# Examine the DCF analysis in Morgan Stanley’s April 2003 report on eBay. For the purpose of this exam, call 2010 the terminal year in the 2003 report’s DCF analysis

Examine the DCF analysis in Morgan Stanley’s April 2003 report on eBay. For the purpose of this exam, call 2010 the terminal year in the 2003 report’s DCF analysis 150 150 Affordable Capstone Projects Written from Scratch

Target Price for eBay: Examine the DCF analysis in Morgan Stanley’s April 2003 report on eBay. For the purpose of this exam, call 2010 the terminal year in the 2003 report’s DCF analysis. The main focus of the DCF analysis is a twelve month target price for eBay stock which the Morgan Stanley team forecasts for mid-2004. However, implicit in the Morgan Stanley team’s analysis is also a forecast of how much eBay’s free cash flow stream would be worth at the end of 2010. For this question, please provide a number, and brief explanation, of what in 2003 the Morgan Stanley team implicitly forecast eBay’s free cash flow stream would be worth at the end of 2010. Briefly explain how you arrive at your answer.

The materials for answering Part 2 consist of:

• Three Morgan Stanley analyst reports on eBay, from 2003, 2010, and 2018 respectively. You should have the reports for 2003 and 2010 in your course materials already;
• DCF tables from the 2003 and 2010 reports, that add a bit of clarity to key features of the valuations;
• a forthcoming paper entitled “Valuation Bias and Limits to Nudges” that focuses on biases in computing intrinsic (or fair) value. You have this as part of your course materials.
• the textbook Behavioral Corporate Finance, especially Chapter 3;
• an Excel spreadsheet with financial statements for eBay, from 2002 – 2017; and
• your course slides, especially the slides from Day 2 AM with pie charts showing the relationship between free cash flow, unlevered cash flow, CapEx, Net unlevered cash flow, and Net CapEx. There are a lot of numbers in the reports, and the pie chart slides display, in quite a simple way, the relationships that allow you to compute key variables fairly easily, instead of getting bogged down in unnecessary and complicated formulas.

Question 2:

Now consider Morgan Stanley’s report on eBay from 2010. In 2010, what value (in 2010 dollars) did the Morgan Stanley analyst team associate to eBay’s forecasted free cash flow stream from 2011 on? In other words, viewed from 2010, what was the present value the Morgan Stanley team assigned to the free cash flow stream beginning in year 2011 and continuing into perpetuity? Note: The 2010 report used different units (millions) from the 2003 report (which used thousands). Briefly explain how you arrive at your answer.

Question 3:

Question 4:

Suppose that in its 2003 report, the Morgan Stanley team forecast that depreciation and amortization (D&A) would be 27% of EBIT in the terminal year (2010). Suppose also that in its 2010 report, the Morgan Stanley team forecast that depreciation and amortization (D&A) would be 23% of EBIT in the terminal year (2019). The 27% figure was accurate, and the 23% figure was accurate for 2017 (the most recent year available). Fill in the following table for the two reports. Note: the word “Compute” signifies that you have to do a computation to come up with the number.

Question 5:

Pages 64-66 of the textbook Behavioral Corporate Finance describe how the Morgan Stanley 2003 report arrived at its DCF-based target price. This question asks you to modify the analysis in both the 2003 report and 2010 report, by explicitly assuming that eBay would be expected to earn its cost of capital exactly during the terminal horizons in these reports. Fill in the table below to show what the values for eBay’s stock price would have been in 2010, for both the forecast from the 2003 report and the 2010 report, assuming that eBay would have been expected to earn its cost of capital exactly during the terminal horizons in its reports. Show any work, especially about computing Terminal Value, below the table.

Hint: To answer this question, use Nudge #1 from the paper “Valuation Bias and Limits to Nudges.”

Question 6:

Write a paragraph discussing the key risk management concerns, if any, associated with the underlying issue you addressed in question 2.5. If relevant, make reference to the data in the tab “ROIC Data” in the Excel spreadsheet containing eBay’s financial statement data.

Question 7:

There is a Note in fine print just below Exhibit 3-3 in the textbook Behavioral Corporate Finance that comes from Morgan Stanley’s 2003 report. As a professional risk manager, assess the statements in this note.

Question 8:

As part of this exam, you have Morgan Stanley team’s report on eBay, dated July 19, 2018, as well as a file with eBay’s financial statements for the period 2002 through 2017. Use the data in the report to fill in the table below. Estimate forecasted depreciation and amortization (D&A) for the terminal year by using the forecasts furthest out in time (2021E) from the Statement of Cash Flows (for D&A) and from the DCF analysis (for EBIT). Then apply the ratio of D&A/EBIT from 2021E to the terminal year (2025E), meaning assume that the value of the ratio in 2025 will be the same as in 2021. After filling out the table below, write down a sentence or two indicating whether you would draw any conclusions from the numbers in the table.

Question 9:

In 2015 eBay divested itself of PayPal. Contrast the nature of the Morgan Stanley team’s forecasts for CapEx and growth in net PP&E (from its July 19, 2018 report) with the actual CapEx and growth of PP&E over the course of eBay’s history; the historical financial statements are provided in an accompanying Excel file. From a risk perspective, briefly explain what relevance this comparison has for Morgan Stanley’s target price (valuation) of eBay. In addition, discuss whether the issues about CapEx and PP&E also apply to Morgan Stanley’s reports on eBay from 2003 and 2010.

Question 10:

In the Excel file containing eBay’s financial statements, you will find a tab titled “Free Cash Flow Data.” This file summarizes the Morgan Stanley free cash flow forecasts from the three reports (2003, 2010, 2018), the mean and median forecasts from your class’s best-low-high forecasts (taken from your responses to Question 67 in the questionnaire), and the actual (meaning historical) free cash flow values provided by Morgan Stanley in its various reports over time. Note: large differences between mean and median values in your class forecasts appears to be due to extremely high forecast values by four members of the class, beginning around the year 2016.

In cells C4:E4, you should enter the values for the terminal growth rates that Morgan Stanley assumed in its report. Doing so will feed through into the table below.

Having done so, briefly analyze how the Morgan Stanley team revised its free cash flow forecasts over time (in respect to the three reports).

Be sure to discuss whether the 2003 and 2010 reports appear to have exhibited any biases.

Analyze whether your class median free cash flow forecasts might have exhibited any biases, and if so which one(s).

Briefly analyze how the Morgan Stanley team revised its free cash flow forecasts over time (in respect to the three reports).

Discuss whether the 2003 and 2010 reports appear to have exhibited any biases.

Analyze whether your class median free cash flow forecasts might have exhibited any biases, and if so which one(s).