE POINTS 2.000%
DECREASE IN SG&A IN PERCENTAGE POINTS -1.000%
CHANGE IN EFFICIENCY PARAMETERS:
CHANGE IN A/R DAYS -3
CHANGE IN INVENTORY DAYS -3
CHANGE IN A/P DAYS 3
CHANGE IN THE RATIO OF ACCRUED EXPENSES TO SALES IN
Professor Charles E. Wasley 64
PERCENTAGE POINTS 1.000%
Q11: Profitability and Efficiency Changes to Produce
Surplus Operating Cash Flow of about $2.4B
DELL
CASH FLOW EFFECTS OF SALES GROWTH PER SE , :
CASH FLOW DETERMINANT AFFECTED BY SALES GROWTH, PER SE $ AMOUNT
% OR DAYS
MEASURE
SOURCE (USE)
OF CASH
A) INCREASE IN SALES IMPACT ON GROSS PROFIT $6 385 050 22 507% $1 437 100 , , . , ,
B) INCREASE IN SALES IMPACT ON SG&A $6,385,050 10.727% ($684,950)
C) INCREASE IN SALES PER DAY IMPACT ON A/R $17,736.250 41.322 ($732,900)
D) INCREASE IN CGS PER DAY IMPACT ON INVENTORY $13,744.306 6.952 ($95,550)
E) INCREASE IN CGS PER DAY IMPACT ON A/P $13,744.306 61.040 $838,950
F) INCREASE IN SALES IMPACT ON ACCRUED EXPENSES $6,385,050 7.115% $454,300
TOTAL CASH FLOW EFFECTS OF GROWTH, PER SE $1,216,950
EXPLANATION FOR THE AMOUNTS ABOVE:
A) PRIOR YEAR GROSS MARGIN RATE TIMES THE INCREASE IN SALES
B) PRIOR YEAR SG&A AS A % OF SALES TIMES THE INCREASE IN SALES
C) PRIOR YEAR A/R DAYS TIMES THE INCREASE IN SALES PER DAY
D) PRIOR YEAR INVENTORY DAYS TIMES IN INCREASE IN CGS PER DAY
E) PRIOR YEAR A/P DAYS TIMES IN INCRASE IN CGS PER DAY
Professor Charles E. Wasley 65

F) PRIOR YEAR ACCRUED EXPENSES AS A % OF SALES TIMES THE
INCREASE IN SALES
Q11: Profitability and Efficiency Changes to Produce
Surplus Operating Cash Flow of about $2.4B
DELL
CASH FLOW EFFECTS OF CHANGES IN PROFITABILITY AND EFFICIENCY
CASH FLOW DETERMINANT AFFECTED BY CHANGES IN PROFITABILITY
AND EFFICIENCY $ AMOUNT
% OR DAYS
MEASURE
SOURCE (USE)
OF CASH
A) CHANGE IN GROSS MARGIN RATE IMPACT ON GROSS PROFIT $24,628,050 2.000% $492,561
B) CHANGE IN SG&A% IMPACT ON SG&A $24 628 050 1 000% $246 281 , , - . ,
C) CHANGE IN A/R DAYS IMPACT ON A/R $68,411.250 -3.000 $205,234
D) CHANGE IN INVENTORY DAYS IMPACT ON INVENTORY $51,645.525 -3.000 $154,937
E) CHANGE IN A/P DAYS IMPACT ON A/P $51,645.525 3.000 $154,937
F) CHANGE IN ACCRUED EXPENSES AS A % OF SALES IMPACT ON
ACCRUED EXPENSES $24,628,050 1.000% $246,281
TOTAL CASH FLOW EFFECTS OF CHANGES IN PROFITABILITY AND
EFFICIENCY $1,500,229
EXPLANATION FOR THE AMOUNTS ABOVE:
A) CHANGE IN GROSS MARGIN RATE TIMES FORECASTED SALES
B) CHANGE IN SGA% TIMES FORECASTED SALES
C) CHANGE IN A/R DAYS TIMES FORECASTED SALES PER DAY
D) CHANGE IN INVENTORY DAYS TIMES FORECASTED CGS PER DAY
E) CHANGE IN A/P DAYS TIMES FORECASTED CGS PER DAY
Professor Charles E. Wasley 66
F) CHANGE IN ACCRUED EXPENSES AS A % OF SALES TIMES
FORECASTED SALES
Q11: Profitability and Efficiency Changes to
Produce Surplus Operating Cash Flow of about
$2.4B
SUMMARY OF THE ANALYSIS:
TOTAL CASH FLOW EFFECTS OF GROWTH, PER SE $1,216,950
TOTAL CASH FLOW EFFECTS OF CHANGES IN PROFITABILITY AND
EFFICIENCY $1 500 229, ,
ADJUSTMENT FOR THE DUAL EFFECTS OF SALES GROWTH PER SE AND
CHANGES IN PROFITABILITY ON THE INVENTORY ACCOUNT $9,512
ADJUSTMENT FOR THE DUAL EFFECTS OF SALES GROWTH PER SE AND
CHANGES IN PROFITABILITY ON THE ACCOUNTS PAYABLE ACCOUNT ($83,516)
(NET) OPERATING CASH FLOW EFFECTS OF GROWTH $2 643 175 , ,
IF < 0, GROWTH CREATES AN OPERATING CASH FLOW SHORTFALL
Professor Charles E. Wasley 67
IF > 0, GROWTH CREATES AN OPERATING CASH FLOW SURPLUS
Question 11: Optional -- Answer
• As noted above …
– From a big picture view we’re talking about
improvements in the Dell’s A/R days, Inventory
days A/P days Accrued Expenses to Sales, , ,
gross margin or SGA as % of sales.
• Grading:
Some combination of changes to all of the–
above is more economically sensible than a
HUGE change in just 1 or 2.
• 2½ points each for just listing a proposed
change to up to 4 of the 6 items above (10 points
so far, 2½ * 4).
• 5 points (each) for performing a numerical
calculation to quantify the benefit for up to four
different efficiency or profitability changes from
Professor Charles E. Wasley 68

the 6 possible above (20 more points here, 5 * 4).
Question 12: Optional
• Based on your analysis in
questions 9 and 10:
– Reconcile the change in the
account balance from year-end
1/29/1999 t d o year-en
1/31/2000 for 3 of the following
accounts:
• Gross profit, A/R, Inventory, A/P or
Accrued Expenses. (15 points)
Professor Charles E. Wasley 69
Q ti 12 O ti l Aues on : p ona -- nswer
• The reconciliations appear on
the following slides.
– Grading:
• Each of the three is worth 5 points
each.
– To get full credit you must have the 2
(or 3) reconciling amounts required to
make the specific account balance.
– Partial credit is given if you get some,
but not all of the reconciling items for a
given account.
Professor Charles E. Wasley 70
Question 12: Optional Answer --
DELL
RECONCILIATION OF KEY INCOME STATEMENT ACCOUNTS:
GROSS PROFIT:
PRIOR YEAR'S AMOUNT $4 106 000 , ,
CASH FLOW EFFECTS OF SALES GROWTH, PER SE: $1,437,100
CASH FLOW EFFECTS OF CHANGES IN PROFITABILITY ($492,561)
ROUNDING $0
FORECASTED YEAR'S AMOUNT $5,050,539
SG&A:
PRIOR YEAR'S AMOUNT $1,957,000
CASH FLOW EFFECTS OF SALES GROWTH, PER SE: $684,950
CASH FLOW EFFECTS OF CHANGES IN PROFITABILITY $246,281
ROUNDING $0
Professor Charles E. Wasley 71

FORECASTED YEAR'S AMOUNT $2,888,231
Question 12: Optional Answer --
DELL
RECONCOLIATION OF KEY BALANCE SHEET ACCOUNTS:
/A R:
PRIOR YEAR'S AMOUNT $2,094,000
CASH FLOW EFFECTS OF SALES GROWTH, PER SE: $732,900
CASH FLOW EFFECTS OF CHANGES IN PROFITABILITY AND EFFICIENCY $136,823
ROUNDING $0
FORECASTED YEAR'S AMOUNT $2,963,723
INVENTORY
PRIOR YEAR'S AMOUNT $273,000
CASH FLOW EFFECTS OF SALES GROWTH, PER SE: $95,550
CASH FLOW EFFECTS OF CHANGES IN PROFITABILITY AND EFFICIENCY ($54,382)
ADJUSTMENT FOR THE DUAL EFFECTS OF SALES GROWTH PER SE AND
CHANGES IN PROFITABILITY ON THE INVENTORY ACCOUNT BALANCE =
(CGS PER DAY ASSUMING CHANGES IN PROFITABILITY AND EFFICIENCY) -
(CGS PER DAY ASSUMING NO CHANGES IN PROFITABILITY OR
EFFICIENCY) * INVENTORY DAYS ASSUMING NO CHANGE IN EFFICIENCY $9,512
Professor Charles E. Wasley 72
ROUNDING $0
FORECASTED YEAR'S AMOUNT $323,680
Question 12: Optional Answer --
A/P
PRIOR YEAR'S AMOUNT $2,397,000
CASH FLOW EFFECTS OF SALES GROWTH, PER SE: $838,950
CASH FLOW EFFECTS OF CHANGES IN PROFITABILITY AND EFFICIENCY ($108,764)
ADJUSTMENT FOR THE DUAL EFFECTS OF SALES GROWTH PER SE AND
CHANGES IN PROFITABILITY ON THE ACCOUNTS PAYABLE ACCOUNT
BALANCE = (CGS PER DAY ASSUMING CHANGES IN PROFITABILITY AND
EFFICIENCY) - (CGS PER DAY ASSUMING NO CHANGES IN PROFITABILITY
OR EFFICIENCY) * ACCOUNTS PAYABLE DAYS ASSUMING NO CHANGE IN
EFFICIENCY $83,516
ROUNDING $0
FORECASTED YEAR'S AMOUNT $3,210,702
ACCRUED EXPENSES :
PRIOR YEAR'S AMOUNT $1,298,000
CASH FLOW EFFECTS OF SALES GROWTH, PER SE: $454,300
CASH FLOW EFFECTS OF CHANGES IN PROFITABILITY AND EFFICIENCY ($246,281)
ROUNDING $0
Professor Charles E. Wasley 73

FORECASTED YEAR'S AMOUNT $1,506,020
Question 13: Optional
• The ratio analysis in Appendix B shows
that Dell’s ROE for the most recent
fiscal year as of the time of the case
(1998, 1/29/1999) is 80.8%. Since
Dell’s pays no dividends this means
the firm’s sustainable growth rate
equals its ROE.
– I claim Dell’s sustainable growth rate is, in
fact higher than 80 8%, . .
– Provide quantitative evidence to support or
refute my claim. Be sure to state and justify
any assumptions (30 points)
Professor Charles E. Wasley 74

Question 13: Optional -- Answer
The key here of course is to• , ,
recognize that Dell has lots of
excess marketable securities .
– The following slide shows cash and
marketable securities over the years
covered by the case.
Professor Charles E. Wasley 75
Question 13: Optional -- Answer
Dell
COMMON-SIZE BALANCE SHEET (SALES)
FISCAL YEAR ENDED 1/29/1999 2/1/1998 2/2/1997 1/28/1996 1/29/1995 1/30/1994 1/31/1993
CASH 2.85% 2.60% 1.48% 1.04% 1.24% 0.12% 0.74%
SHORT-TERM INVESTMENTS 14.59% 12.36% 15.94% 11.16% 13.94% 11.61% 3.99%
Professor Charles E. Wasley 76
Question 13: Optional -- Answer
• Given Dell’s ability to generate significant amounts of cash from operations, it seems fair to assume for the sake of this question that the firm could distribute as much as 2/3 of its marketable securities to shareholders (by repurchasing shares in the open market) without having any impact on its underlying PC operations.
– For the purposes of the question you could , have used a smaller percentage.
– The key of course is to recognize the need to adjust for the excess marketable securities (i.e., non-operating assets).
– …What would be the financial statements effects of this….?
Professor Charles E. Wasley 77
Question 13: Optional -- Answer
• What would be the financial statements effects of
this….?
– Since we are focusing on ROE for fiscal 1998 we
need to adjust both fiscal years 1997 and 1998
b ROE i b d lecause s ase on average va ues.
• The balance sheet would change as follows:
– Marketable securities of (2/3*$2,661,000) would be
eliminated in fiscal 1998 and (2/3*$1,524,000) would be
eliminated in fiscal 1997 Shareholders’ equity would fall .
by the same amount each year.
• The income statement would change as follows:
– The other income of $25,333 (2/3 *$38,000) (assumed
interest and dividend income) would be eliminated in fiscal
1998 and other income of $34,667 (2/3 *$52,000) would
be eliminated in fiscal 1997.
– Pretax income would fall by the same amount and net
income would fall by this amount times (1.0 – Dell’s tax
rate). Income tax expense would also change.
Professor Charles E. Wasley 78

Question 13: Optional -- Answer
• The idea is to make these…
adjustments and re-compute ROE.
– The following slide shows Dell’s “revised”
ROE is about 350% which means its real
sustainable growth rate is (also) about
350%.
• This is off the scale by any sense of the
imagination.
– And it is because the adjusted stockholders’
equity is very small, producing a very high
ROE as a result.
• Dell can continue to grow (Sales) at very
rapid rates without much difficulty (i.e.,
ith t d f t l fi i )
Professor Charles E. Wasley 79
w ou nee o ex erna nanc ng .
Question 13: Optional -- Answer
Dell
RATIOS
FISCAL YEAR ENDED 1/29/1999
RETURN ON EQUITY
ROE 349.8%
ROA MARGIN (NOPAT MARGIN) 7.9%
ASSET TURNOVER 4.37
ROA 34.5%
COMMON EARNINGS LEVERAGE 1.00
FINANCIAL LEVERAGE 10.14
ROE = NOPAT MARGIN * A/T * CEL * LEV 349.8%
ROE = ROA * CEL * LEV 349.8%
Dell
FISCAL YEAR ENDED 1/29/1999
ALTERNATIVE DECOMPOSITION OF ROE:
ALTERNATIVE ROE CALCULATION:
OPERATING ROA -326.8%
FIN'L LEVERAGE EFFECT 676.5%
OPERATING ROA + FINL LEVERAGE EFFECT 349.8%
Professor Charles E. Wasley 80
ROE (FROM ABOVE) 349.8%
DIFFERENCE (SHOULD BE ZERO) 0.0%
Question 13: Optional -- Answer
Grading:•
– The key (of course) was to perform the numerical
calculations.
• If you described (without calculations) the adjustments
you would make (i.e., reduce all of the following,
marketable securities, shareholders’ equity, interest &
dividend income, pretax income, tax expense and net
income), you earn 2 points for each item mentioned up
to 12 points (i e 2*6) . ., .
• To earn the other 18 points you have to “run some
numbers” to show how the adjustments would effect
ROE.
• You DON’T have to produce the same value for ROE
that I did, and you DON’T have to show the effect on
each of the 6 items above to earn 18 points.
• What you do have to do is present a reasonably well-
laid out calculation Partial credit will be given on the
Professor Charles E. Wasley 81
.
numerical part of the question.
Question 14: Optional
• “Quantifying a second aspect of Dell’s competitive advantage.”
– Dell’s inventory management practices are often cited as one of its key competitive d ta van ages.
• a) Use the information in exhibits 6 and 11-15 to quantify how Dell’s inventory management is a comparative advantage C b d 1998 lt (10over ompaq ase on resu s. points)
• b) Is Dell’s competitive advantage over Gateway larger or smaller than that over Compaq? No dollar amount here just yes , or no and the reason why. (2½ points)
• c) Is Dell’s competitive advantage over IBM larger or smaller than that over Compaq? No dollar amount here just yes or no and
Professor Charles E. Wasley 82
, the reason why. (2½ points)
Question 14: Optional -- Answer
Th k h i t ti t th d ll• e ey ere s o es ma e e o ar
amount on the “cash savings” Dell’s
achieves by having such a low days
i t h ld d t hnven ory e compare o eac
competitor, and in particular, Compaq
in this specific instance.
– More specifically, we need to estimate how
much higher Dell’s investment in inventory
would be if it operating at Compaq’ days
inventory held .
• This gives us a measure of the dollar
amount of Dell’s competitive advantage
over Compaq as a result of better managing
in entor nder its b siness model
Professor Charles E. Wasley 83
v y u u .
Question 14: Optional -- Answer
• a) From exhibit 11, the inventory days of Dell, Compaq, IBM, HP and Gateway are 7.0, 34.2, 49.4, 70.4 and 10.0, respectively.
– The firms’ CGS per day (using data from exhibits 6, and 12-15 are):
• Dell ($18,243 - $4,106) / 365 = $38.73M.
– From this we can derive inventory days by dividing the inventory balance by CGS per day: $273 / $38.73 = 7.048.
• Compaq ($31,169 - $9,786) / 365 =$58.58M.
– From this we can derive inventory days by dividing the inventory balance by CGS per day: $2,005 / $58.58 = 34.225.
• IBM ($81,667 - $43,282) / 365 = $105.16M.
– From this we can derive inventory days by dividing the inventory balance by CGS per day: $5,200 / $105.16M = 49.446.
• Gateway ($7,648 - $1,546) / 365 = 16.72M.
– From this we can derive inventory days by dividing the inventory balance by CGS per day: $168 / $16.72 = 10.05.
• HP ($47,061 - $14,989) / 365 = $87.87M.
F thi d i i t d b di idi th
Professor Charles E. Wasley 84
– rom s we can er ve nven ory ays y v ng e inventory balance by CGS per day: $6,184 / $87.87 = 70.38.
Question 14: Optional -- Answer
• a ) The difference between…
Compaq’s and Dell’s inventory
days is 34.2 - 7.0 = 27.2 days.
– If we multiply this by Dell’s CGS per
day of $38.73M we have $1,053.5M
(i li htl billi d ll ).e., s g y over a on o ars .
• This would be Dell’s additional
investment in inventory if it managed
inventory as bad as Compaq (or didn’t
use it’s direct sales business model).
Professor Charles E. Wasley 85
Question 14: Optional -- Answer
• a ) Grading:…
– 5 points for getting Dell’s CGS per
day ($38.73M) and 5 points for
getting the difference between
Dell’s and Compaq’s days inventory
held (27 2 days) . .
– Partial credit is given for alternative
analysis and calculations that make
sense economically, but aren’t like
what’s above
Professor Charles E. Wasley 86
.
Question 14: Optional -- Answer
• b) Dell’s competitive advantage over Gateway is smaller than that over Compaq because Gateway’s inventory days of 10.0 is less than Compaq’s 34.2.
– Grading:
• 2½ points for noting the point just made (no numerical analysis was asked for). No partial credit here.
• c) Dell’s competitive advantage over IBM is larger than that over Compaq because IBM’s inventory days of 49.4 is more than Compaq’s 34.2.
– Grading:
• 2½ points for noting the point just made (no numerical analysis was asked for). No partial credit here.
Professor Charles E. Wasley 87
Question 15: Optional
• Exhibits 6, 11-15 of the case contain
information about Dell and its
competitors, IBM, Compaq, Gateway
and HP.
– Assume you are writing an equity
research report at the time of the case and
the objective of the report is to provide a
rigorous and careful comparison of Dell
with these competitors.
• What are the 2 most important
observations you would make to clearly
distinguish Dell from EACH of the
competitors in the executive summary on
page 1 of your report? (15 points)
Professor Charles E. Wasley 88
Question 15: Optional -- Answer
• Perhaps the best way to answer
this question is to identify the
aspects where Dell has excelled
and where the competitors have
faltered.
– So..
Professor Charles E. Wasley 89
Question 15: Optional -- Answer
• Versus Compaq:
– From exhibit 11 (1998 comparisons):
M ch higher stock price appreciation• u .
• Higher return on equity and return on invested capital.
• Higher compound annual growth in units sold and value of units sold.
• Much shorter inventory days.
• Higher profit margin (return on Sales).
• Lower SG&A as a % of Sales.
– From exhibit 6 versus exhibit 13 (over time comparison):
• Dell tends to exhibit higher ROE (NI / EOY equity) .
• Dell tends to exhibit higher net income as a % of Sales.
• Dell tends to exhibit lower SG&A as a % of Sales.
• Dell tends to exhibit lower gross margins.
• Grading:
– 2 points each for up to 2 reasons from the lists above.
– Other reasons, if sensible, 1 point each up to 2 reasons.
Professor Charles E. Wasley 90
Question 15: Optional -- Answer
• Versus Gateway:
– From exhibit 11(1998 comparisons):
• Much higher stock price appreciation.
• Higher return on equity and return on invested capital.
• Higher compound annual growth in units sold and value of units sold.
• Shorter inventory days.
• Higher profit margin (return on Sales).
• Lower SG&A as a % of Sales.
– From exhibit 6 versus exhibit 15 (over time comparison):
• Dell tends to exhibit higher ROE (NI / EOY equity), more so recently.
• Dell tends to generate more operating cash flow.
• Dell tends to exhibit higher net income as a % of Sales (more so recently).
• Dell tends to exhibit lower SG&A as a % of Sales (more so recently).
• Dell tends to exhibit higher gross margins.
• Grading:
2 points each for up to 2 reasons from the lists above
Professor Charles E. Wasley 91
– .
– Other reasons, if sensible, 1 point each up to 2 reasons.
Question 15: Optional -- Answer
• Versus IBM:
– From exhibit 11 (1998 comparisons):
• Much higher stock price appreciation.
• Higher return on equity and return on invested capital.
• Higher compound annual growth in units sold and value of units sold.
• Shorter inventory days.
• Higher profit margin (return on Sales).
• Lower SG&A as a % of Sales .
– From exhibit 6 versus exhibit 12 (over time comparison):
• Dell tends to exhibit higher ROE (NI / EOY equity).
• Dell tends to generate less operating cash flow, but IBM is obviously much larger.
• Dell tends to exhibit higher net income as a % of Sales (but the differences are not large).
• Dell tends to exhibit lower SG&A as a % of Sales.
• Dell tends to exhibit lower gross margins (IBM sells services which have high gross margins).
• IBM spends more as a percent of Sales on R&D.
• Grading:
Professor Charles E. Wasley 92
– 2 points each for up to 2 reasons from the lists above.
– Other reasons, if sensible, 1 point each up to 2 reasons.
Question 15: Optional -- Answer
• Versus HP:
– From exhibit 11 (1998 comparisons):
• Much higher stock price appreciation.
• Higher return on equity and return on invested capital.
• Higher compound annual growth in units sold and value of units sold.
• Shorter inventory days.
• Higher profit margin (return on Sales) .
• Lower SG&A as a % of Sales.
– From exhibit 6 versus exhibit 14 (over time comparison):
• Dell tends to exhibit higher ROE (NI / EOY equity).
• Dell tends to generate less operating cash flow, but HP is obviously much larger.
• Dell tends to exhibit higher net income as a % of Sales.
• Dell tends to exhibit lower SG&A as a % of Sales.
• Dell tends to exhibit lower gross margins (HP sells services which have high gross margins).
• IBM spends more as a percent of Sales on R&D.
• Grading:
Professor Charles E. Wasley 93
– 1½ points each for up to 2 reasons from the lists above.
– Other reasons, if sensible, ½ point each up to 2 reasons.
Question 16: Optional
• There are 3 parts to this
question.
a) Appendix B provides the usual–
ratio analysis for Dell for the time
period covered by the case (fiscal
years 1991-1998).
• If you were preparing an equity
research report on Dell AT THE TIME
OF THE CASE, what are the 3 most
important observations you would
make in the executive summary on
Professor Charles E. Wasley 94
page 1 of your report? (6 points)
Question 16a: Optional -- Answer
1) I i i th t i t t b ti• n my op n on, e mos mpor an o serva ons to make (in decreasing order of importance are):
– 1) ROE increases dramatically over this period (a good thing).
2) The cash cycle falls dramatically over this period– (a good thing).
– 3) Operating working capital turnover increases dramatically over this period (a good thing) and in fact turns negative in the last two years (which is a d thi D ll t ith NEGATIVEvery goo ng… e opera es w operating W/C).
– 4) Sales grow at an annual rate approaching 50% over this time period (a good thing if managed well and Dell manages growth very well).
– 5) Operating ROA increases dramatically over this period (a good thing) and in fact turns negative in the last two years (which, while it may seem counter-intuitive, is a very good thing… see #3 above).
Professor Charles E. Wasley 95
Question 16a: Optional -- Answer
• 2) Less important items are:
– 1) For the most part, gross margin is rising
over this time period (a good thing).
2) For the most part SG&A as a % of Sales is– ,
falling over this time period (a good thing).
– 3) The net margin is rising over this time period
(a good thing).
– 4) Inventory days falls dramatically over this
period (a good thing).
– 5) A/R days falls dramatically over this period
(a good thing).
– 6) A/P days increases slightly over this period
(a good thing).
– 7) Total asset turnover increases dramatically
thi i d ( d thi )
Professor Charles E. Wasley 96
over s per o a goo ng .
Question 16a: Optional -- Answer
• Grading (6 points maximum):
– Only 3 reasons can be provided,
so...
• 2 points for items from list #1 above.
• 1 point for items from list #2 above.
• No points for items not appearing on
these two lists.
Professor Charles E. Wasley 97
Question 16: Optional
• b) Appendix C provides the usual ratio
analysis for Dell for a period of years
following the time period covered by
the original case (specifically, fiscal
years 1999-2003).
If i it h– you were prepar ng an equ y researc
report on Dell, AT THE END OF FISCAL
YEAR 2003 (1/30/2004), what are the 3
most important observations you would
make in the executive summary on page 1
of your report? (6 points)
Professor Charles E. Wasley 98
Question 16b: Optional -- Answer
• 1) In my opinion, the most important observations to make (in decreasing order of importance are):
– 1) ROE falls and levels off over this period (not a good thing, but its still high).
– 2) The cash cycle falls dramatically over this period (a good thing).
– 3) Operating working capital is negative, but getting “bigger” (a good thing… but Dell is operating with less and less negative operating W/C).
4) S l f ll d l l ff thi– a es grow a s an eve s o over s period (not a good thing, but the industry and markets are maturing).
– 5) Operating ROA is very high over this period (a good thing)
Professor Charles E. Wasley 99
.
Question 16b: Optional -- Answer
• 2) Less important items are:
– 1) For the most part, gross margin is declining over this time period (not a good thing).
– 2) For the most part, SG&A as a % of Sales is falling over this time period (a good thing).
– 3) For the most part the net margin is flat to lower over this time period (effects of titi d k t t i )compe on an mar e s are ma ur ng .
– 4) Inventory days falls over this period (a good thing).
– 5) A/R days falls over this period (a good hi )t ng .
– 6) A/P days increases substantially over this period (a good thing).
– 7) Total asset turnover falls dramatically over
Professor Charles E. Wasley 100
this period (not a good thing).
Question 16b: Optional -- Answer
• Grading (6 points maximum):
– Again only 3 reasons can be,
provided, so...
• 2 points for items from list #1 above.
1 i t f it f li t #2 b• po n or ems rom s a ove.
• No points for items not appearing on
these two lists.
Professor Charles E. Wasley 101
Question 16: Optional
• c) What are the two most
important differences in Dell’s
performance over fiscal years
1999-2003 period when
compared to the time period
covered by the original case
(fiscal ears 1992 1998)? (3 y -
points)
Professor Charles E. Wasley 102
Question 16c: Optional -- Answer
• 1) In my opinion, the most important
observations to make (in decreasing
order of importance are):
– 1) Falling ROE (not a good thing, but the
industry and markets are maturing).
– 2) Cash cycle continues to falls
dramatically (a good thing, Dell continues
to focus on cash management and
generating operating cash flow).
– 3) Sales grow slows dramatically and
levels off (not a good thing, but the
Professor Charles E. Wasley 103
industry and markets are maturing).
Question 16c: Optional -- Answer
• 2) Other, less important, but
nonetheless economically
sensible comparisons can be
made between the two
periods…
– Not enumerated in detail here as
they “fall out” of the answers to
parts a and b of this question.
Professor Charles E. Wasley 104
Question 16c: Optional -- Answer
• Grading (3 points maximum):
– Only 2 reasons can be provided ,
so...
• 1 point for items from list #1 above.
½ i t f it f “li t #2” b• po n or ems rom s a ove.
Professor Charles E. Wasley 105
Appendix A: (Partial) Footnotes from Dell’s
1997 Annual Financial Statements
• The following 2 slides contain
some footnote information from
Dell’s 1997 annual report
(covering fiscal years 1996 and
1997 which ended in February
1997 and 1998, respectively).
Professor Charles E. Wasley 106
Professor Charles E. Wasley 107
Professor Charles E. Wasley 108
Appendix B: Ratio and Related Analysis for Dell
for Fiscal Years 1991-1998
• The following 5 slides contain
ratio analysis and related
information for Dell for the time
period covered by the original
case (fiscal years 1991-1998).
Professor Charles E. Wasley 109
Dell
RATIOS
FISCAL YEAR ENDED 1/29/1999 2/1/1998 2/2/1997 1/28/1996 1/29/1995 1/30/1994 1/31/1993 2/2/1992
RETURN ON EQUITY
ROE 80.8% 89.9% 58.2% 33.5% 26.6% -8.5% 31.6% 26.4%
ROA MARGIN (NOPAT MARGIN) 8.0% 7.7% 6.7% 5.1% 4.3% -1.2% 5.0% 5.7%
ASSET TURNOVER 3.27 3.40 3.02 2.83 2.54 2.78 2.71 2.16
ROA 26.2% 26.0% 20.2% 14.5% 10.9% -3.5% 13.7% 12.4%
COMMON EARNINGS LEVERAGE 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00
FINANCIAL LEVERAGE 3.08 3.46 2.89 2.30 2.44 2.46 2.31 2.13
ROE = NOPAT MARGIN * A/T * CEL * LEV 80.8% 89.9% 58.2% 33.5% 26.6% -8.5% 31.6% 26.4%
ROE = ROA * CEL * LEV 80.8% 89.9% 58.2% 33.5% 26.6% -8.5% 31.6% 26.4%
FISCAL YEAR ENDED 1/29/1999 2/1/1998 2/2/1997 1/28/1996 1/29/1995 1/30/1994 1/31/1993 2/2/1992
KEY DRIVERS OF RETURN ON EQUITY
COST OF GOODS/SALES 77.5% 77.9% 78.5% 79.9% 78.8% 84.9% 77.7% 68.3%
GROSS PROFIT MARGIN 22.5% 22.1% 21.5% 20.1% 21.2% 15.1% 22.3% 31.7%
SGA/SALES 9 8% 9 8% 10 6% 11 2% 12 2% 14 7% 13 3% 20 3%. . . . . . . .
R&D/SALES 1.5% 1.7% 1.6% 1.8% 1.9% 1.7% 2.1% 3.7%
TOTAL OPERATING EXPENSES/SALES 11.3% 11.4% 12.3% 13.0% 14.1% 16.4% 15.4% 24.0%
EBT/SALES 11.4% 11.1% 9.6% 7.2% 6.1% -1.3% 7.1% 8.2%
EBIT/SALES 11.2% 10.7% 9.2% 7.1% 7.2% -1.4% 6.9% 7.7%
EBITDA/SALES 11.2% 10.7% 9.2% 7.1% 7.2% -1.4% 6.9% 7.7%
INCOME TAX/ SALES 3 4% 3 4% 2 8% 2 1% 1 8% 0 1% 2 1% 2 5% . . . . . - . . .
NET INCOME/SALES 8.0% 7.7% 6.7% 5.1% 4.3% -1.2% 5.0% 5.7%
ROE 80.8% 89.9% 58.2% 33.5% 26.6% -8.5% 31.6% 26.4%
DIVIDEND PAYOUT RATIO 0.0% 0.0% 0.0% 4.8% 5.9% -5.4% 0.0% 0.0%
1- DIVIDEND PAYOUT 100.0% 100.0% 100.0% 95.2% 94.1% 105.4% 100.0% 100.0%
SUSTAINABLE GROWTH RATE 80.8% 89.9% 58.2% 31.9% 25.0% -9.0% 31.6% 26.4%
Dell
FISCAL YEAR ENDED 1/29/1999 2/1/1998 2/2/1997 1/28/1996 1/29/1995 1/30/1994 1/31/1993 2/2/1992
ALTERNATIVE DECOMPOSITION OF ROE:
OPERATING ROA -331.1% -177.8% -1177.3% 80.2% 63.2% -12.9% 42.1% 43.1%
FIN'L LEVERAGE EFFECT 411.9% 267.7% 1235.5% -46.8% -36.6% 4.4% -10.5% -16.8%
Professor Charles E. Wasley 110

OPERATING ROA + FINL LEVERAGE EFFECT 80.8% 89.9% 58.2% 33.5% 26.6% -8.5% 31.6% 26.4%
ROE (FROM ABOVE) 80.8% 89.9% 58.2% 33.5% 26.6% -8.5% 31.6% 26.4%
DIFFERENCE (SHOULD BE ZERO) 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Dell
ASSET MANAGEMENT RATIOS 1/29/1999 2/1/1998 2/2/1997 1/28/1996 1/29/1995 1/30/1994 1/31/1993 2/2/1992
A/R TURNOVER 10.19 10.32 9.53 8.38 7.33 7.32 7.47 6.99
INVENTORY TURNOVER 55.88 39.69 17.92 11.72 10.67 9.32 7.28 5.65
ACCOUNTS PAYABLE TURNOVER (PURCHASES) 7 02 7 15 7 86 9 56 7 70 8 16 8 87 7 37 . . . . . . . .
ACCOUNTS PAYABLE TURNOVER (CGS) 7.00 7.16 8.09 9.26 7.50 8.45 7.97 6.93
DAYS' RECEIVABLES 35.32 34.88 37.79 42.96 49.14 49.17 48.17 51.51
DAYS' INVENTORY 6.44 9.07 20.09 30.73 33.75 38.61 49.45 63.68
DAYS' PAYABLE (PURCHASES) 51.29 50.37 45.83 37.65 46.75 44.12 40.58 48.86
DAYS' PAYABLE (CGS) 51.44 50.28 44.49 38.86 47.99 42.62 45.16 51.92
PP&E TURNOVER 42.18 42.73 37.48 35.79 34.09 36.52 34.99 25.02
NET LONG-TERM ASSET TURNOVER 128.47 -145.02 -78.77 92.74 65.01 48.15 43.97 35.72
OPERATING WORKING CAPITAL TO SALES -0.03 -0.04 0.01 0.05 0.05 0.08 0.10 0.10
OPERATING WORKING CAPITAL TURNOVER -31.29 -27.64 142.37 18.79 19.04 13.15 10.29 9.55
CASH CYCLE (IN DAYS) -9.53 -6.42 12.05 36.04 36.14 43.66 57.04 66.33
LIQUIDITY RATIOS 1/29/1999 2/1/1998 2/2/1997 1/28/1996 1/29/1995 1/30/1994 1/31/1993 2/2/1992
CURRENT RATIO 1.72 1.45 1.66 2.08 1.96 1.95 1.73 2.23
QUICK RATIO 1.43 1.23 1.36 1.46 1.42 1.39 0.95 1.39
CASH RATIO 0.14 0.12 0.07 0.06 0.06 0.01 0.03 0.24
OCF TO CL RATIO 0.76 0.73 1.05 0.21 0.38 0.22 -0.11 0.00
Solvency and COVERAGE RATIOS 1/29/1999 2/1/1998 2/2/1997 1/28/1996 1/29/1995 1/30/1994 1/31/1993 2/2/1992
LTD / (LTD +SE) 18.1% 1.3% 2.2% 10.4% 14.8% 17.5% 11.6% 13.1%
LTD / SE 22.1% 1.3% 2.2% 11.6% 17.4% 21.2% 13.1% 15.1%
TOTAL LIABILITIES / TOTAL ASSETS 66.2% 69.7% 63.7% 54.7% 59.1% 58.7% 60.2% 51.0%
TOTAL LIABILITIES / STOCK EQUITY 196 3% 230 1% 236 7% 120 8% 144 6% 142 1% 151 1% 104 1% . . . . . . . .
SE / TOTAL ASSETS 33.8% 30.3% 26.9% 45.3% 40.9% 41.3% 39.8% 49.0%
DEBT-TO-EQUITY RATIO 22.1% 1.3% 2.2% 11.6% 17.4% 21.2% 13.1% 15.1%
NET DEBT-TO EQUITY RATIO -115.0% -141.3% -165.5% -54.8% -63.5% -50.3% -12.7% -41.4%
DEBT-TO-CAPITAL RATIO 18.1% 1.3% 2.2% 10.4% 14.8% 17.5% 11.6% 13.1%
NET DEBT-TO-NET CAPITAL RATIO 767.0% 342.1% 252.7% -121.1% -173.9% -101.3% -14.6% -70.5%
Professor Charles E. Wasley 111
OCF TO TL RATIO 0.65 0.65 0.88 0.17 0.30 0.18 -0.09 0.00
COMMON SHARES REPURCHASES TO OCF 0.62 0.64 0.36 0.00 0.00 0.00 0.00 0.00
OCF TO CAPEX RATIO 8.23 8.51 11.95 1.73 3.82 2.35 -0.83 0.02
FISCAL YEAR ENDED 1/29/1999 2/1/1998 2/2/1997 1/28/1996 1/29/1995 1/30/1994 1/31/1993 2/2/1992
Dell
TREND INCOME STATEMENT (YR-BY-YR)
NET SALES 48.0% 58.9% 46.5% 52.4% 21.0% 42.7% 126.3% 62.9%
COST OF GOODS 47 2% 57 6% 44 1% 54 5% 12 2% 56 0% 157 4% 66 9% . . . . . . . .
GROSS PROFIT 50.8% 63.4% 56.1% 44.6% 70.5% -3.7% 59.3% 55.0%

R & D EXPENDITURES % % % % % % % % 33.3 61.9 32.6 45.3 33.6 15.5 27.8 47.7
GENERAL & ADMINISTRATIVE EXPENSES 48.8% 45.5% 38.8% 40.5% 0.1% 57.8% 48.6% 58.0%
TOTAL OPERATING EXPENSES 46.5% 47.7% 38.0% 41.2% 3.6% 52.0% 45.4% 56.3%
INCOME BEFORE INTEREST AND TAXES 55.5% 84.3% 89.4% 51.2% -738.7% -128.1% 102.6% 51.1%
OTHER INCOME OR EXPENSE -26.9% 57.6% 450.0% -116.5% -14157.0% -93.8% -11.9% -353.0%
INCOME BEFORE TAXES 52.3% 83.1% 95.0% 79.8% -649.4% -127.1% 95.2% 68.5%
PROVISION FOR INCOME TAXES 47.2% 96.3% 94.6% 73.9% -2275.9% -107.0% 85.1% 37.7%
INCOME FROM CONTINUING OPERATIONS 54 7% 77 8% 95 2% 82 3% -516 3% -135 3% 99 6% 87 0%
Professor Charles E. Wasley 112
. . . . . . . .
NET INCOME 54.7% 82.2% 90.4% 82.3% -516.3% -135.3% 99.6% 87.0%
DELL
FISCAL YEAR ENDED 1/29/1999 2/1/1998 2/2/1997 1/28/1996 1/29/1995
NET SALES 18,243,000 12,327,000 7,759,000 5,296,000 3,475,343
TOTAL OPERATING REVENUES 18,243,000 12,327,000 7,759,000 5,296,000 3,475,343
COST OF GOODS 14,137,000 9,605,000 6,093,000 4,229,000 2,737,290
GROSS PROFIT 4,106,000 2,722,000 1,666,000 1,067,000 738,053
R & D EXPENDITURES 272,000 204,000 126,000 95,000 65,361
GENERAL & ADMINISTRATIVE EXPENSES 1,788,000 1,202,000 826,000 595,000 423,429
TOTAL OPERATING EXPENSES 2,060,000 1,406,000 952,000 690,000 488,790
INCOME BEFORE INTEREST AND TAXES 2,046,000 1,316,000 714,000 377,000 249,263
OTHER INCOME OR EXPENSE 38,000 52,000 33,000 6,000 -36,267
INCOME BEFORE TAXES 2,084,000 1,368,000 747,000 383,000 212,996
PROVISION FOR INCOME TAXES 624,000 424,000 216,000 111,000 63,819
INCOME FROM CONTINUING OPERATIONS 1,460,000 944,000 531,000 272,000 149,177
NET INCOME 1,460,000 944,000 518,000 272,000 149,177
CASH FLOW PROVIDED BY OPERATIONS 2,436,000 1,592,000 1,362,000 175,000 243,382
CAPITAL EXPENDITURES 296 000 18 000 114 000 101 000 63 691 , 7, , , ,
DEPRECIATION AND AMORTIZATION FROM THE
STATEMENT OF CASH FLOWS 103,000 67,000 47,000 38,000 33,141
PREFERRED STOCK DIVIDENDS 0 0 0 13,000 8,750
Professor Charles E. Wasley 113
COMMON STOCK DIVIDENDS 0 0 0 0 0
CASH PAID TO REPURCHASE COMMON STOCK 1,518,000 1,023,000 495,000 0 0
DELL Thousands Thousands Thousands Thousands Thousands
FISCAL YEAR ENDED 1/29/1999 2/1/1998 2/2/1997 1/28/1996 1/29/1995
CASH 520,000 320,000 115,000 55,000 42,953
SHORT-TERM INVESTMENTS 2,661,000 1,524,000 1,237,000 591,000 484,294
ACCOUNTS RECEIVABLE 2,094,000 1,486,000 903,000 726,000 537,974
INVENTORIES 273,000 233,000 251,000 429,000 292,925
OTHER CURRENT ASSETS 791,000 349,000 241,000 156,000 112,215
TOTAL CURRENT ASSETS 6,339,000 3,912,000 2,747,000 1,957,000 1,470,361
PROP, PLANT & EQUIP (NET) 523,000 342,000 235,000 179,000 116,981
GOODWILL 15,000 14,000 11,000 12,000 6,658
TOTAL LONG-TERM ASSETS 538,000 356,000 246,000 191,000 123,639
TOTAL ASSETS 6,877,000 4,268,000 2,993,000 2,148,000 1,594,000
FISCAL YEAR ENDED 1/29/1999 2/1/1998 2/2/1997 1/28/1996 1/29/1995
ACCOUNTS PAYABLE 2 397 000 1 643 000 1 040 000 466 000 447 071 , , , , , , , ,
ACCRUED EXPENSES 1,298,000 1,054,000 618,000 473,000 279,402
INCOME TAXES PAYABLE 0 0 0 0 24,937
TOTAL CURRENT LIAB 3,695,000 2,697,000 1,658,000 939,000 751,410
LONG TERM DEBT 512,000 17,000 18,000 113,000 113,429
Other non current liabilities 349 000 261 000 232 000 123 000 77 425 - , , , , ,
TOTAL INTEREST BEARING LTL 512,000 17,000 18,000 113,000 113,429
TOTAL NON-INTEREST BEARING LTL 349,000 261,000 232,000 123,000 77,425
TOTAL LONG-TERM LIABILITIES 861,000 278,000 250,000 236,000 190,854
TOTAL LIABILITIES 4,556,000 2,975,000 1,908,000 1,175,000 942,264
PUT OPTIONS 0 0 279,000 0 0
PREFERRED STOCK 0 0 0 6,000 13
COMMON STOCK 1,781,000 747,000 195,000 430,000 397
PAID IN CAPITAL 0 0 0 0 356,768
RETAINED EARNINGS 606,000 607,000 647,000 570,000 311,217
Other stockholders' equity -66,000 -61,000 -36,000 -33,000 -2,628
Professor Charles E. Wasley 114
Cumulative translation adjustment 0 0 0 0 -14,031
TOTAL SHAREHOLDER EQUITY 2,321,000 1,293,000 806,000 973,000 651,736
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY 6,877,000 4,268,000 2,993,000 2,148,000 1,594,000
Appendix C: Ratio and Related Analysis for Dell
for Fiscal Years 1999-2003
• The following 3 slides contain
ratio and related analysis for
Dell for a period of time (fiscal
years 1999-2003) after the time
period covered by the original
case.
Professor Charles E. Wasley 115
Dell Thousands Thousands Thousands Thousands Thousands
RATIOS
FISCAL YEAR ENDED 1/30/2004 1/31/2003 2/1/2002 2/2/2001 1/28/2000
RETURN ON EQUITY
ROE 47.4% 44.4% 24.2% 39.8% 43.7%
ROA MARGIN (NOPAT MARGIN) 6 1% 5 6% 4 0% 6 8% 6 6% . . . . .
ASSET TURNOVER 2.38 2.44 2.31 2.56 2.75
ROA 14.4% 13.6% 9.2% 17.5% 18.2%
COMMON EARNINGS LEVERAGE 1.05 1.07 1.00 1.00 1.00
FINANCIAL LEVERAGE 3.12 3.03 2.61 2.28 2.41
ROE = NOPAT MARGIN * A/T * CEL * LEV 47.4% 44.4% 24.2% 39.8% 43.7%
ROE = ROA * CEL * LEV 47.4% 44.4% 24.2% 39.8% 43.7%
FISCAL YEAR ENDED 1/30/2004 1/31/2003 2/1/2002 2/2/2001 1/28/2000
KEY DRIVERS OF RETURN ON EQUITY
COST OF GOODS/SALES 81.8% 82.1% 82.3% 79.8% 79.3%
GROSS PROFIT MARGIN 18.2% 17.9% 17.7% 20.2% 20.7%
SGA/SALES 8.6% 8.6% 8.9% 10.0% 9.4%
R&D/SALES 1.1% 1.3% 1.5% 1.5% 1.5%
INTEREST INCOME /SALES 0.5% 0.6% 0.0% 0.0% 0.0%
INTEREST EXPENSE/SALES 0 0% 0 0% 0 0% 0 0% 0 0% . . . . .
Purchased in-process research & development/SALES 0.0% 0.0% 0.0% 0.0% 0.8%
Special charges/SALES 0.0% 0.0% 1.5% 0.3% 0.0%
TOTAL OPERATING EXPENSES/SALES 9.7% 9.9% 11.9% 11.9% 11.7%
EBT/SALES 9.0% 8.5% 5.6% 10.0% 9.7%
EBIT/SALES 8.6% 8.0% 5.7% 8.4% 9.0%
EBITDA/SALES 8.6% 8.0% 5.7% 8.4% 9.0%
INCOME TAX/ SALES 2.6% 2.6% 1.6% 3.0% 3.1%
NET INCOME/SALES 6.4% 6.0% 4.0% 6.8% 6.6%

ROE 47.4% 44.4% 24.2% 39.8% 43.7%
DIVIDEND PAYOUT RATIO 0.0% 0.0% 0.0% 0.0% 0.0%
1- DIVIDEND PAYOUT 100.0% 100.0% 100.0% 100.0% 100.0%
SUSTAINABLE GROWTH RATE 47.4% 44.4% 24.2% 39.8% 43.7%
Dell
FISCAL YEAR ENDED 1/30/2004 1/31/2003 2/1/2002 2/2/2001 1/28/2000
ALTERNATIVE DECOMPOSITION OF ROE:

ALTERNATIVE ROE CALCULATION:
OPERATING ROA 211.7% 193.5% 125.0% 183.2% 249.4%
Professor Charles E. Wasley 116
FIN'L LEVERAGE EFFECT -164.3% -149.2% -100.9% -143.3% -205.7%
OPERATING ROA + FINL LEVERAGE EFFECT 47.4% 44.4% 24.2% 39.8% 43.7%
ROE (FROM ABOVE) 47.4% 44.4% 24.2% 39.8% 43.7%
DIFFERENCE (SHOULD BE ZERO) 0.0% 0.0% 0.0% 0.0% 0.0%
Dell
ASSET MANAGEMENT RATIOS 1/30/2004 1/31/2003 2/1/2002 2/2/2001 1/28/2000
A/R TURNOVER 13.32 14.58 12.07 11.59 10.75
INVENTORY TURNOVER 107.08 99.50 75.70 64.34 60.38
ACCOUNTS PAYABLE TURNOVER (PURCHASES) 5.10 5.26 5.46 6.51 6.80
ACCOUNTS PAYABLE TURNOVER (CGS) 5.09 5.25 5.48 6.50 6.76
DAYS' RECEIVABLES 27.02 24.68 29.82 31.06 33.50
DAYS' INVENTORY 3.36 3.62 4.76 5.60 5.96
DAYS' PAYABLE (PURCHASES) 70.62 68.48 65.98 55.33 52.98
DAYS' PAYABLE (CGS) 70.66 68.54 65.66 55.35 53.29
PP&E TURNOVER 34.11 40.72 34.21 36.22 39.23
NET LONG-TERM ASSET TURNOVER 6.67 6.91 7.75 9.80 14.37
OPERATING WORKING CAPITAL TO SALES -0.12 -0.12 -0.10 -0.06 -0.04
OPERATING WORKING CAPITAL TURNOVER -8.24 -8.63 -10.31 -15.43 -23.18
CASH CYCLE (IN DAYS) -40.24 -40.18 -31.40 -18.67 -13.52
LIQUIDITY RATIOS 1/30/2004 1/31/2003 2/1/2002 2/2/2001 1/28/2000
CURRENT RATIO 0.98 1.00 1.05 1.45 1.48
QUICK RATIO 0.81 0.81 0.82 1.27 1.30
CASH RATIO 0.40 0.47 0.48 0.75 0.73
OCF TO CL RATIO 0.37 0.43 0.54 0.71 0.88
S l d COVERAGE RATIOS 1/30/2004 1/31/2003 2/1/2002 2/2/2001 1/28/2000o vency an
LTD / (LTD +SE) 7.4% 9.4% 10.0% 8.3% 8.7%
LTD / SE 8.0% 10.4% 11.1% 9.1% 9.6%
TOTAL LIABILITIES / TOTAL ASSETS 67.5% 68.5% 65.3% 58.2% 53.7%
TOTAL LIABILITIES / STOCK EQUITY 207.5% 217.5% 188.3% 139.0% 116.1%
SE / TOTAL ASSETS 32.5% 31.5% 34.7% 41.8% 46.3%
DEBT-TO-EQUITY RATIO 8.0% 10.4% 11.1% 9.1% 9.6%
NET DEBT-TO EQUITY RATIO -74.0% -84.8% -72.3% -87.7% -68.3%
DEBT-TO-CAPITAL RATIO 7.4% 9.4% 10.0% 8.3% 8.7%
NET DEBT-TO-NET CAPITAL RATIO -284.6% -557.6% -261.1% -711.3% -215.2%
OCF TO TL RATIO 0.31 0.36 0.46 0.60 0.73
INTEREST COVERAGE (EARNINGS BASIS) 253.14 167.29 #DIV/0! #DIV/0! #DIV/0!
Professor Charles E. Wasley 117
INTEREST COVERAGE (CASH BASIS) 146.63 208.25 127.35 85.96 -9.91
COMMON SHARES REPURCHASES TO OCF 0.54 0.65 0.79 0.64 0.27
OCF TO CAPEX RATIO 11.16 11.60 12.53 8.70 9.89
FISCAL YEAR ENDED 1/30/2004 1/31/2003 2/1/2002 2/2/2001 1/28/2000
Dell
TREND INCOME STATEMENT (YR BY YR) - -
NET SALES 17.1% 13.6% -2.3% 26.2% 38.5%
COST OF GOODS 16.6% 13.2% 0.8% 26.9% 41.8%
GROSS PROFIT 18.9% 15.3% -14.5% 23.5% 27.1%
R & D EXPENDITURES 2.0% 0.7% -6.2% 28.9% 37.5%
GENERAL & ADMINISTRATIVE EXPENSES 16.2% 9.6% -12.8% 33.8% 33.5%
TOTAL OPERATING EXPENSES 14.4% -5.7% -1.6% 27.9% 43.4%
INCOME BEFORE INTEREST AND TAXES 24.6% 59.0% -32.8% 17.7% 10.6%
OTHER INCOME OR EXPENSE 77 8% 53 4% 110 9% 182 4% 394 7% - . - . - . . .
INTEREST EXPENSE -17.6% #DIV/0! #DIV/0! #DIV/0! #DIV/0!
INTEREST INCOME -11.9% #DIV/0! #DIV/0! #DIV/0! #DIV/0!
INCOME BEFORE TAXES 23.0% 74.9% -45.8% 30.3% 17.6%
PROVISION FOR INCOME TAXES 19.2% 86.6% -49.4% 22.0% 25.8%
INCOME FROM CONTINUING OPERATIONS 24.6% 70.3% -44.3% 34.2% 14.1%
Professor Charles E. Wasley 118
NET INCOME 24.6% 70.3% -42.8% 30.7% 14.1%


































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































































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