Team Members: Seth Nitschmann: seth.a.nitschmann@ttu.edu EJ Quilter-Whitley: Edward.j.quilter-whitley@ttu.edu Ricky Wegner: ricky_weg@hotmail.com Jing Wang: jing.wang@ttu.edu Conway Hwang: cons3@hotmail.com

April 28, 2005

1

Table Of Contents ²

1. Executive Summary 5

2. Business and Industry Analysis 8

2.1 Business and Industry overview 8

2.2 Five Forces Model 8

2.2.1 Rivalry Among Existing Firms 8

2.2.2 Threat of New Entrants 11

2.2.3 Threat of Substitute Products 11

2.2.4 Bargaining Power of Buyers 12

2.2.5 Bargaining Power of Suppliers 12

2.3 Trends 13

2.4 Revenues 14

2.5 Key Success Factors 16

2.6 Conclusion 17

3. Accounting Analysis 17

3.1 Key Accounting Policies 18

3.2 Accounting Flexibility 19

3.3 Strategy Analysis 20

2

3.4 Quality of Disclosure 23

3.5 Qualitative 23

3.6 Quantitative 24

3.7 Potential Red Flags 24

4. Ratio Analysis & Forecast 25

4.1 Financial Ratio Analysis 25

4.2 Sustainable Growth Rate 26

4.3 Time Series Trend 27

4.3.1 Financial Ratios 27

4.3.2 Liquidity 28

4.3.3 Profitability 29

4.3.4 Profitability Analysis 29

4.4 Cross Sectional Analysis 30

4.4.1 Liquidity Ratios 30

4.4.2 Profitability Ratios 32

4.4.3 Capital Structure Ratios 34

4.5 Liquidity 35

4.6 Profitability 36

3

4.7 Capital Structure 37

4.8 Forecast Analysis 38

4.8.1 Income Statement 38

4.8.2 Balance Sheet 41

4.8.3 Statement of Cash Flows 43

4.9 Conclusion 43

5. Valuation Analysis 44

5.1 Valuation Preface 44

5.2 Methods of Comparables 45

5.3 Intrinsic Valuation Method 45

5.3.1 Cost of Capital Estimation 45

5.3.2 Free Cash Flows 50

5.3.3 Discounted Residual Income 51

5.3.4 Abnormal Earnings Growth 52

5.3.5 Summary of Results 53

6. Recommendation 54

7. Sources 56

8. Appendix 57

4

Barnes & Noble (BKS)

Company Valued Investment Recommendation SELL Date of valuation 4-11-05 stock ticker and exchange $34.86 EPS forecast 52 week price range $24.77 - 37.58 FYE 2004 2005 2006 2007 Revenue (2004) 4.87B EPS 1.7 1.83 1.68 1.59 market capitalization 2.41B AEG 0.05 0.01 -0.28 -0.21 industry shares outstanding 70.27M your co average Valuation Ratio Comparison Dividend yield N/A Trailing P/E 20.22 8.81 3 month avg daily trading volume Forward P/E 15.56 10.13 percent institutional ownership 71.40% Book value per share(mrq) $16.59

ROE 9.73% Valuation Estimates

ROS 3.61% Est. 5 year EPS growth Rate Actual Current Price (April 1, 2005) $34.19 Cost of Capital Estimates Beta Ke Ratio Based Valuations Ke estimated 0.811 5.64% P/E Trailing 20.21 P/E Forward 15.55 PEG Forward 1.22 Dividend Yield N/A Published Beta 0.557 M/B Kd 0.0725 WACC 0.054 Intrinsic Valuations Discounted Dividends N/A Free cash flows $36.92 Residual Income $15.44 Abnormal Earnings Growth $15.44 Long-run residual income perpetuity

5

1.0 Executive Summary Recommendation – Overvalued Security We believe the current market price for Barnes and Noble (BKS) is

overvalued. We feel this way because two of the three intrinsic valuation

models we used stated that Barnes and Noble was significantly overvalued.

Both the residual income and free cash flow models shows that Barnes and

Noble is priced to high.

Current Financial Position Barnes and Noble for the past five years have had steadily increasing net

income. Even with the increasing of total liabilities, the increasing of total

revenue has been able to offset the growing debt.

Current Strategy Barnes and Noble current strategy is to help them self by expanding the

current book market thus increasing their own market share. Too get this

accomplished Barnes and Noble will keep expanding their flagship stores to

more neighborhoods across the country. Also, with each stores well trained

management aware to their ever changing the surroundings only the most

marketable books will be sold in each area. Along with that, well researched

and highly visible locations Barnes and Noble to continue to grow and be a

house hold name.

6

Risk Barnes and Noble has minimum risk due to the somewhat clam retail book

industry. With the beta of 0.557, Barnes and Noble is significantly less risky

than the market as a whole.

Valuation Based on Barnes and Noble’s valuation models, the company’s stock price is

overvalued. Using abnormal earnings growth and residual income model, we

arrived at a target price around $16.00 per share. Right now, Barnes and

Noble’s stock is trading at a price of $35.00 per share which we came to a

conclusion that it is overvalued.

Competitors Barnes and Noble is the leading bookseller in the country, with that being

said, Barnes and Noble must still be aware of other competitors in the

market. A few of Barnes & Noble’s largest competitors are Borders Group,

Inc., Amazon.com, and Book-a-Million. For Barnes and Noble to stay in the

market, the company would need to increase their diversity. Examples of

this are Barnes and Noble’s current market share in the video game, DVD,

and music cd industry.

7

2.0 Business and Industry Analysis

2.1 Company and Industry Overview

Barnes and Noble is the largest bookseller in the country. Other than

selling books, Barnes and Noble also owns and operates game stop, a video

game store, and entertainment software stores. This project is designed to

analyze Barnes and Noble in relation to its other competitors in the industry.

We plan on doing this by using the five forces model which includes current

competitors, new entrants, alternative products, customer bargaining power,

and supplier bargaining power.

2.2 Five Forces Model

2.2.1 Competitive Force One: Rivalry Amongst Existing Firms

Barnes and Noble is currently one of the top companies in a highly

competitive market. The companies that they compete with are not only just

in book stores but on the internet also.

When trying to find out were there is a competitive advantage Barnes

and Noble does separate themselves in certain ways. Everyone is selling the

same books just different ways. Were Barnes and Noble separates

themselves is by selling video games, DVD’s, computer software, and Music.

8

Barnes and Noble has been getting away from cyclical sales by being

more diverse in what they sale. Instead of just having bulk sales at the

beginning of a semester with books sales, they sale things you will need

throughout the year. Since the window for selling books is not that big they

have to compete with discount. Barnes and Noble currently takes anywhere

from 20 to 30 percent off books.

The current competitors in this market are Amazon.com, Books-A-

Million Inc, Borders Group Inc, and other small business in the industry.

They are also in competition with mass merchandisers stores such as Wal-

Mart and Costco. Another market they are competing with are specialty

retail that offer books in special subject areas. So to sum it all up Barnes and

Noble is competing with anyone that sales books, music, DVD’s and, etc.

Now, to compete with internet based companies, Barnes and Noble is in

agreements with AOL, MSN, Google, and TM. They are hoping that these

high traffic areas will drive people to Barnes and Noble. (See Appendix 2.1)

9

BKS AMZNBAMMBGP

AMZN = Amazon.com Inc

BAMM = Books-A-Million Inc

BGP = Borders Group Inc (MI)

Industry = Retail (Specialty)

10

2.2.2 Competitive Force Two: Threat of New Entrants

The threat of new entrants of the retail book industry is fairly low. Big

firms such as Barnes and Noble, Borders, Books-A-Million, and

Amazon.com are the major competitors in the business today. For this firm

to build revenue, it is important for them to establish an economy of scale.

New entrants hardly ever have a chance to compete with big players such as

Barnes and Noble, Amazon.com, Borders, or any other established retailers

because they may have to force their prices down which puts pressure on

profits in the long-run. Also, Barnes and Noble, Borders, and Amazon.com

have first movers advantage because early created firms such as those three

will have a guaranteed cost advantage over the new entrants.

2.2.3 Competitive Force Three: Threat of Substitute Products

The threat of substitutes in the book store market is reassembly low.

One reason there is not much of a market for substitutes in this industry, is

that there are no exact substitutes. The threat of substitutes depends of price

and relative performance of competing products. The closest thing to book

stores is television, Internet articles, and radio which cannot compare

directly in price, or performance. The only cost for television and radio is the

one time purchase price for the product, and cost for internet articles can be

11

as little as your monthly subscription for the internet. The only threat from

the substitutes is the customer willingness to switch is so easy anybody can

do it from the comfort from their own home.

2.2.4 Competitive Force Four: Bargaining Power of Buyers

Two factors that determine the bargaining power of buyers are price

sensitivity and relative bargaining power. Books being Barnes and Nobles

main product leave them with low differentiation and low switching costs

for the consumers. Competitors such as discount book stores, used book

stores, and websites such as Amazon.com offer the consumers with an

alternative for the same product at the same or cheaper prices. This leaves

the buyer with high price sensitivity. Because there is a high number of

book suppliers and discount book stores along with low switching costs,

consumers have high relative bargaining power. In all, consumers in the

book industry and of Barnes and Noble have high bargaining power.

2.2.5 Competitive Force Five: Bargaining Power of Suppliers

Barnes & Noble is a company that sells books, magazines, music,

video games, and entertainment software either in store or through the

internet. However, most of its revenues are come from the book sells. On the

supply side, first, Barnes & Noble stocks over 100.000 unique book titles in

12

stores and over 1 million unique titles in warehouse, which is more than any

of it’s competitors do. Also, its huge inventory contains over 40,000

publisher imprints. The last marketing element is the lowest price it offers to

customers. After all, Barnes & Noble gains supply bargaining power by

offering books that can not be found anywhere else at prices that can not be

matched.

2.3 Trends

The importance of companies to identify the trends of their

customers is of the utmost importance. Barnes and Noble have done this by

studying a community prior to opening a store and adjusting its title

selection accordingly. Also, another example of how Barnes & Noble

studies trends is after a store opens, mangers have instructions for father

adjusting the selection to better fit the lifestyles and beliefs of the local

community, and adding local writers to the shelves. The company also

thinks the location of its stores in relation to its customers strengthen its

position in the market and increase its franchise value in the eyes of the

customer.

13

2.4 Revenue

Barnes and Noble is the nation’s largest bookseller. As of January 31,

2004 Barnes and Noble operates 842 bookstores and 1514 video-game and

entertainment-software stores. During fiscal 2003, the company’s share of

the consumer book market was approximately 16 percent giving them their

main source of revenue at almost 4.8 billion dollars. The vast majority of

this revenue comes from in store sales and the rest coming from internet

sales. Other revenue comes from their 64 percent ownership in Game Stop.

With consumer spending in the book market expected to increase at a

compound annual growth rate of 2.8 percent, from approximately 18.8

billion dollars in 2002 to approximately 21.6 billion dollars in 2007, future

revenue is looking bright.

14

15

2.5 Key Success Factors

Barnes and Noble is well know and very successful in the book selling

department of their stores. What people don’t know are the other things they

have done to make them so successful. These things include DVD’s, CD’s,

computer software, and video games. They have extended store hours and

put their department in high traffic places to make it more convenient. To

compete in the internet industry Barnes & Noble also started to sell their

book’s online to help better compete with Amazon and Books-A-Millions

Inc.

Barnes and Noble’s ability to compete in all these fields and still be so

widely known is amazing. There brand is well known and internet

companies are to trying to jump on board. Another key success factor has to

how Barnes & Noble has the ability to compete with discount book stores by

cutting prices. When competing with Wal-Mart and Costco you have to be

able to compete with cheap books. Barnes and Noble take 20 to 30 percent

off books sold in their stores.

In conclusion, Barnes and Noble is one the most highly respected

books stores there is. They are growing everyday not only with acquiring

more assets, but also by expanding their costumer base. They have opened

up to the internet with AOL and MSN to compete in the internet market

16

which is expanding rapidity. Barnes and Noble to this day, is making it

easier for anyone to get a book, DVD, CD, computer software, or video

game. Barnes and Noble has a very high customer satisfaction rate and

makes it as convenient as possible for customers.

2.6 Conclusion

Barnes and Noble is a widely recognized company that has continued

to grow and gain market share. They are very competitive and at the top of

the book market. After looking at the five forces model, it is easy to

understand how Barnes and Noble stacks up so well to its competitors.

Barnes and Noble’s ability to recognize current market trends has kept them

in touch with the local communities and has gained them stronger customer

loyalties. With an increasing revenue stream Barnes and Noble looks to

continue to grow and expand.

3.0 Accounting Analysis

In this section we discuss both qualitative and quantitative method to

evaluate the credibility of Barnes and Noble’s financial statements. This

consists of key accounting policies, degree of accounting flexibility, strategy

analysis, quality of disclosure, and potential “red flags.” Undo accounting

17

distortions was omitted because all of the financial statements appear to be

transparent and not misleading.

3.1 Key Accounting Policies

The Company’s fiscal year is comprised of 52 or 53 weeks, ending

on the Saturday closest to the last day of January. Barnes and Noble’s

financial statements are prepared in accordance with accounting principles

generally accepted in the United States. The preparation of these financial

statements require management to make estimates and assumptions in

certain circumstances that affect amount reported in the accompanying

consolidated financial statements and related footnotes. Barnes and Noble

consider cash and cash equivalents to be any short-term, highly liquid

instruments purchased with an original maturity of three months or less.

Revenue from sales of the company’s products is recognized at the time of

sale. Sales returns are recognized at the time returns are made.

Barnes and Noble use several methods of accounting for their

merchandise inventories. These are stated at the lower of cost or market.

The cost is determined primarily by the retail inventory method on the first-

in, first-out or FIFO basis. They use this method for 77 percent and 82

percent of the Company’s merchandise inventories as of January 31, 2004

and February 1, 2003. Merchandise inventories of GameStop, Barnes &

18

Noble.com, and Calendar Club represent 19 percent and 12 percent of

merchandise inventories as of January 31, 2004 and February 1, 2003.

These inventories are recorded based on the average cost method. The

remaining merchandise inventories are valued on the last-in, first-out or

LIFO method.

Barnes and Noble’s property and equipment are carried at cost,

minus the accumulated depreciation and amortization. For financial

reporting purposes, the straight-line method of depreciation is used for the

assets estimated useful life. Barnes and Noble use different methods strictly

for tax purposes. For instance, maintenance and repairs are expensed as they

are incurred. On the other hand, improvements and remodeling costs are

capitalized. Barnes and Noble reviews its long-lived assets for impairment

whenever events or changes in circumstances indicate that the carrying

amount of an asset may not be recoverable in accordance with Statement of

Financial Accounting Standards (SFAS) No. 144, Accounting for the

Impairment or Disposal of Long-Lived Assets .

3.2 Degree of Accounting Flexibility

As a bookseller company, Barnes and Noble is the only one with a

fully operational multi-channel strategy – with retail locations from coast to

coast and an online subsidiary, Barnes and Noble.com. In that case, it has an

19

average degree of flexibility in choosing different accounting policies and

estimates in certain circumstances that affect amounts reported in the

accompanying consolidated financial statements. For example, as the

balance sheet shows, Barnes and Noble has a large amount of accounts

receivable recorded each year from its retail price stores, which means a low

likelihood that materially different amounts would be reported. Also, it has

an option on how to depreciate or amortize intangible assets, such as

goodwill. During 2002, the company adopted statement of Financial

Accounting Standards No. 142, “Goodwill and other Intangible Assets.”

(2003 Annual Report) Changes in market conditions, among other factors,

could have a material impact on testing unamortizable intangible assets.

According to the accounting policies we described above, there could be

some difference between actually and estimably results by using of

assumption as to future uncertainties. In addition to innovations in retailing,

Barnes and Noble has also expanded its approach to bookselling and the

products it offers through its self-publishing program, that’s why it chooses

FIFO in comparison to LIFO.

3.3 Strategy Analysis

Barnes and Noble’s accounting policies compared to competitors

such as Amazon and Books-A-Million are very similar. Barnes and Noble

20

Inc. is engaged in the retail sale of trade books (generally hardcover and

paperback consumer titles, excluding educational textbooks and specialized

religious titles), mass-market paperbacks (such as mystery, romance, science

fiction and other popular fiction), children’s books, off-price bargain books

and magazines.

Barnes and Noble overall follows GAAP but uses non-GAAP for

financial measures. Non-GAAP policies provide consistent and comparable

measures to help investors understand Barnes and Noble’s current and future

operating results.

On February 4, 2001, the Company adopted Statement of Financial

Accounting Standards No. 133, “Accounting for Derivative Instruments and

Hedging Activities” (SFAS 133), as amended, which requires that all

derivative instruments be recorded on the balance sheet at their fair value.

The impact of adopting SFAS 133 on the Company’s consolidated financial

statements was not material.

Under an agreement ending February 2, 2003, Barnes and Noble

uses an interest rate swap as a derivative to modify the interest

characteristics of its outstanding floating rate long-term debt, to reduce its

exposure to fluctuations in interest rates. Barnes and Noble’s accounting

policy is based on its designation of such instruments as cash flow hedges.

21

Barnes and Noble do not enter into such contracts for tentative purposes.

The swap has a notional amount of $55,000. The effective portion of the

gain or loss on the derivative instrument is initially reported as a component

of comprehensive loss in Barnes and Noble’s Statement of Shareholders’

Equity, and later reflected in earnings in the period in which the related

transactions occur. In the first quarter of 2001, Barnes and Noble recorded

an unrealized loss of $(649), net of taxes. No incompetence was recognized

in the first quarter of fiscal 2001 related to these instruments. Also, other

expenses of $5.4 million in the first quarter of 2001 was primarily due to

$4.5 million in legal and settlement costs associated with the lawsuit brought

by the American Booksellers Association (ABA) and $1.0 million in equity

losses in iUniverse.com. Other expense of $2.5 million in the first quarter of

2000 was due to equity losses in iUnivere.com.

Merchandise inventories are stated at the lower of cost ore market.

Cost is determined using the retail inventory method on the FIFO basis for

82 percent, 83 percent, and 82 percent of Barnes and Noble’s merchandise

inventories. The remaining merchandise inventories are valued on the LIFO

method. All cost are recorded based on the average cost method.

22

3.4 Quality of Disclosure

The beginning of Barnes and Nobles most recent 10-k (2004),

describes a book selling giant. Not only is the report in-depth, it has more

than adequate information concerning the inner workings o the corporation.

It also shows Barnes and Noble’s ownership in three other companies that

are all at the top in their respected markets. The report goes on to describe,

in detail, many of the different sectors that have to do with each of their

companies and Barnes and Noble. Also, the 10-k states that their have been

no changes or disagreements on accounting and financial disclosure.

3.5 Qualitative

Merchandising and marketing is one of the sectors of Barnes and

Noble that is described in-depth. The 10-k states that before a store opens,

Barnes and Noble studies the community and other demographics so they

may better customize the title selection with offerings from the area local

publishers and authors. Expansion is another topic that is described in detail

and is very interesting to many potential investors because of the predicted

growth. According to Veronis, an Industry Forecast company, U.S.

consumer spending on books is predicted to jump from $18.8 billion in 2002

to $21.6 billion in 2007. The 10-k also includes a section on industry

background covering e-commerce. This section explains why

23

BarnesandNoble.com is in a very hot and ever expanding market to feather

increase in revenues for Barnes and Noble.

3.6 Quantitative

The 10-k provides adequate financial statements that include the

three major statements: Income statement, balance sheet, and the statement

of cash flows. The Income statement provided shows the basic multi-step

income statement that shows positive net income for the last three years.

The balance sheet also contains the basics, all of the company’s assets,

liabilities, and equity. To finish up with the statements, the statement of

cash flows contains a very precise outlook of how Barnes and Noble has

allocated its cash flows.

3.7 Potential Red Flags

When looking at the balance sheet, income statement, and statement

of cash flows there were no substantial changes or numbers indicating bad

accounting. The fourth quarter is not yet reported and when observing the

third quarter everything looked good. After going through the 10-k and 10-q

we have come up with the conclusion that Barnes and Noble is very

transparent with their information and do not try to obscure or hide anything.

As far as undoing accounting distortions there were not any red flags.

24

4.0 Ratio Analysis and Forecast

The purpose of this section is to analyze the financial conditions of

Barnes and Noble and to forecast their company’s financial conditions for

the next ten years. In addition to computing Barnes and Noble’s ratios we

will also find competitors ratios along with the industry average. By doing

this we can find out where Barnes and Noble stands compared to the rest of

the industry and where Barnes and Noble needs improvement.

The ratio analysis will allow us to dissect Barnes and Noble ratio by

ratio to find out their weaknesses and their strengths. This helps us to create

underlying information for investors and shareholders with information that

is readily available for the public. This will allow us to find trends in each

of the ratios and to also help with forecasting. It helps with forecasting so

that we don’t over guess the rates at which they are growing.

4.1 Financial Ratio Analysis

The goal of financial analysis is to assess the performance of the firm

in the context of its stated goals and strategy. Ratio Analysis involves

assessing how various items on a firm’s financial statements relate to one

another. Ratio Analysis of Barnes and Noble’s past and present success will

provide a solid foundation for predicting the company’s future performance.

25

In this section, you will find previous annual data filed with the SEC used to

perform a ratio analysis of Barnes and Noble. This Information will be used

to find various liquidity, profitability, and capital structure ratios which will

then allow for an evaluation of Barnes and Noble itself and as well as its

main competitors in the book and game industry. Of Barnes and Noble’s

competitors, Amazon.com, Books-A-Million, and Borders Group Inc. have

been chosen to represent their market.

In the ratio analysis we will use several methods to compare each of

the numbers. First, will be the time-series comparison in which ratios for the

firm will be compared over several years. Next, will be the cross-sectional

comparison. Here ratios of Barnes and Noble will be compared to the ratios

of the other firms in the industry, such as the firms listed in the above

paragraph. Last, we will use this information to do a financial statement

forecasting.

4.2 Sustainable Growth Rate

The Sustainable Growth rate is used to evaluate the firm’s ratios in a

comprehensive manner. They use the “SGR” to find out their growth

without having to change its profitability and financial policy. Also, keep in

mind that the “SGR” is used only as a benchmark at which a firm can be

evaluated. After calculating the SGR we found that, Barnes and Noble on

26

record have shown no dividend payouts. So, we have come to the conclusion

that the Return on Equity equals the SGR.

4.3 Time (Time Series) Trend

4.3.1 Financial Ratios

2004 2003 2002 2001 2000

Liquidity Analysis

Current Ratio 1.52 1.53 1.40 1.56 1.35

Quick Asset Ratio 0.38 0.32 0.18 0.12 0.09

Accounts receivable TO 3.71 4.64 7.39 7.05 6.10

Inventory TO 128.83 132.42 131.78 142.63 162.01

Working Capital

Turnover 7.92 8.04 10.80 8.41 10.94

Profitability Analysis

27

Capital Structure Analysis

Debt to Equity Ratio 0.46 0.52 0.67 1.09 0.76

Debt Service Margin 0.87 0.83 1.03 0.23 0.58

Times Interest Earned 16.40 12.28 6.76 2.50 9.77

4.3.2 Liquidity

Overall, Barnes and Noble’s Liquidity is positive analysis. Our

Current Ratio has shown some ups and downs but has been very consistent

for us. After analyzing is Quick Asset Ratio we have found that they are not

in good standing as far as their credit goes. This shows that their Ratio’s are

very low but are improving year by year. Our Accounts Receivable is very

low, and shows that Barnes and Noble are bad about turning their credits in

to cash. Their Inventory stays in storage to long but this could also have to

do with how seasonal book selling is. Their biggest inventories is college

books that are really only sold twice a year. An increase in sales and

working capital has caused a decrease in working capital.

28

4.3.3 Profitability

Gross profit on sales has been consistently in the positives. Expense

ratio also has a positive affect along with net profit margin. These are the

things that we used to look at the efficiency in are company. So our

efficiency was positive with only one drop in Net Profit Margin in 2001.

Our asset turnover over the years has been positive and has increased

almost every year or stayed consistent. This positive production in the Asset

Turnover shows that they can support their sales volume. For every Dollar

invested in 2004 they had 1.70 of sales. Thanks to the Asset Turnover

staying consistent and net profit Margin increasing it has been favorable to

their Return on Asset ratio. (See Appendix 4.1)

4.3.4 Profitability Analysis

Barnes and Noble capital structure shows that they get their assets

efficiently. Except for one year in 2001 their debt-to-equity ratio has been

under 1. This shows that they have been doing a good job with their equity

financing. In 2004 Barnes and Noble had .46 in liabilities for every dollar of

equity. Barnes and Noble Times Interest Earned have shown that their

29

earnings have almost doubled from 2000 to 2004. This also proves that

Barnes and Noble is creditworthy, because their Times Interest Earned is

incredibly higher in 2004 then in 2000. (See Appendix 4.2)

4.4 Cross Sectional (Benchmark) Analysis

4.4.1 Liquidity Ratios: (See Appendix 4.3)

Current Ratio

Barnes & Noble has a higher current ratio than Borders Group, but

lower on compared to Books-A-Million. Even the trend has been slightly

decreasing over the past five years and the company still has enough assets

to cover their current liability. Although they have enough if they keep this

trend they are going to see themselves falling quickly.

Quick Asset Ratio

All three companies are doing poorly on the quick asset ratio, since

the number is below one. Barnes & Noble has fallen down a lot after year

2001, and so do competitors. However, Barnes & Noble still keep declining

while both competitors are arising in 2004. This is saying that the value of

Barnes and Noble is going down and that they do not have enough assets to

pay off their liabilities.

30

Days Supply of Receivables

Days supply of receivables, compare to Borders Group and Books-A-

Million, Barnes & Noble’s number has appear decline since 2002, which is

would not indicated any trouble for the company. This does tell us that

compared to the rest of the industry that we are better are at collecting are

accounts receivable. Barnes and Noble turn receivables into cash fast.

Days Supply of Inventory

Days supply shows how much inventory the company is holding in

term of days. Barnes & Noble is holding fewer inventories than both

competitors, and it is very efficient in managing their inventory. This tells

us that not only are we lower then every one else but we also do not hold are

inventory in stock very long. In the other words, it is good to have a low

Days Supply of Inventory ratio.

Working Capital Turnover

Barnes & Noble seem in the mid position between two competitors,

lower than Borders Group, but higher than Books-A-Million. The number is

not stabled and appears upward in 2004. It is better to increase their current

assets in order to make the working capital turnover smaller. This tells us

31

that Barnes and Noble have a lot more current liabilities then current assets.

This in any business is no good and they need to improve in the area.

4.4.2 Profitability Ratios: (See Appendix 4.4)

Gross Profit Margin

The variation between Barnes & Noble and Borders Group, on the

gross profit margin is very small and there is no real advantage for anyone.

Barnes and Noble are leading their competitors in this category and just need

to keep improving. Although Barnes and Noble is not that high they still are

improving and that is a positive for this ratio.

Operating Expense ratio

Operating expense ratio, the higher the percentage, the less efficient a

company is running. As the chart shows above, Barnes & Noble has the

lowest ratio. Barnes and Noble are not too bad with keeping cost down.

This also has a lot to do with selling books and they don’t make them.

Net Profit Margin

In 2003, Barnes & Noble and Borders Group were falling together.

Especially, Barnes & Noble turn out a negative number, which means they

32

don’t have very much money in hand. This means that Barnes and Noble

are selling more then they are collecting. This usually means that there is a

lot of accounts receivable out there.

Asset Turnover

Barnes & Noble has higher asset turnover than the other two

companies before 2003, and staying fallen below Borders Group. Barnes

and Noble are fine in that their sales are exceeding their totals assets. This

means that we have enough resources to produce are volume.

Return on Asset

Barnes & Noble has shown a decrease line in 2003 than its

competitors. After that, it became arising from -0.02 to 0.05 in 2004, the

highest number over past four years. These numbers show that their

operating efficiency is not very good at all. This also shows that almost

every year their profitability has deteriorated. Finally Between 2003 and

2004 it made a significant jump and hopefully is still on the rise.

33

Return on Equity

The rate of return on equity chart show that Barnes & Noble has about

the same fluctuations as their return on asset for the past five years. They

still have decreased number in 2003 and increased in 2004. This shows that

the owners’ profitability was not that high and finally took a turn for the

better in 2004. Overall, this shows that the owners interest in total assets in

not very high.

4.4.3 Capital Structure Ratios: (See Appendix 4.5)

Debt To Equity Ratio

There has been a slight increase in this debt to equity ratio over the

past five years that means debt has become a larger portion of total financing.

Compared to its competitors, Barnes & Noble has the lowest ratio while it’s

arising in 2003. This shows that Barnes and Noble have had enough

owners’ equity to pay for their total liabilities.

Debt Service Margin

From 2000 to 2002, Barnes & Noble has large number of debt service

margin than its competitors. During year of 2003, it suddenly fallen from

34

1.03 to 0.23, which their ability to make the payment is decreased. They

have only been at more then one dollar per long term debt in these past five

years. They don’t have the adequate amount of cash to pay installments on

their long term debts.

Times Interest Earn

Barnes & Noble trends downward slop from 2000 to 2003 show that

they are doing better than Borders Group, while Books-A-Million stay

relatively low from year to year. Since 2004, Barnes & Noble may have

sufficient money to cove the interest payment on their long term debts.

Besides the increase between 2003 and 2004 they are being very consistent

and have improved most of the time.

4.5 Liquidity

Liquidity refers to how much of a company’s assets are, or are easily

converted to cash or cash equivalents. A company without enough liquidity

can have problem of paying its short-term debts or finding enough cash to

finance unexpected business opportunities.

Overall, Barnes & Noble has a positive liquidity analysis. The current

ratio has changed slightly over the past five years. Through the quick asset

35

ratio is another liquidity ratio that indicates a company’s ability to quickly

payoff current assets if the need arises. Typically this number should be

greater than 1; however, as you can see from the table above, it trend to

increased each year, but still above one. The accounts receivable turnover

ratio and days supply of receivables are close related. For Barnes & Noble,

as the accounts receivable turnover ratio rises the days supply of receivables

goes down. Also, inventory turnover and days of supply inventory looks

stable for recently years. The inefficient working capital has shown sales has

been decreased since current assets and current liability have not changed

much, but still stays positive.

4.6 Profitability

Gross profit margin is gross profit divided by sales, and it is stable as

the table showed us. Operating expense ratio is stayed on 22%, stable as

same as the gross profit margin, except year of 2001 has the highest

number—25%. Net profit margin tells what percentage of sales was retained

by the company as net income. Obviously, it sharply increased from – 1% in

2001 to 3% in 2004, and this is good indicator for Barnes & Noble. A higher

number of asset turnover suggests that the company is producing large sales

volume in relation to its assets. Barnes & Noble’s asset turnover has been

going up and down from 2000 to 2004. It increased from 1.44 in 2000 to

36

1.86 in 2003, and decreased to 1.70 in 2004. Return on asset and return on

equity both have increased over past five years. Positive return on equity

shows the profitability of the owner’s interest in total assets in Barnes &

Noble.

4.7 Capital Structure

Barnes & Noble experienced a decline in debt to equity in 2004 from

2001, which is a good indicator for the company. It dropped from 1.09 in

2001 to 0.46 in 2004. Also, this decrease indicates that debt has become a

smaller proportion of total financing. The debt service margin ratio

illustrates how well a company is able to cover the yearly payments on their

long tern debt. Barnes & Noble has an unchanged debt service margin as the

table shows. The increase in time interest earned ratio indicates that Barnes

& Noble’s income from operations is more adequate to cover required

interest charges.

37

4.8 Forecast Analysis

4.8.1 Income Statement

In order for us to forecast Barnes and Noble’s financial information,

we needed to figure out the percentage change from one year to the next.

The best tool to forecast the future is the past. By saying past, we used

Barnes and Noble’s 10k income statement starting from 1999 to 2003.

To start off, we reviewed our income statement and selected sales,

cost of goods sold, gross profits, and net earnings to forecast. Based on what

we have looked up on finance.yahoo.com, it said that in the year of 2004,

Barnes and Noble’s sales would increase by 3.9%. The website also said that

in the year 2008, the company would take an 8.9% hit. After that, we came

together and decided that because of what happened, we predicted the

percentage sales for the next seven years. As you can see in the table 1

below, we predicted that sales would grow at an average of 12.5% after 2006.

Table 1

2004 2005 2006 2007 2008

$6,159,300,525 $6,251,690,033 $5,695,289,620 $6,549,583,063 $7,335,533,030

38

2009 2010 2011 2012

$8,289,152,324 $9,449,633,650 $10,583,589,688 $11,641,948,657

2013

$12,689,724,036

The next list of numbers that we forecasted are cost of goods sold and

gross profits. To get the gross profit, we took the dollar amount from the

cost of goods sold for the past five years and average them out. We came up

with a growth of 11% per year of goods sold. To calculate an 11% growth

rate for 2004, we took the cost of goods sold of 2003 and multiplied it by

1.11. We did this step for the next 10 years. After calculating the dollar

amount for the forecasted years, we took the sales and subtracted cost of

goods sold to get the gross profit. Table 2 below is an example of what we

did.

39

Table 2

2003 2004 2005 2006

Sales $5,951,015,000 $6,159,300,525 $6,251,690,033 $5,695,289,620

(Cost of goods

sold) $4,323,767,000 $4,712,906,030 $5,231,325,693 $5,231,325,693

Gross Profits $1,627,248,000 $1,446,394,495 $1,020,364,340 $463,963,927

The last set of numbers we forecasted for the income statement is net

earnings. Net earnings stayed mostly constant in the past but in year 2000 it

dipped down into the red of a recorded net loss of 52 million dollars. This

was because of the dot com bubble burst. Other than that, we took the other

four years and came up with an average of a 4% growth rate pre year. We

took that 4% and multiplied it from the year 2003 to get the forecasted dollar

amount for 2004. We executed the same step for the next 10 years to achieve

our forecasting number. Table 3 below will show you a little example of

what we did.

40

Table 3

2003 2004 2005 2006

Net Earnings $151,853,000 $157,927,120.00 $164,244,205 $170,813,973

151,853,000 * 1.04 = 157,927,120

157,927,120 * 1.04 = 164,224,205

164,224,205 * 1.04 =

170,813,973

4.8.2 Balance sheet

Forecasting is a very difficult and highly sensitive process. When

using such large numbers, such as the ones in the Barnes & Noble balance

sheet, even a few percent off can grow into a hundred million dollar mistake.

That is why we have based our forecast growth rates on Barnes & Nobles

past numbers, because like mentioned earlier the best predictor of the future

is the past.

To help forecast the fourth quarter numbers for the 2004 balance sheet,

a lot of attention was paid to the 2003 numbers. At the end of the third

quarter on the 2003 balance sheet total assets, total liabilities, total equity

were all a few percent less than the 2004 numbers. So by comparing the

41

2003 year end total to the third quarter numbers of 2004 I was able to

estimate that it would grow by roughly 8 %. As demonstrated in table 4.

Table 4

2003 2004

$2,193,489,000 $2,456,707,680 Total current assets

$2,247,635,000 $2,427,445,800 Total Liabilities

Total shareholders

equity $1,259,659,000 $1,360,431,720

The main focus of the balance sheet forecasting was on the must

essential, and highly visible of the balance sheet accounts. I feel that total

current assets and total non-current assets which together equal total assets is

a vital element of the overall value of the balance sheet. Largely based on

the previous five years of Barnes & Noble’s Balance Sheets there is a slow

growth of total assets. A conservative sustainable growth rate 8% was used

in forecasting the total assets for the next ten years. A similar philosophy

was used in the forecasting of all the liabilities and equity sections of the

balance sheet. Please see forecasted balance sheet located in appendix at end

of report.

42

4.8.3 Statement of Cash Flows

The forecasts on our statement of cash flows are derived from the

estimates used on the income statement and balance sheet. Using the growth

rates and patterns on these statements, we were able to calculate and forecast

the future cash flows for Barnes and Noble. Therefore, all of the forecasts

are in accordance with the other financial statements and gave us a better

overview helping us make the best estimates possible. Potential errors may

arise from fluctuations or miscalculations in the other financial statement

forecasts which would carry over to the statement of cash flows. Other

fluctuations may be a result of certain or rare economic trends

4.9 Conclusion

After analyzing Barnes and Noble, with their ratios and the industries,

we have come to the conclusion that Barnes and Noble has some advantages

and some disadvantages in the industry. The ratios have also told us that

they are very competitive and are one of the big dogs in the industry. As the

fall and spring semester in college roll around, Barnes and Noble is at the

top. They have done things like expand outside of just walking in and

buying books to just turn on your computer. Things look bright and Barnes

and Noble if they keep improving at this rate will always be on top.

43

5.0 Valuations Analysis

5.1 Valuation Preface

After forecasting financial statements for Barnes and Noble, for the

next ten years, we then tied them into are calculation models to estimate the

value of equity. We are going to base these values on assumptions of future

performance.

The main reason for making these valuations, besides the value of the

company, is to find out if our stock is an attractively priced security. We

will judge the weights of the valuations by which model comes closest to the

market price of are company. Even though one valuation might come closer

than another; the other valuations are still important to have a broad range of

variables. These values can also determine where we think most of the

value of the firm lies, either in the assets already in place, or in the Barnes

and Noble's future.

The valuation methods we will be using are the following: Method of

Comparables, Discounted Free Cash Flows, Discounted Residual Income,

and Abnormal Earnings Growth. We will not be using the Discounted

Dividends model further explained why later.

44

5.2 Methods of Comparables Valuation

The method of comparables valuation was performed using current

share prices and shares outstanding. This method requires that several close

competitors of Barnes & Noble be used to compute rations and then be

averaged. It is non-intrinsic model that is least reliable because it takes only

the competitions information and neglects all firm specific data. Also, the

method of the comparables valuation is not considered to be one of the most

accurate measures, as it can be seen by the range of values.

The P/E ratio conveys what price investors will pay for every dollar

of earnings. In this case, Investors are willing to pay $20.22 for every dollar

that the Barnes and Noble earn. The trailing P/E multiple implies that Barnes

& Noble’s stock, priced at $34.19. That is overvalued by $16.76, and the

P/B ratio implies the company overvalued by more than $0.84. (See

Appendix 5.1)

5.3 Intrinsic Valuation Method

5.3.1 Cost of Capital Estimation

To estimate cost of equity (Ke), cost of debt (Kd), and the weighted

average cost of capital (WACC), we took historical prices from

45

finance.yahoo.com and plugged those numbers in an excel spread sheet. To

get the percentage of total liabilities, we divided each liability by the total

liability before MI. The table below shows the example of how we got the

percentage of total liabilities for accounts payable.

Table 1

Percent of Total

Liabilities 1/31/2004

Current Liabilities:

Accounts payable $858,068,000 42.47%

Accrued liabilities $583,773,000 28.89%

$1,441,841,000 71.37%Total current liabilities

Long-term debt $300,000,000 14.85%

Deferred income taxes $170,066,000 8.42%

Other long-term liabilities $108,441,000 5.37%

total liab before MI $2,020,348,000

We then looked on Edgar scan and obtain the computed interest rate.

We took each interest rate and multiplied it by the percentage of total

liabilities to get the value weighted rate. Table 2 below shows an example of

what we did. Barnes and Noble have an abnormally high percent of

46

liabilities because currently they are opening many new locations across the

United States.

Table 2

Computed

Interest Rate

Percent of Total

Liabilities Value Weighted Rate

0.0588 42.47% 0.02497

0.026 28.89% 0.00751

71.37%

0.0525 14.85% 0.00780

0 8.42% 0.00000

0.063 5.37% 0.00338

After obtaining the entire value weighted rate, we took the sum of

those numbers and came up with our cost of debt.

The way we achieve the cost of equity is by using the CAPM model

and the CAPM series excel sheet. (As seen below)

47

Ke = CAPM = Rf + B( Rm – Rf )

Ke = .03207 + 1.38(.03)

Ke = 7.346%

Beta

Estimate R-Squared

Average

Risk

Free

Rate

Historical

Market

Risk

Premium

Yahoo

Published

Beta

0.810873 8.0744970% 0.03207 0.577 0.03

Estimated Ke 5.640%

Estimated Cost of

Debt 4.37%

short horizon

0.2867 Estimated Ke 4.067%

R^2 0.806%

shorter horizon beta

48

1.3794812 Estimated Ke 7.346%

R^2 5.455%

The way we obtained the weighted average cost of capital, we calculated the

value of debt and the value of equity of the firm.

Vd / Vd + Ve = Value of Debt of the firm

2,247,635,000 / 2,247,635,000 + 1,259,659,000 = .64

Ve / Ve + Vd = Value of Equity of the firm

1,259,659,000 / 1,259,659,000 + 2,247,635,000 = .36

WACC = Vd / (Vd+Ve) (Kd) + Ve / (Ve+Vd) (Ve)

WACC = .64 (.0437) + .36 (.0746)

WACC = .0548

49

5.3.2 Free Cash Flows

After computing and evaluating the Free Cash Flows we come to the

conclusion that, Are market price is smaller then are intrinsic value of the

stock. This method carries the more weight in the overall valuation of

Barnes and Noble. We used year 2013 cash flow to calculate the terminal

value. Our forecasts have shown an increasing trend and the future looks

bright.

Are estimated share price when using this model is 36.92. We used a

weighted cost of capital of 5.4%. After we calculated that are intrinsic

values was higher then the market price we assumed that either a higher

weighted cost of capital, or a negative growth to come closer to the intrinsic

value. (See appendix)

Discounted Dividends

When trying to calculate this model we came to the conclusion that it

was impossible. The reason why is, because Barnes and Noble does not pay

dividends. This is the main factor in not trying to compute the Discounted

Dividends model.

50

5.3.3 Discounted Residual Income Model

Sensitivity Analysis

g

0 0.02 0.05 0.1

Ke 0.03 $51.57 $104.52 N/A N/A

0.05 $26.53 $30.15 N/A N/A

0.07 $16.30 $15.69 $12.50 N/A

0.09 $10.93 $9.74 $5.74 N/A

0.11 $7.73 $6.60 $3.51 $42.98

The discounted residual income model finds the companies estimated

value per share by using their cost of equity, which Ke= 7.25%. Our analysis

found an estimated price $15.44 per share compared to the actual price of

$34.38 per share, which the actual price was twice larger than the estimated

price. For this valuation method we conclude that the firm is overvalued,

because the actual price is higher than our estimated price. In order to

validate our assumption, we performed a sensitivity analysis compare other

possible cost of equity’s and growth rates. When growth rate equals 0,

increase 2% of cost of equity leads a large number decreases.

51

5.3.4 Abnormal Earnings Growth Model

Using the Abnormal Earning growth model the value of the firm’s

equity is expressed as the sum of its book value and discounted forecasts of

abnormal earnings. This model takes into account the present value of the

investment opportunities of the dividends paid to shareholders. It does not

include actual dividend payments (because BKS does not pay dividends),

but they are considered to be found in the earnings per share. The abnormal

earnings are computed as the earnings per share plus any dividend

investment opportunities. Afterwards the normal earnings are subtracted to

find any abnormal earnings. The abnormal earnings are then discounted

back and set up as a continuing perpetuity to find the value of each share.

This model can be found in the Appendix.

Using a cost of equity of 7.25%, this model gave us a present share

value of $15.44. This can be compared to the actual share price of $34.38.

Because Barnes and Noble do not pay dividends, it is hard to say how

effective and accurate this model actually is.

52

Sensitivity Analysis

g

0 0.02 0.05 0.1

Ke 0.03 $21.34 $21.34 N/A N/A

0.05 $18.30 $18.30 N/A N/A

0.07 $15.73 $15.73 $15.73 N/A

0.09 $13.57 $13.57 $13.57 N/A

0.11 $11.73 $11.73 $11.73 $11.73

Conducting a sensitivity analysis test showed that with Ke

equaling .03, gave the closest estimate to the actual share price. This

conflicts with our estimated Ke of .0725 which showed a value of

approximately 15 dollars per share. With no dividends being paid and our

cost of equity giving a considerably low price per share, we have concluded

that this method considers Barnes and Noble overvalued. We do not

consider this model to be a sufficient way of valuing the company and would

need further research, because of the absence of dividends.

5.3.5 Summary of results

The valuation models used to help find the estimated value per

share offer a comprehensive and in-dept picture into the inner workings of

Barnes and Noble. Based on the valuation models used, Barnes and Noble

53

is currently over valued in the residual income and abnormal earnings

growth models. While the discounted free cash flows offers a fairly

accurate depiction of the current market price being only about a point and

half above the price set by the market. Unfortunately, we were not able to

use the discounted dividends method because of the simple fact that Barnes

and Noble does not pay dividends. But, even without a full arsenal of

valuation methods; the valuation as a whole should be accurate and reliable.

The differences in the market price and what has been calculated

by our valuation models are most likely do to a couple of reasons. First, the

market is forever changing, so theoretically even with a perfect valuation of

a company; the next day if the market is open their will be a change in the

value of the firm therefore throwing off the model. Second, in the valuation

models used, forecasting numbers was necessary. When forecasting, the

possibility of human error always exist, whether it is in the estimated future

cash flows, our in the forecasted earnings per share. With that being said

we are very confident with what we believe is a slightly over valued firm.

6.0 Recommendation

Due to our confidence and in the strength of our valuation models,

we feel Barnes and Noble are over valued in the market. With two of are

three models used showing the company as over valued and the other one

54

as only slightly under valued that’s what we base this decision on. Even

with our recommendation of overvalued Barnes and Noble will continue to

grow in what seems to be the ever expanding world of internet sells. We

recommend selling Barnes and Noble.

55

7.0 Sources

1. Barnes and Noble homepage. www.barnesandnoble.com

2. www.barnesandnobleinc.com

3. http://finance.yahoo.com

4. http://edgarscan.pwcglobal.com

www.msnbc.com5.

6. www.ruetors.com

56

8.0 Appendix

2.1

DIRECT COMPETITOR COMPARISON

BKS AMZN BAMM BGP Industry

Market Cap: 2.44B 14.56B 159.33M 2.04B 657.85M

Employees: 40,000 7,800 2,700 15,000 4.35K

Rev. Growth (ttm): 12.90% 33.80% 4.00% 6.20% 11.20%

Revenue (ttm): 6.55B 6.92B 434.61M 3.85B 953.73M

Gross Margin (ttm): 27.70% 23.15% 26.89% 27.70% 36.13%

EBITDA (ttm): 519.86M 516.15M 21.10M 323.40M 80.76M

Oper. Margins (ttm): 5.15% 6.36% 1.33% 5.73% 3.48%

Net Income (ttm): 158.04M 588.45M 2.36M 131.90M 32.58M

EPS (ttm): 2.032 1.386 0.131 1.652 1.00

PE (ttm): 17.05 25.75 74.35 16.43 22.10

PEG (ttm): 1.32 1.58 1.25 1.44 1.16

PS (ttm): 0.37 2.30 0.38 0.54 0.56

Finance.yahoo.com

57

4.1

DIRECT COMPETITOR COMPARISON

BKS AMZN BAMM BGP Industry

Market Cap: 2.44B 14.56B 159.33M 2.04B 657.85M

Employees: 40,000 7,800 2,700 15,000 4.35K

Rev. Growth (ttm): 12.90% 33.80% 4.00% 6.20% 11.20%

Revenue (ttm): 6.55B 6.92B 434.61M 3.85B 953.73M

Gross Margin (ttm): 27.70% 23.15% 26.89% 27.70% 36.13%

EBITDA (ttm): 519.86M 516.15M 21.10M 323.40M 80.76M

Oper. Margins (ttm): 5.15% 6.36% 1.33% 5.73% 3.48%

Net Income (ttm): 158.04M 588.45M 2.36M 131.90M 32.58M

EPS (ttm): 2.032 1.386 0.131 1.652 1.00

PE (ttm): 17.05 25.75 74.35 16.43 22.10

PEG (ttm): 1.32 1.58 1.25 1.44 1.16

PS (ttm): 0.37 2.30 0.38 0.54 0.56

Finance.yahoo.com

58

4.2

2004 2003 2002 2001 2000 Profitability Analysis

Gross Profit Margin 27% 27% 27% 28% 29%

Operating Expense Ratio 22% 22% 22% 25% 22%

Net Profit Margin 3% 2% 1% -1% 4%

Asset Turnover 1.70 1.76 1.86 1.71 1.44

Return on Assets 4% 3% 2% -2% 5%

Return on Equity 12% 10% 7% -7% 15%

59

4.3 Current Ratio: 2000 2001 2002 2003 2004

1.52BKS 1.53 1.40 1.56 1.351.47BGP 1.42 1.3 1.19 1.171.8BAMM 1.83 1.79 1.82 1.74

Current Ratio

0.00

0.200.40

0.60

0.801.00

1.20

1.40

1.601.80

2.00

2000 2001 2002 2003 2004

Years

Valu

e

BKS

BGP

BAMM

Quick Asset Ratio 2000 2001 2002 2003 2004BKS 0.38 0.32 0.18 0.12 0.09BGP 0.41 0.33 0.24 0.12 0.11BAMM 0.1 0.1 0.12 0.13 0.14

Quick Asset Ratio

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

2000 2001 2002 2003 2004

Years

Valu

e

BKS

BGP

BAMM

60

Days supply of receivables 2000 2001 2002 2003 2004

3.71 4.64 7.39 7.05 6.10BKS BGP 9.03 8.36 7.8 7.85 7.91 BAMM 6.2 7.38 8.4 10.2 13.02

Days Supply of Receivables

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

2000 2001 2002 2003 2004

Years

Valu

e

BKS

BGP

BAMM

Days supply of inventory 2000 2001 2002 2003 2004

128.83 132.42 131.78 142.63 162.01BKS BGP 168.86 173.11 180.38 181.34 182.64BAMM 234.39 241.39 231.11 233.07 224.66

Days Supply of Inventory

0.00

50.00

100.00

150.00

200.00

250.00

300.00

2000 2001 2002 2003 2004

Years

Valu

e

BKS

BGP

BAMM

61

Working Capital Turnover 2000 2001 2002 2003 2004

7.92 8.04 10.80 8.41 10.94BKS 6.80 7.68 10.10 15.06 17.61BGP 4.41BAMM 3.93 4.23 4.02 4.3

Working Captial Turnover

0.00

2.004.00

6.008.00

10.00

12.0014.00

16.0018.00

20.00

2000 2001 2002 2003 2004

Years

Valu

e

BKS

BGP

BAMM

62

4.4 Gross Profit Margin 2000 2001 2002 2003 2004

0.27 0.27 0.27 0.28 0.29BKS BGP 0.28 0.27 0.27 0.28 0.28BAMM 0.24 0.23 0.24 0.23 0.23

Gross Profit Margin

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

2000 2001 2002 2003 2004

Years

Valu

e

BKS

BGP

BAMM

Operating Expense Ratio 2000 2001 2002 2003 2004

0.22 0.22 0.22 0.25 0.22BKS 0.94 0.95 0.95 0.95 0.94BGP 0.96 0.98 0.98 0.98 0.97BAMM

Operating Expense Ratio

0.00

0.20

0.40

0.60

0.80

1.00

1.20

2000 2001 2002 2003 2004

Years

Valu

e

BKS

BGP

BAMM

63

Net Profit Margin 2000 2001 2002 2003 2004

0.03 0.02 0.01 -0.01 0.04BKS 0.03BGP 0.03 0.03 0.01 0.030.02BAMM 0.03 0.09 0.07 0.01

Net Profit Margin

-0.02

0.00

0.02

0.04

0.06

0.08

0.10

2000 2001 2002 2003 2004

Years

Valu

e

BKS

BGP

BAMM

Asset Turnover

2000 2001 2002 2003 20041.70 1.76 1.86 1.71 1.44BKS 1.51BGP 1.54 1.56 1.62 1.571.61BAMM 1.44 1.5 1.43 1.41

Asset Turnover

0.00

0.200.40

0.600.80

1.00

1.201.40

1.601.80

2.00

2000 2001 2002 2003 2004

Years

Valu

e

BKS

BGP

BAMM

64

Return on Assets 2000 2001 2002 2003 2004

0.04 0.03 0.02 -0.02 0.05BKS 0.06BGP 0.07 0.06 0.04 0.060.03BAMM 0.01 0.02 0.02 0.03

Return on Assets

-0.03-0.02

-0.010.00

0.010.02

0.030.04

0.050.06

0.070.08

2000 2001 2002 2003 2004

Years

Valu

e

BKS

BGP

BAMM

Return on Equity 2000 2001 2002 2003 2004

0.12 0.10 0.07 -0.07 0.15BKS 0.12BGP 0.12 0.1 0.05 0.130.05 0.01 0.03 0.02 0.05BAMM

Return on Equity

-0.10

-0.05

0.00

0.05

0.10

0.15

0.20

2000 2001 2002 2003 2004

Years

Valu

e

BKS

BGP

BAMM

65

4.5

Debt to Equity Ratio

2000 2001 2002 2003 20040.46 0.52 0.67 1.09 0.76BKS 1.13 1.20 1.28 1.39 1.39BGP 1.18 1.50 1.42 1.37 1.36BAMM

Debt to Equity Ratio

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

2000 2001 2002 2003 2004

Years

Valu

e

BKS

BGP

BAMM

Debt Service Margin

2000 2001 2002 2003 20040.87 0.83 1.03 0.23 0.58BKS 0.38 0.33 0.41 0.22 0.30BGP 0.38 0.11 0.25 0.08 0.12BAMM

Debt Service Margin

0.00

0.20

0.40

0.60

0.80

1.00

1.20

2000 2001 2002 2003 2004

Years

Valu

e

BKS

BGP

BAMM

66

Times Interest Earned 2000 2001 2002 2003 2004

16.40 12.28 6.76 2.50 9.77BKS 23.63 4.93 4.34 4.10 9.28BGP 5.23 2.01 2.45 2.03 3.28BAMM

Times Interest Earned

0.00

5.00

10.00

15.00

20.00

25.00

2000 2001 2002 2003 2004

Years

Valu

e

BKS

BGP

BAMM

67

5.1

Method of Comparables

Name Symbol PPS EPS

Forward

P/E

Trailing

P/E

P/B

ratio PEG

Books-A-Million Inc BAMM 9.03 N/A 12.74 N/A 1.12 1.02

Borders Group Inc BGP 26.51 1.77 12.23 15.02 1.83 1.05

Barnes & Noble Inc BKS 34.19 1.69 15.56 20.22 2.1 1.22

SUM 69.73 3.46 40.53 35.24 5.05 3.29

AVERAGE 17.77 1.77 12.49 15.02 1.47 1.035

68

5.2

Free Cash Flows Free Cash Flow (to firm) Banres and Noble

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012Cash Flow from Operations $585,393,700 $673,202,755 $774,183,168.00 $890,310,643.00 $1,023,857,240.00 $1,177,435,826.00 $1,354,051,200.00 $1,557,158,880.00 $1,790,732,712.00Cash Provided (Used) by Investing Activities ($310,955,645) ($311,266,601) ($311,577,867) ($311,889,445) ($312,201,335) ($312,513,536) ($312,826,049) ($313,138,875) ($313,452,014)Free Cash Flow (to firm) 274,438,055 361,936,154 462,605,301 578,421,198 711,655,905 864,922,290 1,041,225,151 1,244,020,005 1,477,280,698discount rate (5.4% WACC) 0.949 0.900 0.854 0.810 0.769 0.729 0.692 0.657 0.623Present Value of Free Cash Flows 260377661.290 325799749.036 395083390.780 468685758.366 547100362.965 630860628.434 720543780.594 816775076.999Total Present Value of Annual Cash Flows 4,165,226,408Continuing (Terminal) Value (assume no growth) 1401594590.133Present Value of Continuing (Terminal) Value 920,232,412Value of the Firm (end of 2003) 5,085,458,820Book Value of Debt and Preferred Stock $2,247,635,000Value of Equity (end of 2003) 2,837,823,820Estimated Value per Share 36.92

Book Value Per Share $36.92

Actual Price per share $34.38

Ke 0.0725WACC 0.0539955

69

5.3

Abnormal Earning growth Abnormal Earnings Growth Value

1 2 3 4 5 6 Forecast Years 2004 2005 2006 2007 2008 2009 2010 2003 EPS $1.70 $1.83 $1.68 $1.59 $1.86 $1.92 $1.79 DPS $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00

$0.00 $0.00 $0.00 $0.00 $0.00 $0.00 DPS invested at 7.25% $1.83 $1.68 $1.59 $1.86 $1.92 $1.79 Cum-Dividend Earnings $1.82 $1.96 $1.80 $1.71 $1.99 $2.06 Normal Earnings

Abnormal Earning Growth (AEG) $0.01 ($0.28) ($0.21) $0.15 ($0.07) ($0.27)

0.932 0.869 0.811 0.756 0.705 0.657 PV Factor

$0.01 ($0.25) ($0.17) $0.12 ($0.05) ($0.18)PV of AEG $1.70 Core EPS ($0.58) Total PV of AEG Continuing (Terminal) Value $0.00 PV of Terminal Value Total PV of AEG $1.12 Average Perpetuity

Capitalization Rate (perpetuity) 0.0725

pv $15.44 Value Per Share fv 15.716

Ke 0.0725 0 g

Ke

Actual Price per share $34.38

70

71

72