Analysis Team

Chase Mueller [email protected] Mindi Quinn [email protected] Stacy McShurley [email protected] Chris Swanson [email protected] Michael Viotto [email protected] Table of Contents

Executive Summary……………………………………………………………………………………………….8 Business and Industry Analysis……………………………………………………………………………..15 Business Overview…………………………………………………………………………...... 15 Industry Overview……………………………………………………………………………………..17 Five Forces Model………………………………………………………………………………………...... 19 Rivalry of Existing Firms……………………………………………………………………………..21 Industry Growth Rate……………………………………………………………………….21 Concentration and Balance of Competitors…………………………………………23 Degree of Differentiation………………………………………………………………….24 Switching Costs……………………………………………………………………………….25 Learning Economies of Scale…………………………………………………………….25 Economies of Scale………………………………………………………………………….26 Fixed – Variable Costs………………………………………………………………………26 Excess Capacity……………………………………………………………………………….27 Exit Barriers…………………………………………………………………………………….28 Conclusion………………………………………………………………………………………28 Threat of New Entrants………………………………………………………………………………30 Economies of Scale………………………………………………………………………….30 First Mover Advantage……………………………………………………………………..31 Access to Channels of Distribution and Relationships…………………………..32 Legal Barriers………………………………………………………………………………….32 Conclusion………………………………………………………………………………………33 Threat of Substitute Products……………………………………………………………………..34 Relative Price and Performance…………………………………………………………34 Buyers Willingness to Switch…………………………………………………………….35

2 Conclusion………………………………………………………………………………………36 Bargaining Power of Buyers………………………………………………………………………..37 Price Sensitivity……………………………………………………………………………….37 Relative Bargaining Power………………………………………………………………..38 Conclusion………………………………………………………………………………………38 Bargaining Power of Suppliers…………………………………………………………………….40 Price Sensitivity……………………………………………………………………………….40 Bargaining Power…………………………………………………………………………….41 Conclusion………………………………………………………………………………………41 Five Forces Summary…………………………………………………………………………………………..43 Value Creation Analysis………………………………………………………………………………………..44 Economies of Scale and Scope……………………………………………………………………44 Research and Development………………………………………………………………………..45 Superior Product Quality and Variety……………………………………………………………45 Investment in Brand Image………………………………………………………………………..46 Conclusion………………………………………………………………………………………………..46 Competitive Advantage Analysis……………………………………………………………………………47 Superior Product Quality and Variety……………………………………………………………47 Superior Customer Service and Flexible Delivery…………………………………………..48 Research and Development………………………………………………………………………..48 Investment in Brand Image………………………………………………………………………..49 Conclusion………………………………………………………………………………………………..49 Formal Accounting Analysis………………………………………………………………………………….51 Key Accounting Policies………………………………………………………………………………………..53 Recording Research and Development…………………………………………………………53 Capital Leases and Operating Leases…………………………………………………………..55 Defined-Benefit and Pension Plan………………………………………………………………..56 Goodwill……………………………………………………………………………………………………57 3 Conclusion………………………………………………………………………………………………..57 Assess Accounting Flexibility…………………………………………………………………………………58 Flexibility of Research and Development………………………………………………………58 Capital and Operating Leases……………………………………………………………………..59 Defined-Benefit and Pension Plan………………………………………………………………..60 Goodwill……………………………………………………………………………………………………60 Conclusion………………………………………………………………………………………………..61 Evaluate Accounting Strategy……………………………………………………………………………….62 Research and Development………………………………………………………………………..62 Capital and Operating Leases……………………………………………………………………..63 Defined-Benefit and Pension Plan………………………………………………………………..64 Goodwill……………………………………………………………………………………………………65 Conclusion………………………………………………………………………………………………..66 Qualitative Disclosure…………………………………………………………………………………………..67 Research and Development………………………………………………………………………..67 Capital and Operating Leases……………………………………………………………………..68 Defined-Benefit and Pension Plan………………………………………………………………..69 Goodwill……………………………………………………………………………………………………70 Conclusion………………………………………………………………………………………………..71 Quantitative Accounting Measures and Disclosure…………………………………………………..73 Sales Manipulation Diagnostics……………………………………………………………………………..74 Net Sales / Cash from Sales………………………………………………………………………..74 Net Sales / Accounts Receivables………………………………………………………………..76 Net Sales / Inventory…………………………………………………………………………………77 Net Sales / Warranty Liabilities……………………………………………………………………78 Conclusion………………………………………………………………………………………………..79 Sales Manipulation Diagnostics – (Numbers)………………………………………………………….81 Expense Manipulation Diagnostics…………………………………………………………………………82 4 Asset Turnover………………………………………………………………………………………….82 Cash Flow from Operations / Operating Income……………………………………………84 Cash Flow from Operations / Net Operating Assets……………………………………….85 Total Accruals / Change in Sales……………………………………………………………...... 86 Pension Expense / SG&A…………………………………………………………………………….87 Conclusion………………………………………………………………………………………………..88 Expense Manipulation Diagnostics – (Numbers)……………………………………………………..89 Potential Red Flags………………………………………………………………………………………………90 Undoing Accounting Distortions…………………………………………………………………………….91 Financial Analysis, Forecasting Financials, and Cost of Capital Estimation………………….92 Financial Analysis………………………………………………………………………………………………..92 Liquidity Ratio Analysis…………………………………………………………………………………………93 Current Ratio…………………………………………………………………………………………….93 Quick Asset Ratio…………………………………………………………………………………...... 94 Accounts Receivable Turnover…………………………………………………………………….95 Days in Accounts Receivable……………………………………………………………………….96 Inventory Turnover……………………………………………………………………………………97 Days in Inventory………………………………………………………………………………………98 Working Capital Turnover…………………………………………………………………………..99 Cash to Cash Cycle…………………………………………………………………………………..100 Conclusion………………………………………………………………………………………………101 Profitability Ratio Analysis…………………………………………………………………………………..102 Gross Profit Margin………………………………………………………………………………....102 Operating Profit Margin…………………………………………………………………………….103 Net Profit Margin……………………………………………………………………………………..104 Asset Turnover………………………………………………………………………………………..105 Return on Assets……………………………………………………………………………………..106 Return on Equity……………………………………………………………………………………..107 5 Z-Score…………………………………………………………………………………………………..108 Sustainable Growth Rate………………………………………………………………………....109 Internal Growth Rate……………………………………………………………………………….110 Conclusion………………………………………………………………………………………………111 Capital Structure Ratios……………………………………………………………………………………..112 Debt to Equity Ratio…………………………………………………………………………………112 Times Interest Earned………………………………………………………………………………113 Debt Service Margin…………………………………………………………………………………114 Conclusion………………………………………………………………………………………………115 Estimating Cost of Capital…………………………………………………………………………………..116 Cost of Equity………………………………………………………………………………………….116 Back Door Cost of Equity………………………………………………………………………….118 Cost of Debt……………………………………………………………………………………………119 Weighted Average Cost of Capital……………………………………………………………..120 Financial Statement Forecasting………………………………………………………………………….121 Income Statement……………………………………………………………………………………121 Income Statement (Revised)…………………………………………………………………….125 Balance Sheet………………………………………………………………………………………….128 Balance Sheet (Revised)…………………………………………………………………………..132 Statement of Cash Flows………………………………………………………………………….135 Statement of Cash Flows (Revised)……………………………………………………………138 Methods of Comparables…………………………………………………………………………………...141 Price/Earnings Trailing……………………………………………………………………………..141 Price/Earnings Forecast…………………………………………………………………………….142 Price/Book……………………………………………………………………………………………...142 Price Earnings Growth (P.E.G.)………………………………………………………………….143 Price/EBITDA…………………………………………………………………………………………..144 Enterprise Value/EBITDA………………………………………………………………………….144 6 Price/Free Cash Flows………………………………………………………………………………145 Dividends/Price………………………………………………………………………………………..146 Conclusion……………………………………………………………………………………………...146 Intrinsic Valuation Models…………………………………………………………………………………..147 Discounted Dividends Model……………………………………………………………………..147 Discounted Free Cash Flows Model…………………………………………………………...150 Residual Income Model…………………………………………………………………………….153 Abnormal Earnings Growth Model (A.E.G)………………………………………………….157 Long Run Residual Income Model……………………………………………………………..160 Analyst Recommendations………………………………………………………………………………….165 Appendices……………………………………………………………………………………………………….167 References………………………………………………………………………………………………………..205

7 Executive Summary

Investment Recommendation: Fairly Valued, Hold or Buy (4/1/2008)

SNA - NYSE (4/1/2008) $54.32 Altman Z-Scores 52 Week Range $39.78 - $55.32 2003 2004 2005 2006 2007 Revenue 721.6M Initial 2.94 2.92 3.34 2.97 3.14 Market Capitalization 2.92B Revised 2.96 2.94 3.37 2.99 3.21 Shares Outstanding 57.69M Market Price (4/1/2008) $54.32 Initial Revised Book Value Per Share $22.19 $19.35 Financial Valuations Initial Revised ROE 17.58% 1.89% Trailing P/E $47.10 $4.50 ROA 6.83% 0.70% Forward P/E $44.47 $4.79 P.E.G. $47.90 $3.86 Cost of Capital P/B $59.60 $51.97 Estimated R-Squared Beta Ke P/EBITDA $39.00 N/A 3-Month 0.5123 1.23 0.1078 P/FCF $30.89 N/A 6-Month 0.5004 1.21 0.1056 EV/EBITDA $53.51 N/A 2-Year 0.5027 1.21 0.1044 D/P $43.50 $4.27 5-Year 0.5105 1.21 0.1126 10-Year 0.5037 1.21 0.1223 Intrinsic Valuations Discounted Dividends $17.79 $1.99 Back Door Ke 13.50% Free Cash Flows $60.28 $35.92 Published Beta 0.55 Residual Income $33.86 $11.33 Cost of Debt 6.00% LR ROE RI $60.69 N/A WACC (BT) 11.10% A.E.G. $36.68 $4.29

8 Industry Analysis

Snap-On is an industrial tool company that uses both tools and technology to help satisfy their consumers and compete within their industry. Snap-On has three main competitors; Danaher, Stanley-Works, and Black & Decker. The competition within the industry is mostly based on differentiation and technological advances as well as providing the best quality possible. In analyzing the five forces model, rivalry among existing firms is high, not so much due to their products, but more so due to their product quality as well as providing their consumers with the most cutting edge technology. Research and Development is becoming a very large part of the industry. With so many advances in technology firms are required to keep investing in R&D if they want to maintain their customer base and increase their market cap.

Five Forces Competition Level Rivalry Among Existing Firms High Threat of New Entrants Low – Mixed Threat of Substitute Products Mixed Bargaining Power of Buyers Low Bargaining Power of Suppliers Low Conclusion Low - Mixed

One of the things that doesn’t concern members in the tool industry is the threat of new entrants. In an industry that requires so much capital in order to be successful, it would take a start-up company several years as a best case scenario to be competing in the tool industry. There is also the factor of experience and expertise in which a multi-billion dollar company clearly has the advantage. The threat of substitute products

9 is also not much of an issue but is a worry none-the-less. Companies in this industry do not produce identical products but when switching costs are low considering the use of a better product, substitutes become an issue. Tools that are not the same, but perform the same functions are the only substitute threat in this industry. The bargaining power of buyers in industry is largely influenced by both the differentiation of products and the number of competitors within the market. The bargaining power of buyers in this market is low due to the fact that there are very few options to choose from. The degree of saturation of the market’s suppliers has a direct impact on the price and profits that a firm can achieve. Suppliers with few competitors and a high demand for their product have the leverage of quoting an inflated price to their retailers. In order to maintain good relations with suppliers, firms pay the excess amount driving up their cost of manufacturing. In the tool industry this is the case. However there is a twist. You would think that bargaining power of suppliers would be high since the bargaining power of buyer is low. However, because of the high volume customers the suppliers have, they must keep their prices in check. If the suppliers began driving up costs to a ridiculous extent, you would likely see other low cost options enter the market.

Accounting Analysis

The main function for an accounting analysis is to assess how well a firm’s accounting policies portray an accurate view of the company. It is necessary that a company discloses as much information as possible so the financial statements can be analyzed for any distortions. There are many situations where a company can manipulate their financials by disclosing only what the SEC requires. This makes it more difficult for shareholders to have an accurate view of the company, or for an analyst to fairly value the business.

10 Overall, Snap-On did an excellent job of disclosing information in their 10K. Generally Accepted Accounting Principles requires firms to expense R&D costs instead of capitalizing them. When looking at Snap-on, one should take into consideration the amount they spent on Research and Engineering, and how much their sales from new products largely result from these Research and Engineering expenses. Snap-On also disclosed a large amount of capital leases, which shows that they are not trying to understate their assets or liabilities by recording them as operating leases. In addition, Snap-On did a good job of estimating their pension costs by having a reasonable discount rate that exceeded the inflation and risk-free rate. By having a logical discount rate, we can conclude that their liabilities associated with pension plans are accurately accounted for. According to modern accounting procedures goodwill is an asset on the balance sheet. However when defining goodwill one might wonder why it is classified as an asset. Goodwill is basically what you overpaid for the acquisition of a company. Goodwill is asset value that is not liquid at all. For a firm to accurately display its value, goodwill would need to be written off to correctly state what the company’s assets are worth. Snap-On has a very large amount of goodwill and has done a very poor job accounting for it. They seem to be content leaving goodwill as a pure asset and not writing it off to correctly display their actual value. Throughout our valuation of Snap- On, we routinely made adjustments for what the Income statement and Balance sheet and Statement of cash flows would look like if goodwill was written off and the difference is night and day. For Snap-On to display its actual value, they would need to be more responsible for accounting for goodwill.

Financial Analysis, Forecasting, Cost of Capital Estimation

To accurately value Snap-On, we performed a financial analysis by computing the firm’s liquidity ratios, capital structure ratios, and profitability ratios. Understanding 11 these ratios and comparing them to that of our competitors allowed us to more accurately forecast out Snap-On’s financial statements over the next ten years. Also, it allowed us to see which ratios would drive our forecasts. Over the past five years, Snap-On has seen an average sales growth of approximately 7%, but from 2006 to 2007 sales grew by 15.75%. We felt that Snap-On could not sustain such a large growth rate, and forecasted our sales to grow at 11.50%. To link our income statement to our balance sheet, we used an Asset Turnover Ratio of 1.07 to forecast our total assets. We forecasted retained earnings in 2008 by taking our ending retained earnings in 2007, added net income for 2008, and deducted our dividends paid to shareholders. Because this is an equity valuation, our total liabilities became a plug figure, which we derived by taking our total assets minus total shareholders’ equity. We calculated our cost of equity by running regressions using the S&P historical prices, risk free treasury yields, and firm returns. We then used the estimated beta of 1.23 generated by our regression. We inserted our estimated beta into the CAPM equation and calculated our Ke to be 10.78%. This cost of equity seemed low and we felt that it did not accurately price risk involved when investing in Snap-On. We used the back door method and generated a cost of equity of 13.50%. We also computed our weighted average cost of debt to be 6%, which is reasonable because cost of debt has to be lower than cost of equity. The weighted average cost of capital is the weighted sum of the cost of equity and the cost of debt. We then calculated our

WACCBT to be 11.10% Snap-On’s liquidity ratios outperformed the industry averages in some cases, and lagged behind in others. Snap-On’s quick ratio and current ratio were higher than any of the competitors within the industry, which suggests that Snap-On has the liquidity available to pay of its current liabilities. In areas such as Snap-On’s cash to cash cycle, they have had the longest cash cycle until 2007. Snap-On’s profitability ratios continually outperform the industry averages, most notably their gross profit margin which has been approximately 44% over the past five years. Snap-On’s capital 12 structure ratios are lagging behind the industry average with an ROE ranging from 10% in 2003 to 17% in 2007. Snap-On’s ROA had a range of 4% in 2003 to approximately 8% in 2007. Although Snap-On is improving their capital structure ratios, they are still lagging behind the industry.

Valuation Analysis

One of the financial tools we used to help us valuate Snap-On was the Methods of Comparables. The methods of comparables are eight different ratios that all offer speculation as to the value of the firm, while throwing out any outliers that would skew the industry average and Snap-On’s overall price per share. When evaluating Snap-On using these ratios, we determined that they give a fairly valued picture of the firm. Although the comparable with the most explanatory power, forecasted P/E, said Snap- On was overvalued, the average stock price among the eight ratios is $46.65 which is within our 15% error of tolerance. The prices ranged from $38.17 - $59.60. Given this wide range of price variation, the methods of comparables proved to be an inaccurate form of valuation because they are based on historical prices and industry averages. The intrinsic valuation models heavily influenced our overall valuation of Snap- On. These models possess more desirable properties than the methods of comparables because they are grounded in theory and use the present value of future cash flows to determine the estimated share price. The discounted dividend model has the lowest explanatory power of all intrinsic valuation models. This model yielded an estimated share price of $17.79. The discounted free cash flows models uses takes the present valued of free cash flow to the firm, and uses these values to value the firm. This model is unreliable because of our inability to reasonably forecast future cash flows. This model yielded us an estimated share price of $60.28, which suggests that Snap-On is fairly valued. The residual income model has the highest explanatory power of the intrinsic valuation models and uses value added to the firm to generate a share price. 13 This model generated an estimated share price of $33.86, which suggests that Snap-On is overvalued. The abnormal earnings growth model uses a forward price to earnings ratio and is also related to the residual income model. This model generated an estimated share price of $36.68, which suggests that Snap-On is overvalued. The last intrinsic valuation model was the long-run residual income model and when using a Ke of 13.50%, a growth rate of 11.50%, and an average ROE of 16.80%, it generated a share price of $60.69. This price falls into the range of fairly valued prices, which is 15% of our observed price. Overall, we feel that these intrinsic valuation models suggest that Snap-On is a fairly valued company.

14 Business Overview

Snap-On Wrench Company originated in Kenosha, Wisconsin in 1920 by Joseph Johnson and William Seidemann. Snap-On’s innovative idea of marketing ten sockets to five interchangeable handles revolutionized the tool industry and set them apart from their competitors. Later Stanton Palmer and Newton Tarble contributed to Snap-On’s success by marketing the tools straight to the consumers at their business locations.1 This lead to the development of Snap-On Incorporated, which focused primarily on supplying tools for professional users. Today they succeed in being a top global innovator, manufacturer and marketer of tools, diagnostics and equipment solutions. Snap-On has become a staple in the tool industry by providing their customers with unrivaled delivery of products to their doorstep. They are stocked with over 14,000 tools and diagnostic equipment for immediate delivery by specialized technicians. Snap-On is competing on “product quality and performance, product breadth and depth, service, brand awareness and imagery, and technological innovation”.1 No one competitor is able to dominate in all market segments at the scale of Snap-On Incorporated. Snap-On’s main competitors within the commercial and industrial tool industry include: The Stanley Works, The Black and Decker Corporation, and Danaher Corporation. Snap-On has a market capitalization of 2.41 Billion dollars. Snap-On’s market capitalization is higher than the industry standard; however, the market caps for its main competitors are $4.38 Billion (BDK), $23.84 Billion (DHR), and $3.83 Billion (SWK).5 Snap-On focuses their concentration on premium tools used for industrial purposes rather than the ordinary consumer. Snap-On’s market capitalization is considerably lower because of their specialized service to blue collar professionals. Snap-On separates their market segments into three groups: Snap-On Tools Group, Commercial & Industrial Group, and Diagnostics & Information Group. Snap-On Tools Group accounts for 41.44% of total sales, Commercial & Industrial Group makes

15 up 42.40%, and Diagnostics & Information Group comprises of 16.16%.1 From 2002- Present Snap-on Tools has shown a 17.20% increase in sales from $2.109 Billion in 2002 to $2.473 Billion in 2006. Snap-On’s asset value has shown a considerable increase in the past five years. Since 2002 Snap-On’s asset value has increased 33.11% from $1.994 Billion in 2002 to $2.654 Billion in 2006. We feel that this dramatic increase is contributed to the acquisition of ProQuest Diagnostics in which approximately $516 Million were added to total assets.

16 Industry Overview

In the past three decades, there has been a significant transformation in the commercial tool industry. The industry in which Snap-On competes is still largely controlled by Commercial and Industrial tools. The main forces in the tool industry are Stanley Works, Danaher, Black & Decker, and Snap-On. Of these Corporations, tools represent 42% of Snap-On’s total earnings, 9% of Stanley Works, 12% of Black & Decker, and 14% of Danaher. While the percentage of earnings from tools is much higher for Snap-On, the market capitalization rate is considerably larger for the other three companies. However, with increases in technology, the tool industry could soon witness a change in what dominates its market share. Because “We are now witnessing the emergence of a new user interface for digital devices, including laptop computers, advanced cell phones, wireless portable data gadgets and other types of computing products”, advances in technology are limitless.9 The computer transformed the business world and is beginning to transform the tool industry. With huge advancements being made in Diagnostic and Information Technology, it is becoming imperative that businesses spend large amounts of capital in research and development in order to keep up. While the current industry is not dominated by technological advances, it is far and away the fastest growing. General Motors, according to the Wall Street Journal, is looking to outsource their research and development to China for some expense savings.14 Consumers are willing to spend more to have computers do their work for them, especially in the automotive industry. Computers are more error free and are more precise than humans can ever be. Businesses that anticipated this technology growth are currently holding the largest market share. In the industry, Danaher’s industrial technologies comprise 33% of their total sales, while Snap-on contributes 16% of their earnings to diagnostics technology. However, with the dramatic shifts that technology creates, market share in this industry can change overnight making market share slightly unstable. 17 Overall, we feel that the industry is progressing towards a more technologically advanced approach on the manufacturing of new products. Even though there is a push to construct more innovative products, firms such as Stanley Works and Black & Decker continue to be successful while maintaining their focus solely on the tool portion of the industry. Nevertheless, in the Wall Street Journal recently “Stanley works and Black and Decker had high fourth quarter profits…as a slowdown in the U.S. housing market has stifled demand for building equipment.” 10

18 Five Forces Model

The five forces model is comprised of five key components which will allow us to analyze the structure of the industry as well as overall profitability. The degree of actual and potential competition is a key determinate of the price that firms will be able to charge their customers and what customers are actually willing to pay for these products. There are three potential sources of competition within an industry. Rivalry among existing firms is a key factor to determine the average level of profitability within the industry. A high level of competition exists when the rivalry among existing firms is high. The threat of new entrants into the industry can also increase or decrease the level of competition. It also will determine the pricing of existing firms within the market. If it is easier for a firm to enter the market, competition will be relatively high. Another competitive force is the threat of substitute products. This depends heavily on the customer’s perception of similar products and the willingness of that customer to switch to a substitute product. If the threat of substitute products is high within an industry, firms will have to compete on price to be successful. The five forces model also analyzes the bargaining power of buyers and suppliers. Bargaining power for buyers is determined by price sensitivity, which determines if buyers want to purchase a product at a lower price, and relative bargaining power, which determines how well the customers will succeed at dragging down the price. If the bargaining power of buyers is high, firms will have no choice but to cut prices and reduce their overall profitability. Bargaining power of suppliers is determined by the number of suppliers in the industry. If there is only a small number of substitute suppliers for an industry, the bargaining power of suppliers will be high. In this case, firms will have to develop a strong relationship with their supplier to insure their supply chains remain efficient and reliable. These five forces will determine the level of competition within the industry and the key success factors on which the firms must compete. 19 Snap-On resides in an industry with a high level of rivalry among existing firms and little likelihood of firms being able to enter the industry as a new competitor. The industrial tool industry has a somewhat small threat of substitute products becoming a source of major competition. This is turn encourages a high level of product differentiation and in turn drives the prices of the products up due to the lack of price- competition. The goal of Snap-On in the current market would be to produce high quality products that make other companies’ products obsolete.

Five Forces Competition Level Rivalry Among Existing Firms High Threat of New Entrants Low – Mixed Threat of Substitute Products Mixed Bargaining Power of Buyers Low Bargaining Power of Suppliers Low Conclusion Low - Mixed

20 Rivalry Among Existing Firms

The overall profitability level of firms in this industry is derived mostly from the bargaining power over their suppliers. Companies must focus on innovation, differentiation, and brand name to be successful. With a firm’s ability to differentiate themselves from their competitors, they will be able to charge premium prices for their products. These key success factors are vital for a company to maintain their market share within the industry. If a firm is unable to meet the changing needs of customers and continue to develop new and innovative products, their competitors will surely steal that share of the market. Firms can retain their market share and continue to see steady growth if they invest time and money into research and development. Since the tool and equipment industry competes on a world-wide scale, firms can continue to grow by finding and researching new customers in emerging markets.

Industry Growth Rate

Industry Growth

16.81% e

g 11.37% 12.12%

a 10.86%

t 9.59% n

e 6.22% c r e P

2002 2003 2004 2005 2006 2007 Year

*Percentages developed by comparing sales from the 10k Statements of Danaher Corp., Stanley Works, Black and Decker and Snap-On Inc.

21 Being able to understand the industry growth rate will allow us to determine the intensity of competition between existing firms, or the competition between new firms entering the market. If an industry is growing at a high rate, firms will not have to steal market share from each other to continue to grow. Instead, they will need to exploit the new customers entering the market. However, if the industry is growing at a slow rate, or not at all, firms will have no choice but to take market share from existing firms in the industry. In the figure above, it shows that the industry growth rate has been significant in the past five years. We feel that this industry is growing steadily because of the ability of the firms to compete on a global scale. The emerging markets across the globe are providing firms within this industry numerous opportunities to increase their profitability with large increases in sales. Approximately 44% of Snap-On’s revenues in 2006 were generated outside of the United States.1 From 2006 to 2007 we have witnessed a small decline in the industry growth level, mostly due to the fact that Stanley Works only grew their sales by approximately 2%. However, Snap-On exceeded the average industry growth level with a 15.14% increase in sales from 2006 to 2007.Even though the tools product category continues to grow steadily in the industry; the equipment product category seems to be where most firms continue to grow their business. Because the existing firms within the market are growing significantly, they will not have to steal market share from each other. Firms will continue to compete on innovation, differentiation, and brand name to capture their share of the emerging markets.

22 Concentration and Balance of Competitors

Market Share Percentage

Snap-On Stanley Works Black and Decker Danaher

45.58% 44.14% 39.11% 39.72% 36.04%

e 34.26% g 30.65% 32.45%

a 32.12% 30.52% 28.61%

t 26.28% n

e 17.84% 18.23% 17.83% 17.95% c 17.01% 16.34% r

e 15.98% 15.20% 13.22% 11.48% 10.98% 11.63% P

2002 2003 2004 2005 2006 2007 Year

* Percentages computed by dividing (Net Sales / Total Industry Sales) for a current period. Numbers were derived from the 10-K’s of Snap-On, Stanley Works, Black and Decker, and Danaher.

The degree of concentration in an industry is determined by the number of firms in an industry and the relative sizes of those firms. Knowing the degree of concentration in an industry will allow firms to formulate competitive strategies with respect to price controls and other coordination strategies. In industries with lower concentration, firms are forced to compete on a cost leadership strategy which can lead to lower profits for all firms within that industry. However, if there is a large firm in a highly concentrated industry, they will be able to control that industry with any competitive strategy they feel is necessary. This can include charging a premium for their products, lowering prices, and even controlling the supply of goods provided to their customers. Also, if there are a few large companies within an industry, they can collaborate with each other to insure prices will remain unchanged. Using the

23 Herfindahl-Hirschman Index Calculator (HHI), which is a tool used by the Federal Trade Commission to calculate the level of concentration within the industry, we found that the HHI for this industry is 3070.6 This represents a high level of concentration within the industry. The HHI increases both as the number of firms in the market decreases and as the disparity in size between those firms increases.7 Anything above an 1800 is considered to be a concentrated industry. Because of this high level of concentration within the tool and equipment industry, we feel that Snap-On Incorporated and its competitors are able to compete on innovation and differentiation rather than cost leadership strategies.

Degree of Differentiation

If firms within an industry are able to differentiate themselves from their competitors, it gives that firm a huge competitive advantage within that sector of the market. The degree of differentiation that a firm holds in their industry allows them to avoid direct competition with their competitors. If firms produce similar products in an industry, they will have no choice but to compete on price. When choosing between two similar products, customers will be more likely to purchase a product that is sold at a lower price. If firms continue to lower prices to retain their market share, revenues and profits gradually decline over time. Within the tool and equipment industry, firms must continue to manufacture innovative products that meet the changing needs of customers. As technology advances, problems become more complex, and firms in this industry must be able to adapt to these changes. However, because the industry competes on a global scale, firms must also market their brand name and provide excellent customer service to be successful.

24 Switching Costs

Switching costs are the costs associated with a firm in an industry wanting to change the direction of their company and compete in a completely different industry. If switching costs are low within an industry, firms will be able to enter and leave the market at their own discretion. Also, industries with low switching costs are extremely price competitive. When switching costs are high in an industry, firms that have already established themselves have no choice but to continue to compete in that industry. The costs associated with switching to a different industry are too high and will hurt the company’s financial position. The tool and equipment industry experiences high switching costs due to the complexity of their products and the scale of operations in which they compete. Snap-On Incorporated and its competitors compete on a global scale and the costs of switching industries would be overwhelmingly high. The tool and equipment industry experiences high competition with respect to switching costs because they are unable to compete in a totally different industry.

Learning Economies of Scale

Learning economies of scale in an industry is based on the assumption that if a firm has competed in an industry for longer periods of time, they will have an advantage because they are able to learn from their past experiences. This is very true when dealing with an ever evolving tool industry. With the tool industry becoming more technologically based, high levels of R&D costs must be spent in order to keep up with the needs of the customers. In order to introduce new products, as well as improve on existing ones, significant expenses must be incurred in the form of planning, testing, and designing. Firms that are seasoned understand that although it is expensive to perform lots of R&D, it is far more expensive in the long run if you are not keeping up with the industry you compete in. 25 Economies of Scale

Economies of scale exist when firms within an industry have to “get big” to be successful. As firms continue to grow and gain experience within an industry, they tend to become more efficient. This is somewhat true in the tool industry. It takes a large amount of capital and revenues to be successful. However, one must ask what the true statistic is that makes a firm successful? If it is profit percentage, than Snap-On, currently with the smallest market cap among its competitors, would be the most successful, making economies of scale irrelevant. If it is purely revenues, than the largest firm, Danaher, would be considered the most successful.

Fixed - Variable Costs

Fixed to variable costs within an industry can determine the price of a product and the quantity of goods sold. Fixed costs within the tool and equipment industry are relatively high due to the fact that many firms own or lease an extremely high number of manufacturing facilities. This leads to high manufacturing overhead costs. Snap-On owns and leases over 30 manufacturing and distribution facilities world-wide, which is a relatively low number when comparing them to Danaher Corporation, Black and Decker, and Stanley Works.1 Variable costs within the industry are also somewhat high because of the increasing cost of steel world-wide. Firms within the tool and equipment industry do not have to sell large quantities of products because of the premium that is charged to the customer. Overall, we feel that being able to control fixed costs, with respect to manufacturing overhead, and variable costs within the tool and equipment industry, will lead to increased profitability among firms.

26 Excess Capacity

Infrastructure Utilization

Snap-On Danaher Black and Decker Stanley Works 5.5 5 4.5 4 3.5 3 2.5 2 2002 2003 2004 2005 2006 2007

Excess capacity in an industry is when companies have a surplus of products to sell to their customers. In other words, supply is greater than demand. To get rid of this surplus, firms will cut prices to encourage customers to buy more of their product. Above is a chart describing how well companies can utilize their infrastructure. We took the net sales from Snap-On and its competitors, and divided it by property, plant, equipment, and inventory levels. These ratios describe the degree to which a firm can generate sales from its infrastructure. A high ratio is desired by firms because they want to generate as much sales as possible while efficiently managing inventory levels, available space from property that is leased or owned, and the efficiency of machines and equipment. As we can see by the high ratios, firms within this industry are effectively utilizing their infrastructure. Being able to manage excess capacity effectively and efficiently can save firms huge amounts of money. The tool and equipment industry experiences relatively low excess capacity because of the large demand from customers

27 world-wide. Also, with the increases in technology, more advanced tools and equipment solutions are being sought by customers.

Exit Barriers

Exit barriers are obstacles that do not allow firms to leave the industry in which they are competing. These barriers include governmental regulations as well as when firms manufacture specialized types of products. In the tool and equipment industry, exit barriers are high because of the advanced products that firms manufacture. Firms will be very unlikely to leave the industry because of the high costs and the amount of time and money invested in their business. The tool and equipment industry experiences high competition with respect to the high exit barriers.

Conclusion

The rivalry among existing firms in the tool and equipment industry is somewhat high due to the industry growth rate, concentration and balance of competitors, degree of differentiation and switching costs, learning economies of scale, excess capacity, and exit barriers. We feel that the industry growth rate is high only with respect to emerging markets in the global economy. The firms that have already established themselves as a dominant force in the tool and equipment industry have taken advantage of every opportunity globally. This means that there will be little to no new threats entering the market. The concentration in the industry is high, which means firms will have to compete on innovation, differentiation, and brand name. Switching costs are high, which results in higher competition between existing firms. Existing firms within the industry will have an advantage due to the fact there is learning economies of scale. Excess capacity is not a problem in the tool and equipment industry because of the high demand for more advanced and efficient tools. Also, there will be increased competition 28 among existing firms because of the high exit barriers. Overall, these factors contribute to a high degree of competition among existing firms in the market.

29 Threat of New Entrants

When a new business is trying to make its way into an existing market it can be extremely difficult. There are many factors that have to be taken into account such as economies of scale, first mover advantage, channels of distribution and relationships, and legal barriers. So many challenges make it very tough for a business to get started and stay afloat due to product differentiation and low cost competition. In the current state of the industry, it is very hard for emerging businesses to come in and take a large portion of the market share due to the rising prices of steel and related products. The slight opportunity to enter into the market would be in the form of diagnostic and information. However, these opportunities still come with many challenges to overcome.

Economies of Scale

Total Assets

(Millions) 2007 2006 2005 2004 2003 2002

Snap-On $2,765 $2,655 $2,008 $2,139 $1,994 $1,974

BDK* $5,411 $5,248 $5,842 $5,531 $4,223 $4,131

SW** $4,780 $3,935 $3,545 $2,851 $2,424 $2418

Danaher $17,472 $12,864 $9,163 $8,494 $6,890 $6,029

*The Black and Decker Corporation **The Stanley Works Corporation

The business world today promotes larger companies over smaller ones because of economies of scale. In the industry today Danaher controls most of what happens, but the mid-sized businesses get a great deal of profits as well. Most of these 30 companies have been around for a while, which has given then time to accumulate much needed assets. If an up and coming company wanted to enter the industry, it would be difficult to raise the capital necessary to compete. With the emergence of computers, the industry is evolving, and many of the companies are competing for that share in the market. They need to have the financial backing just in case they can’t compete with the others. If they have a large investment in capital, they will be short on cash. However, if they have too much cash, they cannot be competitive in the price among other companies. These large companies are spending huge amounts toward research and development for future products and product lines. The growth of information is increasing the demand in the digital age. Snap-On develops diagnostic equipment to be used in the automotive industry to figure out problems with automobiles.1 These types of programs and machines take extensive time to develop and make. Looking at potential competitors, it would be very difficult for a rising company to compete with Snap-On and competitors in this highly competitive industry.

First Mover Advantage

A company that has a new product or solution to a non existing market, more than likely, has an immense first mover advantage. If the product or solution is very unique and requires special raw materials, the company that produces it would have an immense grasp on that supplier. Because Snap-On produces the majority of their hand tools with certain quality steel, they have a big hold on that supplier not to supply to other companies. Also, companies with the new product or solution may be able to set industry standards that would allow them to have majority control over the market. Patents are another form of first mover advantage. They give specific rights to the design and construction of the product and limit competition in an industry. Many products that are patented are rarely challenged in the market due to the design, image, and recognition of the product. “Snap-On has over 700 active or pending 31 patents in the U.S. and over 1600 outside the U.S.”.1 These patents help Snap-On compete in this highly competitive industry and have products that other companies don’t have. Snap-On also has an advantage in switching costs. Someone buying from Snap-On may have equipment they like or may want to upgrade. Other competitors in the industry may have higher prices on the same types of products or they may try to duplicate designs the Snap-On owns. Because the customers are so comfortable using Snap-On’s specialized equipment, they may be hesitant to use other products that they are not quite so familiar with. Companies that enter markets first can carry a lot of risk; however, if they succeed, many advantages are in their favor.

Access to Channels of Distribution and Relationships

Managing suppliers, distributors, and even competitors in an industry is a major part of any business. Technology today allows for faster processing of orders, ease of communication between channels, and quicker management of the whole business. All these factors equate to a business running efficiently. Snap-On serves their customers through multiple channels of distribution including: mobile franchise van channel, company direct sales, distributors, and e-commerce.1 Companies today have to maintain great relationships with their suppliers to keep their costs low and be competitive in their industry. Although these relationships help with the logistics of the business, they will not always help to drive costs down.

Legal Barriers

Legal barriers in some industries make it incredibly difficult for new businesses to take a big section of a new or existing market. With patents, trademarks, contracts, licenses, and government regulations, today’s industry involves many legal aspects. All of these documents contain extensive background information that could limit a new 32 business. Snap-On’s business continues to grow both nationally and internationally. They have distribution and manufacturing properties extending from China to Sweden, Germany, Spain, and Canada1. Snap-On’s global stance has given them a great portion of the current industry related to the companies that are just located in the U.S.

Conclusion

The tool and diagnostic industry today faces low to medium threats of entrance. Technology is the main reason for the rising switchover from basic hand tools to computer ran diagnostic systems. The industry has a lot of regulations in the form of manufacturing tools but not as many in designing computer diagnostic equipment. Having enough capital to finance research and development and make innovative designs will keep a business in the driver seat of the industry. Maintaining a balance with suppliers and being the first movers into an industry is a major key. Snap-On has shown continuous grown throughout their entire life of the business. Establishing relationships with competitors will also keep a business enacted. These businesses could work together to take down a potential threat to the industry, or they could have total control of the market. Price is an additional contributor to containing the threat of new entrants in the tool industry. Even though Snap-On doesn’t sell the cheapest tools in the market, they make up for it with their innovative products. These are all factors that new and existing companies need to be aware of at all times in order to survive in the tool industry.

33 Threat of Substitute Products

The threat of substitutes is the third component of actual and potential competition. Every company is constantly faced with the threat of some sort of substitute. Substitution can either be the switching or using less of a good. A product does not necessarily have to be replaced by the exact same good, as long as it serves the same function. For instance, there is a threat of substitutes between eyeglasses and contact lenses. The threat depends on the product’s price and the performance of the competing good.

Relative Price and Performance

The relative price and performance of a good will determine if there will be any substitutes. The consumers’ decision is based on their perception. They are looking to see if the two products serve the same purpose for a similar price. If the two products serve the same function, it is unlikely that they will vary in price. In the tool industry, the diagnostics line is emerging. This is due to new and advanced technology, such as computer systems in cars. Therefore, the threat of substitutes is high in this area. However, “U.S. auto sales fell 4.3% in January and slumped to their lowest level in years.” 11 Other companies, such as Danaher Corporation, focus thirty-three percent of their sales in diagnostics. Industrial Technologies, Danaher’s diagnostics division, consists of precision motion control equipment.4 Snap-on’s diagnostics line only comprises twenty percent of their overall sales.1 Therefore, there is a chance that Snap-on will be unable to meet all the diagnostics needs of consumers at the current time. They are currently trying to enhance upon this portion of their company as it is the fastest growing in the industry.

34 The relative price of the company’s products is affected by how much they spend on advertising. Advertising cost for Snap-on in 2006 was $56.4 million, $44.4 million for Stanley Works, and $182.4 million for Black and Decker.1, 2, 3 The more familiar the consumer is with the products; the more likely they are to purchase them. Also, if a company focuses more on advertising, they can raise the price of their product. In this section there is the possibility that Snap-on could be substituted because they are not as concerned with advertising as Black and Decker. Snap-on focuses more on their other attributes, such as customer service, to compensate for their lack of advertising expense.

Buyers’ Willingness to Switch

Another crucial factor in the threat of substitutes is the buyers’ willingness to switch brand loyalty. Some consumers are willing to pay the premium price just for the superior image that the product reveals. For example, a consumer may pay the extra price for a BMW instead of a Chevrolet, simply because they place value on the brand name. Some consumers may be willing to pay the excess costs for Snap-on products because of their excellent service and quality. According to Snap-On, “In the eyes of the customer, Snap-on’s products and services have a reputation for being high quality”.1 On the other hand, one of the risk factors for Black & Decker Corporation is their lack of ability to obtain a high-quality relationship with their customers. They have two huge consumers that account for thirty-three percent of their sales.2 The corporation could lose a large part of their revenue from not successfully creating good relationships. Snap-on’s personal relationship with their customers distinguishes them from their competitors.

35 Conclusion

In conclusion, the threat of substitutes is mixed when looking at the other companies that are in the same industry. Danaher Corporation, Stanley Works, and Black and Decker are successful companies that are constantly a threat to Snap-on. For instance, Snap-on is not as advanced in the diagnostics division, and suffers with lower advertising. However, they are distinguished when it comes to customer service, which can retain customer loyalty.

36 Bargaining Power of Buyers

The bargaining power of buyers in an industry is largely influenced by both the differentiation of products and the number of competitors within the market. When the market is highly competitive, it would force firms to move towards competing on cost, which would give buyers the power. However, on the opposite end, as with the commercial tool industry, when products are highly differentiated and there are few rivals, the power of bargaining leaves the hands of buyers and is given to the firms within the industry.

Price Sensitivity

Price sensitivity is influenced by many factors. Some of the factors include the differentiation of products within the market, the cost of switching to another firm, and the quality of the products. Also, inflation plays a significant part as well. “Recently the CPI rose .8%.” 12 The commercial tool industry is largely differentiated among its firms. A company like Danaher is known for its diagnostic and informational tools while Snap- on is known for its use in automobile repair. This differentiation keeps price sensitivity low and consumer loyalty high. This differentiation also causes the switching costs to be high. For a company to change providers and keep their daily operations the same would be nearly impossible. Because of the amount of capital it takes to enter an almost monopolized industry, firms can set their prices according to their knowledge that other low-cost firms will not be able to survive in the market. When consumers continually use products provided by one firm, there is a guaranteed level of quality that the consumer can count on. There would be no way for a low-cost firm to enter the market and steal loyal consumers.

37 Relative Bargaining Power

The relative bargaining power for consumers in the commercial tool industry is mostly influenced by the cost of not doing business with one another. In this case, the bargaining power of consumers is very low because consumers absolutely have to have the products provided by firms. There is not an abundance of other sources for consumers to obtain from and switching costs are high. If a single consumer boycotts firms because of high prices, the consumer will lose his or her business, whereas a multibillion dollar corporation will only lose a single costumer. In other words, firms can afford to lose a customer much easier than customers can afford to find other suppliers. Firms in this industry have power when buying from suppliers and when people are buying from them. Also, there are not many firms to choose from when buying a commercial and industrial tool, which gives a considerable amount of power to the firms over the consumers. However, some consumers in the commercial tool industry may obtain power with the size of their purchases. Power will, without a doubt, switch from firm to buyer if the buyer is a large client. If the sales generated from one client, or small group of clients, are high enough, than negotiating will take place in order to keep the large consumers. Although this is not the norm, it is still possible for some clients to obtain some bargaining power within this industry.

Conclusion

In conclusion, it is very apparent that the bargaining power of buyers in this industry is low to mixed. Although some large clients will obtain power of negotiation, the majority will not. The industry is too diverse with not enough firms competing for clients in the same area of the industry. Firms in the commercial and industrial tool industry will continue to differentiate themselves to meet the needs of the clients that 38 their particular firm caters to. In doing this, they not only form loyal clients, but also raise the switching costs high enough that even more power will enter the hands of the firms. The more this occurs, the more that bargaining power of buyers will continue to decrease.

39 Bargaining Power of Suppliers

The degree of saturation of the market’s suppliers has a direct impact on the price and profits that a firm can achieve. Suppliers with few competitors and a high demand for their product have the leverage of quoting an inflated price to their retailers. In order to maintain good relations with suppliers, firms pay the excess amount driving up their manufacturing costs. On the contrary, suppliers with low demand for their materials have an inverse relationship to retailers. They are inclined to offer attractive rates as well as quantitative discounts to firms in order to attain their business. Firms in this setting have the upper hand in negotiating the terms of business.

Price Sensitivity

Sensitivity to price ranges from moderate to somewhat high in the tool and equipment industry due to the amount of competition amongst suppliers. While steel, the main component of Snap-On’s manufacturing process, is currently selling at an elevated price, there are enough suppliers in the market to hold price increases to a minimum. According to a recent Wall Street Journal Article, “the price of steel is expected to continue to rise due to the shortage of coal, a chief ingredient in steel manufacturing, in Australia.”8 While suppliers are struggling to produce steel at minimal costs, they are reminded that retailers have the option of attaining it from their competition and remain at the mercy of the firms. Also, “Investment banks are set to announce today that they are imposing new environmental standards that will make it harder for companies to get financing to build coal-fired power plants in the U.S.” 13

40 Bargaining Power

Suppliers to the tool industry have little negotiation power. There is a lack of differentiation in the necessary materials for production. The accessibility of numerous suppliers marketing the same product to retailers leaves suppliers powerless over their customers. It is a supplier’s job to be set apart from competitors. In order to succeed, they must have the best customer service, price, or innovation. They have to create a perceived value to their firms in order to win their business. One of the easiest ways to do this is to make personal relations with a company and maintain a bond. When a company is struggling to have enough materials to supply their customers, they love having a loyal supplier who sees to it that they are able to get their materials. Suppliers who uphold these relations prevail in establishing a devout customer base. Having multiple suppliers with the same product in a market force allows buyers endless options in receiving their materials at a prime price. While the market is constantly fluctuating, Snap-On has had the opportunity to plan ahead and purchase extra steel while the price is lower in an effort to secure against future shortages on the supply end. Firms in the tool and equipment industry benefit from not worrying about forward integration from their suppliers. Because of the great degree of skill and technology used in producing tools to a user friendly standard, it would not be tempting for a supplier to compete with firms in manufacturing tools.

Conclusion

Together, the dynamics of price sensitivity and bargaining power establish the cohesive environment between the suppliers and the firms. Suppliers learn that by developing a responsive relationship and using a strategically low pricing strategy they will develop a loyal and substantial customer base. Firms understand the importance of 41 maintaining a consistent affiliation with suppliers in order to always have the aid of a supplier on their side in times of shortage. This mutually cooperative link is only successful when both the firm and supplier balance their bargaining power and price sensitivity in the market to achieve an overall status of well being. Overall, we feel that the suppliers to the tool industry have relatively low bargaining power.

42 Five Forces Summary

We feel that the rivalry among existing firms is high due to the constant innovation that must take place among firms. With the quick changes that can take place in technological advances, every firm is in competition with one another if they continue to advance their technological capabilities. In examining our industry, we found that the threat of new entrants in this industry is low to mixed. There are many hardships for a company entering the industry to overcome. The capital required, along with the various relationships with suppliers and distribution networks, can put an enormous amount of pressure on any firm trying to enter the industry. The threat of substitutes in this industry is not necessarily high or low. We feel it is mixed due to the number market segments among firms. Segments of one firm will compete with segments of another firm for the same customers. In doing this, cheaper or more efficient products could emerge, swaying customers from one firm’s products to another. The bargaining power of buyers in this industry is considered to be low. Although some firms compete for the same customers, many of the products are specialized. Because of this, customers have fewer options, giving less power to the customers in terms of decision making and negotiation. Suppliers to the industry also have a low level of bargaining power. Due to the saturation of suppliers to the tool industry, firms have a large amount of bargaining power, given their large demand. Since suppliers have many competitors, they are forced to become cost competitive, giving the supplied all the power.

43 Value Creation Analysis

In the rapidly developing society of today, a company must decide what sets them apart from their competitors and capitalize on these factors. A firm creates a perceived value to its customers to distinguish their presence in the industry. Cost leadership and differentiation are the two main categories that establish the grounds on which an industry competes. Cost leadership thrives on using large economies of scale, efficient production, simple designs, and low input, distribution, and research and development costs. While these elements are efficient for some industries, the tool industry as whole is more competitive in using differentiation tactics. Markets competing on differentiation strategies strive to produce an exclusive variable product with superior quality and customer service. They implement a solid brand image, offer an assortment of delivery options, and make a sound investment in research and development to be more innovative than their competitors. To leave a strong presence in the market, a company must decide to compete robustly in one category. The tool industry is largely competitive in differentiation by taking advantage of innovation in technology.

Economies of Scale and Scope

When suppliers are able to produce an abundance of materials, it allows them to pass on the benefit of lower costs to firms and achieve economies of scale. Customers profit by purchasing tools at a discounted price. Economies of scope is selling a bundle of products that complement each other, thus making a more efficient product line. The tool industry capitalizes on both objectives by selling competitively priced products and offering everything from nuts and bolts, to a diagnostic system that shows which parts are out of alignment.

44 Research and Development

In an industry with few firms competing for market share, constant attempts at progression must be made. In the tool industry there is need for constant growth and to be at the cutting edge of advances made in the industry. There is a shift taking place in the tool industry. While firms still mostly compete in tools and equipment, the fastest growing area of the industry is the diagnostic and information segment. For firms to stay competitive, it is imperative that they spend money both investing and researching the capabilities of cutting edge technology. If a firm were to fail to do so with the current industry growth, one could expect to lose considerable market share in the future.

Superior Product Quality and Variety

In the tool industry, quality is as important today as it was a hundred years ago. It is becoming increasingly important for companies to meet the level of quality that they advertise. For companies in the tool industry to maintain growth and customer loyalty, they must keep the trust of the individuals that they serve. If the reputation of a firm suffers, they can certainly expect to see their market share diminish rapidly. With the rapid advancement in tools today, it is imperative that they maintain the quality of the equipment that they are producing. Since nothing is perfect, firms must also provide up to date service departments. Customers need to know that if something does not perform properly, the firm will take it upon themselves to make it right. This ensures a quality product.

45 Investment in Brand Image

For a company to stay successful in any industry, they have to be viewed positively by the public they serve. Having positive brand recognition is extremely important in the tool industry. This is not something a company can accomplish overnight. It takes clever advertising and a high level of quality consistency. A high level of customer service is also necessary. If customers know that a company will stand behind its products and make things right, it will do wonders for the reputation of the company. If a company fails to put a valiant effort into its brand image, they will most likely lose a large number of customers to competing firms who strive to maintain positive brand image.

Conclusion

In order for a company to be profitable, it must make tactical decisions to establish itself in the industry. The company should focus its efforts on having proficient economies of scope and scale, research and development, and superior product quality and variety to achieve a brand image that makes customers prefer their products over competitors’.

46 Competitive Advantage Analysis

Within the commercial tool and equipment industry, firms strive to compete with a differentiation strategy. To be successful using a differentiation within an industry, firms need to identify attributes of a product or service that customer’s value, provide a unique service that fills the needs of each costumer, and price their products to where consumers are willing to pay extra for a certain level of differentiation. Snap-On’s competitive advantages include superior product quality and variety, excellent customer service and flexible delivery, investment in brand image, and investment of time and money into research and development.

Superior Product Quality and Variety

Snap-On distinguishes its products into two distinct categories; tools and equipment. They offer a variety of tools which include, hand tools, power tools, and tool storage products. The equipment category includes solutions for the diagnosis and service of automotive and industrial equipment. The vehicle service and repair sector is a priority for Snap-On Inc. because of the amount of revenues generated from these companies. Approximately 41% of Snap-On’s 2006 revenues were generated by Snap- On’s Tools Group.1 With the continuing advancement in technology among motor vehicles, and the amount of vehicles on the road, Snap-On must continue to produce superior products that can service a variety of different vehicles. Snap-On uses a practical approach when introducing new products to the market. They understand that tools for the ordinary consumer need to be easy to use, and can get the job done. However, in the industrial sector, Snap-On understands that new innovative products and equipment solutions are the only way to see continued growth.

47 Superior Customer Service and Flexible Delivery

As a manufacturer of premium products and services, customer’s expectations are high. One of Snap-On’s most distinct advantages is their mobile franchise van channel. They have mobile vans all over the globe which take Snap-On’s products directly to their customers. Also, Snap-On offers online services to their customers. This has become increasingly important in today’s economy. Snap-On’s e-commerce development has led to nearly 14,000 products available online, and has registered more than 370,000 users.1 Also, Snap-On was the first firm within this industry to provide financing alternatives to their customers. Snap-On’s financing operations are managed through a joint venture with CIT, which manages over 80 Billion dollars in assets world wide.1 Snap-On must continue to improve relations with CIT because if this joint venture failed, Snap-On would be at a major disadvantage in the industry. If Snap-On cannot continue to improve customer satisfaction, their reputation and brand name will lose value, and Snap-On will not be able to charge a premium on their products.

Research and Development

In the tool industry today, the fastest growing segment of the market is the diagnostics and information portion. Snap-On saw its diagnostics sales go up just under 20% from 2002-2006. They also purchased ProQuest Business Solutions, a company known for its advanced technology capabilities. Danaher is the leader in this industry and has shown a 120% increase in the technology sales since 1998. This number for Danaher is indicative of the research and development that needs to take place within firms in this industry. For Snap-On to stay competitive, they have to continue the technological growth that they have begun to embrace. The implementation of the R & D they do could cut costs, increase productivity, and increase profitability. If a firm can 48 be one step ahead of its competitors in this category, they can expect to control the market, much like Danaher has accomplished.

Investment in Brand Image

For any given company, the largest asset they have could simply be their name. This is caused by its recognition and the history of the industry in which it competes. Snap-On has done a good job of representing its name with customer service innovations. In the 1930s, they became the first to offer credit to customers. This helped to get their products into more individual’s hands. In the 1950s, they began putting their products in vans and taking them directly to customers at their locations. Other firms in this industry are extremely conscious of the consequences involved with not making an effort to uphold its positive brand image. Industry leader, Danaher, goes to great lengths to uphold its image. The Danaher Business System is a system that conforms technology to meet the everyday needs of its customers. They do not want firms to have to match their way of doing things, but rather to keep up with what they are comfortable with.

Conclusion

For a firm to remain competitive within the commercial tool and equipment industry, they must continue to differentiate themselves by forming strong competitive advantages. For Snap-On to stay competitive with companies like Danaher Corporation, Black and Decker, and Stanley Works, they must continue to use their competitive advantages effectively. These include: superior product quality and variety, excellent customer service and flexible delivery, and investment in brand image and research and development. Failure to do so will result in huge loses of revenue and profitability.

49 Snap-On strives to compete on these strategies and remain competitive within the industry because of their ability to utilize their competitive advantages. Overall, Snap- On’s differentiation strategy has improved their brand image in the eyes of consumers, given them the ability to charge a premium price for their products, and focus on innovation through investments in research and development.

50 Formal Accounting Analysis

There are six steps to the formal accounting analysis that determine how sound or how outrageous company’s financial statements are being represented. Step one to the analysis is identifying key accounting policies and how the company uses them to measure serious issues and hazards. A competitive strategy gives the company a different way to account for their accounting measures. The next step in the process is to assess the flexibility of the company’s accounting policies and estimates. With a company being able to record high amounts of research and development as an asset, instead of an expense makes their company look better than they might be doing. The third step is to evaluate the accounting strategy of the company. The companies are publicly traded and have pressure from stockholders and investors to perform well. This might entice the managers to overstate revenues and understate expenses to make the financials look good. Also, if the managers have a stock option, they may have a bigger incentive to increase the market share as well to put more money in their pockets. The next step is to evaluate the quality of disclosure within the company. Some companies choose to disclose a lot of information while others prefer minimal disclosure. More available information leads to a better knowledge of the company, but inversely, it is harder for individuals with few resources to decipher the company’s financials. The fifth step in the analysis is to identify potential red flags within the accounting details. Many areas, such as unexplained changes in the accounting records, unexplained boost profits, and large fourth quarter adjustments, could be potential red flags saying the company might be cooking the books.

51 The final step in the accounting analysis is to undo accounting distortions. This is a more in-depth look into how the documents were manipulated and how with the proper adjustments to the documents the errors and problems can be changed to give a better understanding about the company. The accounting analysis is a beneficial process that helps investors and shareholders identify the areas of manipulation for a better understanding of the company. We are going to discuss how Snap-On uses minimum disclosure and practices conservative accounting.

52 Key Accounting Policies

Examining Snap-On’s key success factors and how they are disclosed in the accounting policies gives a clearer view of misrepresentations in the financial statements. The firm can distort figures to exhibit the picture of the company that they want the stockholders to see. The firm has the option of accurately disclosing these factors or giving a narrow view of their competitive advantages. As mentioned previously, Snap-On’s key success factors are superior product quality, variety, customer service, flexible delivery, research and engineering, and innovation. These factors show where distortions may exist. Accounting policies that can distort the actual value of the firm by the way they are recorded are: research and engineering, goodwill, the application of capital or operating leases, and disclosure of pension plans. GAAP allows flexibility in reporting financial information while placing a minimum requirement on disclosure.

Recording Research & Development

Generally Accepted Accounting Principles requires that firms expense their research & development costs instead of capitalizing them as an asset. Snap-On, as all companies in the tool industry, expends a large portion of their profit on research and development. It is an encumbrance that they are unable to record it as an asset because it’s an essential element for their growth in the market.

53 Company Research and Development Net Sales Percentage Danaher $45.70 $2,473.40 1.85% Snap-On $15.30 $2,187 0.70% Black and Decker $139.40 $740.40 18.83% Stanley Works $446 $2,660.30 16.77%

*In Millions *In Millions

In accordance to Snap-On’s 10-K report, $45.7 million was recorded as research and development expense in 2006. Also, Snap-On states, “Sales from new products represent a significant portion of our net sales and are expected to continue to represent a significant component of our future net sales.”1 While Snap-On contributes a large portion of their sales to innovative products, they do not disclose what they use research and development on. Therefore the overall effect of the treatment of R&D is insignificant in valuing Snap-On. However, competitors such as Danaher base a large part of their business on developing their diagnostics portion of the company, which requires massive amounts of research and development. When looking at Snap-on’s competitors, Danaher records $446 million in research and development expense.4 The wide range of variances in the percentage of R&D to net sales for the companies is directly related to the company’s concentration in the diagnostics sector. Therefore, Danaher’s vast amount or R&D expense is attributable to their focus on enhancing the diagnostics portion of their company. Snap-On’s reporting of R&D expense has little effect on the financial statements due to the low amount R&D used. They practice conservative accounting when disclosing research and development.

54 Capital Leases and Operating Leases

A key accounting principal is the effect of capital and operating leases on the liabilities of a company. When recording a capital lease, ownership is shown by documenting it as an asset, which in turn increases the liabilities of the firm. On the contrary, operating leases are simply recorded as rent expense. The difference in recording the two can have a tremendous impact in the apparent value of the firm. Capital and operating leases are complicated to distinguish in actual value due to the lack of precise information offered in the financial statements. In the tool industry as a whole, firms primarily utilize operating leases. The effect of recording a capital lease as an operating lease is shown below.

ASSETS = LIABILITIES + EQUITY REVENUES - EXPENSES = NET INCOME U U N N N N U: Understated O: Overstated N: No Effect

Snap-On has an overwhelming amount of capital leases. They own 72% of their U.S. facilities as well as 70% of their international amenities.1 Competitors in the tool industry use mostly operating leases, causing the effect shown in the chart above. Snap-On uses very few operating leases. Therefore, the small amount of rent expense each year is insignificant on the income statement. It is safe to say Snap-On practices conservative accounting in the treatment of their leases. Recognizing the manner in which leases are recorded within an industry is imperative to successfully compare the values of the companies. Snap-On’s assets are appropriately recorded to reflect their capitalized property.

55 Defined-Benefit and Pension Plan

A defined-benefit plan lays out the benefits employees will receive when they retire. Usually, their compensation is determined by years of service. Pension plans are required to be reported in the financial statements and in the notes. Therefore, companies disclose pension expense as a liability. Snap-On has various types of pension benefit plans in which the assets are invested in different areas to reduce risks such as: equity securities, fixed income securities, real estate, and money market instruments. They base their pension costs on the assumed discount rate and in the expected return on plant assets.1 An understatement of the estimated discount rate will cause an overstatement of liabilities. Inversely, an overstated discount rate will understate liabilities. The average discount rate used by the industry was 5.51%. In the United States, the average inflation rate used for 2006 is 3.24%.15 Obviously, firms use a discount rate above this average so that they can achieve a greater return than with interest alone. The next thing to consider when appraising the clarity of the discount rate used by firms is the current risk free rate, which is most closely related to the t-bond rate at 4.51%.16 Thus, it is reasonable for a company’s discount rate to exceed both the inflation rate and the approximate risk-free rate. The deviation in estimated discount rates can be attributed to different expectations of future economic events. We can conclude that Snap-On and its competitors are equitably computing their discount rates. In turn, their liabilities associated with pension plans are accurately accounted for.

56 Goodwill

Goodwill can only be attained when one company acquires another business. It is the premium a firm pays when purchasing that company and is accounted as an asset and amortized. If the value of goodwill is impaired, the carrying value is greater than fair value, then the balance can be reduced to match fair value but never increased. Goodwill is considered a key accounting policy for Snap-On. Currently, Snap-On’s goodwill is $776.1 million and comprises 29.24% of their total assets. They acquired a large portion of it, $346.1 million, when they bought ProQuest Solutions in November 2006. While it appears Snap-On’s goodwill contributes to too much of their total assets, one must make note that ProQuest is a diagnostics company. This attributes to a large portion of intangible assets and is significant to the future development and innovation within Snap-On. It’s also important to note Snap-On does not impair goodwill. Because Snap-On’s goodwill contributes to almost 30% of their total assets, impairment of goodwill would have a fundamentally negative impact on the asset account of Snap-On. When reviewing the policy for recording Snap-On’s goodwill, we found their estimates to be accurate. Though it increased greatly from 2005 to 2006, it was justly accounted for in the attainment of ProQuest Solutions, a highly technological firm.

Conclusion

In the accounting analysis, we determined the key success factors in which Snap-on operates and derived Snap-On’s key accounting policies: The recording of Research and Engineering, Pension Plans, Operating and Capital Leases, and Goodwill. After further examination we concluded Snap-on properly controls their risks and success factors, and management accurately captures the reality of the firm’s value.

57 Assess Accounting Flexibility

Accounting flexibility is the degree of choice a firm has in determining their policies and estimates. Each of the firm’s level of flexibility is dependent on their accounting standards and regulations. The Federal Accounting Standards Board is a private organization that develops the General Accepted Accounting Principles in the United States.17 The FASB has the legal authority to overlook financial statements. Certain accounting policies and choices have more stringent regulations than others and are more closely examined. For example, there is no leniency for managers when it comes to reporting research and development. On the other hand, when looking at the business’ estimations, such as payment defaults, managers are able to report numbers to their advantage. They can make themselves seem more profitable or suitable in their specific industry. Firms do have the option of selecting their key accounting policies; therefore, managers can hire elite accountants that can adjust an outsider’s view of the company.

Flexibility of Research & Development

There are strict policies when it comes to reporting research and development on the financial statements. Companies are required by GAAP to disclose R&D as an expense. As mentioned previously, it would be beneficial if Snap-On could capitalize R&D. Research and development affects sales revenue because the more a company utilizes it, the more profitable they will be. Snap-On, along with their competitors, encompasses large amounts of R&D. The tool industry is evolving due to the new technologies discovered daily. Snap-On states in their 10K that their current challenge and goal is to keep up with the rapidly increasing rate of technological change within motor vehicles. In order to achieve this,

58 significant amounts of R&D will have to be conducted. Unfortunately, there is no accounting flexibility when it comes to this issue. When analyzing the value of the firm, especially within the tool industry, one would have to take R&D expense into consideration.

Capital and Operating Leases

There are more lenient rules when recording leases. Firms take different viewpoints on whether or not to capitalize their leases. The FASB agrees with capitalizing the lease when it is similar to an installment purchase (Kieso). This means the firm should examine all the benefits and risks of having the lease. Basically there are two main classifications of leases: capital and operating. A capital lease gives the firm control to record it as an asset. It can provide the firm with great benefits along with some risks and gives a more conservative approach to recording leases. On the other hand, an operating lease has no effective ownership. The lease is usually on short term basis and has a residual value. Capital leases are recorded on the balance sheet, where as operating leases go straight to the income statement. Snap-On has leased and owned manufacturing warehouses and distribution and office facilities around the world.1 In the Unites States, 72% of their facilities are owned. In other words, these assets are capitalized on the balance sheet instead of being considered operating. When looking at Snap-On’s competitors in the tool industry, the majority of the leases are classified as operating, which shows a lower net income. When looking at Black & Decker’s 10K, they state that they have an immaterial amount of capital leases. By using operating leases, firms avoid disclosure of their total liabilities because they do not want to recognize them on the balance sheet. Lease agreements have fewer restrictive regulations than other debt agreements. Companies could easily distort their financial statements and make investors think they are more profitable by maintaining certain leases. If a company 59 were to record an operating lease as a capital lease, they would be overstating their assets and liabilities. Analysts need to keep in mind the flexibility of disclosing leases to make sure the firm is not under or over valuing their business.

Defined-Benefit and Pension Plan

A pension plan is an agreement where an employer grants benefits to employees for their years of service that they put in working for a certain company. There are different types of benefit plans that the company holds obligations to. The numbers to these plans are man-made and can be recorded in different methods. Snap-On has to make several assumptions when determining their pension expense. They primarily determine the amount of pension expense by their expected return on plant assets and from the assumed discount rate of 5.3%.1 Accounting flexibility gives firms the opportunity to distort numbers to make their firm appear more valuable. As mentioned previously, the discount rate and final numbers are assumed and are originated from the company’s expectations and view. If a manager wanted to give off a better perception of the firm, he or she could increase the interest rates to lower liabilities. Since these policy choices can be decided by mangers, flexibility should be a big concern and focus for analysts.

Goodwill

Goodwill is often recorded to show an acquisition’s intrinsic value. It is an intangible asset that is sometimes difficult to assign value to. Since goodwill is often very hard to measure, it allows great amounts of flexibility when estimating the value of net intangible assets. However, there is little flexibility in accounting policies when disclosing goodwill. Goodwill should not be capitalized when created internally. The way a company obtains goodwill is by purchasing another business. 60 In Snap-On’s case, there is a lot of goodwill accounted for. This is due to the fact that in November 28, 2006, they purchased ProQuest Business Solutions. This business boosted Snap-on’s assets tremendously. Companies could easily give off the wrong perception of the company by overstating assets or goodwill. The impairment charges on goodwill have a large impact on the future value of Snap-On. They are required to annually perform goodwill impairment tests to make sure that they are providing a transparent view of the company. Unexpected changes in goodwill could significantly affect reported earnings and reduce the net worth and shareholders’ equity.1 It is sometimes difficult to assign value to goodwill; therefore, when performing the accounting analysis, one should examine closely the worth capitalized to goodwill.

Conclusion

Flexibility is a vital step in the accounting analysis. Analysts must take into consideration the flexibility of accounting rules that managers are able to utilize. If there are not strict regulations, there is a possibility that managers may distort their numbers making the company look more profitable. Since certain figures have such a great impact on the financial status of the firm, estimates and policies should be closely examined.

61 Evaluate Accounting Strategy

The key concern when evaluating accounting strategies is management manipulation. While GAAP has specific requirements for how transactions must be recorded, it allows managers a little flex room. Managers have the choice of altering revenues and expenses in order to make certain accounts appear more favorable to investors. The accounting strategies that affect the tool industry are research & development, recognition of leases, pension plans, and the recording of goodwill. Because firms often disclose the bare minimum amount of information, it is difficult to uncover the true effects of the accounting strategies used. When evaluating the usefulness of the firm’s accounting strategy, one must look at how the firm’s policies compare to the industry standard, what incentives managers face in reporting inflated/deflated earnings, changes in policies and estimates, and how realistic estimates are. A chief issue for investors is how transparent the financial statements are to their actual account values.

Research and Development

In an industry where technology is a potent factor to growth in sales and success, the accounting strategy used in recording research and development plays a large role in effectively valuing the firm. Because continuous improvement is essential the tool industry, the effect of expensing research and development rather than capitalizing it plays a huge roll in deriving the actual value of the firm. Research and development is vital to increasing sales; therefore, conceptually you think of it as an asset. GAAP requires that these costs be expensed in the period that they are recognized. The expensing of R&D alters the financial statements greatly. When the expenses are overstated for the period, the net income is understated. This leads to an 62 understatement of retained earnings which reflects lower owner’s equity. Balance sheets show that assets are financed either from liabilities or owner’s equity. Therefore, when owner’s equity is understated, assets are understated as well. This theory is supported by the assumption that research and development should be capitalized as an asset to correctly reflect its value to the firm rather than expensed as required. In most industries, the standard set by GAAP of expensing research and development costs is appropriate. However, in an industry where innovation and technology is pertinent to survival, GAAP requirements hinder the actual value of the firm. Snap-On and its competitors expend an immense amount of their profit on research and development, which has a vast effect on the figures reported on the balance sheet. This gives managers an incentive to record other expenses and revenues in creative ways in order to offset their large R&D costs. Ultimately, this accounting policy set by GAAP requires investors in a technologically advancing industry to look beyond the surface of the financial statements to uncover the true value of the firm.

Capital and Operating Leases

In a large corporation, two different types of leases are commonly used: capital and operating leases. A capital lease can be thought of as “financing to own” while an operating lease is simply expensed. A company’s distribution of capital and operating leases can greatly affect the current ratio of the firm. Snap-On employs both capital and operating leases, but primarily they hold capital leases. As previously stated, Snap-On owns 72% of the properties they operate in the United States. The effect of which type of lease is used is minimal to the overview of the company’s value. Manager’s can be swayed to record leases as an expense rather than liability in order to make the current asset ratio appear more favorable to investors. It is important for firms to consistently record their leases and avoid the mistake of both the lesser and

63 lessee recording an operating lease. To correctly reflect the lease agreement, one party must record an operating lease while the other party records a capital lease. All in all, a manager’s desire to decrease liabilities may cause him to alter the financial statements by recording leases as expenses. Snap-On’s financial statements reflecting lease agreements are fairly accurate due to the fact that they own an overwhelming majority of the properties they utilize.

Defined-Benefit and Pension Plan

A company with a large employee base spends a great portion of their expenses on the employees. Not only does a company compensate employees with their salary but also with supplementary attributes such as health benefits, vacations, and retirement. Retirement is set up in the form of pension plans where growth and discount rates are estimated. Obviously it is difficult for a firm to pin point the precise rate that will be used when the plan expires causing liabilities to under/overstated. By adjusting the estimates to reflect a desired net income and current ratio, managers can alter the financial statements.

Discount Rate 2002 2003 2004 2005 2006 2007 Danaher 7.50% 7.00% 6.00% 5.75% 5.50% 6.00% Snap-On 6.70% 6.50% 5.90% 5.70% 5.30% 6.50% Black and Decker 6.10% 5.50% 6.00% 6.00% 5.75% 6.50% Stanley Works 6.50% 7.00% 6.00% 5.75% 5.50% 5.70% Industry Average 6.70% 6.50% 5.98% 5.80% 5.51% 6.18%

While the financial security of pension plans is very appealing to employees at retirement, they represent high costs to both firms and investors. Snap-On currently 64 uses a discount rate of 6.5%, which is slightly lower than the industry average. Using lower discount rates translates a higher present value of expected cash payments. This results in increasing liabilities and expenses. Stanley Works, Black & Decker, and Danaher could be estimating higher rates in order to make their current ratio more attractive, or they could simply have different expectations of future economic events. When evaluating the value of a company, it is imperative to review the areas of the financial statements in which managers have motive to distort figures in order to make their firm appear more profitable. Because higher performance of the company often reflects an increase in payment to management, managers are tempted to modify transactions of the company in their favor.

Goodwill

The recording of goodwill has a large impact on companies within the tool industry. Goodwill is the net intangible assets that a company earns through the acquisition of other companies. Firms in this industry often have high balances in this account because of the amount of research and development required to be successful in the always evolving tool industry. GAAP requires that this balance can only be impaired if the carrying value is greater than the fair value recorded on the books. When Snap-On purchased ProQuest Business Solutions in November 2006 for $516 million, they acquired $346.1 million of goodwill as well. Goodwill comprises 29.61% of Snap-On’s total assets for 2007.1 Because ProQuest specializes in diagnostics, the large portion of goodwill is attributed to the vast amount of research and development costs that could not be recognized as an asset but contributes to the overall value of the company. While one might assume the recognition of goodwill as an asset offsets the R&D expense, you must remember that goodwill increases only at the point of acquisition of a company. Therefore, a high amount of goodwill in relation to assets can indicate an overstatement of assets. 65 Goodwill as a % of Total Assets 2002 2003 2004 2005 2006 2007 18.37% 19.52% 19.28% 19.83% 29.24% 29.61%

Managers have the incentive to keep the highest possible amount of goodwill on the books in order to make a firm appear to be more profitable. Investors must look closely at the proportion of goodwill to assets to identify an over evaluation. Snap-On’s increase in goodwill is accounted for by their recent acquisition of ProQuest and appears to accurately show the current value of the firm.

Conclusion

Accounting strategies can play a significant role in determining the true value of a firm. Once you understand the motives managers have to distort certain balances, it is easier to verify the intrinsic value of the firm. Because the main goal of a corporation is to maximize shareholder’s wealth, managers face pressure from owners to maximize earnings. When the raw accounting figures do not optimize the firm’s profitably, managers are often tempted to alter the numbers so that they show the value they perceive is expected. If the figures in the financial statements have been manipulated to a great extent, investors believe they are receiving a biased perception of the firm and see this as a weakness of the company.

66 Qualitative Disclosure

The quality of disclosure is an important aspect when evaluating a firm’s accounting quality. Even though GAAP requires only a minimum amount of disclosure from firms, managers still have a choice to decide whether to increase or decrease the quality of disclosure. Quality of disclosure measures the usefulness of information provided by the managers of a firm in the financial statements and also other information within the firm’s annual 10-K report. With this information, analysts can decide whether or not to invest in a certain company. If investors feel that the information provided by the firm is accurate and reliable, they will be more confident that their investment will generate a profitable return. On the other hand, when the quality of disclosure is somewhat sketchy or inadequate, investors will be less likely to invest their resources into that company. Usually, if a firm has poor quality of disclosure, they are trying to boost the firm’s financial performance to increase investor confidence.

Research and Development

Research and development costs are fully disclosed by all firms within the tool and equipment industry. Firms within the industry depend on research and development as a key success factor because it directly affects their ability to compete with other firms within the market. For firms to continue to be successful, they must continue to produce superior quality products, along with new, innovative designs and equipment solutions. “Snap-On’s research and development costs are charged to expense in the year incurred. For 2006, 2005, 2004, research and development costs totaled $45.7 million, $50 million, and 58.2 million.” Snap-On spends the least amount of resources on R&D when compared to its competitors. Also, Snap-On does not

67 disclose what they are actually producing with the resources used for R&D or the success of new product launches. Firms within the industry provide a high level of disclosure of the costs incurred from research and development because they want to show investors that they are continuing to support investment activities that will ultimately lead to a higher profitability for the firm. The degree of disclosure reflected by managers as it relates to R&D is reliable and will help investors when evaluating the firms overall profitability.

Capital and Operating Leases

The level of disclosure that firms demonstrate for their capital and operating leases can have a positive or negative effect on the financial statements, depending on how they are classified. The quality of disclosure for capital and operating leases presented by Snap-On is fair. Snap-On leases facilities and equipment under non- cancelable operating leases extending for different amounts of time. Rent expense, net of sub-lease rental income, for worldwide facilities and equipment was $26.8 million, $29.7 million, and $35.6 million in 2006, 2005, and 2004 respectively.1 Snap-On also discloses the amount of rent expense in millions of dollars that they expect to incur from 2008 – 2012 and after. However, this is quite common among the competitors within the industry. Black and Decker, Danaher Corporation, and Stanley Works, all provide accurate and thorough information regarding their operating and capital leases. Snap-On’s operating leases are a small fraction of the firm and are somewhat insignificant because of the small expense incurred by the firm. Firms within the tool and equipment industry compete in a worldwide market and feel that it is important to disclose the amount of assets and liabilities derived from capital leases, as well as present and future rent expense from operating leases. If firms decided to use capitalize leases when they should be viewed as operating leases, assets and liabilities will be overstated on the balance sheet, and using operating leases instead of capital 68 leases will lead to a decrease in assets and liabilities. With this quality of disclosure provided by Snap-On and its competitors, we can be more confident when determining the actual value of the company.

Prospective Operating Lease Expenses 30 26.5 25 22.7

e 20.2 s 20 n e p x

E 15 13.5

t n e R 10

$ 7.5

5 5.3

0 2007 2008 2009 2010 2011 2012-∞ *In Millions Year

Defined-Benefit and Pension Plan

The quality of disclosure from Snap-On regarding their defined benefit plans is somewhat inadequate when comparing it to the disclosure provided by its competitors. Also, Black & Decker, Stanley Works, and Danaher Corporation, all provide defined benefit plans for their employees. Snap-On is the only firm, when compared to its competitors, that does not provide information regarding the pension benefit plans for their non-U.S locations. Snap-On and its competitors all provide discount rates to find the present value of all pension liabilities. However, the level of disclosure provided by Snap-On is inadequate because they do not differentiate the discount rates from their 69 U.S. and non–U.S. locations. Snap-On’s competitors also provide information with respect to expected growth and decline in future health care costs. Because Snap-On does not disclose any growth rate assumptions, it will be difficult to accurately evaluate the firm’s future pension expenses. Snap-On’s pension expense is somewhat insignificant when comparing it to the total liabilities recognized by the firm. It is also difficult to value Snap-On’s pension liabilities and assets because of the foreign currency risk involved in their non-U.S. locations. All firms within the industry show the initial impact of the foreign currency exchange rates on the total pension liabilities, which is presented on the balance sheet. Even though pension expenses are a small fraction of the total liabilities of the firm, it will still be difficult to evaluate the actual pension expenses and liabilities because of the poor quality of disclosure.

Prospective Benefit Payments 35 33 s

t 30 n e m

y 25 a P

t i f

e 20 n e B

$ 15

10 7.5 8 6.4 6.9 7.9 5 2007 2008 2009 2010 2011 2012-2016 Year *In Millions

70 Goodwill

The quality of disclosure, as it relates to goodwill, is fair within the industry. When a firm acquires a new business of company, the value that is assigned to goodwill is the difference between what the company paid for the business and the revalued assets and liabilities. Each firm assigns goodwill to their balance sheet and depending on how high the percentage of goodwill is to total assets, determines the actual value of the assets of the firm. In 2006, Snap-On acquired ProQuest Business Solutions for $516 million in cash, which includes the $8 million in transaction costs.1 This acquisition is responsible for the large growth in goodwill from 2005 to 2006. “All of ProQuest Business Solutions’ goodwill was assigned to the company’s Diagnostic and Information segment, and the company expects approximately $325 million to be assigned to goodwill.”1 In 2006 total goodwill as presented on the balance sheet totaled $776.1 million out of $2.65 billion in total assets. This is approximately 30% of total assets, which is an extremely significant amount. Also, in 2007, goodwill was computed as 29.61% of Snap-On’s total assets. Because goodwill is such a large percentage of total assets, investors may be less likely to invest in Snap-On if their acquisition of ProQuest does not provide any initial return. This is a huge percentage, as it relates to the industry, and will be an important factor when valuing the company.

71 Goodwill 900 818.8

l 776.1 l

i 800 w d o

o 700 G

o t

600 d e n

g 500 i 441.1 398.3 s 417.6 s A 400 366.4 $

300 2002 2003 2004 2005 2006 2007 *In Millions Year

Conclusion

The quality of disclosure is an important aspect of the valuing process, and analysts will not be able to accurately depict the value of the firm without reliable information provided by the firm. If managers decide to use “aggressive” accounting policies to make their company look better from an investor point of view, it can lead to analysts over valuing the company. If firms can provide reliable information, investors will see a better picture of the firm, which will lead to an easier valuation of the firm. Although they do not provide significant information about the discount rates as it relates to foreign pension liabilities, the overall transparency of the firm is fair.

72 Quantitative Accounting Measures and Disclosure

Quantitative accounting disclosures are intended to effectively communicate the financial statements’ numbers. These numbers can report crucial information regarding the value of the company, as well as the accounting policies they use. Due to the flexibility that GAAP allows companies to have, it is imperative that shareholders and other investors understand the accounting policies used by the company. Certain legal manipulations and disclosures could give a company an unrealistic value as well as mislead its investors. However, if investors and shareholders take the time to understand accounting techniques, they would be able to decipher much more about the company’s value from the limited disclosures they might be given. There are two major measures that we use to help us understand if the company is effectively accounting for its business activities with both precision and reliability. The first of these two measures is the sales manipulation diagnostics. These diagnostic tools are intended to find out what areas of the firm’s business activities affect their net sales. This process is done by taking the firm’s net sales and dividing it by other basic areas of the business activities including: cash from sales, net accounts receivable, unearned revenue, warranty liabilities, and inventory. The second of the two measures is the core expense manipulation diagnostics. This diagnostic is used to help raise any red flags regarding inexplicable increases or decreases in the expense reports. This in turn could not only highlight mistakes, but also help to disclose any accounting policies that might be deemed problematic. If these measures are not used or not used correctly, a firm’s value could be seriously altered. It is the responsibility of the firm to use accounting policies that correctly communicate their value. However, it is also the responsibility of investors and shareholders to do their research and implement the necessary measures to ensure they are making a solid financial decision.

73 Sales Manipulation Diagnostics

Sales manipulation diagnostics are ratios that will assess the credibility of the reported revenues of the firm. This will help us to identify any possible distortions in the accounting numbers, and will expose any irregularities concerning the amount of sales, accounts receivable, and inventory recognized over the past five years. Alone, these ratios do not give us a fair picture about how the firm is performing, but when comparing them over a span of five years, we are able to look for trends and abnormalities that may raise “red flags”. We will also compare these ratios with the top competitors within the industry, which will allow us to see if the ratios are similar throughout the industry, or company specific.

Net Sales/Cash from Sales

Net Sales/Cash from Sales Snap-On Snap-On (Revised) Danaher Black and Decker Stanley Works 1.30

1.20

1.10

1.00

0.90 2002 2003 2004 2005 2006 2007

74 The ratio of net sales to cash from sales allows us to determine the actual amount of cash that a firm is receiving from sales compared the amount of revenue recognized from sales during the period. This ratio should be somewhat close to (1:1) because naturally, when a firm is selling goods and services, they want to receive compensation. Cash from sales can be derived from take the net sales and subtracting the change in net account receivable over the years. If this ratio rises higher than one, this could be a potential “red flag” because firms are recognizing too much sales, and are not receiving any cash from these sales. This increase in sales could possibly be from aggressively recognizing the amount of accounts receivable. Industry wide, the ratio is somewhat close to one and does not raise any questions about the quality of accounting disclosure for any of the firms. Danaher’s ratio is somewhat higher than the rest of the competitors within the industry but has been consistent over the past five years. Overall, we see that Snap-On’s revenues from sales are supported by the cash collected.

75 Net Sales/Accounts Receivable

Net Sales/Accounts Receivable Snap-On Snap-On (Revised) Danaher Black and Decker Stanley Works 6.50

6.00

5.50

5.00

4.50

4.00

3.50 2002 2003 2004 2005 2006 2007

The ratio of net sales to accounts receivable allows us to see if the firm’s revenue from sales is supported by their accounts receivable. If we see a steady increase in sales over time, we should expect to see an increase in accounts receivable. Snap-On’s accounts receivable include their trade accounts, which are every day transactions, and the current portion of franchising financing receivables.1 Net accounts receivable also includes the allowance for doubtful accounts, which are deducted from accounts receivable. When comparing Snap-On to the competitors within the industry, they have a relatively low ratio of sales to accounts receivable. We have seen a steady increase in Net Sales/Accounts Receivable from 2002 to 2005, and seen a decline in 2006. From 2002 to 2003, Stanley Works has seen a spike in this ratio which is due to the large increase in sales, combined with a decrease or steady rate of accounts receivable. Black & Decker has also seen a steady increase in this ratio from 2003 to 2006, which could be from manipulating their sales revenue. This is the most dramatic 76 change within the industry and might raise a “red flag” when taking a closer look at the company. When looking at Snap-On’s ratios over the past five years, we can clearly see that Snap-On’s sales are supported by their accounts receivable.

Net Sales/Inventory

Net Sales/Inventory Snap-On Snap-On (Revised) Danaher Black and Decker Stanley Works 10.00

9.00

8.00

7.00

6.00

5.00 2002 2003 2004 2005 2006 2007

The ratio of Net Sales/Inventory allows us to see if a firm’s sales are supported by their inventory levels. If a firm is increasing their sales year by year, we should also see a decrease in inventory levels. This would lead to an increase in this ratio. As we can see in the graph above, over the past five years Snap-On’s ratio of sales to inventory has increased, and then showed a slight decline from 2005 to 2006. Industry wide, the trend seems to be somewhat stable in that each firm has seen greater increases in sales than in inventory levels. Danaher Corporation has seen a steady rate of Net Sales/Inventory but is much higher than the industry trend. This is because Danaher spends most of its resources competing in a different segment of the market. 77 We feel that the increase in each firm’s ratio is primarily due to the growth levels that each firm has seen over the past five years. Black and Decker has seen a steady decline in net sales to inventory from 2005 to 2007, which could mean that inventory levels are increasing even though their sales have increased. This would lead us to believe that Black and Decker could be manipulating sales to boost the image of their company. Overall, Snap-On’s sales revenue is supported by their inventory levels.

Net Sales/Warranty Liabilities

Net Sales/Warranty Liabilities

Snap-On Danaher Black and Decker Stanley Works

250

200

150

100

50

0 2002 2003 2004 2005 2006 2007

The ratio of Net Sales/Warranty Liabilities allows us to see if the firm’s sales are supported by their warranty liabilities. In the tool and equipment industry, if there is a steady increase in sales, we should also see a steady increase in warranty liabilities. Stanley Works has seen increases over the past five years because the growth in warranties has not kept up with the growth in sales. From 2002 to 2004, their revenue from sales is not supported by their warranty liabilities. This is also true for Danaher 78 Corporation from 2005 to 2006. The low ratio presented by Danaher reflects the amount of warranties that the firm issued during each period. Since Danaher’s sales come mostly from the diagnostic equipment and business solutions sector of the industry, we feel that this is the reason for their large amount of warranty liabilities. Snap-On has seen a steady decline in this ratio from 2002 to 2006 because the increases in warranties have outgrown the increases in sales. This is somewhat insignificant because of the steady decline. Since Snap-On’s main source of revenue comes from hand tools and vehicle repair equipment, there is no need for a large amount of warranties. Overall, warranty liabilities are somewhat insignificant when compared to total liabilities, which shows us that Snap-On’s revenue from sales is supported by the warranty liabilities.

Conclusion

The sales manipulation diagnostics allow us to see if a firm’s sales are supported by their accounts receivable, inventory levels, warranty liabilities, and pension liabilities. The ratios have been somewhat stable when looking at the trends over the past five years. The trend of Net Sales/Cash from Sales has shown that Snap-On’s sales are supported by cash received from sales. As revenue from sales has increased, so has the cash received. Net Sales/Accounts Receivable has shown a fairly steady trend, which would allow us to say that firms have not aggressively recognized sales to improve their perceived value and that Snap-On’s accounts receivable support their sales. The Net Sales/Inventory ratio has also seen a steady trend industry wide, which shows that Snap-On and its competitors have not manipulated sales or inventory levels. Warranty liabilities are quite common within the industry, and over the past five years, we have seen that sales are supported by each firm’s warranty liabilities. Unearned revenues were not disclosed by any of the firms within the industry, which could lead us to

79 believe that they are not relevant to the industry. Overall, we feel that the quality of disclosure, as it relates to sales, is accurately presented by the firms within the tool and equipment industry. Snap-On has continued to see steady trends in these ratios, which would lead us to believe that they have accurately reported sales and have not tried to improve their perceived value.

80 Sales Manipulation Diagnostics

Snap-On 2002 2003 2004 2005 2006 2007 Net Sales/Cash from Sales 1.00 1.00 1.00 0.98 1.03 0.99 Net Sales/Cash from Sales* 1.02 1.03 1.02 1.01 0.99 1.00 Net Sales/Accounts Receivable 3.79 4.08 4.30 4.75 4.42 4.84 Net Sales/Accounts Receivable* 3.79 4.08 4.30 4.69 4.39 4.84 Net Sales/Unearned Revenue N/A N/A N/A N/A N/A N/A Net Sales/Inventory 5.70 6.36 6.81 8.15 7.66 8.81 Net Sales/Inventory* 5.70 6.36 6.81 8.05 7.60 8.82 Net Sales/Warranty Liabilities 181 158 148 137 143 166.15 * Adjusted

Danaher 2002 2003 2004 2005 2006 2007 Net Sales/Cash from Sales 1.20 1.20 1.21 1.21 1.21 0.99 Net Sales/Accounts Receivable 6.03 6.10 5.60 5.67 5.73 5.56 Net Sales/Unearned Revenue N/A N/A N/A N/A N/A N/A Net Sales/Inventory 9.43 9.87 9.79 9.68 9.55 9.24 Net Sales/Warranty Liabilities 74.70 75.10 105.80 38.80 96.90 99.60

Black and Decker 2002 2003 2004 2005 2006 2007 Net Sales/Cash from Sales 1.00 1.02 1.05 1.01 0.99 1.02 Net Sales/Accounts Receivable 5.89 5.54 5.16 5.77 6.14 5.92 Net Sales/Unearned Revenue N/A N/A N/A N/A N/A N/A Net Sales/Inventory 5.73 6.31 5.50 6.22 6.06 5.73 Net Sales/Warranty Liabilities 102.20 110.90 97.80 113.90 107 108.48

Stanley Works 2002 2003 2004 2005 2006 2007 Net Sales/Cash from Sales 0.99 0.98 1.03 1.01 1.04 0.99 Net Sales/Accounts Receivable 4.45 5.55 5.21 5.39 5.36 5.60 Net Sales/Unearned Revenue N/A N/A N/A N/A N/A N/A Net Sales/Inventory 5.83 7.10 7.36 7.13 6.71 7.90 Net Sales/Warranty Liabilities 155.80 219.50 243.70 173.80 198.96 74.11 81 Expense Manipulation Diagnostics

Expense manipulation diagnostics are ratios that will allow us to see if companies have manipulated their expenses to improve their perceived value. By comparing Snap- On to its three largest competitors, we will be able to check for any irregularities in these diagnostics, and determine if the information presented is accurately portrayed by the firms. If the accounting numbers are somewhat distorted, this could lead to an inaccurate valuation of the firm.

ASSET TURNOVER

Asset Turnover

Snap-On Snap-On (Revised) Danaher Black and Decker Stanley Works 2.50

2.00

1.50

1.00

0.50 2002 2003 2004 2005 2006 2007

The asset turnover ratio is computed by dividing the current year’s sales by the previous year’s total assets. If this ratio is declining, it could be attributable to a company’s failure to impair items like goodwill or inaccurate depreciation of their

82 property plant & equipment. Snap-On has seen steady increases and decreases in the growth rate over the past five years, with their largest decline from 2005 to 2006. We feel this major decline is responsive to the acquisition of ProQuest Business Solutions in November of 2006. In the five-week period following the company’s acquisition, sales increased $20.4 million; however, this did not offset the $325 million attributed to goodwill.1 Also, Snap-On does not write off goodwill, which could raise concerns when assessing the value of their total assets. If firms do not accurately depreciate property, plant, and equipment, this ratio will increase. Black & Decker has been somewhat consistent from 2002 to 2003, but in 2004, we start to see a dramatic increase in their asset turnover ratio. This could result from write-offs, changes in depreciation estimates, and even selling off segments of their business. Overall, the most dramatic changes have come from Stanley Works, which has seen dramatic increases and decreases from 2003 to 2005. This could raise a potential “red flag” because of the huge changes in assets or sales recognized during the period. Snap-On has seen declines in this ratio over the past five years, the most dramatic occurred between 2005 and 2006 because of their acquisition of ProQuest. After this decline, we feel that we need to impair Snap-On’s goodwill to get a better picture of the firm’s total assets. As shown in the graph above, after restating goodwill, Snap-On’s sales remained constant while their total assets decreased. This will lead to an increase in the total asset turnover ratio.

83 CASH FLOW FROM OPERATIONS/OPERATING INCOME

CFFO/OI Snap-On Snap-On (Revised) Danaher Black and Decker Stanley Works 2.00

1.50

1.00

0.50 2002 2003 2004 2005 2006 2007

CFFO/OI is a ratio that describes the amount of cash received from operations, and the actual operating income that is reported on the income statement. By understating expenses from operations, we could see an increase in this ratio. This ratio should preferably be (1:1) so that cash received from operations is closely related to operating income. Snap-On has seen a steady ratio over the past five years, which shows that the amount of cash flow from operations is supported by the amount of operating income reported on the income statement. This is true among most competitors within the industry, except for Stanley Works. In 2002 we see a huge jump in this ratio from approximately a (1:1) ratio to almost a (2:1) ratio. This is because from 2002 to 2003, Stanley Works recognized large amounts of cash received from operations, but the operating income reported did not support this fact. This could possibly be from overstating expenses during the period. From 2003 to 2004, Stanley Works showed a major decrease in this ratio that was closer to the industry average.

84 This would have been a potential “red flag” but two years does not make a trend. From 2004 to 2006, the diagnostic shows that they have moved closer to a (1:1) ratio. Overall, Snap-On’s cash from operation is supported by the amount of operating income reported on the income statement.

CASH FLOW FROM OPERATIONS / NET OPERATING ASSETS

CFFO/NOA Snap-On Snap-On (Revised) Danaher Black and Decker Stanley Works 1.20

1.00

0.80

0.60

0.40

0.20

0.00 2002 2003 2004 2005 2006 2007

The ratio of CFFO/NOA allows us to see if a firm’s cash received from operations is supported by its net operating assets. Net operating assets are fixed assets, such as property, plant, and equipment. If firms do not accurately depreciate their operating assets and overstate their depreciation expense, we should see an increase in this ratio. Overall, the industry has seen a somewhat low ratio of cash flow from operations to net operating assets. We would prefer to see a higher ratio because this means that a firm is utilizing their operating assets to generate cash. The higher the ratio, the more cash is being received. Snap-On’s ratio is also low, but we feel this is somewhat insignificant

85 because of the trends shown by other competitors within the industry. It seems that all firms except for Stanley Works have seen a stable ratio of cash from operation to operating assets. These large spikes raise a “red flag” because they could be inaccurately depreciating their assets. This ratio also shows an inconsistency with Stanley Work’s accounting policies over the past five years. We saw the same types of inconsistencies in the CFFO/OI ratio provided by Stanley Works. Even though Snap-On has a relatively low CFFO/NOA ratio, we feel that their cash from operations is supported by their net operating assets.

TOTAL ACCRUALS / CHANGE IN SALES

Total Accurals/Change in Sales Snap-On Snap-On (Revised) Danaher Black and Decker Stanley Works 1.50 1.00 0.50 0.00 -0.50 2002 2003 2004 2005 2006 2007 -1.00 -1.50 -2.00 -2.50

Total accruals are derived by taking operating income and subtracting cash flow from operations. If firms overstate their expenses, operating income would be lower and would lead to a lower ratio. We would like to a see a ratio of approximately (1:1), which would show us that total accruals are supported by sales revenue. Snap-On has 86 seen increases from 2002 to 2005 and then has seen a sharp decrease to 2006. This seems to be the trend in the industry with the exception of Danaher Corporation. They have consistently seen a (1:1) ratio which is relatively different form the industry norm. Because Snap-On’s ratio is consistent with that of its competitors, we feel that their total accruals are supported by the change in sales.

PENSION EXPENSE / SG&A

Pension Expense/SG&A

Snap-On Danaher Black and Decker Stanley Works

0.12

0.10

0.08

0.06

0.04

0.02

0.00 2002 2003 2004 2005 2006 2007

The ratio of pension expense to selling, general, and administrative expenses ratio describes the portion of pension expense that is reflected in operating expenses. A higher ratio reflects a higher pension expense while a lower ratio reflects a lower pension expense. A lower ratio is preferred by companies because this would show that companies do not pay as much to its retired workers. A higher ratio would show that companies are paying their retired workers more money, which will have a negative impact on the firm’s profitability. Throughout the industry the pension

87 expenses are insignificant because they are such a small portion of the firm’s selling, general, and administrative expenses. These retired workers are not generating revenues for the firms but are simply getting paid for work they did in the past. Snap- On’s ratio is relatively low and is consistent with the industry norm. We also see steady increases in most pension expenses which are due to the higher increases in health care costs. Snap-On has seen a steady increase in pension expenses over the past five years and in 2006, pension expense was approximately 6% of SG&A expenses. Black & Decker is the only firm within the industry that has seen a steady decline in the percentage of pension expense to SG&A expenses. This could be a potential “red flag” because they may be understating their pension expenses, which would have a positive effect on net income. Overall, Snap-On has seen a steady increase in pension expense, and shows no sign of irregularities.

Conclusion

The expense manipulation diagnostics show that Snap-On has not manipulated their expenses, and have shown their accounting policies are consistent. The asset turnover ratio and CFFO/NOA should be looked at more closely because Snap-On fails to impair goodwill. They have maintained a consistent ratio as it relates to CFFO/OI and total accruals to changes in sales. Also, Snap-On’s ratio of pension expense to SG&A is relatively stable, and shows that pension expenses are insignificant when compared to the overall expenses reported by the firm.

88 Expense Manipulation Diagnostics

Snap-On 2002 2003 2004 2005 2006 2007 Asset Turnover 1.06 1.04 1.02 1.15 0.93 1.07 Asset Turnover* 1.07 1.16 1.13 1.04 1.27 1.14 CFFO/OI 1.12 1.18 1.03 1.31 1.23 0.71 CFFO/OI* 1.14 1.18 1.03 1.35 1.25 0.71 CFFO/NOA 0.45 0.31 0.28 0.40 0.47 0.29 CFFO/NOA* 0.69 0.54 0.47 0.75 0.69 0.76 Total Accruals/Change in Sales -0.86 -0.79 0.68 0.63 -0.62 0.24 Total Accruals/Change in Sales* -1.93 -0.22 -0.05 1.20 -0.23 0.24 Pension Expense/SG&A 0.04 0.04 0.04 0.05 0.06 0.08 Other Employment Expenses/SG&A N/A N/A N/A N/A N/A N/A * Adjusted Danaher 2002 2003 2004 2005 2006 2007 Asset Turnover 0.76 0.77 0.81 0.87 0.75 0.86 CFFO/OI 1.01 1.02 0.98 0.95 1.02 0.95 CFFO/NOA 0.12 0.13 0.12 0.13 0.12 0.66 Total Accruals/Change in Sales 0.99 0.98 1.07 1.05 0.98 0.06 Pension Expense/SG&A 0.01 0.01 0.02 0.02 0.03 0.05 Other Employment Expenses/SG&A N/A N/A N/A N/A N/A N/A Black and Decker 2002 2003 2004 2005 2006 2007 Asset Turnover 1.03 1.06 0.98 1.12 1.23 2.43 CFFO/OI 1.23 1.33 0.99 0.77 0.84 1.25 CFFO/NOA 0.61 0.64 0.53 0.56 0.67 0.41 Total Accruals/Change in Sales -0.56 .-74 0.01 0.16 -1.54 -1.24 Pension Expense/SG&A 0.01 0.09 0.08 0.08 0.07 0.04 Other Employment Expenses/SG&A N/A N/A N/A N/A N/A N/A Stanley Works 2002 2003 2004 2005 2006 2007 Asset Turnover 0.99 1.10 0.85 1.15 1.02 1.14 CFFO/OI 1.08 1.92 0.89 0.81 0.87 1.21 CFFO/NOA 0.54 1.04 0.67 0.38 1.13 0.37 Total Accruals/Change in Sales 0.09 -0.76 0.15 0.29 0.09 -0.20 Pension Expense/SG&A 0.03 0.03 0.02 0.03 0.03 0.06 Other Employment Expenses/SG&A N/A N/A N/A N/A N/A N/A 89 Potential Red Flags

Potential red flags come from changes that are unexplainable in a firm’s quantitative and qualitative accounting reports. The best way for identifying red flags is with the previously implemented Sales and Core Expense Diagnostics. If a red flag is identified, it is worth an investor’s time to review it and try to figure out where it came from. A red flag does not always mean that there is malicious intent. Many red flags arise from the level of disclosure that firm’s choose to use. Firm’s that have lower levels of disclosure have a higher probability of its investors coming up with red flags. This stems from the amount of data someone can refer to from looking at the statements they release. If a firm has a high level of disclosure, it is easier to see where the numbers came from and if accounting policies changed. If red flags are discovered, the first thing investors should analyze is whether or not their accounting policies or levels of disclosure changed. When looking at Snap-on’s financial statements, we concluded that there was a high level of disclosure with all the sales and core expense diagnostics numbers, and they all remained consistent over the previous five years. However, when looking at their competitor, Stanley Works, we noticed a red flag. When viewing their pension expense since 2002, we noticed that $184 million was paid to pensions. Starting in 2003, that expense dropped to $16 million and remained consistent with that until 2006. This raises some concerns regarding their accounting policies, and someone with money invested in Stanley Works would definitely want to find out why the huge decrease occurred. Although red flags do not always mean there is ill intent, they very well could signal foul play. Firms that improve their financial status by changing disclosures can show signs that the firm is struggling, despite its initial appearance. A good example of this is with goodwill. When a firm purchases another firm, it adds the purchase price to its assets. When the purchased firms’ assets and goodwill is evaluated, goodwill is left as an asset, despite goodwill being the amount you overpaid as a buyer. 90 Undoing Account Distortions

We concluded that Snap-On does not seem to have any questionable accounting policies. They have sufficient disclosure data that is easy to research and verify where numbers come from. However, there are a few things that we believe could help us to better evaluate the firm. There was some ratio data that we found insignificant when evaluating Snap-On. Snap-On has very little capital invested in research and development. Because of this, it should not be considered a determining factor in one’s material view of the firm. Along with R&D, pension benefit plans, and operating leases are also insignificant. Their pension benefit expenses are very small. While some of Snap-On’s competitors have significant pension benefit plans, Snap-On does not. Snap- On also owns the vast majority of its property. Their operating lease expenses are extremely small, and it is even mentioned in their notes that they would like to do away with operating leases all together. Because of the small amounts these expenses contribute to Snap-On’s financial statements, they are insignificant. In addition, we noticed that Snap-On has been accumulating a large amount of goodwill. We calculated how much assets would decrease from 2002 through 2007 if 20% was written off each year from goodwill. From 2002-2007, the decreases in goodwill were $73.3 million, $83.5 million, $88.2 million, $79.7 million, $155.2 million, and $163.76 million respectively. We found these decreases in assets to be a significant factor when valuating Snap-On. Snap-On does not impair its goodwill, and although it is considered an asset, in logical terms Snap-On’s assets are overvalued. The reason for such a large increase in 2006 was the purchase of ProQuest, of which $316 million of the $518 million purchase price was sent to goodwill.

91 Financial Analysis, Forecasting Financials, and Cost of Capital Estimation

To assess the financial position of Snap-on, we will use ratio analysis, forecasting financials, and cost of capital to have a better view of the company. First we will compute the financial ratios, which are used to determine the profitability and growth of the firm (Business Analysis and Evaluation). Then, we will forecast the financials by using the financial ratios previously computed. Forecasting is important to managers, and the future of the company, because it aids the managers in creating their business plans. Finally, we will estimate the cost of capital for Snap-On.

Financial Analysis

Financial statement analysis is essential when evaluating a company. The statements must be closely studied to see if management is falsely disclosing information. The analysis includes sixteen ratios that illustrate three areas: liquidity, profitability, and capital structure. By using these ratios, it allows analysts to compare one firm with their competitors, and view the company’s financial position over several years. They can evaluate the company more efficiently by seeing trends, and by analyzing the industry as a whole. By using these methods we can clearly see who the industry leader is.

92 Liquidity Ratio Analysis

Liquidity ratios measure how quickly a company can convert their assets to cash in order to pay off their liabilities. The most common liquidity ratios used are the Current Ratio, Quick Asset Ratio, Accounts Receivable Turnover, Days in Accounts Receivable, Inventory Turnover, Days in Inventory, and Working Capital Turnover. These ratios show credit risk, and they are commonly used by lenders. Managers can feel pressure by lenders to keep these ratios at a certain level in order to adhere to debt covenants.

Current Ratio

Current Ratio

Snap-On Danaher Black and Decker Stanley Works

2.20

2.00

1.80

1.60

1.40

1.20

1.00 2003 2004 2005 2006 2007

The current ratio of a firm is derived by dividing the current assets by the current liabilities. It is used to show the resources a firm and its ability to cover their current assets with current liabilities. The higher a firm’s current ratio is, the more able a firm is 93 to pay off its liabilities. Investors and lenders look to this ratio to see if a firm will be able to pay off its debts over the next 12 months. An average current ratio required by lenders is 2, allowing a slight cushion for unexpected financial events. Snap-On’s current ratio is consistently higher than that of its competitors. We see that the current ratio significantly increases from 2004 to 2005. This is due to Snap-on’s current liabilities decreasing from 674.20 to 506.10. Snap-on’s balance sheet shows that they paid off a large segment of their current portion of long term debt and capital leases.

Quick Asset Ratio

Quick Asset Ratio

Snap-On Danaher Black and Decker Stanley Works

1.6

1.4

1.2

1

0.8

0.6 2003 2004 2005 2006 2007

The quick asset ratio, or acid-test, uses the firm’s most liquid assets than can quickly be turned into cash for their book value amounts to pay off current debts. The assets included in this ratio are cash, marketable securities, and accounts receivable. This ratio takes a liquidating approach, showing a firm’s ability to cover its liabilities in bad financial times with cash or “near” cash assets. While a ratio of 1 is accepted, a 94 ratio greater than one is preferred. Over the 5 years examined, Snap-On maintained the highest quick asset ratio at an average of 1.09, well above the industry average of .96. Overall, Snap-On has surpassed its competitors, proving that its quick liquidity of assets can sustain the firm’s current liabilities.

Accounts Receivable Turnover

Accounts Recievable Turnover

Snap-On Danaher Black and Decker Stanley Works

6.5

6

5.5

5

4.5

4

3.5 2003 2004 2005 2006 2007

The accounts receivable turnover shows the number of times that a firm’s accounts receivable turns over in the course of a year. Dividing the firm’s sales by the balance of their accounts receivables measures the liquidity of this account. As with all liquidity ratios, a high ratio is preferred. Snap-On is lagging behind the industry in this department with a 5 year average of 4.46, compared to the industry average of 5.28. This lower number can be explained by a longer term allowed to Snap-On’s debtors to repay their outstanding debts than that of others in the tool industry. In essence, this hurts Snap-On’s ability to utilize their assets to maximize their profitability. Considering 95 the theory of the time value of money, Snap-On is losing money each day by waiting longer to collect their debts.

Days in Accounts Receivable

Accounts Recievable Days

Snap-On Danaher Black and Decker Stanley Works

90

85

80

75

70

65

60

55 2003 2004 2005 2006 2007

Days in Accounts Receivable ratio shows how many days it takes the company to collect the money on its accounts receivables. As shown above, Snap-on allows more time to receive their payments when compared to their competitors. The industry average for this ratio is roughly 70 days. When looking at the graph, Snap-on is always above average. Back in 2003, their days in accounts receivable ratio were 89. This information shows that Snap-On is not as efficient in collecting their receivables as their competitors. However, from 2003 to 2007, the company has improved converging to the industry norm.

96 Inventory Turnover

Inventory Turnover

Snap-On Danaher Black and Decker Stanley Works

7 6.5 6 5.5 5 4.5 4 3.5 3 2003 2004 2005 2006 2007

Inventory Turnover is computed by dividing cost of goods sold by inventory. This ratio explains how many times a company has to re-stock their inventory. One can use this ratio to determine liquidity by looking at the amount of inventory held. If a firm has a high inventory turnover, it means that they don’t hold much inventory relative to their sales volume. This shows that the firm has more cash and is more liquid. High numbers of inventory can be bad for a company because of the risk of depreciating prices and the possibility of being stuck with extra products. When analyzing Snap-On, their inventory turnover is about average in comparison to their competitors. Over the last five years, they have increased their ratio from 3.61 to 4.88. This shows that Snap-On is improving the way they handle their inventory.

97 Days in Inventory

Inventory Days

Snap-On Danaher Black and Decker Stanley Works

110

100

90

80

70

60 2003 2004 2005 2006 2007

Days in inventory shows how many days it takes for the money that is put into the inventory to be generated through sales. This is done by dividing the number of days in a year by the inventory turnover. As shown in the inventory turnover graph, Snap-On is once again about average when compared to other firms in the industry. It is impressive to see that Snap-On has become more cost-efficient by lowering their ratio from 101 days to 75 days. This is an excellent indication that Snap-On is increasing their productivity. This is a simple formula for investors to see how quickly companies are converting their inventory into sales.

98 Working Capital Turnover

Working Capital Turnover

Snap-On Danaher Black and Decker Stanley Works

12

10

8

6

4

2 2003 2004 2005 2006 2007

Working capital turnover is determined by dividing a company’s sales by its working capital, current assets less current liabilities. It evaluates how efficient a company uses its working capital balance to create sales. A higher number is desired to attain higher liquidity. Snap-On has the lowest ratio of the industry with an average of 4.67 compared to an industry average of 6.61. While Snap-0n has a low working capital turnover, they can attest to a somewhat more stable ratio over the past 5 years than companies like Danaher and Stanley Works. These changes can be attributed to decreases in current liabilities and/or increases in current assets for a company. Based on its history, an investor can comfortably assume less fluctuations for Snap-On’s liquidity on this ratio than that of competitors in the tool industry.

99 Cash To Cash Cycle

Cash to Cash Cycle

Snap-On Danaher Black and Decker Stanley Works

200 190 180 170 160 150 140 130 120 2003 2004 2005 2006 2007

The cast-to-cash cycle shows how long it takes cash to go in and out of the business. It starts with the company putting money into inventory, and then ends with them collecting on their receivables. This number is computed by adding the number of days in accounts receivable plus the number of days in inventory. A shorter cash to cash cycle is preferred. When looking at the past five years of Snap-On’s financials, we see that in 2003 they had a very high cash-to-cash cycle, but over the years they have become more efficient by converging to the industry standard. In 2007 their ratio is 150, which makes them slightly above average for that year.

100 Conclusion

In conclusion, companies use these ratios to determine how quickly they can convert their assets to cash. When compared against the industry, Snap-on usually performed around average. As discussed earlier, their days in accounts receivable ratio was high, but they put forward a great effort to lower it in the subsequent years. Overall, based on the liquidity ratios, Snap-On did a great job of improving their financial position year after year.

101 Profitability Ratio Analysis

The profitability ratio analysis is used to show how well a firm’s revenues cover its expenses. The “common size income statement” approach is used where sales equals 100%. Each of the ratios is shown as a percentage of sales. For these ratios, the higher the number the more efficient a firm is in terms of generating a profit. The profitability ratios are as follows: gross profit margin, operating profit margin, net profit margin, asset turnover, return on assets, return on equity, Z-scores, Sustainable Growth Rates, and Internal Growth Rates.

Gross Profit Margin

Gross Profit Margin

Snap-On Danaher Black and Decker Stanley Works

46% 44% 42% 40% 38% 36% 34% 32% 30% 2003 2004 2005 2006 2007

Gross profit margin represents the gross profit, sales less cost of goods sold, divided by sales. The gross profit margin exhibits how profitable a company is after

102 deducting its fixed and overhead costs involved in attaining inventory. It is the first of the ratios that show the operating efficiency of a firm and therefore, effects all the latter ratios derived from the income statement. The higher a company’s gross profit margin the more efficient they are at covering their expenses, explaining their greater profitability. Though the graph might suggest a segmented industry, in reality, Snap-On and Danaher are simply more proficient in keeping a low cost of goods sold. Snap-On’s gross profit margin is steady and the top in the industry. It averages out to be 44% compared to the industry average of 40%. Achieving a higher gross profit margin gives hope to a company realizing a net profit rather than loss.

Operating Profit Margin

Operating Profit Margin

Snap-On Danaher Black and Decker Stanley Works 18%

16%

14%

12%

10%

8%

6%

4% 2003 2004 2005 2006 2007

Operating profit margin is computed by dividing a company’s operating income by its sales. Operating income is simply a firm’s selling and administrative expenses deducted from its gross profit. The higher the percentage of sales that operating 103 income is, the more profitable a firm is after accounting for its operating expenses. Snap-0n has a low operating profit margin of 4%, merely half of that of the industry average of 8%. Danaher operates at a much higher margin of 12% and is the most efficient in the industry at covering their operating expenses.

Net Profit Margin

Net Profit Margin

Snap-On Danaher Black and Decker Stanley Works Snap-On (Revised) 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% 2003 2004 2005 2006 2007 -4%

Net Profit Margin is the most basic of the profitability margins. It simply gives profit as a percentage of net sales. It shows how much of each dollar of product sold is profit. Over the past five years, Snap-On has had a constant industry low in profitability margin. A firm with a low profitability margin will likely have trouble keeping up with their competitors. Because the amount of profit is what firms have to both reinvest and fund other growth opportunities, one with an industry low, like Snap-On, will not be able to keep up with competitors, like Danaher, who constantly maintain profitability in the double digits. Danaher will have more money available to fund growth than anyone 104 else in the industry. This could lead us to conclude that Snap-On may face significant growth pains in the future if they cannot bring up their profitability. After revising Snap- On’s net income for adjustments in recording goodwill, Snap-On shows approximately a 4% decrease in profitability each year. Because net profit margin is so closely linked to growth, it is arguably one of, if not the most important of the profitability margins.

Asset Turnover

Asset Turnover

Snap-On Danaher Black and Decker Stanley Works Snap-On (Revised) 1.4

1.3

1.2

1.1

1

0.9

0.8 2003 2004 2005 2006 2007

Asset turnover shows us for each dollar of assets a firm has, how much they produce. For example, in 2003, for every dollar of assets Snap-On possessed, they made $1.04. With the exception of 2006, Snap-On has done quite well at keeping their Asset Turnover above 1. Having an asset turnover less than 1 is not good and shows that a firm is not properly utilizing their assets. For instance, Danaher has not had a year in the past five years where their asset turnover is above 1. The asset turnover that Danaher has maintained over the past five years shows a significant lack in asset 105 productivity. A firm in Danaher’s situation would need to do some serious internal investigating to improve their investment productivity. After adjusting Snap-On’s financial statements, their asset turnover ratio increased due to the decrease in total assets. Since an asset turnover ratio above 1 is preferred, Snap-On’s revisions for goodwill show them in a stronger financial position in terms of profitability.

Return on Assets

Return on Assets

Snap-On Danaher Black and Decker Stanley Works Snap-On (Revised) 20%

15%

10%

5%

0% 2003 2004 2005 2006 2007 -5%

ROA comes from dividing the current year’s net income by the previous year’s assets. The firm uses the previous year’s assets to better reflect profitability for the current year. Snap-On has had the lowest ROA for each of the past five years. Subsequent to adjustments, Snap-On’s return on assets decreased substantially. Because of Snap-On’s acquisition of ProQuest Business Solutions in 2006, there was a greater amount of goodwill impaired during this year. This significantly decreased net income, which is reflected by the dip in the graph above. While they may have the 106 lowest percentage, it has begun to increase over the past two years. This could mean that Snap-On is making an effort to carefully invest in assets that provide profitability in the future.

Return on Equity

Return on Equity

Snap-On Danaher Black and Decker Stanley Works Snap-On (Revised) 60%

50%

40%

30%

20%

10%

0% 2003 2004 2005 2006 2007 -10%

Return on Equity is measured by taking the current year’s net income and dividing it by the previous year’s total owner’s equity. This helps to measure how much return a firm has obtained in relation to the preceding year’s equity. As is the case with several other ratios, Snap-On displays the lowest but also some of the most consistent numbers in their industry. Black & Decker currently has the highest ROE in each of the past five years, even amid a drastic drop from 2004 to 2005. After expensing goodwill in the modifications, net income decreased roughly 10% over the 5 year period. As previously stated, the plunge in 2006 is attributable to the acquisition of ProQuest

107 Business Solutions. Snap-On may be making a push to better utilize its equity seeing that they had an 80% higher ROE in 2007 than it did in 2006.

Z-Score

Z-Score

Snap-On Danaher Black and Decker Stanley Works Snap-On (Revised) 4

3.5

3

2.5

2

1.5

1 2003 2004 2005 2006 2007

The purpose of the Z-score is to help us make calculations that help us to understand where a company stands with their credit risk. A company is considered to be bankrupt when their Z-score is below 1.81. When a firm’s score exceeds 2.67, the firm is considered to have low risks in the bankruptcy and credit categories. This is one category that Snap-On excels in. While the rest of Snap-On’s competitors have never had a Z-score of 2.67, which is classified as less risky, Snap–On has never fallen under 2.67. After adjustments, Snap-On’s creditworthiness slightly increases due to the decrease in retained earnings and total assets. By looking at this ratio, Snap-On stacks up as a credit worthy investment opportunity.

108 Sustainable Growth Rate

Sustainable Growth Rate

Snap-On Danaher Black and Decker Stanley Works Snap-On (Revised) 40% 35% 30% 25% 20% 15% 10% 5% 0% 2003 2004 2005 2006 2007

SGR is a measure of how much growth a firm can sustain while both re- investing, as well as taking on debt. It is calculated by taking your IGR and multiplying it by one plus the debt to equity ratio. For Snap-On, this shows that not only can they grow by 4.39% by internally investing, but can sustain an additional 9.48% of growth by borrowing from financial institutions. With the revisions for treatment of goodwill, Snap-On’s sustainable growth rate decreases as a direct result of a decreasing internal growth rate. Snap-On is beginning to show good signs in both their IGR and SGR. This shows that Snap-On may be making a superior effort to grow by making responsible decisions with their borrowings as well as their retained earnings allocation.

109 Internal Growth Rate

Internal Growth Rate

Snap-On Danaher Black and Decker Stanley Works Snap-On (Revised) 16% 14% 12% 10% 8% 6% 4% 2% 0% 2003 2004 2005 2006 2007

IGR is a measure of how far a firm can go by simply re-investing funds while forgoing any debt. It is measured by taking the ROA and multiplying it by one minus the dividend payout ratio. The dividend payout ratio shows us how much net income will be gone when we begin to re-invest our retained earnings. Snap-On is at the bottom of this category as well. One can assume Snap-On will not be able to grow as fast as their competitors. However, this does not indicate that Snap-On is irresponsible with their investing. It could be an indication that they do not have enough money left over to re-invest. Once the financial statements are revised, Snap-On’s internal growth rate decreases as a result of the decrease of return on assets and net income. A company with a high IGR foreshadows both efficient investing and the ability to take on debt if need be.

110 Conclusion

By looking at the overall effect of the changes in these profitability ratios, an investor can determine how successful a firm is at generating profits in comparison to its industry. When looking at the profitability ratios of Snap-On’s competitors, Snap-On usually underperforms. The SGR and IGR are also lower than all of their competitors, and we feel this is due to the fact that Snap-On is much smaller than its competitors. However, Snap-On’s has the highest gross profit margin which leads us to the conclusion that Snap-On will continue to be profitable in the future.

111 Capital Structure Ratios

When looking at the capital structure of a business we are looking at how the company finances its assets. This is shown on the balance sheet in the liabilities and owner’s equity portion. Debt financing is borrowing money, where as equity financing is selling shares of the company as stock. When looking at these capital structure ratios, analysts should be concerned with the company’s amount of debt, and ability of meeting their loan obligations.

Debt to Equity Ratio

Debt to Equity Ratio

Snap-On Danaher Black and Decker Stanley Works Snap-On (Revised) 4 3.5 3 2.5 2 1.5 1 0.5 0 2003 2004 2005 2006 2007

The debt to equity ratio measures how much of a firm is financed by debt in comparison to the amount internally financed with equity. Aside from 2006, Snap-On has maintained a relatively low debt to equity ratio. Their highest ratio was in 2006

112 when it reached 1.47. This means that for every dollar the company had in equity, they had $1.47 in debt. The ratios have large differences in the tool industry. The ratios vary from the lowest, Danaher with an average of .88 over the past five years, all the way up to the highest, Black & Decker, with an average of 3.1 over the past five years. These wide variations are probably due to the varying ideas regarding debt financing. After adjusting the financial statements for the expensing of goodwill, Snap-On’s debt to equity ratio fluctuates due to the decrease in shareholder’s equity.

Times Interest Earned

Times Interest Earned

Snap-On Danaher Black and Decker 50

40

30

20

10

0 2003 2004 2005 2006 2007

* Stanley Works - N/A

Times interest earned measures how many times you could pay off the interest you incur using the cash flow from operations. It is measured by taking the income from operations and dividing it by the interest expense for the year. For example, Snap- On had a ratio of 8.39 in 2007, this means that Snap-On could pay off their 2007 interest expense 8.39 times with the income they received from operations. Because of 113 what this ratio measures, bigger is certainly better. Snap-On, with the exception of 2007, has remained at the bottom of the list. While they have shown small increases, they have remained consistently well-below average and much less volatile than the other industry competitors.

Debt Service Margin

Debt Service Margin

Snap-On Danaher Black and Decker Stanley Works

10

8

6

4

2

0 2003 2004 2005 2006 2007

The debt service margin shows how much debt is covered by cash flow from operations. This is figured by dividing cash flow from operations by the previous year’s current notes payable. By taking the previous year’s numbers we are actually calculating the installment that will be paid in the current year. Usually the bigger the debt service margin the better because it is more beneficial for a company to cover their liabilities with operating cash flows. Snap-On’s ratios are very volatile. However, each year they are able to pay off their liabilities by operating cash flows at least 1.6 times.

114 Conclusion

The capital structure ratios allow analysts to have a good picture of how the company finances their assets and how high their credit risk is. The debt to equity ratio for Snap-On was fairly low compared to their competitors. When looking at the times interest earned ratio, it was low compared to the industry, but is currently increasing. This is good for Snap-On because it indicates that their income from operations can cover their interest expense. Finally, the debt service margin for Snap-On was not applicable because Snap-On does not have any long-term debt. Overall, Snap-On is again sitting even with the industry average, and there are some periods that reflect them as the leader of their industry.

115 Estimating Cost of Capital

Cost of Equity

The cost of equity is the minimum rate of return that investors require for purchasing stock in a company. The higher the cost of equity, the higher the expected return is for the investors. When investors purchase stock in a company, they take on different levels or risk, and expect to receive compensation for this risk. The cost of equity can be determined by using the Capital Asset Pricing Model (CAPM). This formula is derived by using the risk-free rate (U.S. Treasury Yield), beta (Unsystematic Risk), and the market risk-premium (Market Risk – Risk Free Rate). To calculate the cost of equity, we first had to find the treasury yields, which we gathered from the St. Louis Federal Reserve website. These yields included the 3 month, 6 month, 2 year, 5 year, and 10 year. We used different treasury yields so we will get a more accurate beta after we run our regressions. We also had to find the market return, which we calculated by using S&P 500’s prices. By calculating the change in price from month to month, we were able to calculate the monthly return. With this data, we were able to calculate the market risk premium. After we subtract the various treasury yields from the S&P 500’s monthly returns, we were able to use these market risk premiums in our regressions. We used the market risk premiums and our firms returns to run regression over a 24, 36, 42, 60, and 72 month time period to estimate the beta. When choosing the beta that best represents the unsystematic risk of the firm, we had to analyze the explanatory power (Adj. R2) of the regressions. A higher explanatory power means that the firm’s percent of variation in expected return can be explained by the percent of variation in the market risk premium. After running these 30 regressions, we took the estimated betas and computed the cost of equity. We chose the beta that had the highest explanatory power (R2),

116 which we found using the 3 month treasury yield at 72 months. This provided a 51.23% explanatory power. We feel confident in choosing a 1.23 beta when estimating our cost of equity because of this high explanatory power. The 6 month, 2 year, 5 year, and 10 year treasury yields all provided explanatory power of approximately 50%. The published beta by the company is .55, which is approximately the same beta we found in our regression using a 24 month time horizon and a 6 month treasury yield. We then used our numbers to plug into the CAPM equation, and found our cost of equity to be 10.78%.

3 Month Rate Months Beta Risk Free Rate Adjusted R Squared Cost of Equity 72 1.23 2.16% 51.23% 10.78% 60 1.01 2.16% 27.67% 9.22% 48 0.81 2.16% 16.51% 7.80% 36 0.68 2.16% 15.25% 6.93% 24 0.58 2.16% 9.29% 6.23%

6 Month Rate Months Beta Risk Free Rate Adjusted R Squared Cost of Equity 72 1.21 2.10% 50.04% 10.56% 60 1.01 2.10% 27.60% 9.15% 48 0.79 2.10% 16.12% 7.65% 36 0.71 2.10% 16.52% 7.06% 24 0.54 2.10% 8.81% 5.86%

2 Year Rate Months Beta Risk Free Rate Adjusted R Squared Cost of Equity 72 1.21 1.97% 50.27% 10.44% 60 1.02 1.97% 27.86% 9.08% 48 0.79 1.97% 16.26% 7.51% 36 0.70 1.97% 16.48% 6.90% 24 0.56 1.97% 8.64% 5.91%

117 5 Year Rate Months Beta Risk Free Rate Adjusted R Squared Cost of Equity 72 1.21 2.78% 51.05% 11.26% 60 1.02 2.78% 27.96% 9.92% 48 0.79 2.78% 16.29% 8.32% 36 0.70 2.78% 16.49% 7.69% 24 0.56 2.78% 8.68% 6.71%

10 Year Rate Months Beta Risk Free Rate Adjusted R Squared Cost of Equity 72 1.21 3.74% 50.37% 12.23% 60 1.02 3.74% 27.97% 10.88% 48 0.79 3.74% 16.30% 9.27% 36 0.70 3.74% 16.49% 8.65% 24 0.56 3.74% 8.70% 7.67%

Back Door Cost of Equity

+ = − After running our regressions, we found our cost of equity to be 10.78%, using a beta of 1.23. We feel that this cost of equity is too low and is not sustainable over the long-run. This cost of equity does not accurately price the risk of investing in the firm. We computed a new cost of equity using the back door method, which uses the equation above instead of the Capital Asset Pricing Model equation, and found the cost of equity to be 13.50%. We feel that this more accurately depicts the cost of equity of the firm because a higher cost of equity suggests that there is more risk when investing in the company. 118 Cost of Debt

The cost of debt is the rate at which firms borrow money from banks and other lenders. To find the cost of debt, we use a weighted average formula and take the weight of each liability, which is the dollar amount over the total liabilities, and multiply by the interest rate. Most interest rates can be found in the company’s 10-K accounting notes. The cost of debt is always less than the cost of equity because lenders do not take on as much risk as investors. Also, creditors will be able to collect collateral if companies do not repay the loan and interest payments. They are always the first to be paid if the firm goes out of business, which means less risk for the creditors. Snap- On’s total liabilities in 2007 were approximately $1485 million and we found the cost of debt to be 6%, which is reasonable because our cost of equity is 13.50%.

COST OF DEBT LIABILITIES AND SHAREHOLDERS EQUITY Debt Interest Rate Weight WACD Current liabilities Accounts payable 171.60 0.055 0.12 0.6% Notes payable and current maturities of long-term debt 15.90 0.055 0.01 0.1% Accrued benefits and Accrued Compensation 136.90 0.063 0.09 0.6% Franchisee deposits 51.00 0.056 0.03 0.2% Deferred subscription revenue 25.90 0.055 0.02 0.1% Income taxes 25.50 0.055 0.02 0.1% Other accrued liabilities 212.40 0.065 0.14 0.9% Long-term debt 502.00 0.063 0.34 2.1% Deferred income tax liabilities 91.20 0.055 0.06 0.3% Retiree health care benefits 53.80 0.058 0.04 0.2% Pension liabilities 85.30 0.056 0.06 0.3% Other long-term liabilities 113.50 0.063 0.08 0.5% Total liabilities 1,485.00 6.0%

119 Weighted Average Cost of Capital (WACC)

The weighted average cost of capital is the weighted sum of the cost of equity and the cost of debt. It is also the average rate at which a firm will pay for its financed assets. There are two types of weighted average cost of capital, one before tax, and one after tax. We found that our WAAC before tax to be 11.10% and our WACC after tax to be 10.48%. We also used an effective tax rate of 32.50% which was provided by Snap-On’s 10-K financial statements.

Weighted Average Cost of Capital MVE/MVA Cost of Equity MVD/MVA Cost of Debt Tax Rate WACC WACC (BT) 0.68 13.50% 0.32 6.00% 0 11.10% WACC (AT) 0.68 13.50% 0.32 6.00% 32.50% 10.48%

120 Financial Statement Forecasting

Forecasting financial statements is a great way to value a company within a specific industry. This helps the company by estimating future cash flows and how to better expand the business. With Snap-On, we forecasted out the income statement, balance sheet, and statement of cash flows for ten years to better predict future earnings. We began by finding trends, growth rates, liquidity, profitability, and capital structure ratios for Snap-On and its competitors. With these base line numbers we were able to forecast future earnings for our company.

Income Statement

The income statement is an important instrument when trying to predict future earnings within a business. Many shareholders and investors rely on public information provided by the company to decide whether or not to purchase stock in the company. The first thing we did was take all revenues and expenses as a percentage of sales to better forecast our numbers. With historical information given by Snap-On, we were able to forecast out sales, cost of goods sold, gross profit, operating earnings, and net earnings. We took an average growth rate of net sales and also calculated sales growth in the past 5 years and then forecasted that they would grow in the future years at a rate of 11.50%. Our reason for deciding on a growth rate of 11.50% was because we have continued to see growth in sales and in the past two years sales have doubled. Because of the recent decrease in economic growth, people will continue to drive their older vehicles, and since approximately 44% of Snap-On’s revenue is generated from vehicle repair services, we feel this will help our company’s growth. That is where is see great potential for Snap-On to take great strides in sales. The next thing we forecasted was cost of goods sold. Cost of goods sold as a percentage of sales in the past years was around 56.12% on average. However, 121 because we forecasted that sales were going to increase over the future years, we decided to decrease the percentage of cost of goods sold from 56.12% to 55.75% because of the continued increase in gross profit margin over the past 5 years. This means that our increases in sales are greater than the increases in cost of goods sold. Next we forecasted our gross profit. This number it is basically a plug number from taking sales minus cost of goods sold. But over the past years the average percentage was 43.88%. For forecasting purposes, since we had increases in the other two percentages, we did the same for our gross profit figure to 45.25%. Our operating expenses were consistent with one another over the past five years and with that we feel comfortable forecasting that they will grow at 33% for the next ten years. The last two things we forecasted were operating income and net income. These two entries have great potential over the next ten years because of our recent acquisition of Proquest Diagnostics in 2005. This company had expertise in automotive diagnostic equipment which will give Snap-On a leading edge in automotive repair in the years to come. Taking all these factors into consideration when forecasting these numbers,l we came out with an 11.75% increase in operating earnings over the next ten years which was greater than the average of 7.61%. We then forecasted out our net income with a 6.75% growth rate. We feel that this will continue to grow because of the recent acquisition of ProQuest Business Solutions, and the continued growth in the world economy.

122 Income Statement Actual Income Statement Forecasted Income Statement

(Amounts in millions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Net sales 2109.1 2233.2 2329.1 2281.0 2455.1 2841.2 3167.9 3532.3 3938.5 4391.4 4896.4 5459.5 6087.3 6787.4 7567.9 8438.2 9408.6

Cost of goods sold 1144.2 1268.5 1319.8 1269.8 1375.3 1574.6 1766.1 1969.2 2195.7 2448.2 2729.7 3043.7 3393.7 3784.0 4219.1 4704.3 5245.3

Gross profit 964.9 965.7 1009.3 1011.2 1079.8 1266.6 1401.8 1563.0 1742.8 1943.2 2166.7 2415.8 2693.6 3003.4 3348.8 3733.9 4163.3

Financial services revenue - - 78.1 53.6 49.0 63.0

Financial services expenses - - 44.0 37.9 36.0 40.6

Operating income from financial services 37.7 43.8 34.1 15.7 13.0 22.4

Operating expenses 799.2 858.4 901.1 863.5 930.0 964.2 1045.4 1165.6 1299.7 1449.2 1615.8 1801.6 2008.8 2239.8 2497.4 2784.6 3104.8

Operating earnings 198.3 150.1 142.3 163.4 162.8 324.8 372.2 415.0 462.8 516.0 575.3 641.5 715.3 797.5 889.2 991.5 1105.5

Interest expense 28.7 24.4 23.0 21.7 20.6 46.1

Other income (expense) - net -8.4 -9.0 1.1 3.1 5.3 5.5

Earnings before income taxes 161.2 116.7 120.4 144.8 147.5 284.2

Income tax expense 58.0 38.0 38.7 55.2 45.9 92.5

Earnings before interests and earnings 103.2 78.7 81.7 89.6 101.6 191.7

Minority interests and earnings, net of tax - - - -1.4 -3.7 -2.5

Net earnings from continuing operations - - - 88.2 97.9 189.2

Discontinued operations, net of tax - - - 4.7 2.2 -8.0

Net earnings 106.0 78.7 81.7 92.9 100.1 181.2 213.8 238.4 265.8 296.4 330.5 368.5 410.9 458.1 510.8 569.6 635.1

123 Common Size Income Statement Actual Income Statement Forecasted Income Statement

(Amounts in millions) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Net sales 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Cost of goods sold 56.8% 56.7% 55.7% 56.0% 55.4% 55.8% 55.8% 55.8% 55.8% 55.8% 55.8% 55.8% 55.8% 55.8% 55.8% 55.8%

Gross profit 43.2% 43.3% 44.3% 44.0% 44.6% 44.3% 44.3% 44.3% 44.3% 44.3% 44.3% 44.3% 44.3% 44.3% 44.3% 44.3%

Financial services revenue - 3.4% 2.3% 2.0% 2.2%

Financial services expenses - 1.9% 1.7% 1.5% 1.4%

Operating income from financial services 2.0% 1.5% 0.7% 0.5% 0.8%

Operating expenses 38.4% 38.7% 37.9% 37.9% 33.9% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0%

Operating earnings 6.7% 6.1% 7.2% 6.6% 11.4% 11.8% 11.8% 11.8% 11.8% 11.8% 11.8% 11.8% 11.8% 11.8% 11.8% 11.8%

Interest expense 1.1% 1.0% 1.0% 0.8% 1.6%

Other income (expense) - net -0.4% 0.0% 0.1% 0.2% 0.2%

Earnings before income taxes 5.2% 5.2% 6.3% 6.0% 10.0%

Income tax expense 1.7% 1.7% 2.4% 1.9% 3.3%

Earnings before interests and earnings 3.5% 3.5% 3.9% 4.1% 6.7%

Minority interests and earnings, net of tax - - -0.1% -0.2% -0.1%

Net earnings from continuing operations - - 3.9% 4.0% 6.7%

Discontinued operations, net of tax - - 0.2% 0.1% -0.3%

Net earnings 3.5% 3.5% 4.1% 4.1% 6.4% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8%

124 Income Statement (Revised)

Impairing goodwill 20% over the past five years drastically affects Snap-On’s bottom line, net income. After the impairment, not only are total assets affected, we also have to take the amount of goodwill impaired and subtract it from net earnings. After the adjustment, net earnings decreased $73.28 million, $86.53 million, $88.22 million, $79.66 million, $155.22 million, and $163.76 million respectively from 2002 to 2007. This also led to negative earnings in years 2003, 2004, and 2006. This drastic decrease in earnings will greatly affect profitability ratios such as ROE, ROA, Net Profit Margin, Internal Growth Rate, and Sustainable Growth Rate. These ratios are restated in the graphs above. Also, because of the negative earnings in 2003, 2004, and 2006, we had to re-compute Snap-On’s dividends in the Statement of Cash Flows, which also led to a revision in retained earnings.

125 Revised Income Statement Actual Income Statement Forecasted Income Statement

(Amounts in millions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Net sales 2109.1 2233.2 2329.1 2281.0 2455.1 2841.2 3167.9 3532.3 3938.5 4391.4 4896.4 5459.5 6087.3 6787.4 7567.9 8438.2 9408.6

Cost of goods sold 1144.2 1268.5 1319.8 1269.8 1375.3 1574.6 1766.1 1969.2 2195.7 2448.2 2729.7 3043.7 3393.7 3784.0 4219.1 4704.3 5245.3

Gross profit 964.9 965.7 1009.3 1011.2 1079.8 1266.6 1401.8 1563.0 1742.8 1943.2 2166.7 2415.8 2693.6 3003.4 3348.8 3733.9 4163.3

Financial services revenue - - 78.1 53.6 49.0 63.0

Financial services expenses - - 44.0 37.9 36.0 40.6

Operating income from financial services 37.7 43.8 34.1 15.7 13.0 22.4

Operating expenses 799.2 858.4 901.1 863.5 930.0 964.2 1045.4 1165.6 1299.7 1449.2 1615.8 1801.6 2008.8 2239.8 2497.4 2784.6 3104.8

Operating earnings 198.3 150.1 142.3 163.4 162.8 324.8 372.2 415.0 462.8 516.0 575.3 641.5 715.3 797.5 889.2 991.5 1105.5

Interest expense 28.7 24.4 23.0 21.7 20.6 46.1

Other income (expense) - net -8.4 -9.0 1.1 3.1 5.3 5.5

Earnings before income taxes 161.2 116.7 120.4 144.8 147.5 284.2

Income tax expense 58.0 38.0 38.7 55.2 45.9 92.5

Earnings before interests and earnings 103.2 78.7 81.7 89.6 101.6 191.7

Minority interests and equity earnings, net of tax - - - -1.4 -3.7 -2.5

Net earnings from continuing operations - - - 88.2 97.9 189.2

Discontinued operations, net of tax - - - 4.7 2.2 -8.0

Net earnings 106.0 78.7 81.7 92.9 100.1 181.2 213.8 238.4 265.8 296.4 330.5 368.5 410.9 458.1 510.8 569.6 635.1

Adjustment to Impair goodwill (loss) 73.3 83.5 88.2 79.7 155.2 163.8 190.9 212.9 237.4 264.7 295.1 329.0 366.9 409.1 456.1 508.6 -

Adjusted Net Income 32.7 -4.8 -6.5 13.2 -55.1 17.4 22.9 25.5 28.5 31.7 35.4 39.5 44.0 49.1 54.7 61.0 -

126 Revised Common Size Income Statement Actual Income Statement Forecasted Income Statement

(Amounts in millions) 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Net sales 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Cost of goods sold 56.8% 56.7% 55.7% 56.0% 55.4% 55.8% 55.8% 55.8% 55.8% 55.8% 55.8% 55.8% 55.8% 55.8% 55.8% 55.8%

Gross profit 43.2% 43.3% 44.3% 44.0% 44.6% 44.3% 44.3% 44.3% 44.3% 44.3% 44.3% 44.3% 44.3% 44.3% 44.3% 44.3%

Financial services revenue - 3.4% 2.3% 2.0% 2.2%

Financial services expenses - 1.9% 1.7% 1.5% 1.4%

Operating income from financial services 2.0% 1.5% 0.7% 0.5% 0.8%

Operating expenses 38.4% 38.7% 37.9% 37.9% 33.9% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0%

Operating earnings 6.7% 6.1% 7.2% 6.6% 11.4% 11.8% 11.8% 11.8% 11.8% 11.8% 11.8% 11.8% 11.8% 11.8% 11.8% 11.8%

Interest expense 1.1% 1.0% 1.0% 0.8% 1.6%

Other income (expense) - net -0.4% 0.0% 0.1% 0.2% 0.2%

Earnings before income taxes 5.2% 5.2% 6.3% 6.0% 10.0%

Income tax expense 1.7% 1.7% 2.4% 1.9% 3.3%

Earnings before interests and earnings (loss) 3.5% 3.5% 3.9% 4.1% 6.7%

Minority interests and earnings (loss), net of tax - - -0.1% -0.2% -0.1%

Net earnings from continuing operations - - 3.9% 4.0% 6.7%

Discontinued operations, net of tax - - 0.2% 0.1% -0.3%

Net earnings 3.5% 3.5% 4.1% 4.1% 6.4% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8% 6.8%

Impairment of goodwill (loss) 3.7% 3.8% 3.5% 6.3% 5.8% 6.0% 6.0% 6.0% 6.0% 6.0% 6.0% 6.0% 6.0% 6.0% 6.0% -

Comprehensive Income -0.2% -0.3% 0.6% -2.2% 0.6% 0.7% 0.7% 0.7% 0.7% 0.7% 0.7% 0.7% 0.7% 0.7% 0.7% -

127 Balance Sheet

The balance sheet of a company shows the book value of their assets, liabilities, and shareholder’s equity. The balance sheet can be linked to the income statement via total asset turnover (ATO) and retained earnings. By forecasting our net income over the next ten years, we got a better understanding on how our retained earnings figure will grow relative to the total equity section of the balance sheet. After finding the total equity, our liabilities were a plug figure because we have already forecasted our assets. Since balance sheets have to balance, we decided to sacrifice the accuracy of our liabilities for a more accurate forecasting of equity. The figures that we forecasted out were accounts receivable, inventories, total current assets, property plant and equipment, goodwill, total assets, accounts payable, total current liabilities, total non- current liabilities, total liabilities, retained earnings, and total stockholders’ equity. The first figure we forecasted was our accounts receivable. We accumulated an average over the past five years at 23.94%, we decided to use a rate of 22.50% because the number of accounts receivable seems to be declining, and we feel that it will level out around 22.50%. We feel that this consistently reflects how the company will perform later on. Next, we estimated that inventories will grow at 11.25%. We chose this rate because the levels of inventory that Snap-On has been seeing over the past 5 years are continuing to decline. This could be from Snap-On’s management handling inventory levels more efficiently. Total current assets have been steadily declining over the past 4 years but from 2006 to 2007, we have seen a small increase. We have decided to use a rate of 44% which is slightly higher the percentage of 2006. We estimated property, plant, and equipment next. We said that it would decrease growth from 13.76% on average to 10.75% because from 2002 to 2005 it was decreasing rapidly. In the last 2 years we have seen a slight increase but overall we are seeing a steady decline. A major portion of our assets were goodwill, which was about 30% of our total assets in 2007. This sudden increase over the past couple years was 128 due to the acquisition of Proquest Diagnostics. From 2005 to 2006 our amount of goodwill increased by about 95% from the previous year. Snap-On recorded a huge gain on goodwill and capitalized those amounts to their balance sheet resulting in an increase in total assets. After calculating our assets using the asset turnover ratio we looked to shareholder’s equity. Retained earnings was found by taking the previous year’s retained earnings and adding the next year’s net income for that year and subtracting the cash dividends paid that year also. So we first had to estimate our net income, after that we estimated that our dividends would grow to about $65 million over the next ten years and found our numbers for the retained earnings forecast. Our total shareholder’s equity number was derived by taking the total equity of the previous year and adding the retained earnings of the current year minus the earnings of the previous year. After finding our total equity we turned to finding our total liabilities, which we found by taking our total assets of the current year and dividing them by the current ratio 1.90. This will give us our forecasted total current liabilities. This percentage is low compared to the average; however, when doing an equity evaluation, estimating debt is not as important as accurately estimating equity. After finding total current liabilities, you take your total assets minus your total stockholders’ equity and you find total liabilities. Your total stockholders’ equity plus total liabilities should equal your total assets because a balance sheet has to balance.

129 Balance Sheet Actual Balance Sheet Forecasted Balance Sheet (Amounts in millions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 ASSETS Cash and cash equivalents 18.4 96.1 150.0 170.4 63.4 93.0 Accounts receivable - net of allowances 556.2 546.8 542.0 485.9 559.2 586.9 742.8 828.2 923.4 1029.6 1148.0 1280.0 1427.2 1591.4 1774.4 1978.4 Inventories 369.9 351.1 341.9 283.2 323.0 322.4 371.4 414.1 461.7 514.8 574.0 640.0 713.6 795.7 887.2 989.2 Total current assets 1051.0 1131.7 1192.6 1072.9 1113.2 1187.4 1452.5 1619.6 1805.8 2013.5 2245.0 2503.2 2791.1 3112.0 3469.9 3869.0 Property and equipment - net 330.2 328.6 313.6 295.5 297.1 304.8 354.9 395.7 441.2 491.9 548.5 611.6 681.9 760.3 847.8 945.3 Deferred income tax assets 60.9 16.1 9.4 57.8 55.3 22.0 Goodwill 366.4 417.6 441.1 398.3 776.1 818.8 990.4 1104.2 1231.2 1372.8 1530.7 1706.7 1903.0 2121.8 2365.9 2637.9 Other intangibles - net 65.7 69.5 70.0 64.0 257.8 234.8 Pension assets - 76.8 159.7 20.6 14.0 57.0 Other assets 119.9 98.2 103.7 99.3 141.0 140.3 Total assets 1994.1 2138.5 2290.1 2008.4 2654.5 2765.1 3301.2 3680.8 4104.1 4576.1 5102.3 5689.1 6343.3 7072.8 7886.2 8793.1 Asset Turnover 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 LIABILITIES AND SHAREHOLDERS EQUITY Accounts payable 170.9 189.7 194.9 135.4 178.8 171.6 211.6 245.3 283.0 325.4 372.9 426.2 485.9 552.8 627.8 711.8 Notes payable and long-term debt 56.4 30.2 127.8 24.8 43.6 15.9 Accrued benefits 40.1 35.3 34.5 35.4 41.4 41.3 Franchisee deposits 46.1 49.9 46.9 44.4 48.5 51.0 Deferred subscription revenue 42.5 20.6 26.2 26.6 25.3 25.9 Income taxes 29.8 20.1 21.9 33.1 37.8 25.5 Other accrued liabilities 122.2 172.2 164.8 144.2 216.2 212.4 Total current liabilities 552.4 567.2 674.2 506.1 682.0 639.2 764.5 852.4 950.4 1059.7 1181.6 1317.5 1469.0 1637.9 1826.3 2036.3 Long-term debt 304.3 303.0 203.2 201.7 505.6 502.0 Deferred income tax liabilities 33.6 34.3 76.5 75.3 88.9 91.2 Retiree health care benefits 94.0 89.3 89.0 90.8 69.6 53.8 Pension liabilities 136.6 74.2 73.3 92.7 113.9 85.3 Other long-term liabilities 42.8 59.6 63.2 79.6 118.2 113.5 Total Non-current Liabilities 611.3 560.4 505.2 540.1 896.2 845.8 1116.4 1250.0 1397.0 1558.7 1736.6 1932.3 2147.7 2384.8 2645.8 2933.1 Total liabilities 1163.7 1127.6 1179.4 1046.2 1578.2 1485.0 1880.9 2102.4 2347.4 2618.4 2918.1 3249.8 3616.7 4022.7 4472.1 4969.4 Common stock 66.9 67.0 67.0 67.0 67.1 67.1 Additional paid-in capital 72.9 94.5 105.8 113.3 121.9 137.9 Retained earnings 1064.2 1084.7 1108.7 1143.8 1180.3 1296.7 1433.6 1586.2 1756.3 1946.0 2157.5 2393.37 2656.3 2949.6 3276.49 3641.0 Accumulated other comprehensive income -123.8 38.6 129.1 -56.6 21.2 142.8 Grantor Stock Trust at fair market value -147.5 -159.2 -147.0 -120.3 -19.4 - Treasury stock at cost -102.3 -114.7 -152.9 -185.0 -294.8 -364.4 Total shareholders’ equity 830.4 1010.9 1110.7 962.2 1076.3 1280.1 1420.3 1578.4 1756.7 1957.7 2184.2 2439.3 2726.7 3050.1 3414.1 3823.7 Total liabilities and shareholders’ equity 1994.1 2138.5 2290.1 2008.4 2654.5 2765.1 3301.2 3680.8 4104.1 4576.1 5102.3 5689.1 6343.3 7072.8 7886.2 8793.1

130 Common Sized Balance Sheet Actual Balance Sheet Forecasted Balance Sheet (Amounts in millions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 ASSETS Cash and cash equivalents 0.9% 4.5% 6.5% 8.5% 2.4% 3.4% Accounts receivable - net of allowances 27.9% 25.6% 23.7% 24.2% 21.1% 21.2% 22.5% 22.5% 22.5% 22.5% 22.5% 22.5% 22.5% 22.5% 22.5% 22.5% Inventories 18.5% 16.4% 14.9% 14.1% 12.2% 11.7% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% Deferred income tax assets 2.8% 3.3% 3.4% 3.8% 2.9% 3.1% Prepaid expenses and other assets 2.5% 3.1% 3.6% 2.8% 3.5% 3.5% Total current assets 52.7% 52.9% 52.1% 53.4% 41.9% 42.9% 44.0% 44.0% 44.0% 44.0% 44.0% 44.0% 44.0% 44.0% 44.0% 44.0% Property and equipment - net 16.6% 15.4% 13.7% 14.7% 11.2% 11.0% 10.8% 10.8% 10.8% 10.8% 10.8% 10.8% 10.8% 10.8% 10.8% 10.8% Deferred income tax assets 3.1% 0.8% 0.4% 2.9% 2.1% 0.8% Goodwill 18.4% 19.5% 19.3% 19.8% 29.2% 29.6% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% Other intangibles - net 3.3% 3.2% 3.1% 3.2% 9.7% 8.5% Pension assets - 3.6% 7.0% 1.0% 0.5% 2.1% Other assets 6.0% 4.6% 4.5% 4.9% 5.3% 5.1% Total assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

LIABILITIES AND SHAREHOLDERS EQUITY Accounts payable 14.7% 16.8% 16.5% 12.9% 11.3% 11.6% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% Notes payable and long term debt 4.8% 2.7% 10.8% 2.4% 2.8% 1.1% Accrued benefits 3.4% 3.1% 2.9% 3.4% 2.6% 2.8% Accrued compensation 3.8% 4.4% 4.8% 5.9% 5.7% 6.4% Franchisee deposits 4.0% 4.4% 4.0% 4.2% 3.1% 3.4% Deferred subscription revenue 3.7% 1.8% 2.2% 2.5% 1.6% 1.7% Income taxes 2.6% 1.8% 1.9% 3.2% 2.4% 1.7% Other accrued liabilities 10.5% 15.3% 14.0% 13.8% 13.7% 14.3% Total current liabilities 47.5% 50.3% 57.2% 48.4% 43.2% 43.0% Long-term debt 26.1% 26.9% 17.2% 19.3% 32.0% 33.8% Deferred income tax liabilities 2.9% 3.0% 6.5% 7.2% 5.6% 6.1% Retiree health care benefits 8.1% 7.9% 7.5% 8.7% 4.4% 3.6% Pension liabilities 11.7% 6.6% 6.2% 8.9% 7.2% 5.7% Other long-term liabilities 3.7% 5.3% 5.4% 7.6% 7.5% 7.6% Total liabilities 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Common stock 8.1% 6.6% 6.0% 7.0% 6.2% 5.2% Additional paid-in capital 8.8% 9.3% 9.5% 11.8% 11.3% 10.8% Retained earnings 128.2% 107.3% 99.8% 118.9% 109.7% 101.3% 100.1% 100.5% 100.0% 99.4% 98.8% 98.1% 97.4% 96.7% 96.0% 95.2% Accumulated other comprehensive income -14.9% 3.8% 11.6% -5.9% 2.0% 11.2% Grantor Stock Trust at fair market value -17.8% -15.7% -13.2% -12.5% -1.8% - Treasury stock at cost -12.3% -11.3% -13.8% -19.2% -27.4% -28.5% Total shareholders’ equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Total liabilities and shareholders’ equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 131 Balance Sheet (Revised)

In 2007, 30% of Snap-On’s total assets were goodwill. We felt that this could be somewhat misleading because of the large amounts of goodwill bolstering the firm’s total assets. We decided to impair Snap-On’s goodwill at a rate of 20% a year for the past five years, and then restate the balance sheet. We found that total assets decreased by $73.28 million, $86.53 million, $88.22 million, $79.66 million, $155.22 million, and $163.76 million respectively from 2002 to 2007. This also affected return on assets (ROA), debt to equity ratio (D/E), and asset turnover (ATO). When forecasting our total assets, we used the revised asset turnover ratio of 1.11, up from 1.07 on our actual balance sheet. We used this lower ratio because sales remain constant while our total assets are decreasing because of the impairment. This led to a reduction in the total assets forecasted through 2017. Also, because of the change in dividends, our retained earnings were also affected by the impairment. Retained earnings equals beginning retained earnings, plus net income, minus dividends. After the decrease in retained earnings, total shareholder’s equity also decreased. However, even after the impairment of goodwill, Snap-On continues to show strong total assets throughout.

132 Revised Balance Sheet Actual Balance Sheet Forecasted Balance Sheet (Amounts in millions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 ASSETS Cash and cash equivalents 18.4 96.1 150.0 170.4 63.4 93.0 Accounts receivable - net of allowances 556.2 546.8 542.0 485.9 559.2 586.9 716.0 798.3 890.1 992.5 1106.7 1233.9 1375.8 1534.0 1710.4 1907.2 Inventories 369.9 351.1 341.9 283.2 323.0 322.4 358.0 399.2 445.1 496.3 553.3 617.0 687.9 767.0 855.2 953.6 Total current assets 1051.0 1131.7 1192.6 1072.9 1113.2 1187.4 1400.2 1561.2 1740.7 1940.9 2164.1 2413.0 2690.5 2999.9 3344.9 3729.5 Property and equipment - net 330.2 328.6 313.6 295.5 297.1 304.8 342.1 381.4 425.3 474.2 528.7 589.5 657.3 732.9 817.2 911.2 Deferred income tax assets 60.9 16.1 9.4 57.8 55.3 22.0 Goodwill (Revised) 293.1 334.1 352.9 318.6 620.9 655.0 954.7 1064.4 1186.9 1323.3 1475.5 1645.2 1834.4 2045.4 2280.6 2542.9 Other intangibles - net 65.7 69.5 70.0 64.0 257.8 234.8 Pension assets - 76.8 159.7 20.6 14.0 57.0 Other assets 119.9 98.2 103.7 99.3 141.0 140.3 Total assets 1920.8 2055.0 2201.9 1928.7 2499.3 2601.3 3182.2 3548.2 3956.2 4411.2 4918.4 5484.1 6114.7 6817.9 7602.0 8476.2 Asset Turnover 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 LIABILITIES AND SHAREHOLDERS EQUITY Accounts payable 170.9 189.7 194.9 135.4 178.8 171.6 230.8 270.1 314.0 362.8 417.4 478.2 546.0 621.5 705.8 800.0 Notes payable and long term debt 56.4 30.2 127.8 24.8 43.6 15.9 Accrued benefits 40.1 35.3 34.5 35.4 41.4 41.3 Accrued compensation 44.4 49.2 57.2 62.2 90.4 95.6 Franchisee deposits 46.1 49.9 46.9 44.4 48.5 51.0 Deferred subscription revenue 42.5 20.6 26.2 26.6 25.3 25.9 Income taxes 29.8 20.1 21.9 33.1 37.8 25.5 Other accrued liabilities 122.2 172.2 164.8 144.2 216.2 212.4 Total current liabilities 552.4 567.2 674.2 506.1 682.0 639.2 736.9 821.7 916.2 1021.5 1139.0 1270.0 1416.0 1578.9 1760.5 1962.9 Long-term debt 304.3 303.0 203.2 201.7 505.6 502.0 Deferred income tax liabilities 33.6 34.3 76.5 75.3 88.9 91.2 Retiree health care benefits 94.0 89.3 89.0 90.8 69.6 53.8 Pension liabilities 136.6 74.2 73.3 92.7 113.9 85.3 Other long-term liabilities 42.8 59.6 63.2 79.6 118.2 113.5 Total Non-current Liabilities 611.3 560.4 505.2 540.1 896.2 845.8 1314.3 1579.1 1874.5 2203.8 2570.9 2980.3 3436.7 3945.7 4513.1 5145.9 Total liabilities 1163.7 1127.6 1179.4 1046.2 1578.2 1485.0 2051.2 2400.8 2790.64 3225.3 3709.9 4250.3 4852.8 5524.6 6273.6 7108.8 Common stock 66.9 67.0 67.0 67.0 67.1 67.1 Additional paid-in capital 72.9 94.5 105.8 113.3 121.9 137.9 Retained earnings 990.9 1001.2 1020.5 1064.1 1025.1 1132.9 1147.6 1162.9 1182.2 1202.5 1225.1 1250.4 1278.6 1310.0 1345.0 1384.0 Accumulated other comprehensive income -123.8 38.6 129.1 -56.6 21.2 142.8 Grantor Stock Trust at fair market value -147.5 -159.2 -147.0 -120.3 -19.4 - Treasury stock at cost -102.3 -114.7 -152.9 -185.0 -294.8 -364.4 Total shareholders’ equity 757.1 927.4 1022.5 882.5 921.1 1116.3 1131.0 1147.3 1165.6 1185.9 1208.5 1233.8 1262.0 1292.4 1328.4 1364.4 Total liabilities and shareholders’ equity 1920.8 2055.0 2201.9 1928.7 2499.3 2601.3 3182.2 3548.2 3956.2 4411.2 4918.4 5484.1 6114.7 6817.9 7602.0 8476.2

133 Revised Common Sized Balance Sheet Actual Balance Sheet Forecasted Balance Sheet (Amounts in millions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 ASSETS Cash and cash equivalents 1.0% 4.7% 6.8% 8.8% 2.5% 3.6% Accounts receivable - net of allowances 29.0% 26.6% 24.6% 25.2% 22.4% 22.6% 22.5% 22.5% 22.5% 22.5% 22.5% 22.5% 22.5% 22.5% 22.5% 22.5% Inventories 19.3% 17.1% 15.5% 14.7% 12.9% 12.4% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% Total current assets 54.7% 55.1% 54.2% 55.6% 44.5% 45.6% 44.0% 44.0% 44.0% 44.0% 44.0% 44.0% 44.0% 44.0% 44.0% 44.0% Property and equipment - net 17.2% 16.0% 14.2% 15.3% 11.9% 11.7% 10.8% 10.8% 10.8% 10.8% 10.8% 10.8% 10.8% 10.8% 10.8% 10.8% Deferred income tax assets 3.2% 0.8% 0.4% 3.0% 2.2% 0.8% Goodwill 15.3% 16.3% 16.0% 16.5% 24.8% 25.2% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% Other intangibles - net 3.4% 3.4% 3.2% 3.3% 10.3% 9.0% Pension assets - 3.7% 7.3% 1.1% 0.6% 2.2% Other assets 6.2% 4.8% 4.7% 5.1% 5.6% 5.4% Total assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% LIABILITIES AND SHAREHOLDERS EQUITY Current liabilities Accounts payable 14.7% 16.8% 16.5% 12.9% 11.3% 11.6% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% 11.3% Notes payable and long term debt 4.8% 2.7% 10.8% 2.4% 2.8% 1.1% Accrued benefits 3.4% 3.1% 2.9% 3.4% 2.6% 2.8% Accrued compensation 3.8% 4.4% 4.8% 5.9% 5.7% 6.4% Franchisee deposits 4.0% 4.4% 4.0% 4.2% 3.1% 3.4% Deferred subscription revenue 3.7% 1.8% 2.2% 2.5% 1.6% 1.7% Income taxes 2.6% 1.8% 1.9% 3.2% 2.4% 1.7% Other accrued liabilities 10.5% 15.3% 14.0% 13.8% 13.7% 14.3% Total current liabilities 47.5% 50.3% 57.2% 48.4% 43.2% 43.0% Long-term debt 26.1% 26.9% 17.2% 19.3% 32.0% 33.8% Deferred income tax liabilities 2.9% 3.0% 6.5% 7.2% 5.6% 6.1% Retiree health care benefits 8.1% 7.9% 7.5% 8.7% 4.4% 3.6% Pension liabilities 11.7% 6.6% 6.2% 8.9% 7.2% 5.7% Other long-term liabilities 3.7% 5.3% 5.4% 7.6% 7.5% 7.6% Total liabilities 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Common stock 8.8% 7.2% 6.6% 7.6% 7.3% 6.0% Additional paid-in capital 9.6% 10.2% 10.3% 12.8% 13.2% 12.4% Retained earnings 130.9% 108.0% 99.8% 120.6% 111.3% 101.5% 101.5% 101.5% 101.4% 101.4% 101.4% 101.4% 101.3% 101.3% 101.3% 101.2% Accumulated other comprehensive income -16.4% 4.2% 12.6% -6.4% 2.3% 12.8% Grantor Stock Trust at fair market value -19.5% -17.2% -14.4% -13.6% -2.1% - Treasury stock at cost -13.5% -12.4% -15.0% -21.0% -32.0% -32.6% Total shareholders’ equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Total liabilities and shareholders’ equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

134 Statement of Cash Flows

The statement of cash flows is an important section of a company’s financial statements. It is also the most difficult of the financial statements to forecast. Net cash flow from operating activities includes our forecasted net earnings, plus all other cash items included in operating activities. We grew out net earnings by 11.50% each year and used the same assumption in forecasting our cash received from operations. Our cash received from investing activities has remained somewhat constant from 2002 to 2007, but because of the acquisition of ProQuest Solutions in 2006, cash from investing activities decreased by approximately $546 million. We feel that we will see a steady increase in the amount of cash spent on investing activities and assumed a growth rate of 5% annually. The only aspect of financing activities that we forecasted was the amount of dividends paid to shareholders. Our dividend pay-out ratio has been declining from 2003 to 2007 so we decided to forecast out future dividends by taking 36% of our forecasted net earnings.

135 Consolidated Statement of Cash Flows Actual Statement of Cash Flows Forecasted Statement of Cash Flows (Amounts in millions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Operating activities: Net earnings 106.0 78.7 81.7 92.9 100.1 181.2 213.8 238.4 265.9 296.4 330.5 368.5 410.9 458.2 510.8 569.6 Depreciation 49.9 58.2 58.5 49.5 48.5 53.5 Amortization of other intangibles 1.8 2.1 2.5 2.7 3.4 22.2 Stock-based compensation expense - - - - 16.6 19.0 Excess tax benefits from stock-based compensation - - - - -10.9 -6.0 Deferred income tax provision (benefit) 33.5 9.9 21.6 14.6 -7.3 12.3 Loss (gain) on sale of assets -0.3 0.2 -2.8 -1.1 0.1 -7.0 Gain on mark to market for cash flow hedges -1.3 1.6 1.5 -0.1 - - Changes in operating assets and liabilities, net of effects of acquisitions: (Increase) decrease in receivables 42.5 64.3 47.3 31.5 -19.3 -2.6 (Increase) decrease in inventories 25.8 60.7 23.7 39.5 -22.2 15.2 (Increase) decrease in prepaid and other assets 33.0 -68.9 -81.9 20.2 -16.3 -11.9 Increase (decrease) in accounts payable 22.1 4.4 -9.6 -51.3 31.8 -15.3 Increase (decrease) in accruals, liabilities -86.1 -34.2 4.3 22.7 78.9 -29.5 Net cash provided by operating activities 224.1 177.0 146.8 221.1 203.4 231.1 257.7 287.3 320.4 357.2 398.3 444.1 495.1 552.1 615.6 686.4 Investing activities: Capital expenditures -45.8 -29.4 -38.7 -40.1 -50.5 -61.9 Acquisitions of businesses net of cash acquired -7.9 - - - -507.4 -5.7 Proceeds from disposal of property and equipment 6.0 8.7 17.3 8.9 11.7 16.1 Other - 0.1 0.6 0.3 - -1.4 Net cash used in investing activities -47.7 -20.6 -20.8 -30.9 -546.2 -52.9 -55.5 -58.3 -61.2 -64.3 -67.5 -70.9 -74.4 -78.2 -82.1 -86.2 Financing activities: Net proceeds from issuance of long-term debt - - - - - 298.5 Net proceeds from commercial paper - - - - 314.9 - Payment of long-term debt -1.9 -0.3 -0.5 -100.3 - - Net decrease in short-term borrowings -116.0 -28.9 -2.9 -2.5 -8.9 -335.1 Purchase of treasury stock -12.2 -12.5 -38.2 -32.1 -109.8 -94.4 Proceeds from stock purchase and option plans 20.5 10.0 23.6 31.1 89.5 39.2 Cash dividends paid -56.5 -58.2 -57.7 -57.8 -63.6 -64.8 -77.0 -85.8 -95.7 -106.7 -119.0 -132.7 -147.9 -164.9 -183.9 -205.1 Excess tax benefits from stock-based compensation - - 10.9 6.0 Other - 5.1 - - - -0.8 Net cash provided (used) by financing activities -166.1 -84.8 -75.7 -161.6 233.0 -151.4 Dividend Payout Ratio 53.3% 74.0% 70.6% 62.2% 63.5% 35.8% 36.0% 36.0% 36.0% 36.0% 36.0% 36.0% 36.0% 36.0% 36.0% 36.0%

136 Common Sized Consolidated Statement of Cash Flows Actual Statement of Cash Flows Forecasted Statement of Cash Flows (Amounts in millions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Operating activities: Net earnings 47.3% 44.5% 55.7% 42.0% 49.2% 78.4% 81.3% 81.3% 81.3% 81.3% 81.3% 81.3% 81.3% 81.3% 81.3% 81.3% Depreciation 22.3% 32.9% 39.9% 22.4% 23.8% 23.2% Amortization of other intangibles 0.8% 1.2% 1.7% 1.2% 1.7% 9.6% Stock-based compensation expense - - - - 8.2% 8.2% Excess tax benefits from stock-based compensation - - - - -5.4% -2.6% Deferred income tax provision (benefit) 14.9% 5.6% 14.7% 6.6% -3.6% 5.3% Loss (gain) on sale of assets -0.1% 0.1% -1.9% -0.5% 0.0% -3.0% Gain on mark to market for cash flow hedges -0.6% 0.9% 1.0% 0.0% - - Changes in operating assets and liabilities, net of effects of acquisitions: (Increase) decrease in receivables 19.0% 36.3% 32.2% 14.2% -9.5% -1.1% (Increase) decrease in inventories 11.5% 34.3% 16.1% 17.9% -10.9% 6.6% (Increase) decrease in prepaid and other assets 14.7% -38.9% -55.8% 9.1% -8.0% -5.1% Increase (decrease) in accounts payable 9.9% 2.5% -6.5% -23.2% 15.6% -6.6% - Increase (decrease) in accruals and other liabilities -19.3% 2.9% 10.3% 38.8% -12.8% 38.4% Net cash provided by operating activities 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Investing activities: Capital expenditures 96.0% 143% 186% 130 9.2% 117% Acquisitions of businesses net of cash acquired 16.6% - - - 92.9% 10.8% - Proceeds from disposal of property and equipment -42.2% -83.2% -28.8% -2.1% -30.4% 12.6% Other - -0.5% -2.9% -1.0% - 2.6% Net cash used in investing activities 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Financing activities: Net proceeds from issuance of long-term debt ------197% Net proceeds from commercial paper - - - - 135% - Payment of long-term debt 1.1% 0.4% 0.7% 62.1% - - Net decrease in short-term borrowings 69.8% 34.1% 3.8% 1.5% -3.8% 221% Purchase of treasury stock 7.3% 14.7% 50.5% 19.9% -47.1% 62.4% - Proceeds from stock purchase and option plans -11.8% -31.2% -19.2% 38.4% -25.9% 12.3% Cash dividends paid 34.0% 68.6% 76.2% 35.8% -27.3% 42.8% Excess tax benefits from stock-based compensation - - - - 4.7% -4.0% Other 0.0% -6.0% 0.0% - - 0.5% Net cash provided (used) by financing activities 100.% 100.% 100.% 100.% 100.% 100.%

137 Statement of Cash Flows (Revised)

After the impairment of goodwill, the items on the cash flow statement that were affected include net earnings, cash flow from operations, and the amount of dividends paid to shareholders. Net earnings were drastically reduced because of the large amount of goodwill that was impaired. Net earnings decreased $73.28 million, $86.53 million, $88.22 million, $79.66 million, $155.22 million, and $163.76 million respectively from 2002 to 2007. Cash flow from operations was also reduced because net income is included when calculating CFFO. We used the same assumption to forecast out dividends, which was to take 36% of our net earnings. This drastically reduced the amount of dividends paid to shareholders, and in 2003, 2004, and 2006, the company could not pay dividends because net earnings were negative.

138 Revised Consolidated Statement of Cash Flows Actual Statement of Cash Flows Forecasted Statement of Cash Flows (Amounts in millions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Operating activities: Net earnings (Revised) 32.72 -4.82 -6.52 13.24 -55.12 17.44 22.90 25.54 28.47 31.75 35.40 39.47 44.01 49.07 54.71 61.01 Depreciation 49.90 58.20 58.50 49.50 48.50 53.50 Amortization of other intangibles 75.08 85.62 90.72 82.36 158.62 185.96 Stock-based compensation expense - - - - 16.60 19.00 Excess tax benefits from stock-based compensation - - - - -10.90 -6.00 Deferred income tax provision (benefit) 33.50 9.90 21.60 14.60 -7.30 12.30 Loss (gain) on sale of assets -0.30 0.20 -2.80 -1.10 0.10 -7.00 Gain on mark to market for cash flow hedges -1.30 1.60 1.50 -0.10 - - Changes in operating assets and liabilities, net of effects of acquisitions: (Increase) decrease in receivables 42.50 64.30 47.30 31.50 -19.30 -2.60 (Increase) decrease in inventories 25.8 60.7 23.7 39.5 -22.2 15.2 (Increase) decrease in prepaid and other assets 33.0 -68.9 -81.9 20.2 -16.3 -11.9 Increase (decrease) in accounts payable 22.1 4.4 -9.6 -51.3 31.8 -15.3 Increase (decrease) in accruals and other liabilities -86.1 -34.2 4.3 22.7 78.9 -29.5 Net cash provided by operating activities 226.9 177.0 146.8 221.1 203.4 231.1 242.7 254.8 267.5 280.9 294.9 309.7 325.2 341.4 358.5 376.4 Investing activities: Capital expenditures -45.8 -29.4 -38.7 -40.1 -50.5 -61.9 Acquisitions of businesses net of cash acquired -7.9 - - - -507.4 -5.7 Proceeds from disposal of property and equipment 6.0 8.7 17.3 8.9 11.7 16.1 Other - 0.1 0.6 0.3 - -1.4 Net cash used in investing activities -47.7 -20.6 -20.8 -30.9 -546.2 -52.9 -55.5 -58.3 -61.2 -64.3 -67.5 -70.9 -74.4 -78.2 -82.1 -86.2 Financing activities: Net proceeds from issuance of long-term debt - - - - - 298.5 Net proceeds from commercial paper - - - - 314.9 - Payment of long-term debt -1.9 -0.3 -0.5 -100.3 - - Net decrease in short-term borrowings -116.0 -28.9 -2.9 -2.5 -8.9 -335.1 Purchase of treasury stock -12.2 -12.5 -38.2 -32.1 -109.8 -94.4 Proceeds from stock purchase and option plans 20.5 10.0 23.6 31.1 89.5 39.2 Cash dividends paid 17.4 - - 8.2 - 6.2 8.2 9.2 10.3 11.4 12.7 14.2 15.8 17.7 19.7 22.0 Excess tax benefits from stock-based compensation - - 10.9 6.0 Other 5.1 -0.8 Net cash provided (used) by financing activities -166.1 -84.8 -75.7 -161.6 233.0 -151.4

Dividend Payout Ratio 53.3% 74.0% 70.6% 62.2% 63.5% 35.8% 36.0% 36.0% 36.0% 36.0% 36.0% 36.0% 36.0% 36.0% 36.0% 36.0%

139 Revised Common Sized Consolidated Statement of Cash Flows Actual Statement of Cash Flows Forecasted Statement of Cash Flows (Amounts in millions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Operating activities: Net earnings 14% -3% -4% 6% -27% 8% 9% 10% 11% 11% 12% 13% 14% 14% 15% 16% Depreciation 22% 33% 40% 22% 24% 23% Amortization of other intangibles 33% 48% 62% 37% 78% 80% Stock-based compensation expense - - - - 8% 8% Excess tax benefits from stock-based compensation - - - - -5% -3% Deferred income tax provision (benefit) 15% 6% 15% 7% -4% 5% Loss (gain) on sale of assets 0% 0% -2% 0% 0% -3% Gain on mark to market for cash flow hedges -1% 1% 1% 0% - - Changes in operating assets and liabilities, net of effects of acquisitions: (Increase) decrease in receivables 19% 36% 32% 14% -9% -1% (Increase) decrease in inventories 11% 34% 16% 18% -11% 7% (Increase) decrease in prepaid and other assets 15% -39% -56% 9% -8% -5% Increase (decrease) in accounts payable 10% 2% -7% -23% 16% -7% Increase (decrease) in accruals and other liabilities -38% -19% 3% 10% 39% -13% Net cash provided by operating activities 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Investing activities: Capital expenditures 96% 143% 186% 130% 9% 117% Acquisitions of businesses net of cash acquired 17% - - - 93% 11% Proceeds from disposal of property and equipment -13% -42% -83% -29% -2% -30% Other - 0% -3% -1% - 3% Net cash used in investing activities 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Financing activities: - Net proceeds from issuance of long-term debt - - - - - 197% Net proceeds from commercial paper - - - - 135% - Payment of long-term debt 1% 0% 1% 62% - - Net decrease in short-term borrowings 70% 34% 4% 2% -4% 221% Purchase of treasury stock 7% 15% 50% 20% -47% 62% Proceeds from stock purchase and option plans -12% -12% -31% -19% 38% -26% Cash dividends paid -10% - - -5% - -4% Excess tax benefits from stock-based compensation - - - - 5% -4% Other 0% -6% 0% - - 1% Net cash provided (used) by financing activities 100% 100% 100% 100% 100% 100%

140 Methods of Comparables

The methods of comparables are used by some analysts to help explain their opinion about how a certain company is valued. We say they use them to explain the opinions because they are numbers that are given with really no room for interpretation. A company could have a very valuable asset that is not used when computing these valuations which would in turn give a company an overvalued share price when it would in fact be inaccurate. We decide whether or not a company is overvalued or undervalued by determining if the company’s suggested share price falls within 15% of the actual published share price.

Price/Earnings Trailing

P/E Trailing PPS EPS P/E Industry Average Snap-On PPS Snap-On 54.32 3.14 17.30 15.00 47.10 Snap-On (Revised) 54.32 .30 181.10 15.00 4.50 Danaher 79.00 4.30 18.37 Black and Decker 68.91 8.50 8.11 Stanley Works 49.88 4.29 11.63

The Price to Earnings Trailing ratio is computer using the earnings per share and price per share that was taken from Google Finance on April 1, 2008. We divide the price per share by the earnings per share to help us compute the P/E trailing ratio. If there are any numbers within the industry competitors that are drastically different from the industry average we will choose not to use them. We would not want to use Snap- On’s numbers in the industry average because we are interested in seeing where Snap- on is relative to their competitors. Using Snap-On’s numbers would bring the average closer to their numbers. We concluded that this ratio leaves Snap-On with a fairly valued stock price because this ratio shows that Snap-On should have a PPS of $47.10 and it has a current PPS of $54.32 which is within our 15% error tolerance. It is for this 141 reason that we must use other ratios to determine if this is a justified result. After the adjustment to goodwill, Snap-On’s estimated price per share dropped from $47.10 to $4.50.

Price/Earnings Forecast

P/E Forecast PPS EPS P/E Industry Average Snap-On PPS Snap-On 54.32 3.71 14.64 11.99 44.47 Snap-On (Revised) 54.32 .40 135.80 11.99 4.79 Danaher 79.00 4.36 18.12 *N/A Black and Decker 68.91 5.57 12.37 Stanley Works 49.88 4.30 11.60

The next method we used was the forecasted price to earnings ratio. In this ratio we used earnings per share from the first year forecasted earnings. We got this by dividing the first year forecasted earnings by the number of shares outstanding. After we got this number we multiplied it by the industry average to give us Snap-On’s share price. We found that this gives Snap-On an overvalued stock price given that this ratio tells us their share price should be $44.47 as opposed to their current price of $54.32 which is outside out 15% error tolerance. This ratio has considerably more explanatory power than the P/E Trailing since these are forecasted numbers and not numbers derived from past company performance. Once again we see a huge deduction in the estimated price per share after the impairment of goodwill.

Price/Book

P/B PPS BPS P/B Industry Average Snap-On PPS Snap-On 54.32 22.19 2.45 2.69 59.60 Snap-On (Revised) 54.32 19.35 2.81 2.69 51.97 Danaher 79.00 28.57 2.77 Black and Decker 68.91 23.18 2.97 Stanley Works 49.88 21.50 2.32 142 The reason we use the Price to Book ratio is to see if the company’s value is explained by their book value of equity. We first must take the current price per share and divide it by the book value per share. Once we do this we get multiply the book value per share by the industry average price to book ratio to get the stock price. This ratio has Snap-On as fairly valued since their current price per share is $54.32 and the price to book price per share is $59.60 which falls within our 15% error tolerance. The goodwill adjustment here makes a small difference in comparison to other adjusted comparables.

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

P.E.G. PPS P.E.G. Industry Average Snap-On PPS Snap-On 54.32 1.62 1.21 47.90 Snap-On (Revised) 54.32 17.05 1.21 3.86 Danaher 79.00 1.25 Black and Decker 68.91 1.42 Stanley Works 49.88 0.95

The P.E.G. ratio is computed using the current price per share, forecasted earnings per share and average five year growth. To find the estimated price per share you will take the industry average P.E.G. ratio and multiply it by the average growth rate and the earnings per share. Because $47.90 falls within our 15% error tolerance, it is determined that Snap-On has a fairly valued share price. The adjustment to goodwill directly affects net earnings, and earnings per share, which leads us to an estimated share price of $3.86.

143 Price/EBITDA

P/EBITDA PPS # of Shares EBITDA P/EBITDA Industry Average Snap-On PPS Snap-On 54.32 57.69 426.80 7.34 5.27 39.00 Danaher 79.00 318.30 2060.00 12.21 *N/A Black and Decker 68.91 60.92 744.60 5.64 Stanley Works 49.88 78.27 796.00 4.90

Price over EBITDA is calculated by taking the current market capitalization rate and dividing it by the Earnings plus interest, taxes depreciation and amortization. Market Capitalization rate and shares outstanding can be found from Yahoo Finance. To get the suggested share price, we then take the industry average excluding Danaher because of their abnormally high P/EBITDA and multiply it by the EBITDA we found in step one. After we get the industry average multiplied by EBITDA, we divide this number by the number of shares outstanding. The suggested share price for this ratio is $39.00 which falls outside of out 15% error tolerance.

Enterprise Value/EBITDA

EV/EBITDA PPS # of Shares EV EBITDA EV/EBITDA Industry Average Snap-On PPS Snap-On 54.32 57.69 2653.70 426.80 6.22 7.23 53.51 Danaher 79.00 318.30 2447.00 2060.00 1.19 Black and Decker 68.91 60.92 5140.66 744.60 6.90 Stanley Works 49.88 78.27 6020.00 796.00 7.56

To calculate Enterprise Value / EBITDA we first must find the Enterprise value. EV is calculated by taking the market capitalization rate plus book value of liabilities minus short term investments and cash. We then must find the industry average of

144 EV/EBITDA and multiply it by EBITDA. We then must divide this number by the number of shares outstanding to get the suggested share price. EV/EBITDA suggests that Snap- On is a fairly valued company.

Price/Free Cash Flows

P/FCF PPS # of Shares FCF P/FCF Industry Average Snap-On PPS Snap-On 54.32 57.69 19.20 17.59 10.00 33.14 Danaher 79.00 318.30 584.83 43.00 *N/A Black and Decker 68.91 60.92 404.64 10.37 Stanley Works 49.88 78.27 405.67 9.62

Another valuation model that presents an estimated share price is the price to free cash flows model. This model is calculated by dividing the price per share by the free cash flows of the firm. In order to find free cash flows, cash flows from investing activities has to be added/subtracted from the cash flow from operations. Then, an industry average is computed. However, when looking at Snap-on’s competitors, Danaher had a very high price to free cash flows ratio. Therefore, they were considered an outlier and removed from the industry average computation. We found our industry average to be 10.00. Finally to figure a share price, the industry average is multiplied by the company’s free cash flows. After completing this, the Price to Free Cash Flows model gives Snap-on a $33.14 share price. This share price represents an overvalued firm when compared to our observed share price of $54.32.

145 Dividends/Price

D/P PPS DPS D/P Industry Average Snap-On PPS Snap-On 54.32 1.12 0.0206 0.0257 43.50 Snap-On (Revised) 54.32 .11 .0020 .0257 4.27 Danaher 79.00 0.11 0.0014 *N/A Black and Decker 68.91 1.78 0.0258 Stanley Works 49.88 1.28 0.0257

Dividend over price is calculated by taking the dividend per share over price per share. Once we get this number we take the dividend per share divided by the industry average (excluding Danaher since they are far below the industry average). This will give you the suggested share price for the Dividend over price model. Since $43.50 falls outside of our 15% error tolerance, we determine from this model that Snap-On is overvalued.

Conclusion

In looking at Snap-On’s comparables we have come to the conclusion that Snap- On is a fairly valued company. We took the average of all the suggested share prices and came up with an overall suggested share price of $47.34. Since this number falls within our 15% error tolerance we conclude that Snap-On is fairly valued. This is just the conclusion we reach when using the comparables. Many other tools and opinions are used to fully determine if a company is valued right or not. These numbers leave no room for analyst’s opinions which is a heavily weighted part of the valuation process.

146 Intrinsic Valuation Models

The intrinsic valuation models more accurately reflect the value of the firm when comparing these models to the method of comparables. The intrinsic models include more theory based assumptions while the method of comparables is looking at historical information. The intrinsic models include the Dividend Discount Model (DDM), Free Cash Flow Model (FCFM), Residual Income Model (RIM), Abnormal Earnings Growth Model (AEGM), and the Long-Run Residual Income Model (LRIM). Because these models are generated using forecasted information, we will be able to value the company based on future dividends, free cash flows to the firm, net earnings, and residual income. We will also run sensitivity analysis to show how our estimated PPS will change if we incorrectly stated our growth rates, cost of equity, net earnings, or weighted average cost of capital before taxes. We feel that the intrinsic valuation models will give us a fair picture of the overall value of the firm.

Discounted Dividends Model

Overall, the dividend discount model has the lowest explanatory power of all intrinsic valuation models. It is nearly impossible to value a company based on forecasted future dividends because dividends are subject to change regularly and extremely tough to forecast with reasonable accuracy. Also, the payback period is unrealistic. If the dividend yield is 2% per year, and you invested $100 in the company, it would take 50 years to recover your initial investment. This model uses estimated future dividends on a per share basis, which we forecasted by taking 36% of net earnings and dividing by the number of shares outstanding, and uses the DPS to estimate the company’s share price.

147 = # Once dividends per share have been calculated for 2008 through 2017, we had to discount these values back to December 31, 2007, which is in year zero dollars. We used our Ke as the appropriate discount rate because all dividends are paid to shareholders, who in turn, require a cost of capital equal to the cost of equity. We found the total present value of year by year DPS to be $9.44. This value was calculated by multiplying year by year DPS by the following formula.

= ( + ) Once we calculated the present value of year by year dividends per share, we then had to calculate the present value of the terminal value perpetuity, which starts in the year 2018. We also had to discount this perpetuity back to year zero dollars and add this value to present value of year by year dividends per share. We used a DPS of 3.02 for the perpetuity and after discounting it back to time zero, we calculated the present value of the terminal value perpetuity to be $9.46.

= To get a time consistent price, we have to take( the future− )value of the initial share price, which will give us the price as of April 1, 2008. When using a Ke of 13.50% and a 0% growth rate, we found our time consistent share price of $12.52. The time consistent share price for Snap-On was calculated using the following formula.

( / ) / / = ( / / )( + ) 148 Discounted Dividend Model Growth Rate

Ke 0 0.02 0.04 0.06 0.08 10.75% $16.58 $20.37 $26.40 $37.52 $64.81 11.25% $15.67 $19.06 $24.32 $33.59 $54.26 12.25% $14.11 $16.86 $20.95 $27.66 $40.67 13.50% $12.52 $14.69 $17.79 $22.53 $30.72 14.75% $11.23 $12.99 $15.40 $18.92 $24.53 15.50% $10.56 $12.13 $14.24 $17.24 $21.83 16.25% $9.97 $11.37 $13.23 $15.81 $19.64 Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62 Observed Price $54.32

Discounted Dividend Model (Revised) Growth Rate

Ke 0 0.02 0.04 0.06 0.08 10.75% $1.86 $2.28 $2.95 $4.20 $7.25 11.25% $1.75 $2.13 $2.72 $3.76 $6.07 12.25% $1.58 $1.89 $2.34 $3.09 $4.55 13.50% $1.40 $1.64 $1.99 $2.52 $3.44 14.75% $1.26 $1.45 $1.72 $2.12 $2.75 15.50% $1.18 $1.36 $1.59 $1.93 $2.44 16.25% $1.12 $1.27 $1.48 $1.77 $2.20

Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62

Observed Price $54.32

The chart above shows the sensitivity analysis of the dividends discount model.

When using a Ke of 13.50% and an initial growth rate of 0%, we find our estimated price per share as of April 1, 2008 to be $12.52. This suggests that Snap-On is an extremely overvalued company. As you can see, the dividends are somewhat sensitive 149 to the growth rates because of the effect that they have on the terminal value perpetuity. Our initial estimate of $12.52 is small compared to the $30.72 price when using a growth rate equal to 8%. However, even with the sensitivity that our price is to the estimated growth rates, and the low explanatory power the discounted dividend model price provides, the model highly suggests that Snap-On is an overvalued company.

Discounted Free Cash Flows Model

The discounted free cash flows model allows us to value the firm by taking the present value of the firm’s forecasted free cash flows to the firm, which is estimated cash flow from operations (CFFO) minus estimated cash flow from investing activities (CFFI). We also have to compute the present value of the terminal value perpetuity. We find these present values by using the weighted average cost of capital before tax

(WACCBT) as the discount rate. We use the WACCBT because net income is already taxed and is included in cash flow from operations. This avoids double taxation. To estimate the total value of the firm’s assets, we add the present value of free cash flows year by year to the present value of the terminal value perpetuity. We then compare the present value of free cash flows over the past ten years to the present value of the terminal value perpetuity. This allows us to see how useful this model is when estimating the firm’s overall value. Because Snap-On’s present value of the terminal value perpetuity is approximately 52%, the usefulness of the model is somewhat reduced. The free cash flow model also includes the forecasted book value of liabilities, and because we are performing an equity valuation, we assume that book value of liabilities equals market value of liabilities. To find the market value of equity, we take the total present value of the firm’s assets and subtract the market value of liabilities.

150 We then take the market value of liabilities and divide by the total number of shares outstanding to calculate an estimated price per share. To calculate the present value of year by year cash flows to the firm, we have to take cash flow from operations (CFFO), deduct cash flow from investing activities

(CFFI), and then discount the FCF by the WACCBT. We have to multiply each of the year by year values by the present value factor to get them in year zero dollars, which is December 31, 2007. When using a WACCBT of 11.10% and a 0% growth rate, we found our total present value of year by year cash flows to be $1964.37 million.

= ( + ) To find the total present value of free cash flows to the firm, we take the total present value of year by year FCF to the firm, and add the present value of the terminal value perpetuity. The perpetuity starts in the year 2018, so we have to discount it back to generate its value in December 31, 2007 dollars. To do that, we have to multiply the present value of the perpetuity by the present value factor in 2017. When using a

WACCBT of 11.10% and a 0% growth rate, we found the present value of the terminal value perpetuity to be $2121.84 million.

= To find the initial share price as of December,( 31 2007,− we )deducted market value of liabilities, which was $1485 million, from the total present value of free cash flows to the firm, which was $4086.22 million. This gave us an estimated market value of equity of $2601.22 million. We then divided the market value of equity by the number of shares outstanding and generated an initial share price of $45.09. To get a

151 time consistent price as of April 1, 2007, we had to take the future value of the initial share price. This generated a time consistent share price of $46.29.

= ( + )( / ) ( FCF Growth) Model Growth Rate WACC (BT) 0 0.015 0.03 0.045 0.06 0.075 0.09 9.23% $65.61 $76.01 $91.42 $116.59 $165.15 $297.92 $2162.41 9.57% $61.50 $70.82 $84.39 $106.00 $145.76 $243.16 $853.16 10.25% $54.14 $61.69 $72.37 $88.63 $116.36 $174.33 $371.45 11.10% $46.29 $52.19 $60.28 $72.04 $90.72 $124.96 $208.12 11.95% $39.65 $44.32 $50.56 $59.32 $72.48 $94.53 $138.99 12.46% $36.13 $40.22 $45.61 $53.02 $63.88 $81.31 $113.85 12.97% $32.92 $36.51 $41.18 $47.51 $56.56 $070.57 $95.18

Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62

Observed Price $54.32

FCF Growth Model (Revised) Growth Rate WACC (BT) 0 0.015 0.03 0.045 0.06 0.075 0.09 9.23% $39.43 $47.23 $58.77 $77.65 $114.05 $213.57 $1611.27 9.57% $36.44 $43.43 $53.60 $69.80 $99.61 $172.62 $629.90 10.25% $31.10 $36.77 $44.77 $56.96 $77.74 $121.21 $268.98 11.10% $25.43 $29.86 $35.92 $44.73 $58.74 $84.41 $146.75 11.95% $20.65 $24.15 $28.83 $35.39 $45.26 $61.79 $95.12 12.46% $18.12 $21.19 $25.22 $30.78 $38.92 $51.99 $76.38 12.97% $15.82 $18.51 $22.01 $26.76 $33.54 $44.05 $62.49

Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62

Observed Price $54.32

152 The chart above shows the sensitivity analysis of the discounted free cash flows model. Our initial estimated share price using a WACCBT of 11.10% and a 0% growth rate yielded us a price of $46.29, which is fairly valued. As you can see, our revised estimated share price using the same WACCBT and growth rate, was $25.43, which suggests that Snap-On is overvalued. We can also see that this model is extremely sensitive to the growth rates because of the effect it has on the terminal value perpetuity. Also, we see that our price per share is somewhat sensitive to changes in

WACCBT. Cash flow from operations and cash flow from investing activities are some of the toughest numbers to forecast and are less accurate than other intrinsic valuation models. If we believe these numbers, we are saying that half of what we are investing in this company is in the present value of the terminal value perpetuity. Overall, this model suggests that Snap-On is fairly valued. This valuation model is weak due to the fact that the FCF to the firm is not reasonably forecastable, it is overly sensitive to the growth rates, and has a relatively low explanatory power. Because of these reasons, we will not be too influenced by the results of this model.

Residual Income Model

The residual income model is the most reliable intrinsic valuation models with an explanatory power of up to 90%. This model allows us to value the company based on current book value of equity, plus the present value of the value added by the firm. The value added or destroyed by the firm can be generated by taking the past years net income, and then deducting the “benchmark”, which is the cost of equity multiplied by the previous year’s book value of equity. This is also known as the firm’s residual income. If the net income for the current year is greater than the “benchmark”, the firm has created value, and has generated a positive residual income. Also, if the firm’s current net income is less than its “benchmark”, the firm has destroyed value, and 153 would have generated a negative residual income. This allows us to view the company from a forward looking perspective and limits the weight of the terminal value perpetuity. To find the residual income we took our forecasted net income, and generated Snap-On’s benchmark each year by taking the previous year’s book value of equity and multiplying by the estimated Ke of 13.50%. By deducting the normal income from the firm’s net earnings, we found our residual income. We then had to find Snap-On’s present value of the year by year residual income, and multiply it by its present value factor. This allowed us to see the total present value of residual income in December 31, 2007 dollars. We calculated this value to be $371.97 million dollars.

= ( + ) To find the total present value of residual income generated by Snap-On, we had to add their present value of year by year residual income to the present value of the terminal value perpetuity. The perpetuity starts in the year 2018, so we have to discount it to find its value in time zero dollars. We discounted the perpetuity using by using a Ke of 13.50% and a growth rate of 0%, and found the present value of the terminal value perpetuity to be $240.56 million. This says that the perpetuity is approximately 20% of the total value of the firm’s assets, which is extremely low when comparing it to the percentage in the discounted free cash flows model.

= We found the total present value of residual (income− to )be $1212.53 million and added it to the previous year’s book value of equity. This gave us Snap-On’s total market value of equity. We then divided the market value of equity by the total

154 number of shares outstanding, which generated an initial price per share of $32.81 million. To find a time consistent price, we took the future value of the initial price and found Snap-On’s price per share as of April 1, 2008 to be $33.86 million.

= ( + )( / ) ( )

Residual Income Growth Model Growth Rate

Ke 0 -0.1 -0.2 -0.3 -0.4 -0.5 10.75% $43.85 $40.46 $39.27 $38.67 $38.30 $38.06 11.25% $41.75 $38.73 $37.65 $37.09 $36.75 $36.52 12.25% $37.96 $35.55 $34.64 $34.16 $33.87 $33.66 13.50% $33.86 $32.03 $31.29 $30.89 $30.64 $30.47 14.75% $30.35 $28.94 $28.34 $28.01 $27.79 $27.65 15.50% $28.48 $27.26 $26.73 $26.43 $26.24 $26.11 16.25% $26.76 $25.71 $25.24 $24.97 $24.80 $24.68

Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62

Observed Price $54.32

155 Residual Income Growth Model (Revised) Growth Rate

Ke 0 -0.1 -0.2 -0.3 -0.4 -0.5 10.75% $15.80 $12.84 $11.81 $11.29 $10.97 $10.75 11.25% $14.83 $12.20 $11.25 $10.77 $10.47 $10.27 12.25% $13.11 $11.02 $10.23 $9.81 $9.55 $9.37 13.50% $11.33 $9.73 $9.09 $8.74 $8.53 $8.38 14.75% $9.86 $8.63 $8.10 $7.81 $7.63 $7.50 15.50% $9.09 $8.03 $7.57 $7.31 $7.14 $7.03 16.25% $8.41 $7.49 $7.08 $6.84 $6.69 $6.59

Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62

Observed Price $54.32

The above chart shows the sensitivity analysis of the residual income growth model and as we can see, Snap-On is consistently overvalued. Our initial estimate yielded a price per share of $33.86 when using a Ke of 13.50% and a growth rate of 0%. However, after subjecting Snap-On’s price per share to all estimated costs of equity and negative growth rates, we still find Snap-0n to be an overvalued company. We use negative growth rates in the sensitivity analysis because in rational markets, firms will not be able to consistently beat their cost of capital. This may be true over the long run but there is more variation and risk in the short run. If residual income is positive, and the growth rates are also positive, this suggests that Snap-On will continue to outperform their cost of capital, and we know that this is not possible. In the long-run residual income should equal zero; however, to restore equilibrium, we will need a growth rate less than zero. The more negative the growth rate, the faster the firm will return to equilibrium, meaning net earnings minus the benchmark will equal zero.

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

The abnormal earnings growth model is based on a forward price to earnings per share ratio. Abnormal earnings are equal to the forecasted net earnings, plus dividend reinvestment earnings, minus the “benchmark or normal income. To calculate the dividend reinvestment earnings, we take the previous year’s dividend payment and multiply it by the cost of equity. This gives us our “DRIP” income. To find our cumulative dividend income, we add our net earnings to the DRIP income. To find our A.E.G. year by year, we deduct our benchmark income, which is the previous year’s book value of equity multiplied by the cost of equity, from our cumulative dividend income. We found our total year by year A.E.G. to be $67.65 million.

= +

−

Once we have calculated the A.E.G. year by year, we have a check figure that will allow us to see if we have performed our valuation correctly. The change in the current year’s residual income must be equal to the same year’s A.E.G. year by year. As we can see, our valuation was performed correctly which validates our model.

A.E.G. 5.67 6.07 6.50 6.95 7.43 7.93 8.46 9.02 9.60 10.21 Change in RI 5.67 6.07 6.50 6.95 7.43 7.93 8.46 9.02 9.60 10.21 A.E.G. (Revised) 0.66 0.73 0.81 0.91 1.01 1.13 1.26 1.40 1.56 1.74 Change in RI (Revised) 0.66 0.73 0.81 0.91 1.01 1.13 1.26 1.40 1.56 1.74

157 To find the present value of the year by year A.E.G., we had to discount the

A.E.G. by the present value factors, which were derived using the Ke of 13.50%. We calculated this value to be $38.72million. Once we found this value, we had to also find the present value of the terminal value perpetuity. The perpetuity starts in the year 2018, so to get the perpetuity in time zero dollars; we have to multiply by the present value factor in the year 2017. We found the present value of the terminal value perpetuity to be $24.20 million.

= After adding the present value of the abnormal( earnings− ) to the present value of the terminal value perpetuity, we found the total abnormal earnings in December 31, 2008 to be $276.65 million. This value also included net earnings in 2008. To find the market value of equity as of December 31, 2007, we have to divide the total present value of abnormal earnings by the estimated cost of equity, which is 13.50%. We found the total market value of equity to be $2050.02 million. We then divided the market value of equity by the total number of shares outstanding and generated an initial price of $35.54. To get a time consistent price, we took the future value of the initial price and calculated a price per share of $36.68.

=

158 A.E.G. Model Growth Rate

Ke 0 -0.1 -0.2 -0.3 -0.4 -0.5 10.75% $62.05 $55.69 $53.47 $52.34 $51.66 $51.20 11.25% $55.85 $50.92 $49.15 $48.23 $47.68 $47.30 12.25% $45.87 $42.97 $41.87 $41.29 $40.93 $40.69 13.50% $36.68 $35.31 $34.76 $34.47 $34.28 $34.15 14.75% $29.97 $29.48 $29.27 $29.16 $29.08 $29.03 15.50% $26.80 $26.63 $26.56 $26.52 $26.50 $26.48 16.25% $24.11 $24.18 $24.21 $24.23 $24.24 $24.25

Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62

Observed Price $54.32

A.E.G. Model (Revised) Growth Rate

Ke 0 -0.1 -0.2 -0.3 -0.4 -0.5 10.75% $7.15 $6.31 $6.02 $5.87 $5.78 $5.72 11.25% $6.45 $5.79 $5.55 $5.42 $5.35 $5.30 12.25% $5.33 $4.91 $4.75 $4.66 $4.61 $4.58 13.50% $4.29 $4.06 $3.96 $3.91 $3.88 $3.86 14.75% $3.53 $3.41 $3.35 $3.33 $3.31 $3.30 15.50% $3.16 $3.09 $3.05 $3.03 $3.02 $3.01 16.25% $2.86 $2.81 $2.79 $2.78 $2.77 $2.77

Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62

Observed Price $54.32

159 The chart above shows the sensitivity analysis of the abnormal earnings growth model. Like the residual income model, the prices are less sensitive the changes in the cost of equity and the growth rates. Again we use negative growth rates because we are assuming that firms are unable to outperform their cost of equity on a regular basis, eventually leading to a residual income equal to zero. Our initial price of $36.68 was generated when using a Ke of 13.50% and a growth rate of 0%. This model suggests that our company is overvalued but as the cost of equity decreases, the model shows that Snap-On is fairly valued, generating prices within 15% of our observed price. Overall the A.E.G. model suggests that Snap-On is an overvalued company, which is the same conclusion drawn by our previous intrinsic valuation models.

Long Run Residual Income Model

The long-run residual income model is generated by using our forecasted book value of equity, average return on equity, and a forward earnings average growth rate. We first found our forecasted average return on equity, which is generated by taking net income divided by the previous year’s book value of equity. We estimated our average return on equity to be 16.80%.

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Avg. ROE 16.7% 16.8% 16.8% 16.9% 16.9% 16.9% 16.8% 16.8% 16.7% 16.7% 16.8%

To find our forward five year average growth rate, we estimated that our earnings are growing by 11.50% per year, so we assumed this to be our estimated growth rate. Once we have calculated the average return on equity and the forward earnings growth rate, we can use the following equation to calculate the market value of equity. When using a Ke of 13.50%, a growth rate of 11.50%, and an average ROE

160 of 16.80%, we estimate our market value of equity to be $3392.27 million. After dividing this by the total number of shares outstanding, we find our initial share price to be $58.80. To find a time consistent price we have to take the future value of our initial share price and we calculate our price per share as of April 1, 2008 to be $60.69.

= + − LR RI Model − Growth Rate Ke 9.50% 10.50% 11.50% 12.50% 13.50% 10.75% $132.94 $573.63 - - - 11.25% $95.06 $191.42 - - - 12.25% $60.63 $82.22 $161.40 - - 13.50% $41.80 $48.10 $60.69 $98.48 - 14.75% $31.93 $34.04 $37.45 $43.89 $60.63 15.50% $27.99 $28.98 $30.48 $32.97 $37.96 16.25% $24.92 $25.24 $24.44 $26.42 $27.65 *ROE Held Constant at 16.80%

ROE Ke 14.80% 15.80% 16.80% 17.80% 18.80% 10.75% - - - - - 11.25% - - - - - 12.25% $91.36 $130.95 $161.40 $191.85 $222.31 13.50% $34.35 $49.24 $60.69 $72.14 $83.60 14.75% $21.2 $30.39 $37.45 $44.52 $51.58 15.50% $17.25 $24.73 $30.48 $36.23 $41.98 16.25% $14.55 $20.86 $25.71 $30.56 $35.41 *Growth Rate Held Constant at 11.50%

161 ROE g 14.80% 15.80% 16.80% 17.80% 18.80% 9.50% $30.35 $36.07 $41.80 $47.52 $53.25 10.50% $32.83 $40.46 $48.10 $55.73 $63.36 11.50% $37.79 $49.24 $60.69 $72.14 $83.60 12.50% $52.68 $75.58 $98.48 $121.39 $144.29 13.50% - - - - - *Ke Held Constant at 13.50%

Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62

Observed Price $54.32

LR RI Model (Revised) Growth Rate Ke 9.50% 10.50% 11.50% 12.50% 13.50% 10.75% - - $219.68 $105.49 $74.35 11.25% - - $659.8 $147.86 $90.98 12.25% - - - $740.94 $164.12 13.50% - - - - - 14.75% - - - - - 15.50% - - - - - 16.25% - - - - - *ROE Held Constant at 3.20%

162 ROE Ke 1.20% 2.20% 3.20% 4.20% 5.20% 10.75% $272.62 $246.15 $219.68 $193.22 $166.75 11.25% $818.78 $739.29 $659.80 $580.3 $500.81 12.25% - - - - - 13.50% - - - - - 14.75% - - - - - 15.50% - - - - - 16.25% - - - - - *Growth Rate Held Constant at 11.50%

ROE g 1.20% 2.20% 3.20% 4.20% 5.20% 9.50% - - - - - 10.50% - - - - - 11.50% - - - - - 12.50% - - - - - 13.50% - - - - - *Ke Held Constant at 13.50%

Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62

Observed Price $54.32

The chart above shows the sensitivity analysis for the long-run residual income model. The three variables that were used when running this analysis were the estimated cost of equity, average return on equity, and the estimated growth rates.

When using our initial estimates of a Ke of 13.50%, an estimated growth rate of 11.50%, and an average return on equity of 16.80%, we generated a time consistent price of $60.69, which is within 15% of our observed price. We can also see how sensitive Snap-On’s price per share is to the changes in these three variables. Overall,

163 we feel that this intrinsic model valuation states that Snap-On is a fairly valued company.

164 Analyst Recommendation

Overall, the intrinsic valuation models suggest that Snap-On is a fairly valued company. However, the discounted dividends model and residual income models suggest that Snap-On is somewhat overvalued. We do not add weight to the influence of the discounted dividends model because of the extremely low explanatory power, as well as the inability to forecast out future dividends. The sensitivity analysis of the residual income model highly suggests that Snap-On is an overvalued firm. This model influenced our decision because of the high explanatory power; however, the overvalued prices that this model estimated were just outside 15% of the observed price, which we used as a range of fairly valued prices. A large portion of Snap-On’s total assets were attributed to goodwill, which was approximately 30% in 2007. For this reason, we chose to restate Snap-On’s financial statements by impairing 20% of their goodwill over the past five years. We then ran our intrinsic valuations and found Snap-On to be unanimously overvalued. The discounted free cash flows model, abnormal earnings growth model, and the long-run residual income model suggest that Snap-On is a fairly valued firm. Also, in each case that we used our estimated Ke of 13.50%, which we estimated using the back door method, a growth rate equal to 11.50%, which was the average future earnings growth rate ,and an ROE of 16.80%, we generated a price that was fairly valued. We also feel that Snap-On is in a position to take advantage of opportunities that will present themselves in the emerging markets of the global economy. They have enough capital and influence to compete with companies like Danaher, Black and Decker, and Stanley Works for their share of the global market. Snap-On also acquired ProQuest Business Solutions in November 2006, which is a firm primarily devoted to diagnostic and information technology. Diagnostic and information technology has drastically transformed the tool and equipment industry in the last decade, and with this

165 acquisition, Snap-On will be able to compete for a larger share of the market. For these reasons, we suggest that investors hold or buy Snap-On’s shares of stock.

166 Appendices

Liquidity Ratios

Current Ratio 2003 2004 2005 2006 2007 Snap-On 2.00 1.77 2.12 1.63 1.86 Danaher 2.13 1.33 1.30 1.40 1.40 Black and Decker 1.68 1.63 1.49 1.52 1.51 Stanley Works 1.63 1.67 2.09 1.31 1.38

Cash to Cash Cycle 2003 2004 2005 2006 2007 Snap-On 190 183 159 169 150 Danaher 122 129 132 132 139 Black and Decker 156 175 154 157 158 Stanley Works 149 148 148 153 143

Quick Asset Ratio 2003 2004 2005 2006 2007 Snap-On 1.13 1.03 1.30 0.91 1.06 Danaher 1.52 0.84 0.76 0.80 0.77 Black and Decker 0.85 0.87 0.93 0.78 0.73 Stanley Works 0.88 1.01 1.45 0.74 0.85

A/R Turnover 2003 2004 2005 2006 2007 Snap-On 4.08 4.30 4.69 4.39 4.84 Danaher 6.10 5.60 5.60 5.72 5.56 Black and Decker 5.54 5.16 5.77 5.61 5.92 Stanley Works 5.37 5.21 5.39 5.36 5.29

167 A/R Days 2003 2004 2005 2006 2007 Snap-On 89 85 78 83 75 Danaher 60 65 65 64 66 Black and Decker 66 71 63 65 62 Stanley Works 68 70 68 68 69

Inventory Turnover 2003 2004 2005 2006 2007 Snap-On 3.61 3.86 4.48 4.26 4.88 Danaher 5.88 5.68 5.41 5.33 5.01 Black and Decker 4.07 3.5 4.01 3.95 3.78 Stanley Works 4.52 4.65 4.57 4.27 4.92

Inventory Days 2003 2004 2005 2006 2007 Snap-On 101 95 81 86 75 Danaher 62 64 67 68 73 Black and Decker 90 104 91 92 97 Stanley Works 81 78 80 85 74

Working Capital Turnover 2003 2004 2005 2006 2007 Snap-On 3.96 4.49 4.02 5.69 5.18 Danaher 3.39 9.62 11.64 9.69 9.59 Black and Decker 5.03 4.76 5.95 6.98 6.85 Stanley Works 5.18 5.41 3.46 10.37 10.94

168 Profitability Ratios

Gross Profit Margin 2003 2004 2005 2006 2007 Snap-On 43.65% 43.33% 44.33% 43.98% 44.58% Danaher 40.40% 41.99% 43.25% 44.34% 45.72% Black and Decker 35.59% 36.41% 35.52% 34.77% 33.93% Stanley Works 34.00% 37.00% 36.00% 36.00% 38.00%

Operating Profit Margin 2003 2004 2005 2006 2007 Snap-On 6.72% 6.11% 7.16% 6.63% 11.43% Danaher 15.98% 16.04% 16.00% 16.00% 16.00% Black and Decker 9.56% 11.36% 12.18% 11.48% 8.87% Stanley Works 5.00% 11.00% 11.00% 10.00% 10.00%

Net Profit Margin 2003 2004 2005 2006 2007 Snap-On 3.52% 3.51% 4.07% 4.08% 6.38% Snap-On (Revised) -0.22% -0.28% 0.58% -2.25% 0.61% Danaher 15.80% 10.83% 11.04% 11.85% 12.42% Black and Decker 6.54% 8.25% 8.16% 7.54% 7.89% Stanley Works 4.00% 12.00% 8.00% 7.00% 8.00%

Asset Turnover 2003 2004 2005 2006 2007 Snap-On 1.12 1.09 1.00 1.22 1.07 Snap-On (Revised) 1.16 1.13 1.04 1.27 1.14 Danaher 0.88 1.00 0.93 1.03 0.86 Black and Decker 1.09 1.28 1.18 1.10 1.25 Stanley Works 1.03 1.24 1.15 1.13 1.14

169 Return on Assets 2003 2004 2005 2006 2007 Snap-On 3.95% 3.82% 4.06% 4.98% 6.83% Snap-On (Revised) -0.25% -0.32% 0.60% -2.86% 0.70% Danaher 8.90% 10.83% 10.57% 12.25% 10.65% Black and Decker 7.09% 10.55% 9.62% 8.32% 9.87% Stanley Works 4.46% 15.13% 9.46% 8.17% 9.00%

Return on Equity 2003 2004 2005 2006 2007 Snap-On 9.48% 8.08% 7.94% 10.17% 17.58% Snap-On (Revised) -0.64% -0.70% 1.29% -6.25% 1.89% Danaher 17.84% 20.46% 19.43% 22.09% 20.62% Black and Decker 48.87% 52.64% 34.14% 31.10% 44.53% Stanley Works 10.97% 42.22% 21.80% 20.04% 21.69%

Sustainable Growth Rate 2003 2004 2005 2006 2007 Snap-On 2.18% 2.31% 3.19% 4.49% 9.48% Snap-On (Revised) N/A N/A 0.50% N/A 1.05% Danaher 15.30% 16.39% 16.06% 15.21% 14.51% Black and Decker 29.69% 33.12% 31.15% 27.96% 29.31% Stanley Works 11.05% 34.56% 21.95% 20.24% 24.71%

Internal Growth Rate 2003 2004 2005 2006 2007 Snap-On 1.03% 1.12% 1.53% 1.82% 4.39% Snap-On (Revised) N/A N/A 0.23% N/A 0.45% Danaher 11.10% 11.10% 11.10% 11.10% 11.00% Black and Decker 5.95% 9.33% 8.33% 6.20% 7.90% Stanley Works 3.96% 14.96% 8.96% 7.97% 8.92%

170 Capital Structure Ratios

Debt to Equity Ratio 2003 2004 2005 2006 2007 Snap-On 1.12 1.06 1.09 1.47 1.16 Snap-On (Revised) 1.22 1.15 1.19 1.17 1.33 Danaher 0.89 0.84 0.80 0.94 0.92 Black and Decker 3.99 2.55 2.74 3.51 2.71 Stanley Works 1.79 1.31 1.45 1.54 1.77

Times Interest Earned 2003 2004 2005 2006 2007 Snap-On 6.15 6.19 9.08 10.78 8.39 Danaher 14.33 23.31 41.82 21.02 16.80 Black and Decker 12.18 27.75 17.51 10.03 7.07 Stanley Works N/A N/A N/A N/A N/A

Debt Service Margin 2003 2004 2005 2006 2007 Snap-On 3.14 4.86 1.73 8.20 5.30 Danaher 7.66 N/A 2.83 8.41 N/A Black and Decker N/A N/A N/A 4.01 4.83 Stanley Works 3.31 0.00 7.69 2.96 6.07

Z-Scores 2003 2004 2005 2006 2007 Snap-On 2.94 2.92 3.34 2.97 3.14 Snap-On (Revised) 2.96 2.94 3.37 2.99 3.21 Danaher 2.14 2.33 2.75 2.93 2.97 Black and Decker 1.98 2.04 1.94 1.85 1.7 Stanley Works 1.64 1.53 1.66 2.47 1.31

171 Sales Diagnostics

Net Sales/Cash from Sales 2002 2003 2004 2005 2006 2007 Snap-On 1.00 1.00 1.00 0.98 1.03 0.99 Snap-On (Revised) 1.02 1.03 1.02 1.01 0.99 1.00 Danaher 1.20 1.20 1.21 1.21 1.21 0.99 Black and Decker 1.00 1.02 1.05 1.01 0.99 1.02 Stanley Works 0.99 0.98 1.03 1.01 1.04 0.99

Net Sales/Accounts Receivable 2002 2003 2004 2005 2006 2007 Snap-On 3.79 4.08 4.30 4.75 4.42 4.84 Snap-On (Revised) 3.79 4.08 4.30 4.69 4.39 4.84 Danaher 6.03 6.10 5.60 5.67 5.73 5.56 Black and Decker 5.89 5.54 5.16 5.77 6.14 5.92 Stanley Works 4.45 5.55 5.21 5.39 5.36 5.60

Net Sales/Inventory 2002 2003 2004 2005 2006 2007 Snap-On 5.70 6.36 6.81 8.15 7.66 8.81 Snap-On (Revised) 5.70 6.36 6.81 8.05 7.60 8.82 Danaher 9.43 9.87 9.79 9.68 9.55 9.24 Black and Decker 5.73 6.31 5.50 6.22 6.06 5.73 Stanley Works 5.83 7.10 7.36 7.13 6.71 7.90

Net Sales/Warranty Liabilities 2002 2003 2004 2005 2006 2007 Snap-On 181 158 148 137 143 166.15 Danaher 74.70 75.10 105.80 38.80 96.90 99.60 Black and Decker 102.20 110.90 97.80 113.90 107 108.48 Stanley Works 155.80 219.50 243.70 173.80 198.96 74.11

172 Expense Diagnostics

Asset Turnover 2002 2003 2004 2005 2006 2007 Snap-On 1.06 1.04 1.02 1.15 0.93 1.07 Snap-On (Revised) 1.07 1.16 1.13 1.04 1.27 1.14 Danaher 0.76 0.77 0.81 0.87 0.75 0.86 Black and Decker 1.03 1.06 0.98 1.12 1.23 2.43 Stanley Works 0.99 1.10 0.85 1.15 1.02 1.14

CFFO/OI 2002 2003 2004 2005 2006 2007 Snap-On 1.12 1.18 1.03 1.31 1.23 0.71 Snap-On (Revised) 1.14 1.18 1.03 1.35 1.25 0.71 Danaher 1.01 1.02 0.98 0.95 1.02 0.95 Black and Decker 1.23 1.33 0.99 0.77 0.84 1.25 Stanley Works 1.08 1.92 0.89 0.81 0.87 1.21

CFFO/NOA 2002 2003 2004 2005 2006 2007 Snap-On 0.45 0.31 0.28 0.40 0.47 0.29 Snap-On (Revised) 0.69 0.54 0.47 0.75 0.69 0.76 Danaher 0.12 0.13 0.12 0.13 0.12 0.66 Black and Decker 0.61 0.64 0.53 0.56 0.67 0.41 Stanley Works 0.54 1.04 0.67 0.38 1.13 0.37

Total Accruals/Change in Sales 2002 2003 2004 2005 2006 2007 Snap-On -0.86 -0.79 0.68 0.63 -0.62 0.24 Snap-On (Revised) -1.93 -0.22 -0.05 1.20 -0.23 0.24 Danaher 0.99 0.98 1.07 1.05 0.98 0.06 Black and Decker -0.56 .-74 0.01 0.16 -1.54 -1.24 Stanley Works 0.09 -0.76 0.15 0.29 0.09 -0.20 173 Pension Expense/SG&A 2002 2003 2004 2005 2006 2007 Snap-On 0.04 0.04 0.04 0.05 0.06 0.08 Danaher 0.01 0.01 0.02 0.02 0.03 0.05 Black and Decker 0.10 0.09 0.08 0.08 0.07 0.04 Stanley Works 0.03 0.03 0.02 0.03 0.03 0.06

174 Weighted Average Cost of Debt

COST OF DEBT LIABILITIES AND SHAREHOLDERS EQUITY Debt Interest Rate Weight WACD Current liabilities Accounts payable 171.60 0.055 0.12 0.6% Notes payable and current maturities of long-term debt 15.90 0.055 0.01 0.1% Accrued benefits and Accrued Compensation 136.90 0.063 0.09 0.6% Franchisee deposits 51.00 0.056 0.03 0.2% Deferred subscription revenue 25.90 0.055 0.02 0.1% Income taxes 25.50 0.055 0.02 0.1% Other accrued liabilities 212.40 0.065 0.14 0.9% Long-term debt 502.00 0.063 0.34 2.1% Deferred income tax liabilities 91.20 0.055 0.06 0.3% Retiree health care benefits 53.80 0.058 0.04 0.2% Pension liabilities 85.30 0.056 0.06 0.3% Other long-term liabilities 113.50 0.063 0.08 0.5% Total liabilities 1,485.00 6.0%

Weighted Average Cost of Capital

Weighted Average Cost of Capital MVE/MVA Cost of Equity MVD/MVA Cost of Debt Tax Rate WACC WACC (BT) 0.68 13.50% 0.32 6.00% 0 11.10% WACC (AT) 0.68 13.50% 0.32 6.00% 32.50% 10.48%

175 Weighted Average Cost of Equity

3 Month Rates

SUMMARY OUTPUT – 72 Regression Statistics Multiple R 0.720535752 R Square 0.519171769 Adjusted R Square 0.512302795 Standard Error 0.042063262 Observations 72 ANOVA df SS MS F Significance F Regression 1 0.133728829 0.133728829 75.58213417 9.64741E-13 Residual 70 0.123852259 0.001769318 Total 71 0.257581088 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.008364288 0.00495747 1.687209038 0.096014859 -0.001523074 0.018251649 -0.001523074 0.018251649 X Variable 1 1.231447449 0.14164665 8.693798604 9.64741E-13 0.948942117 1.513952781 0.948942117 1.513952781

SUMMARY OUTPUT - 60 Regression Statistics Multiple R 0.537533873 R Square 0.288942664 Adjusted R Square 0.276683055 Standard Error 0.042954436 Observations 60 ANOVA df SS MS F Significance F Regression 1 0.043486163 0.043486163 23.56866837 9.48116E-06 Residual 58 0.107014847 0.001845084 Total 59 0.15050101 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.009000982 0.005656083 1.591380804 0.116960141 -0.002320898 0.020322863 -0.002320898 0.020322863 X Variable 1 1.008625495 0.207760231 4.854757293 9.48116E-06 0.592748212 1.424502778 0.592748212 1.424502778

176 SUMMARY OUTPUT - 48 Regression Statistics Multiple R 0.427617979 R Square 0.182857136 Adjusted R Square 0.165093161 Standard Error 0.042423263 Observations 48 ANOVA df SS MS F Significance F Regression 1 0.018525925 0.018525925 10.29370582 0.002432634 Residual 46 0.082787731 0.001799733 Total 47 0.101313656 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.01054934 0.006126848 1.721821855 0.091820916 -0.001783364 0.022882044 -0.001783364 0.022882044 X Variable 1 0.805445322 0.251044197 3.20838056 0.002432634 0.30011957 1.310771073 0.30011957 1.310771073

SUMMARY OUTPUT - 36 Regression Statistics Multiple R 0.420359708 R Square 0.176702284 Adjusted R Square 0.152487646 Standard Error 0.037899578 Observations 36 ANOVA df SS MS F Significance F Regression 1 0.010481729 0.010481729 7.29733309 0.01069111 Residual 34 0.048836854 0.001436378 Total 35 0.059318583 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.013865163 0.006316754 2.194982408 0.035091471 0.001027975 0.02670235 0.001027975 0.02670235 X Variable 1 0.681209559 0.252173037 2.701357638 0.01069111 0.168732292 1.193686825 0.168732292 1.193686825

177 SUMMARY OUTPUT - 24 Regression Statistics Multiple R 0.363752751 R Square 0.132316064 Adjusted R Square 0.092875885 Standard Error 0.042438559 Observations 24 ANOVA df SS MS F Significance F Regression 1 0.006042198 0.006042198 3.354854556 0.080582743 Residual 22 0.039622688 0.001801031 Total 23 0.045664886 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.013190256 0.00869124 1.517649364 0.143342659 -0.004834274 0.031214785 -0.004834274 0.031214785 X Variable 1 0.581867988 0.317678349 1.831626205 0.080582743 -0.07695658 1.240692557 -0.07695658 1.240692557

178 6 Month Rates

SUMMARY OUTPUT - 72 Regression Statistics Multiple R 0.712266948 R Square 0.507324206 Adjusted R Square 0.50038511 Standard Error 0.042292068 Observations 72 ANOVA df SS MS F Significance F Regression 1 0.130767719 0.130767719 73.11099723 1.5939E-12 Residual 70 0.126991949 0.001788619 Total 71 0.257759669 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.007758599 0.004950954 1.56709171 0.121539665 -0.002113323 0.017630522 -0.002113323 0.017630522 X Variable 1 1.209195298 0.141418132 8.550496899 1.5939E-12 0.927215555 1.49117504 0.927215555 1.49117504

SUMMARY OUTPUT - 60 Regression Statistics Multiple R 0.536677028 R Square 0.288022233 Adjusted R Square 0.275954813 Standard Error 0.04264219 Observations 60 ANOVA df SS MS F Significance F Regression 1 0.043400086 0.043400086 23.86775612 8.25241E-06 Residual 58 0.107283025 0.001818356 Total 59 0.150683111 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.008889436 0.00556628 1.597015438 0.115604979 -0.002248666 0.020027537 -0.002248666 0.020027537 X Variable 1 1.006921064 0.206105523 4.885463757 8.25241E-06 0.594504868 1.41933726 0.594504868 1.41933726

179 SUMMARY OUTPUT - 48 Regression Statistics Multiple R 0.422752031 R Square 0.178719279 Adjusted R Square 0.161245222 Standard Error 0.042086246 Observations 48 ANOVA df SS MS F Significance F Regression 1 0.018115821 0.018115821 10.22769185 0.00247695 Residual 46 0.083248851 0.001771252 Total 47 0.101364672 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.011122657 0.006012811 1.849826466 0.07063151 -0.000973558 0.023218873 -0.000973558 0.023218873 X Variable 1 0.792145945 0.247694513 3.198076274 0.00247695 0.293848867 1.290443024 0.293848867 1.290443024

SUMMARY OUTPUT - 36 Regression Statistics Multiple R 0.43403861 R Square 0.188389515 Adjusted R Square 0.165200644 Standard Error 0.03772655 Observations 36 ANOVA df SS MS F Significance F Regression 1 0.011563021 0.011563021 8.124134869 0.007274458 Residual 34 0.049815239 0.001423293 Total 35 0.06137826 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.01312988 0.006203699 2.116459737 0.041489482 0.000535701 0.025724059 0.000535701 0.025724059 X Variable 1 0.708441903 0.248551094 2.850286805 0.007274458 0.20385636 1.213027446 0.20385636 1.213027446

180 SUMMARY OUTPUT - 24 Regression Statistics Multiple R 0.359968471 R Square 0.1295773 Adjusted R Square 0.0881286 Standard Error 0.040470686 Observations 24 ANOVA df SS MS F Significance F Regression 1 0.005120344 0.005120344 3.126209026 0.091569624 Residual 22 0.034395405 0.001637876 Total 23 0.039515749 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.01005436 0.008480694 1.185558671 0.249038956 -0.007582208 0.027690928 -0.007582208 0.027690928 X Variable 1 0.537142115 0.303794704 1.768108884 0.091569624 -0.094633555 1.168917785 -0.094633555 1.168917785

181 2 Year Rates

SUMMARY OUTPUT - 72 Regression Statistics Multiple R 0.713888134 R Square 0.509636268 Adjusted R Square 0.502729737 Standard Error 0.042192716 Observations 72 ANOVA Significance df SS MS F F Regression 1 0.131363676 0.131363676 73.79047974 1.34586E-12 Residual 70 0.126395993 0.001780225 Total 71 0.257759669 Standard Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.006454108 0.004944759 1.305242256 0.196024525 -0.003405461 0.016313678 -0.003405461 0.016313678 X Variable 1 1.21060791 0.140929964 8.590138517 1.34586E-12 0.929601547 1.491614273 0.929601547 1.491614273

SUMMARY OUTPUT - 60 Regression Statistics Multiple R 0.539129192 R Square 0.290660286 Adjusted R Square 0.278637579 Standard Error 0.042563117 Observations 60 ANOVA Significance df SS MS F F Regression 1 0.043797596 0.043797596 24.17594354 7.36601E-06 Residual 58 0.106885515 0.001811619 Total 59 0.150683111 Standard Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.007600484 0.005611712 1.354396615 0.180774358 -0.003628526 0.018829493 -0.003628526 0.018829493 X Variable 1 1.015938315 0.206621554 4.916903857 7.36601E-06 0.602489544 1.429387086 0.602489544 1.429387086 182 SUMMARY OUTPUT - 48 Regression Statistics Multiple R 0.424354506 R Square 0.180076747 Adjusted R Square 0.162631571 Standard Error 0.042051451 Observations 48 ANOVA Significance df SS MS F F Regression 1 0.01825342 0.01825342 10.32243817 0.002374978 Residual 46 0.083111251 0.001768324 Total 47 0.101364672 Standard Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.009954743 0.006023438 1.652667987 0.105064231 -0.002162851 0.022072337 -0.002162851 0.022072337 X Variable 1 0.792129422 0.246549996 3.212855143 0.002374978 0.296134815 1.288124029 0.296134815 1.288124029

SUMMARY OUTPUT - 36 Regression Statistics Multiple R 0.433584371 R Square 0.187995407 Adjusted R Square 0.164795275 Standard Error 0.037735708 Observations 36 ANOVA Significance df SS MS F F Regression 1 0.011538831 0.011538831 8.103204446 0.007342713 Residual 34 0.049839429 0.001423984 Total 35 0.06137826 Standard Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.011848173 0.006211654 1.90741045 0.064700446 -0.000762154 0.0244585 -0.000762154 0.0244585 X Variable 1 0.703956689 0.247296256 2.846612802 0.007342713 0.201918602 1.205994777 0.201918602 1.205994777

183 SUMMARY OUTPUT - 24 Regression Statistics Multiple R 0.352774031 R Square 0.124449517 Adjusted R Square 0.086382105 Standard Error 0.041977898 Observations 24 ANOVA Significance df SS MS F F Regression 1 0.005760779 0.005760779 3.269187723 0.083688231 Residual 22 0.04052931 0.001762144 Total 23 0.046290089 Standard Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.010835424 0.008395618 1.290604697 0.209664431 -0.006532235 0.028203082 -0.006532235 0.028203082 X Variable 1 0.562560485 0.311135305 1.808089523 0.083688231 -0.081071928 1.206192897 -0.081071928 1.206192897

184 5 Year Rates

SUMMARY OUTPUT - 72 Regression Statistics Multiple R 0.714460242 R Square 0.510453437 Adjusted R Square 0.503558415 Standard Error 0.042157545 Observations 72 ANOVA Significance df SS MS F F Regression 1 0.131574309 0.131574309 74.03216942 1.26752E-12 Residual 70 0.12618536 0.001777259 Total 71 0.257759669 Standard Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.005589361 0.004946783 1.129898212 0.262321901 -0.004274244 0.015452965 -0.004274244 0.015452965 X Variable 1 1.211795445 0.14083775 8.604194873 1.26752E-12 0.930972952 1.492617938 0.930972952 1.492617938

SUMMARY OUTPUT - 60 Regression Statistics Multiple R 0.539994916 R Square 0.29159451 Adjusted R Square 0.279587637 Standard Error 0.042535079 Observations 60 ANOVA Significance df SS MS F F Regression 1 0.043938368 0.043938368 24.28563346 7.07485E-06 Residual 58 0.106744743 0.001809233 Total 59 0.150683111 Standard Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.006795042 0.005648671 1.202945322 0.233802601 -0.004507922 0.018098007 -0.004507922 0.018098007 X Variable 1 1.019677819 0.206913227 4.928045603 7.07485E-06 0.605645412 1.433710227 0.605645412 1.433710227 185 SUMMARY OUTPUT - 48 Regression Statistics Multiple R 0.424709321 R Square 0.180378008 Adjusted R Square 0.162939242 Standard Error 0.042043724 Observations 48 ANOVA Significance df SS MS F F Regression 1 0.018283958 0.018283958 10.34350767 0.002352909 Residual 46 0.083080714 0.001767675 Total 47 0.101364672 Standard Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.009240421 0.006042575 1.529219119 0.132913212 -0.002915671 0.021396513 -0.002915671 0.021396513 X Variable 1 0.790804345 0.24588675 3.216132409 0.002352909 0.296144017 1.285464672 0.296144017 1.285464672

SUMMARY OUTPUT - 36 Regression Statistics Multiple R 0.433676465 R Square 0.188075276 Adjusted R Square 0.164877427 Standard Error 0.037733852 Observations 36 ANOVA Significance df SS MS F F Regression 1 0.011543733 0.011543733 8.10744455 0.00732883 Residual 34 0.049834527 0.001423844 Total 35 0.06137826 Standard Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.01111354 0.006229715 1.783956235 0.083103356 -0.001533455 0.023760534 -0.001533455 0.023760534 X Variable 1 0.701959948 0.24653032 2.847357468 0.00732883 0.201476794 1.202443102 0.201476794 1.202443102

186 SUMMARY OUTPUT - 24 Regression Statistics Multiple R 0.353386373 R Square 0.124881928 Adjusted R Square 0.086833317 Standard Error 0.041967531 Observations 24 ANOVA Significance df SS MS F F Regression 1 0.005780796 0.005780796 3.282167799 0.083115559 Residual 22 0.040509294 0.001761274 Total 23 0.046290089 Standard Coefficients Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.010222252 0.008401383 1.216734408 0.236044075 -0.007157333 0.027601838 -0.007157333 0.027601838 X Variable 1 0.561425566 0.309893021 1.811675412 0.083115559 -0.079636986 1.202488118 -0.079636986 1.202488118

187 10 Year Rates

SUMMARY OUTPUT - 72 Regression Statistics Multiple R 0.71454151 R Square 0.510569569 Adjusted R Square 0.503676183 Standard Error 0.042152544 Observations 72 ANOVA df SS MS F Significance F Regression 1 0.131604243 0.131604243 74.06658248 1.25676E-12 Residual 70 0.126155426 0.001776837 Total 71 0.257759669 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.005251746 0.004949147 1.061141584 0.292221891 -0.004616573 0.015120065 -0.004616573 0.015120065 X Variable 1 1.212148109 0.140846006 8.606194425 1.25676E-12 0.931309154 1.492987064 0.931309154 1.492987064

SUMMARY OUTPUT - 60 Regression Statistics Multiple R 0.5401394 R Square 0.291750571 Adjusted R Square 0.279746344 Standard Error 0.042530393 Observations 60 ANOVA df SS MS F Significance F Regression 1 0.043961884 0.043961884 24.30398529 7.02732E-06 Residual 58 0.106721227 0.001808834 Total 59 0.150683111 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.006499336 0.005664154 1.147450428 0.255827198 -0.00483461 0.017833283 -0.00483461 0.017833283 X Variable 1 1.020338051 0.206969017 4.929907229 7.02732E-06 0.606194009 1.434482093 0.606194009 1.434482093

188 SUMMARY OUTPUT - 48 Regression Statistics Multiple R 0.424725139 R Square 0.180391444 Adjusted R Square 0.162952964 Standard Error 0.04204338 Observations 48 ANOVA df SS MS F Significance F Regression 1 0.018285319 0.018285319 10.34444773 0.002351929 Residual 46 0.083079352 0.001767646 Total 47 0.101364672 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.008992232 0.006051457 1.485961341 0.143966876 -0.00318173 0.021166193 -0.00318173 0.021166193 X Variable 1 0.790325812 0.245726792 3.216278553 0.002351929 0.295987277 1.284664347 0.295987277 1.284664347

SUMMARY OUTPUT - 36 Regression Statistics Multiple R 0.433737266 R Square 0.188128016 Adjusted R Square 0.164931673 Standard Error 0.037732627 Observations 36 ANOVA df SS MS F Significance F Regression 1 0.01154697 0.01154697 8.110244823 0.007319677 Residual 34 0.04983129 0.001423751 Total 35 0.06137826 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.010872125 0.006237858 1.742925876 0.090127352 -0.001791401 0.02353565 -0.001791401 0.02353565 X Variable 1 0.701490552 0.246322931 2.847849157 0.007319677 0.20142842 1.201552685 0.20142842 1.201552685

189 SUMMARY OUTPUT - 24 Regression Statistics Multiple R 0.353557381 R Square 0.125002821 Adjusted R Square 0.086959466 Standard Error 0.041964632 Observations 24 ANOVA df SS MS F Significance F Regression 1 0.005786392 0.005786392 3.285799046 0.08295616 Residual 22 0.040503697 0.00176103 Total 23 0.046290089 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.010022856 0.008406274 1.192306634 0.245297722 -0.007366846 0.027412558 -0.007366846 0.027412558 X Variable 1 0.561129643 0.309558485 1.812677314 0.08295616 -0.079240869 1.201500154 -0.079240869 1.201500154

190 Methods of Comparables

P/E Trailing PPS EPS P/E Industry Average Snap-On PPS Snap-On 54.32 3.14 17.30 15.00 47.10 Snap-On (Revised) 54.32 .30 181.10 15.00 4.50 Danaher 79.00 4.30 18.37 Black and Decker 68.91 8.50 8.11 Stanley Works 49.88 4.29 11.63

P/E Forecast PPS EPS P/E Industry Average Snap-On PPS Snap-On 54.32 3.71 14.64 11.99 44.47 Snap-On (Revised) 54.32 .40 135.80 11.99 4.79 Danaher 79.00 4.36 18.12 *N/A Black and Decker 68.91 5.57 12.37 Stanley Works 49.88 4.30 11.60

P/B PPS BPS P/B Industry Average Snap-On PPS Snap-On 54.32 22.19 2.45 2.69 59.60 Snap-On (Revised) 54.32 19.35 2.81 2.69 51.97 Danaher 79.00 28.57 2.77 Black and Decker 68.91 23.18 2.97 Stanley Works 49.88 21.50 2.32

P.E.G. PPS P.E.G. Industry Average Snap-On PPS Snap-On 54.32 1.62 1.21 47.90 Snap-On (Revised) 54.32 17.05 1.21 3.86 Danaher 79.00 1.25 Black and Decker 68.91 1.42 Stanley Works 49.88 0.95

191 P/EBITDA PPS # of Shares EBITDA P/EBITDA Industry Average Snap-On PPS Snap-On 54.32 57.69 426.80 7.34 5.27 39.00 Danaher 79.00 318.30 2060.00 12.21 *N/A Black and Decker 68.91 60.92 744.60 5.64 Stanley Works 49.88 78.27 796.00 4.90

EV/EBITDA PPS # of Shares EV EBITDA EV/EBITDA Industry Average Snap-On PPS Snap-On 54.32 57.69 2653.70 426.80 6.22 7.23 53.51 Danaher 79.00 318.30 2447.00 2060.00 1.19 Black and Decker 68.91 60.92 5140.66 744.60 6.90 Stanley Works 49.88 78.27 6020.00 796.00 7.56

P/FCF PPS # of Shares FCF P/FCF Industry Average Snap-On PPS Snap-On 54.32 57.69 220.20 17.59 10.00 38.17 Danaher 79.00 318.30 584.83 43.00 *N/A Black and Decker 68.91 60.92 404.64 10.37 Stanley Works 49.88 78.27 405.67 9.62

D/P PPS DPS D/P Industry Average Snap-On PPS Snap-On 54.32 1.12 0.0206 0.0257 43.50 Snap-On (Revised) 54.32 .11 .0020 .0257 4.27 Danaher 79.00 0.11 0.0014 *N/A Black and Decker 68.91 1.78 0.0258 Stanley Works 49.88 1.28 0.0257

192 Dividend Growth Model

Actual

0 1 2 3 4 5 6 7 8 9 10 Forecasted 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Total Dividends 64.80 73.68 80.31 87.54 95.42 104.01 113.37 123.57 134.69 146.81 160.03 174.43 Number of Shares Outstanding 57.69 57.69 57.69 57.69 57.69 57.69 57.69 57.69 57.69 57.69 57.69 57.69 Dividends Per Share 1.12 1.28 1.39 1.52 1.65 1.80 1.97 2.14 2.33 2.54 2.77 3.02

PV Factor 0.8811 0.7763 0.6839 0.6026 0.5309 0.4678 0.4121 0.3631 0.3199 0.2819 PV YBY Dividends Per Share 1.1253 1.0807 1.0378 0.9967 0.9571 0.9192 0.8828 0.8478 0.8141 0.7819 PV YBY Dividends 9.44 Discounted Dividend Model PV Perpetuity 9.46 Growth Rate

Time Zero PV 2.67 Ke 0 0.02 0.04 0.06 0.08 December 31, 2007 Value $ 12.13 10.75% $ 16.58 $ 20.37 $ 26.40 $ 37.52 $ 64.81 Time Consistent Price (4/1/08) $ 12.52 11.25% $ 15.67 $ 19.06 $ 24.32 $ 33.59 $ 54.26 12.25% $ 14.11 $ 16.86 $ 20.95 $ 27.66 $ 40.67 Ke 13.50% 13.50% $ 12.52 $ 14.69 $ 17.79 $ 22.53 $ 30.72 g 0 14.75% $ 11.23 $ 12.99 $ 15.40 $ 18.92 $ 24.53 15.50% $ 10.56 $ 12.13 $ 14.24 $ 17.24 $ 21.83 16.25% $ 9.97 $ 11.37 $ 13.23 $ 15.81 $ 19.64 Overvalued < $46 $46$62 Undervalued > $62 Observed Price $54.32

193 Revised

0 1 2 3 4 5 6 7 8 9 10 Forecasted 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Total Dividends 6.24 8.25 9.19 10.25 11.43 12.74 14.21 15.84 17.67 19.70 21.96 24.49 Number of Shares Outstanding 57.69 57.69 57.69 57.69 57.69 57.69 57.69 57.69 57.69 57.69 57.69 57.69 Dividends Per Share 0.11 0.14 0.16 0.18 0.20 0.22 0.25 0.27 0.31 0.34 0.38 0.42

PV Factor 0.8811 0.7763 0.6839 0.6026 0.5309 0.4678 0.4121 0.3631 0.3199 0.2819 PV YBY Dividends Per Share 0.1259 0.1237 0.1215 0.1194 0.1173 0.1152 0.1132 0.1112 0.1092 0.1073 PV YBY Dividends 1.16 Discounted Dividend Model (Revised) PV Perpetuity 1.06 Growth Rate

Time Zero PV 0.30 Ke 0 0.02 0.04 0.06 0.08 December 31, 2007 Value $ 1.36 10.75% $ 1.86 $ 2.28 $ 2.95 $ 4.20 $ 7.25 Time Consistent Price (4/1/08) $ 1.40 11.25% $ 1.75 $ 2.13 $ 2.72 $ 3.76 $ 6.07 12.25% $ 1.58 $ 1.89 $ 2.34 $ 3.09 $ 4.55 Ke 13.50% 13.50% $ 1.40 $ 1.64 $ 1.99 $ 2.52 $ 3.44 g 0 14.75% $ 1.26 $ 1.45 $ 1.72 $ 2.12 $ 2.75 15.50% $ 1.18 $ 1.36 $ 1.59 $ 1.93 $ 2.44 16.25% $ 1.12 $ 1.27 $ 1.48 $ 1.77 $ 2.20 Overvalued < $46 $46$62 Undervalued > $62 Observed Price $54.32

194 Discounted Free Cash Flows Model

Actual

0 1 2 3 4 5 6 7 8 9 10 Forecasted 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Net Cash Provided by Operating Activities 231.10 257.68 287.31 320.35 357.19 398.27 444.07 495.14 552.08 615.56 686.35 765.28 Net Cash Used in Investing Activities (52.90) (55.55) (58.32) (61.24) (64.30) (67.52) (70.89) (74.44) (78.16) (82.07) (86.17) (90.48) FCF to Firm 178.20 202.13 228.99 259.11 292.89 330.75 373.18 420.70 473.92 533.50 600.19 674.80

PV Factor 0.9001 0.8102 0.7292 0.6564 0.5908 0.5318 0.4786 0.4308 0.3878 0.3490 PV YBY FCF 181.94 185.52 188.95 192.24 195.40 198.44 201.36 204.17 206.87 209.48 Total PV YBY FCF 1964.37

PV TV Perpetuity 2121.84 FCF Growth Model 6079.31 PV of Total Forecasted FCF 4086.22 Growth Rate BVL 1485.00 WACC (BT) 0 0.015 0.03 0.045 0.06 0.075 0.09 MVE 2601.22 9.23% $ 65.61 $ 76.01 $ 91.42 $ 116.59 $ 165.15 $ 297.92 $ 2,162.41 # of Shares 57.69 9.57% $ 61.50 $ 70.82 $ 84.39 $ 106.00 $ 145.76 $ 243.16 $ 853.16 Intrinsic Value Per Share (12/31/07) $45.09 10.25% $ 54.14 $ 61.69 $ 72.37 $ 88.63 $ 116.36 $ 174.33 $ 371.45 Time Consistent Price (4/1/08) $46.29 11.10% $ 46.29 $ 52.19 $ 60.28 $ 72.04 $ 90.72 $ 124.96 $ 208.12 11.95% $ 39.65 $ 44.32 $ 50.56 $ 59.32 $ 72.48 $ 94.53 $ 138.99 WACC 11.10% 12.46% $ 36.13 $ 40.22 $ 45.61 $ 53.02 $ 63.88 $ 81.31 $ 113.85 g 0 12.97% $ 32.92 $ 36.51 $ 41.18 $ 47.51 $ 56.56 $ 70.57 $ 95.18 Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62 Observed Price $54.32

195 Revised

0 1 2 3 4 5 6 7 8 9 10 Forecasted 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Net Cash Provided by Operating Activities 231.10 242.66 254.79 267.53 280.90 294.95 309.70 325.18 341.44 358.51 376.44 395.26 Net Cash Used in Investing Activities (52.90) (55.55) (58.32) (61.24) (64.30) (67.52) (70.89) (74.44) (78.16) (82.07) (86.17) (90.48) FCF to Firm 178.20 187.11 196.47 206.29 216.60 227.43 238.81 250.75 263.28 276.45 290.27 304.78

PV Factor 0.9001 0.8102 0.7292 0.6564 0.5908 0.5318 0.4786 0.4308 0.3878 0.3490 PV YBY FCF 168.42 159.17 150.43 142.17 134.36 126.99 120.01 113.43 107.20 101.31 Total PV YBY FCF 1323.49

PV TV Perpetuity 1590.62 FCF Growth Model (Revised) 4557.30 PV of Total Forecasted FCF 2914.11 Growth Rate BVL 1485.00 WACC (BT) 0 0.015 0.03 0.045 0.06 0.075 0.09 MVE 1429.11 9.23% $ 39.43 $ 47.23 $ 58.77 $ 77.65 $ 114.05 $ 213.57 $ 1,611.27 # of Shares 57.69 9.57% $ 36.44 $ 43.43 $ 53.60 $ 69.80 $ 99.61 $ 172.62 $ 629.90 Intrinsic Value Per Share (12/31/07) $24.77 10.25% $ 31.10 $ 36.77 $ 44.77 $ 56.96 $ 77.74 $ 121.21 $ 268.98 Time Consistent Price (4/1/08) $25.43 11.10% $ 25.43 $ 29.86 $ 35.92 $ 44.73 $ 58.74 $ 84.41 $ 146.75 11.95% $ 20.65 $ 24.15 $ 28.83 $ 35.39 $ 45.26 $ 61.79 $ 95.12 WACC 11.10% 12.46% $ 18.12 $ 21.19 $ 25.22 $ 30.78 $ 38.92 $ 51.99 $ 76.38 g 0 12.97% $ 15.82 $ 18.51 $ 22.01 $ 26.76 $ 33.54 $ 44.05 $ 62.49 Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62 Observed Price $54.32

196 Residual Income (RI) Model

Actual

1 2 3 4 5 6 7 8 9 10 11 Forecasted 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Net Earnings $213.84 $238.43 $265.85 $296.42 $330.51 $368.51 $410.89 $458.15 $510.83 $569.58 $635.08 Total Shareholders’ Equity 1280.10 1420.26 1,578.37 1,756.68 1,957.68 2,184.18 2,439.33 2,726.65 3,050.11 3,414.13 3,823.68

Net Income $213.84 $238.43 $265.85 $296.42 $330.51 $368.51 $410.89 $458.15 $510.83 $569.58 $635.08 Normal Income 172.81 191.73 213.08 237.15 264.29 294.86 329.31 368.10 411.76 460.91 516.20 Residual Income $41.02 $46.69 $52.77 $59.27 $66.22 $73.65 $81.58 $90.05 $99.07 $108.67 $118.88 $ 130.77

PV Factor 0.881 0.776 0.684 0.603 0.531 0.468 0.412 0.363 0.320 0.282 0.248 PV YBY RI $36.14 $36.25 $36.09 $35.71 $35.16 $34.45 $33.62 $32.70 $31.69 $30.63 $29.52

Residual Income Growth Model Total PV YBY RI $371.97 Growth Rate

TV Perpetuity 240.56 Ke 0 -0.1 -0.2 -0.3 -0.4 -0.5 968.67 BE 1280.1 10.75% $ 43.85 $ 40.46 $ 39.27 $ 38.67 $ 38.30 $ 38.06 MVE $1,892.63 11.25% $ 41.75 $ 38.73 $ 37.65 $ 37.09 $ 36.75 $ 36.52 # of Shares 57.69 12.25% $ 37.96 $ 35.55 $ 34.64 $ 34.16 $ 33.87 $ 33.66 Initial Price (12/31/07) $32.81 13.50% $ 33.86 $ 32.03 $ 31.29 $ 30.89 $ 30.64 $ 30.47 Time Consistent (4/1/08) $33.86 14.75% $ 30.35 $ 28.94 $ 28.34 $ 28.01 $ 27.79 $ 27.65 15.50% $ 28.48 $ 27.26 $ 26.73 $ 26.43 $ 26.24 $ 26.11 Ke 13.50% 16.25% $ 26.76 $ 25.71 $ 25.24 $ 24.97 $ 24.80 $ 24.68 g 0 Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62 Observed Price $54.32

197 Revised

1 2 3 4 5 6 7 8 9 10 11 Forecasted 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Net Earnings $22.90 $25.54 $28.47 $31.75 $35.40 $39.47 $44.01 $49.07 $54.71 $61.01 $68.02 Total Shareholders’ Equity 1116.34 1131.00 1147.34 1165.57 1185.88 1208.54 1233.80 1261.97 1293.37 1328.39 1367.43

Net Income $22.90 $25.54 $28.47 $31.75 $35.40 $39.47 $44.01 $49.07 $54.71 $61.01 $68.02 Normal Income 150.71 152.68 154.89 157.35 160.09 163.15 166.56 170.37 174.61 179.33 184.60 Residual Income -$127.80 -$127.15 -$126.42 -$125.60 -$124.69 -$123.68 -$122.55 -$121.29 -$119.89 -$118.33 -$116.58 $ 114.00

PV Factor 0.881 0.776 0.684 0.603 0.531 0.468 0.412 0.363 0.320 0.282 0.248 PV YBY RI -$112.60 -$98.70 -$86.46 -$75.69 -$66.20 -$57.85 -$50.51 -$44.04 -$38.36 -$33.35 -$28.95

Residual Income Growth Model (Revised) Total PV YBY RI -$692.71 Growth Rate

TV Perpetuity 209.71 Ke 0 -0.1 -0.2 -0.3 -0.4 -0.5 844.44 BE 1116.34 10.75% $ 15.80 $ 12.84 $ 11.81 $ 11.29 $ 10.97 $ 10.75 MVE $633.34 11.25% $ 14.83 $ 12.20 $ 11.25 $ 10.77 $ 10.47 $ 10.27 # of Shares 57.69 12.25% $ 13.11 $ 11.02 $ 10.23 $ 9.81 $ 9.55 $ 9.37 Initial Price (12/31/07) $10.98 13.50% $ 11.33 $ 9.73 $ 9.09 $ 8.74 $ 8.53 $ 8.38 Time Consistent (4/1/08) $11.33 14.75% $ 9.86 $ 8.63 $ 8.10 $ 7.81 $ 7.63 $ 7.50 15.50% $ 9.09 $ 8.03 $ 7.57 $ 7.31 $ 7.14 $ 7.03 Ke 13.50% 16.25% $ 8.41 $ 7.49 $ 7.08 $ 6.84 $ 6.69 $ 6.59 g 0 Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62 Observed Price $54.32

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

Actual

1 2 3 4 5 6 7 8 9 10 Forecasted 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Net Income 213.84 238.43 265.85 296.42 330.51 368.51 410.89 458.15 510.83 569.58 635.08 Total Dividends 73.68 80.31 87.54 95.42 104.01 113.37 123.57 134.69 146.81 160.03 174.43 DRIP Income 9.95 10.84 11.82 12.88 14.04 15.30 16.68 18.18 19.82 21.60 Cumulative Dividend Income 248.37 276.69 308.24 343.39 382.56 426.20 474.83 529.02 589.40 656.68 Change in Residual Income 5.67 6.07 6.50 6.95 7.43 7.93 8.46 9.02 9.60 10.21

Normal (Benchmark) Income 242.70 270.61 301.74 336.43 375.12 418.26 466.36 520.00 579.80 646.47 A.E.G. YBY 5.67 6.07 6.50 6.95 7.43 7.93 8.46 9.02 9.60 10.21 PV Factor 0.881 0.776 0.684 0.603 0.531 0.468 0.412 0.363 0.320 0.282 PV A.E.G. YBY 5.00 4.71 4.45 4.19 3.95 3.71 3.49 3.28 3.07 2.88

Core Earnings of Perpetuity 213.84 A.E.G. Model Total PV of YBY A.E.G. 38.72 Growth Rate

A.E.G TV of Perpetuity 24.20 Ke 0 -0.1 -0.2 -0.3 -0.4 -0.5 75.64 Total Model Perpetuity Earnings 276.75 10.75% $ 62.05 $ 55.69 $ 53.47 $ 52.34 $ 51.66 $ 51.20 Perpetuity Capitalization Rate 13.50% 11.25% $ 55.85 $ 50.92 $ 49.15 $ 48.23 $ 47.68 $ 47.30 MVE 2050.02 12.25% $ 45.87 $ 42.97 $ 41.87 $ 41.29 $ 40.93 $ 40.69 # of Shares 57.69 13.50% $ 36.68 $ 35.31 $ 34.76 $ 34.47 $ 34.28 $ 34.15 Initial Share Price (12/31/07) $ 35.54 14.75% $ 29.97 $ 29.48 $ 29.27 $ 29.16 $ 29.08 $ 29.03 Time Consistent Price (4/1/08) $ 36.68 15.50% $ 26.80 $ 26.63 $ 26.56 $ 26.52 $ 26.50 $ 26.48 16.25% $ 24.11 $ 24.18 $ 24.21 $ 24.23 $ 24.24 $ 24.25 Ke 13.50% Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62 g 0 Observed Price $54.32

199 Revised

1 2 3 4 5 6 7 8 9 10 Forecasted 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Net Income 22.90 25.54 28.47 31.75 35.40 39.47 44.01 49.07 54.71 61.01 68.02 Total Dividends 8.25 9.19 10.25 11.43 12.74 14.21 15.84 17.67 19.70 21.96 24.49 DRIP Income 1.11 1.24 1.38 1.54 1.72 1.92 2.14 2.38 2.66 2.96 Cumulative Dividend Income 26.65 29.72 33.13 36.94 41.19 45.93 51.21 57.10 63.67 70.99 Change in Residual Income 0.66 0.73 0.81 0.91 1.01 1.13 1.26 1.40 1.56 1.74

Normal (Benchmark) Income 26.00 28.98 32.32 36.03 40.18 44.80 49.95 55.70 62.10 69.24 A.E.G. YBY 0.66 0.73 0.81 0.91 1.01 1.13 1.26 1.40 1.56 1.74 PV Factor 0.881 0.776 0.684 0.603 0.531 0.468 0.412 0.363 0.320 0.282 PV A.E.G. YBY 0.58 0.57 0.56 0.55 0.54 0.53 0.52 0.51 0.50 0.49

Core Earnings of Perpetuity 22.90 A.E.G. Model (Revised) Total PV of YBY A.E.G. 5.33 Growth Rate

A.E.G TV of Perpetuity 4.13 Ke 0 -0.1 -0.2 -0.3 -0.4 -0.5 12.92 Total Model Perpetuity Earnings 32.37 10.75% $ 7.15 $ 6.31 $ 6.02 $ 5.87 $ 5.78 $ 5.72 Perpetuity Capitalization Rate 13.50% 11.25% $ 6.45 $ 5.79 $ 5.55 $ 5.42 $ 5.35 $ 5.30 MVE 239.78 12.25% $ 5.33 $ 4.91 $ 4.75 $ 4.66 $ 4.61 $ 4.58 # of Shares 57.69 13.50% $ 4.29 $ 4.06 $ 3.96 $ 3.91 $ 3.88 $ 3.86 Initial Share Price (12/31/07) $4.16 14.75% $ 3.53 $ 3.41 $ 3.35 $ 3.33 $ 3.31 $ 3.30 Time Consistent Price (4/1/08) $4.29 15.50% $ 3.16 $ 3.09 $ 3.05 $ 3.03 $ 3.02 $ 3.01 16.25% $ 2.86 $ 2.81 $ 2.79 $ 2.78 $ 2.77 $ 2.77 Ke 13.50% Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62 g 0 Observed Price $54.32

200 Long Run Residual Income Model (LR RI)

Actual

Initial BVE $1280.1 Average ROE 16.80% Ke 13.50% Forward Earnings Growth Rate 9.50%

End of 2007 Estimated MVE $2336.18 # of Shares 57.69 Initial Share Price (12/31/07) $40.50 Time Consistent Price (4/1/08) $41.80

LR RI Model Growth Rate Ke 9.50% 10.50% 11.50% 12.50% 13.50% 10.75% $132.94 $573.63 - - - 11.25% $95.06 $191.42 - - - 12.25% $60.63 $82.22 $161.40 - - 13.50% $41.80 $48.10 $60.69 $98.48 - 14.75% $31.93 $34.04 $37.45 $43.89 $60.63 15.50% $27.99 $28.98 $30.48 $32.97 $37.96 16.25% $24.92 $25.24 $24.44 $26.42 $27.65 *ROE Held Constant at 16.80%

ROE Ke 14.80% 15.80% 16.80% 17.80% 18.80% 10.75% - - - - - 11.25% - - - - - 12.25% $91.36 $130.95 $161.40 $191.85 $222.31 13.50% $34.35 $49.24 $60.69 $72.14 $83.60 14.75% $21.20 $30.39 $37.45 $44.52 $51.58 15.50% $17.25 $24.73 $30.48 $36.23 $41.98 16.25% $14.55 $20.86 $25.71 $30.56 $35.41 *Growth Rate Held Constant at 11.50% 201 ROE g 14.80% 15.80% 16.80% 17.80% 18.80% 9.50% $30.35 $36.07 $41.80 $47.52 $53.25 10.50% $32.83 $40.46 $48.10 $55.73 $63.36 11.50% $37.79 $49.24 $60.69 $72.14 $83.60 12.50% $52.68 $75.58 $98.48 $121.39 $144.29 13.50% - - - - - *Ke Held Constant at 13.50% Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62 Observed Price $54.32

202 Revised

Initial BVE $ 1,116.34 Average ROE 3.20% Ke 10.75% Forward Earnings Growth Rate 11.50%

End of 2007 Estimated MVE $ 12,354.16 # of Shares 57.69 Initial Share Price (12/31/07) $ 214.15 Time Consistent Price (4/1/08) $ 219.68

LR RI Model (Revised) Growth Rate Ke 9.50% 10.50% 11.50% 12.50% 13.50% 10.75% - - $219.68 $105.49 $74.35 11.25% - - $659.80 $147.86 $90.98 12.25% - - - $740.94 $164.12 13.50% - - - - - 14.75% - - - - - 15.50% - - - - - 16.25% - - - - - *ROE Held Constant at 3.20%

ROE Ke 1.20% 2.20% 3.20% 4.20% 5.20% 10.75% $272.62 $246.15 $219.68 $193.22 $166.75 11.25% $818.78 $739.29 $659.80 $580.30 $500.81 12.25% - - - - - 13.50% - - - - - 14.75% - - - - - 15.50% - - - - - 16.25% - - - - - *Growth Rate Held Constant at 11.50%

203 ROE g 1.20% 2.20% 3.20% 4.20% 5.20% 9.50% - - - - - 10.50% - - - - - 11.50% - - - - - 12.50% - - - - - 13.50% - - - - - *Ke Held Constant at 13.50% Overvalued < $46 Fairly Valued *15% of Observed Price Undervalued > $62 Observed Price $54.32

204 References

1. www.snapon.com – (10-K) 2. www.blackanddecker.com – (10-K) 3. www.stanleyworks.com – (10-K) 4. www.danaher.com – (10-K) 5. www.finance.yahoo.com 6. www.unclaw.com 7. www.usdoj.gov 8. www.wsj.com – “Coal Shortage at BHP may lift steel price” 9. www.wsj.com – “Multitouch Interface is Starting to Spread Among New Devices” 10. www.wsj.com – “Toolmakers Warn of Tough Year” 11. www.wsj.com – “Car Sales in U.S. Decline” 12. www.wsj.com – “Inflation Figures” 13. www.wsj.com – “Wall Street Shows Skepticism Over Coal” 14. www.wsj.com – “Engineering Jobs Become Car Makers’ New Export” 15. www.inflationdata.com 16. www.money.cnn.com 17. www.wikipedia.org

205