Ho me De p o t K e e p s Gr o wi n g

Cash Flow Estimation

and Risk Analysis

© ALAN

SCHEIN/ALAMY

12

CHAPTER

364

Home Depot Inc. (HD) has grown phenomenally

in recent years, and that growth continues. At

the beginning of 1990, HD had 118 stores with

annual sales of $2.8 billion. By early 2008, it had

2,234 stores and annual sales of $77 billion.

Stockholders have benefited mightily from this

growth as the stock’s price has increased from a

split-adjusted $1.87 in 1990 to $40 in early 2007,

or by 2,039%.

However, the more recent news has not been

as good. In the face of a declining housing market,

the company has struggled. In May 2008, it

announced the closing of 12 underperforming

stores. Still, despite the poor housing market, the

company continues to open new stores in areas it

thinks the stores will do well. It costs, on average,

over $20 million to purchase land, construct a

new store, and stock it with inventory. Therefore,

it is critical that the company perform a financial

analysis to determine whether a potential store’s

expected cash flows will cover its costs.

Home Depot uses information from its exist-

ing stores to forecast its new stores’ expected

cash flows. Thus far, its forecasts have been

outstanding, but there are always risks. First, a

store’s sales might be less than projected, espe-

cially if the economy weakens. Second, some of

HD’s customers might bypass the store alto-

gether and buy directly from manufacturers

through the Internet. Third, its new stores could

“cannibalize,” or take sales away from, its exist-

ing stores. To avoid cannibalization while still

opening enough new stores to generate sub-

stantial growth, HD has been developing com-

plementary formats. For example, it recently

rolled out its Expo Design Center chain, which

offers one-stop sales and service for kitchen and

bath and other remodeling and renovation

work; and in 2007, it acquired a Chinese home

improvement chain to jump-start its operations

in that nation.

Rational expansion decisions require detailed

assessments of the forecasted cash flows, along

with a measure of the risk that forecasted sales

might not be realized. That information can then

be used to determine the risk-adjusted NPV

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