Hasbro Valuation Project

Analysis Group

Diana Duran [email protected]

Marianne Francis [email protected]

Ben Gergen [email protected]

Stephen Milkowski [email protected]

Table of Contents

Executive Summary 3

Business and Industry Analysis 8

Company Overview 8

Industry Overview 10

Five Forces Model 11

Rivalry among Existing Firms 12

Threat of New Entrants 17

Threat of Substitute Products 19

Bargaining Power of Buyers 21

Bargaining Power of Suppliers 22

Analysis of Key Success Factors 24

Differentiation 24

Firm Competitive Advantage Analysis 28

Historical Competitive Analysis 28

Accounting Analysis 33 Key Accounting Policies 33

Accounting Flexibility 38

Actual Accounting Strategy 41 Qualitative Analysis of Disclosure 43 Quantitative Analysis of Disclosure 44 Potential Red Flags 51 Undo Accounting Distortions 52

1 Ratio Analysis, Forecast Financials, and Cost of Capital Estimation 61 Liquidity Analysis 61 Profitability Analysis 69 Capital Structure Analysis 77 Internal Growth Rate and Sustainable Growth Rate Analysis 81 Financial Statement Forecasting 83

Income Statement 83

Balance Sheet 87

Statement of Cash Flows 91 Cost of Capital Estimation 94 Valuation Analysis 99

Method of Comparables 99

Intrinsic Valuations 106

Analyst’s Recommendation 117

Appendix 118

2 Executive Summary

Investment Recommendation: Overvalued, Sell April 1, 2004

PUT Z-SCORES IN

HAS- NASDAQ 4/1/08 $29.27 Altman's Z-Score 2003 2004 2005 2006 2007 52 Week Range $21.57-$35.99 2.19 2.84 3.03 3.115 3.356 Revenue (billion)$ 3.92 Valuation Estimates Market Capitalization (billion)$ 5.14 Actual Price 4/1/08 $29.27 Shares Outstanding (million) 142.31 Percentage Institutonal Ownership 11% Financial Based Valuations Initial Revised Trailing P/E$ 28.69 $ 29.16 Forward P/E$ 28.90 $ 28.94 Book Value Per Share$ 9.58 P/B$ 19.97 $ 22.32 ROE 21.65% D/P$ 18.66 $ 18.66 ROA 10.75% PEG$ 22.58 $ 22.90 P/EBITDA$ 37.10 $ 37.10 Cost of Capital P/FCF$ 45.17 $ 45.67 Estimated R-squared Beta Ke EV/EBITDA$ 36.06 $ 35.98 3 Month 0.4047 1.50 15.59% 6 Month 0.4054 1.50 15.59% Intrinsic Valuations Revised 2 Year 0.4079 1.51 15.67% Discount Dividend$ 2.72 5 Year 0.4076 1.50 15.59% Free Cash Flow$ 29.10 10 Year 0.4062 1.49 15.51% Residual Income$ 10.42 Abnormal Earnings Growth$ 9.00 Published Beta 1.59 Long Run RI Perp$ 12.22 Cost of Debt (BT) 5.89% Cost of Debt (AT) 3.65% WACC (BT) 10.07% WACC (AT) 8.85%

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3 Industry Analysis

Hasbro is a toy company and is one of the top leaders in the toys and games industry. The company was organized in 1926 in Rhode Island and has products under brand names such as Playskool, Tonka, Milton Bradley, Scrabble, Jenga, Mr. Potato Head, Easy Bake, etc. The target market is mainly young children under the age of 12 and Hasbro is experiencing what it deems to be the “children growing older younger” effect as is much of the toy and games industry. The industry as a whole is losing some young customers to the video/computer games industry, one that is fundamentally different (no action figures, board games, or dolls) but, one that reflects a change in consumer culture. Rivalry among existing firms is quite low as there are many barriers to entry and exit. The industry is dominated by Mattel, followed closely by Hasbro, there is not much else or much excitement in the industry past these two. This is quite a concentrated market despite what is disclosed in Hasbro’s 10-k which takes the opposite opinion. The only other competitor below these two is JAKKS which produces educational toys and games, if this were a competitive market then children love educational toys and games. Among Hasbro and Mattel, the product lines are diverse, have brand images, and are well known to everyone that is young or a parent. Entering a market such as these is difficult, the two top firms are known to buy out emerging toy and game makers to add to their portfolio of products they currently sell. There is however, the threat of substitute products since everyone can sell dolls and action figures but, in order to land the rights to produce the action figures or dolls for the next upcoming movie you’re out of luck; those go to Mattel or Hasbro, because no other firm could compete. The threat of substitute products is average at best. Key performance measures or Key Success Factors were Brand Image, Cost Control, and good R&D expenditures. Industry growth is something to look out for as the credit crunch and inflation pressures are hurting the U.S. consumer, that is high gas prices, high diesel prices that push up transportation costs, and burdening grocery bills. The Wall Street Journal has reported that “Hasbro Inc.'s (HAS) first-quarter net income rose 14% as the international business returned to profitability and more than offset declining domestic earnings.” This small bit of information about the international nature of the industry

4 certainly displays the ability of firms to offset losses in the credit crunch among other areas of the world. The growth potential of this industry is not grounded in the U.S. anymore; the next big market may be Latin America or India and that shows an international industry in a global economy that has enormous profit potential.

Accounting Analysis

To view the true economic and financial position of the firm in its industry an analysis in accounting measures should display the accounting methods used by the firm and should convey its distortions. The Key Success Factors identified earlier and the accounting policies on that subject are targeted for examination. A better economic and financial position should be shown by undoing these distortions to display how well the firm is meeting its Key Success Factors.

The firm Hasbro had a number of distortions from accounting practices pertaining to Key Success Factors which are both common in the industry and a requirement by GAAP.

The Key Success Factor, brand Image, would be shown under advertising expenses. These are not capitalized into any intangible asset such as brand names or well known products, however this was reasonable given the unpredictability with a successful marketing expenditure and GAAP requirements are correct.

The operating lease arrangement is standard industry practice and allowable under GAAP rules however, this does not show an accurate view of the firm economic or financial because of the ability to inflate key ratios like return on assets and debt-to- equity that measure performance. These leases were capitalized with information given in Hasbro’s 10-Ks and the result displayed more assets and liabilities than Hasbro would have preferred to disclose. Net income showed no net change overall but did show a gain or loss in specific years. These new numbers to the bottom line made a forecast more troubling and were not included in a restatement but were shown separately to show the effect on the balance sheet and income statement. The capitalization did

5 show a net reduction in new leases and displays the firm’s commitment to efficiency through cost control, a Key Success Factor.

R&D expenditures are expensed under GAAP however; they were capitalized to give a different view of the firm not shown in the financials. The capitalization displayed a benefit to net income in the most recent of the past years after amortizing the R&D “assets”. The result showed a strong commitment to a Key Success Factor and meeting that with good expenditures initially with a benefit after capitalization.

Financial Analysis, Forecast Financials, and Cost of Capital Estimation

When valuing a firm it was necessary to look at the ratios of liquidity, profitability and capital structure. With the liquidity ratios we decided that the past three years was more reasonable then the past five years because the calculations were approximately the same. When considering profitability ratios, the operating profit margin for Hasbro were at a steady increase over the past years but still similar to the industry. This shows its ability in creating profit after deducting operating expenses. As for capital structure ratios, Hasbro is outperforming in the debt to service margin ratio which shows their ability to pay short term notes with operating cash flows.

After determining the ratios for Hasbro as well as its competitors we were able to determine what would be best to forecast. This is also important in valuing the firm and in our calculations we forecasted the statements out a total of 10 years. Major forecasts include net income, CFFO, CFFI, retained earnings, and book value of equity. Also included are other parts of the financial statements such as total assets were we used an asset turnover rate of 1.25. This number was determined by looking at the asset turnover ratios from the past five years and seeing that there was a steady increase. Also, retained earnings and stockholder’s equity were adjusted each year by the amount of net income earned and the amount of dividends paid. Cash flows were forecast based on an average CFFO/sales ratio of 13.67%.

6 To find the cost of capital, we need to find the cost of equity and the cost of debt. In order to find our cost of equity, we need to find our beta, which is found by doing different regression analysis. We found out that by using the 2 year treasury constant maturity rate at 36 months gives us the highest adjusted R^2 of .4079 causing our beta to be 1.51, which says that Hasbro is a volatile company. By getting out beta, we plugged that into our cost of equity formula and got 15.67% for our cost of equity. To find our cost of debt, we used the 3 month AA commercial paper rate. We ended up with a cost of debt of 5.89%. With these two pieces of information, we came up with a before tax weighted average cost of capital of 10.07% and an after tax weighted average cost of capital of 8.85%.

Valuations

The purpose of these valuations is to see if your company is overvalued, undervalued, or fairly valued. We have to remember that we are valuing our company as of April1, 2008, so we used that share price of $29.27 throughout these valuations. The first valuations we did were methods of comparables. Doing these eight comparables, the only thing we can conclude is that Hasbro is not a fairly valued company. The only two ratios that showed that it is fairly valued is the trailing price to book and the forward price to book ratios. There was a tie between the last six comparables. Three ratios, price to book, dividend to price, and the price earnings growth, came out to be overvalued and the last three ratios, price to EBITDA, price to future cash flow, and enterprise value to EBITDA, came to show that our Hasbro is undervalued. Our share prices ranged from $18.66- $45.17, so you can see that these methods of comparables are all over the place. The second and more accurate valuation models we used were called intrinsic valuation models. Here we used five different models to value Hasbro: dividend discount model, free cash flow model, residual income model, abnormal earnings growth model, and the long run residual income perpetuity model. Even though we had uncertainty with the methods of comparables, we can conclude that by using the intrinsic models that Hasbro is an overvalued company with using our 15% market error. First of all, the dividend discount

7 model was mostly overvalued, but came out with fairly valued prices. The free cash flow model was the only model that came out to be undervalued with a few fairly valued and overvalued prices. The residual income model, abnormal growth model, and the long run residual income model all had nothing but overvalued values, with their highest share prices of almost $15.

Business and Industry Analysis

Company Overview

Hasbro is one of the top leaders in the toys and games industry. They produce hundreds of thousands of toys a year having a total revenue of $3151.5 million in 2006, as stated in Hasbro’s 10-K. The company was organized in 1926 in Rhode Island and is still to this day located there.

Hasbro’s target market is mainly young children under the age of 12 and they offer a variety of products. As stated in the 10-k, they manufacture a broad variety of games including traditional board, card, hand-held electronic, trading card, role-playing, plug and play and DVD games, as well as electronic learning aids and puzzles. Hasbro also offers its products under brand names such as Playskool, Tonka, Milton Bradley, Scrabble, Jenga, Mr. Potato Head, Easy Bake, etc. (finance.yahoo.com) This is a highly competitive market so they are determined to meet the customer’s needs. They distribute their products in a variety of ways by offering their products to different distributors, wholesalers, and department stores; they also offer catalogs, mail house orders and internet sales. They have also reached an agreement with Thorley Industries to launch two new products in 2008. (WSJ) This could help with their distribution and their target market.

Hasbro’s main facility is in the United Sates but they are internationally located as well. In the 10-K they divide the regions into two different segments, North America and International. North America includes the United States, Canada, and Mexico where as Europe, the Asian Pacific, and Latin and South America are considered to be

8 International. However, from 2005 to 2006 there was a drop of 3% in revenues from the International segment. The weakened U.S. dollar played a large role but in past years they have had a subtle increase.

With all their different locations Hasbro needs a sufficient amount of employees. They had approximately 5,800 employees worldwide and approximately 3,200 in the United States alone. However, in recent news the Wall Street Journal stated, “Hasbro Games said it will cut about 200 manufacturing and support jobs and invest $40 million in its East Longmeadow, Mass.” This is difficult for the employees but will be good for the company in order to modernize their equipment and production.

Hasbro’s stock is up by more than 2%, currently trading at $25.87. Also in the WSJ, it is stated that Hasbro’s board of directors has authorized the company to repurchase an additional $500 million in common stock. This will help add value for their shareholders.

Total Assets Net Sales Sales Growth

2002 3142.88 2816.23 -1.4%

2003 3163.38 3138.66 11.4%

2004 3240.66 2997.51 -4.7%

2005 3301.14 3087.63 3.0%

2006 3096.91 3151.48 2.1%

(www.moneycentral.msn.com)

9 Industry Overview

The toy and game industry is a part of the consumer goods sector of the U.S. economy. “The toy manufacturing industry includes about 900 companies with combined annual revenue of $5 billion. Major companies include Mattel, Hasbro, and JAKKS Pacific.” (mindbranch.com). Many of the firms in the industry have sourced their manufacturing to places with low labor costs like China, while failing to oversee the production process or their suppliers. A massive lead paint toy recall has been underway as of recently due to current industry standards. The industry even has its own association, Toy Industry Association, to promote government advocacy, to keep the public informed, and to encourage the government to recognize the needs of the toy industry. This “not-for-profit trade association for producers and importers of toys and youth entertainment products sold in North America, representing over 500 companies who account for approximately 85% of domestic toy sales” (toyassociation.org). The industry itself has unique characteristics which are high concentration, low competition, brand names, and an international supply chain network. The major players in the industry are dependent on free trade, are sensitive to trade barriers, and currency risk given the international reach of the firms in the industry. The two major competitors appear to be Hasbro and Mattel. Both have a wide variety of popular trademark toys and board games. They are also highly capitalized, well known, and are dependent to consumer confidence and strong purchasing power among the public. Although current income, sales, and growth have shown signs of weakness, the toy and games industry will continue to serve customers into the future.

10 Five Forces Model

The five forces model used in this report will explain the industry profitability by assessing the degree of actual and potential competition and by determining the bargaining power in input and output markets. From this model and through the subcategories of rivalry among existing firms, the threat of new entrants, and the threat of substitute products can the degree of competition be determined for the industry that Hasbro engages in with its competitors. Determining industry competition will reveal the price which consumer’s are willing to pay for the products and services within the industry. The model will also show in detail the industry’s relationship with suppliers and customers and how this affects profit structure of the industry firms.

Consumer goods industry; toys and games – Short overview

1: Rivalry among existing firms LOW 2: Threat of new entrants LOW 3: Threat of substitute products AVERAGE 4: Bargaining power of buyers AVERAGE 5: Bargaining power of suppliers HIGH

11 Rivalry among existing firms

Under this section, the topics of (a) industry growth, (b) concentration and balance of competitors, (c) degree of differentiation and switching costs, (d) scale/learning economies and the ratio of fixed to variable costs, and (e) excess capacity and exit barriers are discussed.

Industry growth

As this chart below demonstrates, the toy and games industry shows some less than spectacular growth. It shows a decline in growth overall for the year 2005. It is important to note that although the chart is dated it may show a trend. It should be mentioned that an expected recession is on the way as “U.S. gross domestic product rose just 0.6% in the fourth quarter, while growth in personal consumption expenditures slowed to 2% from 2.8% a quarter earlier” (money.cnn.com). The Wall Street Journal has picked up on this recently under titles like “U.S. consumer woes hit economy”, while noting that there are “fresh signs that consumer spending is slowing”. The NPD Group has reported “a decline of only 2 percent” of retail sales of toys between 2007 and 2006 stating “The strong performance of two key super-categories helped to offset losses. Sales of Action Figures & Accessories were up 8 percent over 2006, while Vehicles experienced a 6 percent increase over the same time period”. With inflation fears, low consumer spending, slower than expected growth, and consumer confidence down in January of 2008; the growth rate of the toy and game industry could see a dent in the near future. On the optimistic side, the sales figures reported by NPD Group in 2005 were most disheartening in the action figures and accessories and vehicles categories than the 2007 numbers. Growth in this industry 2007 onward will depend on how resilient firms are to a very weak dollar, high gas prices, and grocery bills. As MSNBC has reported, “Food vendors are forced to explain higher prices; poor squeezed” or “U.S. seeing worst food inflation in 17 years”, it would be hard to continue to forecast something less than a rough ride for the firms in the industry past 2007.

12 www.conference-board.org

U.S. Toy Industry Sales Figures Category $ Toy Sales 2005 (USD) % Change from Prior Year Action Figures and Accessories $1.3 billion +4% Arts and Crafts $2.4 billion -4% Building Sets $695.2 million +16% Dolls $2.7 billion -2% Games/Puzzles $2.4 billion -9% Infant and Preschool $3.1 billion -1% Learning and Exploration $392.0 million +5% Outdoor and Sports Toys $2.7 billion -3% Plush $1.3 billion -15% Vehicles $1.8 billion -8% All Other Toys $2.5 billion -4% Total Traditional Toy Industry $21.3 billion -4% Total Video Games $10.5 billion +6% Source: The NPD Group February 2006

13 Concentration and balance of competitors

The toy and game industry is unique in that there are trademark products that different firms own and license out that they have researched and developed or purchased from others. This enables firms to carve out a niche and acquire market share with their trademark products and provides for some flexibility in pricing as the products belong to the firm with which it originated. This has an ability to lock out others in producing the same toy or game and prevents more than just replicating the cosmetic features of a product such as the Monopoly board game. Reproducing that same idea may get you sued. A balance of competitors does not exist in the industry and competition appears to be tight with only two major firms. Hasbro and Mattel are dominating the industry and appear to be unrivaled. To prove the point the chart below shows a big gap in revenue for the top three firms and the firms below. What is interesting is the electronics or video/computer gaming industry which is drawing children from this industry “toy and games” to video/computer games. This is known as “children getting older younger”. Although the video/computer game industry will take away young consumers from this industry, it will lead to further concentration in the future of firms to compete over a dwindling consumer base, young children. In conclusion even though there are many firms here, there are really only two major competitors given their original product line; this is a concentrated market with uneven competition slanted in Mattel and Hasbro’s favor and will continue to be.

Leaders in Total Revenue (ttm) Source: yahoo! finance MATTEL INC [MAT] $5.9 B HASBRO INC [HAS] $3.7 B INTL GAME TECH [IGT] $2.6 B JAKKS PACIFIC INC [JAKK] $810.3 M RC2 CORPORATION [RCRC] $505.0 M LEAPFROG ENTERPRISES [LF] $443.8 M RUSS BERRIE CO INC [RUS] $320.6 M E X X INC CL A [EXX-A] $132.4 M MAD CATZ INTERACTIVE [MCZ] $87.2 M CORGI INTL ADR NEW [CRGI] $67.4 M

14 Degree of differentiation

Given the nature of monopolistic competition this industry finds itself in, the differentiation of the product lines of these firms can be quite diverse. For example, Hasbro owns the rights to the board game Monopoly and Mr. Potato head, while Mattel owns the rights to Barbie and Hot Wheels. Since these firms carve out a niche for themselves by acquiring ownership rights or by developing a unique product line, these firms can “lock out” the competition from the same unique ideas.

Switching costs

Given the brand names of the products themselves and the unique nature of the products offered, the consumer will find difficulty in switching from one product to the other because of the diverse nature of the industry. In other words you can only get Monopoly from Hasbro and Barbie from Mattel which makes switching costs for the consumer high. Differentiation, clever marketing, and the “must have” attitude of many young children contribute to a high switching cost phenomena present in the industry.

Scale/learning economies and the ratio of fixed to variable costs

In an industry where size is an important factor for firms and their success, there will be competition for market share. In this case the size is determined by market capitalization and it is shown that there are two major competitors in terms of size. Given sourcing opportunities, fixed to variable costs are expected to be high and therefore firms have some incentive to reduce price. It should be noted that International Game Technology (IGT) was omitted over disagreement with our Yahoo! Finance source on the grounds that their business was significantly different than the firms mentioned above.

15 Excess capacity and exit barriers

The assets of the firms include many unique products whose trademarks are worth quite a bit. This investment of the firms in their unique assets is a barrier to exit however, buying and selling the rights to these unique products alleviates this to some considerable effect as many of those assets may be sold for a margin which is profitable depending on R&D costs or acquisition costs. Under these circumstances, if a firm decides to leave, the exit barriers may at times prohibit excess capacity to be exacerbated. But in conclusion, given the investment on assets and future return on them, a departing firm should expect the process to be a costly decision. Exit barriers are high and excess capacity will be exacerbated in the process.

Conclusion

The concentration of the firms in this industry is quite intense given the diverse product line and the “lock out” ability it can have. The balance of competitors showing only three or perhaps four major firms and market capitalization showing only two major firms shows how concentrated the industry really is. The switching costs of the consumer were a considerable factor in showing the differentiation in product lines and the monopoly status of the firms in the industry. This is a low competition, highly concentrated industry.

16 Threat of new entrants

Examining the threat of new entrants affects the pricing of the firms within the industry and the ease of entry affects profitability of these firms as well. The factors used to determine the threat of entrants and barriers to them are (a) economies of scale, (b) first mover advantage, (c) access to channels of distribution, and (d) legal barriers.

Economies of scale

The acquisition costs or R&D costs of the product lines will be considerably high for the firms in the industry and therefore the firms will have to spread their fixed costs over a large sales volume. To create a brand from scratch requires advertising costs on top of these R&D costs; a major barrier is created preventing aspiring firms to enter this industry and existing firms are shielded from them.

First mover advantage

There are first mover advantages to this particular industry since the existing firms will have the resources available to acquire the rights to new or upcoming products and “lock out” any entrants. For the existing firms it is especially important to be the first to find and acquire these products or their respective companies before an existing firm can snap them up. These firms will also strive to be first in other similar markets such as the video game industry as the Wall Street Journal notes, “In an effort to tap the fastest-growing segment of the videogame market, Electronic Arts Inc. and Hasbro Inc. have formed a broad alliance to create electronic versions of Monopoly, Scrabble and an array of other Hasbro board games and toys.” The press release titled “Hasbro Closes Acquisition of Cranium, Inc.” (Hasbro, Inc.) should convey the point about snapping up new products; firms aggressively seek anything that may return a profit before their competitors do. Any new entrant could not possibly have this advantage that existing participant’s do, although Cranium was a new entrant, they were also bought out.

17 Access to channels of distribution and relationships

Relationships with firms like Wal-Mart, Target, and others would be necessary to effectively gain a return for any firm in this industry as well as relationships with suppliers where production is sourced to, at times overseas. This provides many obstacles to any firm that wishes to enter into this industry because carving out access to distribution channels through establishing strong relationships will be tough. An unusual and infrequent example is the firm Cranium, Inc. establishing a relationship with Starbucks Corp to advertise a board game through a close relationship with its CEO. As a note, “it was the first board game ever sold at Starbucks” (USA Today) and appears to be an infrequent occurrence, it was also snapped up by Hasbro, Inc.

Legal barriers

While there are many legal barriers at the federal, state and local level, these barriers become too diverse at the state and local level to be mentioned and may be a trivial barrier to a new entrant to this industry. A new entrant may accidentally infringe on copyright law, but given the chances there does not appear to be any major legal barriers worth mentioning which are specific to this industry. Also, according to the Wall Street Journal, “Congress is promoting new legislation to crack down on companies selling products said to be defective or dangerous.” With the many recalls taking place in the U.S. now-a-days from foreign-made toys, this is hurting everyone involved in the industry. Congress wants to make sure this doesn’t happen again, because all of these “defective or dangerous” products are hurting the industry and most importantly the customers buying these products.

18 Conclusion

The threat of new entrants into the toy and game industry appears to be low. There may not be many legal barriers but given the economies of scale factor and the first mover advantage factor, the threat of entrants will not be significant in this industry. Although as a side note the definition of the “toy and games” is in the traditional sense of what we would normally consider toys or games for this report. Take this gem from the 2007 financial statement from Hasbro, Inc., “In addition to contending with competition from other toy and game companies, in our business we must deal with the phenomena that many children have been moving away from traditional toys and games at a younger age. We refer to this as "children getting older younger." As a result, our products not only compete with the offerings of other toy and game manufacturers, but we must compete, particularly in meeting the demands of older children, with the entertainment offerings of many other companies, such as makers of video games and consumer electronic products.” The industry mentioned previously could be more appropriately called the video/computer game industry. In this traditional sense the firm faces few threats when marketing to children of a young age but in a changing environment and culture it faces many threats.

Threat of substitute products

The definition of substitute products does not necessarily mean that the products in question have the same form but, fulfill the same consumer need or in other words, the two products perform the same function. For this industry, a product that performs the same function depends on the price of the two in order to determine whether or not there is a real threat. The customer’s willingness to switch between products and the relative price and performance of a firm, are key to determining the threat of substitute products.

19 Relative price and performance

The price of individual products produced by the firms within the industry is hard to compare as the product line introduced to the market by each firm is relatively diverse. Although toy products can be similar, it appears that effective marketing campaigns are made by the firms tend to help command a premium if the toy brand in particular is popular. For instance toys under the “dolls” category could include the products “Barbie”, “Cabbage Patch Kids”, or “Bratz”. While the products are under the same category, the firms within the industry tend to put an emphasis on differentiation and by marketing effectively to build a loyal consumer base. Within this industry, firms can command a premium price from their respective consumer base. A competing firm or new entrant may have a substitute for the toy brand “Bratz” at a lower price, but the challenge itself would be difficult given existing consumer loyalty or a lawsuit. There are instances of good substitutes like the “Lego’s” product or “Linkin’ Logs” that keep prices from being ridiculous.

Buyer’s willingness to switch

In some instances, it’s not going to happen. These firms market to some very young children and build a devout following among these groups. The switching costs for the parent, the actual buyer, say during Christmas time, may be disastrous. Given the marketing techniques used and the fact that these firms will compete to buy the rights to the next best thing for an exclusive monopoly, the buyer’s willingness to switch is very low. In contrast with the above example of “Lego’s” versus “Linkin’ Logs”, the buyer’s willingness to switch is high.

Conclusion

When competing in this industry there are many ways to defend against substitute products. Effective marketing can work at reducing switching costs and buying ownership rights can give an exclusive monopoly to achieve the same goal. Both strategies lead to a price premium charged by the firms. The threat of substitute products for this industry is average because there are price premiums, ownership

20 rights, and some effective marketing techniques but, some goods are comparable in performance or function.

Bargaining power of buyers

The overall profitability of a firm has a relationship to the bargaining power of consumers attracted to the industry. There are two factors which determine this power these are: Price sensitivity of the buyer and relative bargaining power.

Price sensitivity

Within the toy and game industry, the price sensitivity of the buyer is average. The products are differentiated to some degree even when the products offered fall under the category “dolls”. This does not suggest that these are luxury goods but, the buyer is not in the best position to find substitutes for a “Buzz Lightyear” action figure. If the products are in demand, a premium will appear and emerging firms cannot necessarily offer the same product to bring the premium down. There is ownership rights within the toy and game industry, substitutes may not appear and a big part of revenue for these firms within the industry would be well known brands. Considering switching costs and differentiation of certain products, consumers are not entirely sensitive to price but, many may still find substitutes.

Relative bargaining power

The bargaining position of the consumer for the toy and game industry can rest on the cost of not doing business. With marketing techniques and somewhat exclusive monopolies that present the consumer show that they are not in the best position to switch because these costs can be high. The cost of not doing business could also be quite low because there are still substitutes to be found, for example, there are always plenty of board games to choose from. The relative bargaining power of the consumer is average.

21 Conclusion

While there are some “hot” products out there by competing firms not all of them are without substitutes. The price sensitivity of the consumer can diminish when products are in demand and substitutes cannot be found but, this is not always the case with other products offered by the firms within the industry. Switching costs are therefore averaged out as well as price sensitivity and bargaining power.

Bargaining power of suppliers

In every industry you have to deal with suppliers, just like you have to deal with customers. Dealing with suppliers will always effect how a company works. According to Business Analysis & Valuation by Palepu & Healy they say that “suppliers are powerful when there are only a few companies and few substitutes available to their customers.” This is true for the toy and game industry. There are two factors that also determine this power: price sensitivity and relative bargaining power.

Price sensitivity

In the toy and game industry, the price of sensitivity is high. Since there aren’t many companies in this industry to compete against, the price of sensitivity for the suppliers will be more powerful than for the buyers. There are a limited number of suppliers, so they are going to be concerned about the prices. If suppliers make prices too high, then customers won’t buy them, and they might not do well in the market. Also, these toy and game companies in this industry are known for some products that no one can create substitutes for, so dealing with prices with the suppliers are important to maintain. In some cases, smaller firms can create substitutes for products, but they might not have that loyalty from the consumer, so that won’t get them anywhere. When people see the brand names like “Mattel” and “Hasbro” on the boxes, those are well-known names that make well-known products, so consumers know they can count on those companies to give them good quality products.

22 Relative bargaining power

In the toy and game industry, suppliers play an important role in the industry. With there being many popular items like “Barbie” and “Monopoly,” from large firms in the industry, it is important to create a good relationship with the suppliers. Firms with a high bargaining power are able to work with the suppliers and get the prices they want, because their business is very important to suppliers. There aren’t many companies in this industry, so they have that high bargaining power with the suppliers, because the suppliers need their business to continue on in the market.

Conclusion

Dealing with suppliers is an important aspect in the toy and game industry. With there being only a few companies, suppliers want their business. Even though there are some products you can create substitutes for, many consumers will stick with the brand name product they know that’s been around for a long time. This is good for suppliers, because they know that they will be in the market for a while with this typical industry.

23 Analysis of Key Success Factors

Within the toy industry there is a large amount of competition. It is imperative for a company to devise successful strategies in order to capitalize on its consumers. These strategies will determine the successfulness of the company as well as improve the value of the firm. There are two strategies firms use in general: cost leadership and differentiation. The majority of the strategies used in this industry can be characterized as differentiation. One of the only forms of cost leadership present in the toy industry is efficient production through the use of outsourcing.

Differentiation

Differentiation is the most important strategy that competitors in the toy industry employ. This strategy is defined by offering consumers a product that is unique while remaining affordable. The two main competitors in this industry include Mattel and Hasbro, however there are a number of smaller companies that also use these strategies to gain a competitive advantage. Children do not necessarily focus on the cost of the product; they want to be satisfied with the toy itself. This is why differentiation is extremely important. There are a couple ways this strategy is used in the industry including providing product quality, product variety, flexible delivery, brand image and creativity and innovation.

Superior Product Quality

The quality of products has always been an important part in the toy industry. One of the best ways of improving the image of the company, quality is always in the forefront of a company’s strategy. Product quality has become increasingly important as of late. With more companies using outsourcing as a way to produce their products, toy companies are under pressure to make sure their products are built well and are safe to be used by our children. Unfortunately there has been a lot of news lately referring to the presence of lead in prominent toy brands. According to ToysRus CEO Gerald L. Storch, the main source of this problem can be attributed to substandard

24 housing in China, the location of most outsourced toy production. Nevertheless toy sales have not faltered as much as expected. Parents are still interested in purchasing the hot new toys that their kids are asking for.

Superior Product Variety

Providing a variety of products is important to ensure that the consumers keep returning to purchase another item. Companies will stretch out a product line as long as it remains popular. Larger companies will take this strategy to another level by offering a variety of products with limited availability. Referred to as the “Rolling Mix”, companies will design a line of products and after a certain amount of time reduce or even eliminate certain products and bring in a new set of toys. One example of this is the Hot Wheels line of toy cars made by Mattel. Mattel will design a set of about eight cars and slowly rotate them on and off the shelves of retailers. This is very effective in bringing children back into stores looking for the newest and most exciting toy car. It is important that these toy companies keep the attention of children. This is one way in which companies find a way to keep children coming back.

Flexible Delivery

Flexible delivery is imperative in determining whether a line of toys will sell well or miss its best opportunity to get into the hands of children. There are a number of ways that flexible delivery strategies are used in the toy industry. One use of this strategy is meeting specific dates. Many toys rely on outside factors in order to be successful. For example, Hasbro used the release of the new Star Wars films to its advantage by developing a line of Star Wars action figures. They decided they would wait while the movie builds popularity through advertising and hype in general from the many fans. Only a couple weeks before the movie was set to open, Hasbro released its line of action figures. The timing was perfect as they sold a tremendous amount of toys. The delivery was important because one day late would result in thousands of toys that remain on store shelves. Having a delivery catastrophe and not releasing the

25 action figures until a week after the movie was released would have resulted in a disaster.

Another way toy firms use flexible delivery is to control the amount of toys in the stores. The majority of toys are sold in November and December because of the holiday season. Many times, these few weeks determine whether a company will have a successful year or end up filing for bankruptcy. It is extremely important that the toys are released at the right time.

Depending on the line of toys, companies must be careful not to flood the market with too many deliveries. If a company spots an opportunity to profit from a new idea, the company must decide whether or not the toy will be considered a long term project or a short term money maker. If the line of toys is based off a new television show that has not gained a lot of popularity yet, for example, the company must carefully release only a small amount of toys. Too many toys would result in a loss of interest. This can backfire and cost the company a large sum of money. Eric Johnson, a professor of operations management in Dartmouth, mentions the Teletubbies line of toys as an example of this. When they were first released in England, the company made the mistake of releasing too many toys too quickly. This resulted in many toys sitting in retail stores instead of households. They reduced the amount of toys and began only providing a limited amount to consumers. Months later, popularity rose and finally exploded as people rushed into stores looking for these toys.

Investments in Brand Image

The toy industry employs brand imaging to help market and sell their product. It is crucial that the brand name becomes engrained in the minds of children and their parents. Companies put forth a lot of time and effort into developing a brand image. If a brand has a history of being successful the brand name will sell itself with little advertising. A quality brand name can be an invaluable asset, especially in the toy industry.

26 Creativity and Innovation

There is a lot of importance in creativity and innovation. Children are known to have short attention spans and this carries over into their preference for entertainment. Over the years, toy companies have learned that it is extremely risky to develop a new toy without observing what is popular among children. Nowadays companies will look into what children wish for and design and create toys and games to meet these expectations. This dramatically reduces the risk of a new idea becoming undesirable.

With the advent a new technology the toy industry has put a lot of time and effort into developing innovative toys that use advanced technology. This provides companies with the opportunity to develop new and exciting toys that engage children in a way that was not possible a couple years ago. Technology in toys is primarily used to mimic gadgets and high tech toys that adults love to invest in. Cameras, music players and other interactive devices are highly demanded by children. However, companies are currently not fighting with the high tech gadgets but rather finding ways to fuse play patterns into these gadgets according to the Mattel design vice president Evelyn Viohl. This will remain a current issue in the toy industry for the immediate future and the companies that develop new innovative ways of grasping the imagination of children will succeed.

Cost Leadership

The strategies used in the cost leadership approach are to provide a similar product as one’s competitors but at a reduced price. This is accomplished by reducing costs in production and distribution. The toy industry does not use too many cost leadership strategies because generally children are not worried about the cost of a toy and parents want to satisfy their children’s desires. Nevertheless, companies in this industry have outsourced the production of toys for many years. Toys became much less expensive while not sacrificing quality.

27 Firm Competitive Advantage Analysis

Hasbro is the second largest firm in the toy industry. With total revenue of $3.2 billion dollars and $376 million of that turning into profit, Hasbro has been in the business of providing toys and games since the 1920s. The firm has grown and developed throughout the years, allowing it to develop a competitive advantage in the toy industry. Differentiation strategies such as product variety, flexible delivery, brand image and a large amount of creativity and innovation are the reasons why Hasbro is a successful company.

Historical Competitive Advantage Analysis

In 1923 Henry and Helal Hassenfeld founded Hasbro in Rhode Island. Originally a textile remanent seller, they began producing pencil boxes and school supplies soon afterward. The brothers began the Playskool line of toys in 1928 when two former schoolteachers felt it was important for preschool aged children to learn at home with the help of educational toys. From that point on innovation was a major key success factor in the growth of Hasbro.

Early Innovations

Hasbro produced many successful toys in the first few decades of its existence. The Monopoly board game was introduced in 1935 is still considered the best selling board game ever. Tonka trucks, Candyland and Scrabble are popular games that were developed in the 1940s. Mr. Potato head in 1952 became the first widely successful toy made by Hasbro and also made history as being the first ever toy to be advertised on television. In 1956 Play-Doh was discovered and became the most well known form of modeling clay. The most well known toy that was to be developed by Hasbro in the 1960s is the J.I. Joe. Hasbro labeled this toy the “world’s first action figure”. Hasbro felt that boys at the time did not want to play with a toy that was considered a doll and created this label. It has since turned into an entire category of toys with hundreds of variations and styles. It is apparent that Hasbro used innovation to create toys and

28 games that would grab the attention of children and it proved to be a very successful strategy.

Modern Innovations

One of the things that have drastically morphed the industry since the Hassenfeld’s founded Hasbro in 1923 is the emergence of video games and electronic, interactive toys. What once was a market dominated by dolls and action figures is now one where customers are more and more frequently opting for video and computer games. Customers are now given the choice at the checkout line of whether to buy an action figure, which stimulates a child’s imagination, or an X-Box game which can be played for days upon months without getting tiring. While today’s children are more frequently playing high quality video games, G.I. Joe and Mr. Potato-Head have been relegated to their final resting place on the top shelf of many closets, out of sight and out of mind. With this swiftly changing market innovation in the present and into the future becomes more important than ever. In 2004 Hasbro developed the VIDEONOW COLOR player which quickly became one of the industry’s top innovations, and one of toy retailers’ strongest performers. “VIDEONOW COLOR has raised the bar in the world of electronic entertainment for kids, with a vast collection of great content at a price that offers tremendous value, its sure to be an item kids are asking for,” said Jim Silver, publisher of Toy Wishes Magazine. This portable, personal video player with a color LCD screen features some of the hottest titles for today’s children such as SpongeBob Square Pants and Jimmy Neutron. Though the Hassenfelds could never have imagined something of this nature when they founded Hasbro, it is this continued innovation which is imperative to gaining a competitive advantage over rivals such as Mattel.

29 Superior Product Quality

Hasbro has played a leading role in providing products to its consumers that meet and exceed quality expectations. The toy industry has been under a lot of scrutiny regarding lead paint and other health concerns. Hasbro’s CEO Alfred Verrecchia has reported to the public that “none of our toys or games [were] affected by the recent recalls related to lead paint.” (cafemom.com) The successfulness and growth of Hasbro is directly related to decades of supplying products that meet quality standards. Hasbro’s Playskoool brand is very popular among parents. This popularity exists because of the time and effort that the company puts into making sure those toys will be safe to very young and vulnerable children.

Hasbro has a quality assurance plan that spans over 20 pages. Within these safety and reliability specifications the toy company has mapped out every possible safety issue that could occur. The firm then clearly explains what makes a product suitable for consumers and what attributes make an item stay in the production plant. These qualifications are looked after with the help of Hasbro’s Quality Assurance Department as well as third party labs. Hasbro strives to meet and exceed the regulations and laws enforced by the Consumer Product Safety Commission. The company is also open to comments or concerns the public might have regarding product safety and makes sure there is plenty of contact information on item packaging and the company website.

Superior Product Variety

Hasbro’s product variety is astounding. With over a hundred different brands each providing many different products, Hasbro is able to offer it’s consumers with a wide range of toys and games. During the 2005 Toy Fair in New York, CEO Alfred Verrecchia said that, “today’s consumers can be entertained in so many different ways…as the marketplace evolves, it is Hasbro's job to stay ahead of the curve, and our 2005 product line is reflective of our strategy to provide consumers with the right toys, games and lifestyle products that are relevant and fun…” (Business Wire) It is

30 important for toy companies to provide for different age groups. This will give the firm a larger amount of consumers. Hasbro capitalizes on toddlers up to teenagers. One can say that their line of board games can be aimed at the children’s heart found in adults as well.

Flexible Delivery

Flexible delivery has been and continues to be one of the main tools used by companies in the industry to increase sales. Flexible delivery methods help companies save money on advertising while at the same time relying on outside advertising to increase the hype for their product. Using Spider-Man as an example, Hasbro waited till the trailer and many commercials advertising the movie built up hype for the movie. After this they chose to release the Spider-Man product line in stores and all of the consumers who had been prepared for the movie by the endless advertising were given the chance to buy the product before the movie even came out in theatres. Another flexible delivery method that is very popular in the industry is releasing the bulk of products in the months of November and December before the holidays. This is when most of the products in this industry are sold and as a result by releasing the majority of their products into stores at this time of the year, it helps keep inventory down at other times of the year when sales are lower. This also makes the majority of company’s products available to consumers when the consumers are most likely to buy. Due to this as mentioned previously, the holiday season is when always have and in the future will always continue to realize their profits or losses for a year.

Investments in Brand Image

In the 1920s before the era of television shows and movies, toys such as Mr. Potato-Head and the G.I. Joe flew off the shelves faster than they could be put up in most cases. At this time there was more of an emphasis on research, development and creativity in order to create the next hottest toy that every child had to own. Making the most unique product was often times the key to building a successful corporation and Hasbro excelled at making unique, creative toys and board games that competitors

31 couldn’t produce. As society evolved and television and movies became a bigger part of children’s everyday lives, Mr. Potato-Head and the more unique products on the shelves were being neglected in favor of toys which portrayed children’s favorite movie and TV show heroes. This created a giant niche in the market for company’s to provide authentic, licensed action figures portraying children’s favorite characters from Star Wars, Batman, Superman, etc. With this came the need to purchase licensing rights from corporations such as Disney and Warner Brothers for the right to produce authentic characters. This is why today there aren’t too many giant corporations in the toy industry. With companies such as Hasbro and Mattel purchasing licensing rights, the smaller producers could no longer be competitive with their generic action figures when children could have a Superman or Batman toy identical to their heroes on television and in theatres. Having licensing rights for entire toy lines such as Star Wars and Transformers reflects very positively on Hasbro’s brand image as a whole. Though many children are unfamiliar with what company makes their products, they all know the high quality of not only their action figures but also board games such as Monopoly, most popular board game of all time. These all become commonplace in households throughout the country and their quality reflects on the quality of the name Hasbro.

Cost Leadership

Though product differentiation is what provides Hasbro’s biggest competitive advantage, it is impossible to disregard the importance of providing quality products at not only affordable prices, but prices lower than that of competitors. The reason cost leadership is not more important is because by being the only one to sell Monopoly and Star Wars figurines, Hasbro isn’t worried about Mattel producing a cheaper Monopoly game. In the effort to produce the most affordable products, the industry has begun outsourcing many parts of the production process outside of the US to countries such as China. Though this is much less expensive and leads to cheaper prices on the shelves, this has also sacrificed some of the quality. Recently there were massive recalls in the industry because Chinese factories were using lead paint and chemicals found in date rape drugs in children’s toys. As a result companies that produce there

32 toys in America and charge a higher price on the shelf are actually gaining the competitive advantage because parents are beginning to look and see where there child’s toy was made and if it was made in China are more and more suspicious and many times are buying a substitute product made in America.

Accounting Analysis

The goal of accounting analysis in this report is to determine the accuracy or truthfulness in accounting that a firm uses to disclose the economic and financial picture. In addition to evaluating the appropriateness of the accounting policies of the firm; any distortions can be discovered in the firm’s accounting numbers and will be adjusted. The structure of the accounting analysis used in this report is a six step process to evaluate the firm’s accounting quality from an industry perspective. The first step is to identify key accounting policies based on the industry characteristics and the firm’s key success factors. The next step will be to assess accounting flexibility to determine any constraints by standards and the consequences of such constraints. Following this step will be an evaluation of accounting strategy to determine the firm’s true performance which may be hidden underneath any manipulation. The fourth step would be to determine the quality of disclosure and whether or not managers are only meeting minimum disclosure requirements. The next step would be to use a quality analysis approach to unmask any questionable accounting, the goal being to indicate any “red flags” to the reader. The final step after determining any misleading information discovered would be to undo the accounting distortions and restate all false information to the fullest extent possible.

Key accounting policies

This section serves as a link between that accounting analysis to the outcomes of the five forces classification and the key success factors determined previously. The accounting numbers will indicate how well the business is managing its key success factors within its business strategy. The key success factors for the firms in this industry were brand image, cost leadership, and research and development or differentiation.

33 Measuring these key success factors (especially R&D) accurately by the quality of the manager’s accounting policies is a must.

Research and development Research and development is important for any firm in the toy and games industry and when it comes to the accounting numbers it should be expected to see some solid investment in this area. On the subject of research and development, the firm Hasbro, Inc. reports its expenses and reiterates previous year’s expenses on the same item. The firm also gives an explanation on the driver of the expense figures. Under the section titled selected financial data the firm states that “research and product development expense increased in 2006 to $171,358 or 5.4% of net revenues from $150,586 or 4.9% of net revenues in 2005. This increase is the result of development expenses related to the MARVEL line of products as well as increased investment in the PLAYSKOOL line” (2007 10-k Hasbro, Inc.). The numbers below are the reported figures in the income statement for Hasbro, Inc. 2007 2006 2005 2004 R&D expense $167,194 $171,358 $150,586 $157,162 (2007 10-k Hasbro, Inc. in thousands)

The drivers of the figures from 2004 to 2005 are adequately disclosed as the drivers from 2005 to 2006. In the 2007 10-k under the section titled selected financial data, it is stated that “The decrease reflected increased efficiencies in the product development of certain toy lines resulting from a realignment in 2004. This realignment streamlined the workforce of these toy lines and moved certain product development activity outside of the U.S.” The focus on research and development is key for this industry and the company remarks on this by stating that “while the company strives to incur these costs in the most efficient manner possible, investment in research and product development costs is an important component to the company's strategy to grow core brands and to create new and innovative toy and game products.” This piece of information is critical to investors since we would expect expenses to be incurred as

34 an indication of future profits from such investments. All in all, what was outlined above shows what would be expected to be seen in any firm in the industry, that they are making appropriate investments and are disclosing such information. Accounting transparency over and above GAAP requirements is very much desirable in this area. On the topic of GAAP there is the constraint of viewing all R&D as expenses when it certainly could be an asset. To accurately view a firm in this industry, R&D to some extent ought to be taken out of GAAP and capitalized to get a grasp of potential future profits. On the topic of disclosure in R&D “expenses”, Hasbro, Inc. sufficiently discloses one of its key success factors in the toy and game industry.

Pensions Hasbro has pensions and other postretirement plans, like health and life insurance, for their full-time employees “who retire under any of its United States defined benefit plans and meet certain age and length service requirements” (Hasbro’s 2007 10-K). They are recognized as liabilities. As it is stated above, Hasbro has a defined benefit plans. They use “expected return on assets, expected compensation increases and applicable discount rates” (Hasbro’s 2007 10-K) to compute their benefits. Below it shows how these percentages have determined the benefit cost of the pension plans.

2003 2004 2005 2006 2007 Discount Rate 6.50% 6.0% 5.75% 5.50% 5.83% Rate of future 4.00% 4.00% 4.00% 4.00% 4.00% compensation increases Long term rate of 8.75% 8.75% 8.75% 8.75% 8.75% return on plan assets (Hasbro’s 2007 10-K)

The table shows that the rate of future compensation increase and rate of returns on plan assets haven’t changed at all during the years, so these won’t produce a large change in the pension expenses. The change will come from the discount rates.

35 Hasbro’s discount rates are close to each other year after year, but there is still some movement going on which affects the pension expenses. “A lower discount rate will result in a higher pension expense and vice versa.” In Hasbro’s case if their rate keeps rising then they will be more aggressive then conservative sometime in the future.

Currency Risk and Political Uncertainty

The toy and games industry includes many multinational corporations with facilities spread out over many nations. Many firms have the manufacturing duties sourced to Far East Asia such as China. Currency risk results from many of these firms during any phase of operations since the world is on a system of “dirty floats” or free floating currencies. As one currency may rise in value over another many firms could be negatively affected in their earnings, there is no compensation for taking on this kind of risk. The competitiveness of a firm can slide dramatically in domestic and international markets. If a nation is unstable the monetary authorities in that country could devalue the monetary unit, for example the United States has an issue with inflation given the housing market mess and the resulting credit crunch. This would indirectly and negatively impact the accounting numbers reported and quite possibly the health of the firm.

Operating vs. Capital Leases

Under GAAP there are two ways to account for leases which are common in the toy and games industry. An operating lease transfers the right to use the property over a fixed period. The lessee does not have to endure any risks of ownership so the lease affects the income statement not the balance sheet. Capital leases affect the balance sheet and are depreciated with an interest expense component on payments each year. Operating leases are common in this industry since firms prefer to keep leases off the books and expenses can be deferred if it is an operating lease.

36 Brand Image

The firm Hasbro discloses quite a bit about what are deemed “core brands” these are highly visible products to the public, meaning that they are well known. In the 2008 10-k it was disclosed that “The Company remains focused on growing core owned and controlled brands” and even disclosed its strategy quoted below:

“In 2007, the Company had significant sales of products related to the Company’s license with Marvel Entertainment, Inc. and Marvel Characters, Inc. (collectively “Marvel”), primarily due to the theatrical release of SPIDERMAN-3 in May of 2007. Given the strength of its core brands, the Company may also seek to drive product-related revenues by increasing the visibility of its core brands through entertainment-based theatrical venues. As an example of this, in July of 2007, the TRANSFORMERS motion picture was released and the Company developed and marketed products based on the motion picture. As a result of pairing this core brand with this type of entertainment, both the movie and the product line benefited.”

On the next page is the accounting numbers for advertising expenses as a percentage of sales for the past eight years. This clearly shows that strong expenditures for Hasbro are an important key success factor.

37 Accounting Flexibility

Accounting flexibility is constrained by the Generally Accepted Accounting Principles for firms in the toy and games industry. These principles can change over time and companies are required to keep their statements up to date on these matters. Accounting standards put forth by FASB may not accurately reflect economic reality for a firm and may not allow flexibility in reporting their picture. An example is research and development expenditures that can only be expensed in financial statements even though at times during the development process it may be more logical economically to record under current or long term assets. For this industry, that means at any stage of research and development can no expenditure be capitalized. When managers have flexibility in accounting standards, the accounting numbers may give a better picture of the economic health of the firm and will be more informative. Where managers are constrained an accurate view of the company may not be reported. It is important to determine the level of accuracy in GAAP to make sense of items in the financial statements in order to get a good idea of a company’s value.

Goodwill The most recent change in GAAP that affected many companies and investors concerns goodwill. On January 1, 2002 the GAAP was changed under the SFAS 142, stating that goodwill and other identifiable intangible assets that have indefinite useful lives are to no longer be amortized. Companies have to reduce goodwill if fair value is less than carrying value by using the present value of future cash flows. As it was put by Dr. Stanley Jay Feldman, “The introduction of 141 removed the use of pooling when accounting for acquisitions in favor of the purchase method. FAS142 provides guidance for determining whether tangible and intangible assets and goodwill have lost market value, or in the language of the FASB have been impaired, subsequent to their purchase. Both 141 and 142 break new ground since they focus on the “fair market values” rather than book values of acquired assets, liabilities and goodwill” (Axiom Valuations). The amortization was a concession over the removal of the pooling

38 method. Below is an industry comparison of the carrying amount of goodwill for each major firm.

2007 2006 2005 2004 Mattel $845,649 $845,324 $718,069 N/A Hasbro $471,180 $469,938 $467,061 $469,726 JAKKS $353,340 $338,00 $269,300 $258,330 LeapFrog N/A N/A N/A N/A (Source: 10-k’s from respective firms, in thousands)

In the game and toy industry, goodwill commonly arises from a merger. For example, let’s say Hasbro, Inc. purchased Cranium Inc. for $77.5 million, $77.5 million being the overall value, but there may be only $60 million worth of net assets. This means $17.5 million in goodwill that will be booked by Hasbro, Inc. on the balance sheet.

Research and development Investments in this area under GAAP will not be shown in the assets section of the balance sheet given the required rules put forth by FASB under the SEC. Under the matching principle revenues have to be matched with expenses and an investment under research and development in the toy and games industry is the development of a particular product that could bring about future profits. Since the revenues may not be likely the expenses from R&D cannot be spread over the course of potential revenues. At any point of the R&D process not a single expenditure can be capitalized. At times to get an accurate view of the economic picture it would be a good idea to at least capitalize some R&D, this is because R&D is a critical success factor and is a good indicator of potential future profits from products being developed. An inaccurate view may be shown under GAAP. To tie this all in consider the goodwill example, Cranium Inc. could have R&D expenses of its own on an upcoming product nearly weeks away for sale that is near the end of its R&D process. “When an acquisition is completed, the

39 acquiring company must identify and allocate goodwill to the acquired assets. If an acquired company is conducting research and development on a new product, but that product is not yet being sold, GAAP requires that any premium in the purchase price over book value attributed to that product be expensed. This scenario is referred to as in-process research and development” (Investopedia.com). Remember Cranium Inc. was purchased by Hasbro, Inc. for $77.5 million. Hasbro, Inc. may determine the product to be worth $10 million of the purchase price and GAAP requires that to be expensed as opposed to being treated as goodwill. The goodwill that Hasbro, Inc. has to record to investors appears as $7.5 million not the $17.5 million as previously thought. Earnings will suffer because of the expense, but this does not mean that the merger was a bad deal, what resulted was a constraint in GAAP requirements. GAAP methods and requirements or constraints and inflexibility are not our friend in determining the future value of a firm given its R&D or an acquisition. This inflexibility doesn’t give an accurate economic view for firms in this industry.

Pensions There is flexibility in pension and post retirement plans. The company gets to pick important aspects like how old the employees can be until they can retire, at what age do they start qualifying for these plans, and how long they have been of service at the company to be qualified for these plans; no two companies are the same. Also, the company has to pick a correct discount rate for their plans and rate of return on plan assets. These numbers that the companies pick can either understate or overstate the expenses. Recently, the FASB issued “SFAS No. 158” which states that “the Company is required to recognize on its balance sheet actuarial gains and losses and prior service costs that have not yet been included in income as an adjustment of equity through other comprehensive earnings with a corresponding adjustment to prepaid pension expense or the accrued pension liability” (Hasbro 2007 10-K). This has caused an increase in the pension liability. Now Hasbro has to show these items on their books to show all the costs that were recognized and unrecognized.

40 Operating vs. Capital lease Leases are very common in the toy and games industry and there is flexibility in determining on how to account for the two. The choice offered by GAAP on how to account for the lease would be to classify the lease as an operating lease or a capital lease. The financial accounting standards board states only one of four criteria has to be met to be treated as a capital lease. The criteria are as follows:

(a) The lease life exceeds 75% of the life of the asset (b) There is a transfer of ownership to the lessee at the end of the lease term (c) There is an option to purchase the asset at a "bargain price" at the end of the lease term. (d) The present value of the lease payments, discounted at an appropriate discount rate, exceeds 90% of the fair market value of the asset. (Source: pages.stern.nyu.edu)

This demonstrates that there is some flexibility in GAAP to allow for what should be a capital lease to be treated as an operating lease. Since there is an incentive to use operating leases it is important to understand the impact of this accounting choice. “Since operating leases keep substantial liabilities away from plain sight, they have the added benefit of boosting--artificially, critics say--key performance measures such as return-on-assets and debt-to-capital ratios” (investopedia.com).

Actual Accounting Strategy

In analyzing a company it is necessary to determine the firm’s actual accounting strategy. Managers determine the use of an aggressive or conservative accounting strategy to communicate the financial statements. However, this can lead to a distortion of the true performance of the company while still meeting the requirements as stated by GAAP. Another important factor when assessing the potential of the firm is to

41 determine the level of disclosure. A high level of disclosure allows a true picture of the firm while a low level forces assumptions and can be misleading at times. Disclosure information is required for a firm to report. However, the level of disclosure is determined by management. As in investor the more information disclosed can help determine the performance of the company. Hasbro overall disclosure is good and informing of the company’s financials. With research and development, royalties, and licensing the company has to make assumptions and predictions on the customer’s acceptance of the products. This can lead to many risks and uncertainty in the financials causing an overstatement or understatement and as stated in the 10-K Hasbro is under no obligation to make revisions after the filing date. Also the timing between expenses and revenues makes them borrow more in order to meet their cash flow requirements. This can lead to some confusion in the financials and would not be known until a new filing. With disclosure, managers have a say at what is stated and what is written down, as well as using guidelines stated by GAAP. However, Hasbro uses a more of an aggressive accounting strategy when it comes to goodwill and other intangible assets. As Hasbro stated in their 10K, they determine goodwill is the amount by which the cost of an acquisition accounted for by using the purchase method. However, GAAP requires that goodwill be periodically evaluated for impairment, rather than amortized. At the end of 2007, 14.6% or approximately $471,177 of total assets represented goodwill, a change from 2006 which was approximately $469,938 or 15.2%. (Hasbro’s 10K’s) Due to the change of evaluating goodwill on the fair value of reporting this resulted in a write down of goodwill. This could also be harmful for the financial statements by reducing net income. Hasbro is open with disclosing their financial information unlike some of their competitors. They want you to know about the company and try to include as much information that makes them look profitable. However, managers could end up manipulating the books in order to increase shareholders wealth. So they disclose information based on the outcome of the company and in accordance to GAAP. Given what was discussed earlier about things like operating leases, its consequences, and

42 how common the practice is in this industry; it would be important to undo these operating lease distortions on the financial statements and in numerous ratios like return-on-assets.

Qualitative Analysis of Disclosure A 10-K is each company’s own way of disclosing their financial information to potential investors. With the 10-K being their own way, key word being “own,” sometimes company’s have a tendency to have either almost full disclosure, making company decisions transparent to investors, or limited disclosure, which makes investors guess for themselves as to what goes on behind the books of the company. Compared to other company’s in the industry, with specific comparisons to Mattel’s 10-K, Hasbro has a very high level of disclosure. After reviewing the 10-K there is not much information that a potential investor is left wondering because it is presented very clearly. As other companies have high levels of disclosure but tend to hide things in their 10-K, making it very difficult for a common investor to find, Hasbro has a very easy to read, transparent 10-K. One of the things which stood out in the 10- K, as aforementioned, was the distortions in operating leases. Also numerous ratios seemed to fluctuate more than the industry average which is a sign that manager’s might be making the books look better to make the company seem more profitable than it is in order to attract investors and maximize shareholder wealth. As Hasbro is under no obligation to go back and revise their 10-K, it benefits from being able to capitalize things such as research and development and licensing rights and fees. It is up to Hasbro and companies in this industry to decide how much they think the licensing rights for Spider-Man, as an example, will produce revenue in the future. If they believe that a product under research and development will be a big money generator for years to come, such as Monopoly, capitalizing research and development and licensing expenses is a good way for the managers to overstate Net Income and make the company appear more profitable to investors. Hasbro makes it very clear to investors exactly what is being spent to fund licensing rights and fees as well as the costs of research and development. This and

43 how they portray the future expected earnings based on current research and development and coming from licensing rights are what makes the level of disclosure in Hasbro’s 10-K so much higher and more clear to investors than other’s in the industry such as Mattel which really makes it difficult to see this information.

Quantitative Analysis of Disclosure

A very good way to compare the levels of disclosure and in most cases distortions between companies in this industry is by examining revenue diagnostic ratios. If there seem to be inconsistencies in the ratios it can go a long ways in showing if managers are in fact inflating such things as revenue and net income to make their company seem more attractive to investors and more profitable to shareholders. In the next 5graphs we attempted to show discrepancies in sales among Hasbro and its three competitors by comparing Net Sales/ Cash from Sales, Net Sales/ Net Accounts Recievables, Net Sales/ Warranty Liabilities, Net Sales/ Unearned Revenue, and Net Sales/ Inventory.

44 Net Sales / Cash from Sales

Net Sales/ Cash from Sales

20

10

0 2003 2004 2005 2006 2007

-10

-20 Hasbro Mattel -30 Jakks Marvel -40 Net Sales/ Cash from Sales -50

-60

-70

-80 Year

Net Sales / Cash from Sales shows how much of a company’s sales in a period are collected in cash as apposed to on account, or in other words accounts receivables. This graph shows that for the most part the majority of sales are collected in cash. Though Marvel becomes a huge outlier in 2007 and Hasbro goes above 10 in both 2003, and 2004, for the most part the industry average is right around 0-1, which means for every dollar of sales, one dollar is collected in cash. This makes perfect sense because people buy toys and board games with cash and credit/debit cards and there are not notes payable and long term loans for products they are selling.

45 Net Sales/ Net Accounts Receivables

Net Sales/ Net Accounts Recievables

60

50

40

30 Hasbro Mattel Jakks 20 Marvel

10 Net Sales/ Net Sales/ Net Accounts Recievables

0 2003 2004 2005 2006 2007

-10 Year

Net Sales / Net Accounts Receivable shows what percentages of sales were credit transactions as opposed to cash transactions. It is better to have lower ratios here because accounts receivables are interest free loans and it takes longer to collect on the outstanding receivables. The ratios in this industry are relatively low which is good because you do not want the majority of your sales to be accounts receivables. Despite a large drop in receivables in 2005 by Mattel they returned to their average in 2006 which means there are no real red flags in the industry because despite small increases and decreases the ratios all returned to their norms in subsequent years.

46 Net Sales / Inventory

Net Sales/ Inventory

30

25

20

15

10 Hasbro Mattel 5 Jakks Marvel 0 Net Sales/ Inventory Sales/ Net 2003 2004 2005 2006 2007

-5

-10

-15

-20 Year

Net Sales/ Inventory is a ratio which shows how much a company’s inventory levels contributes to their revenues. The higher the ratio is means that a company has lower inventory costs coupled with high sales while lower ratios signify the opposite, high inventory costs with low sales. Inventory costs are higher in this industry because inventory holding periods are higher than most other industries. Through the flexible delivery system these holding periods are kept lower but this is why these ratios are so low. There were no real red flags which popped up because all firms maintained their normal levels despite minor downs and ups. Marvel might seem like it manipulated its sales however its large drop and gain still kept it right around its average which means they probably changed their inventory system between 2004 and 2005 in order for it to get back to normal levels in 2007.

47 Net Sales / Warranty Liabilities

Net Sales / Warranty Liabilities

25

20

15

10 Hasbro Mattel Jakks 5 Marvel Net Sales / Warranty Liabilities 0 2003 2004 2005 2006 2007

-5

-10 Year

There are very little warranty liabilities in this industry because there are no warranties on most toys, board games, etc. This is the reason why these ratios are so low. Again there are some moderate fluctuations from one year to the next especially by Hasbro and it never really returns to its average which should be red flagged cause it seems like Hasbro and Mattel might have manipulated their sales by underestimating their warranty liabilities.

48 Net Sales / Unearned Revenues

Net Sales / Unearned Revenue

5

4

3

2 Hasbro Mattel Jakks 1 Marvel Net Sales / Unearned Revenue / Unearned Sales Net 0 2003 2004 2005 2006 2007

-1

-2 Year

Unearned Revenues are very low in this industry because there are very little sales on credit and as seen before their accounts receivables are much lower in proportion to their sales in cash. There were some serious fluctuations in Net Sales / Unearned Revenues between two years however in each case it returned to the average which means there are no real red flags suggesting that a firm manipulated its sales by underestimating their unearned revenues.

49 Net Sales/Cash from Sales 2003 2004 2005 2006 2007 Hasbro 12.7 -0.69 0.41 -0.28 11.61 Mattel -0.482.27 6.75 Jakks 0.12 4.43 1.37 -1.87 1.11 Marvel -2.3 0.96 0.68 -4.96 -74.44

Net Sales/ Net Accounts Recievable 2003 2004 2005 2006 2007 Hasbro 6.14 4.89 -1.62 1.93 6.97 Mattel 1.41 0.66 47.63 2.57 6.75 Jakks 0.22 15.96 -5.77 1.58 2.93 Marvel 5.51 7.61 8.48 -0.84 -2.05

Net Sales/ Unearned Revenues 2003 2004 2005 2006 2007 Hasbro 1.4 -1.3 1.9 1.6 2.5 Mattel 2.4 3.1 3.2 3.8 4 Jakks 0.81 1.2 2.4 1.5 1.7 Marvel 0.61 1.2 -0.43 -0.35 1.8

Net Sales/ Warranty Liabilities 2003 2004 2005 2006 2007 Hasbro 4.16 -3.56 6.23 3.65 12.43 Mattel 5.1 7.5 7.4 17.4 20.1 Jakks 0.94 8.3 5.3 9.1 4.8 Marvel 3.5 8.2 -4.7 -1.3 9.2

Net Sales/ Inventory 2003 2004 2005 2006 2007 Hasbro 1.91 -0.72 0.5 0.31 2.65 Mattel 0.19 0.34 0.2 1.23 0.75 Jakks 0.13 5.17 1.31 1.35 0.83 Marvel 3.75 25.14 -13.37 -3.79 12.52

50 Potential Red Flags

In analyzing Hasbro, there were no significant changes in the ratios presenting a red flag. However, the inventory turnover ratio had a minor decline from 2006 to 2007. This is caused by having too much inventory on hand, causing the days’ supply of inventory to increase. This could be due to recent events in the economy where people aren’t spending as much on enjoyable items. There is a fear that this ratio will keep declining in the future years, because of a possible recession that might occur. Another possible red flag would be the amount of goodwill on the books. On Hasbro’s current balance sheet they have $471 million of goodwill; this is in large part of the company’s acquisition of Milton Bradley and Tonka. These two products have “indefinite life” and have to go through impairment. This shows that not every item is reported as goodwill and they are separated into other intangible assets, such as rights, patents, and trademarks. Therefore, according to their financial records, Hasbro hasn’t shown a significant increase or decrease in their statements.

51 Undo Accounting Distortions

Because many of the accounting numbers may be misleading or may not show the true economic view of the firm, Hasbro, Inc., this section of the report will attempt to undo some of these distortions to show a different view. Although not every distortion can be perfectly undone, the changes made here are a rough estimate or a different view than that provided by the firm or GAAP.

Research and development

The following happens to be Hasbro’s R&D expenses from their 10-k and after are adjustments of R&D expenses for the past eight years. The outlays are amortized over a three year period using the straight-line method and half a year’s amortization is taken on last year’s spending.

Hasbro

The following page displays how the calculations were done on capitalizing and expensing Hasbro’s research and development.

52 The adjustments:

R&D assets

2008 2007

Year R&D Proportion Capitalized Asset Proportion Capitalized Asset 2008 $167,194 (1-.33/2) 139607 2007 171,358 (1-.33/2-.33) 85536 (1-.33/2) 143,084 2006 150,586 (1-.33/2-.67) 24,847 (1-.33/2-.33) 76,046 2005 157,162 (1-.33/2-.67) 25,932 Total 250989 245,062 (In dollars, in thousands)

R&D amortization expense

2008 2007

Year R&D Proportion amortized Expense Proportion amortized Expense 2008 $167,194 .33/2 27,587 2007 171,358 .33 56,548 .33/2 28,274 2006 150,586 .33 49,693 .33 49,693 2005 157,162 .33/2 25,932 .33 51,863 2004 153,775 .33/2 23,625 Total 159,760 153,456 (In dollars, in thousands)

53 The entire picture for the firm Hasbro over the past eight years using the above method on the previous page is shown below.

Balance Sheet & Income Statement 54 Note: The adjustment will give rise to a Deferred Tax Liability; we assume a 35% marginal tax rate.

Not all R&D would bring in future revenue but it is safe to assume that some of it will. The above numbers are a best case scenario, even if all R&D didn’t become profitable it would not be as bad as the accounting numbers under GAAP. The graph shows that net income gets a boost in later years as total expenses decrease. The profitability picture of Hasbro changes dramatically. These numbers calculated will be included in the restatement of financials for the forecasts, ratios, and valuations to show a better economic view of Hasbro given the capitalization of research and development.

Goodwill

On Hasbro’s balance sheet there has not been any major increase or decrease in the amount of goodwill reported. The reported numbers do not demand to be redone since they are relatively reasonable.

55 Pensions

As previously mentioned the rate of future compensation increase and rate of returns on plan assets haven’t changed at all during the years, so these won’t produce a large change in the pension expenses.

Operating leases

The weighted average discount rates disclosed in Hasbro’s 10-k in their respective years over the past eight years were used to estimate the payments when capitalizing operating leases. The effect on income should be the focus as there is a benefit in the first couple of years that are offset in later years. Below are the results of the discounting, all numbers in thousands.

56

57

The changes brought to the income and balance sheet to the firm Hasbro are shown below and a tax rate of 35% is assumed, all numbers in thousands.

58

While these numbers show a benefit to Hasbro’s bottom line, the next eight years not shown above but on the discounted payment pages before under the title “effect on income” show a decrease. The effect is neutral overall when looking at the whole time span beyond the past eight years, there is no net change to net income in the end. In other words, the result shows no better or worse economic position when it comes to the bottom line. However, this makes the past eight years look good but the next eight years much worse and may effect forecasting. It should also be noted that lease commitments are decreasing as the years go by, Hasbro may be terminating old lease contracts but the firm is not replacing them. This shows that firm growth may be impaired in some way or may be following a more profitable strategy. All capitalization of leases really did was show was the related debt not previously shown before and the new assets operated by Hasbro. It also broke apart the lease expense account and allocated them into depreciation expense and interest expense. Although the return on

59 assets and debt to capital ratios would be inflated, the new numbers will not be shown in the forecasts, ratios, or valuations as it would distort in a negative way with future estimations, specifically forecasts without giving any better economic view of the firm than before. This is because of the effect on income which shows a benefit in the past eight years and a drag in the future. Below demonstrates the neutral effect on income overall from the capitalization of the 2001 operating lease information from Hasbro’s 10-k, it is highlighted in yellow.

As can be seen the total is zero. All the previous discounting shows a benefit upfront and a drag in what will be the forecasted years, accommodating this would be difficult for us but it is important to know the effect on assets and liabilities on the balance sheet after capitalization going forward, the leases magically appear.

60 Ratio Analysis, Forecast Financials, and Cost of Capital Estimation

Ratio Analysis

LIQUIDITY ANALYSIS

The following ratios show how able a company is to meet their short term debt obligations. These ratios are very significant because if the company does not have enough current assets to meet its short term debt it could pose a default risk and make it a risk for lenders and also a risk to promptly pay off outstanding accounts payable. This leads to higher interest rates and less ability to finance R&D, PP&E expansion among other things. As shown in the following financial statement analysis debt financing is very important in this industry and a company being unable to meet its short term debt obligations is a red flag for not only potential investors but also potential lenders. Ratios differ from industry to industry and that is why it is most effective to compare ratios between competitors in the same industry which is what we have done.

61 Current Ratio

Current Ratio

6

5

4

Hasbro Mattel 3 Jakks Marvel Current Ratio

2

1

0 2003 2004 2005 2006 2007 Year

Current Ratio is a company’s current assets divided by their current liabilities. As seen above in the graph it is very important for that ratio to be above one because that enables them to meet its short term requirements and also make the company more likely to receive loans at lower interest rates. The higher the ratio the more liquid a company is and the lower the ratio the less liquid it is. Hasbro is right on the industry average with a current ratio fluctuating between 1.5 and just over 2. One of the reasons why this industry has higher ratios is because these companies and the industry as a whole have many current assets including inventory for an example. From 2003 to 2004 there was a decreasing trend in the industry but over the past four years apart from Marvel, the industry has seen an increasing trend in their current ratios.

62 Quick Asset Ratio

Quick Asset Ratio

4.5

4

3.5

3

2.5 Hasbro Mattel Jakks 2 Marvel Quick Asset Ratio

1.5

1

0.5

0 2003 2004 2005 2006 2007 Year

Accounts receivables, securities, and cash make up quick assets and thus this ratio is a little better indication of how liquid a company is as it does not take into account current assets. Again Hasbro’s quick asset ratio is right in line with the industry average and has remained relatively stable over the past 5 years while companies such as Marvel have seen their ratios dip and become almost severe outliers. The quick ratio is a better indicator than the current ratio of what position a company is in to meet its debt obligations. The reason this is more effective than current ratio is because it excludes inventory. In this industry, where there is lots of inventory which cannot be readily converted into cash, the quick asset ratio does a much more effective job of representing the true position a company is in should it have to quickly fulfill its debt obligations.

63 Inventory Turnover

Inventory Turnover

30

25

20

Hasbro Mattel 15 Jakks Marvel Inventory Turnover 10

5

0 2003 2004 2005 2006 2007 Year

Inventory Turnover is a very important ratio for this industry because this industry utilizes the flexible delivery system in order to keep inventory low and avoid having a lot of their cash tied up in inventory. Again Hasbro is right in line with the industry average at right around 7 which means that they along with the rest of the companies do a relatively good job of avoiding overproducing and having lots of excess inventory in their factories and as a result have more free cash for investment, which helps relate to their quick asset ratio being where it is. The inventory turnover has remained relatively stable as there is no clear upward or downward trend.

64 Days Supply of Inventory

Days Supply of Inventory

90

80

70

60

50 Hasbro Mattel Jakks 40 Marvel

Days Supply of Inventory Supply Days 30

20

10

0 2003 2004 2005 2006 2007 Year

Days supply of inventory measures the inventory hold period of a firm, or how long it takes a company to turn its inventory into cash. As a result of the large amount of inventory held by companies in the industry, this ratio is consequently pretty large with an average of right around 55. Hasbro is almost right on the industry average while Marvel in 2004 and 2006 did the best in converting their inventory into cash. There was a decreasing trend in the industry from 2003-2004 before going upward from 2005 till the present.

65 Receivables Turnover

Recievables Turnover

14

12

10

8 Hasbro Mattel Jakks 6 Marvel Recievables Turnover

4

2

0 2003 2004 2005 2006 2007 Year

Accounts receivables turnover represents a company’s total sales divided by their accounts receivables. As you can see in the graph the ratios for the company’s in the industry are relatively low because many of their sales are not in cash and therefore they have a larger portion of accounts receivables. As a result of this these low ratios do not show cause for concern because Hasbro is right in line with the rest of the industry. The reason why the accounts receivables make up such a large portion of a company’s sales in the industry is because the stores that sell these company’s products purchase large numbers of inventory and for the most part pay entirely on credit. The purpose of this ratio is to show how effective a firm is at extending credit and collecting on its debts. Having a higher ratio is very important because it means the company is effectively able to collect its accounts receivable. In 2006 Marvel’s ratio was much lower than its competitors and it is clear that Marvel reassessed its policy on credit because by 2007 its ratio was the highest in the industry. The reason it is important to collect the receivables in a quick manner is because the firms are not earning any

66 interest on this money and by collecting them they invest the cash in research and development and other money making activities.

Days Sales Outstanding

Days Supply of Recievables

120.00

100.00

80.00

Hasbro Mattel 60.00 Jakks Marvel

40.00 Days Supply of Supply Days Recievables

20.00

0.00 2003 2004 2005 2006 2007 Year

Day’s sales outstanding represent how long it takes to convert a company’s accounts receivables into cash. As the accounts receivables turnover in the industry is so low, it makes sense that the days supply of receivables would be as high as the bulk of sales are done on credit and therefore take much longer to convert to cash then obviously cash sales would take. The only downside to the higher length of time that it takes to turn accounts receivables to cash is that it prevents the company from using the cash to reinvest. This is important because it is an issue of the liquidity and efficiency of a firm because as mentioned previously,

67 outstanding accounts receivables are zero interest loans, and by having them outstanding for a long period it could mean that should a firm be faced with having to quickly pay off its debt obligations, it would not be able to because of its inability to collect its outstanding receivables.

Working Capital Turnover

Working Capital Turnover

10.00

0.00 2003 2004 2005 2006 2007

-10.00

Hasbro Mattel -20.00 Jakks Marvel

Working Capital Turnover -30.00

-40.00

-50.00 Year

Working capital turnover measures how effectively a company uses its working capital to generate sales. The higher the working capital turnover means that a company is generating more money from sales than the money it is using to fund the actual sales themselves. This is a very important ratio because it tells investors how well a company utilizes their working capital to turn a profit. Marvel’s working capital turnover of -40 definitely sticks out in 2005 as the industry average is right around 5. This could be attributed to them investing heavily in R&D or PP&E in 2005. There is a relatively stable trend in the industry apart from Marvel’s sudden drop in 2005. Working capital turnover is very important because a firm uses working capital to fund its operations and also to purchase inventory which in turn generates sales revenue for the firm. 68 Conclusion

The liquidity ratios are very important because they are used to show a company’s ability to pay off its short term debt. This ability to pay off their short term debt is very important because it shows how risky a company is for creditors when extending credit. After analyzing the liquidity ratios of this industry it shows that the firms in the industry present little risk to creditors as they do a good job at turning inventory into cash and collecting on their outstanding receivables.

PROFITABILITY ANALYSIS

In this section ratios were used to show how successful Hasbro is at generating profit. In the gross profit margin, operating profit margin, net profit margin, return on assets and return on equity graphs it shows how Hasbro utilizes its assets to be productive and stay competitive in the industry while comparing it to the only other competitors in its industry. Gross profit margin, operating profit margin, and net profit margin are profitability ratios and show how profitable companies in the industry are while the other ratios measure the companies productivity and all of the graphs are very important in determining how efficient, profitable, and productive a company is.

69 Gross Profit Margin

Gross Profit Margin

100.0%

90.0%

80.0%

70.0%

60.0% Hasbro Mattel 50.0% Jakks Marvel 40.0% Gross ProfitGross Margin

30.0%

20.0%

10.0%

0.0% 2003 2004 2005 2006 2007 Year

Gross profit margin compares a company’s gross profit to its sales. It is good to have high gross profit margins because that means that the company has a higher proportion of money left over from their revenues after covering their cost of goods sold. Hasbro does a good job of keeping their cost of goods low while reaping the rewards of high selling prices for the same goods. This is a very good tool for evaluation competitors in an industry because the more efficient companies have the higher gross profit margins.

70 Operating Profit Margin

Operating Profit Margin

60.0%

50.0%

40.0%

Hasbro Mattel 30.0% Jakks Marvel

Operating Profit Margin 20.0%

10.0%

0.0% 2003 2004 2005 2006 2007 Year

Operating Profit Margin takes into account how what percentage of sales can be attributed solely to a company’s operating income, or how profitable are a firm’s day to day operations. The higher the operating profit margin the better because it means that the company is keeping their fixed costs low and generating more sales off of fewer operating income. Hasbro is right in line with Jakks and Mattel but Marvel has by far the highest ratio in the industry at well over 40% in 4 out of 5 years. This means that Mattel has been increasing their sales while at the same time keeping their fixed costs and operating expenses stable.

71 Net Profit Margin

Net Profit Margin

50.0%

45.0%

40.0%

35.0%

30.0% Hasbro Mattel 25.0% Jakks Marvel

Net Profit Margin 20.0%

15.0%

10.0%

5.0%

0.0% 2003 2004 2005 2006 2007 Year

Net Profit Margin is similar to operating profit margin except for that it divides sales by net income. Again it is more beneficial to have a higher net profit margin and again Marvel leads the industry while Hasbro for once has the lowest net profit margin. This is an important graph because it shows which company does the best job of keeping costs under control. The higher the net profit margin means a firm has better control over its costs in comparison to its competitors. This is also an important margin because it shows directly how profitable a company is because it measures out of every dollar how much is kept by a company in its earnings.

72 Asset Turnover

Asset Turnover

1.40

1.20

1.00

0.80 Hasbro Mattel Jakks 0.60 Marvel Asset Turnover

0.40

0.20

0.00 2003 2004 2005 2006 2007 Year

Asset turnover measures how productive a company is in using their assets to generate revenue. More directly it shows the amount of sales generated for every dollar’s worth of assets. It is important to have a high asset turnover because it shows a firm’s efficiency at using its assets to generate sales or revenue. This turnover also conversely relates to net profit margin because companies with high net profit margins tend to have lower asset turnovers and vice versa. It is a good sign for the industry that there is an increasing trend in asset turnover since 2003 and with an industry average of approximately one, it means that for every dollar of assets in the industry, there is one dollar of revenue produced.

73 Return on Assets

Return on Assets

0.25

0.20

0.15 Hasbro Mattel Jakks Marvel 0.10 Return on Assets

0.05

0.00 2003 2004 2005 2006 2007 Year

Return on assets measures how a company’s assets in the previous year translated into their net income in the following year. This, like asset turnover, measures how productive a company’s assets are, or how much revenue a company can generate from their assets. This higher the ratio the more profitable a company’s investments in assets have been and can make the company very attractive to potential investors. Once again Marvel seems to be making the most profitable investments in their assets while Hasbro is one of the lowest returns in the industry, almost 5 percent on average below the industry average. Apart from Mattel there is an increasing trend among the firms in the industry in Return on Assets which is a very positive sign for the industry as a whole because it means the company’s are doing a very good job each year of increasing the productivity of their assets.

74 Return on Equity

Return on Equity

0.90

0.80

0.70

0.60

0.50 Hasbro Mattel Jakks 0.40 Marvel Return on Equity Return

0.30

0.20

0.10

0.00 2003 2004 2005 2006 2007 Year

Like return on assets, return on equity divides the current years net income by the previous years equity. This is an important ratio because it lets investors get a sense of how much of a company’s net income is generated by debt as opposed to equity. Marvel leads the industry and finances their operations with the most debt while Hasbro is just below the industry average and does a good job of financing their operations mainly from equity. The more a company finances with equity the higher return that they will get and it is very productive for Hasbro to not rely on debt financing as much as Marvel. The industry trend remained relatively stable and in 2006 it began a small upward movement.

75 Conclusion

Not only do the graphs in this section show the efficiency and profitability of each individual company, but they do a very important job in comparing firms in the industry in order to show which firm is indeed the most efficient, productive, and profitable. After reviewing these graphs it is clear that Hasbro is right in line with the industry average, and the industry as a whole is showing an upward trend in almost all of the charts, which means good things for the industry not only now but in the future.

76 CAPITAL STRUCTURE ANALYSIS

Capital structure analysis shows how well a firm finances its overall operations and growth by using a mix of different sources of funds. These different sources are long and short term debt, and common and preferred equity. These ratios show how risky a company is as they show how much a company finances through debt, which makes the company a riskier bet for investors and creditors alike.

Debt to Equity Ratio

Debt to Equity Ratio

4.00

3.50

3.00

2.50

Hasbro Mattel 2.00 Jakks Marvel

Debt to Equity Ratio 1.50

1.00

0.50

0.00 2003 2004 2005 2006 2007 Year

A firm’s debt to equity ratio shows what proportion of debt and equity the company is using to finance its operations and assets. The higher the ratio the more heavily a company is financing its growth through debt. This is not necessarily a bad thing because some firms could see increased earnings from this debt financing while as if they didn’t finance with debt they would not realize the same earnings. The key to this is that as long as a company is seeing increased earnings higher than the interest they are paying on their debt, than it is a smart

77 move. The ratio shows that the industry trend has remained relatively stable at around .75. Hasbro’s ratio like the rest of the industry has increased slightly since 2006 which means that they are using debt financing to increase their scope of operations and hopefully to bolster earnings in the future.

Debt Service Margin

Debt Service Margin

40.00

35.00

30.00

25.00

20.00 Hasbro Mattel Jakks 15.00 Marvel Debt Service Margin Debt Service 10.00

5.00

0.00 2003 2004 2005 2006 2007

-5.00 Year

Debt service margin shows how much of a company’s cash flow from operations is accounts for the current portion of their long term debt. Hasbro’s margin of 4 remains steady and means that there are 4 dollars of cash from operations to pay for every dollar of long term debt that is about to mature. The industry average is approximately 4 which is right where Hasbro falls. This is a good measure of how much of a default risk a company is and Hasbro’s

78 ratio is very solid and shows that they are not much of a default risk whereas Jakks Pacific would be a red flag for banks and lenders.

Altman’s Z-Score Credit Analysis

Altman Z-Scores

4

3.5

3

2.5

Hasbro Mattel 2 Jakks Z-Score Marvel

1.5

1

0.5

0 2003 2004 2005 2006 2007 Year

Altman’s z-score is analyzed by creditors in order to determine if the firm they are lending to is a default risk. Altman’s z-score is determined by multiplying the weights of 5 variables by five different financial ratios.

79 1.2 (Net Working Capital / Total Assets)

+ 1.4(Retained Earnings / Total Assets)

+ 3.3 (EBIT / Total Assets)

+ 0.6 (Market Value of Equity / Book Value of Total Liabilities)

+ 1.0 (Sales / Total Assets)

By using this model it helps tell creditors what area the firm they are lending to falls under and what that means when relating to their default risk. If a firm has a z-score under 1.81 then it is predicted that they will go bankrupt. There is an unknown area between 1.81 and 2.67 where the Altman z-score model is undetermined. However any firm with a z-score above 2.67 has almost zero risk of default and bankruptcy and therefore is a safe bet to banks and creditors.

Altman Z-scores

2003 2004 2005 2006 2007

Hasbro 2.19 2.84 3.03 3.115 3.356

Mattel 3.299 3.26 3.328 3.313 3.367

Jakks 3.67 3.64 3.58 3.52 3.71

Marvel 2.59 2.91 3.04 3.45 3.51

Despite falling in the unknown area between 1.81 and 2.67 during 2003, Hasbro rebounded to the safety of a z-score above 2.67 from 2004 until the present making them a safe option for banks and lenders wishing to extend them credit. These z-scores were all above 2.67 except for Marvel and Hasbro in 2003 which is a very good sign for the industry as the four biggest competitors are all safely above the mark needed to qualify them as a risk of bankruptcy.

80 Internal Growth Rate and Sustainable Growth Rate Analysis

Internal Growth Rate

IGR

80.00%

70.00%

60.00%

50.00%

Hasbro Mattel 40.00% Jakks Marvel

Internal Growth Rate Growth Internal 30.00%

20.00%

10.00%

0.00% 2003 2004 2005 2006 2007 Year

A firm’s internal growth is calculated by dividing its retained earnings by its total assets. It measures the highest level of growth achievable for a firm without obtaining outside financing (investopedia.com). This level of growth is generated through a company’s cash flows and from looking at the chart the industry average is approximately 58% which means that the industry has room to grow 58% without obtaining outside financing. Hasbro and Mattel are both the lowest among their competitors and this can be attributed to the fact that they already control the largest market share and thus have less room for growth than Jakks and Marvel, two smaller competitors.

81 Sustainable Growth Rate

SGR

90%

80%

70%

60%

50% Hasbro Mattel Jakks 40% Marvel

Sustainable Growth Rate 30%

20%

10%

0% 2003 2004 2005 2006 2007 Year

A firm’s sustainable growth rate is calculated by multiplying its Return on Equity by one minus the dividend payout ratio (EPS/DPS). The sustainable growth rate measures how much room a firm has to grow before it has to borrow more money from another source to facilitate its growth (investopedia.com). It is important to note that both Jakks Pacific and Marvel Enterprises did not pay dividends in the last 5 years and thus their sustainable growth rates were equivalent to their return on equity. That being said Hasbro has the least room to grow before it has to rely on outside sources to facilitate its growth and moreover as an industry there is really not very much room for growth as the industry average is approximately 16%.

82 Conclusion

After doing a complete capital structure analysis of Hasbro and its three competitors it is clear that Hasbro has not only plenty of room for growth in the future but is also right on line with the rest of the industry. It should be re-assuring that Hasbro is not a default risk and neither are any of the other firms in the industry. Hasbro had no outliers in any of the graphs and in all of the charts remained relatively stable.

Financial Statement Forecast

When analyzing a firm, it is necessary to forecast the financial statements in the future and we have included a forecast of Hasbro’s financials for the next ten years. There are many assumptions to be made in forecasting, but if you are thorough in our assumptions, you can get a clear picture of the firm’s value. The forecasting process begins with collecting five years of historical data, including the income statement, balance sheet and statement of cash flows. We then proceeded to calculate a common-sized statement in order to help make the results more realistic. This is all done in order to link the financial statements together and to help predict how Hasbro will perform in the next coming years.

Income Statement Analysis

In looking through our financial statements we decided that for the past three years there is more of a steady relationship between the amounts. Therefore we based our forecast on the past three years. With the income statement it was important to use sales to help determine the industries average.

As we reviewed the data of Hasbro, we decided on our own sales growth to forecast rather then the average calculated. We calculated the change in sales growth from 2006 to 2007 to be approximately 21.77%, which was a drastic increase from the previous years. Therefore, we decided to go with a 3% sales growth in order to forecast a more accurate picture. This big increase was in part due to the new release

83 movies of Spider-Man 3 and Transformers. These box office hits helped Hasbro boost their sales and reveal such a big sales growth. Another factor could have been the modernization of new products using technological advances. For these reasons, we didn’t go with the average growth rate.

Next we forecasted cost of revenue. We used our common sized income statement to determine the change in the past five years. We determined the percentage of cost of revenue and gross profit by averaging the past years since the numbers were all closely related. We found cost of revenue to be 41.38% and gross profit to be 58.62%. This will always total one because cost of revenue and gross profit must equal total revenue.

We determined that research and development didn’t have a direct impact on revenues. However, it does have an impact on the change in net income. As you can see in the restated income statement, the amortization of research and development had a slight increase in operating income, which in turn, a higher forecast was determined.

We also evaluated net income as a percentage of total revenue over the past five years. There was a steady increase over the past years so we decided to continue on with the trend. We found the percentage of sales to be 9%. As a result, our forecast shows a steady increase in the next ten years.

84

HASBRO'S INCOME STATEMENT Actual Accounting Financials Forecast Financial Statements in millions 2003 2004 2005 2006 2007 AVERAGE ASSUME 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Revenue 3,138.66 2,997.51 3,087.63 3,151.48 3,837.56 3% 3,952.69 4,071.27 4,193.41 4,319.21 4,448.78 4,582.25 4,719.71 4,861.31 5,007.15 5,157.36 Total Revenue 3,138.66 2,997.51 3,087.63 3,151.48 3,837.56

Cost of Revenue, Total 1,287.96 1,251.66 1,286.27 1,303.89 1,576.62 1,635.69 1,684.76 1,735.30 1,787.36 1,840.98 1,896.21 1,953.10 2,011.69 2,072.04 2,134.20 Gross Profit 1,850.70 1,745.85 1,801.36 1,847.60 2,260.94 2,317.00 2,386.51 2,458.10 2,531.84 2,607.80 2,686.03 2,766.62 2,849.61 2,935.10 3,023.16

Selling/General/Administrative Expenses, Total 1,286.84 1,225.12 1,238.21 1,220.94 1,506.68 1,580.89 1,628.31 1,677.16 1,727.48 1,779.30 1,832.68 1,887.66 1,944.29 2,002.62 2,062.70 Research & Development 143.18 157.16 150.59 171.36 167.19 193.49 199.30 205.28 211.44 217.78 224.31 231.04 237.97 245.11 252.46 Depreciation/Amortization 76.05 70.56 102.04 78.93 67.72 97.64 100.57 103.59 106.69 109.89 113.19 116.59 120.08 123.69 127.40 Operating Income 344.62 293.01 310.52 376.36 519.35 444.97 458.32 472.07 486.24 500.82 515.85 531.32 547.26 563.68 580.59

Interest Income (Expense), Net Non-Operating (52.46) (23.97) (6.38) 0.09 (4.65) (5.93) (6.11) (40.71) (6.29) (41.93) (6.48) (43.19) (6.67) (44.49) (6.87) (45.82) (7.08) (47.20) (7.29) (48.61) (7.51) (50.07) (7.74) (51.57) Other, NetIncome Before Tax (48.09)244.06 (8.96) 260.096.77 310.91(34.98) 341.47 (52.32) 462.38(39.53) 484.20 498.73 513.69 529.10 544.98 561.33 578.17 595.51 613.38 631.78

Income Tax - Total 69.05 64.11 98.84 111.42 129.38 118.58 122.14 125.80 129.58 133.46 137.47 141.59 145.84 150.21 154.72 Income After Tax 175.02 195.98 212.08 230.06 333.00 355.74 366.41 377.41 388.73 400.39 412.40 424.77 437.52 450.64 464.16

Net Income Before Extra. Items 175.02 195.98 212.08 230.06 333.00 355.74 366.41 377.41 388.73 400.39 412.40 424.77 437.52 450.64 464.16

Total Extraordinary Items (17.35) 0.00 0.00 0.00 0.00 ------Accounting Change (17.35) 0.00 0.00 0.00 0.00 ------Net Income 157.66 195.98 212.08 230.06 333.00 355.74 366.41 377.41 388.73 400.39 412.40 424.77 437.52 450.64 464.16

Income Statement - Common Size 2003 2004 2005 2006 2007 AVERAGE ASSUME Actual Accounting Financials Sales Growth Percent -4.50% 3.01% 2.07% 21.77% 0.03 Revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Total Revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Cost of Revenue, Total 41.04% 41.76% 41.66% 41.37% 41.08% 41.38% 41.38% 41.38% 41.38% 41.38% 41.38% 41.38% 41.38% 41.38% 41.38% 41.38% Gross Profit 58.96% 58.24% 58.34% 58.63% 58.92% 58.62% 58.62% 58.62% 58.62% 58.62% 58.62% 58.62% 58.62% 58.62% 58.62% 58.62%

Selling/General/Administrative Expenses, Total 41.00% 40.87% 40.10% 38.74% 39.26% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% Research & Development 4.56% 5.24% 4.88% 5.44% 4.36% 4.90% 4.90% 4.90% 4.90% 4.90% 4.90% 4.90% 4.90% 4.90% 4.90% 4.90% Depreciation/Amortization 2.42% 2.35% 3.30% 2.50% 1.76% 2.47% 2.47% 2.47% 2.47% 2.47% 2.47% 2.47% 2.47% 2.47% 2.47% 2.47% Operating Income 10.98% 9.78% 10.06% 11.94% 13.53% 11.26% 11.26% 11.26% 11.26% 11.26% 11.26% 11.26% 11.26% 11.26% 11.26% 11.26%

Interest Income (Expense), Net Non-Operating -1.67% -0.80% -0.21% 0.00% -0.12% -0.56% -0.15% -0.15% -0.15% -0.15% -0.15% -0.15% -0.15% -0.15% -0.15% -0.15% Other, Net -1.53% -0.30% 0.22% -1.11% -1.36% -0.82% -1.00% -1.00% -1.00% -1.00% -1.00% -1.00% -1.00% -1.00% -1.00% -1.00% Income Before Tax 7.78% 8.68% 10.07% 10.84% 12.05% 9.88% 12.25% 12.25% 12.25% 12.25% 12.25% 12.25% 12.25% 12.25% 12.25% 12.25%

Income Tax - Total 2.20% 2.14% 3.20% 3.54% 3.37% 2.89% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% Income After Tax 5.58% 6.54% 6.87% 7.30% 8.68% 6.99% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00%

Net Income Before Extra. Items 5.58% 6.54% 6.87% 7.30% 8.68% 6.99% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00%

Total Extraordinary Items -0.55% 0.00% 0.00% 0.00% 0.00% -0.11% Accounting Change -0.55% 0.00% 0.00% 0.00% 0.00% -0.11% Net Income 5.02% 6.54% 6.87% 7.30% 8.68% 6.88% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00%

85 Actual Accounting Financials Forecast Financial Statements

HASBRO'S INCOME STATEMENT RESTATED in millions 2003 2004 2005 2006 2007 AVERAGE ASSUME 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Revenue 3,138.66 2,997.51 3,087.63 3,151.48 3,837.56 3% 3,952.7 4,071.3 4,193.4 4,319.2 4,448.8 4,582.2 4,719.7 4,861.3 5,007.1 5,157.4 Total Revenue 3,138.66 2,997.51 3,087.63 3,151.48 3,837.56

Cost of Revenue, Total 1,287.96 1,251.66 1,286.27 1,303.89 1,576.62 1,635.7 1,684.8 1,735.3 1,787.4 1,841.0 1,896.2 1,953.1 2,011.7 2,072.0 2,134.2 Gross Profit 1,850.70 1,745.85 1,801.36 1,847.60 2,260.94 2,317.0 2,386.5 2,458.1 2,531.8 2,607.8 2,686.0 2,766.6 2,849.6 2,935.1 3,023.2

Selling/General/Administrative Expenses, Total 1,286.84 1,225.12 1,238.21 1,220.94 1,506.68 1,580.9 1,628.3 1,677.2 1,727.5 1,779.3 1,832.7 1,887.7 1,944.3 2,002.6 2,062.7 Research & Development 0.00 0.00 0.00 0.00 0.00 ------Depreciation/Amortization 226.28 215.24 251.37 232.39 227.48 283.27 291.77 300.52 309.54 318.82 328.39 338.24 348.39 358.84 369.61 Operating Income 337.58 305.50 311.78 394.27 526.78 452.84 466.42 480.42 494.83 509.67 524.97 540.71 556.94 573.64 590.85

Interest Income (Expense), Net Non-Operating (52.46) (23.97) (6.38) 0.09 (4.65) (5.93) (6.11) (6.29) (6.48) (6.67) (6.87) (7.08) (7.29) (7.51) (7.74) Other, Net (48.09) (8.96) 6.77 (34.98) (52.32) (39.53) (40.71) (41.93) (43.19) (44.49) (45.82) (47.20) (48.61) (50.07) (51.57) Income Before Tax 244.06 260.09 310.91 341.47 462.38 484.20 498.73 513.69 529.10 544.98 561.33 578.17 595.51 613.38 631.78

Income Tax - Total 71.52 59.73 98.40 105.19 126.78 118.58 122.14 125.80 129.58 133.46 137.47 141.59 145.84 150.21 154.72 Income After Tax 172.54 200.36 212.51 236.28 335.60 355.74 366.41 377.41 388.73 400.39 412.40 424.77 437.52 450.64 464.16

Net Income Before Extra. Items 172.54 200.36 212.51 236.28 335.60 355.74 366.41 377.41 388.73 400.39 412.40 424.77 437.52 450.64 464.16

Total Extraordinary Items (17.35) 0.00 0.00 0.00 0.00 ------Accounting Change (17.35) 0.00 0.00 0.00 0.00 ------Net Income 137.84 200.36 212.51 236.28 335.60 355.74 366.41 377.41 388.73 400.39 412.40 424.77 437.52 450.64 464.16

Actual Accounting Financials

Income Statement - Common Size 2003 2004 2005 2006 2007 AVERAGE ASSUME Sales Growth Percent -4.50% 3.01% 2.07% 21.77% 0.03 Revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Total Revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Cost of Revenue, Total 41.04% 41.76% 41.66% 41.37% 41.08% 41.38% 41.38% 41.38% 41.38% 41.38% 41.38% 41.38% 41.38% 41.38% 41.38% 41.38% Gross Profit 58.96% 58.24% 58.34% 58.63% 58.92% 58.62% 58.62% 58.62% 58.62% 58.62% 58.62% 58.62% 58.62% 58.62% 58.62% 58.62%

Selling/General/Administrative Expenses, Total 41.00% 40.87% 40.10% 38.74% 39.26% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% 40.00% Research & Development 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Depreciation/Amortization 7.21% 7.18% 8.14% 7.37% 5.93% 7.17% 7.17% 7.17% 7.17% 7.17% 7.17% 7.17% 7.17% 7.17% 7.17% 7.17% Operating Income 10.76% 10.19% 10.10% 12.51% 13.73% 11.46% 11.46% 11.46% 11.46% 11.46% 11.46% 11.46% 11.46% 11.46% 11.46% 11.46%

Interest Income (Expense), Net Non-Operating -1.67% -0.80% -0.21% 0.00% -0.12% -0.56% -0.15% -0.15% -0.15% -0.15% -0.15% -0.15% -0.15% -0.15% -0.15% -0.15% Other, Net -1.53% -0.30% 0.22% -1.11% -1.36% -0.82% -1.00% -1.00% -1.00% -1.00% -1.00% -1.00% -1.00% -1.00% -1.00% -1.00% Income Before Tax 7.78% 8.68% 10.07% 10.84% 12.05% 9.88% 12.25% 12.25% 12.25% 12.25% 12.25% 12.25% 12.25% 12.25% 12.25% 12.25%

Income Tax - Total 2.28% 1.99% 3.19% 3.34% 3.30% 2.82% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% Income After Tax 5.50% 6.68% 6.88% 7.50% 8.75% 7.06% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00%

Net Income Before Extra. Items 5.50% 6.68% 6.88% 7.50% 8.75% 7.06% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00%

Total Extraordinary Items -0.55% 0.00% 0.00% 0.00% 0.00% -0.11% Accounting Change -0.55% 0.00% 0.00% 0.00% 0.00% -0.11% Net Income 4.39% 6.68% 6.88% 7.50% 8.75% 6.84% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% 9.00%

86 Balance Sheet Analysis

The next financial statement that needs to be forecasted is the balance sheet. We first forecasted total assets using an asset turnover asset ratio of 1.25% which is has been a steady increase since 2003. We calculated that Hasbro would have approximately $4.1 Billion dollars in 2017.

Next we forecasted accounts receivables. We decided to use the past three years to get an average from the common size statement. This was done because there was an increase from 2005 so we decided to continue on with the trend and use 20.5%.

We went on to determine current assets and non-current assets and then calculated total assets by using the asset turnover ratio. We then used owner’s equity and total assets to find total liabilities by taking total assets minus total equity. Overall total assets will gradually increase at a small rate due to new technology and new development of products. Therefore, because balance sheets have to balance total liabilities and owner’s equity equal the sum of total assets. However, we believe that this could be a good assumption about there financials in the future but there could still be error in these numbers because of assumptions.

87 HASBRO'S BALANCE SHEET Actual Accounting Financials Forecast Financial Statements in millions 20032004 2005 2006 2007 AVERAGE ASSUME 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 ASSETS Cash and cash equivalents 520.75 725.00 942.27 715.40 774.46 0.24 960.33 1,190.81 1,476.60 1,830.98 2,270.42 2,815.32 3,491.00 4,328.84 5,367.76 6,656.02 Accounts receivable 607.56 578.71 523.23 556.2918.22 654.79 0.205 789.02 950.77 1,145.68 1,380.54 1,663.55 2,004.58 2,415.52 2,910.70 3,507.40 4,226.41 Inventories 168.98 194.78 179.40 203.346.27 259.08 0.07 277.22 296.62 317.39 339.60 363.37 388.81 416.03 445.15 476.31 509.65 Prepaid expenses and other current assets 211.98 219.74 185.30 243.29 199.91

Total current assets 1,509.26 1,718.22 1,830.20 1,718.32 1,888.24 1,893.18 1,949.97 2,008.47 2,068.73 2,130.79 2,194.71 2,260.55 2,328.37 2,398.22 2,470.17 Property, plant and equipment, net 199.85 206.93 164.05 181.73 187.96

Other assets Goodwill 463.68 469.73 467.06 469.94 471.18 0.1461 540.02 618.91 709.34 812.97 931.74 1,067.87 1,223.89 1,402.70 1,607.63 1,842.51 Other intangibles, net 710.64 637.93 613.43 532.26 486.23 0.19 578.62 688.55 819.38 975.06 1,160.32 1,380.78 1,643.13 1,955.33 2,326.84 2,768.94 Other 279.94 207.85 226.41 194.67 203.45

Total other assets 1,454.26 1,315.50 1,306.90 1,196.86 1,160.86 40.13% 1,268.97 1,307.04 1,346.25 1,386.64 1,428.24 1,471.08 1,515.22 1,560.67 1,607.49 1,655.72

Total assets 3,163.38 3,240.66 3,301.14 3,096.91 3,237.06ato: 1.25 3,162.15 3,257.01 3,354.72 3,455.37 3,559.03 3,665.80 3,775.77 3,889.04 4,005.72 4,125.89

LIABILITIES AND SHAREHOLDERS EQUITY Current liabilities Short-term borrowings 23.35 17.96 14.68 10.58 10.20 Current portion of long-term debt 1.33 324.12 32.77 0.00 135.35 Accounts payable 158.97 167.59 152.47 160.02 186.20 Accrued liabilities 746.40 638.94 710.81 735.30 555.92

Total current liabilities 930.06 1,148.61 910.73 905.89 887.67 1.83 0.0201 905.51 923.71 942.28 961.22 980.54 1,000.25 1,020.35 1,040.86 1,061.79 1,083.13 Long-term debt, excluding current portion 686.87 302.70 495.62 494.92 709.72 Other liabilities 141.21 149.63 171.32 158.21 254.58

Total liabilities 1,758.14 1,600.94 1,577.67 1,559.02 1,851.97 1,524.83 1,367.14 1,212.69 1,062.37 917.19 778.26 646.84 524.31 412.22 312.30

Shareholders equity Preference stock Common stock 104.85 104.85 104.85 104.85 104.85 Additional paid-in capital 397.88 380.75 358.20 322.25 369.09 Deferred compensation (0.68) (0.10) (0.02) Retained earnings 1,567.69 1,721.21 1,869.01 2,020.35 2,261.56 2,513.79 2,766.35 3,018.51 3,269.46 3,518.30 3,764.00 4,005.40 4,241.21 4,469.97 4,690.06 Accumulated other comprehensive earnings 30.48 82.39 15.35 11.19 74.94 Treasury stock (694.98) (649.37) (623.90) (920.75) (1,425.35)

Total shareholders equity 1,405.24 1,639.72 1,723.48 1,537.89 1,385.09 1,637.32 1,889.88 2,142.04 2,392.99 2,641.83 2,887.53 3,128.93 3,364.74 3,593.50 3,813.59

Total liabilities and shareholders equity 3,163.38 3,240.66 3,301.14 3,096.91 3,237.06 0.0125 3,162.15 3,257.01 3,354.72 3,455.37 3,559.03 3,665.80 3,775.77 3,889.04 4,005.72 4,125.89

Proof of Retained Earnings Beginning Balance of retained earnings 1,567.69 1,721.21 1,869.01 2,020.35 2,261.56 2,513.79 2,766.35 3,018.51 3,269.46 3,518.30 3,764.00 4,005.40 4,241.21 4,469.97 Add Net income for year 195.98 212.08 230.06 333.00 355.74 366.41 377.41 388.73 400.39 412.40 424.77 437.52 450.64 464.16 less total dividends for year -37.09 -58.9 -75.28 -94.1 (103.51) (113.86) (125.25) (137.77) (151.55) (166.70) (183.37) (201.71) (221.88) (244.07) Ending Balance of Retained Earnings 1,726.58 1,874.39 2,023.79 2,259.25 2,513.79 2,766.35 3,018.51 3,269.46 3,518.30 3,764.00 4,005.40 4,241.21 4,469.97 4,690.06 5.37 5.38 3.44 (2.31) Proof of Book Value of Equity Beginning Balance of Book Value of Equity 1,385.09 1,637.32 1,889.88 2,142.04 2,392.99 2,641.83 2,887.53 3,128.93 3,364.74 3,593.50 Add Net income for year 355.74 366.41 377.41 388.73 400.39 412.40 424.77 437.52 450.64 464.16 less total dividends for year (103.51) (113.86) (125.25) (137.77) (151.55) (166.70) (183.37) (201.71) (221.88) (244.07) Ending Balance of Book Value of Equity 1,637.32 1,889.88 2,142.04 2,392.99 2,641.83 2,887.53 3,128.93 3,364.74 3,593.50 3,813.59

88 Balance Sheet - Common Size Actual Accounting Financials 2003 2004 2005 2006 2007 AVERAGE ASSUME ASSETS Cash and cash equivalents 16.46% 22.37% 28.54% 23.10% 23.92% 22.88% 0.24 Accounts receivable 19.21% 17.86% 15.85% 17.96% 20.23% 18.22% 0.205 Inventories 5.34% 6.01% 5.43% 6.57% 8.00% 6.27% 0.07 Prepaid expenses and other current assets 6.70% 6.78% 5.61% 7.86% 6.18% 6.63% 0.07

Total current assets 47.71% 53.02% 55.44% 55.48% 58.33% 54.00% 0.59 Property, plant and equipment, net 6.32% 6.39% 4.97% 5.87% 5.81% 5.87% 0.0587

Other assets Goodwill 14.66% 14.49% 14.15% 15.17% 14.56% 14.61% 0.1461 Other intangibles, net 22.46% 19.69% 18.58% 17.19% 15.02% 18.59% 0.19 Other 8.85% 6.41% 6.86% 6.29% 6.29% 6.94% 0.065

Total other assets 45.97% 40.59% 39.59% 38.65% 35.86% 40.13% 0.4013

Total assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

LIABILITIES AND SHAREHOLDERS EQUITY Current liabilities Short-term borrowings 1.33% 1.12% 0.93% 0.68% 0.55% 0.92% Current portion of long-term debt 0.08% 20.25% 2.08% 0.00% 7.31% 5.94% Accounts payable 9.04% 10.47% 9.66% 10.26% 10.05% 9.90% Accrued liabilities 42.45% 39.91% 45.05% 47.16% 30.02% 40.92%

Total current liabilities 52.90% 71.75% 57.73% 58.11% 47.93% 57.68% 55.00% Long-term debt, excluding current portion 39.07% 18.91% 31.41% 31.75% 38.32% 31.89% Other liabilities 8.03% 9.35% 10.86% 10.15% 13.75% 10.43%

Total liabilities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Shareholders equity Preference stock Common stock 7.46% 6.39% 6.08% 6.82% 7.57% 6.87% Additional paid-in capital 28.31% 23.22% 20.78% 20.95% 26.65% 23.98% Deferred compensation -0.05% -0.01% 0.00% 0.00% 0.00% -0.01% Retained earnings 111.56% 104.97% 108.44% 131.37% 163.28% 123.92% Accumulated other comprehensive earnings 2.17% 5.02% 0.89% 0.73% 5.41% 2.84% Treasury stock -49.46% -39.60% -36.20% -59.87% -102.91% -57.61%

Total shareholders equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

89 HASBRO'S BALANCE SHEET RESTATED Actual Accounting Financials Forecast Financial Statements in millions 2003 2004 2005 2006 2007 AVERAGE ASSUME 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 ASSETS Cash and cash equivalents 520.75 725.00 942.27 715.40 774.46 0.24 960.33 1,190.81 1,476.60 1,830.98 2,270.42 2,815.32 3,491.00 4,328.84 5,367.76 6,656.02 Accounts receivable 607.56 578.71 523.23 556.29 654.79 18.22 0.205 789.02 950.77 1,145.68 1,380.54 1,663.55 2,004.58 2,415.52 2,910.70 3,507.40 4,226.41 Inventories 168.98 194.78 179.40 203.34 259.08 6.27 0.07 277.22 296.62 317.39 339.60 363.37 388.81 416.03 445.15 476.31 509.65 Prepaid expenses and other current assets 211.98 219.74 185.30 243.29 199.91

Total current assets 1,509.26 1,718.22 1,830.20 1,718.32 1,888.24 1,893.18 1,949.97 2,008.47 2,068.73 2,130.79 2,194.71 2,260.55 2,328.37 2,398.22 2,470.17 Property, plant and equipment, net 199.85 206.93 164.05 181.73 187.96

Other assets Goodwill 463.68 469.73 467.06 469.94 471.18 0.1461 540.02 618.91 709.34 812.97 931.74 1,067.87 1,223.89 1,402.70 1,607.63 1,842.51 Other intangibles, net 928.58 866.84 901.16 777.32 737.22 0.19 877.29 1,043.98 1,242.33 1,478.38 1,759.27 2,093.53 2,491.30 2,964.65 3,527.93 4,198.24 Other 279.94 207.85 226.41 194.67 203.45

Total other assets 1,672.20 1,544.42 1,594.63 1,441.93 1,411.85 40.13% 1,268.97 1,307.04 1,346.25 1,386.64 1,428.24 1,471.08 1,515.22 1,560.67 1,607.49 1,655.72

Total assets 3,181.47 3,262.64 3,424.83 3,160.24 3,300.09 ato: 1.25 3,162.15 3,257.01 3,354.72 3,455.37 3,559.03 3,665.80 3,775.77 3,889.04 4,005.72 4,125.89

LIABILITIES AND SHAREHOLDERS EQUITY Current liabilities Short-term borrowings 23.35 17.96 14.68 10.58 10.20 Current portion of long-term debt 1.33 324.12 32.77 0.00 135.35 Accounts payable 158.97 167.59 152.47 160.02 186.20 Accrued liabilities 746.40 638.94 710.81 735.30 555.92

Total current liabilities 930.06 1,148.61 910.73 905.89 887.67 1.83 0.0201 905.51 923.71 942.28 961.22 980.54 1,000.25 1,020.35 1,040.86 1,061.79 1,083.13 Long-term debt, excluding current portion 686.87 302.70 495.62 494.92 709.72 Other liabilities 217.50 229.75 251.38 243.98 342.42

Total liabilities 1,758.14 1,600.94 1,577.67 1,559.02 1,851.97 1,154.66 769.25 364.31 (61.55) (509.83) (982.16) (1,480.34) (2,006.29) (2,562.15) (3,150.21)

Shareholders equity Preference stock Common stock 104.85 104.85 104.85 104.85 104.85 Additional paid-in capital 397.88 380.75 358.20 322.25 369.09 Deferred compensation (0.68) (0.10) (0.02) Retained earnings 1,709.36 1,863.00 2,017.68 2,179.64 2,424.70 2,883.96 3,364.23 3,866.88 4,393.38 4,945.32 5,524.43 6,132.58 6,771.81 7,444.33 8,152.57 Accumulated other comprehensive earnings 30.48 82.39 15.35 11.19 74.94 Treasury stock (694.98) (649.37) (623.90) (920.75) (1,425.35)

Total shareholders equity 1,546.90 1,781.52 1,872.15 1,697.18 1,548.24 2,007.49 2,487.76 2,990.42 3,516.92 4,068.86 4,647.96 5,256.11 5,895.34 6,567.87 7,276.10

Total liabilities and shareholders equity 3,163.38 3,240.66 3,301.14 3,096.91 3,237.06 0.0125 3,162.15 3,257.01 3,354.72 3,455.37 3,559.03 3,665.80 3,775.77 3,889.04 4,005.72 4,125.89

90 Cash Flow Analysis

The statement of cash flows helps us better understand the operating, financing, and investing activities of the company. We first calculated the Cash Flows from Operations/ Sales, Cash Flows from Operations/ Net Income, and Cash Flows from Operations/ Operating Income. We calculating these ratios we determined CFFO/Sales was our best estimate for forecasting cash flows from operations. We used a ratio of 13.67% and forecasted the values for the next ten years. Cash flows from investing activities are reflected by the net change in assets each year. The can be used because when there is an increase in long term assets, cash is used to purchase these items. All this was helpful information to help us predict the future out come of the company.

91 HASBRO'S CASH FLOW Actual Accounting Financials Forecast Financial Statements 2003 2004 2005 2006 2007 AVERAGEASSUME 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Net Income/Starting Line 157.66 195.98 212.08 230.06 333 51% 362.97 395.64 431.24 470.06 512.36 558.47 608.74 663.52 723.24 788.33 Depreciation/Depletion 88.07 75.62 78.1 67.77 88.8 Amortization 76.05 70.56 102.04 78.93 67.72 Deferred Taxes 22.77 34.62 -24.03 24.97 37.58 Non-Cash Items 51.5 -2.31 -2.01 42.27 73.77 Accounting Change 17.35 0 0 0 0 Unusual Items 33.97 -2.45 -2.08 34.4 44.37 Other Non-Cash Items 0.17 0.14 0.07 7.87 29.4 Changes in Working Capital 58.1 -15.97 130.46 -123.35 0.92 Accounts Receivable -13.2 75.59 39.34 -10.71 -74.94 Inventories 34.85 -15.84 10.68 -17.62 -44.27 Prepaid Expenses 7.85 29.42 74.53 -35.17 79.25 Payable/Accrued 16.71 -89.74 33.21 -20.68 64.94 Other Liabilities 11.9 -15.41 -27.31 -39.17 -24.05 Cash from Operating Activities 454.16 358.51 496.62 320.65 601.79 123.03 446.56 486.75 530.56 578.31 630.36 687.09 748.93 816.33 889.80 969.88

Capital Expenditures -63.07 -79.24 -70.58 -82.1 -91.53 Purchase of Fixed Assets -63.07 -79.24 -70.58 -82.1 -91.53 Other Investing Cash Flow Items, Total -1.81 -5.73 -50.09 -1.5 -20.93 Acquisition of Business 0 -9.82 -79.18 0 -18 Sale of Fixed Assets 4.57 4.31 33.08 1.2 0.59 Sale/Maturity of Investment 0 0 0 941.12 43.7 Purchase of Investments 0 0 0 -941.12 -43.7 Other Investing Cash Flow -6.38 -0.21 -3.99 -2.7 -3.52 Cash from Investing Activities -64.88 -84.97 -120.67 -83.6 -112.47 5.87 (119.07) (126.06) (133.46) (141.30) (149.59) (158.37) (167.67) (177.51) (187.93) (198.96)

Financing Cash Flow Items 0 0 0 14.96 -182.99 Other Financing Cash Flow 0 0 0 14.96 -182.99 Total Cash Dividends Paid -20.85 -37.09 -58.9 -75.28 -94.1 10% (103.51) (113.86) (125.25) (137.77) (151.55) (166.70) (183.37) (201.71) (221.88) (244.07) Issuance (Retirement) of Stock, Net 36.51 25.84 -2.75 -370.49 -501.69 Issuance (Retirement) of Debt, Net -388.97 -64.57 -96.99 -36.47 344.86 Cash from Financing Activities -373.31 -75.82 -158.64 -467.28 -433.92 0.5621461 0.6297114 0.7824123 0.8

CFFO/Sales 14.47% 11.96% 16.08% 10.17% 15.68% 13.67% 13.67% 13.67% 13.67% 13.67% 13.67% 13.67% 13.67% 13.67% 13.67% 13.67% CFFO/Net Income 288.06% 182.93% 234.17% 139.38% 180.72% 205.05% 180.00% 180.00% 180.00% 180.00% 180.00% 180.00% 180.00% 180.00% 180.00% 180.00% CFFO/Operating Income 131.79% 122.35% 159.93% 85.20% 115.87% 123.03% 123.03% 123.03% 123.03% 123.03% 123.03% 123.03% 123.03% 123.03% 123.03% 123.03%

92

Cash Flow - Common Size Actual Accounting Financials 2003 2004 2005 2006 2007 AVERAGE ASSUME Net Income/Starting Line 34.71% 54.67% 42.70% 71.75% 55.33% 51.83% 0.51 Depreciation/Depletion 19.39% 21.09% 15.73% 21.14% 14.76% 18.42% Amortization 16.75% 19.68% 20.55% 24.62% 11.25% 18.57% Deferred Taxes 5.01% 9.66% -4.84% 7.79% 6.24% 4.77% Non-Cash Items 11.34% -0.64% -0.40% 13.18% 12.26% 7.15% Accounting Change 3.82% 0.00% 0.00% 0.00% 0.00% 0.76% Unusual Items 7.48% -0.68% -0.42% 10.73% 7.37% 4.90% Other Non-Cash Items 0.04% 0.04% 0.01% 2.45% 4.89% 1.49% Changes in Working Capital 12.79% -4.45% 26.27% -38.47% 0.15% -0.74% Accounts Receivable -2.91% 21.08% 7.92% -3.34% -12.45% 2.06% Inventories 7.67% -4.42% 2.15% -5.50% -7.36% -1.49% Prepaid Expenses 1.73% 8.21% 15.01% -10.97% 13.17% 5.43% Payable/Accrued 3.68% -25.03% 6.69% -6.45% 10.79% -2.06% Other Liabilities 2.62% -4.30% -5.50% -12.22% -4.00% -4.68% Cash from Operating Activities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Capital Expenditures 97.21% 93.26% 58.49% 98.21% 81.38% 85.71% Purchase of Fixed Assets 97.21% 93.26% 58.49% 98.21% 81.38% 85.71% Other Investing Cash Flow Items, Total 2.79% 6.74% 41.51% 1.79% 18.61% 14.29% Acquisition of Business 0.00% 11.56% 65.62% 0.00% 16.00% 18.64% Sale of Fixed Assets -7.04% -5.07% -27.41% -1.44% -0.52% -8.30% Sale/Maturity of Investment 0.00% 0.00% 0.00% -1125.74% -38.85% -232.92% Purchase of Investments 0.00% 0.00% 0.00% 1125.74% 38.85% 232.92% Other Investing Cash Flow 9.83% 0.25% 3.31% 3.23% 3.13% 3.95% Cash from Investing Activities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Financing Cash Flow Items 0.00% 0.00% 0.00% -3.20% 42.17% 7.79% Other Financing Cash Flow 0.00% 0.00% 0.00% -3.20% 42.17% 7.79% Total Cash Dividends Paid 5.59% 48.92% 37.13% 16.11% 21.69% 25.89% Issuance (Retirement) of Stock, Net -9.78% -34.08% 1.73% 79.29% 115.62% 30.56% Issuance (Retirement) of Debt, Net 104.19% 85.16% 61.14% 7.80% -79.48% 35.76% Cash from Financing Activities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

93 Cost of Capital Estimation

Cost of Equity

The estimated cost of equity, “Ke”, is calculated by using the Capital Asset Pricing Model. According to Palepu & Healy’s Business Analysis & Valuation Using Financial Statements, CAPM means “the sum of a required return on riskless assets plus premium for beta or systemic risk.” To break this down into simple terms, the formula we are using is:

(CAPM)Ke= Rf +β (MRP)

The three main components we use in this formula are the risk free rate, “Rf” which comes for the St. Louis Fed website, our beta, “β”, that we got from our highest adjusted R^2 in our regression tables, and lastly our market risk premium,“MRP”, which is calculated by subtracting the market return from the risk free rate.

First of all, we have five points on the yield curve which consists of the treasury constant maturity rates (3 months, 6 months, 2 year, 5 year, and 10 year). Then we ran regressions for five different horizons (72, 60, 48, 36, and 24 months) for each point on the yield curve.

Overall, the data we computed were the firm’s monthly stock returns, the market returns which we got from S&P 500 overall prices, the risk free rates from the treasury constant maturity rates which we computed into monthly rates, and lastly the market risk premiums which we got from subtracting the firm’s monthly stock returns from the risk free rates. These regressions required the monthly stock return data and the market risk premium data from each treasury rate. We ran these regressions to find our highest adjusted R^2, so we can use that beta component. During running these regressions, we noticed that the betas, adjusted R^2’s, and Ke’s were either similar to each other or exactly the same between the different points and horizons.

94 Regression Analysis

3 Month

72 60 48 36 24

β 1.25 1.38 1.47 1.50 1.33

Adj.R^2 0.3350 0.3365 0.3668 0.4047 0.3881

T-stat 6.06 5.56 5.31 4.98 3.57

Risk Free 3.74% 3.74% 3.74% 3.74% 3.74%

Ke 13.61% 14.64% 15.35% 15.59% 14.25%

6 Month

72 60 48 36 24

β 1.25 1.38 1.47 1.50 1.34

Adj. R^2 0.3352 0.3368 0.3671 0.4054 0.3386

T-stat 6.07 5.56 5.32 4.99 3.57

Risk Free 3.74% 3.74% 3.74% 3.74% 3.74%

Ke 13.62% 14.64% 15.35% 15.59% 14.43%

95 2 Year

72 60 48 36 24

β 1.25 1.39 1.48 1.51 1.34

Adj. R^2 .3364 .3398 0.3709 0.4079 0.3400

T-stat 6.08 5.60 5.36 5.01 3.58

Risk Free 3.74% 3.74% 3.74% 3.74% 3.74%

Ke 13.62% 14.72% 15.43% 15.67% 14.33%

5 Year

72 60 48 36 24

β 1.25 1.40 1.48 1.50 1.33

Adj. R^2 0.3363 0.3414 0.3735 0.4076 0.3397

T-stat 6.08 5.62 5.39 5.01 3.58

Risk Free 3.74% 3.74% 3.74% 3.74% 3.74%

Ke 13.62% 14.80% 15.43% 15.59 14.25%

96 10 Year

72 60 48 36 24

β 1.25 1.40 1.48 1.49 1.32

Adj. R^2 0.3358 0.3417 0.3743 0.4062 0.3384

T-stat 6.07 5.62 5.40 4.99 3.57

Risk Free 3.74% 3.74% 3.74% 3.74% 3.74%

Ke 13.62% 14.80% 15.43% 15.51% 14.42%

After running a total of 25 regressions, we found that the 2 year treasury constant maturity rate at 36 months gave us the highest adjusted R^2 of .4079 causing our beta to be 1.51. This is similar to what Yahoo! Finance reported our beta at which is 1.59. Beta is “a measure of the volatility”

(http://www.investopedia.com/terms/b/beta.asp). Since our beta is more than 1, it is more volatile according to investopedia.com. Through out all of our different five point yield curves, the 36 month horizon gave the highest adjusted R^2 across the board. This is what gave us the highest explanatory power for our beta. Also, with our highest adjusted R^2 being in the 2 year treasury constant maturity rate, this shows us that we have a “medium-term investment” (bnet.com), because 2 years is in the “one to three years” investment horizon. We used the 10 year treasury constant maturity rate of 3.74% for our risk free rates through out the different regression periods. We found our market risk premium by taking the “1926-2005 period long run average on the S&P 500’s index of 6.8%” (Business Analysis & Valuation Using Financial Statements) and adding a size premium of 1.1% according to Hasbro’s market cap value and table 8-1 in Palepu and Healy, totaling the market risk premium to be 7.9%. After we collected all of this data, we concluded the calculation of our cost of equity:

Ke= .0374 + 1.51(.079) = 15.67%

Another method we learned about in class to calculate the cost of equity is called “the backdoor approach”. This formula is P/B= 1 + (ROE-Ke)/(Ke-g). We got these variables from Yahoo!

97 Finance and plugged them into the equation. Here we ended up getting a cost of equity of 12.60%, which is slightly less than our cost of equity above, but we felt it was best to go ahead and use our cost of equity of 15.67% at this time in the year.

Cost of debt

When evaluating the cost of debt the 3 month AA commercial paper rate of 2.80% for Hasbro’s accounts payable. For short term borrowings and accrued liabilities a disclosed rate of 4.70% was used. For the current portion of long term debt and long term debt a disclosed rate of 6.50% was used. The pension rate of 8.75% was used for other liabilities. A percentage of total liabilities was acquired for each listing of every item under the current liabilities section of the balance sheet and multiplied by their respective rates to get a summed weighted rate of 2.19% for current liabilities. A percentage of long term liabilities were multiplied by their respective rates mentioned and a total 3.69% was the result. A weighted average cost of debt came to be 5.89% when adding the 3.69% weighted rate to the 2.19%weighted rate.

WACC

The cost of funds being 5.89% for debt and 15.67% for equity was multiplied by an economic weighting that is the percentage of debt and equity to get a before tax WACC of 8.84%. The following equation is the before tax WACC.

(1) Cost of Debt*Economic weight = 3.22%

+

(2) Ke*Economic weight = 6.85%

=

(3) Total before tax WACC = 10.07%

98 The economic weight is assumed to be a capital structure of 54.63% debt and 45.37% equity and that target is assumed to hold reasonably around that target for this report. The after tax WACC has an addition to step one that is a tax rate assumption of 38% or (1-.38) multiplied by the cost of debt and by the economic weighting for a total WACC after tax rate of 8.85%.

Conclusion

After completing our regression analysis to find our beta, we estimated our cost of equity to be 15.67%. With our beta being 1.51, Hasbro tends to be a more risky company, because it is over 1. The cost of debt happened to be 5.89% and it should be noted that this is expected to change given inflation concerns. These calculations show that a 15.1% cost of equity will be used to discount forecasts of abnormal earnings and cash flows for equity holders. The 10.07% WACC will be used to discount abnormal NOPAT and cash flows derived from debt and equity.

Valuation Analysis

The valuation analysis is comprised in two sections, the method of comparables and the intrinsic valuations to estimate the appropriate selling price of Hasbro. The method of comparables section is comprised of the following measures, trailing P/E, forward P/E, B/P, PEG, P/EBITDA, P/FCF, and EV/EBITDA. The intrinsic valuations included the dividend discount model, discounted free cash flows model, abnormal earnings growth, the residual income method, and the residual income perpetuity.

Method of Comparables

The comparables method is the not so accurate, no value added valuation process to determine any off pricing in the marketplace. No value added means that no unique opinion can be factored in; we are not adding any real value using this method of comparables. The method itself revolves around industry averages and backing in to a few ratios to acquire a share price for the firm Hasbro. The graph below is a summary

99 of our results and the deviation of price using the ratios and industry averages. First of all, since we were valuating our company’s as of April1, 2008, we had to use that share price on that day for our company and their competitors. Also, we chose a 15% error tolerance. So anything above $33.66 is considered undervalued and anything below $24.88 is considered overvalued. As can be seen the price can vary widely on the ratio used. Some firms were excluded or thrown out to prevent any extreme abnormality in price when using the ratios and at many times this was the case. Also, we would like to point out that we had to do many of the ratios over because of our restatements on the financial information. Those adjustments caused a little bit of a change in most of all the ratios. There were only two equations which were close and that are the trailing P/E ratio and forward P/E ratio. Since our valuation date for our companies is April 1, 2008, we used that price per share number for each of companies. The models and methods are discussed in more detail past this graph below on calculation and meaning.

Model Suggested Compared to Price Actual price Trailing P/E $29.16 Fairly Valued Forward P/E $28.94 Fairly Valued B/P $22.32 Overvalued D/P $18.66 Overvalued PEG $20.61 Overvalued P/EBITDA $37.10 Undervalued P/FCF $45.67 Undervalued EV/EBITDA $35.98 Undervalued *Actual price on April 1, 2008 is $29.27.

100 Trailing Price to Earnings

PPS EPS Trailing P/E Industry Price Average Hasbro (BR) 29.27 2.13 13.74 13.47 $28.69 Hasbro (AR) 29.27 2.16 13.52 13.47 $29.16 Marvel 27.65 1.70 16.26 JAKKS 28.75 2.77 10.38 Mattel 21.20 1.54 13.77

The trailing P/E ratio is computed by taking a company’s price per share (PPS) and dividing it by their earnings per share (EPS). This ratio compares our share price to our earnings per share, as it states in the equation above. For Mattel, JAKKS, and Marvel, we got their EPS number from Yahoo! Finance. For Hasbro, we got that information from their most recent 10-K. Next, we divided the PPS by the EPS to get the trailing P/E for each company. Then we found an industry average of the three competitors, Hasbro’s trailing P/E ratio wasn’t included in this average, and divided that number by 3 for the number of competitors. To get our share price, we took the industry average, 13.47, and multiplied it by Hasbro’s EPS of 2.16. This price turned out to be $29.16. We can conclude that the trailing P/E ratio turned out to be fairly value, because it is between that 15%.

Forward Price to Earnings

PPS EPS Forward P/E Industry Price Average Hasbro (BR) 29.27 2.56 11.41 11.26 $28.90 Hasbro (AR) 29.27 2.57 11.38 11.26 $28.94 Marvel 27.65 1.61 17.17 Thrown out JAKKS 28.75 2.97 9.68 Mattel 21.20 1.65 12.84

Forward P/E is almost the same as trailing P/E. The only change here is that we used the forecasted out EPS, which are five-years ahead. We did this ratio, because we

101 want to see Hasbro’s and their competitor’s price to earnings ratio in five years. It is interesting to see how it has changed from our trailing price to earnings ratio. We can see that all of the company’s EPS went up except for Marvel. The concept is exactly the same as above. We divided our PPS from the EPS to get our forward P/E. We throw out Marvel’s in the industry average, because their ratio was much higher than all the other competitors. After we got the industry average, we figured out the price by multiplying that average by Hasbro’s forward EPS, which resulting in a share price of $28.94. With our 15% error tolerance, we can conclude that this is fairly valued, because it is in that range.

Price to Book

PPS BPS P/B Industry Price Average Hasbro (BR) 29.27 8.88 3.30 2.25 $19.97 Hasbro (AR) 29.27 9.92 2.95 2.25 $22.32 Marvel 27.65 2.34 11.82 Thrown Out JAKKS 28.75 24.44 1.18 Mattel 21.20 6.38 3.32

The price to book ratio is used to compare the market value to the book value. The market value is the stated price and the book value is the “the value of an asset as it appears on a balance sheet” (investorwords). We computed the price to book ratio by dividing our price per share (PPS) by the book per share (BPS). We found our competitor’s BPS on Yahoo! Finance. To compute Hasbro’s BPS, we took their total stockholder equity and divided that number by their total shares outstanding. We found this information on Hasbro’s 10-K. Then we computed the P/B ratios for each company by dividing the PPS by the BPS. In our industry average we would like to point out that Marvel’s P/B ratio was thrown out again, because is clearly bigger than the rest of the price to book averages and it should not be included in the industry. So we took the industry average of just Mattel and JAKKS, and got 2.25. To get our share price we took the industry average of 2.25 and multiplied it by Hasbro’s books per share of 9.92. This

102 came out to be a total of $22.32. By looking at our price per share on April 1, 2008, we can conclude that this price is overvalued.

Dividends to Price

PPS DPS D/P Industry Price Average Hasbro (BR) 29.27 0.66 0.02 0.04 $18.66 Hasbro (AR) 29.27 0.66 0.02 0.04 $18.66 Marvel 27.65 N/A N/A JAKKS 28.75 N/A N/A Mattel 21.20 0.74 0.04

The dividends to price ratio is computed by taking the dividend per share (DPS) and dividing it by the price per share (PPS). We found Mattel’s DPS on Yahoo! Finance. We computed Hasbro’s DPS by using their 10-K information. Many companies don’t have dividends, like two of our competitors, JAKKS and Marvel. So the only competitor in the industry average is Mattel. To find our share price we dividend Hasbro’s DPS from the industry average and we got a share price of $18.66. This shows that our price is overvalued again.

Price Earnings Growth

P/E EPS PEG Industry Price Average Hasbro (BR) 13.74 2.13 1.37 1.06 $22.58 Hasbro (AR) 13.52 2.16 1.35 1.06 $22.90 Marvel 16.26 1.70 0.91 JAKKS 10.38 2.77 0.96 Mattel 13.76 1.54 1.31 *Hasbro’s growth rate= 10%

The equation for the price earnings growth (PEG) ratio is:

(P/E)/ Growth Rate

103 Here we use our trailing P/E ratios from above for each company. Then for our competitors we got their growth rate that was reported on Yahoo! Finance. We used their “next 5 years” growth rate. For Hasbro’s PEG we computed that their growth rate was 9%, so we divided their P/E of 13.52 from a growth rate of 9% to get a PEG of 1.35. This came out to be the highest PEG out of all the companies in the industry. We took an industry average of the three competitors. To get our share price we took the industry average and multiplied that by our 10% growth rate and multiplied that number by Hasbro’s EPS. We came out with a share price of $22.90, which is overstated according to the April 1, 2008 share price of $29.27.

Price to EBITDA

Market Cap EBITDA P/EBITDA Industry Price (in millions) Average Hasbro (BR) 4230 531.62 7.96 7.50 $37.10 Hasbro (AR) 4230 531.61 7.96 7.50 $37.10 Marvel 2110 279.00 7.56 JAKKS 836.11 133.66 6.26 Mattel 7820 902.16 8.67

The price to EBITDA is computed by taking the market capitalization amount and dividing it by the EBITDA. EBITDA consists of earnings before income, taxes, depreciation, and amortization. If you look at an income statement, this would just be the revenues minus expenses before the income, tax, deprecation, and amortization. The $37.10 price was derived by taking Hasbro’s EBITDA, multiplying it by the industry average, and then dividing that final number by our number of shares outstanding. $37.10 price is over what is reasonable and shows the firm as gravely undervalued or this is just horrible valuation method.

104 Price to Future Cash Flows (FCF)

PPS FCF P/FCF Industry Price (in millions) (in millions) Average Hasbro (BR) 29.27 3.43 8.53 13.16 $45.17 Hasbro (AR) 29.27 3.47 8.45 13.16 $45.67 Marvel 27.65 2.53 10.94 JAKKS 28.75 1.87 15.39 Mattel 21.20 0.12 176.60 Thrown Out

The price to future cash flows comparable uses the price per share divided by free cash flows on a per share basis. Free cash flows are determined by subtracting cash flows from investing activities from operating cash flows. Dividing this by the number of shares outstanding gives the price to future cash flows or free cash flows on a per share basis. The industry average was calculated by adding JAKKS and Marvel together and dividing by two. Mattel was thrown out, because their P/FCF ratio was extremely high. Hasbro’s price of $45.67 was derived by taking the free cash flow of the firm on a per share basis and multiplying that by the industry average. This comparable is way off because a price of $45.67, which came out to be undervalued, is about double what Hasbro’s share price is today.

Enterprise Value to EBITDA

EV EBITDA EV/EBITDA Industry Price (in billions) (in billions) Average Hasbro (BR) 5.30 0.53 9.96 8.55 $36.06 Hasbro (AR) 5.40 0.53 10.16 8.55 $35.98 Marvel 2.37 0.28 8.50 JAKKS 0.71 0.13 5.33 Thrown Out Mattel 7.75 0.90 8.59

Enterprise value was determined by using the equation below.

(Market Capitalization + Book Value of Liabilities) – Cash & Cash Equivalents

105 This was divided by EBITDA to arrive at EV/EBITDA. JAKKS was thrown out for being outside a reasonable measuring range. The EV/EBITDA was divided by two to get the industry average. Hasbro’s price was acquired by taking EBITDA and dividing it by the number of shares outstanding and multiplying that by the industry average. Then cash and cash equivalents were added back with book value of liabilities subtracted to get a price per share of $35.98. This price is reasonably close to Hasbro’s current price and show the company as slightly undervalued.

Conclusion

In conclusion, there are many ways to value your company using ratios, even though these ratios may not be accurate in the end. After computing these eight comparables, we can conclude that the only two ratios that make our company a fairly valued company is the trailing price to earning and forward price to earning ratios. It is hard to conclude whether our company is overvalued or undervalued, because out of our six comparables we had three that were overvalued and three that were undervalued. The competed share prices ranged from $18.66 to $45.67, which are very different from out share price of $29.27 on April 1, 2008. These prices prove that these methods of comparables aren’t the best way to value a company.

Intrinsic Valuations

Another way to value a company is by using intrinsic valuation models, which is a more accurate way of valuation. The information for these models come from our various financial statements and forecasted information. The five models we used to value Hasbro are: dividend discount model, free cash flows model, residual income model, the abnormal earnings growth earnings, and the long run residual income perpetuity model.

106 Dividend Discount Model

The dividend discount model is an old model for valuating firms created by Myron Gordon. Since it is highly probable that the firm will grow at a steady rate this is an appropriate model to use to valuate Hasbro. A growth of 14.4% might be a better indicator over the 10% rate used earlier because it best reflects the past eight years into the next ten years out. The logic being that the past eight years included a sharp recession after the tech bubble burst, a terrorist attack, a fiscal stimulus at the same time, and a slow recovery mirrors the next ten years minus the terrorist attack and replace “tech” with “housing market”. The result was this seen below.

123 45678910 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 DIV 0.16 0.18 0.21 0.24 0.27 0.31 0.36 0.41 0.47 0.54

DIV Growt h 14.4%

As can be seen the dividends go up a first by two or three cents until year five. With the Wall Street Journal announces better than estimated earnings by Hasbro, and considering the growth potential of the firm given its commitment to the key success factors outlined before a rate of 14.4% is something to consider. The 10% rate assumes less growth than the past eight years and is a more pessimistic view of the firm. The result is below.

123 45678910 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 DIV 0.16 0.18 0.19 0.21 0.23 0.26 0.28 0.31 0.34 0.38 DIV Growt h 10.0%

A growing perpetuity for year 11 (2018) was used for the future dividends onward. Using the Ke of 15.67%, the 2018 (year 11) perpetuity of 61 cents discounted back came to be $11.28. With the sum present value of the year by year dividends came to be $1.32. The time consistent value ended as $12.15 with the two added together. After a sensitivity analysis considering a 15% spread over and under the $29.97 (1/4/08 price) the Gordon growth model came to be quite sensitive. A major difference between the Ke and the growth rate showed a significant decline in the value of the firm. The rate of 14.4% would have to be maintained closely with a cost of equity just above it for the firm to have value. The model shows the

107 importance of a solid growth rate for this firm. The original forecasted rate of 10% shows an overvalued firm with a price of $2.72! The price arrived through this model with a 14.4% growth rate was $12.15, a difference of $9.43. Both still convey an overvalued firm. The model relies on numerous assumptions, one being a stable growth rate that can vary from year to year. The sensitivity analysis shows that any deviation from the existing growth rate would result is wildly different numbers. Below is the sensitivity analysis taken from Microsoft Excel.

G 10.00% 12.00% 13.00% 14.40% 15.00% 16.00% 17.00% 12%$ 7.78 N/ A N/ A N/ A N/ A N/ A N/ A 13%$ 5.17 $ 15.52 N/ A N/ A N/ A N/ A N/ A 14%$ 3.87 $ 7.74 $ 15.48 N/ A N/ A N/ A N/ A Ke 15.67%$ 2.72 $ 4.20 $ 5.78 $ 12.15 N/ A N/ A N/ A 16%$ 2.57 $ 3.85 $ 5.14 $ 9.64 $ 15.42 N/ A N/ A 17%$ 2.20 $ 3.08 $ 3.85 $ 5.92 $ 7.69 $ 15.38 N/ A 18%$ 1.92 $ 2.56 $ 3.07 $ 4.26 $ 5.12 $ 7.68 $ 15.35

Mkt within 15% 4/ 1/ 2008 Undervalued > $ 33.66 Overvalued < $ 24.88 Fairly valued

Free Cash Flow Model

The Free Cash Flow model takes the cost of capital and the growth rate of perpetuity into account on a total dollar basis. To start this model, you need your forecasted out information on cash flows from operations (CFFO) and cash flows from investing (CFFI), and the before tax weighted average cost of capital. You use the before tax weighted average cost of capital, because we when we compute the free cash flow to firm, it is already after tax, so we need to use the before tax WACC. Also, the cash flow from operations is an after tax concept, so we can leave that as be. To begin with finding our annual free cash flow units we

108 need to add the CFFI to our CFFO. Then we found the present value of all ten years out using our WACC before tax. Next, we got our present value year by year free cash flows by multiplying the free cash flows units from the present values of each year and we totaled these numbers up. Even though we only forecasted out ten years, we need that eleventh year unit, which is known as our perpetuity. We get this by taking year ten’s annual free cash flow unit and divided it by our before tax WACC minus the growth rate. Then to find the present value of that, we take that number and multiple it by our year ten’s present value factor. Next, we add these two numbers up to get our total present value of free cash flows. Our last step before computing the share price is subtracting the total present value of free cash flows from our book value of equity and preferred stock to get our market value of equity. Lastly, we divide that number by our number of shares outstanding to get our intrinsic value. Since we are valuating our company in April, we move that value up three months, so to get our time consistent price we take that share price and add our WACC to one and finally multiple that by 3/12 and we get a final share price of $29.10. To see how our companied is valued, we changed the before tax WACC and the growth rate to see what would happen to our share price:

Perp Growt h Rat e 0235 79 8.07 41.71 52.07 60.31 92.91 247.35 N/ A 9.07 34.68 41.91 47.32 66.09 121.14 3321.69 WACCbt 10.07 29.1 34.32 38.04 49.87 77.13 206.29 11.07 24.57 28.44 31.09 39.02 54.74 100.85 12.07 20.82 23.75 25.7 31.35 41.18 64.05

Mkt within 15% 4/ 1/ 2008 $29.27 Undervalued >33.66 Overvalued <24.88 Fairly Valued

Overall, this model shows that our company is undervalued. Here we used growth rates from 0% to 9%, because we wanted to see how the model would change for different rates. One thing we want to make sure is that our growth rate is less than our weighted average cost

109 of capital, because if it is the opposite then we will get negative prices for our model. There are some problems with this model though. First of all, it is sensitive to the terminal value growth rate and it also has a low explanatory power, but not as low as the dividend discount model.

Residual Income Model

The residual income model takes the cost of equity, which we computed earlier, and negative growth rates into account. It basically tells us what we have plus the present value of value added. Our growth rates are negative, because we want to restore it back to equilibrium quickly. Unlike the free cash flows model, the residual income model is not that sensitive to errors and has one of the highest explanatory power. Two things you need to forecast for this model are net income and total dividends, which we had to do for ten years out. With these variables on hand you need to compute the book value of equity. The formula to compute this book value of equity is:

BVEo= BVEt-1+NIo-TDo

This formula means we need the net income and total dividends of the current year, but we need to remember that in order to compute this we need to use the book value of equity for the year before. Once we have our book value of equity for each year, we can figure out the normal earnings, which is our benchmark. You figure this out by multiplying the year’s book value per share by the cost of equity variable and drag that out along the years. Next we need the residual income for the year which is computed by subtracting the net income from the normal income. Our next step is to find the present value for each year. Then to find the present value of the residual income you just need to multiple the present values by their residual income for the year and add up all of these to get a sum of present value. Even though we only have to forecast out to ten years, we still have to deal with the terminal perpetuity value. So once we figure this out for year eleven, we can find the market value of equity, which is just our first year’s book value of equity plus our total present value plus our terminal value perpetuity value. Just like the other models you then divide by the number of shares and then make initial share price time consistent by moving it up three months, which makes our share

110 price to be $10. 42. We started out with a zero growth rate and our initial cost of equity of 15.67%, but as we see below we changed both variables:

g 0 -0.1 -0.2 -0.3 -0.4 -0.5 0.1267 14.24 14.44 14.52 14.56 14.58 14.6 0.1367 12.75 13.04 13.32 13.41 13.46 13.5 0.1467 11.49 12.02 12.25 12.38 12.46 12.51 Ke 0.1567 10.42 11.03 11.3 11.45 11.55 11.62 0.1667 9.51 10.15 10.45 10.62 10.73 10.8 0.1767 8.71 9.38 9.68 9.86 9.98 10.06

Mkt within 15% 4/ 1/ 2008 $29.27 Undervalued >33.66 Overvalued <24.88 Fairly Valued

This model shows that Hasbro is completely overvalued and none of the prices are close to our share price of $29.27 at all. Also, we notice that the lower the cost of equity and the higher the negative growth rate, the higher the price will be.

111 Abnormal Earnings Growth Model (AEG)

The abnormal growth model is similar to the residual income model. One thing that is different is that we discount this back to year one instead of year zero. According to the AEG model, if the market to book value goes up then we are holding a lot of residual income, which is excess earnings. The AEG model is our “actual” income vs. our benchmark income. The “actual” income consists of direct wealth, which is our earnings and indirect wealth, which is our DRIP values. The two things you need forecasted here is the net income and total dividends, just like the residual income model. Then we need to find our DRIP model. DRIP stands for our dividend reinvestment income. We do this by multiplying our cost of equity by the total dividends for the year before. Then we need to find our cumulative dividend income, which is just adding our net income to the DRIP values. Then we need the second half of our AEG model, which is our normal income (benchmark). We calculate this by taking our net incomes for the year before multiplying it by one plus our cost of equity. Next we have the AEG year by year numbers, which is computed by subtracting our cumulative dividend income from our normal, income. It is important to note here that this is where our residual income model and our abnormal growth model connect. This is where changes in residual income, from the residual income model, should be the same as the AEG year by year values. You can do this to test if you are doing these two models correctly and see if they match up.

Change in Residual Income -28.85 -28.58 -28.19 -27.66 -26.98 -26.13 -25.08 -23.83 -22.33 20.56 AEG YBY (28.85) (28.58) (28.19) (27.66) (26.98) (26.13) (25.08) (23.83) (22.33) (20.56)

Once we have these values, we find the present value of them and multiply those by the AEG year by year values to get the present value for the AEG. Make sure to add all of these numbers up to get a total for our present value factors. Next we need our CORE earnings of perpetuity which is our first year’s net income. Then we found our AEG terminal value perpetuity for year eleven. Lastly, we did what we have done for every model, which is find the market value of equity, dividing that by the number of shares outstanding to get our share price. To make it time consistent with our projects, we had to push it forward three months again to April. With our cost of equity at 15.67% and our growth rate at zero, we get a share

112 price of $9.00. We use negative growth rates here too, so we can get it back to equilibrium quickly. Here is what our model looks like during the sensitivity analysis:

g 0 -0.1 -0.2 -0.3 -0.4 -0.5 0.1267 12.42 13.37 13.74 13.94 14.06 14.14 0.1367 11.05 11.89 12.23 12.42 12.53 12.61 0.1467 9.93 10.67 10.98 11.15 11.26 11.33 Ke 0.1567 9 9.64 9.92 10.08 10.18 10.25 0.1667 8.21 8.77 9.02 9.17 9.26 9.33 0.1767 7.54 8.02 8.25 8.38 8.47 8.53

Mkt within 15% 29.27 Undervalued >33.66 Overvalued <24.88 Fairly Valued

Just like our residual income model, this model shows that Hasbro is overvalued, with our highest price being $14.14.

Long Run Residual Income Perpetuity Model

The long run residual income perpetuity model is the easiest valuation to compute. It meets all the criteria for valuation models. It has underlining theory, has measurability, not that sensitive, and lastly it does a good job at identifying mispriced companies. The equation for it is:

MVEo= BVEo x (1 +(ROE-ke)/(ke-g))

The return on equity and the growth rate are both the five year ahead average ROE and forwards earnings growth rate. The growth rate is positive, because it comes from what is sitting in our return on equity. The three main components we are dealing with here are the return on equity and growth rate, which we stated above and lastly the cost of equity. This model little similar to the residual income model. First we need our initial book value of equity at time zero. Then we need the three values which are stated above. We use the cost of equity

113 that we computed earlier. Then we need our forward earnings growth rate, which comes from our forecasting. Lastly, we need our average return on equity. We get this value by looking at out residual income model. We take the net income for the year and divide that by the total dividends of the year before:

01 23 4 5 6 7 8 9 10 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Net Income 355.74 366.41 377.41 388.73 400.39 412.40 424.77 437.52 450.64 464.16 Total Divdends 103.51 113.86 125.25 137.77 151.55 166.70 183.37 201.71 221.88 244.07 Book Value Equity 1548.235 1,800.47 2,053.02 2,305.18 2,556.14 2,804.98 3,050.68 3,292.08 3,527.88 3,756.64 3,976.73

0.229772491 0.203510592 0.18382992 0.168632734 0.156638974 0.14702515 0.1392394 0.1329002 0.12773757 0.165476338

Here it shows that we have an average return on equity of .17. Once we have these three values we need to find our estimated market value of equity. The formula for this is:

MVEo= BVEo (1 +(ROE-ke)/(ke-g))

This formula is exactly what the formula is above and all we have to do it plug those numbers in. Once we get the market value of equity, we divide that by the number of shares to get the initial price. Lastly, we have to make it the price time consistent to April, so we take that price and add one plus our cost of equity to the 3/12. Our final price that we get is $12.22 with our cost of equity at 15.67%, our growth rate at 0% and our average ROE at 17%. Since we have three different factors here, we had to do three different sensitivity analysis graphs:

114 Perp Growt h Rat e 023 5 7 9 0.1267 15.01 10.93 11.02 11.09 11.12 11.13 0.1367 13.94 11.01 11.08 11.13 11.16 11.17 0.1467 13.02 11.09 11.14 11.18 11.2 11.21 Ke 0.1567 12.22 11.18 11.21 11.23 11.24 11.24 0.1667 11.5 11.26 11.27 11.28 11.28 11.29 0.1767 10.88 11.35 11.33 11.32 11.32 11.32

ROE 0.14 0.15 0.16 0.17 0.18 0.19 0.1267 11.16 11.13 11.11 11.09 11.06 11.04 0.1367 11.2 11.18 11.16 11.13 11.11 11.08 Ke 0.1467 11.25 11.23 11.2 11.18 11.16 11.13 0.1567 11.3 11.28 11.25 11.23 11.21 11.18 0.1667 11.35 11.32 11.3 11.28 11.25 11.23 0.1767 11.39 11.37 11.35 11.32 11.3 11.28

ROE 0.14 0.15 0.16 0.17 0.18 0.19 0 10.06 10.78 11.5 12.22 12.93 13.65 2 11.36 11.31 11.24 11.18 11.12 11.06 3 11.33 11.29 11.25 11.21 11.18 11.13 g 5 11.3 11.28 11.25 11.23 11.21 11.18 7 11.29 11.27 11.25 11.24 11.22 11.2 9 11.28 11.27 11.26 11.24 11.23 11.22

Mkt within 15% 4/ 1/ 2008 $29.27 Undervalued >33.66 Overvalued <24.88 Fairly Valued

After doing all three of these graphs, we are confident to say that Hasbro is an overvalued firm.

115 Conclusion

In conclusion, looking at these intrinsic values, we can say that Hasbro is an overvalued company as of April 1, 2008.

Model Outcome

Dividend Discount Model Overvalued

Free Cash Flow Model Undervalued

Residual Income Model Overvalued

AEG Model Overvalued

Long Run RI Model Overvalued

HASBRO OVERVALUED

The only model that disproves this point is the free cash flow model, because that came out mainly undervalued, but we have to remember that this model is sensitive to the growth rates. The residual income model, abnormal growth rate model, and the long run residual income perpetuity model all convey that Hasbro is overvalued, but the dividend discount model was almost the only model to show that we way overvalued. We are going to have to agree with these conclusions, because the last three models, especially the long run residual income perpetuity model meets the criteria, which is four rules: has theory underlining, has measurability, not that sensitive to growth rates, and does a good job identifying mispriced companies.

116 Analyst’s Recommendation

Hasbro, Inc is an overvalued firm and that conclusion is based on the industry analysis, accounting analysis, forecasts, method of comparables, and the valuation models. To begin with the industry analysis shows Hasbro second to Mattel in an environment with high concentration and low competition. The nature of the industry favors a firm like Hasbro given the product line Hasbro has acquired and the brand names associated with them. Industry growth was made up for during troubled times internationally with nations outside the U.S., this will continue to show profit potential for Hasbro in the coming years. The industry analysis gave a positive outlook for the firm. On the accounting analysis the firm has strong expenditures in R&D, Brand Image, but shows less lease obligations over time. That may be a sign of shrinking revenues and a firm scaling back or maybe a move towards efficiency. The capitalization of R&D displayed a much better economic position for Hasbro outside of GAAP requirements. The capitalization of operating leases showed much more assets and liabilities than the method chosen by Hasbro but, these are decreasing following the trend that was discovered in this report. The accounting analysis overall showed a trend that looked promising. The method of comparables showed more mixed and less definitive results. There were three undervalued conclusions, three overvalued conclusions, and two displayed Hasbro as fairly valued. The intrinsic valuations undo the nice pretty picture displayed earlier in the report. All the valuations except the free cash flow model show a gravely overvalued firm. While Hasbro may be one of the “3 stocks that blew the market away” (fool.com), our valuation models showed an overvalued firm. This report concludes that current investors should sell their shares and that potential investors look elsewhere.

117 Appendix

References

About.com:

http://retailindustry.about.com/od/seg_toys/a/toy_sales.htm

Axiom: http://www.axiomvaluation.com/documents/2004.04.27-GoodwillImpairmentPrimer.pdf BNet.com:

http://findarticles.com/p/articles/mi_m0EIN/is_2004_May_7/ai_n6016454 http://findarticles.com/p/articles/mi_qa5440/is_200603/ai_n21388610 (Bnet.com)

Business Wire: http://findarticles.com/p/articles/mi_m0EIN/is_2005_Feb_11/ai_n9511270

Cafemom.com: http://www.cafemom.com/journals/read.php?post_id=518809

Cnn.com: http://money.cnn.com/2008/01/31/news/economy/barr_recession.fortune/index.htm?p ostversion=2008020104

Conference-Board.org:

http://www.conference-board.org/economics/ConsumerConfidence.cfm

Eric Johnson, Dartmouth University: http://mba.tuck.dartmouth.edu/digital/Research/AcademicPublications/CMRToys.pdf

118 Fool.com:

http://www.fool.com/investing/general/2008/04/28/3-stocks-that-blew-the-market- away.aspx

Hasbro Quality Assurance: http://64.233.167.104/search?q=cache:CvJNsf8x9zYJ:www.dianyuan.com/bbs/u/39/11 42050346.pdf+hasbro+product+quality&hl=en&ct=clnk&cd=27&gl=us

Investopedia:

http://www.investopedia.com/articles/analyst/100902.asp http://www.investopedia.com/articles/stocks/04/102004.asp http://www.investopedia.com/terms/b/beta.asp

Investor Words: http://www.investorwords.com/549/book_value.html Mindbranch.com:

http://www.mindbranch.com/catalog/find.jsp?cat=cs-toys

Msnbc.com

http://www.msnbc.msn.com/id/24127314/

NPD

http://www.npd.com/press/releases/press_080212.html

Toy Association:

http://www.toyassociation.org/AM/Template.cfm?Section=About_TIA&Template=/Tagg edPage/TaggedPageDisplay.cfm&TPLID=3&ContentID=2546

USAToday.com:

http://www.usatoday.com/money/companies/management/2006-05-08-cranium- exec_x.htm

119 Wall Street Journal:

http://online.wsj.com/article/SB118670816533693824.html?mod=hps_us_whats_news

http://online.wsj.com/article/SB119820110371043929.html

http://online.wsj.com/article/SB119457459136887486.html

http://online.wsj.com/article/SB120026504989687063.html

http://blogs.wsj.com/holidaysales/2007/12/12/toys-r-us-ceo-talks-about-toy-safety-and- the-future/

http://online.wsj.com/article/SB119803123397338477.html

http://online.wsj.com/article/SB119458129368387655.html

http://online.wsj.com/article/SB119819930986543637.html

Yahoo.com:

http://biz.yahoo.com/ic/ll/315tor.html

http://biz.yahoo.com/bw/080125/20080125005695.html?.v=1

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/AccPrimer/lease.htm

Palepu & Healy’s Business Analysis & Valuation Using Financial Statements

120 Regression 3 Month Regression Data

SUM M ARY OUTPUT- 7 2

Regression Statistics Multiple R 0.586834924 R Square 0.344375228 Adjusted R Square 0.33500916 Standard Error 0.061644833 Obser vat i ons 72

ANOVA df SS MS F Significance F Regression 1 0.139723015 0.139723 36.76839 6.04554E-08 Residual 70 0.26600598 0.0038 Total 71 0.405728996

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.010751295 0.007265091 1.479857 0.143398 -0.003738473 0.02524106 -0.003738473 0.025241062 X Variable 1 1.251691129 0.206423853 6.063694 6.05E-08 0.839991742 1.66339052 0.839991742 1.663390517

121 SUMMARY OUTPUT-60

Regression Statistics Multiple R 0.589710328 R Square 0.347758271 Adjusted R Square 0.336512724 Standard Error 0.052344487 Obser vat i ons 60

ANOVA df SS MS F Significance F Regression 1 0.084730307 0.08473 30.92409 7.12666E-07 Residual 58 0.15891683 0.00274 Total 59 0.243647137

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.006862893 0.006855232 1.001118 0.320928 -0.006859345 0.02058513 -0.006859345 0.02058513 X Variable 1 1.384934112 0.249046631 5.560943 7.13E-07 0.88641312 1.8834551 0.88641312 1.883455104

SUM M ARY OUTPUT- 4 8

Regression Statistics Multiple R 0.616664541 R Square 0.380275156 Adjusted R Square 0.366802877 Standard Error 0.047525652 Observations 48

ANOVA df SS MS F Significance F Regression 1 0.063754822 0.063755 28.22649 3.05508E-06 Residual 46 0.103899629 0.002259 Total 47 0.167654451

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.006418854 0.006859773 0.935724 0.354302 -0.007389153 0.02022686 -0.007389153 0.020226861 X Variable 1 1.468076883 0.276325116 5.312861 3.06E-06 0.911863282 2.02429049 0.911863282 2.024290485

122 SU M M A RY OUTPU T- 3 6

Regression Statistics Multiple R 0.649370826 R Square 0.42168247 Adjusted R Square 0.404673131 Standard Error 0.046256871 Observations 36

ANOVA df SS MS F Significance F Regression 1 0.053045752 0.053046 24.79123 1.8284E-05 Residual 34 0.072749736 0.00214 Total 35 0.125795488

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.010754413 0.007715884 1.393802 0.172421 -0.004926149 0.02643498 -0.004926149 0.026434975 X Variable 1 1.501108166 0.301483073 4.979079 1.83E-05 0.888420848 2.11379548 0.888420848 2.113795483

SU M M A RY OUTPUT- 2 4

Regression Statistics Multiple R 0.605699455 R Square 0.36687183 Adjusted R Square 0.338093277 Standard Error 0.051062172 Observations 24

ANOVA df SS MS F Significance F Regression 1 0.033238696 0.033239 12.7481 0.001708878 Residual 22 0.057361599 0.002607 Tot al 23 0.090600296

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.016427606 0.01053258 1.559694 0.133103 -0.005415629 0.03827084 -0.005415629 0.03827084 X Variable 1 1.338128804 0.374778971 3.570448 0.001709 0.560884794 2.11537281 0.560884794 2.115372815

123 6 Month Regression Data

SUMMARY OUTPUT

Regression Statistics Multiple R 0.58707461 R Square 0.344656598 Adjusted R Square 0.335294549 Standard Error 0.061631604 Obser vat i ons 72

ANOVA df SS MS F Si g n i f i c a n c e F Regression 1 0.139837175 0.139837 36.81423 5.95314E-08 Residual 70 0.26589182 0.003798 Total 71 0.405728996

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.010906112 0.007263756 1.501443 0.137739 -0.003580992 0.02539322 -0.003580992 0.025393215 X Variable 1 1.251944964 0.20633713 6.067473 5.95E-08 0.84041854 1.66347139 0.84041854 1.663471388

SUMMARY OUTPUT

Regression Statistics Multiple R 0.58994627 R Square 0.348036602 Adjusted R Square 0.336795854 Standard Error 0.052333318 Obser vat i ons 60

ANOVA df SS MS F Si g n i f i c a n c e F Regression 1 0.084798122 0.084798 30.96205 7.03641E-07 Residual 58 0.158849015 0.002739 Total 59 0.243647137

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.007052872 0.006848036 1.029912 0.307327 -0.006654961 0.02076071 -0.006654961 0.020760706 X Variable 1 1.384777048 0.248865679 5.564355 7.04E-07 0.886618271 1.88293582 0.886618271 1.882935825

124 SUMMARY OUTPUT

Regression Statistics Multiple R 0.616896717 R Square 0.380561559 Adjusted R Square 0.367095506 Standard Error 0.047514669 Obser vat i ons 48

ANOVA df SS MS F Si g n i f i c a n c e F Regression 1 0.063802839 0.063803 28.26081 3.02174E-06 Residual 46 0.103851612 0.002258 Total 47 0.167654451

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.006652521 0.006858471 0.969971 0.337134 -0.007152866 0.02045791 -0.007152866 0.020457908 X Variable 1 1.468919379 0.276315764 5.31609 3.02E-06 0.912724603 2.02511416 0.912724603 2.025114156

SUMMARY OUTPUT

Regression Statistics Multiple R 0.649877567 R Square 0.422340852 Adjusted R Square 0.405350877 Standard Error 0.046230533 Obser vat i ons 36

ANOVA df SS MS F Significance F Regression 1 0.053128573 0.053129 24.85824 1.7921E-05 Residual 34 0.072666914 0.002137 Tot al 35 0.125795488

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.010969885 0.007713361 1.422193 0.16408 -0.004705549 0.02664532 -0.004705549 0.02664532 X Variable 1 1.502604114 0.301376508 4.985804 1.79E-05 0.890133363 2.11507486 0.890133363 2.115074865

125 SUMMARY OUTPUT

Regression Statistics Multiple R 0.606087606 R Square 0.367342186 Adjusted R Square 0.338585013 Standard Error 0.051043201 Obser vat i ons 24

ANOVA df SS MS F Significance F Regression 1 0.033281311 0.033281 12.77393 0.001694069 Residual 22 0.057318985 0.002605 Total 23 0.090600296

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.016569346 0.010534302 1.572894 0.130015 -0.00527746 0.03841615 -0.00527746 0.038416152 X Variable 1 1.338695922 0.374558481 3.574064 0.001694 0.56190918 2.11548266 0.56190918 2.115482664

2 Year Regression Data

SUMMARY OUTPUT

Regression Statistics Multiple R 0.588031859 R Square 0.345781467 Adjusted R Square 0.336435488 St an d ar d Er r o r 0.061578687 Obser vat i ons 72

ANOVA df SS M S F Significance F Regression 1 0.140293567 0.140294 36.99788599 5.59726E-08 Residual 70 0.265435428 0.003792 Total 71 0.405728996

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.011244843 0.007258316 1.549236 0.125834634 -0.00323141 0.025721097 -0.003231411 0.025721097 X Variable 1 1.251645303 0.205775099 6.082589 5.59726E-08 0.841239815 1.662050792 0.841239815 1.662050792

126 SUMMARY OUTPUT

Regression Statistics Multiple R 0.592408641 R Square 0.350947998 Adjusted R Square 0.339757446 Standard Error 0.052216337 Observations 60

ANOVA df SS MS F Significance F Regression 1 0.085507475 0.085507 31.36109866 6.15638E-07 Residual 58 0.158139662 0.002727 Total 59 0.243647137

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.007282503 0.006825428 1.066967 0.290408094 -0.00638007 0.020945081 -0.006380075 0.020945081 X Variable 1 1.393144744 0.248771489 5.600098 6.15638E-07 0.895174508 1.89111498 0.895174508 1.89111498

SUMMARY OUTPUT

Regression Statistics Multiple R 0.619911841 R Square 0.38429069 Adjusted R Square 0.370905705 Standard Error 0.047371429 Obser vat i ons 48

ANOVA df SS MS F Significance F Regression 1 0.064428045 0.064428 28.7105806 2.61833E-06 Residual 46 0.103226406 0.002244 Total 47 0.167654451

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.006816792 0.006838156 0.996876 0.324040056 -0.0069477 0.020581285 -0.006947702 0.020581285 X Variable 1 1.476318264 0.275523727 5.358226 2.61833E-06 0.921717775 2.030918753 0.921717775 2.030918753

127 SUMMARY OUTPUT

Regression Statistics Multiple R 0.651803182 R Square 0.424847388 Adjusted R Square 0.407931135 Standard Error 0.046130124 Observations 36

ANOVA df SS MS F Significance F Regression 1 0.053443884 0.053444 25.114745 1.66003E-05 Residual 34 0.072351603 0.002128 Total 35 0.125795488

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.010888665 0.007695828 1.414879 0.166197892 -0.00475114 0.026528469 -0.004751139 0.026528469 X Variable 1 1.506455914 0.300602121 5.011461 1.66003E-05 0.895558908 2.11735292 0.895558908 2.11735292

SUMMARY OUTPUT

Regression Statistics Multiple R 0.607206968 R Square 0.368700302 Adjusted R Square 0.340004862 Standard Error 0.050988385 Observations 24

ANOVA df SS MS F Significance F Regression 1 0.033404356 0.033404 12.84874155 0.001651975 Residual 22 0.057195939 0.0026 Total 23 0.090600296

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.016313837 0.010512313 1.551879 0.13495904 -0.00548736 0.038115039 -0.005487365 0.038115039 X Variable 1 1.338732506 0.373476699 3.584514 0.001651975 0.564189242 2.113275771 0.564189242 2.113275771

128

5 Year Regression Data

SUMMARY OUTPUT

Regression Statistics Multiple R 0.587900864 R Square 0.345627426 Adjusted R Square 0.336279247 St an d ar d Er r o r 0.061585936 Obser vat i ons 72

ANOVA df SS MS F Significance F Regression 1 0.140231069 0.140231 36.9727 5.64474E-08 Residual 70 0.265497927 0.003793 Total 71 0.405728996

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.011874013 0.007261788 1.635136 0.10651 -0.002609167 0.026357192 -0.002609167 0.026357192 X Variable 1 1.250266435 0.205618411 6.080518 5.64E-08 0.840173451 1.660359418 0.840173451 1.660359418

SUMMARY OUTPUT

Regression Statistics Multiple R 0.593802603 R Square 0.352601531 Adjusted R Square 0.341439489 Standard Error 0.052149782 Obser vat i ons 60

ANOVA df SS MS F Significance F Regression 1 0.085910354 0.08591 31.58934 5.70509E-07 Resi d u al 5 8 0.157736783 0.00272 Tot al 59 0.243647137

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.007824098 0.006801935 1.150275 0.254751 -0.005791455 0.021439651 -0.005791455 0.021439651 X Variable 1 1.400203593 0.249127074 5.620439 5.71E-07 0.901521577 1.89888561 0.901521577 1.89888561

129

SUMMARY OUTPUT

Regression Statistics Multiple R 0.621951164 R Square 0.386823251 Adjusted R Square 0.373493321 Standard Error 0.047273904 Observations 48

ANOVA df SS MS F Significance F Regression 1 0.06485264 0.064853 29.01915 2.37444E-06 Residual 46 0.102801811 0.002235 Total 47 0.167654451

Coefficient s Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.007164232 0.006825284 1.049661 0.299358 -0.006574352 0.020902815 -0.006574352 0.020902815 X Variable 1 1.477884018 0.274345595 5.386943 2.37E-06 0.925654986 2.03011305 0.925654986 2.03011305

SU M M A RY OU TPU T

Regression Statistics Multiple R 0.651570657 R Square 0.424544321 Adjusted R Square 0.407619154 Standard Error 0.046142276 Obser vat i ons 36

ANOVA df SS MS FSignificance F Regression 1 0.05340576 0.053406 25.08361 1.67549E-05 Residual 34 0.072389728 0.002129 Total 35 0.125795488

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.010977504 0.007698663 1.425897 0.163015 -0.004668062 0.026623069 -0.004668062 0.026623069 X Variable 1 1.500824228 0.299664154 5.008354 1.68E-05 0.8918334 2.109815057 0.8918334 2.109815057

130 SUMMARY OUTPUT

Regression Statistics Multiple R 0.606987272 R Square 0.368433549 Adjusted R Square 0.339725983 Standard Error 0.050999157 Observations 24

ANOVA df SS MS F Significance F Regression 1 0.033380188 0.03338 12.83402 0.001660165 Residual 22 0.057220107 0.002601 Total 23 0.090600296

Coefficient s Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.016355831 0.010516263 1.555289 0.134146 -0.005453564 0.038165225 -0.005453564 0.038165225 X Variable 1 1.332621804 0.371985076 3.58246 0.00166 0.561171978 2.104071631 0.561171978 2.104071631 10 Year Regression Data

SUMMARY OUTPUT

Regression Statistics Multiple R 0.587513965 R Square 0.34517266 Adjusted R Square 0.335817983 Standard Error 0.061607332 Observat i ons 72

ANOVA df SS MS F Significance F Regression 1 0.140046556 0.140047 36.89841 5.78722E-08 Residual 70 0.265682439 0.003795 Total 71 0.405728996

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.012430853 0.007267867 1.710385 0.091624 -0.00206445 0.026926157 -0.00206445 0.026926157 X Variable 1 1.249180967 0.205646606 6.074406 5.79E-08 0.83903175 1.659330185 0.83903175 1.659330185

131 SUMMARY OUTPUT

Regression Statistics Multiple R 0.594002042 R Square 0.352838426 Adjusted R Square 0.341680467 Standard Error 0.052140239 Observat i ons 60

ANOVA df SS MS F Significance F Regression 1 0.085968072 0.085968 31.62213 5.64312E-07 Resi d u al 5 8 0.157679065 0.002719 Tot al 59 0.243647137

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.00836834 0.006787532 1.232899 0.222587 -0.005218381 0.021955062 -0.005218381 0.021955062 X Variable 1 1.402285903 0.249368157 5.623356 5.64E-07 0.903121308 1.901450499 0.903121308 1.901450499

SUMMARY OUTPUT

Regression Statistics Multiple R 0.622599586 R Square 0.387630245 Adjusted R Square 0.374317859 Standard Error 0.047242785 Observat i ons 48

ANOVA df SS MS F Significance F Regression 1 0.064987936 0.064988 29.11801 2.30142E-06 Resi d u al 4 6 0.102666515 0.002232 Tot al 47 0.167654451

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.007566695 0.006822945 1.109007 0.273192 -0.006167181 0.021300571 -0.006167181 0.021300571 X Variable 1 1.475667163 0.273468643 5.396111 2.3E-06 0.925203343 2.026130983 0.925203343 2.026130983

132 SUMMARY OUTPUT

Regression Statistics Multiple R 0.650511873 R Square 0.423165696 Adjusted R Square 0.406199982 Standard Error 0.046197515 Observat i ons 36

ANOVA df SS MS F Significance F Regression 1 0.053232335 0.053232 24.9424 1.74758E-05 Residual 34 0.072563152 0.002134 Tot al 35 0.125795488

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.011201421 0.007710119 1.452821 0.155441 -0.004467426 0.026870268 -0.004467426 0.026870268 X Variable 1 1.492969396 0.298938437 4.994237 1.75E-05 0.885453403 2.10048539 0.885453403 2.10048539

SUMMARY OUTPUT

Regression Statistics Multiple R 0.605980253 R Square 0.367212067 Adjusted R Square 0.338448979 Standard Error 0.05104845 Obser vat i ons 24

ANOVA df SS M S F Significance F Regression 1 0.033269522 0.03327 12.76678 0.001698154 Residual 22 0.057330774 0.002606 Total 23 0.090600296

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.016537979 0.010534135 1.569942 0.130701 -0.00530848 0.038384438 -0.00530848 0.038384438 X Variable 1 1.324589079 0.37071525 3.573063 0.001698 0.55577271 2.093405448 0.55577271 2.093405448

133

% of Total Cost of Debt 07 $ Amount Liab Rate Used Wgt Rate Source Link St Borrowings 10,201 0.6% 4.70% 0.03% Hasbro 10-k page 55 2007 A/P 186,202 10.1% 2.80% 0.28% 90 asset backed commercial paper http://www.federalreserve.gov/releases/cp/ Current portion L 135,348 7.3% 6.50% 0.48% Accrued Liab 555,920 30.0% 4.70% 1.41% Curr Liab 887,671 47.9% 2.19%

LT Deb 709,723 38.3% 6.50% 2.49% Hasbror 10 k, page 57 2007 Other Liab 254,577 13.7% 8.75% 1.20% Hasbro 10-k 2007 LT Liab 964,300 52.1% 3.69%

Total Liab 1,851,971 100.0% 5.89%

Wgt Avg Cost of Debt 5.89%

Cost of Equity Source Link Risk free Rate 3.74% 10 yr US Treasury http://www.treas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml Beta 1.51 Validated with Regression http://finance.yahoo.com/q/ks?s=HAS Market Risk Premium 6.8% Retun of Market less Risk Free rate Size Premium 1.1% Market Cap 3.95 B - Yahoo Finance Ke 15.1%

2007 Source Total Debt$ 1,851,971 54.63% Hasbro 10 K 2007 Total Equity$ 1,537,890 45.37% Hasbro 10 K 2007 $ 3,389,861

Weighted Avg Cost of Capital Economic Cost of Funds Wgt Wgt Cost

Debt 5.89% 54.63% 3.22% Equity 15.1% 45.37% 6.85% Bef Tax WACC 10.07%

Tax Rate 38%

Debt 3.65% 54.63% 1.99% Equity 15.1% 45.37% 6.85% Aft Tax WACC 8.85%

134 Dividend Discount Model

123 45 67891011 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 DIV 0.16 0.18 0.21 0.24 0.27 0.31 0.36 0.41 0.47 0.54 0.61 DIV Growt h 14.4% Per pet ui t y Ke 15.67% Pr i ce (1/ 4/ 08) $ 29.27 PV Fact or 0.865 0.747 0.646 0.559 0.483 0.418 0.361 0.312 0.270 0.233 PV DIV YBY $ 0.138 $ 0.137 $ 0.135 $ 0.134 $ 0.132 $ 0.131 $ 0.129 $ 0.128 $ 0.127 $ 0.125 SU M PV DI V YBY $ 1.317 Per pet ui t y 2018$ 48.37 Time Zero PV Perp $ 11.28 PV Tot F DIV$ 12.60 Time consistent value$ 12.15 G 10.00% 12.00% 13.00% 14.40% 15.00% 16.00% 17.00% Mkt within 15% 12% $ 7.78 N/ A N/ A N/ A N/ A N/ A N/ A 4/ 1/ 2008 13% $ 5.17 $ 15.52 N/ A N/ A N/ A N/ A N/ A Undervalued > $ 33.66 14% $ 3.87 $ 7.74 $ 15.48 N/ A N/ A N/ A N/ A Overvalued < $ 24.88 Ke 15.67% $ 2.72 $ 4.20 $ 5.78 $ 12.15 N/ A N/ A N/ A Fairly valued 16% $ 2.57 $ 3.85 $ 5.14 $ 9.64 $ 15.42 N/ A N/ A 17% $ 2.20 $ 3.08 $ 3.85 $ 5.92 $ 7.69 $ 15.38 N/ A 18% $ 1.92 $ 2.56 $ 3.07 $ 4.26 $ 5.12 $ 7.68 $ 15.35

135 Free Cash Flow Model

Hasbro 123 4 5 678910 #'s in Millions 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 CFFO 446.56 486.75 530.56 578.31 630.36 687.09 748.93 816.33 889.80 969.88 1193.25 CFFI -119.07 -126.06 -133.46 -141.30 -149.59 -158.37 -167.67 -177.51 -187.93 -198.96 -198.96 FCF 327.49 360.69 397.10 437.02 480.77 528.72 581.26 638.82 701.87 770.92 994.29

FCF growth rate YBY 10.14% 10.09% 10.05% 10.01% 9.97% 9.94% 9.90% 9.87% 9.84% Average 9.98%

PV Fact or 0. 909 0. 825 0.750 0.681 0.619 0.562 0.511 0.464 0.422 0.383 WACCbt 10.07% Prep Growth Rate 0.00% PV YBY FCF 297.53 297.71 297.78 297.73 297.57 297.31 296.95 296.50 295.96 295.34

FCF t o f i r m 770. 92

To t al PV YBY FCF 2 9 7 0 . 3 9 Perpetuity Yr 11 7655.61 PV TV Per pet ui t y 2932. 85 PV To t FC FCF 5903. 25 Perp Growt h Rat e Mkt within 15% 0235 79 4/ 1/ 2008 $29.27 BV of Debt & PS 1852.00 8.07 41.71 52.07 60.31 92.91 247.35 N/ A Undervalued >33.66 MVe 4051.25 9.07 34.68 41.91 47.32 66.09 121.14 3321.69 Overvalued <24.88 # shares outstanding 142.60 WACCbt 10.07 29.1 34.32 38.04 49.87 77.13 206.29 Fairly Valued Intrinsic Value PS 28.41 11.07 24.57 28.44 31.09 39.02 54.74 100.85 Time consistent price 29.10 12.07 20.82 23.75 25.7 31.35 41.18 64.05

Residual Income Model

012345 67891011Perp 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Net Income 355.7418 366.4141 377.4065 388.7287 400.3905 412.4023 424.7743 437.5176 450.6431 464.1624 478.09 Total Dividends 103.51 113.861 125.2471 137.7718 151.549 166.7039 183.3743 201.7117 221.8829 244.0712 268.478282 BVE 1,548.24 1,800.47 2,053.02 2,305.18 2,556.14 2,804.98 3,050.68 3,292.08 3,527.88 3,756.64 3,976.73 4,186.34

Normal Income 242.6084 282.1331 321.7082 361.2216 400.5465 439.54 478.0409 515.8683 552.8191 588.6658 623.1541204

Residual Income for Year 113.1334 84.28092 55.69827 27.50709 -0.15599 -27.1377 -53.2666 -78.3508 -102.176 -124.503 (145.07) Change in RI -28.8525 -28.5826 -28.1912 -27.6631 -26.9818 -26.1289 -25.0842 -23.8253 -22.3274

PV Factor 0.864528 0.747409 0.646157 0.558621 0.482943 0.417518 0.360956 0.312057 0.269782 0.233234 PV YBY RI 97.80703 62.99235 35.98981 15.36603 -0.07533 -11.3305 -19.2269 -24.4499 -27.5653 -29.0385

BE 1548.24 Total PV YBY RI 100.4688 Terminal Value of Perp -215.92 -925.7617896 MVE (12/ 31) 1432.789 Sh a r e 1 4 2 . 6 g Initial Share Price 10.04761 0 -0.1 -0.2 -0.3 -0.4 -0.5 Time Consistent Price 10.42001 0.1267 14.24 14.44 14.52 14.56 14.58 14.6 Mkt within 15% 0.1367 12.75 13.04 13.32 13.41 13.46 13.5 4/ 1/ 2008 $29.27 Ke 0.1567 0.1467 11.49 12.02 12.25 12.38 12.46 12.51 Undervalued >33.66 Growth Rate 0 Ke 0.1567 10.42 11.03 11.3 11.45 11.55 11.62 Overvalued <24.88 0.1667 9.51 10.15 10.45 10.62 10.73 10.8 Fairly Valued 0.1767 8.71 9.38 9.68 9.86 9.98 10.06

136 Abnormal Earnings Growth Model

012345678910 01234567891011Perp 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Net Income 355.74 366.41 377.41 388.73 400.39 412.40 424.77 437.52 450.64 464.16 478.0872 Total Divdends 103.51 113.86 125.25 137.77 151.55 166.70 183.37 201.71 221.88 244.07 268.4783 DRIP Income 16.22002 17.84202 19.62622 21.58884 23.74773 26.1225 28.73475 31.60822 34.76905 38.24595

Cumulative Div Income 382.63 395.25 408.35 421.98 436.15 450.90 466.25 482.25 498.93 516.33 Normal Income (Benchmark) 411.4866 423.8312 436.5461 449.6425 463.1317 477.0257 491.3365 506.0766 521.2589 536.8966

Change in Residual Income -28.85 -28.58 -28.19 -27.66 -26.98 -26.13 -25.08 -23.83 -22.33 20.56 AEG YBY (28.85) (28.58) (28.19) (27.66) (26.98) (26.13) (25.08) (23.83) (22.33) (20.56) 0.05 0.049434 0.05037

PV Factor 0.864528 0.747409 0.646157 0.558621 0.482943 0.417518 0.360956 0.312057 0.269782 PV AEG YBY -24.94378 -21.36294 -18.21592 -15.45317 -13.03066 -10.90928 -9.054289 -7.434839 -6.023545 CORE Earning (of Perp) 355.74 Total PV of YBY AEG -126.428

AEG TV Perp -35.403 -131.228 Total Model Adjusted Perp 193.91 g MVE 1,237.46 0 -0.1 -0.2 -0.3 -0.4 -0.5 Divide by shares 142.60 0.1267 12.42 13.37 13.74 13.94 14.06 14.14 Mkt within 15% Initial Share Price 8.68 0.1367 11.05 11.89 12.23 12.42 12.53 12.61 39539 29.27 Time Consistent Price 9.00 0.1467 9.93 10.67 10.98 11.15 11.26 11.33 Undervalued >33.66 Ke 0.1567 9 9.64 9.92 10.08 10.18 10.25 Overvalued <24.88 Ke 0.1567 0.1667 8.21 8.77 9.02 9.17 9.26 9.33 Fairly Valued Growth Rate 0 0.1767 7.54 8.02 8.25 8.38 8.47 8.53

LR RI Perp Model

137 Initial BVE 1,548.24 Perp Growth Rate Average ROE 0.18 023579 Ke 0.1567 0.1267 15.01 10.93 11.02 11.09 11.12 11.13 Mkt within 15% Forward Earnings Growth Rate 2 0.1367 13.94 11.01 11.08 11.13 11.16 11.17 4/ 1/ 2008 $29.27 Est MVE 1528.665 0.1467 13.02 11.09 11.14 11.18 11.2 11.21 Undervalued >33.66 Divide by shares 142.6 Ke 0.1567 12.22 11.18 11.21 11.23 11.24 11.24 Overvalued <24.88 Initial Share Price 10.71995 0.1667 11.5 11.26 11.27 11.28 11.28 11.29 Fairly Valued Time Consistent Price 11.11726 0.1767 10.88 11.35 11.33 11.32 11.32 11.32

0 1 2 3 4 5 6 7 8 9 10 11Perp 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Net Income 355.74 366.41 377.41 388.73 400.39 412.40 424.77 437.52 450.64 464.16 478.09 Total Divdends 103.51 113.86 125.25 137.77 151.55 166.70 183.37 201.71 221.88 244.07 268.478282 Book Value Equity 1548.235 1,800.47 2,053.02 2,305.18 2,556.14 2,804.98 3,050.68 3,292.08 3,527.88 3,756.64 3,976.73 4,186.34

0.229772491 0.203510592 0.18382992 0.168632734 0.156638974 0.14702515 0.1392394 0.1329002 0.12773757

0.165476338 ROE 0.14 0.15 0.16 0.17 0.18 0.19 0.1267 11.16 11.13 11.11 11.09 11.06 11.04 0.1367 11.2 11.18 11.16 11.13 11.11 11.08 Ke 0.1467 11.25 11.23 11.2 11.18 11.16 11.13 0.1567 11.3 11.28 11.25 11.23 11.21 11.18 0.1667 11.35 11.32 11.3 11.28 11.25 11.23 0.1767 11.39 11.37 11.35 11.32 11.3 11.28

ROE 0.14 0.15 0.16 0.17 0.18 0.19 0 10.06 10.78 11.5 12.22 12.93 13.65 2 11.36 11.31 11.24 11.18 11.12 11.06 3 11.33 11.29 11.25 11.21 11.18 11.13 g 5 11.3 11.28 11.25 11.23 11.21 11.18 7 11.29 11.27 11.25 11.24 11.22 11.2 9 11.28 11.27 11.26 11.24 11.23 11.22

138

139