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Molex Inc.

Project Group Members:

Johnnie Davis johnnie.davis@ttu.edu

Eric Gordon eric.gordon@ttu.edu

Monica Longer monica.longer@ttu.edu

Katelyn Owens katelyn.owens@ttu.edu

Allina Pokorny allina.pokorny@ttu.edu

 

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Table of Contents

Executive Summary 12

Business and Industry Analysis 21

Company Overview 21

Industry Overview 22

Five Forces Model 25

Rivalry of Existing Firms 26

Industry Growth Rate 27

Concentration of Competitors 28

Differentiation 30

Switching Costs 30

Economies of Scale 31

Learning Economies 32

Exit Barriers 33

Conclusion 33

Threat of New Entrants 34

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Economies of Scale 34

First Mover Advantage 36

Legal Barriers 36

Conclusion 37

Threat of Substitute Products 38

Relative Price and Performance 38

Customers’ Willingness to Switch 39

Conclusion 40

Bargaining Power of Customers 40

Switching Cost 41

Differentiation 41

Importance of Product for Cost and Quality 41

Number of Customers 42

Volume of Customers 42

Conclusion 43

Bargaining Power of Suppliers 43

Switching Cost 43

Differentiation 44

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Importance of Product for Cost and Quality 44

Number of Suppliers 44

Volume of Suppliers 45

Conclusion 45

Customer and Supplier Bargaining Power Conclusion 45

Analysis of Key Success Factors for Value Creation in the Industry 46

Cost Leadership 46

Economies of Scale and Efficient Production 47

Lower Input Costs 48

Simpler Product Designs 48

Differentiation 49

Product Quality 49

Product Variety 50

Brand Image 51

Flexible Delivery 52

Customer Service 52

Research and Development 53

Conclusion 54

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Firm Competitive Advantage Analysis 54

Product Quality and Brand Image 55

Product Variety 55

Customer Service 56

Flexible Delivery 56

Research and Development 57

Conclusion 58

Formal Accounting Analysis 58

Key Accounting Policies 59

Research & Development 59

Goodwill 61

Pension Liabilities 62

Operating and Capital Leases 63

Currency Risk 64

Accounting Flexibility 65

Research & Development 65

Operating and Capital Leases 67

Pension Plans 68

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Goodwill 69

Currency 70

Evaluate Accounting principles 71

Research and Development 71

Operating and Capital Leases 73

Pension Plans 74

Goodwill 76

Currency 78

Qualitative Analysis 78

Research and Development 79

Operating and Capital Leases 80

Pensions 81

Goodwill 82

Currency 82

Quantitative Accounting Measures and Disclosure 83

Sales Manipulation Diagnostic 84

Net Sales/Accounts Receivables 84

Net Sales/Cash from Sales 86

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Net Sales/Inventory 88

Conclusion 90

Expense Manipulation Diagnostic 90

Asset Turnover 90

CFFO/OI 93

CFFO/NOA 95

Total Accruals/Sales 97

Pension/SG&A 98

Conclusion 100

Potential Red Flags 101

Undoing Accounting Distortion or Irregularities 102

Goodwill 104

Conclusion 107

Financial Analysis Forecasting Financials and Cost of Capital Estimation 108

Financial Analysis 108

Liquidity Ratio Analysis 108

Current Ratio 109

Quick Asset Ratio 110

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Working Capital Turnover 112

Accounts Receivables Turnover 113

Days Sales Outstanding 115

Inventory Turnover 116

Days Supply Inventory 118

Cash to Cash Cycle 119

Conclusion 121

Profitability Analysis 122

Gross Profit Margin 122

Operating Expense Ratio 124

Operating Profit Margin 125

Net Profit Margin 126

Asset Turnover 128

Return on Assets 129

Return on Equity 131

Conclusion 132

Firm Growth Rate Ratios 133

Internal Growth Rate 134

Sustainable Growth Rate 135

Conclusion 137

Capital Structure Analysis 137

Debt to Equity 138

Times Interest Earned 139

Debt Service Margin 141

Z-scores 143

Conclusion 145

Estimating Cost of Capital 145

Cost of Equity 145

Size Adjusted 148

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Alternative Cost of Equity 148

Cost of Debt 149

Weighted Average Cost of Capital 150

Financial Statement Forecasting 152

Income Statement 152

Income Statement (Restated) 157

Balance Sheet 160

Balance Sheet (Restated) 164

Statement of Cash Flows 167

Statement of Cash Flows (Restated) 171

Valuation Analysis 174

Method of Comparables 174

Price/Earnings Trailing 174

Price/Earnings Forecast 175

Price/Book 176

Price Earnings Growth (P.E.G.) 177

Price/EBITDA 178

Enterprise Value/EBITDA 179

Price/Free Cash Flows 180

Dividends/Price 182

Conclusion 182

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Intrinsic Valuation Models 183

Discounted Dividends Model 183

Discounted Free Cash Flows Model 185

Residual Income Model 187

Abnormal Earnings Growth Model (A.E.G.) 190

Long Run Residual Income Model 192

Analyst Recommendations 196

Appendices 198

Sales Manipulation Diagnostic Ratios 198

Expense Manipulation Diagnostic Ratios 199

Liquidity Ratios 202

Profitability Ratios 205

Firm Growth Rate Ratios 208

Capital Structure Ratios 210

Altman Z-Scores 212

Cost of Debt 213

Weighted Average Cost of Capital 214

Weighted Average Cost of Equity 215

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Year 1 Rates 215

Year 3 Rates 216

Year 4 Rates 217

Year 5 Rates 218

Year 6 Rates 219

Methods of Comparables 220

Intrinsic Valuation Models 224

Works Cited 238

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Executive Summary

MOLX ‐ NYSE (11/3/2008)                                      $14.89  Altman Z ‐ score 

52 week range:  $10.28 ‐ $30.61        2003  2004  2005  2006  2007 

Revenue:    Initial Scores:  53.2 

28.02  24.84  19.67 

25.83 

Market Capitalization:  2,250,000,000    Revised Scores:  53.2 

28.02  24.84  19.67 

25.83 

Shares Outstanding:   

176,070,000          

     Current Market Share Price (11/03/2008)                                $24.36       

        

   Stated  Restated     Financial Based Valuations Book Value Per Share: 

 $            15.03  

 $             14.10         Stated 

Restated    

Return on Equity:  10.60%  6.20%     Trailing P/E:  $       9.72  

 $       4.70     

Return on Assets:  8.10%  4.70%     Forward P/E:  $    11.84  

 $       6.63     

      Dividends to Price:  $    17.76  

 $    17.76     

                  Price to Book:   $    14.33  

 $    13.09     

Cost of Capital   P.E.G. Ratio   $    28.25  

 $    51.81     

Estimated 

R‐Square

d  Beta  Ke Upper Bound 

Lower Bound  Price to EBITA: 

 $    14.92   N/A    

2 ‐ Year   0.2667 1.0701  0.12586  18.38%  67.80% 

Enterprice Value / EBITA: 

 $    16.93   N/A    

3 ‐ Year  0.3041 1.3871  0.15117  20.70%  9.36% 

Price to Free Cash Flows: 

 $    37.67  

 $    21.69     

4 ‐ Year   0.2427 1.24

2  0.140133  19.04%  8.99%                   

5 ‐ Year  0.2873 1.3369  0.147152  19.03%  10.42%  Intrinsic Valuations 

6 ‐ Year  0.3859 1.4694  0.157753  19.25%  12.30%     Stated 

Restated    

      Discounted Dividends:  $       2.55  

 $       2.55     

Back Door Ke:  10.03%     Free Cash Flows:  $    28.79  

 $    23.77     

Published Beta:  1.61     Residual Income:  $    13.86  

 $    22.35     

Cost of Debt:  3.69%     Long Run Residual Income:  $       4.10   N/A    

WACC (BT):     13.95%       Abnormal Earnings Growth: 

 $       7.85  

 $       7.20     

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Industry Analysis

Molex was founded in 1938 by Frederick August Krebiel and son Edwin Krebiel

who developed a plastic molding material from limestone and waste by-products, and

called it “Molex.” Molex has grown over the years to become one of the industry’s

leading worldwide suppliers of interconnect products. The firm’s portfolio consists of

over 100,000 reliable products that are used within a wide variety of industries. Molex

has identified six prominent product divisions to which it supplies its interconnect

products. These product divisions include transportation, commercial, micro,

automation & electrical, integrated, global sales and marketing. Molex offers a wide

variety of products including: connectors, keypads, antennas for telecommunications,

backplanes, connectors used in the automobile industry, and also connectors used in

the medical industry. Molex employs over 33,000 highly skilled individuals dedicated to

the innovation, development and distribution of its diversified range of products.

Molex’s primary competitors include Amphenol Corp. (APH), Methode Electronics

Inc. (MEI), Tyco Electronics, Ltd. (TEL), and a few other small competitors. These firms

all differ in size, market share, concentration, location, market cap, etc., but all firms in

this industry compete on the idea of offering competitive prices and quality products to

their customers. Because the global connector industry is constantly changing due to

constant innovation, firms operating within this industry must continue to incur high

research and development costs in order to remain competitive. The global connector

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industry is so competitive it is difficult for one firm to establish a competitive advantage

over their competitors. The industry is characterized as having high amounts of

differentiation, switching costs, learning economies of scale, barriers to entry and a

mixed concentration of competitors. All of these factors contribute to the high level of

competition experienced in the global connector industry.

The capacities at which some of these companies within the electronic connector

industry are operating make it difficult for a new company entering into the market to

directly compete. New entrants would have to invest a considerable amount of capital

in their first years of operation, most likely forcing them to compete at a cost

disadvantage, compared to that of their competitors. Legal barriers such as patents and

trademarks also serve to deter new entrants from entering the interconnect product

market. The degree of competition within the various segments of the industry is easily

analyzed using the five forces model summarized below.

Five Forces Concentration

Rivalry Among Existing Firms HIGH

Threat of New Entrants LOW

Threat of Substitute Products MIXED

Bargaining Power of Buyers LOW

Bargaining Power of Suppliers LOW

Accounting Analysis

The evaluation of accounting strategies has become increasingly important in

recent years due to the realization of misrepresentation of accounting numbers by

many companies. It is important when evaluating a company to assess the quality of

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disclosure within their financial statements and annual reports. High disclosure is

characterized by firm’s ability to represent thorough information regarding accounting

numbers, policies, and personal strategies implemented to the public. Low disclosure is

characterized by the hesitance of a company to provide thorough information to the

public, which makes them appear untrustworthy. Low disclosure can be a red flag to

investors, implicating the possibility of distortion within the firm’s financial statements.

The level of disclosure within the interconnector industry is generally high

concerning the disclosure of leases, pensions, goodwill, currency, and research and

development. Research and development continues to be a driving competitive factor

within this growing market, and while the majority of the firms in operation disclosed an

abundant amount of information one in particular chose not to. Molex and its

competitors Amphenol and Methode choose to implement a high level of disclosure in

reporting research and development, while Tyco Electronics chooses to simply

generalize. While comparing retirement benefits throughout the industry we concluded

that Methode had very low disclosure compared to its competitors, revealing limited if

not minimal information concerning its pension plans. On the other hand, the remaining

competitors within the industry disclosed a vast amount of information concerning their

specific pension, post-retirement, and defined contribution plans. The high level of

disclosure demonstrated by Molex is consistent with the levels established by its

competitors within the industry. A high level of disclosure suggests a firm’s willingness

to disclose thorough information regarding its accounting policies and strategies;

therefore implying the company is less likely to distort financial information.

Financial Analysis, Cost of Capital Estimation, and Forecasting

To successfully evaluate a company an analyst must complete a three step

process that includes ratio analysis, the forecasting of financials, and determining the

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cost of capital of the company. Financial ratios produce easily comparable numbers so

that analysts, investors and creditors seeking information can identify relationships and

trends within the industry. Ratios were developed to measure the liquidity, profitability,

growth and capital structure of firms. The calculation of the liquidity ratios allows

analysts to measure the ability of a firm to meet its short-term financial obligations.

Molex’s current and quick ratio were significantly higher than their competitors, which

suggests a high level of liquidity. Molex demonstrated a low accounts receivable

turnover ratio compared to its competitors which we attributed to inefficiencies in debt

collections. After examining all the liquidity ratios we can see that many of Molex’s

competitors have comparably similar ratios, while some ratios including days supply in

inventory illustrate vast differences between firms. Profitability ratios measure the

ability of a firm to effectively generate revenues and cover expenses. By using sales

and income figures as the denominator in these ratios we can accurately view how

Molex successfully uses cost management to operate the firm. When viewing ratios

such as gross profit margin and operating expense ratio, Molex out performs the

industry average. We attribute this to Molex’s success in sales and gross profit.

However, when observing operating profit margin and net profit margin Molex performs

below the industry average. Our reasoning behind this factor is that Molex might have

significant expenses or poor cost management that overall negatively affects earnings.

When comparing Molex’s asset turnover to the industry we are the only company that is

able to maintain a stable and sound growth over a five year period thus suggesting that

Molex is effective at using assets to generate sales. When comparing Molex’s return on

assets to the rest of the industry, Molex initially appears to have a stable five year

growth, however, after restating Molex’s financials, Molex is below the industry

average. We attribute this drop to Molex acquiring two companies in 2006 and 2007.

The impairment of goodwill associated with the two acquisitions negatively affected

assets and therefore decreased the return on assets on the restatement. Finally, when

examining return on equity the industry trend is downward sloping. However, when

observing Molex we might fall below the industry average but we do not follow the

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downward sloping trend. In fact Molex is the only company to maintain a steady growth

in the five year period. Overall when using profitability ratios to compare Molex to the

rest of the global connector industry it is obvious that Molex excels in sales and

generating revenue from assets, however, other ratios suggest that there could be

efficiency or cost management problems in the firm. This is an important factor to

consider when investing in Molex. Capital structure ratios are used to explain how a

firm finances their assets. Firms can use debt or equity to fund projects and assets.

Debt comes from loans or bonds while equity is from selling shares of company stock.

Capital structure ratios can measure the firm’s financial leverage, credit worthiness,

ability to make interest payments, and ability to pay off debt holders. A firm that has

little to no equity will have a poor credit rating which means high interest rates. A firm

with lots of equity can make its payments on debt with ease and do so with a low

interest rate. The three capital structure ratios used are debt to equity, times interest

earned, debt service margin.

We also examined growth rates because they can help evaluate if a firm can

maintain its future increasing profits without the need of outside financing or changing

capital structure. The two growth rates used are the sustainable (SGR) and internal

growth rates (IGR). Graphing these two growth rates can help distinguish trends or

irregularities between the firm and the industry.

The next step in our prospective analysis was calculating the cost of capital. In

order to find the appropriate rate for our valuations, we had to find the

weighted average rates of both debt and equity financing. To find the cost of equity, we

first calculated beta from a series regression analysis. After deriving the 4.02% risk

free rate from the St. Louis Federal Reserve, a market risk premium of 8% and our beta

of 1.47, we used CAPM to calculate an initial cost of equity of 15.78%. However, when

computing CAPM it fails to account for the market value of the firm also known as the

“size effect”. Therefore, the appropriate cost of equity for Molex based on our market

value is 17.48%. When comparing our size adjusted cost of equity of 17.48% to our

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backdoor cost of equity of 10.03%, we feel that the size adjusted cost of equity is a

more accurate representation of our company based on our explanatory power of

38.6% and our market value of 2.26 billion. Next we derived our cost of debt. By

using the three month financial AA grade commercial paper rating for the St. Louis

Federal Reserve, we were able to account for the debt associated with accounts

payable, salaries, bonuses, commissions and other accrued expenses. We then applied

the 10 year treasury yield for risk free rate as the interest rate for income taxes payable

and used the interest rates as stated in the 10-K to account for long term debt and debt

associated with short term loans, pensions and postretirement benefits. With our cost

of debt as 3.69% and our cost of equity of 17.48%, we found our weighted average

cost of capital before tax to be 13.95% as stated and 13.7% restated.

The final step and a key part in the valuation of the company in the financial

analysis is the forecasting of financial statements. The most vital part of the forecasting

is to foresee what net sales growth is going to be because the rest of the forecasting is

linked back to this growth rate. A major item that was taken into consideration is the

recession that the economy is currently in. Due to this we decided to use a negative

growth rate for the first two years and a slow positive growth rate for the third year.

The fourth year, 2012, is the year that we foresee the economy recovering and Molex

with have a stable 15% growth year for the flowing years. When forecasting many of

the entries in the financial statements we used the averages and results that came from

the profitability, liquidity, and capital structure ratios. For example, in the balance sheet

when we forecasted our current liabilities we used our already forecasted current assets

and divided by our current ratio of 2.7 to get the current liabilities for each year. This

method of uses ratios was used in many other lines in order to keep the numbers as

accurate as possible. One thing to keep in mind is that statement of cash flows would

be the least precise. We are certain that our numbers on the income statement and

balance sheet were done with accuracy, but the fact is that the statement of cash flows

is the most challenging for even the most talent analysis to forecast to the point that

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one major part, the cash flows from financing activities, cannot even be reasonably

assumed. We feel that our forecasted numbers would very beneficial in an investor

that is looking at Molex.

Valuation

To accurately value a firm you must utilize both methods of comparables and

intrinsic methods of valuation. Methods of comparables are a set of eight ratios that

compute an estimated price per share which is then compared to a published stock

price to determine the value of a firm. Information is collected and used to calculate

these ratios for the industry competitors, which is then used in the calculation of the

industry average. The industry average, which excludes the data of Molex, was then

multiplied by a correlating factor to determine the implied price per share. We used a

15% margin of safety when comparing the implied price per share to Molex’s published

November 3, 2008 price of $14.89. If the price implied by the methods was below

$12.66 Molex was considered overvalued, and if the implied price was above $17.19

then it was considered undervalued. The results varied from each method of

comparable which suggests that these ratios offer limited to no reliability. The implied

price per share is dependent on the performance of Molex’s competitors, therefore

making the methods of comparables an inadequate method of valuation.   

The intrinsic valuation methods are considered a more reliable form of valuation

compared to the methods of comparables. These models are supported by financial

theories which assure a higher level of explanatory power. The firm’s performance is

estimated by forecasting the financial statements of a firm. The financial statements

are forecasted to predict company performance, then discounted back into present day

values. The intrinsic valuation method consists of five models which include: discounted

dividends, discounted free cash flows, residual income, abnormal earnings growth , and

long-run residual income. Dividends are the most difficult item on the financials to

forecast, therefore the discounted dividends model yields the least amount of

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explanatory power. Dividends are sensitive to growth rates, even the smallest changes

in growth dramatically affect the time consistent price based on the model. The

discounted free cash flows model is considered unreliable based on the inability to

accurately forecast future cash flows of a firm. As with the discounted dividend model,

the discounted free cash flow model is sensitive to increasing growth rates which

causes its prices to vary significantly. Molex’s estimated share price using WACCBT of

13.7% and a 0% growth rate produced a share price of $21.35, which assumes Molex

is undervalued. The residual income model can be considered a reliable factor when

valuing a firm because it offers one of the highest explanatory powers. This model

yielded an estimated price of $13.68 implying Molex is overvalued. The abnormal

earnings growth model directly correlates with the residual income model in that if you

subtract A.E.G. of any given year by residual income in that same year it should equal

zero. This implies that A.E.G offers the same amount of explanatory power as the

residual income model. A.E.G. produced an estimated share price of $9.33 which

suggests that Molex is considerably overvalued. The last intrinsic value model is the

long-run residual income model which is very solid is the direction of the company

being overvalued. The model has a good explanatory power which helps in the valuing

process. After conducting the various valuation models we consider Molex to be

overvalued.

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Business and Industry Analysis

Company Overview

Molex was founded in 1938 by Frederick August Krebiel and son Edwin Krebiel

who developed a plastic molding material from limestone and waste by-products, and

called it “Molex.” They began using the Molex plastic material to make a variety of

products, including flower pots, toys, salt dispensers, clock cases, and insulators.

“Molex is the second-largest manufacturer of electronic connectors worldwide in terms

of revenue.” “Net revenue was $3.3 billion for fiscal 2008.” “Molex is a leading supplier

of connector products, with their core business being the manufacture and sale of over

100,000 different electronic components” (Molex 10-K). Molex is a top supplier of

connector components to telecommunications, computer, consumer, automotive and

industrial electronics markets. They offer a wide variety of products including:

connectors, keypads, antennas for telecommunications, backplanes, connectors used in

the automobile industry, and also connectors used in the medical industry. “Molex’s

products are essential to a large number of original equipment manufacturers

throughout the world.” “Molex’s headquarter is located in Lisle, Illinois with operating

locations in 17 different countries.” (Molex.com)

The company’s telecommunications division offers many products for mobile

phones and devices, networking equipment, and switches and transmission equipment.

Some of their products include high speed optical signal lines, backplane connectors,

keyboards, and antennas. These products are mainly produced for the mobile phone

industry. Molex also manufactures connectors for home and portable audio, CD and

DVD players, as well as plasma and LCD televisions. In addition to all of these

products, “they offer manufacturing services to integrate specific components into a

customer’s product” (Molex 10-K).

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Molex is a fairly large company with 45 manufacturing locations that are located

in 17 countries, and employed over 32,000 as of June 2008(Molex 10-K). Their primary

competitors include Amphenol Corp. (APH), Methode Electronics Inc. (MEI), Tyco

Electronics, Ltd. (TEL), and a few other small competitors. “These competitors offer

products in some, but not all, of the markets that Molex serves”(Molex 10-K). Molex is

traded on the NASDAQ and has a current market cap of $4.30 billion

(http://finance.yahoo.com).

Molex (Total assets and sales figures)

MOLX

* in millions

2003 2004 2005 2006 2007 2008

Total Assets* 2,333.9 2,575.3 2,730.2 2,974.4 3,316.1 3,599.5

Net Sales* 1,839.8 2,249.0 2,554.5 2,861.3 3,265.9 3,328.3

Sales Growth 7.49% 22.25% 13.58% 12.01% 14.14%

1.91%

(Molex 2008 10-K)

Industry Overview

“Molex operates in the global connector industry, which is estimated to represent

approximately $46 billion in revenue during the 2008 fiscal year”(Molex 10-K). The

majority of this industry is made up of the telecommunications and data products

markets, which constitute about 48% of market space between the two alone(Molex

10-K). The companies in this industry do not compete in all of the different markets,

due to the split industry, but do operate in certain sectors of the market. The firms in

this industry must provide quality products and continually invest in innovation in order

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for them to continually gain market share. The firms competing for market share in this

industry include Amphenol Corporation, Tyco Electronics, Ltd., Methode Electronics Inc.,

and many other small and large firms(Molex 10-K). These firms all differ in size, market

share, concentration, location, market cap, etc., but the one thing that all firms in this

industry compete on is the idea of offering competitive pricing and quality products to

their customers.

These companies must incur high research and development cost, in order to

compete in this very innovative industry. “We must continue to make investments in

research and development in order to continue to develop new products, enhance

existing products and achieve market acceptance for such products”(Molex 10-K).

In an industry where connectors and electronic devices are continually getting smaller

and smaller, and more technologically advanced, it is vital for a company in this market

to invest substantial amounts of revenue in research and development. Molex exceeds

the global connector industry average in terms of research and development expenses,

“Incurring costs of $164 million in 2008, and $159 million in 2007”; which is a lot higher

than the industry average of research and development costs(Molex 10-K).

Manufacturing costs within the connector industry are relatively high, but

companies are well compensated by the large amounts of profits that are received. The

industry, as a whole, has seen substantial amounts of growth during the last five-six

years due to the increasing demand throughout the telecommunications and data

markets. Most of the companies in this industry manufacture around 100,000 different

products, so the firms tend to differ in size, sales, total assets, etc. The four firms listed

below (shown with their net sales figures and total assets) are four of the main

competitors in the global connector industry.

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Global Connector Industry (Total assets and sales figures)

(Statistics came from the companies 10-K’s)

According to Molex, “the 10 largest connector suppliers, as measured by revenue,

represent approximately 54% or the worldwide market in terms of revenue.” (Molex 10-

K)

The global connector industry is so competitive it is difficult for one firm to

establish a competitive advantage over their competitors. There are so many large

firms in the industry new entrants will suffer on the basis of economies of scale. These

new entrants will initially be at a cost disadvantage from the existing firms in the

industry (Palepu & Healy). In order for these smaller firms to survive in a cost driven

industry, they must be able to offer competitive pricing and a very innovative product.

Net Sales

* in millions

2003 2004 2005 2006 2007

Molex* 1,839.8 2,249.0 2,554.5 2,861.3 3,265.9

Amphenol* 1,239.5 1,530.4 1,808.1 2,471.4 2,851.0

Tyco* 9,217.0 10,608.0 11,433.0 12,300.0 13,460.0

Methode 363,057 358,867 392,725 421,615 448,427

Total Assets

* in millions

2003 2004 2005 2006 2007

Molex* 2,333.9 2,575.3 2,730.2 2,974.4 3,316.1

Amphenol* 1,181.4 1,306.7 1,932.5 2,195.4 2,675.7

Tyco* 18,132.0 18,789.0 18,473.0 19,091.0 23,688.0

Methode 315,474 314,188 356,681 374,583 411,740

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Lately, some of the firms in the industry have downsized their operations due to

the recent decline in the stock market. This has mainly been seen in the automotive

side of their operations because of the recent incline in gas prices. Tyco Electronics

stated, “That they plan to close three plants and consolidate production of its

automotive products in Europe…”. “They plan to take charges of $115 million in an

effort to streamline its portfolio and reallocate resources to core operations”

(online.wsj.com). Overall, the connector industry, as a whole, is experiencing nominal

growth rates and will continue to grow as long as we remain a technology based

economy.

Five Forces Model

When analyzing an industry it is important to thoroughly understand what issues

drive and power a business. In order to do so, you must be able to identify key success

factors that create value for the company. The five forces model is an analysis of how

five competitive factors can determine a company’s profitability and a firm’s success in

an industry. It is important to understand how these factors influence competition and

what issues can make or break a business. Porter’s five forces focus on rivalry amongst

existing firms, threat of new entrants, threat of substitute products, bargaining power

of buyers, and bargaining power of suppliers. The following is a table that reflects how

each force influences profitability and competition in our industry. We will discuss how

firms handle the five forces and how they successfully compete in the global connector

industry.

Five Forces Concentration

Rivalry Among Existing Firms HIGH

Threat of New Entrants LOW

Threat of Substitute Products MIXED

26 

 

Bargaining Power of Buyers LOW

Bargaining Power of Suppliers LOW

Rivalry Among Existing Firms

When observing a particular industry you need to be able to evaluate the level of

competition that exists between operating firms. The level of competition within an

industry determines different strategies implemented by firms. If firms decide to

implement an aggressive pricing strategy they choose to push prices closer to marginal

cost. Another strategy is the coordination between competitors to compete with similar

prices, or in non-price dimensions. The technology industry is forever growing and

expanding, and as a result the firms operating in the production of electronic

connectors are forced to compete at a very high level. A number of factors including,

industry growth rate, concentration, differentiation, switching costs, scale economies,

learning economies, excess capacity and exit barriers are considered when determining

the level of competition within a particular industry.

Industry Growth

27 

 

In an industry like the one of electronic connectors, that is constantly innovating

and changing, it’s important to take into account the growth experienced by the

diversified electronics industry as a whole. Each of the companies operating within this

industry has experienced rapid growth as more and more of their products are needed

to operate both commercial and specialty items demanded by their customers (Refer to

graph above). This growth in the industry has lead to an increase in the functionality of

electrical connectors in products ranging from mobile phones to robotics. In terms of

industry growth, it’s not a priority of individual firms to concentrate on capturing a

greater percentage of market shares when the industry is growing constantly. But, price

wars will develop in an industry when it becomes sluggish, because competing with

other firms in the industry on price is the only way for the company to grow. A good

implication of growth is the comparison and calculation of percentage change in sales of

major firms operating within the industry. Commonly high percentage growth in the

industry suggests low competition, while low percentage suggests high competition.

This particular industry is an exception to this regularity in that it operates in a highly

00.020.040.060.080.10.120.140.160.18

2003 2004 2005 2006 2007

Industry Sales Growth 

Industry Sales Growth 

28 

 

competitive market, and yet has continued to experience steady growth throughout the

years.

Concentration of Competitors

In order to calculate the degree of concentration in an industry you must be able

to determine the number of firms in operation, as well as their sizes relative to the

market. A monopoly describes an industry with a high concentration in which the

dominant firm can dictate prices, as well as other rules of competition. The presence of

a handful of dominant competing firms is an illustration of an oligarchy, in which

competing firms can choose to coordinate prices to avoid unprofitable price

competition. The concentration within the connector industry is relatively mixed, a

number of firms hold a greater market share compared to their competitors. These

firms have utilized their resources efficiently and have the opportunity to differentiate

their products by price, while the remaining firm’s must aggressively coordinate, or

compete in the pricing of their products. The concentration of the global connector

industry is mixed forcing firms within the industry to differentiate their products using

factors other than price. ( Palepu & Healy, 10-K: Tyco Electronics, Methode, Amphenol,

Molex Inc.)

29 

 

Market Share Based on Sales Revenue amongst competing firms

As supported by the data included in both the graph and table above, Tyco

Electronics holds the largest percent of the market share compared to the remaining

0102030405060708090

2003 2004 2005 2006 2007

Methode

Amephenol

Tyco

Molex

2003 2004 2005 2006 2007

Molex 10.62% 11.2% 11.62% 12.07% 16.28%

Tyco 82.56% 81.74% 78.63% 77.5% 67.28%

Amphenol 5.38% 5.69% 8.23% 8.91% 14.21%

Methode 1.44% 1.37% 1.52% 1.52% 2.23%

Total

Industry

Sales

$12,659,322,

000

$14,746,331

,000

$16,178,330,0

00

$24,635,400,0

00

$30,091,581,0

00

30 

 

firms operating within its industry. Although the remaining firms’ market shares are

minuscule in comparison to Tyco Electronics, each firm’s market share has been slowing

growing each year while Tyco Electronics has experienced decreases.

Differentiation

The attempt made by firms competing in highly competitive markets to set their

products apart from their competitors is referred to as differentiation. It is vital for firms

to differentiate their products as well as other business strategies in order to

accommodate the ever changing needs of consumers. Differentiation can be a detail as

insignificant as color or shape, but can help a product to appear unique when compared

to the products of a competitor. Limited opportunities to differentiate a product’s

physical attributes results in a firm’s focus on aspects such as customer service, brand

recognition, and quality. Firms competing in the global connector industry have

unlimited opportunities to differentiate their products. They are constantly innovating

and redesigning their products to appeal to the industry’s changing consumer. Firms

within the industry also make a valid effort to differentiate and improve the services

offered to their consumers. Differentiation of products within the market remains the

driving factor of success in the global connector industry (10-K : Molex Inc., Tyco

Electronics).

Switching Costs

The commitment firms have to their specific industry depends on the costs

associated with switching the labor of their resources into another market. There are

many risks a firm has to take into account with considering switching into a different

industry including: exit fees, search costs, and equipment costs. Although firms

producing global connectors operate within many diverse markets, the cost of

completely exiting the market and entering into a different industry would be very high.

Their manufacturing process consists of automated machines producing high numbers

31 

 

of complex connectors; it would be difficult for the firms to use their pre-existing

resources for another type of production other than electronic connectors. Because of

the difficulty firms would face in trying to use their resources in another industry, we

would classify the industry as having high switching costs. (Wikipedia, 10-K: Molex Inc)

Economies of Scale

As the number of goods increases in production so must the efficiency as stated

in economies of scale. Larger companies that continue to reduce price per unit as

output increases, are able to use their resources to compete on a larger geographical

scale. Smaller firms are limited in their ability to grow and sometimes encounter

increases in production costs as output is also increased. Electronic connector firms

operate in many different markets, and own production facilities in numerous countries.

32 

 

The amount of capital and resources at their disposal enables the firms to

compete at the level they do. To compete within the connector industry you must own

many production facilities, operate in a number of markets and generate considerable

revenues to own a large percentage of the total market share. Measuring and

comparing the total property, plant, and equipment owned and operated by firms

competing in the industry is a valuable way to support or disprove the assumption given

in the theory of economy of scales. Refer to the table above, most of the firms

competing in the global connector industry are able to achieve economies of scale due

to their individual size and total current assets. (investopedia.com, Answers.com,

molex.com, tycoelectronics.com)

Learning Economies

Firms operating within this industry spend a large percentage of yearly revenues

on the research and development of new products. By continuing to invest in research

and development these firms are serving as a catalyst in the development of new

products, as well as the improvement of products in existence. Because these firms

operate in an industry that is constantly changing and developing it’s paramount to

their existence to acquire highly innovative and intelligent personnel. Firms operating in

Total Assets 2003 2004 2005 2006 2007

Molex 2,333,854 2,575,286 2,730,162 2,974,420 3,316,108

Amphenol 1,181,384 1,306,711 1,932,540 2,195,397 2,675,733

Tyco 18,132,000 18,789,000 18,473,000 19,091,000 23,688,000

Methode 315,474 314,188 356,681 374,583 411,740

Total Assets:

Industry

21,962,712

22,985,185

23,492,383

24,635,400

30,091,581

33 

 

the electronic connector industry continue to be very competitive in their search for

qualified engineers and technicians.

Exit Barriers

Exit Barriers refer to the consequences a company accepts when deciding to exit

the industry. Some important exit barriers to consider are the investment of specialized

equipment, specialized skills, and high fixed costs. If the company has a large amount

of asset worth in specialized equipment it faces a difficult exit barrier because the

equipment is not easily transferrable between markets. Property, plant and equipment

are considered assets of the company but they are not easily transferred into a liquid

asset such as cash or marketable securities, thus it will be harder for a company to

dispose of these assets without considerable time and effort. Skills that are exclusive to

your industry are also another asset that is difficult to transfer between markets, the

costs of retraining can be extremely costly in both time and money. Contracts entered

into by companies also serve as barriers to exit, in that they are obligated to perform

the said duties presented in contracts. In the global connector industry has high exit

barriers because its equipment and skills are highly specialized, making it difficult for

them to exit the industry without incurring significant costs. (10-k: Molex Inc.,

www.agmrc.org, Palepu & Healy)

Conclusion

The global connector industry is highly competitive as a result of its industry

growth rate, concentration of competitors, level of differentiation, switching costs, exit

barriers, economies and learning economies of scale. The industry continues to

experience steady growth year after year as a result of our innovative nature which

allows unlimited opportunities for growth within the industry. The concentration of

competitors within the industry is mixed, forcing firms with lower market share to

differentiate their products using factors other than price, like customer service, and

34 

 

quality. Differentiation within the industry remains high, and important to the success of

any firm operating in the global connector market. Switching costs are high making it

difficult for existing firms to use their current resources in alternate industries. High

level of learning economies of scale force firms to compete aggressively when recruiting

personnel within the industry. High barriers to exit will force companies to remain and

compete within the market. All of these factors contribute to the high level of

competition experienced in the global connector industry.

Threat of New Entry

Firms operating within certain industries fear the threat of new entrants, and

new entrants and new products that may make their existing products obsolete. The

technology industry is constantly changing, forcing companies to constantly innovate

their products. The capacity at which some of these companies within the electronic

connector industry are operating make it difficult for a new company entering into the

market to directly compete. Factors such as, economies of scale, first mover advantage,

distribution access, relationships, and legal barriers act as deterrents to new entrants in

the electronic connector industry.

Economies of Scale

The size and resources of a company continue to be a significant barrier to entry

in the global connector industry. Firms operating within the connector industry have

large amounts of capital invested in property, plant & equipment as well as research

and development. Both of these assets are very important to the success of such

35 

 

companies that supply their products to a number of industries and countries around

the world. Each company reports the reinvestment of at least 5% of their revenues

back into the company in the form of research and development. If a new firm were to

try to enter into the industry they would have to invest a large sum in both of these

areas to be able to compete on the same level as the companies in existence. The

graph below further illustrates the average assets available in the global connector

industry, without significant capital or property, plant and equipment a new entrant

would fail to successfully penetrate the market. New entrants would have to invest a

considerable amount of capital in their first years of operation, most likely forcing them

to compete at a cost disadvantage, compared to that of their competitors.

0

5000000

10000000

15000000

20000000

25000000

30000000

35000000

2003 2004 2005 2006 2007

Total Assets : Industry

Total Assets : Industry

36 

 

First Mover Advantage

Early entrants into the industry can experience a number of advantages not

available to those entering at a later time. The earliest entrants have the opportunity to

develop relationships with suppliers, as well as the possibility of developing the

standards of the industry they operate in. Information reflected in many of the firms’

10-Ks has indicated that each individual firm chooses to purchase the raw materials

needed for their products from a limited number of suppliers in order to take advantage

of competitive pricing. The firms operating within the industry have recognized that the

raw materials that they use in the production of global connectors have continued in to

increase in price; therefore they remain faithful to a smaller pool of suppliers in order to

receive the best price. The relationships developed between supplier and firm can lead

to exclusive contracts in which the companies in agreement only deal with one another,

this can be disheartening to those firms entering the industry at a later time. The

opportunity for a firm to develop the industry standards is an incredible advantage to

those early entrants. This insures that all entrants from now on have to adhere to the

standards and regulations exemplified by these early entrants. Pre-existing firms within

the connector industry have been in existence as early as 1932, most starting out

producing simple products and growing throughout the years into intercontinental

production powerhouses. A company trying to enter into the electronic connector

industry would lack the experience, knowledge, and understanding already maintained

by firms in operation.

Legal Barriers

In a research intensive industry, like that of electronic connectors, legal barriers

such as patents, copyrights, contracts, and regulations limit the number of firms able to

enter. Many, if not all of the firms producing electronic connectors have patents on a

majority of their products, making it hard for new entrants to start production without

extensive research of existing patents held by competitors. Molex, one of the industry

37 

 

competitors claims in its most recent annual 10-K to have received over 539 patents for

its products. While some firms like Tyco and Amphenol believe that the number of

patents it has doesn’t affect its overall competitive position, others like Methode believe

that its ability to compete within its industry depends on its ability to maintain the

propriety nature of their technology. The accumulation of patents a company considers

valued assets can serve as a major deterrent to firms trying to enter into the industry

because they would have to spend a large amount of time researching the competitor’s

products as not to infringe any legitimate patents. The firms operating within the

connector industry own production facilities around the globe, and as a result must

comply with regulations enforced by the different governments. Due to the recent focus

on environmental consciousness the European Union has enforced new regulations

involving environmental and equipment disposal within the connector industry. This

specific government has imposed RoHS, which stands for the “restriction of the use of

certain hazardous substances in electrical and electronic equipment”. This regulation

prohibits the production and selling of new electrical and electronic equipment

containing more than agreed levels of lead, cadmium, mercury, hexavalent chromium,

polybrominated biphenyl (PBB) and polybrominated diphenyl ether (PBDE) flame

retardants. New entrants considering opening production facilities must take into

account these newly enacted regulations. Barriers to entry for firms considering

entering a particular market in the future are very high due to the many patents in

effect, and the addition of environmental regulations.

Conclusion

Threat of new entrants into the electronic connector industry remains low. The

industry is constantly innovating and expanding across the globe and has made it

necessary for companies to have high amounts of capital, and revenues invested in

tangible assets as well as research and development. Existing companies can also utilize

the first mover advantage, by using their knowledge of the business, and recognition of

the industry standards. Firms wanting to enter into the connector industry must also

38 

 

consider the many patents held by companies in existence. These potential new

entrants must also take into account the regulations regarding production within the

industry. These factors make it difficult for new entrants to compete or succeed in the

global connector industry without proper funding and planning.

Threat of Substitute Products

“The threat of substitute products depends on the price and performance of

competing products, as well as the customers’ willingness to substitute the product.”

(Palepu & Healy) Some of the firms in the industry do not supply the same products as

their competitors, but the industry as a whole, provides the same main product line

from company-to-company. Firms in the connector industry produce a lot of products

that can fairly easily be substituted by their competitors. So firms have lower bargaining

power and more incentive to offer competitive pricing among the existing firms in the

industry. But, since part of the industry deals with a lot of technology based products,

there is room for companies to compete on the basis of innovation and technology

advances throughout the market place. The threat of substitute products in the global

connector industry leads to competitive pricing and products for the consumer to

choose from.

Relative Price and Performance

One key factor associated with the threat of substitute products is the

competitors’ relative price and performance. “The threat of substitutes depends on the

relative price and performance of the competing products or services and on customers’

willingness to substitute.” (Palepu & Healy) “In an industry where there is low product

39 

 

differentiation between suppliers, the buyer tends to have a relative high bargaining

power, leading to a high level of price competition among firms.”

The increasing competition among firms in the global connector industry is

constantly leading firms to create new innovative products. Our economy is continually

moving towards a more technology based world, and firms in the connector industry

are going to have to capitalize on this in order to succeed. Since firms are spending

around five percent of total revenue on R&D, prices are going to tend to move upward,

which in turn is going to lead to more product differentiation among firms in the

connector industry. The firms who decide to produce these more sophisticated products

will, in turn, separate themselves from their competitors. This will give the more

innovative companies an incentive to continually develop more profitable products.

These more advanced products are going to be used to substitute the cheaper

products, on the basis of quality and performance, but will not compete on price. Firms

in the industry must rely on their products to perform at a level higher than the overall

industry standard in order to succeed.

Customers’ Willingness to Switch

Another factor that deals with the threat of substitute products is the customers’

willingness to switch products. A small price difference in a product can create a

customers’ willingness to switch to a different product. So very competitive pricing is

needed in an industry where there is an absence of high switching costs. Brand loyalty

is also a factor than can lead a customer to switching to a more effective product.

The connector industry is an industry which experiences rapid change and

improvements on products as well as innovation. This makes firms stay up to date on

40 

 

the latest technological improvements and advancements, and also have the latest, and

fastest products. In an industry where a customer has an incentive to do some research

on products and find out which firm produces the best, there are going to be some

moderate switching costs. Due to the fact, that it is very timely and costly to perform

this kind of research on so many companies and their products. Companies’ in this

industry want to create strong relationships with customers’ in order to build a powerful

brand image, and gain the “brand loyalty” that every firm seeks.

Conclusion

In an industry where there is a moderate amount of substitute products, firms

must compete on the basis of competitive pricing and quality products, in order to

create value for their customers’. In an industry where firms are spending adequate

amounts of their revenue on R&D the customer has a smaller a smaller incentive to look

around for substitute products. So overall, the threat of substitute products in the

industry is moderate.

Bargaining Power of Customers

In the competitive industry of electronic connectors competition is everywhere.

The largest customer’s in the industry are mega companies such as: Dell, Cisco, Ford,

GM, IBM, Motorola and Nokia. There are thousands of other companies who use

electrical connectors in their products. Electrical connectors are in almost every

electronic device in the World. Connectors are in high demand, but do the customers or

suppliers have the majority of bargaining power?

41 

 

Switching Cost

The switching cost for customers depends on the connector they are using.

Some companies use generic, off-the-shelf connectors which require low switching

costs. Other companies have custom connectors made specifically for their products.

The custom-made connectors have to be designed to fit their manufacturing process.

To switch from one custom connector to another could cause the manufacturing

process to be reformatted thus increasing the cost of switching. With the use of the

internet manufactures can search for new products by the millions. Using a Google

search engine with the key word search of “electronic connectors” over 992,000 web

sites appear. Almost every large connector company has online catalogs that allow

manufactures to research products and compare prices. The convenience of this online

shopping saves time and money due to increased efficiency of switching products with

a push of a button.

Differentiation

Many connectors provide the same function as each other but there are multiple

factors that differentiate them for the others. The differences may be in size, wattage,

frequency, material, durability, and application. The customers have a wide range of

products to choose from. Many connectors are specifically made so that only like

connectors can be used and a competing brand cannot be substituted.

Importance of Product for Cost and quality

Electronic connectors are an inexpensive input into the final product. Due to

small fraction of cost to the end product, customers will not spend much effort

shopping for the lowest possible price. Large manufactures pay close attention to prices

especially when they are having financial troubles. According to the Wall Street Journal,

Dell Computers is cutting cost everywhere it can to save money and to increase profits.

Dell Computers puts pressure on their suppliers which includes the connector

42 

 

companies to lower prices. A threat of switching suppliers can be enough to influence

the electronic connector supplier to lower their cost (Scheck, A1).

The quality of the electronic connector is essential for the final product. If a

connector is of poor quality it can cause the final product to malfunction. A faulty

connector in a line of computers can cause a malfunction creating a partial or full loss

of ability. Many repairs to replace a faulty connector require costly disassembly and

remanufacturing.

Number of Customers

The lists of customers are enormous. As mentioned before there are connectors

in almost every electronic device in the world. High competition between customers is

very common. The computer and telecommunication industry uses large amounts of

connectors compared the consumer product industry. A computer can have hundreds of

connectors when a washing machine may only have three or four. According to

(electronic-oems.com) they have over 1,526 electronic manufactures listed in their

index. There are thousands more that are unlisted that also use connectors in their

manufacturing processes.

Volume of Customers

Customers usually buy connectors in bulk orders with little lead time. The orders

of connectors could be in the million unit range or more. Long term contracts for

connectors are uncommon because of the rapid technology changes and the ever

changing trends in the electronics industry. Selling connectors in large orders creates

economies of scale because the costs are divided between millions of products lowering

manufacturing cost and transportation cost per unit. Customers tend to stock up

components before holidays such as Christmas to meet dramatically increased

demands.

43 

 

Conclusion

Customers of electronic connectors can be classified as less price sensitive due

to differentiated connectors, the high switching cost due to reformatting the

manufacturing process, and the small cost of the connector to the final product.

Customers do not spend large amounts of efforts trying to shop for the lowest cost

connectors. Backwards integration is not a likely threat to the industry because the

connector industry is highly diversified. Owning your suppliers creates more risk and

would increase losses if the industry takes a downturn.

The customers do not hold as much price setting power as suppliers but they do

hold the power of demand. The customers create a large demand with their final

products such as HD TV’s or new cell phones causing the connector industry to

compete with innovated new products and low prices to influence customers to use

their products by the millions.

Bargaining Power of Suppliers

When suppliers have little competition and few substitutes they can become very

powerful. The materials sold by suppliers to make electronic connectors are palladium

salts, plastic resins, copper alloys, gold, and components. The price and availability of

these products play a critical role in the connector industry. Most of these commodities

have very few substitutes and a high level of competition.

Switching Cost

The switching cost for the connector industry to switch suppliers is very low due

to the large number of suppliers available. When switching from one brand of high

grade copper to another, it will not change anything within the manufacturing process

or end products; unless the copper comes in bars instead of wire spools or is of a lower

44 

 

quality. Often manufactures order supplies from multiple suppliers because their orders

are two large to be filled by just one. Overall, switching suppliers is easy and very low

cost.

Differentiation

The undifferentiated products supplied by supplier’s causes them to lose some

power over the connector industry. High grade copper alloy from one supplier will be

physically identical to another’s. To distinguish a competitive advantage over other

copper suppliers the company may have great customer service, large inventories, and

fast delivery to satisfy the need of a large connector company. In overall product there

is no differentiation.

Importance of product for Cost and Quality

The cost of the raw supplies is the number one determining factor as to what

the connector industry will charge for their products. Many of the commodities listed

previously have volatile prices. For example, oil is the main ingredient for plastic, and as

the supply and price of oil fluctuates so does the price of plastic (How plastics are

made, 1). According to the Wall Street Journal light crude oil prices have increased27%

from September 12, 2007 to September 12, 2008 (Reuters, 1). If a commodity is in

short supply and high demand prices will skyrocket creating profit losses in the

connector industry. The quality of the product supplied will be very close if not

undistinguishable. Plastic resins may have slight chemical differences form one supplier

to another but the overall products are almost identical.

Number of Suppliers

There are thousands of suppliers in the global market for the connector industry.

Most of these suppliers provide their products to many various other industries not just

for connectors. Just a few examples of how raw copper can be used is to make pipe,

45 

 

kitchen ware, or electronic connectors. According to (Copper.org) in the United States

there are more than 80 raw copper suppliers. Copper suppliers can be found

throughout the world not just the United States. The high level of competition among

suppliers will help keep prices down.

Volume of Suppliers

Suppliers sell in bulk orders to the connector industry. The commodities sold

have long shelf lives allowing the buyers to buy before anticipated price increases and

not having to worry about their inventories becoming obsolete. Commodities may be in

short demand and could even increase the value of a connector company’s inventory;

also the exact opposite could happen creating a loss in the value of inventory.

Conclusion

Suppliers are very price sensitive due to undifferentiated products and low

switching cost. Due to this price sensitive condition the connector industry will shop

around for the lowest cost product available. The lower they buy the commodities

needed the higher profits they will make. When commodity prices fluctuate the market

determines the price, the supplier then adds their cost of overhead, labor, and a small

spread of profit to determine the price for the buyers in the connector industry.

Customer and Supplier Bargaining Power Conclusion

Customer and supplier power over the connector industry does not produce a

clear cut winner. The huge customers like Dell, and IBM have a great amount of power

over demand and specifications of the products. The suppliers seem determine prices

due to the fluctuations in the commodities they sell. The connector industry is

comprised of customers and suppliers where no one force dominates over the other.

Both suppliers and customers do their part to set price and supply a demand.

46 

 

Analysis of Key Success Factors for Value Creation in the Industry

Identifying and analyzing the key success factors of a firm’s given industry is vital

in determining a firm’s future profitability, industry standing, and best competitive

strategy. The most prominent and practiced of strategies are cost leadership and

differentiation. The cost leadership strategy attempts to gain a competitive advantage

primarily by reducing its economic costs below its competitors. For example, tight cost

controls, global sourcing, economies of scale and scope, and a simpler product design

that reduces manufacturing costs. The differentiation strategy seeks individuality within

an industry. Firms that compete applying the differentiation strategy use three

guidelines to be successful. First firms must define characteristics of a product or

service that the customers deem important and valuable. Then the firm must meet the

chosen customer need in a matchless way. Finally the firm must attain their

individuality at a cost that is lower than what the customer would want to pay. While

the global connector industry is a highly technological market that puts a huge

emphasis differentiation, it is also extremely important to consumers and investors that

a high quality product is made while also minimizing costs. Thus we will discuss how

both strategies are vital to the success of a firm in the global connector industry(Palepu,

Healy 2-9).

Cost Leadership

The global connector industry manufactures thousands of different types of

products. While most products created and manufactured in this industry are of a

highly differentiated nature, some products are considered commodities and can be

purchased from several different companies. Due to this situation, switching costs for

this industry are fair making the industry reasonably price competitive while still putting

the bulk of the emphasis on differentiation. A few examples of how the global

47 

 

connector industry competes on cost are simpler product design, efficient production,

and economies of scale.

Economies of scale and efficient production

When working in an industry that is as highly competitive as that of global

connectors, it is not only important to set yourself apart from other competing firms by

differentiation, but by also making sure that the firm is able to make a product that is of

an impeccable quality and at the most affordable price. It is common in this industry to

mass produce products that create large volumes of inventory causing costs to

decrease thus driving down prices for consumers(Amphenol, Molex, Tyco 10ks). While

all firms in this industry follow this trend Molex describes the industry process very

thoroughly. “In the global connector industry firms analyze and design the

manufacturing patterns of the customers along with their own supply chain economics

to help ensure that the manufacturing operations are of sufficient scale and are located

strategically to minimize production costs and maximize customer service”(Molex 10K).

Another method that companies in the global connector industry use to expand and

become more efficient is by mergers and acquisitions of existing companies. From

1999 to 2007 Tyco, Molex, Amphenol, and Methode all acquired other companies in the

global connector industry. Companies in the global connector industry participate in

acquisitions in hope that as a company grows production increases thus lowering

production costs and improving production efficiency. In many cases acquisitions lower

costs but another reason why companies in the global connector industry participate in

acquisitions is because they can also diversify customer base thus increasing company

sales. Efficient production is an important factor to consider when analyzing the

connector industry because it ultimately creates more value for the company in terms of

cutting costs, ensuring customer satisfaction, and encouraging brand loyalty.

48 

 

Lower input costs

While economies of scale and efficient production are some of the most common

ways to cut costs for firms in the global connector industry, lowering input costs such as

materials cost and outsourcing are other beneficial ways to control costs in this

competitive industry. For example, outsourcing is extremely common in any type of

technological business because it may be cheaper to design a product in China,

manufacture it in Taiwan, and sale it in the United States then it would be to design,

make, and sale a product in just one country. Another method of lowering input costs

is by having control over suppliers and obtaining the best quality materials at the lowest

cost. However, in the global connector industry a majority of products used such as

plastics, copper, and gold have experienced an over-all price increase in the past year

due to soaring petroleum prices and the increase of certain commodities. An example

of this situation is the automobile industry, an industry in which a majority of companies

in the global connector industry have as a customer base. According to The Wall Street

Journal, the automobile industry is suffering from huge sales declines. Rather than

cutting prices, some companies are being forced to increase them due to certain

increases in commodities(Takahashi 1). This is an excellent example of how firms in

certain industries cannot always control certain factors associated with costs and pricing

that ultimately drive down or damage a firm’s value. While the automobile industry

operates differently from the global connector industry they do correlate. Due to the

fact that the automobile industry is a primary customer of companies in the global

connector industry, a large decline in automobile sales could result in a large decline in

connector industry sales. This is an important factor to consider when investing in

companies in the global connector industry.

Simpler product designs

While the global connector industry is characterized by aggressive advances in

technology and innovative product development, some products are considered

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commodities that require little originality and have a 25-30 year life span, for instance,

wiring and cables. Although a majority of firms in this industry spend more time and

money towards research and development, in the global connector industry it is

possible to create a simple approach to making certain products that are not only cost

effective but of a reputable quality. It is important to consider these factors in this

industry due to the broad variety of products each firm produces(Amphenol, Molex,

Tyco 10Ks).

Differentiation

When pursuing the differentiation strategy, a company must find a way to stand

out from their competitors in such a way that customers will value. Being unique in an

industry is the key for a company to distinguish themselves from others. It is crucial for

a company to determine what products are in demand, listen to their customers needs,

and then produce the best products based on that information. This will ensure that

the company will provide good customer service and maintain a positive image of the

company. In respect to the electronic connectors industry, this holds especially true

due to the heavy competition between companies like Molex Inc., Tyco Electronics,

Amphenol Corporation, and Methode Electronics. If another firm is doing a better job in

differentiating themselves then that company will receive a better competitor advantage

in the industry. An example of this would be if Tyco had a way of delivering products

to customers quicker than the others then they would be differentiating themselves and

gaining a competitor advantage. When a company stands out from their competitors is

when the company gains the differentiation and competitor advantage.

Product quality

Companies must produce high quality products in order to keep a competitive

edge. If a company’s product quality is not up to the standard of its competitors in the

market, then the company will surely fail. Most customers will be well informed about

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the quality of all the products on the market and compare different companies to make

the best decision. For example, if Methode has many glitches in their connectors and

has a history of having problems, but Amphenol has never had any issues with their

products, any well informed customer would clearly choose Amphenol. In the electronic

connectors industry their many companies for customers to choose from; therefore, if

one of the companies were to start slacking off and having problems with products, like

a poor connection with the wires, then the other companies would start receive some of

their business and vice-versa. Maintaining the quality of all the products is imperative

to the success of a company; a firm never wants a customer to feel that they were let

down by their products. Word of mouth publicity can have a serious effect on a

company’s success.

Product variety

While preserving the quality of a product, it is also essential that a firm offers

more than one product for a customer to choose from, especially when it comes to

returning customers. Customers often develop brand loyalty quite easily, which can

ensure the success of a company for many years. In the electronic connectors industry

firms usually compete in more than one segment of the industry. For example,

according to Amphenol’s 10-k, Amphenol competes in three different markets which

are: information technology and communications, industrial and automotive, and

commercial aerospace and military. The main markets that Tyco competes in are

electronic components, network solutions, wireless systems (Tyco 10-k). Methode

mainly competes in the markets such as automotive, interconnect, and power products

(Methode 10-k). The company Molex participates in the telecommunications, data

products, automotive, consumer, and industrial markets (Molex 10-k). By a company

having more than just more product line it enable the company to offer more products

to their customers so that they have a variety of choices.

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Brand Image

The way a consumer feels about a certain brand is referred to as brand imaging.

Brand imaging can be based on the quality of the company’s products, the customer

service that is offered, or personal experiences consumers have had with the company.

In the electronic connectors industry, it is very important for a firm to have a good

brand image, due to the many competitors within this niche business. Since there are

so many companies all selling the same products, it is important for a company to

separate itself from the others by creating a strong brand image.

The concept of brand imaging goes hand-in-hand with product quality and

loyalty in that if a company like dell has been buying their goods from Molex for quite

some-time and feel secure with the company, then they have no reason to even look at

what Tyco, Amphenol, or Methode have to offer (Molex 10-k). Companies without a

strong brand image can lose sales because of their unfamiliarity to the customer and in

its particular industry. An example of a company that gains sales from positive brand

images is Intel, a computer company that buys their parts from electronic connector

companies. Intel has a new computer chip to enter the market that is receiving strong

reviews from computer makers (Clark). When a company such as Intel gets praised for

their new products so do the companies that supply the business that is having success.

Computer companies get their supplies from electronic connector industry companies,

therefore, when Intel looks good so does the company that supplies them. When dell

produces a new product Molex is the company that is also getting the thumbs up from

other companies. When a company has a recognizable brand image, then customers

will feel safer is purchasing their products. Since the connector industry services to

other businesses and does not spend much money on advertising and marketing the

companies to not release information regarding the amount of money that is spent on

marketing. Due to this being the case, there is not a way to show marketing to sales

ratio for the companies.

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Flexible delivery

Flexible delivery refers to having more than one option in getting the goods to

the customer. If a firm only has one location that it ships all of its products from, then

they may lose the business from distant customers. The faster and easier it is for a

customer to receive their product, the more appealing the company will look. Due to

outsourcing helping cut costs, many industries have started to build more locations all

around the world, which helps in the delivery process. The companies Molex, Tyco,

Amphenol, and Methode all have locations around the world in places such as North

America, South America, Europe, Africa, Asia, Middle East, and New Zealand (Molex 10-

k, Tyco 10-k, Amphenol 10-k, Methode 10-k). By having so many locations it allows the

company to have less time in delivery for customers.

Customer service

Customer service is the willingness of a company to offer their services to assist

current and prospective customers. The better the customer service offered, the

happier the customer will be, which will most likely result in repeat customers. A prime

example of quality customer service is the service that comes from small businesses

because of the need for them to differentiate themselves. As stated by Kelly Spors,

“…a vivid reminder that small businesses need to figure out how to stand out in world

where they are competing against so many larger, wealthier rivals. And the answer is

often customer service.” In industries like electronic connectors competitors look every

similar and by acting like a small business in offering impeccable customer service by

taking time with customers, they can stand out from their other opponents. Most

customers expect a company to provide things like manufacturer’s warranty’s,

customers support, and other accommodations to help the customer with their

purchase. “In addition, most customers have a single Molex customer service contact

and a specific field salesperson to provide technical product and application expertise”

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(Molex 10-k). Molex is exceeding customer’s expectations in order to provide their

clients in a way that they can be proud of.

Customer service, in some consumers’ eyes, is just as important as the products

themselves when they evaluate a company. Electronic companies highly value their

customers which is why they insist on establishing such strong working relationships

with their customers, according to Tyco’s 10-k. A company needs to feel obligated to

take the time to create very sturdy bases with their customers.

Research and Development

Research and Development means that a company is taking the time and money

to produce new products. The real key to research and development is to come up

with an innovative product that is going to help your company. When a company

develops a brand new product not only do the reputation of the company improve, but

the company gains the competitive advantage of being able to patent their product.

Research and development can make or break a company; therefore, it should be well

funded and well planned in every company.

In the electronic connecters industry research and development is one of the

most important segments of a company. If the company does not give sufficient

funding to that part of the business, then they will not have a chance in keeping up

with the herd. The company’s in the industry spend very different amounts of this

segment of the business. Companies such as Tyco will spend the enormous amount of

fifteen percent of net of their net revenue on their research and development

department (Tyco 10-k). On the other hand, there are companies like Molex that will

spend a fair five percent of net revenue on that branch of the company. The following

chart shows the actual percentages that the companies have spent on research and

development. Due to the lack of years that Tyco releases to the public we did not

include them because it would not have added value to analysis.

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Annual Percentage of Sales Invested In Research and Development

2002 2003 2004 2005 2006 2007

Amphenol 2.3% 2.1% 2.1% 2.0% 2.2% 2.2%

Methode 6.4% 5.3% 5.4% 5.3% 5.0% 4.8%

Molex Inc. 5.1% 5.0% 5.3% 5.2% 5.0% 4.9%

Industry

Average

4.6% 5.4% 4.2% 4.1% 4.0% 4.0%

In the chart you can see that Ampenol spends the least amount, Molex is in the middle,

and Methode spends the biggest percentage of net sales on research and development.

Conclusion

Within the electronic connectors industry, both cost leadership and differentiation

are key to the success of the business. Although cost control is imperative, the industry

has very little control over certain factors such as prices of commodities. For instance,

the plastics, gold, and copper used in making global electrical connectors. What the

company does have control over are direct labor, overhead costs, as well as selling and

distribution expenses. Thus, we have concluded that differentiation is the best

competitive strategy. Within the technological market, it is important for firms to set

themselves apart based on the aspects of research and development, customer service,

and brand imaging to ensure long lived success.

Firm Competitive Advantage Analysis

While cost control and differentiation both contribute to the success of firms in

the global connector industry, it is more common for firms in this industry to compete

using the differentiation strategy. Molex strives to be the best in the global connector

industry by basing their main advantages on several core competencies. For instance,

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product quality, brand image, product variety, customer service, flexible delivery, and

research and development. We will discuss how Molex maintains and upholds these

key success factors in all aspects of their business.

Product Quality and Brand Image

As the world’s second largest manufacturer of electronic connectors, as stated in

Molex’s 10-K, Molex strives to have the best products on the market. It is true that

Molex produces in six different markets, but they are confident their expertise in all six

markets is sufficient enough to compete in each. According to Molex’s 10K, “We focus

on markets where we have the expertise, qualifications, and leadership position to

sustain a competitive advantage.” Not only having the capabilities to produce, but also

the understanding of the products is a highly valued component of the firm. Molex

would never put a product on the line unless they felt that it would meet their

customer’s and the industry’s standards. Molex strongly believes that the quality of the

product is associated with the brand image of the company. They have maintained

their positive brand image by patenting and trade marking their products to insure

brand recognition among customers in their markets. The purpose of their patents and

trademarks is to ensure that their quality products will only be associated with their

company and not confused with any of their competitors.

Product Variety

While keeping a focus on electronic connectors, Molex still has more than

100,000 products available for consumers. All of these different products are grouped

in the markets of telecommunications, data products, automotive products, consumer

products, and industrial electronics. For almost 70 years, Molex has been a well known

supplier of interconnect solutions (Molex 10k). The company supplies in 5 different

markets in order to fulfill all the needs of their consumers in the industry. By having

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such a broad variety of electronics to choose from, there is no need for a consumer to

shop anywhere else.

Customer Service

Customer service can make or break a sale, especially in the highly competitive

industry of electronic connectors. Molex is a company that takes the time to prioritize

their customers’ needs and take care of them as fast as possible. Molex will even go so

far as to have engineers sit down with a customer to provide one-on-one assistance in

order to create a product for the customer’s specific design needs (Molex 10k). The

company wants to ensure that every customer has a great experience working with the

corporation. According to Molex’s 10-k, “most customers have a single Molex customer

service contract field salesperson to provide technical product and application

expertise.” This firm definitely has a very impressive customer service division within

the company and they take pride in it. To go to the extent of customer service that

Molex does really raises the bar for customer service in the industry; giving customers

individual attention rewards Molex with an excellent reputation with its customers.

Flexible delivery

In the electronic connectors industry, customers must have their products

functional at all times. This puts quite a bit of pressure on companies in the industry to

provide fast shipping to get the products customers need quickly. According to Molex’s

10k, the company “owns 45 manufacturing locations, 16 of which are located in North

America and 29 of which are located in other countries.” Due to Molex having so many

locations all over the world, it is easy for the company to ship out an order to any part

of the world. This gives the firm the ability to be flexible in the delivery process and

meet more customers’ needs.

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Research and Development

Research and development is highly stressed in the electronic industry due to the

world constantly changing and finding more efficient ways of doing everyday tasks. It

is imperative that a company in this industry aggressively pursues the development of

new, creative, and innovative products; otherwise, it will most-likely fail. Molex, in the

fiscal year of 2008, generated about 23% of their revenue from new products alone

(Molex 10k). It is crucial to the firm’s success to create innovative products to keep

customers happy. The fact that a significant portion of the company’s revenue comes

from their innovative products proves that they have been successful in satisfying their

customers in this way. According to Molex’s 10k, the company spends approximately

five percent of net revenue in research and development. The following table shows

the percentage of net sales that was devoted towards research and development:

Annual Percentage of Sales Invested In Research and Development

2002 2003 2004 2005 2006 2007

Amphenol 2.3% 2.1% 2.1% 2.0% 2.2% 2.2%

Methode 6.4% 5.3% 5.4% 5.3% 5.0% 4.8%

Molex Inc. 5.1% 5.0% 5.3% 5.2% 5.0% 4.9%

Industry

Average

4.6% 5.4% 4.2% 4.1% 4.0% 4.0%

Due to the limited years that Tyco releases their information to the public we did

not feel that they would add much value to the chart. You can see in the chart that

when compared to their competitors, Molex spends a fair percentage of their sales on

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research and development. Research and development enables the company to be

more creative in their product designs.

Conclusion

While all firms in the global connector industry compete using different cost

leadership strategies, in order to stand out from competitors firms must differentiate.

Molex prides itself on being a leader in innovative products while also providing

impeccable quality, customer service, and variety. Molex is a leader in research and

design in the global connector industry, thus creating new and up to date products to

ensure brand imaging and customer loyalty.

Formal Accounting Analysis

The accounting analysis is a series of six crucial steps to help acutely evaluate

and determine the reliability of a firm’s financial statements. Publicly traded companies

release their financial statement to potential investors or current shareholders in an

effort to attract or retain their monetary investment. When analysts use the following

steps, they can determine if the accounting methods used by the firm cause the firm to

be overvalued, undervalued, or stated correctly. The first step is to Identify Principal

accounting polices used by the firm and the industry. The key success factors of the

firm play a large role in determining which accounting policies are used. Step two is

evaluating how much accounting flexibility is present or possible in the firms accounting

methods and estimates. The third step is evaluating the accounting strategies used.

Managers may choose one strategy over another to hide unfavorable performance. The

next step is to evaluate the quality of disclosure. This boils down to how much

information the firm allows the public to see. If very little information is disclosed are

they hiding something? The fifth step is indentifying potential ‘red flags’ or

questionable accounting methods. Unexpected or unexplained write-offs could raise a

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‘red flag’ for further investigation. The final step is undoing accounting distortions,

which if left unadjusted would be misleading to the analyst. Restating information to

adjust the distortions will allow the analyst to form a more accurate and true opinion of

the firm. Steps 1-6 derived from (Palepu & Healy)

Key Accounting Policies (KAP)

Molex has created a competitive advantage using key success factors such as

product differentiation, product variety, cost leadership, economies of scale, and global

distribution. These key success factors create opportunities for distortion and are

directly linked to key accounting policies that the firm will use. The firm chooses key

accounting policies that will produce the most favorable financial image to its

shareholders. Sometimes a firm will use accounting policies to distort or hide financial

problems. These accounting distortions may exist in areas such as; research and

development, goodwill, defined-benefit pension plans, capital leases and operating

leases, and currency risk. Not all distortions are deliberately created; some are caused

by estimation errors that occur when managers try to forecast future events such as

discount rates. Generally Accepted Accounting Principles (GAAP) allows managers to

choose the accounting policies that best fit their firm due to the managers “superior

knowledge of the business to determine how best to report the economies of key

business events” (Palepu & Healy). The following topics, as mentioned above, are

areas that managers use flexible accounting policies to distort their financial

statements.

Research and Development (R&D)

Research and Development is a key component for future growth in the

technology industry. Molex must invest large amounts of time and money into R&D,

trying to develop new products or manufacturing methods to gain a competitive

advantage over their competition. Many expensive projects in the R&D department are

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scraped and left for dead. On the other hand some projects may be revolutionary and

create billions of dollars in revenue over the products lifespan. The electronic connector

industry must invest heavily in R&D to keep up with the fast evolving pace of

technology. Many connectors have short life spans before they are made obsolete by

new and improved products. In success or failure all R&D cost are treated as expenses

due to GAAP rules. Molex would benefit greatly if R&D cost were capitalized as an

asset instead of a costly expense. Molex must expense large amounts of R&D, causing

expenses to be overstated and the net income to be understated which will also cause

assets and equity to be understated. The following chart shows how much Molex and

its competitors spend on R&D.

Research and Development Cost

*in millions 2003 2004 2005 2006 2007

Molex 117 119 134 141 159

Amphenol 26.4 32.5 40.1 53.7 62.4

Tyco N/A N/A 424 467 520

Methode 19.1 19.4 20.6 21.1 21.3

Ever year Tyco spends more on R&D than all the other three listed companies

combined. Tyco is the largest producer of electronic connectors in the world and

manufactures more than 500,000 products. Tyco’s net sales in 2007 were $13.46

billion; the driving force behind the net sales was innovative products from R&D (Tyco

10K).

Molex’s large R&D budget will have a large effect on the financial statements due

to high R&D cost. Tyco’s even larger R&D budget could cause the firm’s assets to be

severely understated and expenses to be extremely overstated.

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Goodwill

Goodwill is created when the purchase price of an acquisition exceeds the

estimated fair market value of the newly attained firm. The difference between the

purchased price and fair market value becomes an intangible asset called goodwill. A

yearly test is done to see if the fair market value is less than the carrying value, and if

this occurs it is called an impairment. As impairments occur the old carrying value is

written down to the new market value. Goodwill is challenging to measure and creates

opportunities for distortion. The companies 10K should explain in great detail where

the firm acquires its goodwill, how much current goodwill the firm has, and how they

perform their impairment test. Managers who must meet certain goals to earn bonuses

or keep their job may overstate the financial statements by not writing down the

goodwill impairment. As shown below managers can create situations where the true

value of the firm is hard to distinguish.

Effect on Financial Statements by Not Reporting Impairments

Assets = Liabilities + Equity Revenues - Expenses = Net Income

Overstated No effect Overstated No effect Understated Overstated

Goodwill

*in

thousands

2004 2005 2006 2007

Molex 164,915 143,872 149,458 334,791

Amphenol 545,411 886,720 926,242 1,091,828

Tyco 7,461,000 7,423,000 7,135,000 7,177,000

Methode 7,202 7,202 28,893 51,520

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Goodwill as a Percent of Long Term Assets

2007

*before

impairment

Goodwill Percentage*

Molex 20.65%

Amphenol 73.5%

Tyco 57.80%

Methode 26.55%

Analysts would be concerned with the amount of goodwill held by Amphenol in

2007. Amphenol had over a billion dollars of goodwill which represented 73.5% of their

total long term assets (Amphenol 10K). The larger the amount of goodwill within a firm

tends to increases the risk of errors or manipulation by managers.

Goodwill should decrease over time, but due to the trend of convergence of

markets, acquisitions of small firms by large firms are increasing (Molex 10K). The

increase in acquisitions can be explained by firms trying to achieve economies of scale.

Molex currently holds 20.65% of total long term assets in the form of goodwill. Due to

the small percentage of goodwill held by Molex this area might be of little concern to an

analyst.

Pension Liabilities

A defined-benefit and pension plan is a projected benefit package provided by a

firm to provide a steam of cash flows to a retired employee. The post retirement value

provided by the firm is hard to predict due to changing discount rates, healthcare cost,

inflation rates, and longevity of life. The cost of the benefit and pension plans are

recorded as liabilities at the present value of the future expenditures. Mangers must

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use good judgment when estimating the discount rate and expected return on assets. If

a manager were to use a discount rate that is too low the liabilities will be overstated

and if too high the liabilities will be understated. If managers wanted to cut cost by

manipulation they could adjust discount rates by fractions of a percent saving millions

of dollars. If managers were to continue this behavior, the pension plans would not

have adequate funds to meet their obligations. Companies should provide full

disclosure on information pertaining to estimation methods, cost of pension liabilities,

and forecasted rates of return on investments.

U.S. Pension Plan Discount Rates

2004 2005 2006 2007

Molex 6.30% 5.80% 5.50% 6.20%

Amphenol 5.75% 5.50% 5.75% 6.25%

Tyco 6.00% 6.00% 5.25% 6.00%

Methode Not comparable b/c of use of 401K plans

Molex’s discount rate for the last three years has been between its two

competitor’s rates and does not seem to be much of a concern. If Molex were too set

its rate much higher than its competitors this could be an attempt to understate

liabilities. For the most part Molex does not provide pension plans for its foreign work

force except for selective executives and management. Methode does not use defined

benefit retirement plans, instead they use 401k plans which are not comparable

(Methode 10k).

Capital Leases and Operating Leases

Capital leases are treated as an asset by the lessee and can increases the

liabilities of a firm. Capital leases are amortized over the life of the lease. Operating

leases are treated as rent and is not recorded on the balance sheet. When Operating

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leases are used there is no depreciation or interest cost. These two methods when used

in different combinations can cause radical differences in the value of a firm. For

instance, if a company uses a lot of operating leases this reduces your liabilities, over

states your net income and the equity balances. Obviously this accounting method can

make a company look more valuable than they really are which is why it is extremely

important for investors to examine how much information companies disclose on

operating leases.

When examining the global connector industry, it is quite common for companies

to use both operating and capital leases. A lot of companies in this industry do

business in foreign countries therefore, making capital and operating leases a must.

Molex however, has had the best practice of maintaining their operating leases below

15% of their long term liabilities. Tyco, Amphenol, and Methode have all had their

operating leases total well above 15% of their long term liabilities thus creating a

potential ‘red flag’ for investors.

Currency Risk

When any company deals with currencies from multiple countries they run the

risk of losing value due to fluctuations in currencies rates. Every dominate company in

the electronic connector industry has multination operations, meaning they all must

deal with currency risk. Molex derives 72% of revenue from foreign markets. GAAP

requires financial statements to be composed of a uniform currency to give all financial

information comparable values. If Molex did not convert all foreign currency’s you

could not compare financials statement to Tyco or any other competitor without

performing very time consuming exchange rate conversions. The most common

currencies to be exchanged with our Dollar are; Euro, Japanese Yen, British Pound,

Chinese Renminbi, and Korean Won.

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Due to volatile currency fluctuations and the vast amount of foreign operations in

the connector industry disclosure of currency risk management is essential. There are a

number of tools to help reduce the effect of volatile currencies, such as forwards

contracts and natural hedging. Molex uses natural hedging which means products are

Accounting Flexibility

The policies and approximations that a firm uses to produce the numbers on the

financial statements are known as accounting flexibility. These policies and

approximations include any methods and ways that the company measures to present

the companies disclosures. The flexibility of the company depends on how strict they

are with their policies and the standards that they hold. GAAP, General Accepted

Accounting Principles, has set certain standards that all companies are to meet, yet

there is room for flexibility. GAAP can only place so much control over a company’s

financial choices for their statements, so there are still grey areas where a firm has to

make official conclusions. For example, when evaluating the goodwill of a company

there is no true way to distinguish a set amount because it is an intangible asset.

Accounting flexibility can lead to a company having distorted numbers on their financial

statements due to not all firms having the same ethics and policies. It is highly relevant

for an analysis to know the flexibility that a business holds in order to have a better

understanding of the value a company holds.

Research and Development

Research and development is a vital role played within a company that operates

in the electronic connectors industry. In order to meet customer needs a company has

to have an amble amount of money flowing into the research and development portion

of the company. GAAP ruling states research and development should be expensed

regardless of the impact that it has in the company’s products. According to the

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companies 10-k’s, Molex and all of their competitors report research and development

expenses at the time that it occurs. The reason for doing such a thing is that it is

compliance with the regulations that GAAP holds. Research and development

contributes to tremendous amount to sales revenue because the better a company is at

utilizing such a resource the better the resulting products will be.

The electronic connector’s industry spends a significant amount of net sales on

research and development due to the importance that this sector of the business. The

size of a company depends on how much money they will be able to send to this

division of the business. Some companies such as Tyco will spend up to fifteen percent

of their net revenue on their research and development department (Tyco 10-k). Then

there are companies like Molex that will spend a fair five percent of net revenue on that

branch of the company (Molex 10-k). The bigger the company the more funding they

will be able to have for research and development. It is difficult to determine exactly

what is included in the research and development expense. According to Molex’s 10-k,

the costs incurred from innovation are included in selling, general, and administrative

expenses, which makes it difficult to break down into segments. The only other

company that gave any information regarding what composes this expense is Tyco.

According to Tyco’s 10-k, items included in the research and development expense are:

salaries, direct costs incurred, building, and overhead. It is difficult to find a company

that is open about the costs that they have within research and development. With this

information, it can be concluded that the electronic connector’s industry has low

disclosure with research and development expenses.

Within the electronic connector’s industry there is a limited flexibility in recording

research and development. The accounting department does not provide sufficient

information regarding the expenses due to them not having the flexibility within that

segment of the business, even though it is such a large expense of the company. With

this knowledge one would need to keep in mind this expense, despite the lack of

flexibility.

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Operating and Capital Leases

Majority companies do not own one-hundred percent of their assets; therefore,

they need to have leases on items that they do not own. Companies are given the

option to use operating or capital leases for their assets. An operating lease is treated

like a rent expense, where it never actually hits the books even though cash does flow

out. With an operating lease you can use the asset, but you do not have ownership of

the asset. A capital lease is very different from an operating lease. A capital lease is a

lot like a mortgage in the since that it is recorded in the books as long-term assets and

long-term liabilities. With this type of lease a company has to have extra cash for

interest expense and depreciate on the asset, but the company is considered to have

ownership on the asset.

Molex owns and leases their assets in all of their locations around the world.

As stated in Molex’s 10-k, “We own 88% of our manufacturing, design, warehouse and

office space and lease the remaining 12%.” The remaining twelve percent of the

company’s assets are leased using a capital lease, even though it comes with risks such

as taxes, interest, and payments. Some of Molex’s competitors use both operating and

capital leases, while others like Methode use only operating leases for their assets

(Methode 10-k). When a company uses operating leases it gives the company the

option to understate liabilities and overstate their net income. By using an operating

lease a company does not have to disclose their total liabilities on the balance sheet

which could potential lead to more distortion. A company choices the lease that they

feel is going to suit them the best whether it is a capital or an operating lease, it just

depends on how the firm want to have the lease in their records.

With firms having the option to choose between operating, capital, or even use

both types of leases it gives the accountants many options with typing by the financial

statements. By giving a firm such alternatives it makes it really easy to have distortion

of numbers slip onto the balance sheet. Another part to leases is that a company could

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switch the type of lease that they are using in order to rearrange numbers even more.

If a company starts with an operating lease and decides that they want to switch to a

capital lease they have every right to do that, as long as it fits with the contract of the

asset. With operating and capital leases there is plenty of room for accounting

flexibility.

Pension Plans

A pension plan is an agreement between an employer and an employee to make

regular benefit payments following the employee’s retirement. The amount of the

payments is based on the number of years served by the employee as well as the

compensation that was received during the employee’s last year of service. The way a

company decides the amount of pension that is going to be rewarded is based on a

discount rate that is up to the company to settle on. A discount rate is essentially an

estimation that is used to discount future payments to the present value. With pension

plans the firm has to make an educated guess at how long an employee is going to

work for the company as well as how long the person is going to live after retiring.

Molex, as every company does, has their own way of creating a discount rate to

be used for pension plans. As stated in Molex’s 10-k, “The discount rate is determined

based on high-quality fixed income investments that match the duration of expected

benefit payments…is based on a yield curve constructed from a portfolio of high quality

corporate debt securities with various maturities.” Although it is for the company to

determine what a good fixed income investment would be, Molex seems to try and be

reasonable and fair with the amount of pension rewarded to the employees.

The following data, from Molex’s 10-k, shows the discount rate used in the years

2008 and 2007 in both the United States as well as the non-United States locations:

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U.S. Pension Non-U.S. Pension PostretirementBenefits Benefits Medical Benefits

2008 2007 2008 2007 2008 2007Discount 6.2% 6.3% 3.8% 3.9% 6.2% 6.3%Expected

return on 8.2% 8.4% 6.5% 6.5% — —

Rate of

compensati 3.7% 3.7% 3.5% 3.4% — —

Health care

cost trend — — — — 10.0% 10.0%

Ultimate

health care — — — — 5.0% 5.0%

In reference to Molex’s competitors, the company seems to have a pretty

average number for their discount rate. Discount rates within the electronic connectors

industry seem to be increasing which means that the industry is doing well.

With pension plans there comes a lot of accounting flexibility. With firms being

able to determine their own discount rate and deciding what is fair, there is a lot of

room for distortion of numbers. Although Molex uses a yield curve to determine the

discount rate, it is still management’s opinion as to what the fair net income investment

is. With there being so many choices within the pension plan, there is a lot of

accounting flexibility and should be something to be viewed by a financial analyst.

Goodwill

Goodwill is an account that is recorded when the purchase price of the asset

being exchanged surpasses the fair market value. Goodwill is an intangible asset that

can be difficult to determine; therefore, the amount is left to be determined by the

company. The structure of goodwill, which was determined by GAAP, is to not be

amortized. The purpose of this was to encourage companies to more honest when

recording the value of goodwill. Any company that has goodwill on their financial

statements carries the option of flexibility.

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Molex has quite a bit of goodwill accounted for on their financial statements.

The reason behind this is that on August 9, 2006 the acquisition of Woodhead

Industries, Inc. was completed (Molex 10-k). This gain was a tremendous step in

helping Molex to expand their products and the potential of the company as a whole.

Every year an annual goodwill impairment analysis is conducted; it is also possible for it

to occur more often if the company feels that it is needed. There has not been any

reporting of goodwill impairment since the fiscal year of 2005 in which Molex had a

charge of $22.9 million (Molex 10-k). This could bring up the concern that the

company could be over estimating the value of their newly acquired company. Molex

does give a decent description of the way that goodwill is measured, yet it all lenks

back to management’s opinion. When it comes down to it, if there is no real way to

determine the value of goodwill there will always be a lot of flexibility. Until the day

comes that goodwill can be properly measured and there is no opinions involved, there

will always be a large amount of flexibility and a possibility of manipulation of goodwill

in the financial statements.

Currency

For the foreign exchange rate there is very little room for accounting flexibility.

When the currency is exchanged there is always a set rate at which the money is

valued and that is really the only rate that a company can use. A foreign exchange rate

is public information; therefore, anyone could jump on their computer and verify that a

company is using a fair rate. Molex does a lot of business overseas and so they have to

deal with the currency rate fairly often. If the company were to try and distort the rate

at which the money is being traded it would be rather obvious when the auditor is

going through all of the financial statements. With the currency market there are ways

of confirming that a company is using a proper rate. With that being said, there is very

low flexibility involved with currency exchange.

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Evaluating Accounting Principles

The evaluation of accounting strategies has become increasingly important in

recent years due to the realization of misrepresentation of accounting numbers by

many companies. The Securities and Exchange Commission has enacted many new

regulations to limit the possibility of manipulation of financial statements. However,

there are a number of “loop holes” allowed within the regulations under generally

accepted accounting principles that management can employ to otherwise manage their

books. It is important when evaluating a company to assess the quality of disclosure

within their financial statements and annual reports. A company with high disclosure

presents thorough information regarding accounting numbers, policies, and personal

strategies implemented. High disclosure is characterized by a company’s ability to

present relevant and helpful information in addition to the required SEC and GAAP

disclosures. A company implementing low disclosure in relation to its financial

statements presents the minimum information required by SEC and GAAP. Low

disclosure is characterized by the hesitance of a company to provide thorough

information to the public, which makes them appear untrustworthy. Another important

characteristic of accounting strategy that is helpful to evaluate is the company’s use of

conservative versus aggressive accounting policies. After determining both the

company’s level of disclosure, and its particular accounting policies a person should be

able to successfully evaluate the company’s accounting strategy.

Research and Development

Research and development is a vital role played within a company that operates

in the electronic connectors industry. In order to meet customer needs a company has

to have an amble amount of money flowing into the research and development portion

of the company. GAAP ruling states research and development should be expensed

regardless of the impact that it has in the company’s products. According to the

companies 10-k’s, Molex and all of their competitors report research and development

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expenses at the time that it occurs. The reason for doing such a thing is that it is in

compliance with the regulations that GAAP holds. Research and development

contributes to tremendous amount to future sales revenue because the better a

company is at utilizing such a resource the better the resulting products will be.

The electronic connector’s industry spends a significant amount of net sales on

research and development due to the importance that this sector of the business. The

following table shows research and development as a percentage of net sales for each

of the companies:

Annual Percentage of Sales Invested In Research and Development

2002 2003 2004 2005 2006 2007

Amphenol 2.3% 2.1% 2.1% 2.0% 2.2% 2.2%

Methode 6.4% 5.3% 5.4% 5.3% 5.0% 4.8%

Molex Inc. 5.1% 5.0% 5.3% 5.2% 5.0% 4.9%

Industry

Average

4.6% 5.4% 4.2% 4.1% 4.0% 4.0%

Due to the lack of information that Tyco releases to the public we did not feel

that including them in the analysis would be beneficial. The size of a company depends

on how much money they will be able to send to this division of the business. The

chart shows that Methode seems to be the leader in the highest percentage for the

most part and then Molex takes the lead at the end. The bigger the company the more

funding they will be able to have for research and development. It is difficult to

determine exactly what is included in the research and development expense.

According to Molex’s 10-k, the costs incurred from innovation are included in selling,

general, and administrative expenses, which makes it difficult to break down into

segments. The only other company that gave any information regarding what

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composes this expense is Tyco. According to Tyco’s 10-k, items included in the

research and development expense are: salaries, direct costs incurred, building, and

overhead. It is difficult to find a company that is open about the costs that they have

within research and development. With this information, it can be concluded that the

electronic connector’s industry has low disclosure with research and development

expenses.

Within the electronic connector’s industry there is a limited flexibility in recording

research and development. The accounting department does not provide sufficient

information regarding the expenses due to them not having the flexibility within that

segment of the business, even though it is such a large expense of the company. With

this knowledge one would need to keep in mind this expense, despite the lack of

flexibility.

Operating and Capital Leases

Majority companies do not operate by owning one-hundred percent of their

assets; therefore, they need leases on the assets that they do not own. Companies are

given the option to use operating or capital leases for their assets. An operating lease

is treated like a rent expense, where it never actually hits the books even though cash

does flow out. With an operating lease you can use the asset, but you do not have

ownership of the asset. A capital lease is very different from an operating lease. A

capital lease is a lot like a mortgage in the since that it is recorded in the books as long-

term assets and long-term liabilities. With this type of lease a company has to have

extra cash for interest expense and depreciate on the asset, but the company is

considered to have ownership on the asset.

Molex owns and leases their assets in all of their locations around the world.

As stated in Molex’s 10-k, “We own 88% of our manufacturing, design, warehouse and

office space and lease the remaining 12%.” The remaining twelve percent of the

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company’s assets are leased using a capital lease, even though it comes with risks such

as taxes, interest, and payments. Some of Molex’s competitors use both operating and

capital leases, while others like Methode use only operating leases for their assets

(Methode 10-k). When a company uses operating leases it gives the company the

option to understate liabilities and overstate their net income. By using an operating

lease a company does not have to disclose their total liabilities on the balance sheet

which could potential lead to more distortion. A company choices the lease that they

feel is going to suit them the best whether it is a capital or an operating lease, it just

depends on how the firm want to have the lease in their records.

With firms having the option to choose between operating, capital, or even use

both types of leases it gives the accountants many options with typing by the financial

statements. By giving a firm such alternatives it makes it really easy to have distortion

of numbers slip onto the balance sheet. Another part to leases is that a company could

switch the type of lease that they are using in order to rearrange numbers even more.

If a company starts with an operating lease and decides that they want to switch to a

capital lease they have every right to do that, as long as it fits with the contract of the

asset. With operating and capital leases there is plenty of room for accounting

flexibility.

Pension Plans

Defined benefit plans and defined contribution plans are two of the retirement

plans a firm can choose to implement. Defined benefit plans are like pensions, ensuring

a fixed monthly payment with respect to increasing costs of living. If a company

chooses to employ the use of defined benefit plans they are guaranteeing retirement

income security for all employees involved in the plan. Defined benefit plans also

provide minimal to no investment risk, while allowing adjustments to changes in cost of

living throughout the years. A defined contribution plan allows the individual employee

to assist in the savings of his retirement. Amounts contributed to the plan are based on

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income, expenses, gains and losses. One disadvantage of a defined contribution plan is

that there is no promised set of monthly payments during retirement, the payment

received is a result of the investment of both the employer and employee. An example

of a defined contribution plan is a 401 (k) and that is the type of plan Molex’s

competitor Methode employs. While comparing retirement benefits throughout the

industry we concluded that Methode had very low disclosure compared to its

competitors, revealing limited if not minimal information concerning its pension plans.

On the other hand, company’s like Molex, Amphenol and Tyco Electronics disclosed a

vast amount of information concerning their specific pension, post-retirement, and

defined contribution plans. The companies also disclosed estimates used in determining

the expenses associated with each plan. Molex and Amphenol choose to implement

both a defined contribution plan, as well as a defined benefit plan. Both of these

companies determine the discount rate based on high quality fixed income investments

that match the duration of the benefit payments expected. These firms also employ a

weighted average actuarial assumption to determine benefit obligation for the plans.

Molex also discloses, in addition to its information regarding its fixed contribution plans

and benefit plans, a description of its post retirement medical benefit plan that is

available to most U.S. employees.

Components of Net Periodic Benefit Cost for U.S. Pension Benefit as stated for Molex Inc.

(in thousands)

2006 2007 2008

Service Cost $ 3,239 2,287 3,380

Interest Cost $ 2,291 2,962 3,683

Expected Return on Plan Assets (3,070) (3,939) (4,625)

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Recognized actuarial losses 716 ______ _____

Curtailment (gain)/loss 4 (12) (2,356)

Net periodic benefit cost $3,290 $1,702 $59

All three companies present estimates concerning the changes in basis points,

and the effects on the discount rate used to calculate future obligations. The discount

rates estimated for the both Molex and Amphenol’s U.S. pension plans for 2006 & 2007

was 6.3%, and Tyco Electronics was 5.25%. Both Molex and Amphenol employ the help

of third party specialists to assist in the estimation of the expense associated with

pension and post retirement plans. After evaluating the retirement plans presented by

firms within the industry we conclude that there is a mixed level of disclosure. This is

due to the fact that Methode discloses minimal information concerning pension plans

resulting in low disclosure, while the remaining companies choose to disclose more

information than required by U.S. GAAP resulting in high disclosure.

Goodwill

“Goodwill is recorded when the purchase price paid for an acquisition exceeds

the estimated fair value of the net identified tangible and intangible assets acquired”

(Molex 10-K). In other words goodwill is the “premium” paid for acquiring a business,

which is attributed to certain assets such as intangibles like patents, and copyrights.

The presentation of goodwill within the financial statements has changed in recent

years. Originally companies amortized goodwill annually over a maximum of 40 years.

After December 31, 2001 companies were required by FASB to impair goodwill rather

than amortize it, leading to an increase in assets across the board. When observing the

accounting policies concerning goodwill we found that the companies operating within

the global connector industry adopted a similar yearly impairment evaluation. The

companies undergo a two step approach which requires the company to determine the

fair value of the asset and compare that value to the assets carrying value plus

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goodwill. If the asset’s carrying value exceeds the fair value estimated then the asset is

impaired. After the realization of impairment, a company must take the necessary steps

and tests in estimating the impairment loss. Molex, and its competitors disclose

definitions for goodwill, as well as the step-by-step process involved in calculating the

impaired goodwill of an acquired company or asset. All companies reveal amounts

attributed to goodwill, and account for increases with information involving current and

previous acquisitions. Under Financial Accounting Standard Board regulations all

companies are required to perform annual goodwill impairment evaluations. Molex’s

competitors, Amphenol and Methode both disclosed a considerable amount of

information concerning their firm’s goodwill, but Molex chose to disclose segmented

information concerning recent acquisitions that summarized estimated fair values of

assets acquired and liabilities assumed for Woodhead Industries, Inc. This amount of

disclosure helps readers of the financial statements to account for the purchasing price

of the acquired firm and the amount of goodwill so that it is not perceived as a made

up number. Molex and its competitors Amphenol and Methode appear to employ an

aggressive accounting approach to the recording of goodwill, seeing as none of the

companies has reported impairment to goodwill in recent years. This can be attributed

to the stable value associated with the acquired assets of acquired firms, or as neglect

on the part of the firms to realize a loss on goodwill. Molex’s competitor, Tyco

Electronics, was the only firm to disclose amounts of impaired goodwill in the recording

of its financials. In conclusion, we believe that Molex and the industry in which it

operates has a high level of disclosure in reference to goodwill. We have also come to

the conclusion that Molex, Amphenol and Methode employ aggressive accounting

policies which are reflected in their failure to report impairment, while Tyco Electronics

utilizes conservative accounting policies reflected in its disclosure of impairment to

goodwill.

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Currency

Firms operating within the connector industry market conduct their business

throughout the globe. All companies that compete within this industry own multiple

sets of operations in many different countries. Molex, for example, attributed 52% of its

fiscal 2008 revenue to sales derived in the Asia-Pacific region alone. Firms operating

within other countries typically denominate purchases and sales made in that particular

country’s currency. Issues such as these are especially important during the translation

of foreign revenues into U.S. dollars. Companies operating in foreign markets are

subject to currency exchange rates assigned to each country throughout the globe. It is

our belief that Molex and its competitors practice conservative accounting policies in

reference to currency translation because the currency exchange rates of all countries

are given by a higher authority making them difficult to use in the distortion of

translating foreign currency. Molex discloses a sufficient amount of information

concerning the effect translation of currency has on their books. The company

accounted for every increase and decrease in certain aspects of the books with an

explanation. In conclusion, Molex provided ample information concerning the

translation of currency and its effects on the books. This further supports the firm’s

ongoing devotion to high disclosure throughout its company’s statements.

Qualitative analysis

The quality of disclosure is an important aspect to consider when investing in a

company. GAAP requires only a certain amount of disclosure and ultimately allows a lot

of flexibility for a firm to potentially hide certain factors that if disclosed would keep

someone from investing in a firm. It is up to the company to disclose additional

information to ensure credibility and provide a certain faith in a firm. The more

companies disclose the more honest their financials are thus creating a more accurate

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value of a firm. If the information is deemed accurate or reliable there is a greater

chance of people investing in the firm. If the information does not match up it is

usually because the company purposefully stated their financials in a manner that

would initially look appealing but in reality is ‘red flag’ to potential financial trouble a

company could be in.

Research and development

Research and development expenses in the global connector industry are highly

disclosed. While it is required by GAAP to show how much research and development is

expensed by companies, each firm in the global connector industry discloses how much

money was spent each year on research and development, what the money went

towards, and how the percentage of research and development relates to net income

and sales. For example, Molex states that, “Our research and development activities

are directed toward developing technology innovations, primarily high speed signal

integrity, miniaturization, higher power delivery, optical signal delivery and sealed harsh

environment connectors that we believe will deliver the next generation of products.”

Molex realizes that it is extremely important to disclose what research and development

is going towards in order to provide support so that they can keep up with industry

trends and stay on the cutting edge of technology.

One reason companies in the global connector industry find it important to

disclose research and development is due to the fact that the global connector industry

is highly differentiated. Meaning there is a huge need to use research and development

to set companies apart in this industry. Companies in this industry feel that by stating

they spend a lot of money on their research and development they could potentially

gain more investors due to R&D being a key success factor in the global connector

industry.

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Operating and Capital Leases

The level of disclosure that companies provide on their operating and capital

leases could have a positive or negative effect on the analysis of the company’s

financial information. Firms in the global connector industry have the choice of using

either operating leases or capital leases. An operating lease is treated like a rent

expense, where it never actually hits the books even though there is a cash outflow. A

capital lease is almost like a mortgage where it is recorded as a long-term asset or

liability. Molex offers a high level of disclosure regarding operating and capital leases.

Molex states in their 10-K, “We own 88% of our manufacturing, design,

warehouse and office space and lease the remaining 12%.” These twelve percent of

leases that Molex operates under are treated as capital leases. The industry offers a

moderate amount of disclosure on their operating and capital leases. Some of Molex’s

other competitor use both operating and capital leases and Methode uses only

operating leases.

The flexibility that companies have when reporting their operating and capital

leases makes it very easy for a manager to manipulate or distort numbers to make the

firm seem more valuable. If firms decided to capitalize leases when they should be

computed as operating leases, then assets and liabilities will be overstated on the

balance sheet. On the other hand, if a company decided to use an operating lease

when a capital lease was appropriate, then assets and liabilities will be understated. It

is imperative that potential investors understand operating and capital leases so that

they can correctly assign a value to the firm. With the quality of disclosure and

conservative accounting practices that Molex and its competitors offer, we believe that

we can effectively asses their operating and capital leases.

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Defined benefit and pension plan

The quality of disclosure that Molex provides concerning defined benefit and

pension plans is considered average to their competitors. While Methode does not use

a defined benefit plan, Molex provides the same type of information as that of

Amphenol and Tyco. Each company discloses discount rates and expected costs of

future medical expenses, however, these discount rates can be extremely misleading.

For instance, Molex uses a higher discount rate for their U.S. pensions than their foreign

pensions making their liabilities look smaller than they possibly are. Another important

rate to examine is the health care cost trend. It states that medical costs are on

average 10% per year, however, it states that they think the rates will be 5% in 2010

and 2011. This percentage rate is unrealistic when you consider that costs usually rise

with time.

Molex also continues to say that, “Our overall investment strategy for the assets

in the pension funds is to achieve a balance between the goals of growing plan assets

and keeping risk at a reasonable level over a long-term investment horizon. In order to

reduce unnecessary risk, the pension funds are diversified across several asset classes

with a focus on total return”(Molex 10K). However, the 10K just states that U.S. plan

assets are 68% equity and 32% bonds. No where does it mention the types of stocks

and bonds they invest in that could help a potential investor know how much risk is

directly involved in these assets.

While Molex’s level of disclosure is average of their competitors some of their

statements can be misleading. It is quite common for this to happen in the global

connector industry, however, this does not mean that these actions or methods of

recording financial statements are deemed acceptable.

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Goodwill

The quality of disclosure that Molex provides concerning goodwill is a little above

average of its competitors. For instance, each company in the industry performs an

annual impairment evaluation on their goodwill accounts to determine if an impairment

is necessary. In late 2006, Molex acquired Woodhead industries for $238.1 million and

a U.S. based company in 2007 for $42.5 million of which $23.9 million was goodwill.

The total for goodwill in 2007 was $334,791,000 which makes goodwill 20.6% of long

term assets. This percentage is higher than it should be and suggests that Molex needs

to restate their goodwill and allow for an impairment. However, 20.6% is not a large

number compared to Amphenol’s goodwill that totaled to 75% of their long term assets

or Tyco’s that totaled out to 57.7% of their long term assets. While Molex needs to

restate their financials and allow for an impairment of goodwill, they are still disclosing

and stating their financials better than most companies in their industry.

Currency

Molex has a large amount of disclosure regarding currency exchange rates. As

stated, “since a significant portion of our business is conducted outside the U.S., we

face substantial exposure to movements in non-U.S. currency exchange rates” (Molex

10-K). They explain how this currency risk could harm the results of operations and

how their measures to reduce currency risk may not be effective. They also disclose

that they may use financial instruments to hedge the U.S. dollar and other foreign

currencies arising from accounts receivable and accounts payable. Molex states that the

weakening of the U.S. dollar has cause foreign currency translation losses over the past

two years. “Certain products that we manufacture in Japan and Europe are sold in other

regions of the world at selling prices primarily denominated in or closely linked to the

U.S. dollar. As a result, changes in currency exchange rates may affect our cost of sales

reported in U.S. dollars without a corresponding effect on net revenue” (Molex 10K).

They provide forecasts for currency volatility during each year, and explain that if these

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forecasts are over or understated that they could experience unanticipated currency or

hedge gains and losses. So we believe that Molex offers an accurate and substantial

amount of currency disclosure.

Quantitative Accounting Measures and Disclosure

Quantitative accounting disclosures are intended to help managers effectively

communicate a company’s financial statements. Financial statements allow shareholders

and potential investors the ability to see important information regarding the company

and in turn, the ability to extract a value of the company. Managers are allowed flexible

accounting standards under GAAP in order to better report the underlying economic

substance of transactions and events. Managers have the ability to distort the

accounting numbers in order to alter the apparent value of the firm, which could cause

investors to see a skewed version of what the underlying value of the firm is. This is

why it is important for analyst and potential investors to understand accounting

measures and how they are used to decipher information about a company’s financial

statements. Sales and expense diagnostic ratios allow analyst to asses the true value of

the firm and help to spot out potential “red flags” in their financial statements.

There are two quantitative accounting measures used to determine if the

company is accurately and reliably presenting their financial information. The first of

these two measures is the sales manipulation diagnostics. These ratios show the affect

of what various areas of the firm’s business activities have on their net sales. The ratio

is computed by dividing the firm’s net sales by the various areas of the firm’s business

activities including: cash from sales, net accounts receivable, unearned revenue,

warranty liabilities, and inventory. These ratios will help spot out any manipulation in

the accounting numbers, and if so, would lead to a “red flag” being raised. The second

quantitative measure is to look at the expense manipulation diagnostics. These ratios

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are used to determine if there are any manipulations in a company’s reported expenses.

Managers want their company to appear profitable, and within the accounting flexibility

allowed by GAAP sometimes they are able to “cook the books”, or manipulate the

numbers. This is why it is important for investors to understand accounting techniques

in order to effectively assign a value to the firm.

Sales Manipulation Diagnostics:

The sales manipulation diagnostics is a tool used to review the financial

statements of Molex and their top competitors. By using financial ratios that assess the

revenues, accounts receivables, and inventories of the global connector industry, we

can study industry trends over the past five years and determine if Molex has raised

any ‘red flags’ that potential investors should be concerned with. These ratios will

ultimately determine is proper disclosure on financial statements has been achieved.

Net sales/ accounts receivable

This ratio compares the amount of total net sales to the amount of sales that are

credit transactions. This is an important ratio to examine, due to the fact that, the firm

has already performed a service in return for a promise that a company will pay them at

a later date. This does not mean cash will always be received, which is why we must

also examine the allowance for doubtful accounts to determine the odds of receiving

payment. Firms usually want a high ratio because this means they are reducing their

accounts receivable balance and receiving cash. The ratio is an excellent example of

how liquid the company is thus making the firm more appealing to investors.

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0

1

2

3

4

5

6

7

8

2003 2004 2005 2006 2007

Molex

Amphenol

Methode

Tyco

Net Sales/AccountsReceivable (raw) 

‐20

0

20

40

60

80

100

120

2003 2004 2005 2006 2007

Molex

Amphenol

Methode

Tyco

Net Sales/Accounts Receivable (change)

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The chart above shows a majority of the companies with the exception of

Methode, have remained fairly steady in their ratios throughout the years. Molex is still

the lowest compared to the other two companies. However, Molex is one of largest

companies which can lead investors to believe that they deal with more customers and

more credit transactions. This is appealing to customers but can steer potential

investors away if there is a steady decrease in ratios year to year. A potential ‘red flag’

that is raised in this chart is for Methode from 2004 to 2006. As stated in the change

form graph you see and a 100% increase and then a 100% decrease in a two year

span which causes investors to question their accounting methods. This could have

happened by understating their accounts receivable balance or overstating their net

sales.

Net sales/ cash from sales

This ratio assesses the company’s net sales in relation to how much cash they

received from sales compared to the amount of total revenue earned. This ratio should

be close to 1:1. If not this means the company is recognizing too much or too little as

their net sales thus creating a potential ‘red flag’ to investors. Over all this ratio should

not vary extensively from year to year or that is another potential ‘red flag’ that

suggests the company is using accounting distortions on their financial statements.

87 

 

0.9

0.92

0.94

0.96

0.98

1

1.02

1.04

1.06

1.08

2003 2004 2005 2006 2007

Molex

Amphenol

Methode

Tyco

Net Sales/Cash from Sales (raw)

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2003 2004 2005 2006 2007

Molex

Amphenol

Methode

Net Sales/Cash from Sales (change)

88 

 

As seen from the graph, Molex and their competitors stay around the 1:1 ratio

over the five year period. The quality of accounting disclosure in relation to net sales

and cash from sales among the firms in this industry is acceptable, therefore, no ‘red

flags’ have been raised until we examine the change graph. As shown, Methode does

not consistently stay in the 1:1 ratio causing investors to assume they are over or

understating their Net sales and accounts receivable balances.

Net sales/ inventory

This ratio is used to determine if the amount of sales a company has coincides

with their inventory levels. For instance, if there are high amounts of sales you should

see a reduction in your inventory levels. A low ratio implies poor sales and, therefore,

excess inventory. A high ratio implies either strong sales or ineffective buying. High

inventory levels are harmful because they represent an investment with a zero return

rate. It can also be a potential problem for a company if prices begin to fall.

0

2

4

6

8

10

12

14

2003 2004 2005 2006 2007

Molex

Amphenol

Methode

Tyco

Net Sales/Inventory

89 

 

The graph shows that Methode has been unsuccessful with keeping their sales

up and their inventories down. In fact, Methode has seen an increase in sales each

year along with a steady increase in their inventory account causing their ratio to fall

year after year. Molex has been successful at containing a constant ratio for the past

five years meaning we are able to successfully keep their inventory at a level that

healthily represents sales. Amphenol has seen the most success with their ratio

growing gradually each year. The only potential ‘red flag’ to report in this industry

would be with Methode due to their sharp increase in 2004 and the vast decrease in

2005. However, over the past two years they have kept a ratio that is not volatile

enough to raise a real concern in their accounting methods.

‐10

‐5

0

5

10

15

2003 2004 2005 2006 2007

Molex

Amphenol

Methode

Tyco

Net Sales/Inventory (Change)

90 

 

Conclusion

When reviewing the sales manipulation diagnostics Molex has held average to

the other firms in the industry. The only potential concern to investors is that Molex is

the lowest in the industry when comparing the net sales to accounts receivable ratio.

This is probably due to the fact that Molex is a top leader in the industry which can

cause firms to have a higher amount of credit transactions. The only potential ‘red

flags’ that were raised in the sales manipulation diagnostics involve Methode and how

they recorded certain accounts. Methode’s ratios are extremely volatile in percent

change from year to year causing investors to believe that they are under or overstating

their net sales and accounts receivable balances.

Expense Manipulation Diagnostics:

Expense diagnostics are another measure to assure that Molex and its main

competitors are not manipulating any line items in their financial statements. These

ratios analyze the different line items throughout the financial statements and record

the various correlations between the two. The financial statements that are used to

evaluate the firm’s expense diagnostics include: the balance sheet, income statement,

and the statement of cash flows. These ratios will compare the firms in the global

connector industry, and hopefully spot out any manipulations or irregularities, which

could lead to potential ‘red flags’.

Asset Turnover

A firm’s asset turnover ratio is computed by dividing the firm’s net sales over

total assets. This ratio indicates the relationship between assets and net sales, and is

also used to determine the amount of sales that are generated from every dollar of

assets. Asset turnover also demonstrates how well a company can use its assets to

generate revenue and if the firm is properly depreciating or writing off these assets.

Companies with low profit margins will tend to have a high asset turnover ratio and vice

91 

 

versa for companies with high profit margins; this is mainly due to competitive pricing

strategies. Companies in the connector industry should have an asset turnover of

around 1 due to the fact that firms in this industry compete on both price and

innovation. This should force their asset turnover ratio to be located somewhere in the

middle. Any major changes in the ratio from year-to-year would lead to a potential red

flag in their financial statements.

0

0.2

0.4

0.6

0.8

1

1.2

1.4

2003 2004 2005 2006 2007

Molex

Amphenol

Methode

Tyco

Asset Turnover (raw)

92 

 

According to the graph, there is a moderate asset turnover ratio for the global

connector industry. This is mainly due to the two different strategies of competitive

pricing and product differentiation. However, the fact that Tyco’s ratio is so low could

indicate that they are experiencing very high profit margins because of their product

differentiation compared to the rest of the industry. This is also due to the significantly

larger amount of assets that are reported on Tyco’s balance sheet. Molex’s ratio is

steadily increasing from years 2003 to 2007, which can be explained by the large

amount of industry growth during these years. The connector industry is becoming

more competitive everyday which is driving firms to offer more competitive pricing and

in turn decreasing their profit margin.

‐3

‐2

‐1

0

1

2

3

4

2003 2004 2005 2006 2007

Molex

Amphenol

Methode

Tyco

Asset Turnover (change)

93 

 

CFFO/OI

The ratio CFFO/OI is calculated by dividing the firm’s cash flow from operations

by the amount of operating income that is reported on the income statement. This ratio

will describe the correlation between the firm’s amount of cash received from

operations and income from operations. Investors preferably would want to invest in a

firm with a ratio of 1 to 1, which would mean that the cash flows from operations are

mainly a result from earnings from operations. If the ratio fluctuates dramatically from

year-to-year then this could lead to the need for further examination of the situation

and possibly a potential “red flag”.

0

0.5

1

1.5

2

2.5

3

3.5

2003 2004 2005 2006 2007

Molex

Amphenol

Methode

Tyco

CFFO/OI  (raw)

94 

 

According to the graphs, Amphenol has had the most consistent ratio out of its

competitors. Amphenol has seen a steady growth rate in both its cash flows from

operations and also its operating income. Methode began reverting back towards 1

between the years 2003 to 2006, but then from 2006 to 2007 they had a dramatic

increase in cash flows and a very small accompanying increase in operating income.

This led to the increase in the CFFO/OI ratio from 2006 to 2007. Molex is the only

company that raises concerns because of the dramatic drop in their ratio from 2003 to

2004. This can be described by the net loss in cash flow from operations resulting in a

decrease of 4.2%. This decrease in cash flow from operations was accompanied by a

116% increase in income from operations. So after reviewing this graph and the 10-K’s

of the various companies, there seems to be no distortions in the companies’ numbers

for cash flow from operations and operating income, leading us to raise no “red flags”

‐25

‐20

‐15

‐10

‐5

0

5

10

15

2003 2004 2005 2006 2007

Molex

Amphenol

Methode

Tyco

CFFO/OI (change)

95 

 

CFFO/NOA

The ratio CFFO/NOA allows you to see the correlation between the firm’s cash

flow from operations and its net operating assets. A firm’s net operating assets are

fixed assets which include property, plant, and equipment or PP&E. A large CFFO/NOA

ratio indicates that the company is making more efficient use of its operating assets and

how these assets generate can inflows. A firm could record a significant increase in

cash flow from operations or a decrease in operating assets which would lead to the

ratio being manipulated in order to better portray the CFFO/NOA ratio.

0

0.2

0.4

0.6

0.8

1

1.2

1.4

2003 2004 2005 2006 2007

Molex

Amphenol

Methode

Tyco

CFFO/NOA (raw)

96 

 

According to the graphs, Amphenol is utilizing their assets the best out of all of

its competitors. This means that Amphenol is receiving the highest return on their

operating assets. Methode’s cash flow from operations has been decreasing from 2003

to 2006, but its net operating assets have been steadily increasing which leads to the

decreasing ratio from 2003 to 2006. The sudden spike that occurs in 2007 was a result

of a dramatic increase in cash flow from operations. This could be a potential “red flag”

when analyzing Methode’s accounting numbers. Molex has the lowest ratios compared

to its industry competitors. This is mainly due to the fact that Molex has the largest

amounts of operating assets compared to the other firms in the industry. Molex’s

property, plant, and equipment are almost seven times the size of the other firm’s in

the industry. Therefore, Molex may not be utilizing their assets to full potential and

could mean that they may need to alter their asset utilization policies.

‐10

‐8

‐6

‐4

‐2

0

2

4

6

8

2003 2004 2005 2006 2007

Molex

Amphenol

Methode

Tyco

CFFO/NOA (change)

97 

 

Total accruals/Total Sales

The ratio total accrual/total sales allows you to determine the correlation

between a firm’s accruals and sales. The ratio is calculated by taking a firm’s cash flow

from operations and subtracting out the net earnings of that period. Then you take the

previous amount and divide it by the total sales for that period. This ratio will allow us

to determine how well a company’s sales are derived. If the ratio is relatively higher

than 1 then we can conclude that most of the firms’ sales are accounts receivable. On

the other hand, if it is relatively lower than one then we can conclude that most sales

were made on some form other than credit accounts. The closer the firms’ ratio is to

one then the more diverse the company is between the two different payment forms.

However, as you can see below none of the firm’s are even close to one, suggesting

that the majority of their sales could be made on a non-credit basis.

0

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

0.18

2003 2004 2005 2006 2007

Molex

Amphenol

Methode

Tyco

Total Accruals/Total Sales (raw)

98 

 

According to the graph above, it can be said that Molex and its competitors have

seen a lot of fluctuation in their cash flows from operations. This is illustrated by the

highly fluctuating ratios and all of the peaks and valleys throughout the graph.

Amphenol has seen the most consistency among its competitors in relation to total

accruals, but Molex has been the closest to 1 throughout the 5 years. The industry as a

whole seems to have no distortion in their total accruals or total sales, leading us to

believe that there are no “red flags” being raised.

Pension Expense/SG&A

The ratio pension expense/SG&A describes the correlation between pension

expenses and selling, general, and administrative expenses, or operating expenses. The

ratio is calculated by taking a firms pension expense and dividing it by the SG&A

expenses. This ratio computes the amount of money that the company is spending on

‐1

‐0.5

0

0.5

1

1.5

2

2003 2004 2005 2006 2007

Molex

Amphenol

Methode

Tyco

Total Accruals/Total Sales (change)

99 

 

retired workers’ now and in the future. Investors want this ratio to be substantially low,

meaning that the company does not have a lot of its expenses tied up in retired

workers. If the ratio is high, this could mean that company is spending too much of its

expenses on past workers, and maybe they should reconsider their current pension

plan.

0

0.1

0.2

0.3

0.4

0.5

0.6

2003 2004 2005 2006 2007

Molex

Amphenol

Tyco

Pension Expense/SG&A (raw)

100 

 

According to the graphs, Molex is utilizing their pension expenses the best out of

their competitors. They have had the lowest ratio throughout the last five years that

this chart illustrates. We believe that Amphenol changed their pension plan in 2003

which has lead to the downward slope in their pension/SG&A ratio. Their new pension

plan has lead to a 100% decline in their pension expense throughout the last five years.

Methode was not included in this graph because they do not use a defined benefit plan,

so we were not able to include them. Tyco only had available pension numbers for 2006

and 2007 which is why they do not show up on this graph. However, their change form

ratio for 2007 was 0.83. The industry, as a whole, does not seem to have any distortion

in their pension or SG&A numbers leading us to raise no “red flags”.

Conclusion

According to the expense diagnostic ratios, Molex has not manipulated any of its

expenses and seem to show consistency in their accounting processes. Molex’s asset

turnover ratio is very close to one every year meaning that for every dollar of assets

‐1.5

‐1

‐0.5

0

0.5

1

1.5

2

2.5

2003 2004 2005 2006 2007

Molex 

Amphenol

Tyco

Pension Expense/SG&A (change)

101 

 

they have a dollar in sales. They have maintained very consistent CFFO/OI and Pension

Expense/SG&A ratios for the last five years, leading the industry in both from 2004 to

2007. Molex lags behind according to the CFFO/NOA ratio, meaning that they might not

be utilizing their property, plant, and equipment to its full potential. Although Molex’s

numbers fluctuate from year-to-year, we did not find any manipulations in their

financials that would cause us to raise any “red flags”.

Potential Red Flags

A potential red flag is when issues arise in the financial statements that are

questionable and are unexplained. Unexplained concerns can be a sudden growth in

profit, gaps between statements, large write-offs, and other things of that nature.

These types of signs help analysts to see what they need to look into more than what

has been presented. In order to get real picture of the company an analyst has to look

at past year’s financial statements in order to see how accounts have come to be what

they are. Not all questionable items are red flags, but it is up to the analysts to

determine what is and is not. Once all the red flags have been identified then proper

measures can be taken to fix the distortions.

When reviewing Molex’s financial statements a red flag was raised in the

impairment of goodwill. The company has not reported any impairment of goodwill

since the fiscal year of 2005. When digging deeper into the issue it was discovered that

the reasoning behind this is issue is that in 2006 the acquisition of Woodhead

Industries, Inc. was completed. Molex went from impairing $22.9 million of goodwill in

2005 to zero in 2006 and on (Molex 10-k). Molex is overvaluing their new acquired

company by not impairing their goodwill. A company that does not report impairment

of goodwill ends up overstating their assets and understating their expenses in order to

portray that the company is better off than it actual is. An analyst would conclude that

Molex’s lack of impairment has distorted the numbers on the financials, so in order to

have the true value of the company goodwill must be restated.

102 

 

When a red flag is raised it is imperative for an analysts to review the situation

thoroughly and even go to the step of restating the financial statements is it is a big

enough issue. With Molex’s goodwill a red flag was raised due to the company amount

reported each year with only having impairment one year between the fiscal years of

2002 and 2008. This problem was to the point that the net income was highly distorted

and needed to be restated. The following section shows the restated income statement

and balance sheet.

Undoing Accounting Distortion

When a company has a serious red flag raised it is crucial that an analyst gather

information and restate the financial statements to give an accurate assessment of the

company’s value. By calculating a more accurate value of a company a clearer view of

the company’s assets, earnings, expenses, and revenues can be created. With Molex

having taken a “big bath”, understating the company’s earnings to manipulate the

income statement, the past few years they have managed to make their net income

look fantastic. The reality of the company’s financial statements is shown in the

following tables.

103 

 

Molex's Restated Income Statement

2002 2003 2004 2005 2006 2007 2008 Net revenue 1,711,497 $ 1,843,098

2246715 2554458 2861289 3265874 3328347 Cost of sales 1,174,946 1,263,850

1469969 1721796 1918659 2249166 2314112 Gross profit 536,551 579,248 776,746 832,662 942,630 1,016,708 1,014,235

Selling, general and administrative expenses 438600 476990 555563 606522 632886 695158 696285

Goodwill Impairment 32036 57775 79203 115013 103601 149839 194596

Income form Operations 65,915 44,483 141,980 111,127 206,143 171,711 123,354

Total Other Gains/Loses 4,730 (7,784) (18,709) 19,937 18,140 16,707 20,698

Income before taxes 70,645 36,699 123,271 131,064 224,283 188,418 144,052

Income taxes at 28% 19,781 10,276 34,516 36,698 62,799 52,757 40,335

Net Income 50,864 26,423 88,755 94,366 161,484 135,661 103,717

Molex's Restated Balance Sheet

2002 2003 2004 2005 2006 2007 2008

Total Current Assets 915,343

962113 1168644 1,374,063

1,548,233 1590827 1782960

Long-Term Assets:

Property, Plant, and Equipment 1,067,590

1007948 1022378 984,237

1,025,852 1121369 1172395

Goodwill 128144 102957 85712 28859 45857 184952 179027

Non-current deferred income taxes 61,000

108313 119532 126,987

130,471 103626 62521

Other Assets 49,807

90764 96877 98,513

120,406 165495 208038

Total Assets 2221884 2272095 2493143 2612659 2870819 3166269 3404941

Liabilities:

Total Current Liabilities 359,593

356148 428464 469,504

594,812 530951 649438

Long-Term Liabilities 66,675

77154 77888 89904 97739 262126 273253

Total Liabilities 426268 433302 506352 559408 692551 793077 922691

Stockholder's Equity:

Total Common Stock 10628 10680 10734 10,791

10900 11020 11107

Paid-in Capital 311,631

341530 369660 400,173

442,586 520,037 569046

Retained Earnings 1905452 2017592 2009238 2171818 2361288 2500631 2590503

Treasury Stock -362479 -509161 -437234 -568917 -743219 -799894 -

1009021

Accumulated other Comprehensive Income -69616 -21848 34393 39386 106,713 141,398 320615

Total Stockholder's Equity 1795616 1838793 1986791 2053251 2178268 2373192 2482250

Total Liabilities and Stockholder's Equity 2221884 2272095 2493143 2612659 2870819 3166269 3404941

104 

 

Goodwill

Molex’s Goodwill as a Percent of Long-Term Assets

2002 2003 2004 2005 2006 2007 2008

14.34% 14.63% 14.73% 13.29% 13.04% 26.02% 27.07%

On Molex’s financials goodwill was the asset that raised a red flag and has been

restated. The asset goodwill has been up to 27.07% of the company’s long-term assets

in the past seven years. The table below shows the exact percent, for the past seven

years, that goodwill is of long-term assets before the goodwill impairment adjusted.

Molex’s Impairment of Goodwill

2002 2003 2004 2005 2006 2007 2008

Goodwill

Before

Impairment

160,180 160732 164915 143872 149458 334791 373623

Goodwill

After

Impairment

128,144 102,957 85,712 28,859 45,857 184,952 179,027

In the process of restating the goodwill of the company it was extended back to

2002 so that the growth of the distortion can be shown. The first step to restating

goodwill is to impair the asset so that the distortion amount can come out and the

financials and from there it can be corrected. In order to calculate an accurate amount

for goodwill, an impairment of 20% was applied to the asset. The following table

shows the before and after the 20% goodwill impairment was applied.

105 

 

Molex’s Long-Term Assets Value

2002 2003 2004 2005 2006 2007 2008

Before

Impairment

1,277,577 1,259,444 1,284,170 1,226,622 1,295,716 1,621,655 1,753,956

After

Impairment

1,245,541 1,201,669 1,204,967 1,111,609 1,192,115 1,471,816 1,559,360

After impairing Molex’s goodwill, the total long-term asset value for the company

was calculated by subtracting the value of impairment on goodwill from the total assets

provided in the financial statements for each year. Goodwill is considered an asset on

the balance sheet, therefore, the impairment of that account affects the total assets of

a company as well. To impair goodwill is a direct decrease in total asset value of a

company as evident in the table above.  

Molex’s Impairment Expense

2002 2003 2004 2005 2006 2007 2008

Dollar

Amount 32,036 57,775 79,203 115,013 103,601 149,839 194,596

To determine the impairment expense from year to year, you take your total

long term assets before the impairment and subtract total long term assets after the

impairment. After determining Molex’s impairment expense, we have a better idea of

how much net income will decrease from year to year. However, when determining net

income you must use a corporate tax rate that is based on revenues you earn in a given

year. This rate can change substantially if you see extensive increases or decreases in

earnings. Molex, however, does not state their corporate tax rate. Therefore, we

averaged the tax rates of previous years to determine the rate we would use in Molex’s

tax table.

106 

 

Molex’s Tax Table

2002 2003 2004 2005 2006 2007 2008

Taxable

Income

70645 36699 123271 131064 224283 188418 144052

Taxes 19781 10276 34516 36698 62799 52757 40335

Estimated

Tax Rate

28% 28% 28% 28% 28% 28% 28%

After averaging six years of tax rates together we concluded that 28% would be

the best representation of a tax rate to restate Molex’s income statement. We found

our taxable income by expensing our new impairment costs from income before taxes

and multiply this value by 28%. This table reflects our restated taxable income and

taxes for the past six years.

Molex’s Net Income

2002 2003 2004 2005 2006 2007 2008

Before

Impairment

Expense

76,479 84,918 175,950 154,434 236,091 240,768 215,437

After

Impairment

Expense

50864 26423 88755 94366 161484 135661 103717

After the impairment expense was included into the financial statements it took a

pretty good sized chunk out of net income. Looking at the following chart you can see

that the difference between the before and after net incomes keep getting bigger. It

even gets to the point that in 2008 the difference between the two net incomes was

107 

 

over one-hundred thousand dollars. The table below describes our estimates in retained

earnings after the impairment of goodwill.

Molex’s Retained Earnings

2002 2003 2004 2005 2006 2007 2008

Before

Impairment

1,937,488 2,003,440 2,160,368 2,286,826 2,464,889 2,650,470 2,785,099

After

Impairment 1905452 2017592 2009238 2171818 2361288 2500631 2590503

As you can see, the impairment of goodwill decreased the retained earnings

account in every year from 2002 to 2008. After reviewing Molex’s restated financial

statements for the past seven years you can see that the company took a “big bath” by

understating their expenses, which in turn lead to a misinterpretation of their net

earnings.

Conclusion

We believe that our restated financial statements offer potential investors a more

accurate view of what Molex’s real earnings and expenses are. Our restatements show

that Molex’s assets, earnings, expenses, and revenues were manipulated. The “big

bath” that Molex took understated their expenses enough for a ‘red flag’ to be raised

and for us to offer additional assessment. We believe that the financial statements

shown above are the more accurate view of the underlying events of Molex.

108 

 

Financial Analysis, Forecast Financials, and Cost of Capital Estimation

To successfully evaluate a company an analyst must complete a three step

process that includes ratio analysis, the forecasting of financials, and determining the

cost of capital of the company. The calculation of ratios allows easily comparable

numbers for the analyst to use in determining industry norms and trends. The ratios will

also be utilized in the forecasting of Molex’s financial income statement, balance sheet,

and statement of cash flows. Using data from the past 6 years we will be forecasting

Molex’s financial statements out 10 years. After completing these first two steps we will

finally compute Molex’s cost of capital that will assist us in our evaluation of the

company.

Financial Analysis

Analysts, creditors and investors frequently compare the financial statements of

competitors within a certain industry. Ratios were developed to help ease the process

by producing smaller, easily comparable numbers for these analysts to utilize. The

financial ratios can help analysts evaluate an individual firm, its competitors and its

industry. Ratios were developed to measure the liquidity, profitability and capital

structure of firms. The comparable numbers derived from these ratios allow analysts,

investors and creditors seeking information to compare data over a number of years.

These ratios will allow us to compare the financial worth of Molex compared to its

competitors and its industry.

Liquidity Ratio Analysis:

The calculation of the liquidity ratios allows analysts to measure the ability of a

firm to meet its short-term financial obligations. High liquidity ratio results reflect the

ability of a firm to keep higher levels o f assets compared to its liabilities. Therefore

high liquidity ratio results illustrate to the analyst that a firm is able to meet current

obligations if needed. Liquidity ratios include the current ratio, quick ratio, accounts

109 

 

receivable turnover, days sales outstanding, inventory turnover, days supply inventory,

and working capital turnover.

Current Ratio:

The current ratio is calculated by dividing a firm’s current assets by its current

liabilities. This ratio helps demonstrate the firm’s ability to meet its short-term

obligations with the use of its short-term assets. As stated above, the higher the ratio,

the more capable the company is in meeting its short-term liabilities. As illustrated in

the graph and table, Molex’s current ratio is significantly higher compared to its

competitors and the industry. After observing the provided information it is evident that

Molex does not maintain a constant ratio. Its ratio increased significantly in 2007

compared to previous years, and could be a result of the acquisition of Woodhead

Industries earlier this year. Molex’s competitors’ ratios fluctuate over the years, and are

also not held at a constant. In conclusion Molex would be more than able to meet

short-term obligations if needed.

0

1

2

3

4

5

6

7

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

110 

 

2002 2003 2004 2005 2006 2007

Molex 2.56 2.70 2.73 2.93 2.60 6.26

Molex - Rest. 2.55 2.70 2.73 2.93 2.60 5.96

Amphenol 1.65 2.07 1.91 2.11 2.09 5.14

Methode 3.30 3.55 2.96 3.15 2.98 5.68

Tyco N/A 1.73 1.95 1.86 2.08 3.83

Industry Avg. 1.65 2.45 2.27 2.37 2.38 4.88

Quick Asset Ratio:

The quick asset ratio or acid test ratio is very similar to the current ratio. It

differs in that it deducts inventory from total current assets and then is divided by total

current liabilities. Inventory is not included in the quick asset ratio because some assets

held in inventory are considerably difficult to liquidate. When creditors assess the

credibility of firms a quick asset ratio of 1 or higher is considered a positive indication

that a firm is able to settle current liabilities, while a ratio of less than one implies the

opposite.

111 

 

2002 2003 2004 2005 2006 2007

Molex 1.95 2.1 2.03 2.21 1.93 2.16

Molex - Rest. 1.95 2.1 2.03 2.21 1.93 2.16

Amphenol 0.64 0.9 0.88 1.02 1.02 1.33

Methode 2.27 2.48 2.22 2.34 2.1 1.92

Tyco N/A N/A N/A 0.84 0.92 0.59

Industry Avg. 1.46 1.69 1.55 1.68 1.56 1.63

Again, Molex’s ratio is higher compared to the industry average but it is obvious

that its numbers have decreased significantly after the deduction of inventory from the

ratio. This implies that Molex keeps a majority of its assets in the form of inventory.

While Molex has experienced ratios closer to the range of 2 for the past 5 years, some

of its competitors have experienced ratios below 1. This ratio also supports the

0

0.5

1

1.5

2

2.5

3

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

112 

 

assumption that Molex would be able to meet all short-term obligations even without

the liquidation of its inventory.

Working Capital Turnover:

The working capital turnover is a calculation that helps analyze the relationship

between a firm’s assets that are used in the operations of the company and the sales

that result from the firm’s operations. The working capital turnover is calculated by

dividing a firm’s sales by its working capital. A firm’s working capital is found by

subtracting current liabilities from current assets. A high turnover is observed when a

firm is able to sell more relative to the amount needed to fund its operations.

0

1

2

3

4

5

6

7

8

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

113 

 

2002 2003 2004 2005 2006 2007

Molex 3.08 3.04 3.04 2.82 3.00 3.08

Molex - Rest. 3.08 3.04 3.04 2.82 3.00 3.08

Amphenol 6.70 5.30 6.09 4.84 5.08 1.32

Methode 2.77 2.88 3.20 2.82 2.87 3.27

Tyco N/A 4.08 3.78 4.20 3.62 3.65

Industry Avg. 3.16 4.09 4.36 3.95 3.85 2.75

Molex has maintained a lower working capital turnover relative to the industry

average. Its turnover has remained in a constant range and closely resembles the

turnover of its competitor Methode. Amphenol exhibits a high turnover that fluctuates

from 2002-2006, then its turnover experiences a significant decrease in 2007. Although

Molex’s working capital turnover has been slightly lower than the industry average until

2006, it recently surpassed the industry average in 2007.

A/R Turnover:

Many firms extend credit to their customers in the form of accounts receivable,

which allows customers to pay for inventory and services at a later date. The accounts

receivable turnover is a calculation that helps measure how efficiently a firm is in

collecting its customer’s outstanding debts. The ratio is calculated by A higher ratio

implies that the firm is able to collect outstanding receivables quickly. On the contrary,

a lower ratio indicates that receivables are collected at a slower rate, and payment is

not realized for a longer period of time. Molex has maintained relatively low accounts

114 

 

receivable turnover compared to its competitors operating within the industry. Although

their turnover is less than that of their competitors, the company’s turnover has not

fluctuated much in the past five years. A conclusion can be drawn from the graph and

table below that Molex collects receivables at a slower rate compared to that of the

industry.

2002 2003 2004 2005 2006 2007

Molex 4.43 4.65 4.24 4.73 4.33 4.76

Molex - Rest. 4.43 4.65 4.24 4.73 4.33 4.76

Amphenol 7.82 7.19 7.15 5.97 6.44 5.59

Methode 4.99 6.23 5.49 6.00 5.68 5.66

Tyco N/A N/A N/A 5.03 5.05 5.01

Industry Avg. 6.41 6.71 6.32 5.67 5.72 5.42

0

1

2

3

4

5

6

7

8

9

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

115 

 

Days Sales Outstanding:

The day’s sales outstanding ratio is another calculation that helps measure the

ability of a firm to collect outstanding debt from its customers. This calculation is

directly related to the accounts receivable turnover, it provides the analyst with more

detail concerning collections. Days sales outstanding is calculated by dividing the

number of days in a year, or 365, by the firm’s accounts receivable turnover. The

quicker a firm collects its outstanding receivables, the quicker it is able to reinvest those

assets within the company.

0

10

20

30

40

50

60

70

80

90

100

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

116 

 

2002 2003 2004 2005 2006 2007

Molex 82.35 78.58 86.04 77.09 84.28 76.63

Molex - Rest. 82.35 78.58 86.04 77.09 84.28 76.63

Amphenol 46.66 50.79 51.08 61.14 56.69 65.34

Methode 73.15 58.56 66.48 60.79 64.26 64.45

Tyco N/A N/A N/A 72.54 72.23 72.84

Industry Avg. 59.90 54.66 58.78 64.82 64.39 67.54

Because days sales outstanding is directly related to the accounts receivable

turnover the information depicted in the graph and table above support the information

concerning the accounts receivable turnover. Compared to the collection of its

competitors and the industry, Molex takes longer to collect its receivables. It takes

Molex 81 days on average to collect its receivables from customers. Its competitors,

with the exclusion of Tyco, try to collect their receivables in under 70 days. Because

Molex takes approximately 11 more days than its competitors to collect its receivables it

is deprived the opportunity to reinvest funds sooner. The industry average for the past

five years demonstrates a steady increase in the DSO, this could be somewhat of an

advantage to Molex. If the DSO continues to increase, then the spread that exists

between Molex and the industry will lessen and the firm will be comparable to its

competitors.

Inventory Turnover:

It’s beneficial for analysts to calculate the inventory turnover ratio to analyze a

firm’s effectiveness in selling and replacing its inventories throughout the year. The

inventory turnover ratio is calculated by taking a firm’s cost of goods sold (located on

the financial income statement) and dividing it by its inventory. Although inventory is

117 

 

considered an asset to a company, its returns are recognized if and only if it is sold. A

low turnover ratio implies that the firm experienced low sales, which leaves them with

an inventory surplus. A high inventory ratio implies the opposite, a high level of sales

throughout the year and a low inventory.

2002 2003 2004 2005 2006 2007

Molex 6.99 7.05 5.54 5.94 5.52 5.73

Molex - Rest. 6.99 7.05 5.54 5.94 5.52 5.73

Amphenol 3.36 3.71 4.19 3.71 4.04 4.20

Methode 7.27 9.16 9.85 7.37 7.36 6.61

Tyco N/A N/A N/A 5.07 4.86 4.89

Industry Avg. 5.31 6.44 7.02 5.38 5.42 5.23

0

2

4

6

8

10

12

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

118 

 

Molex has maintained a turnover relatively similar to the industry average, it

doesn’t have the highest or lowest compared to competitors. For the past five years

Methode has maintained the highest inventory turnover compared to its competitors

which reflects strong sales. Molex has maintained the second highest turnover ratio, its

numbers have fluctuated for the past five years. A significant decrease occurred from

2003 to 2004, which is a result in the increase of inventory. Normally evidence of

excess inventory would be considered a disadvantage, but since Molex’s ratio resembles

the industry’s it can be assumed that that the affect is minimal.

Days’ Supply in Inventory:

Like the calculation of days sales outstanding is directly related to the accounts

receivable turnover ratio, the days supply in inventory is directly related to the

inventory turnover ratio. It is calculated in much the same way, by dividing the number

of days in a year, 365, by the firm’s inventory turnover ratio. This calculation provides

the analyst with the amount of days it takes for a company to turnover its entire

inventory. The ultimate goal of a company is to sell its inventory, and therefore it is

best to have the least amount of days needed to turnover a firm’s inventory. Although

Molex’s inventory turnover closely resembled the industry average, its days supply in

inventory is on average 10-15 days less. It has taken Molex an average of 60 days to

turnover its entire inventory. It is evident that Molex takes less time to turnover its

inventory compared to Amphenol that averages 95 days to complete a full turnover of

its inventory. Methode exhibited the highest inventory turnover and therefore holds the

lowest days supply in inventory. If Molex continues to have a lower DSI relative to the

industry it can be assumed that its excess inventory poses a minimal threat regarding

competition within the industry.

119 

 

2002 2003 2004 2005 2006 2007

Molex 52.20 51.77 65.89 61.50 66.07 63.73

Molex - Rest. 52.20 51.77 65.89 61.50 66.07 63.73

Amphenol 108.58 98.46 87.22 98.49 90.31 86.81

Methode 50.22 39.83 37.04 49.50 49.56 55.25

Tyco N/A N/A N/A 71.96 75.04 74.63

Industry Avg. 79.40 69.14 62.13 73.31 71.64 72.23

Cash to Cash Cycle:

The cash to cash cycle is a calculation that attempts to determine the number of

days each input dollar remains in the production and sales process before it is

converted to cash. The cash to cash cycle is calculated by adding days supply inventory

and days sales outstanding. This calculation takes into account the time needed to sell

0

20

40

60

80

100

120

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

120 

 

a firm’s inventory, and the time needed to collect outstanding receivables. If a firm is

able to convert its assets into cash quickly its cash to cash cycle will generally be a low

number. If a company exhibits a low cash to cash cycle they are perceived as being

more credit worthy.

2002 2003 2004 2005 2006 2007

Molex 134.6 130.3 151.9 138.6 150.3 140.1

Molex - Rest. 134.6 130.3 151.9 138.6 150.3 140.1

Amphenol 155.2 149.2 138.3 159.6 147.0 152.2

Methode 123.4 98.2 103.5 110.3 113.8 119.7

Tyco N/A N/A N/A 144.5 144.4 147.5

Industry Avg. 139.3 123.8 120.9 138.1 135.1 139.8

0

20

40

60

80

100

120

140

160

180

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

121 

 

The number of days that Molex takes to convert its assets into cash has

remained closely related to the industry average, with the exclusion of 2004. In 2004

Molex’s cash to cash cycle exceeded the industry’s average by over 20 days, and then

dropped back down to relative levels in 2005. Molex’s competitor Methode has exhibited

the lowest number of days compared to its competitors and the industry average for

the past 5 years. Referring back to previous tables, we can observe that Methode

maintained a lower DSI and DSO compared to its competitors. In order for Molex to

decrease its cash to cash cycle it would have to adopt an accounts receivable collection

similar to its competitor Methode, and/or decrease the amount of days it takes to

turnover its entire inventory.

Conclusion

After calculating the various liquidity ratios, we are able to compare the liquidity

of Molex to its competitors within the industry. Molex’s current ratio is significantly

higher than its competitors and the industry. Molex’s current ratio also increased

significantly in 2007. After comparing the quick ratio of Molex and its competitors we

also see that its ratio is higher than the industry average and its competitors. We

concluded that Molex held a significant amount of inventory because its quick ratio

decreased significantly with the deduction of inventory. Molex’s low accounts receivable

turnover may indicate inefficiencies in debt collections compared to its competitors.

After examining all the liquidity ratios we can see that many of Molex’s competitors

have comparably similar ratios, while some ratios including days supply in inventory

illustrate vast differences between firms. These instances of vast differences make it

difficult to establish a trend between the competitors operating within the industry.

122 

 

Profitability Ratio Analysis:

In this section, we will discuss Molex as well as other companies in the global

connector industry and their ability to effectively generate revenues and cover

expenses. In order to successfully analyze profitability, we will examine ratios such as

gross profit margin, operating expense ratio, net profit margin, asset turnover, return

on assets, and return on equity.

Gross Profit Margin:

Gross profit margin is calculated by taking a company’s gross profit and dividing

it by net sales. In order to determine gross profit you must take a company’s net sales

and subtract their cost of goods sold. Gross profit is used to measure if a company is

effectively generating a profit in relation to how much it costs to produce a good. Two

factors that affect gross profit margin are, “The price premium that a firm’s products or

services command in the marketplace and the efficiency of the firm’s procurement and

production process” (Palepu Healy). If gross profits are low, this usually indicates that

costs associated with making a product are high and that a company should try a more

cost effective approach to making the item or increase the selling price of the product.

A high gross profit ratio usually indicates that a company is maintaining high sales with

a healthy amount of cost of goods sold. The higher the gross profit margin the better;

this indicates that a company can successfully make profits from their sales and be able

to pay off future expenses and costs.

123 

 

2002 2003 2004 2005 2006 2007

Molex 0.317 0.314 0.346 0.326 0.329 0.311

Molex - Rest. 0.317 0.314 0.346 0.326 0.329 0.311

Amphenol 0.318 0.338 0.324 0.332 0.319 0.326

Methode 0.160 0.194 0.198 0.223 0.202 0.197

Tyco N/A N/A 0.282 0.299 0.298 0.256

Industry Avg. 0.239 0.266 0.268 0.285 0.273 0.260

As the graph indicates, Molex is consistently generating a high gross profit ratio.

Molex has kept their average between .3 and .35, while the industry average has

consistently been between .25 and .3 for the past five years.

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

124 

 

Operating Expense Ratio:

The operating expense ratio is calculated by taking total operating expenses and

dividing by it by the gross profit. Operating expenses include items such as wages,

advertising, maintenance and repairs, utilities, etc.. The lower the ratio the more

appealing a firm would look to investors. This is because a low ratio indicates that

operating expenses are low meaning that a firm is being managed well and that the

company can effectively cover the costs that are associated with operating a firm. As

shown in the graph, Molex has the highest operating expense ratio compared to other

companies and the industry average. This is a negative factor that could steer investors

away from Molex because it suggests that they are inefficient at operating their

company and spending too much on wages, advertising, utilities, etc... A low ratio also

suggests that the operating income of the company could be low thus lowering net

profits.

0

0.05

0.1

0.15

0.2

0.25

0.3

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

125 

 

2002 2003 2004 2005 2006 2007

Molex 0.258 0.259 0.247 0.226 0.212 0.202

Molex - Rest. 0.258 0.259 0.247 0.226 0.212 0.202

Amphenol 0.149 0.143 0.140 0.142 0.139 0.132

Methode 0.125 0.099 0.112 0.119 0.119 0.112

Tyco N/A N/A 0.139 0.127 0.119 0.124

Industry Avg. 0.137 0.121 0.131 0.129 0.126 0.123

Operating Profit Margin:

The operating profit margin is calculated by taking operating income and dividing

it by net sales. This ratio reveals how efficient the company is in converting sales to

profits thus meaning the higher the profit margin the more lucrative the company.

Molex is consecutively lower than the industry average over the past five year period.

However, if you consider that Amphenol outperformed all the other companies

significantly this greatly effects the industry average therefore, in comparison to Tyco

and Methode, Molex performs pretty consistently while predominately staying in the .05

to .1 range. However, when restating Molex’s operating profit margin it is obvious that

there were some cost structure issues and that Molex might not be efficiently

controlling their cost of goods sold or the selling general and administrative expenses.

126 

 

2002 2003 2004 2005 2006 2007

Molex 0.059 0.055 0.098 0.080 0.108 0.098

Molex - Rest. 0.039 0.024 0.063 0.044 0.072 0.053

Amphenol 0.169 0.165 0.181 0.190 0.172 0.194

Methode 0.001 0.091 0.081 0.093 0.073 0.073

Tyco N/A N/A 0.068 0.083 0.090 0.056

Industry Avg. 0.085 0.128 0.110 0.122 0.112 0.108

Net Profit Margin:

The Net Profit margin is calculated by taking net income and dividing it by net

sales. This ratio examines how much profit a firm retains after expenses in relation to

0

0.05

0.1

0.15

0.2

0.25

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

127 

 

sales. A high net income is desired most by investors, for net income is the most

significant number on the income statement because it is the last line item. A high net

profit ratio is a good indicator that a firm is able to manage their costs and maintain

stable to high net sales. While a low ratio indicates low sales or poor cost

management.

2002 2003 2004 2005 2006 2007

Molex 0.045 0.046 0.078 0.059 0.083 0.074

Molex - Rest. 0.030 0.014 0.040 0.037 0.056 0.042

Amphenol 0.078 0.084 0.107 0.114 0.103 0.124

Methode 0.012 0.060 0.055 0.065 0.040 0.058

Tyco N/A N/A 0.065 0.096 0.093 -0.041

Industry Avg. 0.045 0.072 0.076 0.092 0.079 0.047

‐0.06

‐0.04

‐0.02

0

0.02

0.04

0.06

0.08

0.1

0.12

0.14

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

128 

 

As the graph shows, the industry average indicates a steady growth from 2002

to 2005 and then a rapid decline from 2005 to 2007. This could be explained by many

reasons such as companies being unable to make high sales due to economic recession

or that companies are having a hard time managing costs. While Molex saw growth

from 2005 to 2006 and a fall in 2006 to 2007, Amphenol and Methode had the reverse

effect and experienced a decline in 2005 to 2006 and growth from 2006 to 2007, while

the leader in the industry Tyco experienced a steady decline from 2005 to 2006 and

then a rapid decline from 2006 to 2007. Tyco’s decline from 2006 to 2007 was so

significant that when observing the industry average you can tell that the slope of the

curve was also greatly affected because Amphenol, Molex, and Methode have not

experienced declines of that magnitude.

Asset Turnover:

Asset turnover is calculated by taking sales revenue of a given year and dividing

it by total assets of the previous year. This ratio examines the amount of return a

company receives in relation to the dollar amount a firm obtains in their asset accounts.

A high asset turnover is desirable because it reflects proficient assets in terms of

generating revenue for a company. Methode has been the most successful at

maintaining a steady asset turnover, while Amphenol has been consecutively above the

industry average but inconsistent at maintaining a sound growth. While Molex has

experienced the most solid growth compared to the rest of the companies in the

industry, Tyco has been the least successful at obtaining a turnover remotely close to

that of the industry average or the rest of the companies. It is important to keep in

mind that an impairment of goodwill negatively affects assets therefore, after an

impairment of goodwill the restated version of Molex’s asset turnover improved each

year. This is an excellent indicator that Molex has learned how to efficiently use assets

to generate sales.

129 

 

2002 2003 2004 2005 2006 2007

Molex 0.76 0.79 0.87 0.94 0.96 0.98

Molex - Rest. 0.77 0.81 0.90 0.98 1 1.03

Amphenol 0.95 1.05 1.17 0.94 1.13 1.07

Methode 1.10 1.15 1.14 1.11 1.13 1.09

Tyco N/A 0.51 0.59 0.64 0.67 0.57

Industry Avg. 1.02 0.90 0.97 0.90 0.97 0.91

Return on Assets:

Return on assets is the greatest indicator of profitability by examining how much

return a company receives in relation to total assets. Return on assets is calculated by

taking net income of a given year and dividing it by total assets of the previous year.

0

0.2

0.4

0.6

0.8

1

1.2

1.4

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

130 

 

By using a lag method you can see how effective the previous year’s assets affected the

current year’s income. A high ratio is desirable because this reflects management’s

success in maintaining costs and utilizing assets to create income for a firm. As stated

in the graph, the global connector industry experienced significant growth from 2002 to

2005 and then a steady slow down from 2005 to 2007. Molex has seen secure growth

in the past five years and surpassed the industry average in 2006. However, after

restating the financials Molex has one of the lowest consecutive growths in the industry.

This is probably attributed to the acquisition of two new companies one in 2006 and

one in 2007 causing the impairment of goodwill to decrease net income.

2002 2003 2004 2005 2006 2007

Molex 0.035 0.038 0.076 0.058 0.087 0.081

Molex - Rest. 0.023 0.012 0.039 0.038 0.062 0.047

Amphenol 0.078 0.096 0.138 0.158 0.132 0.161

Methode 0.013 0.075 0.062 0.081 0.048 0.070

‐0.05

0

0.05

0.1

0.15

0.2

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

131 

 

Tyco N/A N/A 0.040 0.061 0.065 -0.030

Industry Avg. 0.030 0.057 0.080 0.100 0.082 0.067

Return on Equity:

Return on equity is extremely similar to return on assets in the sense that ROE is

an excellent indicator of a firm’s performance. ROE provides insight as to how well

managers are using the funds invested by the firm’s shareholders to create returns

(Palepu Healy). To calculate return on equity you must take a firm’s net income in a

given year and divide it by the firm’s shareholders equity of the previous year. As the

graph indicates the industry average is downward sloping. However, if you study the

graph closely you notice that companies such as Tyco, Molex, and Methode do not

follow this industry trend. In fact it is safe to say that the industry average tends to

follow Amphenol’s movement. This could be in large part due to Amphenol’s ROE being

significantly higher than the other companies. For instance, from 2004 to 2006 the

industry average indicates a steady decline in ROE just like Amphenol, but overall

Methode, Molex, and Tyco saw a steady increase in their ROEs.

While Molex does have a lower ROE compared to the other companies, Molex

also has the most stable growth out of all the companies in the global connector

industry. Although, after restating the financials Molex’s ROE dropped but still shows a

steady growth for the five year period. The drop in ROE can be attributed to the

acquisition of two companies which caused Molex to expense goodwill therefore causing

net income to be lower each year.

132 

 

2002 2003 2004 2005 2006 2007

Molex 0.042 0.048 0.093 0.073 0.109 0.106

Molex - Rest. 0.028 0.015 0.048 0.047 0.079 0.062

Amphenol 0.773 0.623 0.505 0.428 0.371 0.391

Methode 0.017 0.095 0.077 0.103 0.060 0.089

Tyco N/A N/A 0.115 0.139 0.121 -0.050

Industry Avg. 0.395 0.359 0.232 0.223 0.184 0.144

Conclusion

When comparing the profitability ratios of the different firms in the global

connector industry, it is easy to see exactly where Molex lies in terms of efficiency and

organization. When comparing ratios such as operating expense ratio and gross profit

margin Molex is the leader in the industry. However, after taking selling, general, and

administrative expenses into consideration you see a Molex start to lag behind their

‐0.1

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

133 

 

competitors for example, they are lower in their operating profit and net profit margins.

This is usually attributed to poor cost management and could possibly steer investors

away from Molex. When comparing asset turnover Molex starts out behind their

competitors but is able to maintain a solid growth therefore, surpassing the industry

average in 2006. While Molex’s ROA and ROE started off being lower than the industry

average, Molex was able to maintain a stable and increasing growth unlike a majority of

their competitors. Overall, Molex’s profitability performance is excellent but is greatly

affected by their subpar cost management as compared to their competitors.

Firm Growth Rate Ratios:

Calculating growth rate ratios of a firm can help evaluate if a firm can maintain

its future increasing profits without the need of outside financing or changing capital

structure. Using these ratios can help you compare firms of different sizes without

distortion, and distinguish trends or irregularities between the firm and the industry.

Maintaining growth rates can be difficult because if a growth rate continues to grow

rapidly with no change in liabilities it will cause the debt to equity ratio to shrink. With a

smaller debt to equity ratio and increased assets, the firms will continually improve their

credit rating and borrowing cost will go down thus causing a change in cost of capital.

If the firm borrowed money now it would be an advantage because of their lower cost

of borrowing. The firm could increase their leverage which would be beneficial if they

could earn more off of a new project financed by debt than they owe, and debt can be

a tax write-off. To keep a firms internal growth rate and sustainable growth rate

constant they must; cut dividends, increase net profit margin, and sell more without

changing the amount of assets.

134 

 

Internal Growth Rate:

The internal growth rate, also called IGR, is the highest rate that a firm can

expand to without using outside financing. This growth is generated by cash flows

retained by the firm. The IGR can be calculated by taking return on assets also know as

(ROA) which equals, (net income divided by last year’s total assets) and multiplying it

by the plowback ratio which is as follows (1-dividends paid, divided by net income).

2002 2003 2004 2005 2006 2007

Molex 0.026 0.029 0.067 0.048 0.074 0.062

Molex - Rest. 0.014 0.003 0.031 0.027 0.048 0.028

Amphenol 0.078 0.096 0.138 0.150 0.127 0.156

Methode -0.011 0.050 0.035 0.058 0.027 0.050

‐0.05

0

0.05

0.1

0.15

0.2

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

135 

 

Tyco N/A N/A 0.040 0.061 0.065 -0.033

Industry Avg. 0.033 0.073 0.071 0.090 0.073 0.058

The graph above shows the IGR’s of Molex and its competitors. Molex is not

used in the calculation of the industry average so that comparisons can be made

between Molex and the average IGR’s of its competitors. Molex restated is consistently

lower and moves directly opposite of the industry average until mid year 2006 when

they both declined at the same pace. Amphenol has consistently been above average is

likely to continue its rapid growth in to the next few years. The Molex restated IGR is

well below average and in 2005 was 6.3% below average. This below average growth

rate shows that Molex does not have much potential for growth in the next few years

unless they can at least reach industry averages. Tyco is experiencing a very negative

growth rate which began around the time they spun off from Tyco international (Tyco

10K).

Sustainable Growth Rate:

The sustainable growth rate or (SGR) is the highest rate of growth that a firm

can sustain without increasing its financial leverage or changing its capital structure.

The SGR can be used as a benchmark to evaluate a firm’s growth rate plans. The SGR

can be calculated by taking return on equity also know as (ROE) which equals, (net

income divided by last year’s total equity) and multiplying it by the plowback ratio which

is as follows (1-dividends paid, divided by net income).

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2002 2003 2004 2005 2006 2007

Molex 0.032 0.036 0.084 0.061 0.096 0.082

Molex - Rest. 0.018 0.004 0.039 0.035 0.064 0.037

Amphenol 0.506 0.352 0.375 0.420 0.308 0.330

Methode -0.014 0.062 0.045 0.073 0.036 0.063

Tyco N/A N/A 0.040 0.115 0.110 -0.068

Industry Avg. 0.246 0.207 0.153 0.203 0.151 0.108

The sustainable growth rates above are almost identical to the IGR’s. With

Molex’s low restated SGR we can predict that due to their small pool of funds they will

have very little growth within the industry. Decrease in retained earnings can increase

‐0.1

0

0.1

0.2

0.3

0.4

0.5

0.6

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

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the cost of borrowing creating a change in the capital structure of a firm. Tyco is

Molex’s largest competitor, but because of Tyco’s negative SGR we can predict no

growth until the firm makes radical changes to their capital structure. Amphenol in 2007

with its SGR of 9.9% above the industry average will most likely continue to outperform

the industry at least for the short run.

Conclusion

Molex needs to increase retained earnings and or cut dividends so they can grow

their pool of equity which in turn will fuel future growth. Cutting dividends is not a good

sign for a firm and can scare away shareholders. If Molex does not change some of

their financial policies they will not be able to reach or beat the industry average. With

the current 2008 economy downward spiral the industry average is likely to be radically

lower in the years to come. Growth comes easy when the economy is booming but with

a worldwide recession growth will be extremely hard in some industries. Consumers will

have less money to spend on new cell phones, cars, TV’s, and other electronics which

all involve connectors. The connector industry will likely take a hard hit in a full blow

global recession. Tyco may have trouble keeping their lights on if they see negative

growth rates for too many years in a row.

Capital Structure Ratios:

Capital structure ratios are used to explain how a firm finances their assets. Does

the firm use debt or equity to fund projects and assets? Debt comes from loans or

bonds while equity is from selling shares of company stock. A firm that has little to no

equity will have a poor credit rating which means high interest rates. A firm with lots of

equity can make its payments on debt with ease. There are three capital structure

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ratios we will look at to help measure ability to make interest payments, financial

leverage, and firm credit rating.

Debt to Equity:

Debt to equity is the backbone of the capital structure. Firms must increase

assets and projects to stimulate growth in profits and equity. If a company wanted to

build a new $65 million headquarters they could either take out an interest bearing loan

for that amount or sell company stock to increase equity to fund the project. A

company with large amounts of debt and little equity on their books has a greater risk

of default than a company with a small amount of debt and large amounts of equity.

Having the right mix of debt to equity is important; having no debt can be a bad thing.

Using debt financing can provide important tax write-offs, and if a firm has a great

credit rating their cost of borrowing will be low. If you can pay 1% interest on a loan

that provides you an asset that creates 7% returns taking on debt is to your advantage.

To calculate debt to equity you take total liabilities and divide it by total equity.

0

1

2

3

4

5

6

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

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2002 2003 2004 2005 2006 2007

Molex 0.241 0.228 0.245 0.258 0.304 0.314

Molex - Rest. 0.237 0.236 0.255 0.272 0.318 0.334

Amphenol 5.46 2.65 1.71 1.80 1.43 1.12

Methode 0.261 0.237 0.264 0.262 0.284 0.700

Tyco N/A N/A N/A 0.896 0.709 1.081

Industry Avg. 2.86 1.45 0.989 0.988 0.808 0.822

Molex and Methode have about the same debt to equity ratio which is lower than

the industry average. Both companies have maintained a very consistently flat debt to

equity ratio. Amphenol started out with an extremely high amount of debt but has cut it

down to just above the industry average. The industry average may be skewed because

of Amphenol’s much higher debt to equity ratio. Tyco seems to be taking on more debt

while all its competition is cutting their debt. Tyco with its negative growth rates and

increasing debt could lead to big trouble, especially during a recession. Molex is in a

good position due to their low debt to equity. Molex has a good credit rating and in

times of a credit crunch fuel by the onset of a recession, companies like Tyco might find

it hard to pay for their debt unlike Molex.

Times Interest Earned:

Times interest earned is a ratio used to measure how much income is provided

from operations to pay interest expenses. As debt increases the interest expense will

changing the capital structure. To calculate times interest earned you take net income

before interest and taxes (NIBIT) and divide it by the interest expense. If a firm does

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not have enough money to cover its interest expense, than it would be in great risk of

defaulting.

2002 2003 2004 2005 2006 2007

Molex 16.73 12.52 59.01 31.52 31.52 37.47

Molex - Rest. 11.01 5.45 37.88 17.23 20.76 20.01

Amphenol 3.79 6.93 12.27 14.25 10.94 14.99

Methode N/A N/A N/A N/A 102.4 109.38

Tyco N/A N/A N/A 3.36 4.53 3.26

Industry Avg. N/A N/A N/A 8.81 39.29 42.55

0

20

40

60

80

100

120

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

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Methode has skewed the industry average because they have extremely low

levels of interest expense compared to their competitors. Molex restated has stayed

between, 17 and 21 for the past three years. To clarify what this means in 2007 Molex’s

time’s interest earned was at 20.01, this means they have $20 for every $1 of interest

expense. A high number is desirable because it insures shareholders that the firm can

easily cover their interest expense. Tyco is at risk because they are increase debt thus

increasing interest but are not increasing NIBIT. If Tyco cannot make its interest

payment they could very likely go bankrupt. Molex is at a very safe number and is in no

threat of not covering its interest payments.

Debt Service Margin:

The debt service margin measures how much cash is available to cover current

portions of long term notes. To calculate this ratio you take Operating cash flows and

divide it by the previous year’s current portion of long term notes payable. The higher

the number produced by the ratio the higher the amount of cash held by the firm

available to cover the debt.

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2002 2003 2004 2005 2006 2007

Molex 22.17 18.07 20.80 43.19 62.58 3.53

Molex - Rest. 20.73 14.61 14.59 37.17 52.06 2.71

Amphenol 0.232 0.319 0.482 0.300 0.428 0.538

Methode N/A N/A N/A N/A N/A N/A

Tyco N/A N/A N/A 0.405 0.494 0.456

Industry Avg. N/A N/A N/A 0.352 0.461 0.497

Methode’s 10K did not provide any information about current portions of long

term debt due. The reason for large variations between firms might be explained by

when liabilities become due. It appears that Molex had no current portions of long term

debt due until 2007. This explains why Molex dropped from 62.58 down to 3.53 or just

below industry average. Molex appears to be able to generate more operating cash

0

10

20

30

40

50

60

70

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

143 

 

flows then their competitors while have fewer amounts of current long term notes

payable.

Altman’s Z-Score:

Altman’s Z-score is a formula that uses five weighted variables to compute a

bankruptcy score (Palepu & Healy). Risk averse shareholders would want to use this

test on companies they may buy stoke in to ensure that the company is in no risk of

bankruptcy. The Z-score also can be used as a credit score indicator; it can help you

compare the credit risk among firms. If a firm has a Z-score below 1.81 then the model

strongly predicts bankruptcy. If a score is between 1.81 and 2.67 they are said to be in

a gray area. And a firm with a score above 2.67 is considered to good. The higher the

Z-score the better credit rating the firm has. A firm with a Z-score above 3.00 will have

a much lower interest rate than a firm with a 2.00. To calculate the Altman’s Z-score

use the formula below.

1.2(Net Working Capital/Total Assets)

+1.4(Retained Earnings/Total Assets)

+ 3.3(Earnings before Interest and Taxes/Total Assets)

+ 0.6(Market Value of Equity/Book Value of Liabilities)

+ 1.0(Sales/Total Assets) = Altman’s Z-Score

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2002 2003 2004 2005 2006 2007

Molex 53.20 28.02 24.84 19.67 32.13 25.83

Molex - Rest. 53.20 28.02 24.84 19.67 32.13 25.83

Amphenol 8.91 7.91 17.64 13.99 19.86 20.84

Methode 13.56 15.69 19.71 13.13 19.68 21.95

Tyco N/A N/A N/A N/A N/A N/A

Industry Avg. 11.23 11.80 18.68 13.56 19.77 21.39

The Z-scores for Molex and their competitors are all safely above the bankruptcy

and gray area. Molex has the highest Z-score making them the safest and most credit

worthy firm. Molex will have much lower interest rates than their competition. Lower

0

10

20

30

40

50

60

2002 2003 2004 2005 2006 2007

Molex

Molex Restated

Amphenol

Methode

Tyco

Industry Avg.

145 

 

interest rates will allow Molex to borrow money to finance new project for a lot less

money than Amphenol. Most firms are right at average which is still far from danger.

Conclusion

Capital structure analysis using the three ratios: debt to equity, times interest

earned, and debt service margin will give you a great view of how each firm is

structured. Starting with debt to equity, Molex has one of the industry’s lowest ratios

which is good because they have much more equity than debt. Molex’s time’s interest

earned has consistently stayed above, or right at average. Molex has always had more

than enough net income before interest and taxes to cover their interest expense. The

debt service margin has large variations caused by the periodic current long term notes

that become due. Molex experienced large declines when their debt became payable;

but they still remain above average. Molex has continually been a top performer in their

industry and will most likely continue this trend.

One more test can sum up what we have already concluded about Molex. The Z-

score show that Molex is the safest and has the best credit score in the industry. Due to

their safe rating and sound capital structure; Molex will most likely survive and

outperform the competition in this troubled global economy. Tyco is showing signs of

trouble and will most likely continue to struggle in the years to come unless they

improve upon their capital structure by decreasing debt and increasing cash inflows.

Estimating Cost of Capital

Cost of Equity:

According to investopedia.com, the cost of equity is the minimum rate of return

a firm must offer shareholders to compensate them for waiting for their returns, and for

bearing some type of risk(investopedia.com). The cost of equity is usually higher than

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the cost of debt since it cost more to finance equity. We used the Capital Asset Pricing

Model (CAPM) to calculate Molex’s cost of equity. The cost of equity is calculated by

taking the estimated beta of the firm and multiplying it by the market risk premium and

then adding this to the risk free rate.

Cost of Equity = Beta of the firm (return of the market – risk free rate) + risk free rate

We used regression analysis to calculate the appropriate beta for Molex. A firm’s

beta measures the firm’s amount of systematic risk that can be explained by the risk of

the market, we then multiplied this beta by the market risk premium. The market risk

premium is the return for the market (S&P 500) minus the risk free rate, which we

derived from the St. Louis Federal Reserve. The current risk free rate according to the

Federal Reserve is approximately 4.02%. We believe the current market risk premium is

equal to 8%.

In order to perform the regression analysis, we took Molex’s monthly stock prices

over the last seven years, we gathered 3 month, 6 month, 2 year, 5 year, and 10 year

risk free rates, and then took an average return of the S&P 500. We then ran the

regression analysis for 24, 36, 48, 60, and 72 month investment horizons in order to

estimate the most effective beta. We broke down the regression output by looking for

the highest adjusted R^2 value. The higher the firms adjusted R^2 the higher the

explanatory power of the estimated beta. Our highest value of adjusted R^2 was

38.6%, which was presented in the 72 month holding period, and had an accompanying

beta of 1.47. After we calculated all of the variables that make up the Capital Asset

Pricing Model, we computed Molex’s cost of equity to be 15.78%. We believe that this

number is accurate because of the extremely high explanatory power that Molex has.

We also used a 95% confidence interval to derive our upper and lower bound betas of

1.90 and 1.04. We computed our upper bound cost of equity, using a 95% confidence

interval, to be 19.25% and our lower bound to be 12.30%.

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Cost of Equity

15.78% = 1.47 (0.08) + 0.0402

Cost of Equity with 95% CI

Upper Ke: 19.25% = 1.90 (0.08) + 0.0402

Lower Ke: 12.30% = 1.04 (0.08) + 0.0402

Size adjusted

CAPM is most commonly used method to find the cost of equity, however, data

indicates the model is imperfect. Factors such as the “size effect” can affect the

amount of return an investor receives, for instance, smaller firms tend to generate

higher returns. The answer as to why the size effect can affect capital is uncertain,

although, this could be because smaller firms are riskier investments or that they are

underpriced. Thus meaning if we use returns based on firm size as an indicator of the

cost of capital, we assume that larger firms carry less risk. The best method to

estimate the cost of capital associated with the “size effect” is by adding the size

premium associated with the firm to the firm’s CAPM or more simply put, the cost of

equity = the riskless rate of return + beta risk(market risk premium) + size

premium(Palepu Healy). Based on Molex’s market value of 2.26 billion we found their

size premium to be 1.7, therefore, making our cost of equity associated with the “size

effect” 17.48%.

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Size adjusted

1.47(.08)+.0402+.017= 17.48%

Alternative Cost of Equity

We used the backdoor cost of equity to get an alternative measure of Molex’s

cost of equity. We computed the backdoor method and came up with a cost of equity of

10.03%, which we believe is a little too low. We believe the size adjusted cost of equity

of 17.48% is more accurate. We have came to the conclusion that the backdoor cost of

equity is not very accurate in explaining Molex’s current financial position, so we think

that investors should always use the sized adjusted cost of capital model when

determining the risk associated with investing in Molex.

ROE Growth Rate P/B Cost of Equity

Molex 9.86% 7.04% 0.99 10.03%

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Cost of Debt

Cost of Debt

Liabilities Debt Interest rate

Weight WACD

Short Term Loans $66, 687 1.3% .069 .09%

Accounts payable $350,413 2.13% .38 .81%

Salaries, commissions, and bonuses $74,689 2.13 .08 .17%

Other accrued expenses $84,525 2.13 .094 .2%

Income Taxes Payable $73,124 3.69% .079 .29% Other noncurrent liabilities $21,346 7.8% .023 .18%

Pensions and postretirement benefits

$105,574 6.2% .115 .71%

Long term debt $146,333 7.8% .159 1.24%

Total Liabilities 922,691 3.69%

A company’s value consists of both debt and equity, therefore it is important to

assess the costs associated with these accounts. Cost of debt is calculated as the

weighted average of a firm’s interest rates applied to its liabilities. Evaluating the cost of

debt can’t help assess a company’s riskiness compared to that of its competitors.

Although compared to cost of equity, cost of debt tends to be a lower percentage. Cost

of debt generally is lower than cost of equity because equity holders are characterized

with having a risk claimant which makes them more susceptible to risk of default.

Equity holders have uncertain returns due to the fact that they are compensated when

and only when all debt has been alleviated in the occurrence of liquidation.

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In the above table we have presented the associated interest rates for the

liability accounts using Molex’s 10-K , and other available resources. Molex’s 10-K

disclosed the interest rates applicable for short term loans, pensions and postretirement

benefits and long term debt. The 10-K stated that long term debt varied from 1.3% to

7.8%, therefore we utilized the accounting principle of conservatism to determine the

interest rate we would apply to Molex’s long term debt (7.8%). We estimated the

interest rates for accounts payable, salaries, bonuses ,commissions and other accrued

expenses using the 3 month financial rate AA grade commercial paper from the St.

Louis Federal Reserve (2.13%). We applied the 10 year treasury yield for risk free rates

as the interest rate for income taxes payable(3.69%). We calculated the weighted

average cost of debt of the liabilities by multiplying the individual accounts debt by the

applicable interest rate and dividing that total by the sum of the firm’s total liability. We

then calculated the weight of each of the accounts debt by dividing the previously

calculated weighted average cost of debt over the assigned interest rate of each of the

accounts. After these calculations we determined Molex’s cost of debt to be 3.69%.

Weighted Average Cost of Capital (WACC)

A company is either financed by equity or debt, the weighted average cost of

capital is a weighted sum of the cost of equity and debt which helps firms determine

what interest rate is used to finance the firm. In order to find WACC you must take into

consideration WACC before and after taxes. Without tax the WACC before tax is

13.95%, whereas, if you use the effective tax rate of 36% as provided in Molex’s 10K

you find that the WACC after tax is 13.61%. Due to the acquisition of two companies in

2006 and 2007, we had to impair goodwill and restate Molex’s financials. This

negatively affected equity therefore, dropping the WACCbt to 13.7 % and WACCat to

13.38%.

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Weighted Average Cost of Capital

Cost of debt

MVL/MVA Tax rate Cost of equity

MVE/MVA WACC

WACCbt 3.69% 25.63% 0% 17.48% 74.37% 13.95%

WACCat 3.69% 25.63% 36% 17.48% 74.37% 13.61%

WACCbt

Revised

3.69% 27.1% 0% 17.48% 72.9% 13.7%

WACCat

Revised

3.69% 27.1% 36% 17.48% 72.9% 13.38%

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Financial Statements Forecasting

In order for a business to make more informed decisions about the future, a

company has to forecast out their financial statements. Forecasting is the method of

reviewing current and historical data in order to make educated assessments of the

company’s future trends. In order to make these evaluations, an analyst will use

trends, growth rates, averages, and ratios to calculate the future values. The following

section will include both the original and restated version of the balance sheet, income

statement, and statement and cash flows forecasted out ten years.

Income Statement:

When forecasting the financial statements the income statement is the most

important which is why an analyst starts with this statement to begin the process. The

reasoning behind this is that assumptions made in the income statement will flow into

the balance sheet as well as the statement of cash flows. Also due to the importance of

this financial statement it is imperative that it is as accurate as possible so that the

future expectations are reasonable and managers of the company can make better

decisions for the future.

The first step to take in forecasting the income statement is to look at the sales

growth rate in order to determine future sales revenue. At this point in time of the

economy we are in a recession much like the one that occurred in 2000-2001 time

frames. When deciding on a growth rate we took those years into consideration. The

2008 sales growth rate look much like the one back in the early 2000’s right before the

company was affected by the recession. By using this information we decided to use

the decline of 10% growth rate to show that the company is going to hit hard by the

recession in the same way that it was 2002. This is due to the way people are reacting

to the economic situation and losing faith in the market. We also believe that the

economy is not going to recover near as quickly as it did in the early 2000’s and the

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company would experience another hard year in 2010 and have a declining growth of

6%. We choose 6% because it is 40% less of a hit for the company when compared to

the one for 2009. With 2008, the current year, being an election year we feel that in

2011 policies from the new president will be starting to improve the economic situation

but not quite to the extent that sales return to their normal state. This is why we gave

2011 a growth rate of 7.5%, which half of our chosen growth rate. An economy cannot

just bounce right back into a normal state after a recession, it takes time. In 2012, we

believe that the economy will have completely pulled out of the recession and the

company’s growth rate will remain at 15% for the remainder of the forecasted years.

We chose 15% because that is the approximate average growth rate for the company

when it is not in a recession.

The next thing that we forecasted was cost of goods sold. In order to create a

consistent rate to use for this entry across the board we had to find the average of the

past years cost of goods sold. All of the years had a relatively low fluctuation so we

included all of the past years in the average since there were no outliers. The average

for cost of goods sold turned out to be 67.4%. We kept the 67.4% the same because

the gross profit margin decreased in 2005 quite a bit and then very slow started to

increase again. Due to this keeping the 67.4% seemed reasonable and there was no

reason to move it up or down. Since cost of goods sold is a percentage of net sales, we

multiplied our average by the net sales of the year.

As mentioned earlier our analysis of key success factors, this industry takes on

the differentiated strategy rather than cost leadership. Due to this being the strategy of

the company, costs are not of big importance. Although the costs that a company

endures are important, they are not a top priority for the company to worry about when

forecasting.

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The next item on the income statement to be forecasted is gross profit. As

accounting tells us, gross profit is calculated by subtracting cost of goods sold from net

sales. When looking at gross profit you can see that it is 32.6% of net sales. In

reference to the gross profit margin you can see that there are fluctuations, but overall

it remains fairly consistent. For this reason we believe that Molex should not have any

problems in the future with liquidity or with the overall profit of the company.

After gross profit the next item to be forecasted is operating income. Accounting

tells us that operating income is equal to gross profit minus selling, general, and

administrative expenses as well as other expenses and impairment. It is virtually

impossible to figure out what a company’s impairment is going to be as well as all of

the casual expenses that a company is going to experience each year. Due to this we

did not use the accounting formula. In order to be more accurate with the estimate we

used the average operating profit margin of 8.3% of total net sales. Operating income

tells what the income is before items such as interest and taxes are taken into

consideration.

The last item on the income statement to forecast is net income. Normally this

number is calculated by subtracting out interest expense and taxes from operating

income. Due to it being unreasonable to predict taxes because the tax rate can

change, we do not use this approach. The net profit margin is mostly increasing;

therefore, it can be concluded that net income is going to increase along with that of

net sales. We chose to use the growth rate of 7.18% for after the recession passes

because it is the best average from the net profit margin.

155 

 

156 

 

157 

 

Restated Income Statement:

The difference between the original and the restated income statement is that

the restated includes goodwill impairment expense. Since this expense is included into

the statement the net income will be affected as well. In the original income statement

a growth rate for the years that were not in a recession used a growth rate of 7.18%,

yet in the restated income statement net income a growth rate of 4.2% is used.

Goodwill is an asset that has to be impaired and by Molex not originally taking that

expense out of net income it makes a bad impression to investors. Although goodwill

or goodwill impairment cannot reasonably be forecasted, it is still known that net

income will have this significant difference. The two different growth rates were both

configured by taking the average of past net incomes, the difference come out so

strong because of the impairment expense. If Molex were to be honest about their

expense issues like this would not arise.

158 

 

159 

 

160 

 

Balance Sheet:

The second financial statement to forecast is the balance sheet. This statement

informs an investor about the company’s assets, liabilities, and stockholder’s equity to

the extent that an investor would need to know about a company. By predicting a

company’s balance sheet a manager can have a better view of how retained earnings

are going to look in the future.

The base of the balance sheet comes from the future sales growth that was

anticipated on the income statement and to further link the two statements asset

turnover is used. By using the forecasted sales from the income statement and

combining those numbers into with the total asset turnover ratio of 1.05, the value for

future assets can be forecasted. The figure 1.05 was used for asset turnover because it

was the best fit in reference to the trend that was shown on the graph.

The next step in forecasting the balance sheet after predicting total assets is to

determine non-current assets. This is calculated by having non-current assets as a

percentage of total assets. The decided percentage of total assets as non-current

assets is 50%. In the electronics industry about half of the assets are current and half

of them are non-current which is why we are comfortable with using this percentage for

Molex. From here the current liabilities can be forecasted by using the current ratio

that was already configured and the current assets that has already been forecasted.

The current ratio that we decided to use was 2.7 because of the prior year’s ratios.

After assets and liabilities you move down to the stockholder’s equity portion of

the balance sheet. When forecasting retained earnings the following formula is used:

Retained Earnings = beginning balance retained earnings + Net Income – Dividends.

By using parts from all three of the financial statements retained earnings can be

forecasted. After retained earnings are calculated stockholder’s equity can be obtained

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by simply adding the change in retained earnings to the previous year’s stockholder’s

equity.

After obtaining stockholder’s equity as well as total assets the last thing to

forecast is total liabilities. In order to find liabilities the common accounting equation,

assets = liabilities + equity, is used. According to accounting rules the equation for the

balance sheet has to balance or else there are serious problems. By subtracting out

current liabilities from total liabilities you get non-current liabilities to finish forecasting

the liabilities section of the balance sheet.

At this point there are still a few gaps that have to be filled in such as accounts

receivable as well as inventory. In order to find these numbers we simply used the

turnover for both of them. For accounts receivable we configured a 4.52 turnover, so

by multiplying net sales for the year by 4.52 will give you the accounts receivable

balance. The 4.52 turnover was taken from the accounts receivable turnover. To find

inventory a turnover of 5.97 was used which was taken from the inventory turnover

equation. By discovering these numbers investors will be able to have a good idea of

where the company’s balance sheets numbers will come from.

162 

 

163 

 

164 

 

Restated Balance Sheet:

Due to Molex having understating their goodwill impairment, the financial

statements had to be restated so that investors could see the real status of the

company. Since goodwill is an asset the financial statement that gets affected the most

is the balance sheet. In the process of restating the financials goodwill was impaired by

20% which in-turn affects both assets and stockholder’s equity.

Given that stockholder’s equity is decreased because of the restating and net

earnings being decreased, retained earnings will also reflect this change. The total

assets turnover rate changed from 1.05 to 1.1 for the restated balance sheet. The

problem with this increase is that it decreases means that total assets is going to be

less than what the original version of the balance sheet states. Even though goodwill

was impaired it can be assumed that total assets will increase over time because of the

consistent sales growth. Since assets as a whole is decreasing non-current assets,

accounts receivable, and inventory will all use the same growth rates that were used in

the original balance sheet.

Net sales can only increase as much as inventory is increased because a

company cannot sell goods that it does not have. The goal of a company would be as

efficient as possible which would mean as inventory comes in the company wants to sell

it as soon as it can. If Molex has goods sitting on the floor for a long time then they

are losing money, and if they are selling goods before they have them problems will

come.

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Statement of Cash Flows:

  The final statement to forecast is the statement of cash flows. This statement is

forecasted last because it is the most difficult and imprecise, this holds true even when

have all of the information because the statement of cash flows does not always match

the company’s income statement and balance sheet. Despite the difficulty of this

statement it is still needs to be forecasted because of the information that it holds. The

statement tells investors the cash flow from operations, cash flow from investing, and

cash flow from financing activities. Out of all three of these components of the

statement the cash flow from operations is the most important because it tells how

efficient the firms is as well as if the firm is gather more debt or contributing to

operations for the future.

When forecasting the statement of cash flows we looked for what rate was going

to give Molex a stable guide in evaluating the growth and or decline. In finding the

cash flow from operation there are three choices which are: CFFO/Net Sales, CFFO/Net

Income, and CFFO/Operating Income. The equation that gave the best results for

Molex was CFFO/Net Sales. The equation told us that 16.5% was the rate to use in

order to calculate the growth for cash in operating activities. Net income was

calculated in the income statement so it was transferred to the statement of cash flows.

After the operating activities are calculated we moved down to the investing

activities. Since the electronics industry does not invests as quite as much as they

spend in operating activities, we felt that it was necessary to use a growth rate of 15%,

for the years not in recession, which is just below the growth rate of operating

activities. The 15% growth rate was calculated by analyzing the growth rate in non-

current assets.

The final section of the statement of cash flows is the cash flow from financing

activities. The first part of the financing activities to compute is the dividends. Looking

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back at Molex’s dividend history we found that it increased about every three years at a

30% growth rate. We applied that same concept to the forecasting of dividends in

order to create the numbers. Due to the difficulty that the statement of cash flows

already holds, it is nearly impossible to calculate financing activities. It is an

unpredictable number to measure without having more information provided by Molex.

 

 

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Restated Statement of Cash Flows:

The restated statement of cash flows is calculated the exact same as the original

statement of cash flow. The differences between the two are that the restated includes

the goodwill impairment which affects net income a significant amount. Since net

income is affected, that means that cash flows from operating activities is less than

what is stated on the original version of the statement. The difference between the

restated and original net incomes, after the recession in 2012, comes out to be 58%.

The difference between the two net incomes is a significant amount due to the lack of

goodwill impairment in the original financials.

 

 

 

 

 

 

 

 

 

 

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Valuation Analysis

Methods of comparables

The methods of comparables are ratios used by analysts to determine the appropriate

value of a firm. The computed prices are based on industry averages that are fast,

simple, and easy to apply, however, the methods of comparables do not identify all the

factors that increase the value of a firm and often produce contradictory results. By

using comparables such as P/E trailing, enterprise value/EBITDA, P.E.G. ratio, etc. and

a margin of safety of 15%, we are able to offer an educated recommendation

concerning the value of Molex. Molex’s share price as stated on November 3, 2008 was

$14.89 thus making our margin of safety lie between $12.66 and $17.12.

Price/Earning Trailing

P/E trailing

PPS EPS P/E Trailing Computed Price

Molex 14.89 1.22 9.72

Molex restated 14.89 .59 4.70

Amphenol 29.16 11.26

Tyco 19.89 4.73

Methode 7.71 7.92

Average 7.97

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The trailing price to earnings ratio is a method of comparable that

uses available information to determine value. The trailing P/E is simply

the current price per share closed on the valuation date divided by the

current period’s earnings per share. We obtained the current period’s price

and earnings per share from yahoofinance.com. A P/E trailing industry average is

computed by taking the P/E trailing ratios as stated on Yahoofinance.com adding them

together and dividing by three. By doing so the global connector industry average

totaled to 7.97. By excluding Molex from the industry average we are able to get a

more accurate view of how Molex stands in the industry. Then to get the computed

price we multiplied the industry average P/E trailing to Molex’s earnings per share. The

computed prices based on an industry average of 7.97 are 9.72 and 4.70. Both

computed prices are below our 15% margin of safety thus meaning the P/E trailing

ratio suggests Molex is overvalued.

Price /Earnings Forecast

Forecasted P/E

Company PPS EPS 1yr Out

P/E Forecast

Industry ave P/E

Computed price

Molex 14.89 1.09 10.86 11.84

Molex restated

14.89 .61 10.86 6.63

Amphenol 29.16 11.21

Tyco 19.89 8.93

Methode 7.71 12.43

The next method we used was the forecasted price to earnings ratio. First we

had forecast our earnings per share by one year out. To do this we had to take our

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forecasted income from 2009 and then divide it by the number of shares outstanding.

Next we calculated an industry average of the P/E forecast. By taking the P/E forecasts

of Molex’s competitors off of yahoo finance and dividing it by three we obtained an

average of 10.86. Finally, by using the industry average of 10.86 and multiplying by

Molex’s EPS one year out, we found that the computed price was $11.84 as stated and

$6.63 restated. It was expected to see a reduction in the restated price due to the

impairment of goodwill, however, both prices are below our 15% margin of safety

suggesting that Molex’s price per share is overstated.

Price /Book

The price to book ratio compares the firm’s stock market value to the book value

of equity reflected in its financial statements. The ratio is calculated by dividing a firm’s

current price per share by its book value of equity per share. Price per share is the

current market value of a firms stock which is reflected in its current stock price. Book

Price/Book

PPS BPS P/B Industry

Avg.

Molex

PPS

Molex 14.89 13.52 1.10 1.06 14.33

Molex

Rest.

14.89 12.35 1.21 1.06 13.09

Amphenol 29.16 26.20 1.11

Methode 7.71 8.08 0.95

Tyco 19.89 17.68 1.13

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value of equity per share is calculated by dividing the firm’s current book value of equity

as presented in its most recent disclosure of financial statements by the total shares of

common stock outstanding. With the exclusion of Molex, we determined the industry

average. After determining the industry average we multiplied the average by Molex’s

book value of equity per share to determine Molex’s price per share. We implemented

the use of a 15% margin of safety, therefore the calculated price per share suggests

that Molex’s stock is fairly valued.

Price Earnings Growth (P.E.G.)

Comparable Company P/E Growth P.E.G. Industry Avg. Molex PPS Molex 29.74 .3342 .89 .95 28.25 Molex Rest. 54.54 .6128 .89 .95 51.81 Amphenol 11.73 17.00 .69 Methode 7.96 5.14 1.55 Tyco 4.37 7.05 .62 *Based on five year P.E.G.’s

Price earnings growth or P.E.G. is a valuation metric that gives an estimated

stock price that takes into account a growth in earnings. To calculate P.E.G. you need

your forecasted growth in earnings and calculated earning per share. If any firm’s

P.E.G. numbers radically differ from the numbers calculated for other firms they are

excluded from the industry average and considered outliers. To determine the industry

average, only consider the competitor’s P.E.G.s and exclude your own firm from the

calculation. The industry average is .95 which correlates with the consistent and logical

PEG value of one. Molex’s current stock price as of November 3, 2008 was $14.89, and

is considered when undervalued compared to the estimated price per share calculated

using the P.E.G. model. Molex’s restated PPS is very high at $51.81 because the five

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year growth is almost double that of the non-restated growth rate. The formula for

P.E.G. is provided below. Note: a five year P.E.G. is being used and numbers are

projected and may not be accurate.

P.E.G. = [(Price per share x shares outstanding)/ (Net Income (ttm))] / [(NI13-NI08)/ (NI08)]

P.E.G. = (P/E)/G (five yr.)

Price/EBITDA

To calculate price/EBITDA you divide the firm’s current market capitalization rate

by its earnings before interest, taxes, depreciation and amortization (EBITDA). To

derive the firm’s market capitalization rate you simply multiply its current price per

share by the number of shares it has outstanding. The information used in the

calculation of Molex’s price/EBITDA ratio was collected from its financial statements

disclosed in its most recent annual 10-K. The information used to calculate the ratios of

Molex’s competitors was collected using the informative Yahoo Finance website.

After collecting all the relevant information from Molex’s 10-K and the Yahoo

Finance website we were able to calculate the price/ EBITDA ratio for the firms

Market Cap ($ Bil)

EBITDA ($ Bil)

P/EBITDA Industry Avg.

Molex PPS

Molex 2.50 0.61 4.10 4.30 14.92

Molex Rest. N/A N/A N/A

Amphenol 4.63 0.73 6.34

Methode 0.31 0.89 3.48

Tyco 8.35 2.70 3.09

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operating within our industry. We then calculated the industry average, excluding Molex

and multiplied that by Molex’s price per share. We converted our answer to a per share

basis by dividing our calculation by Molex’s number of shares outstanding. The ratio’s

suggested price per share for Molex is within our 15% margin of safety which implies

that the company is fairly valued.

Enterprise Value/EBITDA

EV ($ Bil) EBITDA ($ Bil) EV/EBITDA Industry Avg.

Molex PPS

Molex 2.46 0.61 4.03 4.88 16.93

Molex Rest. N/A N/A N/A

Amphenol 5.81 0.73 7.96

Methode 0.20 0.89 2.25

Tyco 12 2.70 4.44

The enterprise value / EBITDA ratio is preferred by many analysts to the price to

book ratio because this particular ratio is unaffected by a firm’s capital structure. The

components of this ratio allow analysts to compare values of a business, free from debt,

to its earnings before interest. The components within this ratio consist of the firm’s

enterprise value and its earnings before interest, taxes, depreciation and amortization.

The first step in calculating the EV/EBITDA comparable is to determine the

enterprise value of the firm. Enterprise value is derived in adding the market value of

equity and the firm’s book value of liabilities minus cash and investments. After

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determining the first component, we then concentrate on the calculation of the firm’s

earnings before interest, taxes, depreciation and amortization. To calculate EBITDA we

simply subtract the firm’s expenses, excluding interest, taxes, depreciation, and

amortization from its revenues. After determining both components of the equation you

then divide the firm’s enterprise value by its earnings before interest, taxes,

depreciation and amortization. After calculating each individual firm’s EV/EBITDA ratio

we then took an industry average, excluding Molex. Molex’s price per share using this

ratio is $16.93, which suggests that it is fairly valued under our assumed 15% margin

of safety.

Price to Free Cash Flows (P/FCF)

Price to free cash flows or P/FCF is a valuation metric that gives an estimation of

price per share. To calculate P/FCF, first take price per share and multiply that amount

by the total number of shares outstanding, which gives you the market cap. Second,

take the market cap and divide it by the firm’s free cash flows. Free cash flows are

calculated by using cash flows from operations and adding or subtracting cash flows

from investing activities. Next, the industry average is calculated by averaging the

P/FCFs of the industry competitors, excluding the company being analyzed. If any of

the competitor’s P/FCF numbers are negative they are considered to be outliers and are

left out of the industry average.

P/FCF= (Number of shares outstanding x Price per share)

(Cash flows from operations +/_ Cash flows from investing)

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To find P/FCF per share you multiply the industry average by the firm’s FCF, and

then divide by the number of shares outstanding. According to its most recent 10-K the

number of shares outstanding for Molex is 176.07 million. Molex’s stock price as of

November 3, 2008 was $14.89 and according to the calculated P/FCF per share the

price of Molex is estimated at $37.67 and as restated at $21.69. The calculated price to

free cash flows exceeds the current stock price, which implies that Molex’s current stock

is undervalued. Using the restated P/FCF per share, Molex’s current market price is

undervalued by $6.80 per share.

Market

Cap

FCF P/FCF Industry

Avg.

P/FCF per

share

Molex 2,380.00 260.98 9.12 25.42 $37.67

Molex Rest. 2,380.00 150.26 15.84 25.42 $21.69

Amphenol 4,830.00 108.82 44.39

Methode 312.44 48.45 6.45

Tyco 7,730.00 (3.00) (2576.67) outlier

*Market cap and free cash flows in millions

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Dividends/Price

Dividends/Price

PPS DPS D/P Industry average

MOLX PPS

Molex 14.89 .45 .0302216 .0253 17.76

Molex restated

14.89 .45 .0302216 .0253 17.76

Amphenol 29.16 .6 .021

Tyco 19.89 .58 .029

Methode 7.71 .2 .026

The dividends to price ratio is calculated by taking dividends per share and

dividing it by the price per share. After finding each companies D/P, we calculated an

industry average by adding Molex’s competitors together and dividing by three. Our

industry average totaled to .0253 D/P. By taking the industry average of .0253 and

dividing it by dividends per share, we obtained the computed price of $17.76. While

$17.76 is extremely close to our 15% margin of safety, it is still higher suggesting that

Molex’s price per share is undervalued to fairly valued.

Conclusion

As mentioned earlier, the methods of comparables valuation is an inconsistent

way to accurately value a firm. This method fails to assess factors that can potentially

create value in a firm. When observing the comparable ratios Molex is considered over,

under, and fairly valued, therefore, it is difficult to determine accurate assessment of

Molex based on method of comparables valuation. So we believe analysts or investors

should concentrate on our intrinsic valuation models when computing the most accurate

stock price of Molex.

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Intrinsic Valuation Models

The intrinsic valuation models offer a more accurate valuation of a firm when

compared to the method of comparables. This model offers more theory based

assumptions which enable you to compute a current stock price estimation of a firm.

The intrinsic valuations include: the dividend discount model, discounted free cash flow

model, residual income model, abnormal earnings growth model, and the long-run

residual income model. The sensitivity analysis will show us how small changes in the

cost of equity or growth rate affect the time consistent price per share. We believe that

the intrinsic valuation models will present us with an accurate overall value of Molex.

Discounted Dividend Model

The dividend discount model is a calculation of the present value of all future

dividends to be paid from a company. This model has the lowest explanatory power out

of all of the intrinsic valuation models; mainly because of the difficulty of forecasting

future dividends ten years down the road. This model has many fatal flaws that should

concern investors or analysts when using it. First, the model assumes that dividends are

going to grow at a constant rate throughout time, but even if we assume this it is still

very difficult to forecast how much a company is going to pay in dividends years and

years into the future. Another flaw of this model is that it assumes the same rate of

return throughout time, when in real life the rate of return is going to change

throughout time.

To calculate the value of Molex’s stock using the dividend discount model we took the

total dividends paid from our companies forecasted financial statements and divided

them by the number of shares outstanding. This gave us the total amount of dividends

per share. We then calculated the present value of each year’s dividend by taking the

dividend per share for that year and multiplying it by a present value factor. This gave

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us the present value of year- by- year dividends which we then added them all together

to get a total present value of $1.77. We calculated the terminal value perpetuity by

taking an average 2018 dividend and divided it by cost of equity minus the growth rate.

We then took this number and multiplied it by the present value factor in time 10 in

order to get the present value of the terminal value perpetuity, which was $0.46. We

then added the present value of year- by- year dividends to the terminal value

perpetuity and came to an estimated model price of $2.23. We found the time

consistent price of $2.55 by forwarding the model price to November 3, 2008 and using

a cost of equity 17.48% and a 0% growth rate.

This chart shows the sensitivity analysis of the Molex’s dividend discount model.

We calculated the sensitivity analysis using a 17.48% cost of equity and 0% growth

rate, and came to the conclusion that Molex is an overvalued company. We decided

that Molex is overvalued for any number less than $12.66, fairly valued for anything

between $12.66 and $17.19, and undervalued for anything greater than $17.19.

Because of the effect that the growth rates have on the dividend discount model we

Discounted Dividends Model Growth Rate

Ke 0.00 0.02 0.04 0.06 0.08 0.10 0.12

12.30% 2.69 2.82 3.03 3.37 4.03 5.84 31.79

14.03% 2.62 2.73 2.88 3.10 3.48 4.22 6.44

15.75% 2.58 2.66 2.78 2.94 3.18 3.59 4.44

17.48% 2.55 2.62 2.71 2.83 3.00 3.26 3.72

18.07% 2.55 2.61 2.69 2.80 2.96 3.19 3.57

18.66% 2.54 2.60 2.68 2.78 2.92 3.12 3.45

19.25% 2.54 2.59 2.66 2.76 2.88 3.06 3.34

Overvalued<$12.66 $12.66<Fairly Valued>$17.19 Undervalued>$17.19

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found that these number are somewhat skewed. Also, because dividends are so

sensitive to growth rates it suggests that this model is not very accurate in computing a

relevant stock price. But in the end, the dividend discount model suggests that Molex is

an overvalued company.

Discounted Free Cash Flow Model

The discounted free cash flows model is used to determine the intrinsic value of

a firm’s equity. The model uses both present values of forecasted cash flows and

present values of the continuing perpetuity. To find the present value of the perpetuity

we used the weighted average cost of capital before taxes (WACCBT ). The WACCBT is

used to avoid the double taxation of net income, because it is included in cash flows

from operations. To find the present value of forecasted cash flows take cash flows

from operations (CFFO) minus cash flows from investments (CFFI) for time zero

through time ten. The numbers calculated above must now be multiplied by their

individual present value factor. The present value factor gives you the value of equity

from time zero through time ten and is calculated using the following formula = 1/

[(1+WACCBT) ^n]. Then you must add all the year by year cash flows and the present

value of the terminal perpetuity. The perpetuity starts in year 2019, so it we must

discount it back to time zero dollars. Take the total present value of the year by year

cash flows and add the free cash flow perpetuity to get the market value of assets as of

December 31, 2008. To find the market value of equity take the market value of assets

and subtract book value of debt and preferred stock. Finally take market value of equity

and divide it by the total number of shares outstanding to get price per share as of

Dec.31, 2008.

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FCF Growth Model

0 0.02 0.04 0.06 0.08 0.10 0.120.1230 23.77 27.95 34.13 44.25 67.77 117.25 883.780.1265 23.12 27.03 32.76 41.93 58.99 101.80 408.060.1318 22.19 25.76 30.88 38.85 52.98 84.88 224.92

0.137 21.35 24.62 29.23 36.24 48.17 72.99 156.210.1509 19.40 22.02 25.59 30.73 38.77 53.13 86.080.1717 17.06 19.02 21.57 25.04 30.03 37.79 51.570.1925 15.23 16.74 18.66 21.15 24.52 29.35 36.86

Overvalued > 12.66 12.66 < Fairly Valued < 17.19

Undervalued > 17.19 Restated FCF Growth Model

0 0.02 0.04 0.06 0.08 0.1 0.120.1230 28.79 32.41 37.70 46.25 62.59 107.04 741.730.1265 28.27 31.68 36.60 44.39 58.72 94.44 348.800.1318 27.53 30.66 35.10 41.91 53.86 80.62 197.48

0.137 26.86 29.75 33.77 39.81 49.96 70.90 140.690.1509 25.28 27.65 30.83 35.34 42.30 54.61 82.630.1717 23.37 25.20 27.54 30.68 35.12 41.95 53.940.1925 21.84 23.30 25.12 27.44 3.00 34.91 41.61

Overvalued > 12.66 12.66 < Fairly Valued < 17.19

Undervalued > 17.19

The FCF and restated FCF growth models are both displayed above. Both models

represent the sensitivity analysis of discounted free cash flows. Molex’s first estimated

share price using WACCBT of 13.7% and a 0% growth rate produced a share price of

$21.35. Utilizing a margin of safety of 15%, the only fairly valued prices were yielded

using a WACCBT of 19.25% and growth rates of 0% and 2%. The restated FCF growth

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model produced an initial share price of $26.86 while using a WACCBT of 13.7% and a

growth rate of 0%. Both as stated and restated models assume Molex’s current stock

price is undervalued. Both models are very sensitive to growth rates due to the effect

they have on the terminal value of perpetuity. Because cash flows are difficult to

accurately forecast, errors are likely to occur when forecasting CFFO and CFFI. Taking

that into account this model can be considered less accurate than other intrinsic

valuations because it creates uncertainty. Due to fact that cash flows are difficult to

forecast and the models are extremely sensitive, the results will not be as influential as

other intrinsic valuation models.

Residual Income Model

Residual income is the income that a company has after items such as loans,

mortgages, and other debts have been paid. The residual income model is one of the

most valuable valuations because the model offers an explanatory power up to 90%.

The reasoning behind this is that it is less responsive when the growth rate is changed.

Another reason is that because the model does not respond to changes in the growth

rate strongly, the model focuses on the company’s book value of equity as well as the

presented value of the value added by the company. In order to find the value added

or destroyed that the company had for the year you take the net income and subtract

out the benchmark, annual normal income. The benchmark value is configured by

multiplying the cost of equity by last year’s book value of equity. The value that is

added or destroyed by the firm is the firm’s residual income for the year. If the

benchmark for the year is less than the net income then the firm has added value,

therefore, the company would have a positive residual income. On the other hand, if

the benchmark is more than income then the firm has destroyed value, then the

company would have a negative residual income for the company’s fiscal year.

To calculate the residual income you start with the forecasted net income as

well as the forecasted book value of equity starting with the base year of 2008, the last

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year given in Molex’s 10-k. The book value of equity is determined by taking the book

value of equity of the past year plus the net income for the current year and then

subtracting out the forecasted dividends for the year. The next step to the residual

income model is to configure the benchmark, also known as the annual normal income.

The benchmark is calculated by multiplying the book value of equity of the previous

year by the cost of equity, Ke, which in Molex’s case is 15.78%. From here you subtract

out the benchmark value from the net income for the year in order to find the firm’s

residual income. After all of these values have been calculated it is time to put them all

into the current year’s dollars. This can be done by taking the residual income and

multiplying it by the present value factor for the year which is one plus the cost of

equity raised to the time period, (1+Ke)t. This number gives the year by year present

value of residual income.

The next number to calculate is the terminal value of the perpetuity. To order

estimate the perpetuity year’s, 2019, residual income by making it nine-two percent of

the last year’s, 2018, residual income and then divide that number by the result of cost

of equity minus the growth rate. The reason for this rate is that the book value of

equity is increasing about eight percent which means that the residual income is going

to decrease at the same rate. The reasoning behind the negative growth rate is

because the equilibrium theory states that residual income over a lengthy period of time

regresses back to zero.

To get the new market value of equity you add the book value of equity, the

total present value of year by year residual income, and the terminal value perpetuity.

From this point you divide by the number of shares outstanding, for Molex is 176,070

thousand, to get the estimated price per share which comes out to be $21.31. These

numbers are all according to the rules of the residual income model. To find the time

consistent price we divided the estimated price per share by (1+Ke)(10/12). The time

uses only ten months out of the year since the observed price is taken at November 3,

2008. From this point the time consistent price can be compared to the observed

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model price of $14.89. For Molex, we decided to use a 15% margin of acceptance

which means that anything in-between 12.66 and 17.12 is fairly valued.

Sensitivity Analysis Residual Income Model Growth Rate

Ke -10% -20% -30% -40% -50% -60% -70%9.48% 15.71 13.33 11.89 10.86 10.07 9.42 8.88

11.48% 15.20 13.56 12.41 11.53 10.81 10.20 9.6713.48% 14.75 13.65 12.75 12.00 11.34 10.77 10.2715.48% 14.34 13.64 12.95 12.30 11.72 11.19 10.7117.48% 13.94 13.56 13.03 12.49 11.96 11.47 11.02

Over Valued < 12.66 12.66 < Fairly Valued <17.19

Under Valued > 17.19

Restated Sensitivity Analysis Residual Income Model Growth Rate

Ke -10% -20% -30% -40% -50% -60% -70%9.48% 11.60 11.20 10.66 10.13 9.65 9.20 8.80

11.48% 14.11 13.07 12.21 11.49 10.86 10.31 9.8213.48% 16.09 14.60 13.49 12.61 11.87 11.23 10.6815.48% 17.66 15.85 14.56 13.54 12.71 12.00 11.3917.48% 18.92 16.88 15.44 14.32 13.41 12.64 11.99

Over Valued < 12.66 12.66 < Fairly Valued < 17.19

Under Valued > 17.19

The charts above show the sensitivity analysis for both the original and restated

residual income growth model. By looking at the model we discovered that Molex is for

the mostly overvalued, somewhat fairly valued, and slightly undervalued. In the two

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different models we noticed that the restated version is quite similar to the original

except for a slight shift up so that a couple of the boxes are undervalued.

Abnormal Earnings Growth Model

Abnormal earnings growth model is based off of information strictly from the

financial statements. In order to determine AEG there are several factors in which we

calculated first, for instance dividend reinvestment, cumulative dividend income, and

normal earnings. In order to calculate dividend reinvestment (DRIP), we multiplied the

cost of equity by dividends of the previous year. DRIP is based on the speculation that

investors will reinvest their cash dividends in a company’s stock with a return based on

the cost of equity. The cumulative dividend income is calculated by taking forecasted

earnings and adding it to the DRIP. Finally, Normal earnings are calculated by taking

net income of the previous year and multiplying it by one plus the cost of equity. After

obtaining the normal earnings and cumulative dividend income, A.E.G. can be

computed. By simply subtracting normal earnings from cumulative dividend income we

calculated Molex’s A.E.G. for each year. To ensure that our A.E.G. was accurate we

used the residual income as a check figure. By subtracting A.E.G. from our residual

income we received zeros for every year this insures our A.E.G. is correct.

Next we found the present value factor. The PV factor is calculated by

discounting back each year to 2009 by our cost of equity or by simply using the formula

1/(1+Ke)t. After calculating the PV factor, we multiplied the A.E.G of each year by the

PV factor of each year to determine the present value of A.E.G.. Finally, we computed

the total present value of A.E.G. by adding all the sums of the present values of A.E.G..

The next step to abnormal earnings growth model is to calculate the present value of

the terminal value perpetuity. To calculate the terminal value of perpetuity we took the

AEG of 2018 and multiplied it by a -1.5% growth rate. Then we took that number and

multiplied it by the present value factor of 2018 and discounted it back to time zero.

191 

 

Subsequently, by adding Molex’s net income, total present value of A.E.G., and the

present value of the terminal value, we found our total average net income of the

perpetuity.

After computing the average net income we were able to find the EPS of the

perpetuity. By dividing the total average net income of the perpetuity by the total

shares outstanding of 176,070,000, we calculated the earnings per share of the

perpetuity to be 1.64 as stated and 1.43 restated. Next we calculated the intrinsic

value per share by dividing the EPS of the perpetuity by the cost of equity and found

that to be 9.38 as stated and 8.16 restated. After finding the intrinsic value we put our

values on a time consistent basis. To do this we took our intrinsic value per share price

times one plus the cost of equity to the 10/12 power.

Sensitivity Analysis AEG Model Growth Rate

Ke -10% -20% -30% -40% -50% -60% -70% 9.48% 27.38 25.24 24.19 23.56 23.14 22.85 22.62 11.48% 19.45 18.35 17.79 17.44 17.21 17.04 16.91 13.48% 14.51 13.95 13.64 13.45 13.32 13.48 13.15 15.48% 11.27 10.98 10.82 10.71 10.64 10.59 10.55 17.48% 9.03 8.89 8.81 8.76 8.72 8.69 8.67

Over Valued < 12.66 12.66 < Fairly Valued < 17.19

Under Valued > 17.19

Restated Sensitivity Analysis AEG Model Growth Rate

Ke -10% -20% -30% -40% -50% -60% -70% 9.48% 18.81 17.24 16.46 16.00 15.69 15.47 15.31 11.48% 13.85 12.97 12.51 12.24 12.05 11.91 11.81 13.48% 10.70 10.19 9.91 9.74 9.62 9.54 9.47 15.48% 8.58 8.28 8.11 8.00 7.92 7.87 7.83 17.48% 7.09 6.91 6.80 6.73 6.68 6.65 6.62

Over Valued < 12.66 12.66 < Fairly Valued < 17.19

Under Valued > 17.19

192 

 

When reflecting on our sensitivity analysis our findings show that our company is

overvalued when the cost of equity increases and undervalued when the cost of equity

decreases. However, when observing the restated sensitivity analysis, Molex is

overvalued until the cost of equity is 11.48% and the growth rate is -20%. By using

negative growth rates we are able to drive earnings back to equilibrium and ensure that

Molex will provide return based on capital in the future.

Long Run Residual Income

The long-run residual income model is created by using the forecasted net

income and book value of equity. By using the formula net income of this year dividend

by the book value of equity from the past year the return on equity can be found.

From here we found the average return on equity as well as the average growth rate

for the return on equity. After we did the calculations we estimated our return on

equity average to be 9.86%.

   2009  2010  2011  2012  2013  2014  2015  2016  2017  2018  Avg. 

ROE  7.19%  6.53%  7.61%  8.44%  9.32% 10.19% 11.03% 11.95% 12.79%  13.55% 9.86%

Once the average growth rate and the average return on equity have been calculated

then the market value of equity can be computed. In order to find the market value of

equity we used our Ke of 17.48%, average ROE of 9.86%, growth rate of 7.51%, and

book value of equity of 2,676,846. From here we insert the numbers into the equation: 

ROE Restated 

2009  2010  2011  2012 2013 2014 2015 2016 2017  2018 Avg.  

4.31%  4.00%  4.96%  5.65% 6.42% 7.36% 8.62% 10.30% 12.17%  14.83% 7.86%

193 

 

MVE = BVE ( 1 + (ROE – Ke)/(Ke – G))

After the market value of equity of 631,203 was computed we then divided it by the

number of shares outstanding to get the initial share price of $3.58. To get the time

consistent price we then multiplied the initial share price by (1 + Ke)10/12 with gave us

$4.10 for November 3,2008.  

Growth Rate 

Ke  4.51%  5.51% 6.51% 7.51% 8.51% 9.51%  10.51%

14.48%  9.13  8.25 7.15 5.74 3.85 1.20  N/A15.48%  8.36  7.48 6.40 5.06 3.32 1.01  N/A16.48%  7.72  6.85 5.80 4.52 2.93 0.87  N/A17.48%  7.17  6.32 5.31 4.10 2.62 0.77  N/A18.48%  6.71  5.87 4.90 3.75 2.37 0.69  N/A19.48%  6.30  5.49 4.56 3.46 2.17 0.62  N/A

20.48%  5.95  5.16 4.26 3.22 2.00 0.57  N/A

ROE held constant at 9.86% Over Valued < 12.66    12.66 < Fairly Valued <17.19  Under Valued > 17.19 

ROE 

Ke  6.86%  7.86%  8.86% 9.86% 10.86% 11.86%  12.86%

14.48%  N/A  0.85  3.30 5.74 8.18 10.62  13.0615.48%  N/A  0.75  2.90 5.05 7.20 9.36  11.5116.48%  N/A  0.67  2.60 4.52 6.45 8.37  10.3017.48%  N/A  0.61  2.35 4.10 5.84 7.59  9.3318.48%  N/A  0.56  2.15 3.75 5.35 6.94  8.5419.48%  N/A  0.52  1.99 3.46 4.94 6.41  7.88

20.48%  N/A  0.48  1.85 3.22 4.59 5.96  7.32

Growth Rate held constant at 7.51% Over Valued < 12.66    12.66 < Fairly Valued <17.19  Under Valued > 17.19 

194 

 

ROE 

Growth  6.86%  7.86%  8.86% 9.86% 10.86% 11.86%  12.86%

4.51%  3.15  4.49  5.83 7.17 8.51 9.85  11.195.51%  1.96  3.41  4.87 6.32 7.77 9.22  10.686.51%  0.55  2.14  3.72 5.31 6.89 8.48  10.067.51%  N/A  0.61  2.35 4.10 5.84 7.59  9.338.51%  N/A  N/A  0.68 2.62 4.56 6.49  8.439.51%  N/A  N/A  N/A 0.76 2.95 5.13  7.31

10.51%  N/A  N/A  N/A N/A 0.87 3.37  5.86

Ke held constant at 17.48% Over Valued < 12.66    12.66 < Fairly Valued <17.19  Under Valued > 17.19 

Revised Growth Rate 

Ke  14.87%  15.87%  16.87% 17.87% 18.87% 19.87%  20.87%

14.48%  283.63  90.93  59.49 46.59 39.58 35.16  32.1315.48%  N/A  326.45  103.03 66.57 51.62 43.48  38.3716.48%  N/A  N/A  369.85 115.29 73.75 56.72  47.4417.48%  N/A  N/A  N/A 413.84 127.71 81.02  61.8818.48%  N/A  N/A  N/A N/A 458.41 140.30  88.3919.48%  N/A  N/A  N/A N/A N/A 503.56  153.05

20.48%  N/A  N/A  N/A N/A N/A N/A  549.29

ROE held constant at 9.86% Over Valued < 12.66    12.66 < Fairly Valued <17.19  Under Valued > 17.19 

195 

 

Revised ROE 

Ke  4.86%  5.86%  6.86% 7.86% 8.86% 9.86%  10.86%

14.48%  N/A  242.48  216.18 189.88 163.58 137.28  110.9815.48%  N/A  N/A  N/A N/A N/A N/A  N/A16.48%  N/A  N/A  N/A N/A N/A N/A  N/A17.48%  N/A  N/A  N/A N/A N/A N/A  N/A18.48%  N/A  N/A  N/A N/A N/A N/A  N/A19.48%  N/A  N/A  N/A N/A N/A N/A  N/A

20.48%  N/A  N/A  N/A N/A N/A N/A  N/A

Growth Rate held constant at 7.51% Over Valued < 12.66    12.66 < Fairly Valued <17.19  Under Valued > 17.19 

Revised ROE 

Growth  4.86%  5.86%  6.86% 7.86% 8.86% 9.86%  10.86%

14.87%  N/A  N/A  N/A N/A N/A N/A  N/A15.87%  N/A  N/A  N/A N/A N/A N/A  N/A16.87%  N/A  N/A  N/A N/A N/A N/A  N/A17.87%  537.87  496.53  455.18 413.84 372.50 331.16  289.8118.87%  162.51  150.91  139.31 127.71 116.11 104.51  92.9119.87%  101.26  94.52  87.77 81.02 74.28 67.53  60.78

20.87%  76.15  71.39  66.63 61.88 57.12 52.37  47.61

Ke held constant at 17.48% Over Valued < 12.66    12.66 < Fairly Valued <17.19  Under Valued > 17.19 

196 

 

The charts shown above contain the sensitivity analysis for the model long-run

residual income for both the original and restated versions. The inputs that change in

the models were the average return on equity, the estimated growth rate, and the cost

of capital. The sensitivity analysis with a 15% margin of safety shows that Molex is

overvalued which is consistent with the previous models.

Analyst Recommendation

After reviewing all of the financial statements and all of the facts, we have come

to the conclusion that Molex is an overvalued company. This ending comes from

reviewing how Molex is compared to their competitors, model valuations, accounting

policies, and the financial analysis. The models are all based on a 15% margin of

safety. Despite the model abnormal earnings growth which does not completely agree

with this conclusion we still feel that this is the right value for the firm. Both the

discounted dividends as well as the discounted free cash flows models strongly reflect

that Molex is overvalued. Even though the discounted dividend model does not have a

very strong explanatory power, it points so strongly towards the company being

overvalued that we kept its results in mind.

The residual income model mostly points to the direction of the company being

overvalued and slightly to being fairly valued. Since this model has a high explanatory

power we strongly looked into the results for the bases of our decision. Since Molex

has a significant portion of assets attributed to goodwill and the company needing to be

restated because of a lack of goodwill impairment, we looked at the restated version of

residual income to also help in the decision process. When looking at the restated

version we saw that the model still sides with the company being overvalued more than

it being fairly valued. Even though there was a slight shift between the models, it was

not significant enough to move our decision towards being fairly-valued.

197 

 

The long run residual income and the abnormal earnings growth models are

other models that also lean towards Molex being overvalued. We used our Ke of

17.48%, growth rate of 15.08% as our average future earnings growth rate, and an

ROE of 9.86% to generate these models. With this information the long run residual

income is amongst the other models in suggesting that the company is overvalued.

The abnormal earnings growth model is pretty in between all three of the options. For

this model it is not until you look at the restated version due to see the strong reference

to the company being overvalued. Due to the impact that goodwill impairment has on

net income the model has quite a change after the impairment.

We feel that Molex is an overvalued company, at least at this point in time.

However, we feel that in the future the company will have the opportunity to raise the

value of their firm so that they will not be looked at as being so overvalued. As long as

the Molex can pull strong through the recession we feel that they will increase the value

of the firm. As for the time being, we would recommend to investors to sell their stock

in the company.

198 

 

APPENDICES

Sales Manipulation Diagnostics

Net Sales/Accounts Receivables (RAW) 2003 2004 2005 2006 2007

Molex 4.64 4.25 4.73 4.33 4.76 Amphenol 7.19 7.15 5.97 6.43 5.59

Tyco Electronics

5.03 5.05 5.01

Methode 6.23 5.49 5.98 5.68 5.66

Net Sales/Accounts Receivables(CHANGE) 2003 2004 2005 2006 2007

Molex 12.07 3.08 30.84 2.53 16.18 Amphenol 4.30 6.98 3.13 8.19 2.99

Tyco Electronics

5.77 4.6

Methode -7.46 -0.589 99.88 3.39 5.41

Net Sales/Cash from Sales (RAW) 2003 2004 2005 2006 2007

Molex 1.01 1.06 1.00 1.04 1.01 Amphenol 1.03 1.03 1.05 0.97 0.96

Tyco Electronics

0.96 1.01

Methode 0.98 1.02 1.00 1.02 1.01

Net Sales/Cash from Sales(CHANGE) 2003 2004 2005 2006 2007

Molex 1.46 1.43 0.713 1.57 0.81 Amphenol 1.15 1.0015 1.20 0.99 1.13 Methode 0.92 0.24 0.83 1.40 0.88

199 

 

Net Sales/Inventory 2003 2004 2005 2006 2007

Molex 10.26 8.48 8.81 8.24 8.32 Amphenol 5.6 6.19 5.55 5.93 6.67

Tyco Electronics

7.24 6.66 6.58

Methode 11.36 12.29 9.44 9.23 8.23

Net Sales/Inventory(CHANGE) 2003 2004 2005 2006 2007

Molex 10.69 4.75 12.34 5.36 8.92 Amphenol 9.4 7.32 3.53 11.23 11.28

Tyco Electronics

0.59 -0.80

Methode 3.05 7.05 2.74 1.76 -8.64

Expense Manipulation Diagnostics

Asset Turnover 2003 2004 2005 2006 2007

Molex 0.79 0.87 0.94 0.96 0.98 Amphenol 1.05 1.17 0.936 1.13 1.07

Tyco Electronics 0.51 0.56 0.62 0.64 0.57 Methode 1.15 1.14 1.10 1.13 1.09

Asset Turnover (CHANGE) 2003 2004 2005 2006 2007

Molex 1.6 1.7 1.97 1.26 1.18 Amphenol 1.73 2.32 0.44 2.52 0.79

Tyco Electronics

2.12 -2.61 1.4 0.25

Methode 1.84 3.26 0.8 1.61 0.72

200 

 

CFFO/OI (raw)

2003 2004 2005 2006 2007

Molex 2.98 1.32 2.12 1.43 1.40 Amphenol 0.78 0.75 0.67 0.68 0.70

Tyco Electronics

0.74 0.78 1.18 1.19

Methode 1.59 1.53 1.23 0.97 1.72

CFFO/OI (change)

2003 2004 2005 2006 2007

Molex -21.07 -0.11 -7.75 0.12 0.64 Amphenol 0.91 0.68 0.32 0.74 0.77

Tyco Electronics

0.98 -0.21 0.98

Methode 0.38 2.09 0.11 2.59 12.76

CFFO/NOA (raw)

2003 2004 2005 2006 2007

Molex 0.30 0.29 0.44 0.43 0.40 Amphenol 0.89 1.05 0.90 1.06 1.23

Tyco Electronics

0.40 0.52 0.54 0.44

Methode 0.64 0.50 0.49 0.33 0.65

201 

 

CFFO/NOA (change)

2003 2004 2005 2006 2007

Molex 1.52 -0.89 -3.64 0.31 0.08 Amphenol 1.58 2.51 0.38 2.96 2.34

Tyco Electronics

-8.37 1.24 -0.30

Methode 0.96 -1.77 0.17 7.14 -7.34

Total Accruals/Total Sales (raw)

2003 2004 2005 2006 2007

Molex 0.12 0.06 0.11 0.07 0.06 Amphenol 0.04 0.03 0.01 0.01 0.01

Tyco Electronics

0.05 0.04 0.04 0.16

Methode 0.09 0.07 0.05 0.03 0.07

Total Accruals/Total Sales (change)

2003 2004 2005 2006 2007

Molex -0.77 -0.23 0.51 -0.24 0.03 Amphenol 0.02 -0.04 -0.08 0.02 0.00

Tyco Electronics

-0.09 0.08 1.39

Methode -0.13 1.53 -0.15 -0.23 0.66

202 

 

Pension Expense/SG&A (raw)

2003 2004 2005 2006 2007

Molex 0.12 0.09 0.12 0.12 0.17 Amphenol 0.57 0.47 0.43 0.40 0.27

Tyco Electronics

0.32 0.36

Pension Expense/SG&A (change)

2003 2004 2005 2006 2007

Molex 0.43 -0.08 0.72 0.26 0.65 Amphenol -0.08 0.05 0.18 0.33 -1.06

Tyco Electronics

0.83

Liquidity Ratios

Current Ratio

2002 2003 2004 2005 2006 2007

Molex 2.56 2.70 2.73 2.93 2.60 6.26

Molex - Rest. 2.55 2.70 2.73 2.93 2.60 5.96

Amphenol 1.65 2.07 1.91 2.11 2.09 5.14

Methode 3.30 3.55 2.96 3.15 2.98 5.68

Tyco N/A 1.73 1.95 1.86 2.08 3.83

Industry Avg.

1.65 2.45 2.27 2.37 2.38 4.88

203 

 

Working Capital Turnover

2002 2003 2004 2005 2006 2007 Molex 3.08 3.04 3.04 2.82 3.00 3.08

Molex - Rest. 3.08 3.04 3.04 2.82 3.00 3.08 Amphenol 6.70 5.30 6.09 4.84 5.08 1.32 Methode 2.77 2.88 3.20 2.82 2.87 3.27

Tyco N/A 4.08 3.78 4.20 3.62 3.65 Industry Avg. 3.16 4.09 4.36 3.95 3.85 2.75

Accounts Receivables Turnover

2002 2003 2004 2005 2006 2007 Molex 4.43 4.65 4.24 4.73 4.33 4.76

Molex - Rest. 4.43 4.65 4.24 4.73 4.33 4.76 Amphenol 7.82 7.19 7.15 5.97 6.44 5.59 Methode 4.99 6.23 5.49 6.00 5.68 5.66

Tyco N/A N/A N/A 5.03 5.05 5.01 Industry

Avg. 6.41 6.71 6.32 5.67 5.72 5.42

Quick Ratio

2002 2003 2004 2005 2006 2007

Molex 1.95 2.1 2.03 2.21 1.93 2.16

Molex - Rest. 1.95 2.1 2.03 2.21 1.93 2.16

Amphenol 0.64 0.9 0.88 1.02 1.02 1.33

Methode 2.27 2.48 2.22 2.34 2.1 1.92

Tyco N/A N/A N/A 0.84 0.92 0.59

Industry Avg. 1.46 1.69 1.55 1.68 1.56 1.63

204 

 

Days Sales Outstanding

2002 2003 2004 2005 2006 2007 Molex 82.35 78.58 86.04 77.09 84.28 76.63

Molex - Rest. 82.35 78.58 86.04 77.09 84.28 76.63 Amphenol 46.66 50.79 51.08 61.14 56.69 65.34 Methode 73.15 58.56 66.48 60.79 64.26 64.45

Tyco N/A N/A N/A 72.54 72.23 72.84 Industry

Avg. 59.90 54.66 58.78 64.82 64.39 67.54

Inventory Turnover

2002 2003 2004 2005 2006 2007 Molex 6.99 7.05 5.54 5.94 5.52 5.73

Molex - Rest. 6.99 7.05 5.54 5.94 5.52 5.73 Amphenol 3.36 3.71 4.19 3.71 4.04 4.20 Methode 7.27 9.16 9.85 7.37 7.36 6.61

Tyco N/A N/A N/A 5.07 4.86 4.89

Industry

Avg.

5.31 6.44 7.02 5.38 5.42 5.23

205 

 

Days Supply in Inventory

2002 2003 2004 2005 2006 2007 Molex 52.20 51.77 65.89 61.50 66.07 63.73

Molex - Rest. 52.20 51.77 65.89 61.50 66.07 63.73 Amphenol 108.58 98.46 87.22 98.49 90.31 86.81 Methode 50.22 39.83 37.04 49.50 49.56 55.25

Tyco N/A N/A N/A 71.96 75.04 74.63 Industry

Avg. 79.40 69.14 62.13 73.31 71.64 72.23

Cash to Cash Cycle

2002 2003 2004 2005 2006 2007 Molex 134.6 130.3 151.9 138.6 150.3 140.1

Molex - Rest. 134.6 130.3 151.9 138.6 150.3 140.1 Amphenol 155.2 149.2 138.3 159.6 147.0 152.2 Methode 123.4 98.2 103.5 110.3 113.8 119.7

Tyco N/A N/A N/A 144.5 144.4 147.5 Industry

Avg. 139.3 123.8 120.9 138.1 135.1 139.8

Profitability Ratios

Gross Profit Ratio

2002 2003 2004 2005 2006 2007 Molex 0.317 0.314 0.346 0.326 0.329 0.311

Molex - Rest. 0.317 0.314 0.346 0.326 0.329 0.311 Amphenol 0.318 0.338 0.324 0.332 0.319 0.326 Methode 0.160 0.194 0.198 0.223 0.202 0.197

Tyco N/A N/A 0.282 0.299 0.298 0.256 Industry

Avg. 0.239 0.266 0.268 0.285 0.273 0.260

206 

 

Operating Expense Ratio

Operating Expense

2002 2003 2004 2005 2006 2007

Molex 0.258 0.259 0.247 0.226 0.212 0.202 Molex - Rest. 0.258 0.259 0.247 0.226 0.212 0.202

Amphenol 0.149 0.143 0.140 0.142 0.139 0.132 Methode 0.125 0.099 0.112 0.119 0.119 0.112

Tyco N/A N/A 0.139 0.127 0.119 0.124 Industry

Avg. 0.137 0.121 0.131 0.129 0.126 0.123

Operating Profit Margin

2002 2003 2004 2005 2006 2007 Molex 0.059 0.055 0.098 0.080 0.108 0.098

Molex - Rest. 0.039 0.024 0.063 0.044 0.072 0.053 Amphenol 0.169 0.165 0.181 0.190 0.172 0.194 Methode 0.001 0.091 0.081 0.093 0.073 0.073

Tyco N/A N/A 0.068 0.083 0.090 0.056 Industry

Avg. 0.085 0.128 0.110 0.122 0.112 0.108

Net Profit Margin

Net Profit Margin

2002 2003 2004 2005 2006 2007

Molex 0.045 0.046 0.078 0.059 0.083 0.074 Molex - Rest. 0.030 0.014 0.040 0.037 0.056 0.042

Amphenol 0.078 0.084 0.107 0.114 0.103 0.124 Methode 0.012 0.060 0.055 0.065 0.040 0.058

Tyco N/A N/A 0.065 0.096 0.093 -0.041 Industry

Avg. 0.045 0.072 0.076 0.092 0.079 0.047

207 

 

Asset Turnover

Asset

turnover

2002 2003 2004 2005 2006 2007

Molex 0.76 0.79 0.87 0.94 0.96 0.98

Molex - Rest. 0.77 0.81 0.90 0.98 1 1.03

Amphenol 0.95 1.05 1.17 0.94 1.13 1.07

Methode 1.10 1.15 1.14 1.11 1.13 1.09

Tyco N/A 0.51 0.59 0.64 0.67 0.57

Industry

Avg.

1.02 0.90 0.97 0.90 0.97 0.91

Return on Assets

2002 2003 2004 2005 2006 2007

Molex 0.035 0.038 0.076 0.058 0.087 0.081

Molex - Rest. 0.023 0.012 0.039 0.038 0.062 0.047

Amphenol 0.078 0.096 0.138 0.158 0.132 0.161

Methode 0.013 0.075 0.062 0.081 0.048 0.070

Tyco N/A N/A 0.040 0.061 0.065 -0.030

Industry

Avg.

0.030 0.057 0.080 0.100 0.082 0.067

208 

 

Return on Equity

2002 2003 2004 2005 2006 2007

Molex 0.042 0.048 0.093 0.073 0.109 0.106

Molex - Rest. 0.028 0.015 0.048 0.047 0.079 0.062

Amphenol 0.773 0.623 0.505 0.428 0.371 0.391

Methode 0.017 0.095 0.077 0.103 0.060 0.089

Tyco N/A N/A 0.115 0.139 0.121 -0.050

Industry

Avg.

0.395 0.359 0.232 0.223 0.184 0.144

 

Firm Growth Rate Ratios

Internal Growth Rate

2002 2003 2004 2005 2006 2007

Molex 0.026 0.029 0.067 0.048 0.074 0.062

Molex -

Rest.

0.014 0.003 0.031 0.027 0.048 0.028

Amphenol 0.078 0.096 0.138 0.150 0.127 0.156

Methode -0.011 0.050 0.035 0.058 0.027 0.050

Tyco N/A N/A 0.040 0.061 0.065 -0.033

Industry

Avg.

0.033 0.073 0.071 0.090 0.073 0.058

209 

 

Sustainable Growth Rate

2002 2003 2004 2005 2006 2007

Molex 0.032 0.036 0.084 0.061 0.096 0.082

Molex -

Rest.

0.018 0.004 0.039 0.035 0.064 0.037

Amphenol 0.506 0.352 0.375 0.420 0.308 0.330

Methode -0.014 0.062 0.045 0.073 0.036 0.063

Tyco N/A N/A 0.040 0.115 0.110 -0.068

Industry

Avg.

0.246 0.207 0.153 0.203 0.151 0.108

210 

 

Capital Structure Ratios

Debt to Equity

2002 2003 2004 2005 2006 2007

Molex 0.241 0.228 0.245 0.258 0.304 0.314

Molex -

Rest.

0.237 0.236 0.255 0.272 0.318 0.334

Amphenol 5.46 2.65 1.71 1.80 1.43 1.12

Methode 0.261 0.237 0.264 0.262 0.284 0.700

Tyco N/A N/A N/A 0.896 0.709 1.081

Industry

Avg.

2.86 1.45 0.989 0.988 0.808 0.822

Times Interest Earned

2002 2003 2004 2005 2006 2007

Molex 16.73 12.52 59.01 31.52 31.52 37.47

Molex -

Rest.

11.01 5.45 37.88 17.23 20.76 20.01

Amphenol 3.79 6.93 12.27 14.25 10.94 14.99

Methode N/A N/A N/A N/A 102.4 109.38

Tyco N/A N/A N/A 3.36 4.53 3.26

Industry

Avg.

N/A N/A N/A 8.81 39.29 42.55

211 

 

 

 

 

 

 

 

 

Debt Service Margin

2002 2003 2004 2005 2006 2007

Molex 22.17 18.07 20.80 43.19 62.58 3.53

Molex -

Rest.

20.73 14.61 14.59 37.17 52.06 2.71

Amphenol 0.232 0.319 0.482 0.300 0.428 0.538

Methode N/A N/A N/A N/A N/A N/A

Tyco N/A N/A N/A 0.405 0.494 0.456

Industry

Avg.

N/A N/A N/A 0.352 0.461 0.497

 

 

 

 

 

212 

 

Altman Z-Scores

Altman Z-Scores

2002 2003 2004 2005 2006 2007

Molex 53.20 28.02 24.84 19.67 32.13 25.83

Molex - Rest. 53.20 28.02 24.84 19.67 32.13 25.83

Amphenol 8.91 7.91 17.64 13.99 19.86 20.84

Methode 13.56 15.69 19.71 13.13 19.68 21.95

Tyco N/A N/A N/A N/A N/A N/A

Industry Avg. 11.23 11.80 18.68 13.56 19.77 21.39

213 

 

Cost of Debt

Cost of Debt

Liabilities Debt Interest rate

Weight WACD

Short Term Loans $66, 687 1.3% .069 .09%

Accounts payable $350,413 2.13% .38 .81%

Salaries, commissions, and bonuses

$74,689 2.13 .08 .17%

Other accrued expenses $84,525 2.13 .094 .2%

Income Taxes Payable $73,124 3.69% .079 .29% Other noncurrent liabilities $21,346 7.8% .023 .18%

Pensions and postretirement benefits

$105,574 6.2% .115 .71%

Long term debt $146,333 7.8% .159 1.24%

Total Liabilities 922,691 3.69%

214 

 

Weighted Average Cost of Capital

Weighted Average Cost of Capital

Cost of debt

MVL/MVA Tax rate Cost of equity

MVE/MVA WACC

WACCbt 3.69% 25.63% 0% 15.78% 74.37% 12.67%

WACCat 3.69% 25.63% 36% 15.78% 74.37% 12.34%

WACCbt

Revised

3.69% 27.1% 0% 15.78% 72.9% 12.5%

WACCat

Revised

3.69% 27.1% 36% 15.78% 72.9% 12.14%

215 

 

Weighted Average Cost of Equity

1 Year Rates

SUMMARY OUTPUT 

Regression Statistics Multiple R  0.546452 R Square  0.29861 Adjusted R Square  0.266729 Standard Error  0.062744 

Observations  24 

ANOVA 

   df  SS  MS  F Significance 

F Regression  1  0.036874  0.036874 9.366291 0.005731Residual  22  0.086611  0.003937Total  23  0.123485          

   Coefficients Standard Error  t Stat  P‐value 

Lower 95% 

Upper 95% 

Lower 95.0% 

Upper 95.0% 

Intercept  ‐0.01045  0.013104  ‐0.79767  0.433587  ‐0.03763  0.016723  ‐0.03763  0.016723 X Variable 1  1.070073  0.349647  3.06044  0.005731  0.34495  1.795196  0.34495  1.795196 

216 

 

3 Year Rates

SUMMARY OUTPUT 

Regression Statistics Multiple R  0.569234 R Square  0.324028 Adjusted R Square  0.304146 Standard Error  0.066191 

Observations  36 

ANOVA 

   df  SS  MS  F Significance 

F Regression  1  0.071405  0.071405 16.29792 0.000291Residual  34  0.148962  0.004381Total  35  0.220367          

   Coefficients Standard Error  t Stat  P‐value 

Lower 95% 

Upper 95% 

Lower 95.0% 

Upper 95.0% 

Intercept  0.005043  0.011124  0.453286  0.653223  ‐0.01757  0.02765  ‐0.01757  0.02765 X Variable 1  1.38713  0.343598  4.037068  0.000291  0.688854  2.085406  0.688854  2.085406 

217 

 

4 Year Rates

SUMMARY OUTPUT 

 

 

ANOVA 

   df  SS  MS  F Significance 

F Regression  1  0.068909  0.068909 16.06237 0.000222Residual  46  0.197343  0.00429

Total  47  0.266252          

 

   Coefficients Standard Error  t Stat  P‐value 

Lower 95% 

Upper 95% 

Lower 95.0% 

Upper 95.0% 

Intercept  ‐0.00026  0.009467  ‐0.02793  0.97784  ‐0.01932  0.018792  ‐0.01932  0.018792 X Variable 1  1.249458  0.311757  4.007789  0.000222  0.621923  1.876993  0.621923  1.876993 

 

Regression Statistics Multiple R  0.508734 R Square  0.25881 Adjusted R Square  0.242697 Standard Error  0.065499 

Observations  48 

218 

 

5 Year Rates

SUMMARY OUTPUT 

 

Regression Statistics Multiple R  0.547158 R Square  0.299382 Adjusted R Square  0.287302 Standard Error  0.061555 

Observations  60 

ANOVA 

   df  SS  MS  F Significance 

F Regression  1  0.093907 0.093907 24.78405 6.08E‐06 Residual  58  0.219762 0.003789

Total  59  0.313669         

   Coefficients Standard Error  t Stat  P‐value 

Lower 95% 

Upper 95% 

Lower 95.0% 

Upper 95.0% 

Intercept  ‐0.0012917  0.0079478  ‐0.162523  0.871459 ‐

0.0172008  0.0146175 ‐

0.0172008  0.0146175 

X Variable 1  1.3378974  0.2687427  4.9783581  6.076E‐06  0.7999504  1.8758443  0.7999504  1.8758443 

219 

 

6 Year Rates

SUMMARY OUTPUT 

Regression Statistics Multiple R  0.628169449 R Square  0.394596857 

Adjusted R Square  0.38594824 Standard Error  0.060282106 Observations  72 

ANOVA 

   df  SS  MS  F Significance 

F Regression  1  0.165799731  0.165799731 45.625432  3.48745E‐09Residual  70  0.25437526  0.003633932

Total  71  0.420174991          

   Coefficients Standard Error  t Stat  P‐value 

Intercept  ‐0.0018941  0.007138232 ‐

0.265345952  0.79152284 X Variable 1  1.469410734  0.217540295  6.754660021  3.48745E‐09 

Lower 95% Upper 95% 

Lower 95.0% 

Upper 95.0% 

‐0.01613085  0.0123427 ‐

0.0161309  0.012343 1.035540302  1.9032812 1.0355403  1.903281

220 

 

Methods of Comparables

Price/Earning Trailing

Price /Earnings Forecast

Forecasted P/E

Company PPS EPS 1yr Out

P/E Forecast

Industry avg P/E

Computed price

Molex 14.89 1.09 10.86 11.84

Molex restated

14.89 .61 10.86 6.63

Amphenol 29.16 11.21 Tyco 19.89 8.93

Methode 7.71 12.43

P/E trailing PPS EPS P/E Trailing Computed

Price

Molex 14.89 1.22 9.72

Molex restated

14.89 .59 4.70

Amphenol 29.16 11.26

Tyco 19.89 4.73

Methode 7.71 7.92

Average 7.97

221 

 

Price /Book

Price Earnings Growth (P.E.G.)

Price/Book PPS BPS P/B Industry

Avg. Molex PPS

Molex 14.89 13.52 1.10 1.06 14.33

Molex Rest.

14.89 12.35 1.21 1.06 13.09

Amphenol 29.16 26.20 1.11

Methode 7.71 8.08 0.95 Tyco 19.89 17.68 1.13

ComparableCompany P/E Growth P.E.G. Industry Avg. Molex PPS Molex 29.74 .3342 .89 .95 28.25 Molex Rest. 54.54 .6128 .89 .95 51.81 Amphenol 11.73 17.00 .69 Methode 7.96 5.14 1.55 Tyco 4.37 7.05 .62 *Based on five year P.E.G.’s

222 

 

Price/EBITDA

Enterprise Value/EBITDA

EV ($ Bil) EBITDA ($ Bil) EV/EBITDA Industry Avg.

Molex PPS

Molex 2.46 0.61 4.03 4.88 16.93

Molex Rest. N/A N/A N/A

Amphenol 5.81 0.73 7.96

Methode 0.20 0.89 2.25

Tyco 12 2.70 4.44

Market Cap ($ Bil)

EBITDA ($ Bil)

P/EBITDA Industry Avg.

Molex PPS

Molex 2.50 0.61 4.10 4.30 14.92

Molex Rest. N/A N/A N/A

Amphenol 4.63 0.73 6.34

Methode 0.31 0.89 3.48

Tyco 8.35 2.70 3.09

223 

 

Price to Free Cash Flows (P/FCF)

Market

Cap

FCF P/FCF Industry

Avg.

P/FCF per

share

Molex 2,380.00 260.98 9.12 25.42 $37.67

Molex Rest. 2,380.00 150.26 15.84 25.42 $21.69

Amphenol 4,830.00 108.82 44.39

Methode 312.44 48.45 6.45

Tyco 7,730.00 (3.00) (2576.67) outlier

*Market cap and free cash flows in millions

Dividends/Price

Dividends/Price

PPS DPS D/P Industry average

MOLX PPS

Molex 14.89 .45 .0302216 .0253 17.76

Molex restated

14.89 .45 .0302216 .0253 17.76

Amphenol 29.16 .6 .021

Tyco 19.89 .58 .029

Methode 7.71 .2 .026

224 

 

Valuation Models

Discounted Dividends Model

WACC(BT) 0.1395 Kd 0.0369 Ke 0.1748

Relevant Valuation Item 0 1 2 3 4 5 6 7 8 9 10 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Total Dividends Paid 55.18 75 74.24 73.30 72.56 99.05 13.52 21.41 28.95 28.66 39.12 52.49 Number of Share Outstanding 176.07 176.07 176.07 176.07 176.07 176.07 176.07 176.07 176.07 176.07 176.07 176.07 Dividends Per Share 0.31 0.42 0.42 0.42 0.41 0.56 0.08 0.12 0.16 0.16 0.22 0.30 1.72

Present Value Factor 0.88 0.77 0.68 0.59 0.52 0.46 0.40 0.35 0.31 0.27 Present Value of YBY Dividends 0.37 0.32 0.28 0.24 0.29 0.04 0.05 0.06 0.05 0.06 PV of YBY Dividends 1.77

Sensitivity Analysis Discounted Dividends Model PV of Terminal Value Perp 0.46 Growth Rate Estimated Model Price 2.23 Ke 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% Time Consistent Price (11/03/08) 2.55 12.30% 2.69 2.82 3.03 3.37 4.03 5.84 31.79Observed Share Price $14.89 14.03% 2.62 2.73 2.88 3.10 3.48 4.22 6.44

15.75% 2.58 2.66 2.78 2.94 3.18 3.59 4.44Cost of Equity 0.1748 17.48% 2.55 2.62 2.71 2.83 3.00 3.26 3.72Perpetuity Growth Rate 0 18.07% 2.55 2.61 2.69 2.80 2.96 3.19 3.57

18.66% 2.54 2.60 2.68 2.78 2.92 3.12 3.4519.25% 2.54 2.59 2.66 2.76 2.88 3.06 3.34

Overvalued<12.66 12.66<Fairly Valued<17.19

Undervalued>17.19

225 

 

Discounted Free Cash Flow WACC(BT 0.1395 Kd 0.0369 Ke 0.1748

0 1 2 3 4 5 6 7 8 9 10

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Cash Flow From Operations (Millions)

479,134

494,260

464,604

499,449

574,367 660,522

759,600

873,540

1,004,571

1,155,256

1,328,545

Cash Flow From Investing Activities

(218,156)

(250,879)

(288,511)

(331,788)

(381,556) (438,790)

(504,608)

(580,299)

(667,344)

(767,446)

(882,563)

FCF Firm's Assets 260,978

243,380

176,093

167,661

192,810 221,732

254,992

293,241

337,227

387,811

445,982

PV Factor (WACC) 88.75% 78.77% 69.92% 62.05% 55.08% 48.88% 43.39% 38.51% 34.18% 30.33%

PV YBY Free Cash Flows 216,011

138,715

117,222

119,646 122,120

124,645

127,223

129,854

132,539

135,280

Total PV YBY FCF 1,363,257 Sensitivity Analysis Residual Income Model

FCF Perp 4,169,753 Growth Rate

Market Value of Assets (12/31/2008)

5,533,009 WACC(BT 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0%

Book Value Debt & Preferred Stock

922,691 12.30% 23.77 27.95 34.13 44.25 67.77 117.25 883.78

Market Value of Equity 4,610,318 12.65% 23.12 27.03 32.76 41.93 58.99 101.80 408.06

divide by Shares to Get PPS at 12/31

$ 26.18 13.18% 22.19 25.76 30.88 38.85 52.98 84.88 224.92

Time consistent Price (11/3/2008) $ 23.77 13.70% 21.35 24.62 29.23 36.24 48.17 72.99 156.21

Oberved Share Price (11/3/2008) $ 14.89 15.09% 19.40 22.02 25.59 30.73 38.77 53.13 86.08

17.17% 17.06 19.02 21.57 25.04 30.03 37.79 51.57

WACC(BT) 0.123 19.25% 15.23 16.74 18.66 21.15 24.52 29.35 36.86

Perp Growth Rate 0 Undervalued >

17.19

12.66 < Fairly Valued < 17.19

Overvalued > 12.66

226 

 

Restated

Discounted Free Cash Flow WACC(BT) 0.137 Kd 0.0369 Ke 0.1748

0 1 2 3 4 5 6 7 8 9 10 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Cash Flow From Operations (Millions) 367,414 329,506 309,736 331,417 381,130 438,300 504,045 579,651 666,599 766,589 881,577 Cash Flow From Investing Activities

(218,156) 342,080

(89,593)

(205,424)

(236,238)

(271,673)

(312,424)

(359,288)

(413,181)

(475,158)

(546,432)

FCF Firm's Assets 149,258 671,587 220,143 125,993 144,892 166,626 191,620 220,363 253,418 291,430 335,145 PV Factor (WACC) 88.75% 78.77% 69.92% 62.05% 55.08% 48.88% 43.39% 38.51% 34.18% 30.33% PV YBY Free Cash Flows 596,065 173,416 88,089 89,911 91,770 93,668 95,605 97,582 99,600 101,660

Total PV YBY FCF 1,527,367 Restated Sensitivity Analysis Discounted Free Cash Flow Model FCF Perp 2,813,261 Growth

Market Value of Assets (12/31/87) 4,340,628 WACC(BT) 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0%

Book Value Debt & Preferred Stock 922,691 0.1230 28.79 32.41 37.70 46.25 62.59 107.04 741.73 Market Value of Equity 5,263,319 0.1265 28.27 31.68 36.60 44.39 58.72 94.44 348.80 divide by Shares to Get PPS at 12/31 $ 29.89 0.1318 27.53 30.66 35.10 41.91 53.86 80.62 197.48 Time consistent Price (11/3/08) $ 26.86 0.137 26.86 29.75 33.77 39.81 49.96 70.90 140.69 Oberved Share Price (11/1/08) $ 14.89 0.1509 25.28 27.65 30.83 35.34 42.30 54.61 82.63

0.1717 23.37 25.20 27.54 30.68 35.12 41.95 53.94

WACC(BT) 0.137 0.1925 21.84 23.30 25.12 27.44 30.54 34.91 41.61

Perp Growth Rate 0 Overvalued > 12.66

12.66 < Fairly Valued < 17.19

Undervalued > 17.19

227 

 

Residual Income

0 1 2 3 4 5 6 7 8 9 10

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Net Income (Thousands) 215,437

192,569

181,015

217,336

249,937

287,427

330,541

380,122

437,141

502,712

578,118

Total Dividends (Thousands) (74,598)

(96,977)

(96,977)

(111,524)

(128,253)

(128,253)

(128,253)

(166,728)

(166,728)

(166,728)

(216,747)

Book Value Equity (Thousands)

2,676,846

2,772,437

2,856,474

2,962,286

3,083,970

3,243,145

3,445,433

3,658,827

3,929,239

4,265,222

4,626,594

Percent Change in RI 0.10

(0.07)

(0.05)

(0.06)

(0.06)

(0.06)

(0.09)

(0.09)

(0.09)

Annual Normal Income (Benchmark)

467,913

484,622

499,312

517,808

539,078

566,902

602,262

639,563

686,831

745,561

Annual Residual Income (275,344)

(303,608)

(281,976)

(267,871)

(251,651)

(236,361)

(222,140)

(202,422)

(184,119)

(167,443)

pv factor 0.85

0.72

0.62

0.52

0.45

0.38

0.32

0.28

0.23

0.20

YBY PV RI (234,375)

(219,981)

(173,908)

(140,627)

(112,455)

(89,907)

(71,925)

(55,789)

(43,194)

(33,437)

Book Value Equity (Thousands)

2,676,846 Sensitivity Analysis Residual Income Model

Total PV of YBY RI (1,175,598 Growth Rate

Terminal Value Perpetuity (881,276) Ke -10% -20% -30% -40% -50% -60% -70%

MVE 12/31/87 2,971,167 9.48% 15.71 13.33 11.89 10.86 10.07 9.42 8.88

divide by shares 16.87 11.48% 15.20 13.56 12.41 11.53 10.81 10.20 9.67

Model Price on 11/03/2008 14.89 13.48% 14.75 13.65 12.75 12.00 11.34 10.77 10.27

time consistent Price 13.68 15.48% 14.34 13.64 12.95 12.30 11.72 11.19 10.71

17.48% 13.94 13.56 13.03 12.49 11.96 11.47 11.02 Observed Share Price 11/03/2008 Over Valued < 12.66

Initial Cost of Equity (Ke) 17.48% 12.66 < Fairly Valued <17.19

Perpetuity Growth Rate (g) 0% Under Valued > 17.19

228 

 

Restated Residual Income

0 1 2 3 4 5 6 7 8 9 10

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Net Income (Millions) 103,717

106,940

100,523

126,482

145,455

167,273

192,364

221,218

254,401

292,561

336,445

Total Dividends (Millions) (74,598)

(96,977)

(96,977)

(111,524)

(128,253)

(128,253)

(128,253)

(166,728)

(166,728)

(166,728)

(216,747)

Book Value Equity (Millions) 2,482,250

2,492,212

2,495,758

2,510,717

2,527,919

2,566,939

2,631,050

2,685,540

2,773,213

2,899,046

3,018,744

Percentage Change RI 0.0250

(0.0756)

(0.0528)

(0.0641)

(0.0665)

(0.0688)

(0.0991)

(0.1062)

(0.1139)

Annual Normal Income (Benchmark)

433,897

435,639

436,259

438,873

441,880

448,701

459,908

469,432

484,758

506,753

Annual Residual Income (326,958)

(335,115)

(309,776)

(293,419)

(274,607)

(256,337)

(238,689)

(215,031)

(192,196)

(170,308)

pv factor 0.851 0.725 0.617 0.525 0.447 0.380 0.324 0.276 0.235 0.200

YBY PV RI (278,309)

(242,810)

(191,054)

(154,039)

(122,714)

(97,505)

(77,283) -59264 -45089 -34009

Book Value Equity (Millions) 2,482,250 Restated Sensitivity Analysis Residual Income Model

Total PV of YBY RI (1,302,076 Growth Rate

Terminal Value Perpetuity (1,071,731 Ke -10% -20% -30% -40% -50% -60% -70%

MVE 12/31/87 4,856,057 9.48% 11.60 11.20 10.66 10.13 9.65 9.20 8.80

divide by shares 27.58 11.48% 14.11 13.07 12.21 11.49 10.86 10.31 9.82

Model Price on 12/31/87 14.89 13.48% 16.09 14.60 13.49 12.61 11.87 11.23 10.68

time consistent Price 22.35 15.48% 17.66 15.85 14.56 13.54 12.71 12.00 11.39

17.48% 18.92 16.88 15.44 14.32 13.41 12.64 11.99 Observed Share Price (11/1/1988) $20.88 Over Valued < 12.66 Initial Cost of Equity (You Derive) 17.48% 12.66 < Fairly Valued < 17.19

Perpetuity Growth Rate (g) 0 Under Valued > 17.19

229 

 

AEG WACC(AT) 0.1267 Kd 0.0369 Ke 17.48%

0 1 2 3 4 5 6 7 8 9 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Net Income (Thousands) 215,437

192,569

181,015

217,336

249,937

287,427

330,541

380,122

437,141

502,712

578,118

Total Dividends (Thousands) (74,598)

(96,977)

(96,977)

(111,524)

(128,253)

(128,253)

(128,253)

(166,728)

(166,728)

(166,728)

(216,747)

Dividends Reinvested at 17% (Drip)

(16,952)

(16,952)

(19,494)

(22,419)

(22,419)

(22,419)

(29,144)

(29,144)

(29,144)

Cum-Dividend Earnings 197,966

234,288

269,431

309,846

352,960

402,541

466,285

531,856

607,262

Normal Earnings 226,230

212,656

255,326

293,625

337,669

388,320

446,568

513,553

590,586

Abnormal Earning Growth (AEG) (28,263)

21,632

14,104

16,220

15,290

14,221

19,717

18,303

16,677

PV Factor 0.8512

0.7246

0.6167

0.5250

0.4469

0.3804

0.3238

0.2756

0.2346

PV of AEG (24,058)

15,674

8,699

8,515

6,833

5,409

6,384

5,044

3,912

Residual Income Check Figure

(28,263)

21,632

14,104

16,220

15,290

14,221

19,717

18,303

16,677

diff 0 0 0 0 0 0 0 0 0

Core Net Income 192,569

Total PV of AEG 36,413

Continuing (Terminal) Value 93,974

PV of Terminal Value 22,046 Restated Sensitivity Analysis AEG Model

Total AEG 124,328 Growth Rate

Total Average Net Income Perp (t+1)

251,027 Ke -10% -20% -30% -40% -50% -60% -70%

Divide by shares to Get Average EPS Perp 1.43 9.48% 27.38 25.24 24.19 23.56 23.14 22.85 22.62 Capitalization Rate (perpetuity) 17.48% 11.48% 19.45 18.35 17.79 17.44 17.21 17.04 16.91

13.48% 14.51 13.95 13.64 13.45 13.32 13.48 13.15 Intrinsic Value Per Share (11/03/2008) 8.16 15.48% 11.27 10.98 10.82 10.71 10.64 10.59 10.55 time consistent implied price 11/03/2008 9.33 17.48% 9.03 8.89 8.81 8.76 8.72 8.69 8.67 Nov 3, 2008 observed price $14.89 Over Valued < 12.66 Ke 17.48% 12.66 < Fairly Valued < 17.19

230 

 

WACC(AT) 0.1267 Kd 0.0369 Ke 0.1748

Restated AEG 0 1 2 3 4 5 6 7 8 9

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Net Income (Thousands) 103717.4

4 106,940

100,523

126,482

145,455

167,273

192,364

221,218

254,401

292,561

336,445

Total Dividends (Thousands) -74598 (96,977)

(96,977)

(111,524)

(128,253)

(128,253)

(128,253)

(166,728)

(166,728)

(166,728)

(216,747)

Dividends Reinvested at 17% (Drip)

(13,040)

(16,952)

(16,952)

(19,494)

(22,419)

(22,419)

(22,419)

(29,144)

(29,144)

(29,144)

Cum-Dividend Earnings 119,980

117,475

143,434

164,949

189,691

214,782

243,637

283,545

321,705

365,590

Normal Earnings 121,847

125,633

118,095

148,591

170,880

196,512

225,989

259,887

298,870

343,701

Abnormal Earning Growth (AEG) (1,868)

(8,158)

25,339

16,358

18,811

18,270

17,648

23,658

22,835

21,889

PV Factor 85.12% 72.46% 61.67% 52.50% 44.69% 38.04% 32.38% 27.56% 23.46%

PV of AEG (6,944)

18,360

10,089

9,876

8,164

6,713

7,660

6,293

5,135

Residual Income Check Figure

(8,158)

25,339

16,358

18,811

18,270

17,648

23,658

22,835

21,889

Difference 0 0 0 0 0 0 0 0 0

Core Net Income 106,940

Total PV of AEG 65,345

Continuing (Terminal) Value Restated Sensitivity Analysis AEG Model 123,984

PV of Terminal Value 29,086

Growth Rate

Total AEG 154,782 Ke -10% -20% -30% -40% -50% -60% -70%

Total Average Net Income Perp (t+1)

201,372 9.48% 18.81 17.24 16.46 16.00 15.69 15.47 15.31

Divide by shares to Get Average EPS Perp 1.14 11.48% 13.85 12.97 12.51 12.24 12.05 11.91 11.81 Capitalization Rate (perpetuity) 17.48% 13.48% 10.70 10.19 9.91 9.74 9.62 9.54 9.47

15.48% 8.58 8.28 8.11 8.00 7.92 7.87 7.83 Intrinsic Value Per Share (11/03/2008) 6.54 17.48% 7.09 6.91 6.80 6.73 6.68 6.65 6.62

g 0 Under Valued > 17.19

231 

 

time consistent implied price 11/3/2008 7.48 Over Valued < 12.66 Nov 1, 1988 observed price $14.89 12.66 < Fairly Valued < 17.19 Ke 17.48% Under Valued > 17.19 g 0%

Long Run ROE RI

Average Growth of ROE 7.51% Average ROE 9.86%

Book Value of Equity 2,676,846

initial ke 17.48%

Model MVE 631,649

Shares Outstanding 176070 initial share price 3.59

Growth Rate 7.51% ROE 9.86%

Book Value of Equity 2,676,846

initial ke 17.48%

Model MVE 631,203

Shares Outstanding 176070 Divided by shares 3.58 Time consistent price 4.10

232 

 

 

Growth Rate 

Ke  4.51%  5.51%  6.51% 7.51% 8.51%  9.51% 10.51% 

14.48%  9.13 8.25 7.15 5.74 3.85 1.20 N/A15.48%  8.36 7.48 6.40 5.06 3.32 1.01 N/A16.48%  7.72 6.85 5.80 4.52 2.93 0.87 N/A17.48%  7.17 6.32 5.31 4.10 2.62 0.77 N/A18.48%  6.71 5.87 4.90 3.75 2.37 0.69 N/A19.48%  6.30 5.49 4.56 3.46 2.17 0.62 N/A20.48%  5.95 5.16 4.26 3.22 2.00 0.57 N/A

ROE held constant at 9.86% Over Valued < 12.66

12.66 < Fairly Valued <17.19

Under Valued > 17.19

233 

 

ROE 

Ke  6.86%  7.86%  8.86% 9.86% 10.86% 11.86% 12.86%

14.48%  N/A 0.85 3.30 5.74 8.18 10.62 13.0615.48%  N/A 0.75 2.90 5.05 7.20 9.36 11.5116.48%  N/A 0.67 2.60 4.52 6.45 8.37 10.3017.48%  N/A 0.61 2.35 4.10 5.84 7.59 9.3318.48%  N/A 0.56 2.15 3.75 5.35 6.94 8.5419.48%  N/A 0.52 1.99 3.46 4.94 6.41 7.8820.48%  N/A 0.48 1.85 3.22 4.59 5.96 7.32

Growth Rate held constant at 7.51% Over Valued < 12.66

12.66 < Fairly Valued <17.19

Under Valued > 17.19

ROE 

Growth  6.86%  7.86%  8.86% 9.86% 10.86% 11.86% 12.86%

4.51%  3.15 4.49 5.83 7.17 8.51 9.85 11.195.51%  1.96 3.41 4.87 6.32 7.77 9.22 10.686.51%  0.55 2.14 3.72 5.31 6.89 8.48 10.067.51%  N/A 0.61 2.35 4.10 5.84 7.59 9.338.51%  N/A N/A 0.68 2.62 4.56 6.49 8.439.51%  N/A N/A N/A 0.76 2.95 5.13 7.31

10.51%  N/A N/A N/A N/A 0.87 3.37 5.86Ke held constant at 17.48% 

Over Valued < 12.66

12.66 < Fairly Valued <17.19

Under Valued > 17.19

234 

 

Restated Long Run ROE RI

Average growth of ROE 15.08%Average ROE 0.0786Book Value of Equity 2676846initial ke 0.1748

Model MVE (8,046,090)

Shares Outstanding 176070initial Share Price (45.70)

Growth Rate 0.1508ROE 0.0786Book Value of Equity 2482250initial ke 0.1748

Model MVE (7,467,435)

Shares Outstanding 176070Divided (42.41)Time consistent price -48.51

235 

 

Revised Growth Rate 

Ke  14.87%  15.87%  16.87%  17.87%  18.87%  19.87% 20.87%

14.48%  283.63 90.93 59.49 46.59 39.58 35.16 32.1315.48%  N/A 326.45 103.03 66.57 51.62 43.48 38.3716.48%  N/A N/A 369.85 115.29 73.75 56.72 47.4417.48%  N/A N/A N/A 413.84 127.71 81.02 61.8818.48%  N/A N/A N/A N/A 458.41 140.30 88.3919.48%  N/A N/A N/A N/A N/A 503.56 153.0520.48%  N/A N/A N/A N/A N/A N/A 549.29

ROE held constant at 9.86% Over Valued < 12.66

12.66 < Fairly Valued <17.19

Under Valued > 17.19

236 

 

Revised ROE 

Ke  4.86%  5.86%  6.86% 7.86% 8.86% 9.86% 10.86%

14.48%  N/A 242.48 216.18 189.88 163.58 137.28 110.9815.48%  N/A N/A N/A N/A N/A N/A N/A16.48%  N/A N/A N/A N/A N/A N/A N/A17.48%  N/A N/A N/A N/A N/A N/A N/A18.48%  N/A N/A N/A N/A N/A N/A N/A19.48%  N/A N/A N/A N/A N/A N/A N/A20.48%  N/A N/A N/A N/A N/A N/A N/A

Growth Rate held constant at 7.51% Over Valued < 12.66

12.66 < Fairly Valued <17.19

Under Valued > 17.19

237 

 

Revised ROE 

Growth  4.86%  5.86%  6.86% 7.86% 8.86% 9.86% 10.86%

14.87%  N/A N/A N/A N/A N/A N/A N/A15.87%  N/A N/A N/A N/A N/A N/A N/A16.87%  N/A N/A N/A N/A N/A N/A N/A17.87%  537.87 496.53 455.18 413.84 372.50 331.16 289.8118.87%  162.51 150.91 139.31 127.71 116.11 104.51 92.9119.87%  101.26 94.52 87.77 81.02 74.28 67.53 60.7820.87%  76.15 71.39 66.63 61.88 57.12 52.37 47.61

Ke held constant at 17.48% Over Valued < 12.66

12.66 < Fairly Valued <17.19

Under Valued > 17.19

238 

 

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