MicrosoftFinancial AnalysisStudent Managed Investment FundSpring 2013

Julian Naiken

Table of ContentsI. Company Overview Pg. 1

II. Fundamental Analysis Pg. 2

a. Revenue & Growth

b. EBIT & Growth

c. Net Income & Growth

d. Cash Flow From Operations & Growth

III. Operating Efficiency & Operating Margins Pg. 8

a. Asset Turnover

b. Inventory Turnover

c. Receivables Turnover

d. Gross Margin

e. EBIT Margin

f. Net Profit Margin

g. Return on Equity (ROE)

h. Return on Assets (ROA)

IV. Long-Term Solvency Ratios Pg. 16

a. Long-Term Debt Equity

b. Financial Leverage

c. Times Interest Earned

V. Short-Term Solvency Pg. 19

a. Current Ratio

b. Quick Ratio 1

c. Quick Ratio 2

VI. Relative Valuation Pg. 22

a. Comparables

b. P/E Relationship

c. Price Estimates

VII.Pro-Forma Income Statement Pg. 25

a. Market Share

b. Revenue

c. Cost of Goods Sold

d. SG&A Expense

e. Net Non-Operating Income Expense

f. Interest Expense

g. Unusual Expense

h. Income Tax

i. Net Income & EPS

(Continued)

VIII.Absolute Valuation Pg. 31

IX. Risk Factors for Consideration Pg. 35

a. Competitive Landscape In Emerging Business Segments

b. Business Model Competition

c. Investment in New Products and Services Risk

d. Intellectual Property Rights Risks

e. Legal Claims

f. Security of Customer’s Products and Services

I. Company Overview

Microsoft is a software technology company who holds products in many different areas of both consumer and commercial applications. The company was founded by Bill Gates in 1975 and went public in 1986. The company is headquartered in Redmond, WA with close to 100,000 employees and a global presence. Since going public Microsoft has grown to a substantial size. Its market capitalization is currently $278 billion dollars. Although this number today is less than half of the size of the it once was in 1999 of $616 billion, which was recently overtaken by its closest competitor Apple who reached close to $660 billion. The company’s main competitors historically have been are Apple, Google, Oracle, and more recently Amazon.

Microsoft’s most significant product line is the Windows operating system, which was introduced in 1985 and has since grown to over 90% of the market share of personal computer operating systems. Aside from the Windows product line, Microsoft has many productivity software solutions and technology platforms such as Microsoft Office, Microsoft exchange, and the Microsoft SQL server. The Five business segments that the company operates in is: Windows & Windows Live Division (Windows Division), Server and Tools, Online Services Division (OSD), Microsoft Business Division (MBD), and Entertainment and Devices Division (EDD).

In the past couple years with Microsoft has taken measures to enter new, emerging business segments, the most prominent of which is the mobile space in which the company debuted their new Windows Mobile operating system and the Windows Table PC as a response to the mobile devices being introduced by companies like Apple and Google . Some of the other new emerging business segments include software solutions in cloud technology, like the Microsoft Azule platform in which virtual software hosted on the cloud can store data and give the ability to collaborate in real-time among users. Microsoft has also contributed much of its resources developing their Bing search engine and to acquire other companies to add to their existing business portfolio, the largest of which being Skype.

Overall the Microsoft is still holding on to a strong position in the marketplace that has been rooted from their early existence. The company maintains a enough market share and resources to continue operations for some time. Going forward, Microsoft’s ability to succeed relative to their past performance will depend on whether they can make traction in their new business segments that will continue to return value to shareholders the way they have historically. Microsoft remains to be one of the most valuable companies in the world.

II. Fundamental Analysis

Financial Performance

RevenueRevenue is the amount of money that a company receives during a specific period. It is an income number from which costs are subtracted to determine net income. Revenue research for Microsoft and its industry was conducted based on the Income Statement on FactSet. The 2013 revenue number adds the actual reported revenues for the first three quarters of 2012 and or 2013, with a fourth quarter estimate from FactSet.Microsoft is displayed alongside Apple and Google, as these are its most major competitors. Similarly, Microsoft is displayed alongside IBM, Hewlett-Packard and Oracle because they themselves also produce similar products, as well as all being considered as computer technology corporations.The graph below shows that Microsoft has much smaller Revenue than its closest competitor Apple, as well as IBM. The graph also shows that Microsoft has reported a larger revenue figure than Google and Oracle.

For the Year of 2013, Microsoft expects to see an increase in revenue as well as remaining above its competitors, Google and Oracle, in terms or Total Revenue.

Revenue GrowthThese graphs show the average annual revenue growth for the periods from 2008-2013 and 2003-2013 for Microsoft and its industry. Our Industry group includes the major companies in the Technology Sector. Apple, Google, IBM, HPQ and Oracle are all considered to be a part of this industry. There have been slight changes in the last five years. The industry overall is growing at a relatively fast rate than it was from 2003-2008, and Microsoft’s growth has slowed.

Earnings Before Interest and Taxes (EBIT)EBIT shows a company’s profitability before taking into account interest expense and income taxes. Research on EBIT for Microsoft, and the Technology Industry was conducted based on the Income Statement on FactSet. The 2013 revenue number adds the actual reported EBIT revenues for the first three quarters of 2012 and or 2013, with a fourth quarter estimate from FactSet.Much like the revenue numbers, the graph shows that Schlumberger has a much higher EBIT than its closest competitor, Halliburton, while Nabors has a lower EBIT than its closest competitor, Diamond Offshore Drilling, although their 2012 EBITs are roughly the same.

EBIT GrowthMicrosoft earnings had been growing at faster rate from 2003-2008, which was slower than the industry at this time period. The five year numbers show that Microsoft’s EBIT has been growing at a slower rate than the industry.

Net IncomeNet income is calculated by starting with a company's total revenue. From this, the costs of goods sold, as well as any other expenses the company incurred, are deducted to calculate earnings before taxes.

Like the Revenue and EBIT numbers, the graph shows that Microsoft has a higher net income than each competitor, with the exception of Apple.

Net Income GrowthNet Income growth has been relatively small for Microsoft through years 2003-13. However the industry has seen significant growth throughout this time frame. Additionally, in the last five years, a period that experienced the financial crisis and tough times for the Technology Industry, the overall industry is actually experiencing positive growth. Microsoft has seen a slight decline in years 2011-12, but expects to see a moderately small increase in 2013.

Cash Flow OperationsCash flow is less susceptible to accounting manipulation than many other metrics, and therefore could provide a clearer picture of current business operations.

Much like the earlier valuation metrics, the graph shows that Microsoft generated much higher cash flow from operations than its competitors, with the exception of Apple.

Cash Flow from Operations GrowthThe Technology Industry has been through a lot in the recent years. However, we have seen an exceptional amount of growth in Cash Flow from Operations. This is displayed in years 2008-13. It is important to note that Microsoft within this time has seen relatively small growth in comparison to the Industry. The industry’s cash flow from operations annual average growth is positive at a higher rate than Microsoft.

III. Operating Efficiency and Profitability Margins

Asset Turnover

The Asset Turnover Ratio measures the amount of sales generated per one dollar of assets. In accordance with the industry average a higher number is generally accepted as better performance. Microsoft’s asset turnover ratio has been consistently lower than the industry through years 2003-2013. In addition, the industry average has continued to decline slowly throughout this time frame.

Inventory Turnover

The Inventor Turnover ratio measures how many times a company's inventory is sold and replaced over a period. A low turnover rate can reflect a planned inventory buildup in the case of material shortages or in anticipation of rapidly rising prices. A high inventory turnover ratio can indicate better liquidity, but it can also indicate a shortage or inadequate inventory levels, which may lead to a loss in business.

Receivables Turnover

The Receivables Turnover ratio measures the effectiveness a company has collecting its receivables. Over the past ten years, Microsoft has moved closer to the industry average at a relatively slow rate, indicating that it has been lower than the industry average for the past ten years.

Gross MarginThis number represents the proportion of each dollar of revenue that the company retains as gross profit. The higher the percentage, the more the company retains on each dollar of sales to service its other costs and obligations. The levels of gross margin can vary drastically from one industry to another depending on the business. For example, Tech companies will generally have a much higher gross margin than a manufacturing firm. Gross margin is what is left over after costs associated directly with the sale of a product or service, such as materials and direct labor, are paid for. This is an extremely important number for every new and small business to manage, as it impacts both the likelihood of reaching breakeven and the amount of profit that is earned beyond breakeven. In other words, it directly impacts risk and return.

The following graph shows that Microsoft’s Gross Margin is relatively higher than each of its competitors, as well as being above the industry average each year for the past ten years.

EBIT MarginEBIT margin is a measurement of a company's operating profitability. EBIT margin allows the investors to analyze the performance of the company’s operations while eliminating all non-operating and non-recurring items such as depreciation and amortization which is counted to get to EBIT, interest expense, taxes and one time charge such as non-recurring costs.The following graphs depicts that Microsoft’s EBIT Margin has continued to be relatively higher in comparison to the industry average for the past 10 years. The analysis suggests that Microsoft will experience a miniscule decrease in its EBIT Margin for 2013, while still being greater than that of the industry average.

Net Profit MarginLooking at the earnings of a company often does not tell the entire story. Increased earnings are good, but an increase does not mean that the profit margin of a company is improving. For instance, if a company has costs that have increased at a greater rate than sales, it leads to a lower profit margin. This is an indication that costs need to be under better control. The net margin provides an indication of how well a company is controlling its costs. A high net profit margin demonstrates effectiveness at converting sales into actual profit. The measure is very useful when comparing several companies from within the same industry. Higher net margins can provide a company a significant competitive edge as it looks to improve and expand its operations.

The following graph shows that Microsoft’s Net Profit Margin has been continually higher than the industry average for the past ten years. . The analysis suggests that Microsoft will experience a miniscule decrease in its Net Profit Margin for 2013, while still being greater than that of the industry average.

Return on Equity (ROE)The ROE is useful for comparing the profitability of a company to that of other firms in the same industry. ROE is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. ROE indicates how well a company is being managed to allow a profit on its shareholder's money. It is also a reliable indicator of a company's future earnings. The best-performing companies tend to have ROEs of 20 to 30 percent and sometimes even higher.

The following graph suggests that Microsoft’s ROE has slowly decline in the past five years. However, it has stayed relatively close to the industry average of 22%.

Return on Assets (ROA)ROA tells what earnings were generated from invested capital (assets). ROA for public companies can vary substantially and will be highly dependent on the industry. This is why when using ROA as a comparative measure, it is best to compare it against a company's previous ROA numbers or the ROA of a similar company. A high ROA indicates that management is effectively utilizing the company’s assets to generate profit. If a company has a ROA of 20%, it means that the company earned $0.20 for each $1 in assets. As a general rule, anything below 5% is very asset-heavy (manufacturing, railroads), anything above 20% is asset-light (advertising firms, software companies).

The following graph suggests that Microsoft’s ROE has declined as a slow rate over the recent years. However, it has remained relatively greater that the industry average over the past ten years.

IV.Long-Term Solvency Ratios

Long-Term Debt to EquityThe Long Term Debt to Equity Ratio shows the proportion of long term debt per dollar of equity that a company is using to finance its assets. If the ratio is a higher, the firm is financing its assets with a greater amount of debt. There is no Long-Term Debt to Equity figures for Microsoft prior to 2009. However, with the data that we do have, Microsoft’s Long-term Debt has been significantly lower than that of the industry.

Financial Leverage

Financial Leverage is a way, or various techniques a firm can utilize to multiply its gains and losses. Microsoft’s Financial Leverage has remained relatively stable throughout a ten year period. Throughout a ten year period, Microsoft’s Financial Leverage has not surpassed the industry average. This shows that Microsoft has been using less and less leverage to finance its assets over the past ten years.

Times Interest EarnedTimes Interest Earned is a measure of how many times a company can cover its interest charges on a pre-tax basis. Microsoft has no information on Times Interest Earned prior to 2010. However, with what data we do have, from the year 2010 Microsoft’s Times Interest Earned has remained higher than that of the industry average. However this may be the case because a few varying outliers that the industry possesses.

V. Short-Term Solvency

Current Ratio The current ratio shows the ability of a firm to pay its short term liabilities with current assets, if this ratio is greater than one; the firm is able to pay off its short term liabilities with assets. Microsoft’s current ratio has been relatively stable, given the exception of 2003-04. From 2005-2009 it has continually decreased, and from 2008 and on, it has continued to increase.

Quick Ratio 1

The Quick Ratio 1 is a more conservative measure of the current ratio because it excludes inventories from current assets. The number for the Quick Ratio is quite similar to that of the current ratio for the years 2003-2013. In addition, it is similar to the industry average, and has recently been a much larger figure that that of the industry average (2011-2013).

Quick Ratio 2

The Quick Ratio includes a sum of liquid items. The number for the Quick Ratio is quite similar to that of the current ratio for the years 2003-2013. In addition, it is similar to the industry average, and has recently been a much larger figure that that of the industry average (2011-2013).The Quick Ratio is much similar to that of Quick Ratio 1 and the Current Ratio for the years 2003-2013. The Quick Ratio of Microsoft was significantly larger than the Quick Ratio of the industry for the year of 2012.

VI.Relative Valuation

Relative Valuation is a fairly simple and effective way to identify under or overvalued stocks. An estimate of price is gathered by comparing a company to other similar companies using multiples such as the P/E ratio as in this case. It is quite important to choose comparable companies wisely because dissimilar companies can make the results inaccurate.

ComparablesThe industry group used in this analysis includes the Technology Sector. Each company used in the relative valuation are very close competitors to Microsoft and provide similar services and or produce similar products to Microsoft.

P/E RelationshipsThe next step was to calculate the P/E relationships between the designated comparable companies by dividing the above P/E ratios. These relationships will contribute directly into the final price estimate. Once again, choosing suitable comparables is very important because all of these calculations are relative and the more related the comparables are the more accurate the estimate.

Company Price As Of 4/29/13

E[EPS]13' E[EPS]14' P/E

ActualForward P/E 2013

Forward P/E 2014

Microsoft $ 32.61 1.995 2.690 17.263 16.35 12.123

Apple $ 430.12 39.77 44.09 10.745 10.82 9.756

Google $ 819.06 39.13 45.20 25.247 20.93 18.121

IBM $ 199.15 15.92 17.60 14.143 12.51 11.315

HPQ $ 20.50 2.31 2.65

- 8.87 7.736

Oracle $ 32.24 2.43 2.73 15.598 13.27 11.810

Price EstimatesThe final step in relative valuation is plugging in all of the above calculations in order to acquire a relative price estimate. There were three possible adjustment factors used in order to see some alternative scenarios and assess which is most accurate. The adjustment factor originates from the P/E relationships; the four that were chosen were the average of past 10 & 5 years and the median of the past 10 & 5 years.

Relative Price Estimate = Comparable P/E * E(EPS1) * Adjustment Factor

VII.Pro-Forma Income Statement

In order to derive an EPS number for the 2014 fiscal year we created a Pro-Forma Income Statement. The process began by generating statistics for market share, in terms of revenue, in relation to the industry group that was initially generated. The significance of generating a market share allows us to make a relevant assumption about what the market share figure may look like alongside our observations about industry trends and specific company proceedings and outlooks. Beginning with fiscal year 2001 and stretching into the year-to-date 2013, revenue figures were generated for the industry group on a LTM basis to coincide with Microsoft’s fiscal year end.

Market Share

Microsoft’s observed trend within the industry group is relatively flat from 2001 to their 2013 year to date. Although, the table depicts that market share increases from 2001 to 2008, but declines from 2008 back around where it was again in 2012. As can be seen in the chart above, while competitors Apple and Google have increased marketshare, IBM and Hewlett Packard have seen declining marketshare, Microsoft has only been experiencing fluctuations of no more than three percentage points from its 2001 numbers. Its most recent year-by-year performance suggests that it is experiencing a decline in its marketshare from its recent high in 2008 of about -5.24% per year. This coupled with our industry trend analysis led us to assign a 13.59% marketshare number to the 2014 marketshare estimate.

Revenues

The marketshare number that we acertained was used to derive our revenue number for the forecast year. We began by aggregating revenues from all industry peers on a year-by-year basis. For the 2014 year in which we

Microsoft• Technology Industry• Apple• Google• IBM• HPQ• Oracle

were forecasting industry peer revenues, were based on data sourced from factset. Similar to the way that the historical revenue figures were generated, each of these estimates that were pulled from FactSet contained quarterly estimates to create a fiscal year end in June for each of the industry peers for purposes of maintaining relevent figures to Microsofts fiscal year end. This led to a total industry peers revuenes of $501.84 billion, with the market share number that we alllocated for our 2014 fiscal year. The formula for Microsoft’s revenues from which will serve as an approximation of microsofts topline for 2014 is the total industry peers revenue multiplied by the inverse of the total industry peer marketshare:

Cost of Goods Sold:

The forecasting of cost of goods sold entails looking into what it has historically been in previous years. The measure we use to understand its effect on the income statement is by taking its percentage of revenue over a specific period of time. This method allows us to see, beginning from 2001, what has been happening with COGS as time goes on. Microsoft categorizes COGS as costs incurred with the manufacturing and distribution of products sold and licensed, operating costs for product support and distribution centers, and marketing costs, such as costs incurred to drive traffic to Microsoft websites through way of online advertisings. Our analysis of the financial statements suggested that increases in COGS grew in line with increasing volume of Microsoft’s business segments and some non-reoccurring charges such as costs associated with Yahoo search engine agreements, payments made to Nokia in “joint strategic initiatives”. In the Pro-Forma Income Statement that was built, COGS was also segmented into two parts, one line devoted to simply cost of revenue and another for depreciation and amortization. COGS ex. D&A has been rising from its initial 8.65% of revenue in 2001 to 20.53% in its YTD 2013 number. However the most recent two years suggests only modest year of year increase of about 5.4%, which was used for our forecast year. This assessment led us to a forecast for COGS ex. D&A of $17.073 billion. Depreciation and amortization was also segmented into two separate items. Amortization was sourced directly from Microsoft’s most recent 10Q, which provided an estimated amortization schedule for 2014 of $613 million. Depreciation saw a large increase between Microsoft’s 2012 year-end to their YTD 2013. Since it was difficult to ascertain whether or not such a large increase will continue going forward, the forecasted number was generated from the average of the 2012 year end and the YTD 2013 number.

SG&A Expenses

Similar to the way that COGS was determined, SG&A was also generated from its historical percentage of revenue. SG&A is comprised of research and development cost and other SG&A. The relationship between the year-by-year research and development expenses does not indicate any particular trend. It remains relatively flat hovering some 1% - 2% of 14%. The forecasted year included a five period average, which was 13.81%. The forecasted number for research and development is $10.89 billion. Other SG&A was found the same way research and development expense was, the only difference being that only a four-year period was used. This course of action was taken because Microsoft did not provide guidance going into the next fiscal year. Our estimated Other SG&A expense for 2014 is 25.76% of revenue, or $20.32 billion.

Net Non-Operating Income/Expense

Microsoft is a company that happens to sit on a considerable amount of cash and short-term securities, and financial investments. This is the reason why they also make a considerable amount of income on yearly interest on these items they hold in their balance sheets. This Interest and Investment income can be seen as a function of the cash and short-term securities plus total investments and advances. According to Microsoft, these financial investments include mainly “highly liquid investment grade fixed-income securities”. In the prior years, from 2009 to 2012, Microsoft was able to generate between $700 million to $900 million in income from these assets. The way that we were able to forecast this number is by taking a historical investment income number and dividing it by the total of its prior year’s cash and ST securities plus total investments. This gave us an interest rate number, which we took to be the average interest rate received on existing assets. For the 2014 fiscal year we began by estimating the cash and ST securities, and total investments for the 2013 year end by the rate they had been increasing for the previous 3 quarters. The total of this number was then multiplied by the interest rate received from the prior years assets as a close approximation interest income in 2014. This number is estimated to be $994 million. The next line item, other income/expense, is one that fluctuates without any real pattern. This was forecasted as simply the average of what these numbers were between the years 2008 – 2012, which is $455 million.

Interest Expense

Microsoft currently has 13 different bonds outstanding with varying maturity dates, each of which represent a portion of the companies interest expense that is required to be paid on a yearly basis. The outstanding debt schedule was sourced from FactSet. The interest expense was found by multiplying the amounts outstanding with their rates at which they are to be paid. In this case Microsoft will be liable for $388 million dollars in coupon payments in 2014.

Unusual Expense

As far as other net (Unusual Expense) goes, finding a relevant number to forecast is a challenging task. In the prior years, Microsoft attributed other expenses to items such as legal charges, asset impairments, investment losses, and goodwill write-off. Finding these items listed in the financial statements are dependent upon whether management foresees any future contingencies that may be reflected in unusual expenses. One item that we were able to notice as being more prevalent is legal expenses. Luckily, management did stipulate $419 million in accrued liabilities for legal matters from which we used as a possible component to our unusual expense.

Income Taxes

The projection of taxes that Microsoft would be liable for is based on the rate taken from their 2012 income statement of 23.75%. This gives us an approximation of $6.63 billion in taxes for the 2014 fiscal year.

Net Income & EPS

After taxes are deducted net income is projected to be approximately $21.31 billion. From this point our task was to assign a meaningful number that best reflect earnings per share. The information we uncovered in the financial statements indicated that Microsoft is in the process of a share repurchase program that was announced September 8, 2008. This led us to model scenarios that would give a realistic assumption of what effect the share repurchase program will have on shares outstanding in 2014. As of March 31, 2013 the program is listed as having around $4.6 billion remaining. Further analysis showed that Microsoft has been committed to purchasing around 1 billion dollars worth of shares on a quarterly basis. Although it is important to note that modeling these scenarios is not an exact science. One observation that was made is even in historical cases in which there was a share repurchase program, with shares being taken out of the market, the actual share count rose. The way that we chose to model this scenario is using an assumption that Microsoft will continue to purchase a billion dollars worth of shares the following quarter. The second approach consisted of using a five period adjustment factor between diluted shares outstanding and actual shares outstanding. The diluted shares outstanding for 2014 we projected after taking into account shares repurchased and applying this adjustment factor is 8.47 billion. Dividing out projected net income with this number yielded an EPS number of $2.51 a share.

VIII.Absolute Valuation

In our absolute valuation model we attempted to find the intrinsic value of Microsoft’s future growth prospects. This was based off the Dividend Growth that Microsoft has had, and our belief of what they might be doing going forward. We began by first coming across a meaningful cost of capital that we would use in our model. Our initial thought is that we would chose two costs of capital that would be the more conservative and realistic options. The way in which the costs of capital were calculated consisted of using both the CAPM and the WACC model.

If you notice in the box below the K(s) in which we generated were very similar to one another with differences of only a few basis points. All costs of capital use Microsoft’s 10- year monthly, Bloomberg’s Adjusted Beta of 0.958, and a 10-year market return of 10.078%. In our CAPM model we chose to select the K that incorporated a 10 Y risk free rate treasury strip as the risk free rate. We felt that this was appropriate because it provided us the highest K while utilizing a 10-year rate, which is closer to what we would expect the potential holding period would show. The second K that was used was sourced from Bloomberg, which calculated Microsoft’s weighted average cost of capital (WACC) using the and equity risk premium of 8.063%, and country risk premium of 8.417% and a market return of 10.78%. Furthermore, it should be noted that both costs of capital are very similar.

  10Y 30Y        

CAPM, K1: WACC Alt. K:  

I25 9.739% 9.803% 9.600% 5.7817%F82 9.742% 9.803% 9.600%  

I39 9.760% 9.813%   9.700%    

After our cost of capital was found, we moved on to assess how the dividends are growing historically speaking. The chart below gives the measures of how it is performing during certain time periods. Two scenarios were chosen. Our analysis concluded that the dividends are growing at an average of 13.15% in the previous

seven-year period and that FCFE at that same time is growing at 9.24%. Our belief with respect to some of the issues Microsoft is facing as a company (The decline of the PC market, whether or not their Windows phone will gain any traction, etc.) may affect their ability to continue to grow dividends in the future. Because of this we opted to use a second scenario in which dividend growth rates would reflect FCFE after the first three years post 2013 going into 2019.

Geo Rate 10Y 7Y 5Y       

EPS (diluted) 12.20% 8.64% 7.09%Dividends per Share - 13.15% 14.27%

FCF Cash flow 7.88% 9.24% 13.55%

After growing the dividends at 2012 to 2019 using both scenarios we were able to come up with two different dividends at 2019, and two different present values.

  JUN E'19

DIV g1 1.805DIV g2 1.568

PV of CF g1 1.032PV of CF g2 0.897

From this point we used the Gordon Growth Model after the 2019 period with different growth rates applied to them from 1% - 9%. Both scenarios were tested using both costs of capital. The tables below are the results we discovered:

K1 g1:Growth

Rate: 2020Constant Growth PV 2013

Total PV of CF

1.00% 1.82 21 11 172.00% 1.84 24 12 193.00% 1.86 28 14 214.00% 1.88 33 17 245.00% 1.90 40 21 276.00% 1.91 51 27 337.00% 1.93 70 36 438.00% 1.95 111 58 649.00% 1.97 259 135 142 31

K2 g1:Growth

Rate: 2020Constant Growth PV 2013

Total PV of CF

1.00% 1.82 21 11 182.00% 1.84 24 13 193.00% 1.86 28 15 214.00% 1.88 34 18 245.00% 1.90 41 22 286.00% 1.91 53 28 357.00% 1.93 74 39 468.00% 1.95 122 64 719.00% 1.97 328 173 179 33

K1 g2:Growth

Rate: 2020Constant Growth PV 2013

Total PV of CF

1.00% 1.58 18 9 162.00% 1.60 21 11 173.00% 1.62 24 12 194.00% 1.63 28 15 215.00% 1.65 35 18 246.00% 1.66 44 23 297.00% 1.68 61 32 388.00% 1.69 96 50 569.00% 1.71 225 117 123 28

K2 g2:Growth

Rate: 2020Constant Growth PV 2013

Total PV of CF

1.00% 1.58 18 10 162.00% 1.60 21 11 173.00% 1.62 24 13 194.00% 1.63 29 15 225.00% 1.65 36 19 256.00% 1.66 46 24 317.00% 1.68 65 34 408.00% 1.69 106 56 629.00% 1.71 285 150 156 29

As the tables show, both scenarios seem to suggest that the market is pricing Microsoft with inference of a growth rate 6% -7%. In line with our analysis the conclusion that we would draw from this would be that if Microsoft’s operations prove to yield returns that allow growth above the 6% - 7% range than it would appear that the stock would be a good buying opportunity. However, if in the long run if Microsoft does in fact fall down to these more normalized growth rates that the market is implying, than the stock is fairly valued.

IX. Risk Factors For Consideration

Competitive Landscape In Emergig Business Segments: Although Microsoft has held significant marketshare and has been a dominant player in the market, other firms have been able to penetrate new markets in which Microsoft has not. Currently, companies like Apple, Google, and Amazon have significant resources that are comparable to Microsoft and benefit from the fact that developed business models in segments that Microsoft is currently trying to gain traction.

• Existing: Microsoft’s product lines function similar to the way that Apple and Google’s product line do in that they seek to have user adaptation across the grander cross-platform ecosystem in which users selectively opt of use their products for mobile devices, Desktop Computing, and other software solutions that Microsoft also develops. Integration amongst all these product lines allows greater user retention and the ability to scale.

• Emerging: With the already established market share of some of the other competing products Microsoft lacks the proper incentrive to maintain adaquate user retention in their newly created platforms as they are being developed.

Business Model Competition: Many companies offer services that compete with Microsoft’s product, but generate income utilizing a different business model. One example would be Google Docs, a competitor of Microsoft Word, which offers the service free of charge, but generating revenue through way of online advertising as opposed to software licensing agreement.

Investment in New Products and Services Risk: With an ever-changing landscape in which users are constantly changing the software products, cloud based services, and mobile platforms used, Microsoft risks the chance that the resources devoted towards developing and producing a product may not be relevant in the long run if it is not found to be appealing to users and the greater marketplace.

Intellectual Property Rights Risks: Microsoft has experienced on a global level a substantial amount of copyright infringement. Piracy of Microsoft products has contributed to a significant loss of revenue and the firm may not have the adequate protection it needs to counteract these issues.

Legal Claims: All the more recently Microsoft has been one of the many companies that have been accused of intellectual property infringement and including the way certain software and products are developed. The risks associated with such action could potentially mean loss of royalties and court order to prevent the sale of such products.

Security of Customer’s Products and Services: With the Windows being the dominant operating system in the world, vulnerabilities that can be exploited within the operating system can lead to customers information and data being stolen, which may open Microsoft up to litigation in the event that a class action suit may occur and a court rule is granted in the parties against Microsoft.

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