Johns Hopkins University

Carey Business School

Department of Finance

FINANCIAL MANAGEMENT
SEMESTER PROJECT
Company : Hewlett-Packard
Market Index : S &P 500

Fall Semester 2008

HANG L. NGUYEN

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 Table of Contents

1. Introduction………………………………………………………………………………3
1.1 Hewlett-Packard Company…………………..……………………………….…...…..3
1.2 Company’s Revenue……………………...………………...………………….…......3
1.3Company’s History…………...………………………………………………….….....3
1.4 Competitors…………………………………………………..………………….…....4

2. Company Beta and Portfolio Analysis………………………………………………….5

2.1 HPQ 10 Years Historic Data Analysis……………………………..………………….5
2.2 SPY 10 Years Historic Data Analysis………………..…………….…………….…...5
2.3 Correlation and Covariance…………………………...…………….………….……..5
2.4 Beta Determination………………………………….……………….……….…........5
2.5 Portfolio Analysis…………………………………….……………….…….………...7
2.6 Required Rate of Return of HPQ using CAMP.……….………………….……….…9

3. Stock Price Estimation…………………………………………………………………11

3.1 Technique and Formulas………………...…………………………………………...11
3.2 Results and Discussion…………………….………………………………………...11

4. Free Cash Flow Calculation………………………………………………………........12

4.1 HP’s Free Cash Flow Summary from 2007 and 2006………….………………........12
4.2 Calculation and Observation…………………………………………………………12

5. Ratios…………………………………………………………………………………….14
5.1 Ratio Summary………………...………………………………………………….....14
5.2 Calculations………...…………..…………………………………………………….15
5.3 Industry Benchmarks.………..….…………………………………………………...15
5.4 Data Observation…………………..………………………………………………...16

6. Conclusion………………………………………………………………………………19

7. References……………………………………………………………………………….22

8. Appendix………………………………………………………………………………...23

9. List of Tables……………………………………………………………………………24

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 1. Introduction
1.1 Hewlett-Packard Company Overview
Hewlett-Packard Company (HP), founded by William Hewlett and David Packard in 1939
in California, is a technology corporate which specializes in hardware, software, and a full range
of services to design, implement, and support IT infrastructure. The major product lines of HP
Company include personal computing devices, enterprise servers, related storage devices, as well
as a variety of printers and other imaging products. Other product lines, including electronic test
equipment and systems, medical electronic equipment, were spun off as Agilent Technology Inc.
in 1999. According Wikipedia.org, at the end of fiscal year 2007, HP is named the fifth largest
software company in the world and the largest technology company with a turnover in 2006 of
$94,000 million and in 2007 of $104,000 million. In 2002, HP merged with Compaq, which had
bought Tandem Computers in 1997 and Digital Equipment Corporation in 1998. After the
merger, the new ticker symbol became “HPQ” to show the significance of the alliance. During
the fiscal year 2007, its operations were organized into seven business segments: Enterprise
Storage and Servers, HP Services, and HP Software, the Personal Systems Group, the Imaging
and Printing Group, HP Financial Services, and Corporate Investment.
1.2 Company’s Revenues
In 1939, the founders of HP, William Hewlett and David Packard, started their company
with the initial investment of $538.00 and earned their first revenue of $5,369.00. As reported by
Wikipedia.org, HP posted $91.7 billion in annual revenue in 2006, making it the world’s largest
technology vendor in term of sales. In 2007 the revenue was $104 billion, making HP the first
Information Technology (IT) Company in history to report revenues exceeding $100 billion. In
2008, HP’s revenue is increased to $113.05 billion.
1.3 Company’s History
On Jan 1st 1939, when Hewlett and Packard defined their partnership and decided the name
of their company with a coin toss, HP was a company of 2 employees and headquartered in
Packard’s garage in Palo Alto, California, where later become the state historical landmark. HP
officially incorporated on August 8, 1947, and went public on November 6, 1957 as a traded
company. The company’s initial offering is $16.00 per share. In 1961, when its revenue had
grown to $87.9 million with 5040 employees, HP was listed on New York Stock Exchange’s
“big board” for the first time. HP is acknowledged by Wired magazine as the producer of the
world's first personal computer, in 1968, the Hewlett-Packard 9100A. HP has successful lines of
printers, scanners, digital cameras, calculators, PDAs, servers, workstation computers, and
computers for home and small business serving millions of customers in the global markets.

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 1.4 Competitors
1.4.1 Dell
Dell is a multinational technology company, which develops, manufactures, sells, and
supports personal computers and other computer-related products. Dell grew during the 1980s
and 1990s to become (for a time) the largest seller of PCs and servers. As of 2008 it held the
second spot in computer-sales within the industry behind the Hewlett-Packard Company. The
company currently sells personal computers, servers, data storage devices, network switches,
software, computer peripherals and televisions. Dell’s revenue (2008) is $ 61.133 billion USD.
1.4.2 Canon Inc.
Canon is a multinational corporation headquartered in Tokyo, Japan that specializes in the
manufacture of imaging and optical products, including cameras, photocopiers and computer
printers. The most recent revenue reported for Canon is 4,481,346 million Yen.
1.4.3 Xerox Corporation
Xerox is a global document management company which manufactures and sells a range of
color and black-and-white printers, multifunction systems, photo copiers, digital production
printing presses, and related consulting services and supplies. Xerox’s revenue is $17.2 billion as
indicated in the most recent report of the company’s finance.
1.4.4 International Business Machines Corporation (IBM)
IBM is a multinational computer technology and consulting. The company is one of the few
information technology companies with a continuous history dating back to the 19th century.
IBM manufactures and sells computer hardware and software, and offers infrastructure services,
hosting services, and consulting services in areas ranging from mainframe computers to
nanotechnology. Despite falling behind Hewlett-Packard in total revenue since 2006, it remains
the most profitable. IBM has been among the Worldwide Top 20 Semiconductor Sales Leaders
in past years, and in 2007 IBM ranked second in the list of largest software companies in the
world. IMB’s revenue is $ $98.8 billion.

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 2. Company Beta and Portfolio Analysis

2.1 HPQ from Jan 1998 to Dec 2008

Historical data of HPQ in the past 10 years was downloaded from Yahoo Finance for
calculating the following data:
Monthly average return (assuming continuous compounding): 1.03%
Monthly standard deviation of the return: 11.54%
Coefficient of variation (ratio of std deviation to mean): 11.16%
Formula used:
Monthly Std. Deviation / Monthly Average Return = 11.54% / 1.03%

2.2 Market Returns of SPY from Jan 2008 to Dec 2008

Historical data of SPY in the past 10 years was downloaded from Yahoo Finance for
calculating the following data:
Monthly average return (assuming continuous compounding): 0.15%
Monthly standard deviation of the returns: 4.60%
Coefficient of variation: 30.67%
Formula used:
Monthly Std. Deviation / Monthly Average Return = 4.60% / 0.15%

2.3 Correlation and Covariance Between HPQ and the Market

The following calculations are obtained using historical data of HPQ and the Market from
Jan 1998 to Dec 2008.
Correlation between HPQ and SPY (ρ): 0.57
Covariance between HPQ and SPY (COV): 0.00305
Formula used:
Covariance (COV) = ρ * σ(stock) * σ(market)
σ(stock) 11.54%
σ(market) 4.60%

2.4 Beta determination

2.4.1 Determine beta of HPQ
The slope of a regression line provides an estimate of the stock’s beta. Beta coefficient of HP
is estimated using regression, where HP’s returns is represented on the y-axis and the market
SPY’s returns is on the x-axis. Regression shows that the slope or beta of HP is 1.44.

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2.4.2 Graphical Support

Figure 1: Returns of HPQ vs. SPY

Figure 1 above is graphed based on the historical data of monthly returns of HPQ vs.
SPY in the past 10 years. The graph is constructed via Regression function on Excel with the
returns of HPQ on the y-axis and returns of SPY on the x-axis.

As indicated in figure 1, the slope or beta of HPQ is 1.44. Since beta is greater than 1.0,
the stock of HPQ is more risky than the market. R² is 0.329, and it shows a dispersion of data
among the returns of HPQ and SPY, and this also indicates that about 32.9% of the variance
in HPQ returns is explained by the market returns. The beta, also referred as market risk, is
the amount of risk that a stock contributes to the market portfolio as defined under the
Capital Assets Price Model.

While the market risk, also known as beta coefficient of HPQ, is represented on this
graph as the slope of the regression line with the value of 1.44 as mentioned previously, the
diversifiable risk of HPQ is represented by the errors on regression. Due to the fact that R² of
the above regression HPQ’s returns vs. SPY’s returns is about 32.9%, over 67.1% risk comes
from diversifiable risk and this percentage of the return cannot be predicted by the movement
of the market in the future.

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 2.5 Portfolio Analysis
2.5.1 Portfolio Average Return and Standard Deviation
Assume a portfolio of interested made of 60% of HPQ stock and the rest of SPY
Weight E ( r ) Sigma Correlation (ρ): 0.57
HPQ 60% 1.03% 11.54%
SPY 40% 0.15% 4.60%
Formulas used to calculate portfolio return and portfolio standard deviation, respectively:
E ( rP )  w A E ( rA )  wB E ( rB )
 P  sqrt  w 2A  2A  wB2  2B  2 w A wB  A  B  

The average return of the portfolio is 0.68%

Average return = 60%*1.03% + 40%*0.15% = 0.68%
The standard deviation is 8.12%
Std. Deviation = sqrt(0.6²*0.1154² + 0.4²*0.046² + 2*0.6*0.4*0.1154*0.046) = 8.12%

2.5.2 Standard Deviation Comparison

Sigma
HPQ 11.54%
SPY 4.60%
Portfolio 8.12%

Table 1: Summary of Standard Deviation Values

As shown in table 1, the standard deviation of market SPY is 4.60%, whereas the standard
deviation of HPQ is 11.54%. The smaller standard deviation of the market indicates that the
market’s volatility is less than that of HPQ. The standard deviation of the portfolio is 8.12%, less
than that of HPQ alone, indicating that the riskiness can be reduced by diversification of stocks.

2.5.3 Portfolio Calculation, with weights from 0% to 100% in 5% increments

Table 2 below shows the expected return and standard deviation for the portfolio of HPQ and
SPY, when the weight given to HPQ varies between 0% and 100% in 5% increments.

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 Weight
HPQ SPY E(r) Sigma
0% 100% 0.15% 4.60%
5% 95% 0.19% 4.72%
10% 90% 0.24% 4.89%
15% 85% 0.28% 5.10%
20% 80% 0.33% 5.35%
25% 75% 0.37% 5.62%
30% 70% 0.41% 5.93%
35% 65% 0.46% 6.25%
40% 60% 0.50% 6.60%
45% 55% 0.55% 6.96%
50% 50% 0.59% 7.33%
55% 45% 0.63% 7.72%
60% 40% 0.68% 8.12%
65% 35% 0.72% 8.53%
70% 30% 0.77% 8.94%
75% 25% 0.81% 9.36%
80% 20% 0.85% 9.79%
85% 15% 0.90% 10.22%
90% 10% 0.94% 10.66%
95% 5% 0.99% 11.10%
100% 0% 1.03% 11.54%

Table 2: Portfolio Returns and Standard Deviation (in the 5% increment weights)
2.5.4 Graphical Support

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 Figure 2: Standard Deviations vs. Expected Return of Portfolio
In figure 2 above, the correlation coefficient between HPQ and SPY is 0.57 as found in
section 2.5.1. The y-axis of the graph represents the portfolio’s expected returns, as the x-axis
represents the standard deviation of the portfolio.

Figure 3: Standard Deviations vs. Expected Returns with Different Correlation Coefficient.
In a similar method, the figure 3 is conducted to show the relationship between the standard
deviations of the portfolio versus the expected returns of portfolio. The difference between
figures 2 and 3 is the values of correlation coefficients. In figure 3, correlation coefficient was
0.0, 0.25. 0.75. and 1.0, respectively.

2.6 Required Rate of Return of HPQ using CAPM

2.6.1 Risk Free Rate
According to Brigham and Ehrhardt in their book Financial Management, the risk-free rate is
generally measured by the expected return on long-term U.S. Treasury bonds. Internet surfing
indicates that the Risk Free rate is approximately 5%.
2.6.2 Required Rate of Return of HPQ
To calculate required rate of return of HPQ, on an annualized basis, the following Capital Assets
Pricing Model (CAPM) formula was used:
E ( ri )  rrf   i  E ( rMkt )  rrf 
Risk free rate: 5%
Beta: 1.44
Market Rate 1.80% (on annualized basis)

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 Because the market rate 1.80% is much smaller than that of the risk free rate 5%, the CAPM
model does not make sense. Therefore, the returns of SPY were calculated with a longer range of
date, from 1993 to 2008 as available in Yahoo Finance, instead of the historical data of 10 years
used in all of the previous sections.

Rate of returns of SPY was calculated monthly and then converted into the annual basis. The
new market rate is obtained to be 6.90%. With is new figure, CAPM was applied to find the
required rate of return of HPQ as follow:

E(r) = 0.05 + 1.44*(0.069 - 0.05) = 0.077

E(r) = 7.7%

According to CAPM, the market risk premium, which can be calculated by taking the
difference of the market’s return and the risk-free rate, is quite small 1.90%, the low required
rate of return of the stock is 7.7% is satisfactory. It is important to keep in mind that as the key
concept of CAPM specifies that required return should only affected by non-diversifiable risks;
however, the insight of this model is not absolute.

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 3. Stock Price Estimation
3.1 Technique and Formulas
In the past 10 fiscal years, HPQ has paid its dividend quarterly. Due to the fact that the
dividend information for the full 2008 is not yet available, HPQ’s dividend history from 1998 to
2007 is taken into account to estimate its stock price. The dividends were then converted in
annual basis and summarized in the table below:
Fiscal Dividend Dividend Growth Rate Value of Stock
Year (Dollar) (%) (Dollars)
1998 0.31
1999 0.32 3.23 0.29
2000 15.91 4871.72 0.27
2001 0.32 -97.99 12.72
2002 0.32 0 4.13
2003 0.32 0 4.13
2004 0.32 0 4.13
2005 0.32 0 4.13
2006 0.32 0 4.13
2007 0.32 0 4.13
Table 3: HPQ Stock Value Estimation

Since the dividend growth of HPQ is not a constant rate, Gordon Model was not employed to
estimate the stock price. The period from 1999 to 2001 has non-constant growth rate, present
values of the dividends are calculated using the following formula of the stock valuation method
P = D / (1+r) ^n
Where P is the stock’s intrinsic value today, D is annual dividend, r is the discount rate and
equals 7.74% as calculated in the previous section, and n is the number of year.
From 2002 to 2007, HP Company’s dividend remains constant over time, and thus it has a
zero growth rate. During this period, HPQ resemble a perpetuity where stock value can simply
estimate by dividend divided by the discount rate or P = D / r

3.2 Results and Discussion

Take the sum of the present values of HPQ over time, the stock price estimated to be $38.09.
At the time of this project is conducted, the current market price of HPQ is $35.23, which is
lower than the estimated stock price. The difference between the theoretical price of HPQ and its
current market price can be due to a number of factors. The stock valuation method, which was
deployed as seen above, takes into account the discounted rate normally including a risk
premium based on the CAPM. Although this model provides insights on how required return of a
company should not be affected by diversifiable risk but only by non-diversifiable risk, its
assumptions does not explain all variations in equity returns such as the impact of taxes,
transaction costs, etc. Another factor that might contribute to the difference between the
estimated price and the current price of HPQ is the fact that HPQ had made an extremely high
dividend in its second quarter of fiscal year 2000, which in turn significantly creates a high
growth rate only in a short period of time before coming back to the normal. One might argue
that this financial analyst can justify value to be close to the current price by fine-tuning the

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growth assumptions. Yet, after this sudden big dividend payment, HPQ keep its dividend
payment constant over time and makes the growth rate to be zero.

4. Free Cash Flow Calculation

4.1 HP’s Free Cash Flow Summary for 2007 and 2006
2007 2006
NOWC $19,695,000 $21,161,000
Total Net Operating Capital $27,493,000 $28,024,000
NOPAT $5,679,600 $4,464,000
FCF $6,210,600 -$2,990,000
Table 4: Summary of HP’s Free Cash Flow in 2007 and 2006
4.2 Calculations and Observation
The followings are calculation samples explained results obtained for 2007. In a similar manner,
the same calculation steps were done for the fiscal year 2006 and the total results are summarized
in Table 4 Summary of HP’s Free Cash Flow in 2007 and 2006 above.
Net Operating Working Capital (NOWC)
= Operating Current Assets – Operating Current Liabilities
= (Cash + A/R + Inventory) – (A/P)
= (11,293,000 + 8,033,000 + 26,191,000) – (25,822,000)
= $19,695,000
Total Net Operating Capital = NOWC + Operating long-term assets
= 19,695,000 + 7,798,000
= $27,493,000
NOPAT = EBIT (1 – Tax Rate)
= 9,466,000 (1 – 0.4)
= 9,466,000 * 0.6
= $5,679,600
HP has $28,024,000 of total net operating capital at the end of 2006, and $27,493,000 at the end
of 2007. Therefore, during 2007, it made a net investment in operating capital of:
Net Investment in Operating Capital = 27,493,000 – 28,024,000
= - $531,000

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HP Free cash flow in 2007 was:
Free Cash Flow = NOPAT – Net investment in operating Capital
= 5,679,600 – (- 531,000)
= $6,210,600
From 2006 to 2007, HP decreased its operating capital by $531,000 during 2007
($27,493,000 - $28,024,000). Although in 2006, HP Free cash flow as negative, it could have
been a sign that the company is making large investments of $7,454,000 which might have the
potential to long-term profit. In 2007, HP has $6,210,600 available for distribution to all
investors, including both shareholders and debt-holders.

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 5. Fundamental Financial Ratios
5.1 Ratio Summary
Groups Ratios Results
Liquidity Ratios Current Ratio 1.21 Times
Quick Ratio (Acid Test Ratio) 1.0 Time
Asset Management Ratios Inventory Turnover Ratio 12.98 Times
Days Sales Outstanding 91.67 Days
Fixed Assets Turnover Ratio 2.20 Times
Total Assets Turnover Ratio 1.18 Times
Debt Management Ratios Debt Ratio 56.57%
Time-Interest-Earned (TIE) 32.75 Times
Profitability Ratio Profit Margin on Sales 6.97%
Basic Earning Power (BEP) 10.67%
Return on Total Assets (ROA) 8.19%
Return on Common Equity (ROE) 18.85%
Market Value Ratio Price/Earnings Ratio 11.62 Times
Price/Cash Flow Ratio 6.18 Times
Book Value per Share 15.72
Market/Book Ratio 2.39 Times
Table 5: Summary of Five Group Ratios

5.2 Calculations
This section explains the results summarized in table 3 above with formulas and calculations.

Liquidity Ratios
Current Ratios = Current Assets / Current Liabilities
= 47,402,000 / 39,260,000 = 1.21 times
Quick or Acid Test Ratio = (Current Assets – Inventories) / Current Liabilities
= (47,402,000 – 8,033,000) / 39,260,000 = 1.00 time

Asset Management Ratios

Inventory Turnover Ratio = Sales / Inventories
= 104,286,000 / 8,033,000 = 12.98 times
Days Sales Outstanding = Receivables / (Annual Sales /365)
= 26,191,000 / (104,286,000 / 365) = 91.67 days
Fixed Assets Turnover Ratio = Sales / Net Fixed Assets
= 104,286,000 / 47,402,000 = 2.20 times
Total Assets Turnover Ratio = Sales / Total Assets
= 104,286,000 / 88,699,000 = 1.18 times
Debt Management Ratio
Debt Ratio = Total Liabilities / Total Assets
= 50,173,000 / 88,699,000 = 56.57%
Time-Interest-Earned (TIE) = EBIT / Interest Changes
= 9,466,000 / 289,000 = 32.75 times

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Profitability Ratio
Profit Margin on Sales = Net Income / Sales
= 7,264,000 / 104,286,000 = 6.97%
Basic Earning Power (BEP) = EBIT / Total Assets
= 9,466,000 / 88,699,000 = 10.67%
Return on Total Assets (ROA) = Net Income / Total Assets
= 7,264,000 / 88,699,000 = 8.19%
Return on Common Equity (ROE) = Net Income / Common Equity
= 7,264,000 / 38,526,000 = 18.85%
Market Value Ratio
Price / Earning (P/E) Ratio = Price per Share / Earnings per Share
= 37.50 / 3.228 = 11.62 times
Price / Cash Flow Ratio = Price per Share / Cash Flow per Share
= 37.50 / 6.07 =6.18 times
Book Value per Share = Common Equity / Shares Outstanding
= 38,526,000 / 2,450,000 =15.72
Market / Book Ratio = M/B = Market Price per Share / Book Value per Share
= 37.50 / 15.72 = 2.39 times

5.3 Industry Benchmarks

Four technology companies including Canon, Dell, IBM, and Xerox were selected to be the
benchmark for calculating the industry’s ratios, which are necessary for an accurate assessment
of HP’s business performance and management.

Hewlett-Packard Company: Summary of Financial Ratios

Ratio HPQ CAJ DELL IBM XRX Average
Liquidity
Current 1.21 2.08 1.07 1.20 2.09 1.53
Quick 1 1.63 1.01 1.14 1.77 1.31

Asset Management
Inventory Turnover 12.98 7.95 51.81 37.08 13.20 24.60
Days Sales Outstanding (DSO) 91.67 64.69 45.93 112.60 119.84 86.95
Fixed Assets Turnover 2.2 1.72 3.08 1.86 2.02 2.17
Total Assets Turnover 1.18 0.99 2.22 0.82 0.73 1.19

Debt Management
35.20 86.11 76.36 63.52
Total Debt to Total Assets 57.00% % % % % 63.64%
Times-Interest-Earned (TIE) 32.75 522.19 86.04 24.71 3.48 133.84

Profitability
10.90 10.55
Profit Margin on Sales 6.97% % 4.82% % 6.59% 7.96%

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 17.03 10.42 12.54
Basic Earning Power (BEP) 10.67% % % % 8.57% 11.84%
10.82 10.69
Return on Total Assets (ROA) 8.19% % % 8.65% 4.82% 8.64%
16.71 78.90 36.59 13.22
Return on Common Equity (ROE) 18.85% % % % % 32.85%

Market Value
Price/Earnings (P/E) 11.62 8.53 7.57 9.42 9.24 9.27
Price/Cash Flow 6.18 4.88 2.20 11.00 6.13 6.08
Market/Book (M/B) 2.39 1.46 5.31 3.76 0.62 2.71
Table 6: Summary of Financial Ratios of HPQ and its competitors

5.4 Data Observation

Current Ratio:
In the perspective of short-term creditors, liquidity ratios of HP are lower in comparison to its
industry indicating a smaller margin of safety that the company possesses to cover short-term
debts. The current ratio of HP is 1.21, and is lower than the industry average of 1.53, meaning
that for every $1 of debt or liability, HP has $1.21 of cash, and that its short-term debt is covered
over by 1.21 times as compare to 1.53 times of the industry average. The current ratio of HP also
implies HP has a lot of money tied up in non-productive assets, and this is due to large inventory
holdings, which might well become obsolete before they can be sold.

Quick Ratio:
The key liquidity ratio that focuses on the firm’s more liquid assets is the acid-test ratio or quick
ratio as its calculation eliminates inventory and prepaid assets, which are often the least liquid
current assets of a firm. Even though HP’s quick ratio of 1.0 is much lower than the industry
average 1.31, it is still satisfactory for the company to meet its current obligations with the
readily convertible assets on hand. In fact, if all of the creditors of the company were to demand
their money at this time, HP would have sufficient reserves to pay off its short-term debt. It has
$1.0 of liquid cash for every $1.0 in short-term debt.

Inventory Turnover Ratio:

Inventory Turnover Ratio of HP is lower than that of the industry average ratio, 12.98 times
versus 24.60 times. An Inventory Turnover Ratio of 12.98 is roughly means that the average
dollar volume of Inventory is used up 13 times during the fiscal year. The difference in ratios
suggests that HP is holding on its inventory much more than other companies in the same
industry. As a rule of thumb, a low turnover is usually a bad sign because products tend to
deteriorate as they sit in a warehouse, decrease cash flow, and reduce warehousing and other
related costs. However, a closer look at the increase in sales in 2007 as compared to 2006 by
about 14% along with about 4% of inventory increase in 2007, the low inventory turnover ratio
of HP might just be a factor of higher demand.

Days Sales Outstanding:

The industry average yields almost 90 days of sales outstanding (DSO) meaning that it takes 90
days for a typical company technology firm must wait after making a sale before receiving cash.
Sale terms call for payment of HP is within 92 days, slightly above its industry average, indicates

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that HP generally sells its products to customers on credit and taking longer to collect money
compare to its competitors. Due to the high important of cash in running a business, HP should
work to collect outstanding receivables as quickly as possible for a more efficient business
operation.

Fixed Assets Turnover Ratio:

As fixed assets turnover ratio measures how effectively the firm uses it plant and equipment,
with the fact that fixed assets turnover ratio of HP is comparatively close to the industry average,
2.2 and 2.17 respectively, it indicates that the company is using its fixed assets about as
intensively as are other firms.

Total Assets Turnover Ratio:

Fairly close total assets turnover ratios between HP and the industry average, 1.18 and 1.19
respectively, reveal that HP is generating a sufficient volume of business in relation to other
competitor firms in the industry.

Debt Ratio:
In comparison of a company’s total debt to its total assets, the debt ratio is used to gain the
general idea as to the amount of leverage being used by a company. HP’s debt ratio is 57.00%,
lower than that of the industry average 64.00%. This ratio implies that HPs creditors have
supplied more than haft of the total financing for HP, and HP is less dependent on leverage such
as money borrowed or owed as compared to its competitors. This ratio is also helpful when used
in conjunction with other measures of HP’s financial health to determine the company’s level of
risk.

Times-Interest-Earned (TIE):
While industry has 133.84 times to cover its interest charges on a pretax basis, due to the large
TIE ratio of Canon of 522, HP’s interest is covered at a much lower rate 32.75 times. In this
sense, HP has a better ability to sustain earnings compared to other company in general.

Profit Margin on Sales:

With a profit margin of almost 7%, HP has generated a net income of $0.07 for every dollar of
sales, which is still a little bit lower than the industry average of 8%. This ratio also points out
that other companies in the same industry have slightly better control over its costs than HP. This
also implies that HP has costs that have increased at a greater rate than sales compared to others.
This is another point that HP can improve to ensure an efficient operation while expanding its
profit in earnings.

Basic Earning Power (BEP):

Because tax situations and degrees of financial leverage are different from one company to
another, BEP is useful for comparing firms in their basic profitability in assets. The industry
average is 11.84%, slight higher than HP ratio of 10.67%. However, these figures are not
sufficient to make any comment on whether HP has a lower return on its assets as is the average
company among its competitors.

Return on Total Assets (ROA):

The return on total assets of HP is 8.19% is lower than the industry average by approximately
1%. The low return can result from 2 possible causes such as the company’s low basic earning

17
power as calculated above, and high interest costs. Therefore, in relation to its competitors in the
same industry, HP has lower earnings in proportion to its assets and slightly less effective in
using its assets.

Return on Common Equity (ROE):

In an accounting sense, stockholders invest to get a return on their money and this ratio tells how
well they are doing. The return of HP is 18.85% is below the industry average of 33.00%. It
somewhat reflects on HP inefficient use of debt.

Price / Earnings Ratio (P/E):

While the industry average price / earnings ratio is 9.27%, the ratio of HP is 11.62%. It shows
that investors of HP are willing to pay $11.62 for every dollar of earnings and they have more
earning power than average of the technology industry.

Price / Cash Flow Ratio:

In comparison of the price/ cash flow ration, HP’s ratio is relatively close to the industry average,
6.18 times and 6.08 times respectively. This ratio suggests the growth prospects of HP are about
the average among the competitors.

Market / Book Ratio:

The market /book ratio of HP is 2.39, slight lower than the industry average of 2.71. Since
market/book ratio typically exceeds 1.0, this means that investors are willing to pay more for
stocks than their accounting book values. It also means that HP’s value in the market place is
higher than its actual book value.

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 6. Conclusion
Founded in 1939, Hewlett-Packard (HP) Company has become the world’s largest
technology company, provides printing and personal computing products and IT services,
software, and solution to consumers and businesses. The company now serves more than one
million customers in more than 170 countries on six continents. To date, it has approximately
320,000 employees worldwide. Its revenue for the four fiscal quarters end Oct. 31 2008 is $118.4
Billion. According to Yahoo Finance reports, the market capital of HP is $81.81billions, it issues
2.44 billion shares, and the stock price quoted as $33.53 at the time of the project is conducted.
Based on the data of HP Company in the past 10 fiscal years from 1998 to 2008, historical
average monthly return is calculated to be 1.03% and the standard deviation is 11.45%. Using the
same procedures, the SPY standard deviation is 4.60% and the portfolio of 60% of HPQ and
40% of SPY has a standard deviation of 8.12%. Although, an investment on HPQ alone has a
higher rate of return 1.03% on monthly average compare to 0.68% of the portfolio, HP has a
larger standard deviation which indicates a greater variation of returns and thus a greater chance
that the actual return may be substantially lower than the expected return. However, this does not
mean that HP is a riskier investment than a portfolio consisting of HPQ and SPY. Since
coefficient of variation takes account of the effect of both risk and return, it provides a more
meaningful basis for comparison in this case of different returns and standard deviation. The
covariance of HPQ is 11.16% while that of SPY alone is 30.67%, and this indicates that SPY is
almost three times as risky as HPQ.
Section 2 of this project includes an analysis of a portfolio made of 60% of HPQ and
40% of SPY. The average return of the portfolio of interest is 0.68%, is less than that of HPQ
alone, but its standard deviation is 8.12%. As the effect of combining stocks is to reduce
riskiness of an investment, a correlation coefficient of 0.57 as in the case of the portfolio of HPQ
and SPY, it shows that combining stocks, or diversification, reduces risk (σ has reduced from
11.54% as of HPQ alone to 8.12%). However, diversification does not completely eliminate the
riskiness of investment as graphically illustrated in figure 3 Standard Deviations vs. Expected
Returns with Different Correlation Coefficient, where graphs covered the possible range of
correlation coefficient from 0 to 1. Figure 3 also shows that as the correlation coefficient
increase, the standard deviation or the riskiness of portfolio also rises. In the case of perfect
positive correlation, ρ = 1.0, diversification of stocks still does not help in reducing risk. The part
of the HPQ’s risk that can be eliminated when it is combined with SPY in the portfolio is
referred to as diversifiable risk, which is caused by random events. The part of risk that cannot
be eliminated is called market risk or beta, which stems from factors that systematically affect

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most firms such as inflation, recessions, and high interest rates. Regression estimates that the
market risk of HPQ is 1.44, equals to the slop of the regression line as shown in figure 1 Returns
of HPQ vs. SPY.

The value of beta, the risk degree that reflects on the expected returns of the stock, also
implies that HPQ is 1.44 as risky as the market. Capital Asset Price Model (CAPM) was
employed in this project to understand the relationship between beta and required rate of return
of HPQ. However, it is observed relationships reflect statistical problems rather than the true
nature of capital markets as the average realized rate of return on an annualized basis of HPQ is
40.67% while the required rate of return was calculated to be 7.7%. The limitations of CAPM is
that it only takes into account of the security’s beta coefficient, yet, in reality there are other
factors contributing to the required return of a stock. Using the stock valuation, the theoretical
stock price of HPQ was calculated to be $38.09, which is a little higher than the current market
price of HPQ $35.23. Although from fiscal year 2001 until present, HPQ has made a dividend
payment of $0.08 quarterly; in the second quarter of 2000 HP paid a dividend of $15.59 when it
completes the separation of Agilent Technology Inc, a company rooted in the founding of HP
and specializes in designing and manufacturing test, measuring, and monitoring instruments and
systems. As of May 2000, for each HP common share outstanding, the distribution was made on
the basis of 0.3814 of a share of Agilent. HP held 380 million shares, about 84.1 percent of the
outstanding common stock. As discussed in the previous section, the discrepancy between the
stock price and the stock valuation finding was probably due to limitation of CAPM or the
sudden raise in dividend payment in HP Company’s dividend history.
HP annual reports including balance sheet and the income statement were obtained for
fiscal years 2006 and 2007. Calculations show that free cash flow (FCF) of 2006 was a negative
number (-$2,990,000). This is not necessary a bad sign for the growth of HP Company in
concerns on the highly competitive nature of the computer industry. Yet, a negative FCF might
have been due to the fact that company has put its earnings into investment with the strategy of
pay off in the long run. In fact, in 2006, HP spent $7,454,000 in net investment in operating
capital. In 2007, HP was able to generate its internal growth into $6,210,600 to distribute to its
stockholders. The financial analysis of HP led on the analysis of fundamental ratios on which
HP’s performance was compared to the average of the industry benchmarks including HP’s
major competitors Canon, Dell, IBM, and XEROX. The average ratios of the industry were
considered as a prediction of the industry’s norm which provides indications of potential
problem areas in HP’s business practice. Both of HP liquidity ratios are lower than the industry
average, and this suggests that HP has lower margin of safety to cover any short term debts.
However, HP has passed the figurative acid-test, its quick ratio is 1.0, indicates that even though
its ability to pay off its short-term debts obligations is weaker than industry average, its quick
ratio indicates financial integrity

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 In relation to its peer in the same industry sector, HP’s assets management is about the
average. Its Inventory Turnover Ratio is lower than the industry average ratio, but other ratios
such as Days Sales Outstanding, Fixed Assets Turnover, and Total Assets Turnover are fairly
close to the benchmarks. At a quick look at income statement and balance sheet in 2006 and
2007, HP has pushed up its sales whose demand brings up some percentage in inventory.
However, it would be more favorable for HP to reduce its Days Sales Outstanding to collect
outstanding receivables more quickly to generate more cash for business. Both Fixed Assets
Turnover and Total Assets Turnover ratios indicates that HP’s business operation is as
intensified as other major players such as Canon, Dell, IBM, and Xerox. Debt management of
HP, in the perspective of creditors, shows a more safe investment and a better financial stability
than its industry average. In fact, it has a lower Debt Ratio and a lower Times-Interest-Earned
than the industry average. This is also implies that HP is less dependent on leverage and has
sufficient income to cover its interest payments requirements. However, HP’s profitability does
not yield a better result compared to its competitors. HP generate almost about same Profit
Margin on Sales and Basic Earning Power as the industry average but its Return on Total Assets
and Return on Common Equity is lower than the average, indicating somewhat less effectiveness
in using assets and debt. Market value of HPQ shows that even though its investors are willing to
pay more for every dollar of earnings, HP investment is no more attractive than any other stock
in the technology industry as its measured Price per Cash Flow ratio same as the average.
Compared the stock’s market price to the amount of cash flow, the company generates on a per-
share basis about the same as the industry average. HP’s accounting value, as indicated in the
market/book ratio, could mean that the company’s assets are undervalued.

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 7. References

Brigham, U. & Ehrhardt, M. (2008). Financial Management: Theory and Practice. South-
Western Cengage Learning. ISBN-13: 987-0-324-42269-6

Business Wire. (2000). HP Broad Sets Record Data and Distribution Date for Agilent Stock
Dividend. Business Network Journal. Retrieved from
http://findarticles.com/p/articles/mi_m0EIN/is_2000_April_7/ai_61374274 on Nov 31,
2008

Hewlett-Packard Company Official Website. Retrieved from

http://h30261.www3.hp.com/phoenix.zhtml?c=71087&p=irol-irhome on Nov 20, 2008

Wikipedia. (2008). Hewlett-Packard. Retrieved from

http://en.wikipedia.org/wiki/Hewlett-Packard on Nov 20, 2008

Yahoo! Finance http://finance.yahoo.com/q?s=HPQ

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 8. Appendix
Figure 1: Returns of HPQ vs. SPY
Figure 2: Standard Deviation vs. Expected Return of Portfolio
Figure 3: Standard Deviations vs. Expected Return with Different Correlation Coefficient

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 9. List of Tables
Table 1: Summary of Standard Deviation Values
Table 2: Portfolio Returns and Standard Deviation (in the 5% increment weights)
Table 3: HPQ Stock Value Estimation
Table 4: Summary of HP’s Free Cash Flow in 2007 and 2006
Table 5: Summary of Five Group Ratios
Table 6: Summary of Financial Ratio of HPQ and Its Competitors

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