Kraft Foods Inc. Equity Valuation and Analysis - Mark E. Moore

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Kraft Foods Inc. Equity Valuation and Analysis Valued at November 1, 2006

Lauren Groenteman: [email protected]

Rachel Watkins: [email protected]

Jeremy Anthony: [email protected]

Andrew Little: [email protected]

Nate Claxton: [email protected]

Neel Huey: [email protected]

mailto:[email protected]






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Kraft Foods Inc. Valuation

Table of Contents

Executive Summary 3

Business Strategy Analysis 6

Industry Overview 8

Firm Competitive Advantage Analysis 13

Accounting Analysis of Firm and Industry 15

Financial Statement Ratio Based Analysis 27

Cross Sectional Analysis 29

Forecasted Financial Statement Analysis 37

Equity Valuation 40

Intrinsic Valuation 41

Valuation Conclusion 47

Appendix 48

Appendix A 49

Appendix B 52

Appendix C 58

Appendix D 61

Appendix E 68

Resources 69

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Executive Summary Investment Recommendation: Overvalued, Sell 11/1/2006

KFT- NYSE $34.36 52 Week Ranges $27.44-$36.67 Revenue (2005) $34,113 Mil. Market Capitalization $57.614.5 Mil. Shares Outstanding 1,670,000,000 Dividend Yield 2.87% 3-Month Avg Daily Trading Volume 2,799,040 Percent Institutional Ownership 84% Book Value Per Share (mrq) $17.72 ROE 8.89% ROA 4.57% Est. 5 Year EPS Growth Rate 1% Cost of Capital Est. R2 Beta Ke

20-Year .093 .531 .0697 5-Year .092 .528 .0696 1-Year .092 .529 .0696 1-Month .085 .511 .0689 Published .65 Ke Estimated 6.97% KD .0655 WACC .0677 Altman Z-Score (2005) Moderate Risk 2.123

EPS Forecast FYE 1/31 2005(A) 2006(A) 2007(E) 2008(E)EPS $1.55 $1.57 $1.58 $1.60 Ratio Comparison Kraft Industry Trailing P/E 15.01 21.09 Forward P/E 39.20 20.85 Forward PEG 19.86 0.1475 M/B 1.59 3.07 Valuations Estimates Actual Current Price $34.36 Ratio Based Valuations P/E Trailing 15.01 P/E Forward 39.20 PEG Forward 19.86 Dividend Yield 2.8% M/B 1.59 Intrinsic Valuations Discounted Dividends $27.72 Free Cash Flows $30.07 Residual Income $25.55 Abnormal Earning Growth $32.34 Long-Run Residual Income Perpetuity $26.52 Chart Source: Big Charts

http://www.kraft.com/index.html

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Executive Summary

Kraft is the world’s second largest food and beverage company in the world. Kraft has

established their place in the market based on their marketing, high research and

development, and low costs. Their name and brand image are key staples within the

industry. Although the dominant company in the industry, Kraft have two main

competitors; Sara Lee and ConAgra Foods. Their threat of new entrants is low due to

the various barriers to entry since the major diversified foods industry is highly

competitive. (www.kraft.com)

Kraft’s accounting policies are very conservative. Their accounting disclosure is very

transparent. Due to these factors of their disclosure we can reasonably assume that

their accounting policies are reliable and trustworthy. In Kraft’s annual reports, they

also reveal any negative information and discuss how they plan to correct their

problems. These practices show the lack of a need to manipulate their annual reports.

This lack of a need is due to Kraft’s solid framework.

By computing the core financial ratios, we were able to get a better view of Kraft within

the industry. While looking at the liquidity ratios specifically, we could see that even

with Kraft having the highest inventory turnover, they were still one of the most illiquid

companies in the industry. On the other hand, Kraft seems to be a very profitable

company. They show strong gross profit margins and net profit margins compared to

the industry. Kraft’s capital structure seems to be fairly steady within the industry.

They have the lowest debt to equity ratio, which shows that they pay off their debt

within a timely manner. However, their times interest earned was the largest, which is

bad for the investors.

By forecasting out Kraft’s annual reports, as well as their ratios, we were able to gain a

better understanding of what Kraft’s position will be like in ten years. We found that

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Kraft will grow at a steady rate within the next ten years. Due to the importance of

these projected numbers, we tried to forecast as accurately as possible.

After analyzing our valuations of Kraft, we found that they are overvalued in each of the

five valuation models. Kraft’s actual price per share is $34.36. The first four valuation

models, dividend discount model, discounted free cash flows, residual income, and

long-run residual income perpetuity all showed estimated values ranging from $25-$28.

The abnormal earnings growth model calculated to be $32.34, showing the closest

estimate to the actual market price. Based on these valuations, we found Kraft to be

overvalued and strongly recommend selling.

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Business Strategy Analysis

Strategy analysis for Kraft Foods Inc. consists of an analytical view of the company’s

business and industry structure. Key strategic factors emphasized include the five

forces model, competitive advantage tactics, and corporate strategy. We started by

examining the business and industry Kraft Foods Inc. competes in, along with their use

of the five forces model. We also classified the industry Kraft Foods Inc. is in, identified

their key success factors, and determined their competitive strategy analysis. The final

portion of this section discloses the corporate structure of Kraft Foods Inc. in reference

to value creation and imperfections at the corporate level.

Business Summary

Kraft Foods Inc. is the largest U.S. branded food and beverage company, and the

second largest in the world. It is grouped with the major diversified foods industry

since it covers so many market segments for food. Kraft Foods covers five major

segments including snacks, beverages, cheese and dairy, grocery, and convenience

meals. Kraft’s brands include more than 50, with the largest two being Kraft and

Nabisco. Kraft is the world leading brand of cheese, as well as the company’s best

known brand for salad and spoonable dressings, packaged dinners, barbecue sauce and

other products. Nabisco is the umbrella brand for the world’s leading cookies and

cracker business. Some of Kraft’s other brands include Oscar Meyer, the leading U.S.

processed meats brand; Maxwell House, a leading coffee brand; Philadelphia, the

world’s largest cream cheese; and Post, the third largest brand of ready-to-eat cereals

in the U.S. Kraft was started in 1903 by J.L. Kraft and is now headquartered in

Northfield, Illinois. (Kraft S&P 500 Report 10/3/2006)

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Kraft products can be purchased in over 150 countries around the

world. Its major market segments are the United States, Western

Europe, Latin America, and Canada. Kraft has currently 207

facilities world wide. (Kraft 2005 10K)

Over the last five years, Kraft’s annual sales volume growth has been .5%, while Kraft’s

main competitors Sara Lee and ConAgra Foods Inc. have had annual sales volume

growth of 1% and -13% respectively. The industry average is a -12% over the last five

years, proving that Kraft is a strong member in terms of sales growth in the diversified

major foods industry.

From 2001-2005, Kraft’s earnings growth has been 9% on an annualized basis, while

Sara Lee and ConAgra Foods Inc. has been .5% and -2% respectively. The industry

average is -1.5% and again Kraft proves a leader in the diversified foods industry.

(Kraft Value Line; November 3, 2006)

Kraft has a market capitalization of $58.4 billion dollars, making it a large cap company.

Kraft’s total assets over the last five years average around $58 million dollars. Over the

last five years, Kraft’s stock price has fluctuated to around $40 and has dropped to as

low as around $27. As of November 1, 2006 the price was $34.36.

(www.yahoo.finance.com)

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Industry Overview and Analysis

Five Forces

Competitive Force 1: Rivalry Among Existing Firms

Rivalry among existing firms already in the industry is the main influence of the average

level of profitability. Some industries compete aggressively on price, while others

compete on non-price elements, such as brand image.

Competitors Moderate

Threat of New Entrants Low

Substitute Products Relatively High

Customer Power High

Supplier Power Low

In the major food industry, Kraft Foods is the world’s second largest food and beverage

company. Their brand portfolio is very well known with more than 50 brands including:

Maxwell House, Milka, Oscar Mayer, Philadelphia, and Post. Since Kraft is one of the

strongest packaged foods company, there is only moderate competition between the

main competitors. Kraft realizes that they cannot fully compete on price within the

industry, but on other elements like brand image and loyalty. (www.kraft.com)

Kraft has worked hard to diversify their products from other firms in the industry, such

as focusing on value added products and starting to capitalize on the national trend of

healthy eating. By diversifying their products, Kraft reduces their switching costs in the

industry.

By customers continuously buying Kraft products, brand loyalty has affected the

company in a positive way. Kraft is making better use of their assets to generate

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savings to reinvest in brand building which ultimately increases switching costs for

consumers.

Competitive Force 2: Threat of New Entrants

New Entrants may want to enter into an industry to earn greater profits. However, the

ease with new firms entering into the industry is a key element of profitability.

New entrants into the major food industry face a hard time competing within this large

economy of scale. Kraft alone competes in seven different business segments: North

America Beverages, North America Cheese and Foodservice, North America Convenient

Meals, North America Grocery, North America Snacks and Cereals, European Union, and

Developing Markets, Oceania and North Asia.

Since Kraft was one of the first major food industries they set the standard and

developed the first mover advantages. For example their brand loyalty has increased

the switching costs which make it difficult for other companies to compete in this

industry. New Entrants have a very difficult time contending with the existing

relationships that have already developed within the industry.

Competitive Force 3: Threat of Substitute Products

The food industry has a fairly high threat of substitute products. These threats exist

because of the price gaps between store bought products and privately labeled

products. For example, Kraft macaroni and cheese may sometimes struggle with Great

Value macaroni and cheese because of a price difference. If consumers believe these

products are similar, then they often substitute one for the other depending on the

cheaper price. However, customers that are not concerned with the price of the item

will choose Kraft because of the higher quality taste of a premium product.

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In the food industry, companies often compete with its substitute products during a

recession within the economy. For example, during these slow times, consumers tend

to purchase store brand salad dressing instead of Kraft in order to save money. During

slow revenue generated periods, Kraft can increase their advertising spending and their

efforts to narrow adverse price gaps. Even though substitute threats exist, Kraft is still

one of the largest food manufacturers and will continue to grow.

Competitive Force 4: Bargaining Power Buyers

There are two factors that affect the powers of buyers: price sensitivity and relative

bargaining power. Major food industry buyers are more price sensitive because their

products are undifferentiated. For example the packaging for Kraft salad dressing

containers represent a large portion of the buyer’s costs. If these packaging costs

increase, then Kraft may shop for lower cost alternatives.

Relative bargaining power is another aspect to determine the bargaining power of

buyers. Consumers have a higher bargaining power than major food industries because

they can decide whether or not to buy their products. In return, the industry has the

lower bargaining power because consumers cause a greater threat to the companies by

not doing business with them.

Competitive Force 5: Bargaining Power of Suppliers

Bargaining power of suppliers directly relates to the bargaining power of buyers. Thus,

suppliers have very little bargaining power. Due to the large amount of substitutes

available to their customers it makes it difficult for suppliers to compete and gain

power.

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Value Chain Analysis

Having and maintaining a competitive advantage in an industry is vitally important to a

company’s success. To achieve competitive advantage the company must have

strategies that allow them to create value for the firm. There are several factors and

strategies that allow the company’s within the industry a competitive advantage. The

most important for all companies including Kraft is the relationship with their

consumers. All the firms within our industry take great pride in trying to build superior

customer brand value. They achieve the advantage by giving more product benefits to

the consumers. With the high level of competition, every firm competes on prices.

Quality of food and packaging is also very important in creating an advantage. Kraft is

extremely good in all these areas. This is reflected by them being one of the leaders in

the industry. Kraft’s wide variety of helpful services along with the strong brand image

keeps consumers satisfied and willing to buy Kraft products time and time again.

The relationship with trade partners is also very important. Having the same trade

partner for years can become quite an asset to a company. It can help drive down

costs and raise profits. This will also allow companies to pass even more savings on to

the consumers. With this leaner cost structure along with making better use of the

assets in the company, Kraft can generate new savings which will allow for more

reinvestment into the company. This will help expand the company and create an ever

larger advantage over the competition. They also try to align with the trends of the

industry and channels within the industry.

Another major strategy for the industry is to expand globally. There are many countries

around the world growing at rapid rates. Being able to develop relationships within

these countries would help boost the companies tremendously. They could become

some of the world’s largest manufacturers and sellers of packaged foods and

beverages. The global market today allows for many opportunities to help expand any

company that can create an advantage in those markets.

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Another strategy that firms can use is integrity in the workplace. While this is closely

related to consumer and customer service, having a well-grounded company in the

community is a huge benefit. This starts with having a good core of employees. By

showing support to the employees, they will respond better to the challenges they face

everyday in the business world. They will respond better to consumer and customer

complaints and be more helpful to those people who have the complaints or questions.

Having a good environment to work in can never be underestimated either. A good

environment creates more efficiency and quality in the workplace and in the products

being produced. More efficiency in the workplace will lead to lower production costs and

higher profits.

Six different but equally important values are what a good company within our industry

should stand for. These values are innovation, quality, safety, respect, integrity, and

openness. Company wide participation is these values will help create and maintain any

advantage they can get. These values should be what the world expects of a firm and

what they expect of themselves. Most of these values should be incorporated into the

more specific strategies above, but these values can not be under-valued. They will

help any company create a competitive advantage in their industry. Looking at Kraft

specifically, their vision of helping people around the world eat and live better is a key

underlying value of all their strategies to gain different advantages in the industry.

Being able to differentiate yourself not only in quality of product, but also in the quality

of your company will lead any company to the front of their industry. This is what Kraft

strives to achieve. (www.kraft.com)

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Firm Competitive Advantage Analysis

The strategic choice a company makes is one of the most influential factors in

positioning themselves within an industry. Kraft Foods Inc. has three main competitive

core strategies: research and development, cost differentiation, and marketing.

Kraft’s strategy includes “helping people around the world eat and live better.” This

mainly shows the dedication Kraft has toward customer service and the health of those

customers. Expansions in property lines such as the Nabisco 100 calorie packs and

South Beach Diet Cereal Bars are just a beginning of the shift towards helping the

consumer eat healthier. Kraft is not in the business of making a low quality, generic

product. The company uses a lot of time and effort in their Research and Development

department to differentiate their products from the competition. Higher quality goods

and nutritional value are part of Kraft’s stance in the competitive industry pointing their

competitive advantage towards differentiation.

When a customer purchases a product from Kraft they are not only getting a fair priced

good, but also one of high quality backed by a strong brand image. Kraft has an image

that has 35 major brands that have lasted over a century. This directly affects Kraft’s

ability to maintain low costs in a highly competitive industry. As the largest brand food

and beverage company headquartered in the U.S. and the second largest worldwide,

Kraft has the ability and capital to give high quality products at low costs. With a Market

Capital of 58.4 billion dollars, Kraft is capable of marketing many of the world’s leading

food brands while keeping them affordable. Their Market Capital not only allows these

products to be sold in the United States but in five different sectors worldwide. This

again shows Kraft’s differentiation and competitive advantage against its competitors.

In December of 2000, Kraft acquired Nabisco, expanding their manpower and respected

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brand name. Nabisco helped expand Kraft’s product line and stabilize them as the

leading competitor in their industry.

In a world whose boundaries are getting smaller by the minute, a company in the food

and beverage industry must capitalize among the widely expanding market. Kraft’s

newly elected Chief Executive Officer Irene Rosenfeld has decided to increase

advertising spending which will directly correspond with the companies expected

growth. For example, discounts and coupons are advertised daily in newspapers and

magazines all over the world, not to mention that you can find popular children’s movie

and cartoon characters on the front of many of Kraft’s products to help increase

consumer demand. Kraft foods international beverage business accounted for more

than 40% of their revenues in 1999. Due to Kraft’s recent financial flexibility, they were

able to purchase select European assets from United Biscuits. This should give Kraft a

much-needed boost in global cookie sales. With this just being one example of the

many products Kraft is taking global; it is a window view of the global success that is to

come.

Being such a large, diverse company such as Kraft can result in some risks. These can

include large scale marketing issues and increasing distances among shipping. Also

costs can come into play, requiring higher product profit and consumer consumption.

However, with diverse problems and situations come solutions that make Kraft what

they are today. By producing high valued products and healthy alternatives, Kraft can

maintain their strong consumer brand loyalty. (Kraft Value Line; November 3, 2006)

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Accounting Analysis of Firm and Industry

Key Accounting Policies

Kraft Foods, Inc. follows an accounting policy or method that is generally accepted in

the United States (US GAAP). Some estimates are made to the financial statements

and are based off of historical experience and/or other assumptions they feel is

reasonable. The key success factors for Kraft Foods Inc. are keeping costs low,

marketing effectively, and research and development.

Keeping costs low across the board is a major concern for Kraft. Since Kraft products

are mainly products with many substitutes offered, keeping their cost of goods sold

down reduces the final price for the product. In reducing the final price, customers are

more willing to purchase a Kraft product rather than their competitor since the Kraft

brand image is so strong. According to Kraft’s income statements from 2001 to 2005,

cost of goods sold is becoming a larger part of net sales, stating that cost of goods sold

is increasing, while net sales is not.

Marketing for Kraft Foods Inc. is a key principle for this company. Marketing provides

their consumers with knowledge of their new products or reminders of their old.

Marketing costs for Kraft Foods, Inc. include advertising, consumer incentives and trade

promotions. Such programs include discounts, coupons, rebates, in-

store display incentives and volume based incentives. Advertising costs

are expensed as incurred. Consumer incentive and trade promotions

activities are recorded as a reduction of revenue based on amounts

estimated as being due to customers and consumers at the end of the period, based

primarily on historical utilization and redemption rates. (Kraft 2005 10K)

Research and development are key for Kraft to stay competitive. With the increasing

demand for low fat, low calorie products, Kraft must continually pump money into

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research and development to maintain a competitive advantage. Kraft’s research and

development disclosure is quite clear and detailed in their 10K statements.

In review, there are many key success factors for Kraft Foods, Inc. All must be checked

for impairment and watched for significant changes. Monitoring these key elements will

help outside investors see how successful Kraft Foods, Inc. truly is.

Accounting Flexibility

As mentioned in the key accounting policies section of this report, Kraft’s key success

factors are keeping cost low, marketing effectively, and research and development. To

achieve these goals, Kraft uses its basic knowledge of the firm’s activities to predict and

make estimates on the company’s financial position.

In a highly competitive market, such as Kraft’s, consumers are looking for the lowest

prices possible. From time to time the Company may need to reduce the prices of some

of its products to respond to competitive and customer pressures and to maintain

market share. Kraft does this by trying to avoid, and if necessary, respond to

commodity and other cost increases. Operation results will suffer if profit margins

decrease, so Kraft tries to remain consistent but flexible on cost allocation and cost of

goods sold values. With consolidation of some supermarkets, warehouse clubs, and

other food distributors, the buying power of these sophisticated customers is increasing.

This can reduce inventories and induce lower pricing placing extra costs on the books

for Kraft. To counter some of these costs, the Company tries to induce supply chain

efficiency, including efforts to align product shipments more closely with consumption

by shifting some of its customer marketing programs to a consumption based approach,

financial condition of customers and general economic conditions (Kraft 10K). Also, in

relation to financial statements, Kraft adjusts some long-lived asset impairment and

forecasts probabilities of inventory inflow and outflow through distributors, adjusting

inventory levels before losses are incurred. By adjusting production amounts

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accordingly to predictions, the Company can reduce cost of productions and cost of

goods sold.

Marketing costs are an important expense for a company in a competitive market. As

required by U.S. GAAP, marketing costs are expensed in the year in which the costs

relate. The company also expenses advertising costs as they are incurred. Amounts on

the year-end consolidated balance sheet, with respect to marketing costs, are not

deferred. Kraft takes a conservative standpoint in relation to recording marketing costs

by not delaying the recording of the expenses. Kraft believes that this outlook keeps

financial statements current and very dependable when making forecasts or doing

valuations to acquire future cost figures and avoid revenue overstatements.

When taking a first look at Kraft, one would think that Research and Development

would not be an influential area on the financial statements. The truth is that Kraft

spends an adequate amount of time and funds in this area. R&D expenses are

accounted for in the year incurred and can sometimes be distributed through the Altria

Group, Inc. This assists in distributing costs efficiently and increasing profitability

figures.

Kraft Foods, Inc. implements flexible plans that help keep it competitive among its

industry. The allocation of costs in the areas of marketing, research and development,

and production keeps Kraft’s financial statements current and valuable in firm analysis.

This is why the Company’s good financial flexibility helps it stay on top of accounting

struggles that disable others among the competition. (Kraft 2005 10K)

Accounting Strategy

After careful review of past financial statements, it is accurate to assume that Kraft’s

accounting strategy and policies are conservative and reflect the economic realty of the

company. Kraft’s policies are in accordance with generally accepted accounting

procedures as set forth by the Financial Accounting Standards Board. Although Kraft

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uses several different accounting methods of valuation within its multi-national

company, everyone is a choice offered by the GAAP.

Kraft’s accounting policies are very similar to some of its competitors, for example,

General Mills and Sara Lee. Some of the methods that they share include revenue

recognition and retail inventory. Revenue is recognized upon shipment or delivery of

goods when title and risk of loss are passed to the customers. For Kraft, shipping and

handling costs are classified as part of cost of sales. When dealing with inventory, Kraft

along with its competitors use the LIFO accounting method for a majority of its

domestic inventories. For Kraft, the cost of other inventories is determined using the

average cost method. The industry uses the straight line method for depreciation of

property, plant, and equipment. However, the useful lives used for depreciation will

vary from asset to asset and company to company.

Though the companies are similar, Kraft has made some recent changes in the Stock

Options department. In 2005 stockholders approved the Kraft 2005 Incentive Plan. With

this plan, Kraft may grant to eligible employees awards of stock options, stock

appreciation rights, restricted stock, and other awards based on Kraft’s Class A common

stock. A maximum of 150 million shares of Kraft Class A common stock may be issued

under this new plan. Kraft applies the intrinsic value-based method in accounting for

the various stock plans. Compensation expense is what is recognized for the restricted

stock awards. In 2004, the FASB issued SFAS No. 123 a.k.a. “Share-Based Payment”.

(Kraft 2005 10K). It requires companies to measure compensation cost for share-based

payments at fair value. Kraft adopted this new standard on January 1, 2006; fortunately

it will not have a material impact on its consolidated financial position, results of

operations or cash flows.

With regards to Kraft’s key success factors, the “2005 plan” directly relates to having

employees who show integrity and efficiency in the workplace. This plan encourages

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employees to do just that. With more efficiency in the workplace the lower production

costs will be and will result in higher profits.

Qualitative and Quantitative Analysis

Qualitative and quantitative factors were used when determining the quality of Kraft’s

quality disclosures. The tables below are the sales and core expense manipulation

diagnostics tables. They contain three ratios each for the past five years (2001-2005).

Kraft (sales) 2001 2002 2003 2004 2005

Net Sales / Cash from Sales 0.9966

0.9995

1.0084

1.0054

0.9954

Net Sales / Accounts Receivable 9.3370

9.5388

9.0525

9.0844

10.0777

Net Sales / Inventory 9.6609

8.7886

9.1229

9.3322

10.2043

Kraft’s net sales to cash from sales ratio has hovered around 1 for the past five years

with a slight rise in 2003-2004, but then declining again in 2005. This could be a

potential red flag; however, it is best to compare it with the industry to see if it is just

within Kraft, or an industry change. There also may be concern with the net sales to

accounts receivable ratio. It was increasing from 2001-2002, but then began to

decrease, and then increased again in 2005. The increase in 2005 could be caused by

a decrease in accounts receivables for that year. The net sales to inventory ratio has

continued to increase with just a slight decrease in 2002. Again, it is necessary to look

at the industry analysis before raising concern.

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The following tables are the sales manipulation diagnostics for two competitors, Sara

Lee and ConAgra Foods.

Sara Lee (sales) 2001 2002 2003 2004 2005

Net Sales / Cash from Sales

0.9866

1.0169

0.9975

1.0032

1.0101

Net Sales / Accounts Receivable

10.8140

9.6275

10.0101

10.3458

9.4382

Net Sales / Inventory

6.4415

7.0259

6.7451

7.0084

7.1470

ConAgra Foods (sales) 2001 2002 2003 2004 2005


1.0147

0.9855

0.9720

1.0370

0.9992

Net Sales / Accounts Receivable

15.6101

17.4988

20.6438

10.8064

11.274


4.9415

5.4783

6.7330

5.5958

5.5716

Comparing Kraft with Sara Lee and ConAgra Foods will help to determine whether or

not there is an industry change or a potential red flag within Kraft. In the net sales to

cash from sales ratio, both the industry and Kraft has hovered around one. They have

all increased and decreased a little bit throughout the years proving that this is mostly

due to a change within the industry. Kraft seems to be moving in an opposite direction

with the net sales to accounts receivable ratio. This could be a potential red flag for

Kraft. Kraft’s net sales to inventory ratio seems to be increasing and decreasing along

the same lines as the industry confirming that it is a change with in the industry. All of

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these ratios are fairly consistent with the industry verifying that Kraft is most likely not

manipulating their sales numbers.


0.920.94

0.960.98

11.02

1.041.06

2001 2002 2003 2004 2005

KraftSara LeeConAgraIndustry Average

Net Sales / Accounts Receivables

0

5

10

15

20

25

2001 2002 2003 2004 2005

Kraft

Sara Lee

ConAgra

Industry Average


0

2

4

6

8

10

12

2001 2002 2003 2004 2005

Kraft

Sara Lee

ConAgra

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It is also important to compare the core expense diagnostics. Below is Kraft’s core

expense manipulation diagnostics:

Kraft Foods Inc. 2001 2002 2003 2004 2005

Sales / Assets 0.52 0.52 0.51 0.54 0.59

Changes in CFFO / OI 0.02

0.06

0.07

(0.02)

(0.11)

Changes in CFFO / NOA 0.01

0.06

0.05

(0.01)

(0.07)

Some factors stand out in these ratios. First the negative results in the last two ratios,

as well as some inconsistency in the last two ratios. In the sales to assets ratio, the

numbers are fairly consistent with a slight increase in 2005. This could either be to an

increase in sales or a decrease in assets. In 2004 and 2005, the changes in cash flow

from operations were negative. This caused the negative ratios in changes in cash flow

from operations to operating income and net operating assets.

In order to determine if Kraft’s ratios were in line with its competitors, it is best to

compare them with the competitors in their industry. Below are the core expense ratios

for Sara Lee and ConAgra Foods.

Sara Lee 2001 2002 2003 2004 2005

Sales / Assets

1.64

1.28

1.15

1.29

1.34

Changes in CFFO / OI

(0.02)

0.20

0.06

(0.01)

0.18

Changes in CFFO / NOA

(0.02)

0.11

0.03

(0.01)

0.06

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ConAgra Foods Inc. 2001 2002 2003 2004 2005

Sales / Assets

1.52

1.44

1.10

0.99

1.14


(0.50)

1.77

(1.26)

(0.08)

0.46


(0.30)

1.42

(0.95)

(0.05)

0.35

When comparing the industry’s sales to asset ratio to Kraft, they all seem to be fairly

consistent with a slight increase in 2005. However, Kraft’s sale to asset ratio is a lot

smaller than the industry. This is because Kraft’s assets are nearly double of what their

sales are each year. The changes in cash flow from operations to operating income and

net operating assets ratios seem to be steady in year 2004. For each company they are

all negative ratios, which could be a result of an industry change. However, all the

ratios for each company seem a little bit irregular from each other making it a difficult

to make any conclusions about the industry average.

Sales / Assets

0

0.5

1

1.5

2

2001 2002 2003 2004 2005


- 24 -


-1.5-1

-0.50

0.51

1.52

2001 2002 2003 2004 2005



-1.5-1

-0.50

0.51

1.52

2001 2002 2003 2004 2005

Kraft

Sara Lee

ConAgra

Quality of Disclosure

Kraft Foods Inc. is very thorough in their business section of the 10-K. They break

down segments of their company such as, beverages, cheese, convenient meals,

snacks, and cereals, in North America and Internationally. This gives even greater

detailed information about the condition of their company in each of these segments.

They also disclose information about threats of competitors within the American and

International market. They explain how they plan to increase their advertising to

improve their brand image, which helps gain a competitive advantage over other

- 25 -

companies. Kraft also discusses their three-year restructuring program. This program

is designed to improve its cost structure and consumption of assets.

Kraft’s footnotes of their financial information are specific in explaining the way that

they report their employee benefit and postretirement plans, goodwill, and income

taxes. They also disclose how they handle their foreign exchange rates. Kraft uses

forward foreign exchange contracts to alleviate any changes in exchange rates.

Overall Kraft reports a good quality of disclosures on their 10-K statements.

Potential “Red Flags”

In order to evaluate Kraft’s accounting procedures, it is important to look for potential

“red flags” that might catch an analyst’s eye within the firm. As discussed earlier in the

previous qualitative and quantitative factors, Kraft has certain issues that might be

looked into further as far as accounting policy goes. However, this is no cause for

alarm. Kraft has been involved in certain changes within the organization that have led

them to slight ups and downs in regard to their financials. The company justifies these

changes by thoroughly disclosing all the potential “red flag” information within the

Management’s Discussion and Analysis of Financial Condition section of the 10-K. For

example, Kraft’s internal restructurings have affected the net impact of lower asset

impairment, exit and implementation costs on earnings, and diluted earnings per share

from continuing operations. Kraft consistently explains the affect of these

circumstances within their financials and the value to which they were incurred. This in

return eliminates any further suspect within the firm in regard to US GAAP. In

comparison to the industry, Kraft continues to fade away from potential suspicion due

to their high market share, consistent revenues, and their superior brand loyalty. (Kraft

2005 10K)

- 26 -

As stated before, Kraft has chosen to go with a more conservative approach to their

accounting methods. All of which comply with the U.S. GAAP regulations and

procedures. Kraft uses the LIFO method for their domestic inventory. This means that

they have a lower net income and therefore pay fewer taxes on that income. As stated

in the Accounting Strategy section, Kraft recognizes its revenue upon shipment or

delivery of goods. This strategy helps lower the risk and cost of lost goods to the

company; because, they recognize the revenue only after that risk is transferred to the

customer. Kraft has also been very informative about their new retirement and

incentive plan. With Kraft’s high level of disclosure about their accounting methods and

everything that goes into their 10-K reports, there is little room to be able to accuse

Kraft of falsifying their financial reports.

- 27 -

Financial Statement Ratio Based Analysis

The purpose of this section is to review the financial ratios for Kraft in the past five

years, as well as forecast the following ten years of financial statements. Using these

ratios it is possible to analyze Kraft’s past and present performance in order to look for

any possible trends in the company. There are several different methods for

performance of measures that are used in the ratio analysis which include liquidity,

operating efficiency, profitability, and capital structure. From these ratios we will be

able to determine the company’s overall standing in the food produce industry and

evaluate its progress over time.

In the following sections, the basic 14 ratios will be used when assessing Kraft’s

performance in the areas of liquidity, operating efficiency, profitability, and capital

structure. Also, the forecast of the next ten years will help us to determine in what

direction the company is headed and what can be done to continue these positive

trends and/or remove the negative ones. This analysis is vital to Kraft because it

provides its investors with public information that gives them the ability to compare

with other competitors in its industry.

Ratio Analysis

Financial statement analysis helps to evaluate management performance and trends

within the company. Kraft’s analysis was broken down into four major areas: liquidity,

operating efficiency, profitability, and capital structure.

Liquidity ratios explain how liquid the company actually is. They try to measure the

firm’s ability to pay back their current liabilities. In Kraft the current ratio was

increasing until 2005, when there was a negative change. This was due to the

- 28 -

decrease in current assets in 2005. There was essentially no change in the quick asset

ratio in the past two years.

Operating efficiency measures how efficient the firm is in terms of their operations

management. Kraft’s accounts receivable ratio increased in year 2005. This increase

reduced the number of days’ sales outstanding, which helped Kraft become more

efficient because there was less accounts receivable tied up. Inventory turnover acted

in the same way as the receivables turnover. Working capital turnover seems to be the

most unstable. The changes in working capital are mostly because of the changes in

current assets and current liabilities.

The profitability analysis measures how profitable a firm is in terms of sales and net

income. For Kraft, the gross profit margin and net profit margin decreased in 2004 due

to an increase in sales. The operating expense ratio began to decrease in 2002. This

was probably also caused by an increase in sales each year. Asset turnover remains

stable, with a slight increase in 2005. Return on assets and return on equity also began

to decrease in 2004 because of a decrease in net income from the previous years.

Capital structure analysis is the last area examined in financial statement analysis. This

refers to the companies sources of financing. The debt to equity ratio has been

decreasing each year. This is a good thing because this indicates that debt has become

a smaller proportion of the total financing. Times interest earned has greatly increased

since 2001. This ratio shows the sufficiency of income from operations to cover

required interest charges. The debt service margin measures how much of cash that is

provided by operation that will cover the annual payments on long-term liabilities.

There was a big increase in 2002, but then has been decreasing since then. (Kraft

2005 10K)

- 29 -

CROSS-SECTIONAL ANALYSIS

Liquidity Ratios

Current Ratio

This ratio is very important in analyzing a company’s liquidity. Kraft shows that they are

constantly around a ratio of one. Compared to the industry, Kraft usually has the lowest

ratio. This means that they usually have just enough current assets to cover their

current liabilities. Their competitors and the industry show more liquidity with higher

current ratios.

Current Ratio

0

0.5

1

1.5

2

2001 2002 2003 2004 2005Years

Valu

es

KraftSara LeeConAgra FoodsIndustry Avg.

Quick Asset Ratio

Looking at the graph, we can see that the industry as a whole as increased from year to

year since 2001. Kraft increased with the industry until 2003. Then they decreased a

bit, and leveled off in 2005. In terms of liquidity, Kraft doesn’t vary too much, but

recently has been the lowest in the industry.

Quick Asset Ratio

00.20.40.60.8

2001 2002 2003 2004 2005Years

Valu

es


- 30 -

Inventory Turnover

From this graph, we can see that the all the firms in the industry stay fairly close to

each other. Kraft definitely shows the highest of the firms, and has increased in recent

years. This means that Kraft would have a lower days supply of inventory than the rest

of their competitors and the industry. In 2005, their days supply of inventory is 55.9.

This means that they have enough in inventory to cover almost 56 days of supplies to

the consumers.

Inventory Turnover

0

2

4

6

8

2001 2002 2003 2004 2005Years

Valu

es


Accounts Receivable Turnover

This graph shows that Kraft and Sara Lee’s turnover ratio are the lowest. This means

that they do not have a lot of cash from sales. Most of their sales are put on account.

ConAgra Foods is by far the highest, and they move in the same directions as the

industry. The lower turnover ratios for Kraft and Sara Lee will result in higher days sales

outstanding. Kraft’s days sales outstanding are 36.21 for 2005. This means that Kraft

has credit sales outstanding for about 36 days.

Accounts Receivable Turnover

05

10152025

2001 2002 2003 2004 2005Years

Valu

es

Kraft

Sara Lee

ConAgraFoodsIndustry Avg.

- 31 -

Working Capital Turnover

From this graph, one can see that the firms are sporadic in their respective turnovers.

This is mostly contributed to the varying current ratios. Kraft usually moves against the

other firms in the industry. In recent years, Kraft has dropped below their competitors.

This shows again that Kraft’s liquidity is lower than that of their competitors and the

industry.

Working CapitalTurnover

-100-50

050

100150200

2001 2002 2003 2004 2005

Years

Valu

es


Profitability Ratios

Gross Profit Margin

Kraft and Sara Lee show the highest margins, and they seem to move together. Kraft’s

high margin is a good sign, in that they receive more profit on each sale than some of

the other firms. This is good for profitability and operating efficiency.

Gross ProfitMargin

0.00%10.00%20.00%30.00%40.00%50.00%

2001 2002 2003 2004 2005Years

Valu

es


- 32 -

Operating Expense Ratio

From this graph, one can see that firm’s ratios are spread out. Kraft is the lowest by far.

This shows that Kraft has found ways to cut down on their SG&A expenses. This leads

to more profit on each sale. One way that Kraft could have lowered their expenses is by

spreading their expenses out over more operations.

Operating ExpenseRatio

0.00%10.00%20.00%30.00%40.00%

2001

2002

2003

2004

2005

Years

Valu

es


Net Profit Margin

This graph shows that in the recent years, Kraft is definitely outperforming the industry.

This means that Kraft is able to retain more of its sales in net income than the rest of

the industry. This is a big key to a profitable firm that wants to grow.

Net Profit Margin

0.00%2.00%4.00%6.00%8.00%

10.00%12.00%14.00%

2001 2002 2003 2004 2005Years

Valu

es


- 33 -

Asset Turnover

The competitors and industry average move together; while Kraft stays at the very

bottom of the industry. This can be attributed to Kraft not holding as many assets as

the other firms. This assumption can also be seen with the low current ratios stated

earlier.

Asset Turnover

0

0.5

1

1.5

2

2001 2002 2003 2004 2005Years

Valu

es


Return on Assets

From this ratio, one can see that in the more recent years the industry moves together.

With the low asset turnover and current ratios, Kraft again is towards the bottom of the

industry.

Return on Assets

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

2001 2002 2003 2004 2005Years

Valu

es


- 34 -

Return on Equity

With the last profitability ratio, one can see Kraft and ConAgra Foods are very similar.

In more recent, years the industry has moved more towards them at the bottom. This

shows that Kraft’s investors do not get as much of a return on their investment as what

other investors get from the other companies in the industry.

Return on Equity

0.00%50.00%

100.00%150.00%200.00%250.00%

2001

2002

2003

2004

2005

Years

Valu

es

Kraft

Sara Lee


Capital Structure Ratios

Debt to Equity

From this graph, one can see that the companies started off in different areas, but have

all pretty much moved with the industry to lower levels. Kraft has decreased a little, but

definitely remains at the bottom. This means that Kraft has higher equity compared to

its liabilities than the rest of companies in the industry. Kraft certainly has the best

ratio.

Debt to Equity

02468

10

2001 2002 2003 2004 2005Years

Valu

es

Kraft

Sara Lee


- 35 -

Times Interest Earned

For the most part the industry moves together except for Kraft. In more recent years,

Kraft maintains the highest ratio in the industry. This shows that Kraft has the most

operating income to cover its interest expense.

Times InterestEarned

02468

10

2001 2002 2003 2004 2005Years

Valu

es

Kraft

Sara Lee


Debt Service Margin

Overall, Kraft definitely moves with the industry trends. Kraft started out with the

highest ratio, but has recently fallen to the middle of the industry. This means that Kraft

used to have plenty of income from operations to cover its current installments on long-

term debt, but more recently has had either its income go down or its current

installments on long-term debt go up.

Debt Service Margin

0

5

10

15

20

2001 2002 2003 2004 2005Years

Valu

es

Kraft

Sara Lee


- 36 -

Liquidity

Kraft seems to not be very liquid. We can see this most when we look at the current

and quick asset ratios. These mainly deal with the most liquid assets, and Kraft is

towards the bottom of the industry. They do have a bright spot in the inventory

turnover though. The increase and being the highest in the industry is very favorable

for their liquidity. When we look at the account receivable turnover, we go back to the

same story of Kraft not being very liquid. With the working capital turnover, we saw the

Kraft usually moved against the trends and was the highest in the industry for a while,

but in more recent years, Kraft has fallen to the bottom.

Profitability

Kraft’s profitability is a totally different story than its liquidity. Kraft shows strong gross

profit margins and net profit margins compared to the industry. Team that up with the

lowest operating expense ratio, Kraft looks to be a very profitable company. Kraft hits a

little bit of a snag with their asset turnover, return on assets, and return on equity.

Kraft performs at the bottom of the industry in all three of these ratios, but the industry

has moved down towards Kraft in the recent years. Overall, Kraft seems to be a fairly

profitable company within the industry.

Capital Structure

For the most part, Kraft’s capital structure seems pretty steady within the industry.

They have the lowest debt to equity ratio. This means that their debt is usually paid off

in a timely manner. Kraft’s times interest earned is definitely higher than the industry

which is not a great thing for the investors. Until recent years, Kraft has had a high

debt service margin compared to the industry. This would indicate that Kraft usually has

plenty of income from operations to cover current payments on their long-term debt.

That is a good key to any strong capital structure. (Sara Lee 2005 10K and ConAgra

2005 10K)

- 37 -

Forecast Financial Statements and Analysis Income Statement Analysis In order to forecast Kraft for the next 10 years, it is important to recognize the internal

growth rate and sustainable growth rate calculations. The equations used to calculate

are: IGR = ROE(1 - Dividend Payout Ratio) and SGR = IGR(1 + D/E).

Kraft 2001 2002 2003 2004 2005 ROE .080 .131 .121 .090 .090

Dividend Payout Ratio .119 .276 .313 .480 .546

SGR 15% 21% 17% 9% 8%

IGR 7% 9.5% 8.3% 4.7% 4.1%

The average IGR and SGR for the five years is 6.72% and 14%. The separate IGR and

SGR percentages are distributed evenly around their respective averages. It is easy to

see the common fluctuations as far as growth is considered for a large major foods

diversified company. Due to Kraft’s size, it is very uncommon for sales to significantly

increase or decrease from year to year. From 2001 to 2005, Kraft has gradually

increased their revenue at a very slow rate. Again, we believe sales will not change

very much due to the large market share that Kraft owns and the steady rate we’ve

observed from the past five years. Ultimately, we believe Kraft will continue to have

similar sales growth for the next 10 years. These assumptions are confirmed with the

above noticed SGR and IGR rates for Kraft foods.

Kraft’s costs of sales have also been very similar for the past five years. Their

marketing, research, and administration costs have increased slightly. Due to our

research, a large change is not forecasted for these costs over the next 10 years.

Gross profit forecasts are calculated by subtracting these cumulative costs minus net

sales forecasts. Marketing, research, and administration costs are calculated as a

percentage of net sales for the next 10 years.

- 38 -

In order to calculate earnings projections, we subtracted our marketing, administration,

and research costs from our forecasted gross profit outlook. These earnings numbers

should reflect close to around 15-20% of net sales.

Interest and other debt expense represent a very small percentage of net sales. For

example, over the past 5 years, the ratio never surpassed more than 5%. Next, our

forecasted net profit margin for the next 10 years came near 10%. This was calculated

using the average margin of the last 5 years.

In order to round up our income statement analysis, net income was calculated by

multiplying our suggested net sales by our net profit margin of 10%.

Balance Sheet Analysis

A very similar analysis was used to determine our balance sheet forecasts as the

income statement. Raw material and finished product inventories have been extremely

close numbers for the past 5 years. We believe this is because Kraft should not have to

change their work in progress if they are already a top leader in the industry. This is

represented in the inventory forecast as well. Inventory makes up about 5% of total

assets for Kraft. In order to forecast total assets, we used our forecasted sales

numbers and divided that by the asset turnover ratio. These reflections will continue to

be similar due to the analysis of the SGR.

Current liabilities also have very small changes over the past 5 years. A noticeable

outlier would be an increase from 2004 to 2005 in current portion of long term debt

outstanding. As far as non-current liabilities are concerned, the balance has not

changed more than 5% up or down. Thus, total liabilities have not changed very much

in the past five years either. Our forecasts show a minimal change in liabilities for Kraft

in the next 10 years.

- 39 -

To continue Kraft’s minimal change trend, Owner’s equity has increased slightly over

the past 5 years. By dividing total liabilities by the debt to equity ratio our forecasts

show a continual small increase in the equity account in regard to shareholders.

Balance sheet data is present at the end of the report.

Statement of Cash Flows Analysis

Kraft provides similar changes once again with cash provided from operating activities.

The small change from the previous 5 years again backs up the understanding that

Kraft doesn’t need to change their internal processes to adapt to the market. Cash

from investing activities shows negative balances from 2001 to 2004. However in 2005

due to a purchase of businesses, the balance fell back to positive. Unless Kraft decides

to acquire more companies in the near future, the balance should remain somewhat

unchanged for 2005 to 2015. Financing activities also show negative balances. A

gradual decrease for the past 5 years shows forecasts to remain similar for the next 10

years.

- 40 -

Equity Valuation Analysis

In the valuation of Kraft, Inc. we evaluated the company using intrinsic valuation

methods and came to the conclusion that the firm’s share price is overvalued. With the

several valuation models, we were able to come up with a relevant value of the

company. In order to start evaluating, the methods of comparables were calculated.

After that, the discounted dividends, discounted free cash flows, residual income, long-

run residual income, and abnormal earnings growth models were used as well to value

Kraft. With the use of these several valuation methods, our value of the firm was

accurately determined.

Methods of Comparables According to our knowledge of price multiples, this valuation method is relatively

simplistic and easy to implement. We used four different performance measures to

calculate the firm’s value: earnings per share, book value per share, dividends per

share, and price per share. Kraft’s main competitors are Con Agra and Sara Lee. We

used these two companies to compare Kraft’s value according to the comparables

method.

2004

EPS BPS DPS PPS

Kraft Foods Inc. 1.87 17.54 0.75 35.61

Sara Lee 1.59 3.71 0.75 46.08

ConAgra 1.5 9.3 1.03 29.45 2005

EPS BPS DPS PPS Kraft Foods Inc. 1.88 17.72 0.85 28.21

Sara Lee 1.36 3.74 0.78 36.95

ConAgra 1.35 9.38 1.07 20.28

- 41 -

Comparables (KFT) P/E Trailing P/E Forecast P/B D/P P/S PEG P/EBIT P/EBITDA M/BKraft's Price (2004) $19.04 $39.44 $136.64 $25.86 $27.54 $20.09 $35.11 $84.37 2.03$ Kraft's Price (2005) $15.01 $39.20 $106.67 $22.97 $22.68 $19.86 $29.47 $71.59 1.59$ Industry Avg. (2004) 24.31 21.09 7.79 0.029 1.46 0.341 13.01 12.98 3.78Industry Avg. (2005) 21.09 20.85 6.02 0.037 1.11 0.1475 10.34 10.36 3.07

According to our data, Kraft’s P/E trailing price for 2004 and 2005 is less than the

industry average. Also, our forecasts show that Kraft price to earnings will increase.

However, the industry forecasts based on the averages will decline respectively. It is

significant to note that Kraft has larger earnings per share in the year 2004 and 2005

compared to its competitors. Also, book value per share is larger than the Kraft’s two

main competitors. As for dividends per share and price per share, Kraft fits right in the

middle with Con Agra and Sara Lee.

It is consistent to notice that Kraft has similar yet more impressive calculations as far as

their financial ratios are concerned. Although, we believe that Kraft is still overvalued

according to the rest of our data that we have collected. It’s easy to compare Kraft’s

financial ratios with its competitors and industry but in order to truthfully value the firm,

more information is needed to make a final decision. (Kraft Value Line; November 3,

2006) (www.yahoo.finance.com)

Intrinsic Evaluations

Discounted Dividends Method

In order to analyze Kraft based on the Discounted Dividends Model, it is important to

first recognize the cost of equity of the firm and dividends in the future. According to

our forecasted data, our dividends are shown to grow at an increasing rate for the next

10 years as well as the terminal period. Cost of Equity is 6.97%. Based on our

- 42 -

gathered data, growth and dividends have a high correlation between each other. In

other words, observable increases in firm value should also increase dividends

respectively. Our estimated value per share in the year 2005 is $26.06. The market

value per share is $34.36. Therefore, according to the discounted dividends model,

Kraft seems tends to look overvalued. However, as we continue to analyze Kraft with

other valuation models, we will come up with a final decision after all models have been

looked into.

Sensitivity Analysis g 0 0.01 0.03 0.05 0.07 0.09 0.02 $105.51 $197.60 N/A N/A N/A N/A 0.03 $68.95 $97.04 N/A N/A N/A N/A 0.04 $50.75 $63.62 $166.54 N/A N/A N/A 0.05 $39.89 $46.97 $82.35 N/A N/A N/A 0.06 $32.70 $37.03 $54.34 $140.92 N/A N/A

Ke 0.07 $27.60 $30.44 $40.37 $70.19 N/A N/A 0.08 $23.80 $25.76 $32.02 $46.63 $119.69 N/A 0.09 $20.87 $22.27 $26.47 $34.87 $60.07 N/A

According to our sensitivity analysis, it’s hard to believe that the discounted dividends

model is the most accurate way of valuing the firm. As stated earlier, other valuation

methods give a better look at the firm in order to overvalue or undervalue Kraft, Inc.

Free Cash Flows

Along with the discounted dividends model, the free cash flows method has two

components to look into in order to find a worthy valuation. These two components are

the weighted average cost of capital and the future free cash flows of the firm. Along

with dividends, we estimate that Kraft’s free cash flows will also continue to increase at

a slow rising rate for the next 10 years. This is calculated by subtracting cash flow from

investing activities from cash flow from operations. The weighted average cost of

capital is 6.77%. The total present value of free cash flows totals near $20 billion

dollars. This is found by adding all the annual cash flows from 2005 all the way to

- 43 -

2015. Also the terminal value of continuing growth throughout the years is near $27

billion dollars.

Sensitivity Analysis g 0 0.01 0.02 0.03 0.04 0.05

0.020 $103.59 $191.20 N/A N/A N/A N/A 0.025 $82.66 $127.35 $350.81 N/A N/A N/A

WACC 0.030 $68.72 $95.44 $175.62 N/A N/A N/A 0.035 $58.77 $76.30 $177.22 $321.82 N/A N/A 0.040 $51.31 $63.55 $88.03 $161.47 N/A N/A 0.045 $45.52 $54.45 $70.52 $108.02 $295.51 N/A 0.050 $40.90 $47.63 $58.85 $81.29 $148.62 N/A 0.055 $37.12 $42.33 $50.52 $65.26 $99.65 $271.60 0.060 $33.98 $38.09 $44.27 $54.57 $75.16 $136.93 0.065 $31.32 $34.63 $39.41 $46.93 $60.46 $92.02 0.070 $29.05 $31.75 $35.53 $41.20 $50.65 $69.56

According to our sensitivity analysis, as the weighted average cost of capital and growth

rise, prices remain rather sensitive. Although, when using the free cash flows model, it

is common to conclude that large changes in prices occur often. As for the free cash

flows model as a method of valuation, it is imperative to look at the remaining valuation

methods to conclude whether Kraft is over and under valued.

Residual Income

Our third intrinsic valuation method is the residual income model. This model is based

upon accounting data relating to book value, dividends, and earnings of the firm.

These values are all based upon a per share basis. In relation to the two previous

methods, two components are used to find residual income. Cost of equity of the firm

and earnings per share are these components. Earnings per share are forecasted to

increase over the next 10 years. Book value per share increases as well over the

forecasted time period. Average return on equity is valued at approximately 8.5%.

The estimated value in 2005 and 2006 both reflect that Kraft is overvalued. The actual

market price is $34.36. The 2005 and 2006 values are $25.55 and $26.28 respectively.

- 44 -

Sensitivity Analysis G 0 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.02 $83.69 $138.22 N/A N/A N/A N/A $1.91 $7.36 $10.99 0.03 $55.20 $69.28 $111.52 N/A N/A N/A N/A $5.92 $10.14

0.04 $40.31 $46.26 $56.84 $88.59 N/A N/A N/A $3.94 $9.23 0.05 $32.45 $34.73 $38.53 $46.13 $68.92 N/A N/A $0.54 $8.14

Ke 0.06 $26.78 $27.79 $29.31 $31.84 $36.90 $52.09 N/A N/A $6.54 0.07 $22.74 $23.16 $23.74 $24.61 $26.07 $28.98 $37.71 N/A $2.79 0.08 $19.72 $19.84 $20.00 $20.21 $20.54 $21.09 $22.18 $25.46 N/A 0.09 $17.38 $17.35 $17.30 $17.24 $17.15 $17.02 $16.80 $16.36 $15.05 0.10 $15.52 $15.40 $15.26 $15.07 $14.83 $14.49 $13.97 $13.11 $11.39 0.11 $13.99 $13.84 $13.66 $13.42 $13.13 $12.73 $12.17 $11.34 $9.95

According to our sensitivity analysis, cost of equity of Kraft must fall to 3% and growth

must fall to 1% in order to remain at market price. The discounted dividends model,

free cash flows model, and residual income model all conclude that Kraft is overvalued.

We now begin to see an ongoing trend with Kraft.

Long Run Residual Income Perpetuity

P=BVE+BE ((ROE-Ke)/(Ke-g))

In order to analyze Kraft based upon the long run residual income perpetuity method,

there are a few components to consider. These components are the book value of

equity per share which is $17.72. Next, return on equity has a value of 8.4%. Thirdly,

cost of equity is 6.97%. Fourth, the growth rate is 4%. Finally our estimated price per

share that we came up with is $26.52. The long run residual income valuation is rather

important to consider. According to our knowledge, this particular valuation tool is used

often when valuing firms. This is because the margin for incorrect forecasting is smaller

than the previous methods. However, not by any means are we jumping to conclusions

regarding the valuation of Kraft. Although, once again we notice that Kraft is

overvalued according to the number compiled with this valuation model.

- 45 -

0 0.01 0.02 0.03 0.04 0.050.02 $74.84 $131.95 N/A N/A N/A N/A0.03 $49.89 $65.98 $114.23 N/A N/A N/A

Ke 0.04 $37.42 $43.98 $57.12 $96.51 N/A N/A0.05 $29.93 $32.99 $38.08 $48.26 $78.79 N/A0.06 $24.95 $26.39 $28.56 $32.17 $39.40 $61.070.07 $21.38 $21.99 $22.85 $24.13 $26.26 $30.540.08 $18.71 $18.85 $19.04 $19.30 $19.70 $20.360.09 $16.63 $16.49 $16.32 $16.09 $15.76 $15.270.10 $14.97 $14.66 $14.28 $13.79 $13.13 $12.21

gSensitivity Analysis

Abnormal Earnings Growth

Evaluating Kraft by using this particular model gives the firm the opportunity of

reinvesting the company’s dividends. In order to find this number of dividends to

reinvest, we subtracted normal earnings from cumulative-dividend earnings. Our

abnormal earnings growth from 2005 to 2015 starts off deteriorating but then starts to

increase after 7 years.

Sensitivity Analysis g -0.08 -0.06 -0.04 -0.02 0 0.02 0.04

0.02 $93.45 $95.89 $99.96 $108.09 $132.49 N/A N/A 0.03 $61.36 $62.73 $64.89 $68.76 $77.81 $123.02 N/A 0.04 $45.33 $46.20 $47.51 $49.69 $54.05 $67.14 N/A 0.05 $35.73 $36.33 $37.19 $38.54 $40.98 $46.66 $75.08

Ke

0.06 $29.34 $29.77 $30.37 $31.27 $32.76 $35.75 $44.72 0.07 $24.80 $25.12 $25.55 $26.17 $27.15 $28.91 $33.02 0.08 $21.41 $21.65 $21.97 $22.41 $23.09 $24.21 $26.45 0.09 $18.78 $18.96 $19.21 $19.54 $20.02 $20.77 $22.13

According to our sensitivity analysis, growth and cost of equity must both increase for

Kraft to be at market price. Once again, we realize that the firm is observably

overvalued. The abnormal earnings growth model is also considered to be rather

- 46 -

accurate. Along with each other valuation method, Kraft is noticeably overvalued

according to our calculations.

Risk Analysis In order to compute the credit risk for Kraft, a popular method was used called the

Altman Z-score. This particular score is based upon ratios that are derived from certain

sections of the financials. According to our calculations, Kraft has a Z-score of 2.089 in

2005 and 2.123 as an average of the past five years. Therefore, Kraft has a moderate

Z-score rating. This isn’t necessarily a terrible rating for Kraft because it is in between

low and high risk. In regard to Kraft’s credit rating in the industry, it has room to

improve but they aren’t by any means in danger of financial grief.

- 47 -

Valuation Conclusion

According to our knowledge as analysts, it is vital to evaluate Kraft’s price through the

use of intrinsic valuation models. Due to our forecasts, it is apparent that our data

could be less than perfect. However, the numbers we have calculated are disclosed

with the best of our abilities. Each significant factor that we have compiled such as

Cost of Equity, Cost of Debt, Weighted Average Cost of Capital, and each other

valuation method contain forecasts carefully evaluated by our team. According to our

research, we recognize that Kraft, Inc. is an overvalued firm. All of our valuation

models confirm our analysis of the company.

While showing poor liquidity compared to the industry, Kraft can still boast about good

profitability and capital structure. We feel their good profitability and capital structure is

due to them already having a firm grip on a big share of the industry. Kraft’s

established place in the market helps keep the profitability and capital structure steady.

In this highly competitive market full of substitutes, it is imperative to have a loyal

customer base. Kraft achieves this base with a superior brand image and quality of

service. Even with our forecasts of success in the future, we still feel that Kraft is

overvalued due to our analysis of the intrinsic valuation methods. Since we feel Kraft is

overvalued within the industry, we recommend selling the stock. However considering

our forecasted upward trend in the future, we feel with an investment horizon of more

than five years that Kraft would not be detrimental to a portfolio.

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APPENDIX

Appendix A. Core Financial Ratios

Appendix B. Forecasted Financials

Forecasted Balance Sheet

Common Sized Balance Sheet

Forecasted Income Statement

Common Sized Income Statement

Forecasted Statement of Cash Flows

Financial Ratios

Appendix C. Cost of Capital

Cost of Equity

Weighted Average Cost of Debt

Weighted Average Cost of Capital

Appendix D. Valuation Models

Discounted Dividends

Free Cash Flows

Residual Income

Long-Run Residual Income Perpetuity

Abnormal Earnings Growth

Appendix E. Core Manipulations

- 49 -

Appendix A. Core Financial Ratios

Current Ratio 2001 2002 2003 2004 2005

Kraft Foods Inc. 0.79 1.04 1.03 1.07 0.93Sara Lee 1.03 0.91 1.15 1.06 1.17

ConAgra Foods 1.06 1.49 1.59 1.71 1.89Industry 1.05 1.20 1.37 1.39 1.53

Quick Asset Ratio 2001 2002 2003 2004 2005Kraft Foods Inc. 0.37 0.46 0.49 0.42 0.42

Sara Lee 0.42 0.39 0.55 0.47 0.52ConAgra Foods 0.26 0.36 0.42 0.66 0.63

Industry 0.34 0.38 0.49 0.57 0.57

A/R Turnover 2001 2002 2003 2004 2005



Inventory Turnover 2001 2002 2003 2004 2005



Working Capital Turnover 2001 2002 2003 2004 2005Kraft Foods Inc. -15.64 103.56 115.96 49.95 -59.74

Sara Lee 141.98 -36.96 24.26 60.58 22.84ConAgra Foods 63.69 13.03 8.79 6.78 6.82

Industry 102.84 -11.97 16.53 33.68 14.83

Gross Profit Margin 2001 2002 2003 2004 2005

Kraft Foods Inc. 39.91% 40.38% 39.24% 36.95% 35.96%Sara Lee 42.20% 39.30% 39.60% 38.60% 36.20%

ConAgra Foods 14.30% 14.80% 19.30% 22.00% 21.30%Industry 28.25% 27.05% 29.45% 30.30% 28.75%

- 50 -

Operting Expense Ratio 2001 2002 2003 2004 2005Kraft Foods Inc. 4.92% 2.85% 2.18% 2.07% 1.86%

Sara Lee 33.00% 30.40% 30.40% 30.10% 28.70%ConAgra Foods 8.70% 8.80% 11.60% 12.50% 12.60%

Industry 20.85% 19.60% 21.00% 21.30% 20.65%

Net Profit Margin 2001 2002 2003 2004 2005Kraft Foods Inc. 6.44% 11.42% 11.40% 8.28% 7.72%

Sara Lee 12.80% 5.70% 6.70% 6.50% 3.70%ConAgra Foods 2.30% 2.80% 3.90% 6.10% 4.40%

Industry 7.55% 4.25% 5.30% 6.30% 4.05%

Asset Turnover 2001 2002 2003 2004 2005Kraft Foods Inc. 0.52 0.52 0.51 0.54 0.59

Sara Lee 1.75 1.28 1.21 1.31 1.34ConAgra Foods 1.65 1.78 1.32 1.02 1.14

Industry 1.70 1.53 1.27 1.17 1.24

ROA 2001 2002 2003 2004 2005



ROE 2001 2002 2003 2004 2005



Debt to Equity Ratio 2001 2002 2003 2004 2005



Times Interest Earned 2001 2002 2003 2004 2005



- 51 -

Debt Service Margin 2001 2002 2003 2004 2005



- 52 -

Appendix B. Forecasted Financials

Forecasted Balance Sheet (Millions) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

ASSETSCash and cash equivalents 162 215 514 282 316 354 396 444 497 557 624 699 782 876 981 Assume 12% growth rateReceivables (less allowances of $92 in 3131 3116 3369 3541 3385 3503 3626 3753 3884 4020 4161 4307 4457 4613 4775 Assume 3.5% growth rate2005 and $118 in 2004)Inventories:

Raw materials 1281 1372 1375 1367 1363Finished product 1745 2010 1968 2080 1980

Total Inventories 3026 3382 3343 3447 3343 3343 3344 3344 3344 3345 3345 3345 3346 3346 3346 Assume .01% growthDeferred income taxes 466 511 681 749 879Assets of discontinued operations held for sale 1458

Other current assets 221 232 217 245 230

Total current assets 7006 7456 8124 9722 8153 8561 8989 9438 9910 10406 10926 11472 12046 12648 13280 Assume 5% growth rateProperty, plant and equipment, at cost:

Land and land improvements 387 387 407 400 388Buildings and building equipment 2915 3153 3422 3545 3551Machinery and equipment 9264 10108 11293 11892 12008Construction in progress 706 802 683 646 651

13272 14450 15805 16483 16598Less accumulated depreciation 4163 4891 5650 6498 6781

9109 9559 10155 9985 9817Goodwill 35957* 24911 25402 25177 24648Other intangible assets, net 11509 11477 10634 10516Prepaid pension assets 2675 2814 3243 3569 3617Other assets 1051 851 884 841 877

TOTAL ASSETS 55798 57100 59285 59928 57628 61086 64751 68636 72754 77119 81746 86651 91850 97361 103203 Assume 6% growth rate

LIABILITIESShort-term borrowings 681 220 553 1818 805Current portion of long-term debt 540 352 775 750 1268Due to Altria Group, Inc. and affiliates 1652 895 543 227 652Accounts payable 1897 1939 2005 2207 2270 2338 2408 2480 2555 2632 2710 2792 2876 2962 3051 Assume 3% growth rateAccrued liabilities:

Marketing 1398 1474 1500 1637 1529Employment costs 658 610 699 732 625Other 1821 1316 1335 1537 1338

Income taxes 228 363 451 170 237

Total current liabilities 8875 7169 7861 9078 8724 9073 9436 9813 10206 10614 11039 11480 11939 12417 12914 Assume 4% growth rate'Long-term debt 8134 10416 11591 9723 8475Deferred income taxes 5031 5428 5856 6468 6067Accrued postretirement health care costs 1850 1889 1894 1887 1931Notes payable to Altria Group, Inc. and afiliates 5000 2560Other liabilities 3430 3806 3553 2861 2838

Total liabilities 32320 31268 30755 30017 28035 29297 30615 31993 33432 34937 36509 38152 39869 41663 43537 Assume 4.5% growth rate

Contingencies (Note 18)SHAREHOLDERS' EQUITY

Class A common stock, no par value (555,000,000shares issued in 2005 and 2004)Class B common stock, no par value (1,180,000,000shares issued and outstanding in 2005 and2004.00

Additional paid-in capital 23655 23655 23704 23762 23835Earnings reinvested in the business 2391 4814 7020 8304 9453Accumulated other comprehensive losses -2568 -2467 -1792 -1205 -1663(including currency translation of $(1,290)in 2005 and $(890) in 2004)

23478 26002 28932 30861 31625Less cost of repurchased stock (65,119,245 -170 -402 -950 -2032Class A shares in 2005 and 29,644,926 ClassA shares in 2004)

Total shareholders' equity 23478 25832 28530 29911 29593 31073 32626 34258 35970 37769 39657 41640 43722 45908 48204 Assume 5% growth rate

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY 55798 57100 59285 59928 57628 31073 32626 34258 35970 37769 39657 41640 43722 45908 48204

Book Value Per Shares 13.53199 14.92317 16.56794 17.54311 17.72036

Shares Outstanding 1735 1731 1722 1705 1670

Current Market Value 34.03 38.93 32.22 35.61 28.17

- 53 -

Common Sized Balance Sheet (Millions) 2001 2002 2003 2004 2005

ASSETSCash and cash equivalents 0.29% 0.38% 0.87% 0.47% 0.55%Receivables (less allowances of $92 in 5.61% 5.46% 5.68% 5.91% 5.87%2005 and $118 in 2004)Inventories:

Raw materials 2.30% 2.40% 2.32% 2.28% 2.37%Finished product 3.13% 3.52% 3.32% 3.47% 3.44%

5.42% 5.92% 5.64% 5.75% 5.80%Deferred income taxes 0.84% 0.89% 1.15% 1.25% 1.53%Assets of discontinued operations held 2.43%for saleOther current assets 0.40% 0.41% 0.37% 0.41% 0.40%

Total current assets 12.56% 13.06% 13.70% 16.22% 14.15%Property, plant and equipment, at cost:

Land and land improvements 0.69% 0.68% 0.69% 0.67% 0.67%Buildings and building equipment 5.22% 5.52% 5.77% 5.92% 6.16%Machinery and equipment 16.60% 17.70% 19.05% 19.84% 20.84%Construction in progress 1.27% 1.40% 1.15% 1.08% 1.13%

23.79% 25.31% 26.66% 27.50% 28.80%Less accumulated depreciation 7.46% 8.57% 9.53% 10.84% 11.77%

16.32% 16.74% 17.13% 16.66% 17.04%Goodwill 43.63% 42.85% 42.01% 42.77%Other intangible assets, net 0.00% 20.16% 19.36% 17.74% 18.25%Prepaid pension assets 4.79% 4.93% 5.47% 5.96% 6.28%Other assets 1.88% 1.49% 1.49% 1.40% 1.52%

TOTAL ASSETS 100.00% 100.00% 100.00% 100.00% 100.00%

LIABILITIESShort-term borrowings 1.22% 0.39% 0.93% 3.03% 1.40%Current portion of long-term debt 0.97% 0.62% 1.31% 1.25% 2.20%Due to Altria Group, Inc. and affiliates 2.96% 1.57% 0.92% 0.38% 1.13%Accounts payable 3.40% 3.40% 3.38% 3.68% 3.94%Accrued liabilities:

Marketing 2.51% 2.58% 2.53% 2.73% 2.65%Employment costs 1.18% 1.07% 1.18% 1.22% 1.08%Other 3.26% 2.30% 2.25% 2.56% 2.32%

Income taxes 0.41% 0.64% 0.76% 0.28% 0.41%

Total current liabilities 15.91% 12.56% 13.26% 15.15% 15.14%Long-term debt 14.58% 18.24% 19.55% 16.22% 14.71%Deferred income taxes 9.02% 9.51% 9.88% 10.79% 10.53%Accrued postretirement health care costs 3.32% 3.31% 3.19% 3.15% 3.35%Notes payable to Altria Group, Inc. and afiliates 8.96% 4.48%Other liabilities 6.15% 6.67% 5.99% 4.77% 4.92%

Total liabilities 57.92% 54.76% 51.88% 50.09% 48.65%

Contingencies (Note 18)SHAREHOLDERS' EQUITY

Class A common stock, no par value (555,000,000shares issued in 2005 and 2004)Class B common stock, no par value (1,180,000,000shares issued and outstanding in 2005 and

2004.00Additional paid-in capital 42.39% 41.43% 39.98% 39.65% 41.36%Earnings reinvested in the business 4.29% 8.43% 11.84% 13.86% 16.40%Accumulated other comprehensive losses -4.60% -4.32% -3.02% -2.01% -2.89%(including currency translation of $(1,290)in 2005 and $(890) in 2004)

42.08% 45.54% 48.80% 51.50% 54.88%Less cost of repurchased stock (65,119,245 0.00% -0.30% -0.68% -1.59% -3.53%Class A shares in 2005 and 29,644,926 ClassA shares in 2004)

Total shareholders' equity 42.08% 45.24% 48.12% 49.91% 51.35%

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY 100.00% 100.00% 100.00% 100.00% 100.00%

- 54 -

(Millions) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Net revenues 29,234 29,723 30,498 32,168 34,113 35,478 36,897 38,372 39,907 41,504 43,164 44,890 46,686 48,553 50,496 Assume a 4% growth rateCost of sales 17,566 17,720 18,531 20,281 21,845 21,948 22,826 23,739 24,689 25,677 26,704 27,772 28,883 30,038 31,239 Grew at Average of Gross Profit Margin

Gross profit 11,668 12,003 11,967 11,887 12,268 13,529 14,070 14,633 15,218 15,827 16,460 17,119 17,803 18,516 19,256Marketing, administration and research 5,748 5,709 6,123 6,658 7,135costsIntergration costs and a loss on a sale of a food plant 82 111Separtation programs 142Asset impairment and exit costs 6 603 479(Gains) losses on sales of businesses, 3netAmortization of intangibles 962 7 9 11 10

Operating income 4,884 6,114 5,860 4,612 4,752 4,895 5,041 5,193 5,348 5,509 5,674 5,844 6,020 6,200 6,386 Assume 3% growth rateInterest and other debt expense, net 1,437 847 665 666 636 639 642 646 649 652 655 659 662 665 669 Assume .05% growth rate

Earnings from continuing operations before 3,447 5,267 5,195 3,946 4,116income taxes and minority interest

Provision for income taxes 1,565 1,869 1,812 1,274 1,209

Earnings from continuing operations before 1,882 3,398 3,383 2,672 2,907minority interest

Minority interest in earnings from continuing 4 4 3 3operations, net

Earnings from continuing operations 3,379 2,669 2,904(Loss) earnings from discontinued operations, 97net of income taxes

Net earnings 1,882 3,394 3,476 2,665 2,632 2,599 2,625 2,652 2,678 2,705 2,732 2,759 2,787 2,815 2,843 Assume 1% growth after 2006

Per share data:Basic earnings per share:

Continuing operations 1.90 1.95 1.56 1.72Discontinued operations 0.06 0.06

Net earnings 1.17 1.96 2.01 1.56 1.56 1.58 1.59 1.61 1.62 1.64 1.66 1.67 1.69 1.71 1.72 Assume 1% growth rate

Diluted earnings per share:Continuing operations 1.90 1.95 1.55 1.72Discontinued operations 0.06 0.06

Net earnings 1.17 1.96 2.01 1.55 1.55 1.57 1.58 1.60 1.61 1.63 1.65 1.66 1.68 1.70 1.71 Assume a 1% growth rate

(8) (80) (31) (108)962 7

(4) (272)

(0.16)

(0.17)

Forecasted Income Statement

- 55 -

Common Sized Income Statement

Net revenues 100.000% 100.000% 100.000% 100.000% 100.000%Cost of sales 60.088% 59.617% 60.761% 63.047% 64.037%

Gross profit 39.912% 40.383% 39.239% 36.953% 35.963%Marketing, administration and research 19.662% 19.207% 20.077% 20.698% 20.916%costsIntergration costs and a loss on a sale of a food plant 0.280% 0.373% 0.000% 0.000% 0.000%Separtation programs 0.000% 0.478% 0.000% 0.000% 0.000%Asset impairment and exit costs 0.000% 0.000% 0.020% 1.875% 1.404%(Gains) losses on sales of businesses, -0.027% -0.269% -0.102% 0.009% -0.317%net 3.291% 0.024% 0.000% 0.000% 0.000%Amortization of intangibles 3.291% 0.024% 0.030% 0.034% 0.029%

Operating income 16.707% 20.570% 19.214% 14.337% 13.930%Interest and other debt expense, net 4.916% 2.850% 2.180% 2.070% 1.864%

Earnings from continuing operations before 11.791% 17.720% 17.034% 12.267% 12.066%income taxes and minority interest

Provision for income taxes 5.353% 6.288% 5.941% 3.960% 3.544%

Earnings from continuing operations before 6.438% 11.432% 11.093% 8.306% 8.522%minority interest

Minority interest in earnings from continuing 0.000% 0.013% 0.013% 0.009% 0.009%operations, net

Earnings from continuing operations 0.000% 0.000% 11.079% 8.297% 8.513%(Loss) earnings from discontinued operations, 0.000% 0.000% 0.318% -0.012% -0.797%net of income taxes

Net earnings 6.438% 11.419% 11.397% 8.285% 7.716%

Per share data:Basic earnings per share:

Continuing operations 0.000% 0.006% 0.006% 0.005% 0.005%Discontinued operations

Net earnings 0.004% 0.007% 0.007% 0.005% 0.005%

Diluted earnings per share:Continuing operations 0.000% 0.006% 0.006% 0.005% 0.005%Discontinued operations

Net earnings 0.004% 0.007% 0.007% 0.005% 0.005%

(Miilions) 2001 2002 2003 2004 2005

- 56 -

Forecasted Statement of Cash Flows

(Millions) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

CASH PROVIDED BY (USED IN) OPERATING ACTIVITIESNet earnings 1,882 3,394 3,476 2,665 2,632Adjustments to reconcile net earningsto operating cash flows:

Depreciation and amortization 1,642 716 813 879 879Deferred income tax (benefit) provision 414 278 244 41(Gains) losses on sales of businesses, 3netIntegration costs, net of cash paid 82 111Seperating Programs 142Loss on sale of discontinued operations 32Impairment loss on discontinued operations 107Asset impairment and exit costs, net of 6 493 315cash paidCash effects of changes, net of the effectsfrom acquired anddivested companies:

Receivables, net 23 116 23 65InventoriesAccounts payableIncome taxesAmounts due to Altria Group, Inc. and affiliates 138Other working capital items 90

Change in pension assets and postretirementliabilities, netOther 143 234 228

Net cash provided by operating activities 3,328 3,720 4,119 4,008 3,464 3,498.64 3,603.60 3,711.71 3,823.06 3,937.75 4,055.88 4,177.56 4,302.89 4,431.97 4,564.93 Assume 1% growth rate

CASH PROVIDED BY (USED IN) INVESTING ACTIVITIESCapital expendituresPurchases of businesses, net of acquired cashProceeds from sales of businesses 1,668Other 52 35 38 69 28

Net cash provided by (used in) investing 525 Assume .1% growth rateactivities

CASH PROVIDED BY (USED IN) FINANCING ACTIVITIESNet (repayment) issuance of short-term 2,505 819borrowingsLong-term debt proceeds 4,077 3,325 1,577 832 69Long-term debt repaidRepayment of notes payable to Altria Group,Inc. and affiliatesNet Proceeds from sale of Class A Common Stock 8,425Increase (decrease) in amounts due to Altria 142 660 107Group, Inc. and affiliatesRepurchase of Class A common stock (170)Dividends paidOther

Net cash used in financing activities

Effect of exchange rate changes on cash 1 15 34and cash equivalents

Cash and cash equivalents:Increase (decrease) 53 299 34Balance at beginning of year 162 215 282

Balance at end of year 162 215 514 282 316

Cash paid:Interest 1,433 825 642 633 679

Income taxes 1,058 1,368 1,726 1,610 1,957

(408)(8) (80) (31) (108)

(26) (1) (1)

(45)(107) (220) 197 (65) (42)(73) (116) (116) 152 74

74 277 (125) (251) (33)(244) 169 74 273

(407) (552) (167) (432)(245) (34) (419) (436) (10)

(87) (68)

(1,101) (1,184) (1,085) (1,006) (1,171)(194) (122) (98) (137)

21 219 96 18

(1,222) (1,052) (1,049) (1,056) (1057.06) (1058.11) (1058.11) (1059.17) (1059.17) (1060.23) (1060.23) (1061.29) (1061.29) (1062.35)

(1,036) (635) (1,005)

(705) (609) (491) (842) (775)(16,350) (3,850) (2,757)

(525) (585)

(372) (688) (1,175)(225) (936) (1,089) (1,280) (1,437)

52 (20) 265

(2,131) (2,616) (2,786) (3,218) (3,951)

(4) (4)

(29) (232)191 514

- 57 -

Financial Ratios

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Liquidity Analysis

Current Ratio 0.79 1.04 1.03 1.07 0.93 0.94 0.95 0.96 0.97 0.98 0.99 1.00 1.01 1.02 1.03Quick Asset Ratio 0.37 0.46 0.49 0.42 0.42 0.43 0.43 0.43 0.43 0.43 0.43 0.44 0.44 0.44 0.45

Efficiency Analysis

Accounts Receivable Turnover 9.34 9.54 9.05 9.08 10.08 10.13 10.18 10.22 10.27 10.32 10.37 10.42 10.47 10.52 10.58Days Sales Outstanding 39.09 38.26 40.32 40.18 36.22 36.04 35.87 35.70 35.53 35.36 35.19 35.02 34.85 34.68 34.51Inventory Turnover 5.81 5.24 5.54 5.88 6.53 6.56 6.83 7.10 7.38 7.68 7.98 8.30 8.63 8.98 9.34Days' Inventory 62.88 69.66 65.85 62.04 55.86 55.60 53.47 51.41 49.44 47.55 45.72 43.97 42.28 40.66 39.10Working Capital Turnover -15.64 103.56 115.96 49.95 -59.74 -69.25 -82.51 -102.27 -134.90 -199.00 -382.51 -5542.64 439.20 210.18 137.69

Profitability Analysis

Gross Profit Margin 39.91% 40.38% 39.24% 36.95% 35.96% 38.13% 38.13% 38.13% 38.13% 38.13% 38.13% 38.13% 38.13% 38.13% 38.13%Operating Expense Ratio 4.92% 2.85% 2.18% 2.07% 1.86% 1.80% 1.74% 1.68% 1.63% 1.57% 1.52% 1.47% 1.42% 1.37% 1.32%Net Profit Margin 6.44% 11.42% 11.40% 8.28% 7.72% 7.33% 7.12% 6.91% 6.71% 6.52% 6.33% 6.15% 5.97% 5.80% 5.63%Operating Profit Margin 16.71% 20.57% 19.21% 14.34% 13.93% 13.80% 13.66% 13.53% 13.40% 13.27% 13.15% 13.02% 12.89% 12.77% 12.65%Asset Turnover 0.52 0.52 0.51 0.54 0.59 0.58 0.57 0.56 0.55 0.54 0.53 0.52 0.51 0.50 0.49Return on Assets 3.37% 5.94% 5.86% 4.45% 4.57% 4.26% 4.05% 3.86% 3.68% 3.51% 3.34% 3.18% 3.03% 2.89% 2.75%Return on Equity 8.02% 13.14% 12.18% 8.91% 8.89% 8.37% 8.05% 7.74% 7.45% 7.16% 6.89% 6.63% 6.37% 6.13% 5.90%

Capital Structure Analysis

Debt to Equity Ratio 1.38 1.21 1.08 1.00 0.95 0.94 0.94 0.93 0.93 0.93 0.92 0.92 0.91 0.91 0.90Times Interest Earned 3.40 7.22 8.81 6.92 7.47 7.66 7.85 8.04 8.24 8.45 8.66 8.87 9.09 9.32 9.55Debt Service Margin 1.75 1.92 2.05 1.82 1.53 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50

Other RatiosAccounts Payable Turnover 15.41 15.33 15.21 14.58 15.03 15.17 15.32 15.47 15.62 15.77 15.92 16.08 16.24 16.39 16.55Days' Payable 23.68 23.81 24.00 25.04 24.29 24.05 23.82 23.59 23.37 23.14 22.92 22.70 22.48 22.27 22.05

IGR= ROE*(1-dividend payout ratio) 0.06 0.10 0.08 0.05 0.04 0.03 0.03 0.02 0.02 0.01 0.01 0.00 -0.01 -0.01 -0.02SGR= IGR(1+(d/e)) 0.15 0.21 0.17 0.09 0.08 0.07 0.06 0.04 0.03 0.02 0.01 0.00 -0.01 -0.02 -0.03

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SUMMARY OUTPUT Rf 0.046960 months MRP 0.043

Regression StatisticsMultiple R 0.330308084 Beta Adjusted R^2 KeR Square 0.10910343 60 0.53055 0.09319 0.069714Adjusted R Square 0.093194563 48 0.69809 0.08773 0.076918Standard Error 0.055283247 36 0.59747 0.07036 0.072591Observations 58 24 0.50647 0.02803 0.068678

ANOVAdf SS MS F FSignificance

Regression 1 0.020959756 0.0209598 6.8580263 0.01133158Residual 56 0.171149292 0.0030562Total 57 0.192109048

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.005377743 0.007260877 0.7406465 0.4620021 -0.0091675 0.019923028 -0.009167542 0.019923028

0.027391362 0.530546785 0.20259285 2.6187834 0.0113316 0.12470454 0.936389029 0.124704541 0.936389029

Appendix C. Cost of Capital

20 Year Regression

Cost of Equity: Ke

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Close Dividends Firms Returns Date Close Market Returns Date Values 20 Year Rates Market Premium34.36 -0.0012 1-Nov-06 1367.81 -0.007434.4 -0.0353 2-Oct-06 1377.94 0.0315 2006-10-01 4.94 0.0041167 0.0273914

35.66 0.25 0.0590 1-Sep-06 1335.85 0.0246 2006-09-01 4.93 0.0041083 0.020457933.91 0.0466 1-Aug-06 1303.82 0.0213 2006-08-01 5.08 0.0042333 0.017040932.4 0.0485 3-Jul-06 1276.66 0.0051 2006-07-01 5.25 0.0043750 0.000710830.9 0.23 -0.0595 1-Jun-06 1270.2 0.0001 2006-06-01 5.29 0.0044083 -0.004321733.1 0.0595 1-May-06 1270.09 -0.0309 2006-05-01 5.35 0.0044583 -0.0353752

31.24 0.0307 3-Apr-06 1310.61 0.0122 2006-04-01 5.22 0.0043500 0.007805730.31 0.23 0.0150 1-Mar-06 1294.87 0.0111 2006-03-01 4.91 0.0040917 0.007004230.09 0.0221 1-Feb-06 1280.66 0.0005 2006-02-01 4.73 0.0039417 -0.003488629.44 0.0451 3-Jan-06 1280.08 0.0255 2006-01-01 4.65 0.0038750 0.021591828.17 0.23 0.0004 1-Dec-05 1248.29 -0.0010 2005-12-01 4.73 0.0039417 -0.004894128.39 0.0032 1-Nov-05 1249.48 0.0352 2005-11-01 4.83 0.0040250 0.031161128.3 -0.0749 3-Oct-05 1207.01 -0.0177 2005-10-01 4.74 0.0039500 -0.0216907

30.59 0.23 -0.0058 1-Sep-05 1228.81 0.0069 2005-09-01 4.51 0.0037583 0.003190631 0.0147 1-Aug-05 1220.33 -0.0112 2005-08-01 4.53 0.0037750 -0.0149970

30.55 -0.0396 1-Jul-05 1234.18 0.0360 2005-07-01 4.48 0.0037333 0.032234931.81 0.205 -0.0131 1-Jun-05 1191.33 -0.0001 2005-06-01 4.35 0.0036250 -0.003767732.44 0.0009 2-May-05 1191.5 0.0300 2005-05-01 4.56 0.0038000 0.026152032.41 -0.0194 1-Apr-05 1156.85 -0.0201 2005-04-01 4.75 0.0039583 -0.024066933.05 0.205 -0.0058 1-Mar-05 1180.59 -0.0191 2005-03-01 4.89 0.0040750 -0.023192633.45 -0.0156 1-Feb-05 1203.6 0.0189 2005-02-01 4.61 0.0038417 0.015061733.98 -0.0458 3-Jan-05 1181.27 -0.0253 2005-01-01 4.77 0.0039750 -0.029265435.61 0.205 0.0472 1-Dec-04 1211.92 0.0325 2004-12-01 4.88 0.0040667 0.028391534.2 0.0267 1-Nov-04 1173.82 0.0386 2004-11-01 4.89 0.0040750 0.0345199

33.31 0.0501 1-Oct-04 1130.2 0.0140 2004-10-01 4.85 0.0040417 0.009972631.72 0.205 0.0206 1-Sep-04 1114.58 0.0094 2004-09-01 4.89 0.0040750 0.005288931.28 0.0239 2-Aug-04 1104.24 0.0023 2004-08-01 5.07 0.0042250 -0.001937730.55 -0.0357 1-Jul-04 1101.72 -0.0343 2004-07-01 5.24 0.0043667 -0.038657231.68 0.18 0.0670 1-Jun-04 1140.84 0.0180 2004-06-01 5.45 0.0045417 0.013447429.86 -0.0927 3-May-04 1120.68 0.0121 2004-05-01 5.46 0.0045500 0.007533432.91 0.0281 1-Apr-04 1107.3 -0.0168 2004-04-01 5.16 0.0043000 -0.021090832.01 0.18 -0.0474 1-Mar-04 1126.21 -0.0164 2004-03-01 4.72 0.0039333 -0.020292333.79 0.0491 2-Feb-04 1144.94 0.0122 2004-02-01 4.94 0.0041167 0.008092432.21 -0.0003 2-Jan-04 1131.13 0.0173 2004-01-01 5.01 0.0041750 0.013101432.22 0.18 0.0231 1-Dec-03 1111.92 0.0508 2003-12-01 5.11 0.0042583 0.046507131.67 0.0883 3-Nov-03 1058.2 0.0071 2003-11-01 5.17 0.0043083 0.002820229.1 -0.0136 1-Oct-03 1050.71 0.0550 2003-10-01 5.21 0.0043417 0.050619829.5 0.18 -0.0007 2-Sep-03 995.97 -0.0119 2003-09-01 5.21 0.0043417 -0.016286029.7 0.0680 1-Aug-03 1008.01 0.0179 2003-08-01 5.39 0.0044917 0.0133815

27.81 -0.1456 1-Jul-03 990.31 0.0162 2003-07-01 4.92 0.0041000 0.012123732.55 0.15 0.0093 2-Jun-03 974.5 0.0113 2003-06-01 4.34 0.0036167 0.007705632.4 0.0485 1-May-03 963.59 0.0509 2003-05-01 4.52 0.0037667 0.047132030.9 0.0957 1-Apr-03 916.92 0.0810 2003-04-01 4.91 0.0040917 0.076952528.2 0.15 -0.0426 3-Mar-03 848.18 0.0084 2003-03-01 4.82 0.0040167 0.0043409

29.61 -0.0703 3-Feb-03 841.15 -0.0170 2003-02-01 4.87 0.0040583 -0.021062031.85 -0.1819 2-Jan-03 855.7 -0.0274 2003-01-01 5.02 0.0041833 -0.031598038.93 0.15 0.0405 2-Dec-02 879.82 -0.0603 2002-12-01 5.01 0.0041750 -0.064507637.56 -0.0491 1-Nov-02 936.31 0.0571 2002-11-01 5.04 0.0042000 0.052869639.5 0.0834 1-Oct-02 885.76 0.0864 2002-10-01 5.00 0.0041667 0.0822822

36.46 0.15 -0.0795 3-Sep-02 815.28 -0.1100 2002-09-01 4.87 0.0040583 -0.114082739.77 0.0749 1-Aug-02 916.07 0.0049 2002-08-01 5.19 0.0043250 0.0005564

37 -0.0965 1-Jul-02 911.62 -0.0790 2002-07-01 5.51 0.0045917 -0.083595940.95 0.13 -0.0449 3-Jun-02 989.82 -0.0725 2002-06-01 5.65 0.0047083 -0.077163743.01 0.0480 1-May-02 1067.14 -0.0091 2002-05-01 5.81 0.0048417 -0.013923141.04 0.0618 1-Apr-02 1076.92 -0.0614 2002-04-01 5.85 0.0048750 -0.066292738.65 0.13 -0.0082 1-Mar-02 1147.39 0.0367 2002-03-01 5.93 0.0049417 0.031797239.1 0.0550 1-Feb-02 1106.73 -0.0208 2002-02-01 5.61 0.0046750 -0.0254412

37.06 0.0890 2-Jan-02 1130.2 -0.0156 2002-01-01 5.69 0.0047417 -0.020315534.03 0.13 0.0314 3-Dec-01 1148.08 0.0076 2001-12-01 5.76 0.0048000 0.002773833.12 1-Nov-01 1139.45 0.0752 2001-11-01 5.33 0.0044417 0.070734333.75 1-Oct-01 1059.78 0.0181 2001-10-01 5.34 0.0044500 0.013649034.37 4-Sep-01 1040.94 -0.0817 2001-09-01 5.53 0.0046083 -0.086331732.25 1-Aug-01 1133.58 -0.0641 2001-08-01 5.58 0.0046500 -0.068758430.95 2-Jul-01 1211.23 -0.0107 2001-07-01 5.75 0.0047917 -0.0155318

31 1-Jun-01 1224.38 -0.0250 2001-06-01 5.82 0.0048500 -0.02988541-May-01 1255.82 2001-05-01 5.92 0.0049333 -0.00493332-Apr-01 1249.46 2001-04-01 5.78 0.0048167 -0.00481671-Mar-01 1160.33 2001-03-01 5.49 0.0045750 -0.00457501-Feb-01 1239.94 2001-02-01 5.62 0.0046833 -0.00468332-Jan-01 1366.01 2001-01-01 5.65 0.0047083 -0.0047083

20 Year Data

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Cost of Debt (Kd)

LIABILITIES 5 Year Avg % of Total Liabilites Weighted Avg

0.049 Short-term borrowings 681 220 553 1,818 805 849 0.028 0.0010.049 Current portion of long-term debt 540 352 775 750 1,268 786 0.026 0.0010.055 Due to Altria Group, Inc. and affiliates 1,652 895 543 227 652 579 0.019 0.0010.055 Accounts payable 1,897 1,939 2,005 2,207 2,270 2,105 0.070 0.0040.059 Accrued liabilities:

Marketing 1,398 1,474 1,500 1,637 1,529 1,535 0.051 0.003Employment costs 658 610 699 732 625 667 0.022 0.001Other 1,821 1,316 1,335 1,537 1,338 1,382 0.046 0.003

Income taxes 228 363 451 170 237 305 0.010 0.001

Total current liabilities 8,875 7,169 7,861 9,078 8,724 8,208 0.2730.0549 Long-term debt 8,134 10,416 11,591 9,723 8,475 10,051 0.335 0.0180.065 Deferred income taxes 5,031 5,428 5,856 6,468 6,067 5,955 0.198 0.0130.085 Accrued postretirement health care costs 1,850 1,889 1,894 1,887 1,931 1,900 0.063 0.0050.055 Notes payable to Altria Group, Inc. and afiliates 5,000 2,560 2,560 0.085 0.0050.082 Other liabilities 3,430 3,806 3,553 2,861 2,838 3,265 0.109 0.009

Total liabilities 32,320 31,268 30,755 30,017 28,035 30,019 1.000

Kd 0.065 Weighted Average Cost of Capital

2005Value of the Firm $57,628Value of Equity (Ke) $29,593Value of Debt (Kd) $28,035

WACC(BT) 0.068WACC(AT) 0.057

WACC(BT)=(Ve/Vf)(Ke)+(Vd/Vf)(Kd)WACC(AT)=(Ve/Vf)(Ke)+(Vd/Vf)(Kd)(1-T)

Tax rate 35%

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Appendix D. Valuations Models

Discounted Dividend Model

Kraft Foods Inc.(Amounts in millions of dollars except per share data)

Years from valuation date 1 2 3 4 5 6 7 8 9 102005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Terminal

Dividends per share 0.85 0.94 1.03 1.13 1.24 1.37 1.51 1.66 1.82 2.00 2.20 2.20Present Value Factor 0.935 0.874 0.817 0.764 0.714 0.667 0.624 0.583 0.545 0.510

Present Value of Future Dividends $0.87 $0.90 $0.92 $0.95 $0.98 $1.01 $1.03 $1.06 $1.09 $1.12

Total Present Value of Forecast Future Dividends $9.94Continuing (Terminal) Value (assume no growth) $31.62Present Value of Continuing (Terminal) Value $16.12

Estimated Value per Share 2005 $26.06Estimated Value per Share November 2006 $27.72Earnings Per Share $1.57 $1.58 $1.60 $1.61 $1.63 $1.65 $1.66 $1.68 $1.70 $1.71Dividends per share $0.94 $1.03 $1.13 $1.24 $1.37 $1.51 $1.66 $1.82 $2.00 $2.20Book Value Per Share $17.72

Actual Price per share $34.36Cost of Equity 6.97% gGrowth Rate 0 0 0.01 0.03 0.05 0.07 0.09

0.02 $105.51 $197.60 N/A N/A N/A N/A0.03 $68.95 $97.04 N/

Sensitivity Analysis

A N/A N/A N/A0.04 $50.75 $63.62 $166.54 N/A N/A N/A0.05 $39.89 $46.97 $82.35 N/A N/A N/A0.06 $32.70 $37.03 $54.34 $140.92 N/A N/A

Ke 0.07 $27.60 $30.44 $40.37 $70.19 N/A N/A0.08 $23.80 $25.76 $32.02 $46.63 $119.69 N/A0.09 $20.87 $22.27 $26.47 $34.87 $60.07 N/A

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Discounted Free Cash Flows Model

1 2 3 4 5 6 7 8 9 10 20152005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Terminal

Cash Flow from Operations 3,498.64 3,603.60 3,711.71 3,823.06 3,937.75 4,055.88 4,177.56 4,302.89 4,431.97 4,564.93Cash Provided (Used) by Investing ActivitiesFree Cash Flow (to firm) 3,502.58Discount Rate (6.77% WACC) 0.937 0.877 0.822 0.770 0.721 0.675 0.632 0.592 0.555 0.520Present Value of Free Cash Flows 2286.85 2233.08 2180.39 2127.09 2074.97 2022.51 1971.28 1919.96 1869.89 1819.93Total Present Value of Annual Cash Flows 20,506Continuing (Terminal) Value (assume no growth) 51766.56Present Value of Continuing (Terminal) Value 26,898Value of the Firm (end of 2005) 47,404Book Value of Debt and Preferred Stock $114.9

(1,057.06) (1,058.11) (1,058.11) (1,059.17) (1,059.17) (1,060.23) (1,060.23) (1,061.29) (1,061.29) (1,062.35)2,441.58 2,545.49 2,653.59 2,763.89 2,878.58 2,995.65 3,117.33 3,241.60 3,370.68 3,502.58

Value of Equity (end of 2005) 47,289 0 0.01 0.02 0.03 0.04 0.05Estimated Value per Share December 2005 $28.32 0.020 $103.59 $191.20 N/A N/A N/A N/AEstimated Value per Share November 1 2006 $30.07 0.025 $82.66 $127.35 $350.81 N/A N/A N/ABook Value per Share 17.72 WACC 0.030 $68.72 $95.44 $175.62 N/A N/A N/AActual Price per share $34.36 0.035 $58.77 $76.30 $177.22 $321.82 N/A N/A

0.040 $51.31 $63.55 $88.03 $161.47 N/A N/AWACC 6.77% 0.045 $45.52 $54.45 $70.52 $108.02 $295.51 N/AGrowth Rate 0.00% 0.050 $40.90 $47.63 $58.85 $81.29 $148.62 N/A

0.055 $37.12 $42.33 $50.52 $65.26 $99.65 $271.600.060 $33.98 $38.09 $44.27 $54.57 $75.16 $136.93

Shares Outstanding 1670 0.065 $31.32 $34.63 $39.41 $46.93 $60.46 $92.020.070 $29.05 $31.75 $35.53 $41.20 $50.65 $69.56

g

(Amounts in millions of dollars except per share data)


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Residual Income Model

1 2 3 4 5 6 7 8 9 10 Terminal2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Beginning BE (per share) $17.72 $18.35 $18.90 $19.37 $19.74 $20.00 $20.14 $20.14 $20.00 $19.69Earnings Per Share $1.57 $1.58 $1.60 $1.61 $1.63 $1.65 $1.66 $1.68 $1.70 $1.71Dividends per share $0.94 $1.03 $1.13 $1.24 $1.37 $1.51 $1.66 $1.82 $2.00 $2.20Ending BE (per share) $17.72 18.35 18.90 19.37 19.74 20.00 20.14 20.14 20.00 19.69 19.20Ke 6.97%"Normal" Income 1.24 1.28 1.32 1.35 1.38 1.39 1.40 1.40 1.39 1.37Residual Income (RI) 0.33 0.30 0.28 0.26 0.25 0.25 0.26 0.27 0.30 0.34 0.3395Discount Factor 0.93 0.87 0.82 0.76 0.71 0.67 0.62 0.58 0.55 0.51Present Value of RI 0.31 0.26 0.23 0.20 0.18 0.17 0.16 0.16 0.16 0.17ROE 8.83% 8.62% 8.45% 8.33% 8.25% 8.23% 8.25% 8.33% 8.48% 8.70%Average ROE 8.446% Growth 0.00 0.01 0.02 0.03

BV Equity (per share) 2004 $17.72Total PV of RI (end 2004) 2.01Continuation (Terminal) Value 11.42601PV of Terminal Value (end 2004) 5.8240Estimated Value (2005) $25.55Estimated Value (November 2006) $26.28 0 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08

0.02 $83.69 $138.22 N/A N/A N/A N/A $1.91 $7.36 $10.990.03 $55.20 $69.28 $111.52 N/A N/A N/A N/A $5.92 $10.14

Actual Price per share $34.36 0.04 $40.31 $46.26 $56.84 $88.59 N/A N/A N/A $3.94 $9.23Growth 0.04 0.05 $32.45 $34.73 $38.53 $46.13 $68.92 N/A N/A $0.54 $8.14

0.06 $26.78 $27.79 $29.31 $31.84 $36.90 $52.09 N/A N/A $6.540.07 $22.74 $23.16 $23.74 $24.61 $26.07 $28.98 $37.71 N/

(0.02) (0.02) (0.01) (0.01) (0.00)Avg: (0.002)

A $2.790.08 $19.72 $19.84 $20.00 $20.21 $20.54 $21.09 $22.18 $25.46 N/A0.09 $17.38 $17.35 $17.30 $17.24 $17.15 $17.02 $16.80 $16.36 $15.050.10 $15.52 $15.40 $15.26 $15.07 $14.83 $14.49 $13.97 $13.11 $11.390.11 $13.99 $13.84 $13.66 $13.42 $13.13 $12.73 $12.17 $11.34 $9.95

G

Residual Income Valuation


Ke

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Residual Income Model Graph

Residual Income Futrure Growth Prediction

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Residual Income

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Long Run Residual Income Model

BV Equity per Share 17.72Return on Equity 8.446%Ke 6.97%Growth Rate 0.04

Estimated Price per Share 26.52

0 0.01 0.02 0.03 0.04 0.050.02 $74.84 $131.95 N/A N/A N/A N/A0.03 $49.89 $65.98 $114.23 N/A N/A N/A

Ke 0.04 $37.42 $43.98 $57.12 $96.51 N/A N/A0.05 $29.93 $32.99 $38.08 $48.26 $78.79 N/A0.06 $24.95 $26.39 $28.56 $32.17 $39.40 $61.070.07 $21.38 $21.99 $22.85 $24.13 $26.26 $30.540.08 $18.71 $18.85 $19.04 $19.30 $19.70 $20.360.09 $16.63 $16.49 $16.32 $16.09 $15.76 $15.270.10 $14.97 $14.66 $14.28 $13.79 $13.13 $12.21

gSensitivity Analysis

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Abnormal Earnings Growth Model

-0.02830 -0.02272 -0.01649 -0.00956 -0.00184 0.00673 0.01624 0.02680 0.03850 0.000001 2 3 4 5 6 7 8 9 Perp

Forecast Years2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

EPS 1.57 1.58 1.60 1.61 1.63 1.65 1.66 1.68 1.70 1.71DPS 0.94 1.03 1.13 1.24 1.37 1.51 1.66 1.82 2.00 2.20DPS invested at 6.97% 0.065 0.072 0.079 0.087 0.095 0.105 0.115 0.127 0.140Cum-Dividend Earnings 1.65 1.67 1.69 1.72 1.74 1.77 1.79 1.82 1.85Normal Earnings 1.67 1.69 1.71 1.73 1.74 1.76 1.78 1.80 1.81Abnormal Earning Growth (AEG) 0.006726 0.016242 0.026797 0.038497 0.0385

PV Factor 0.935 0.874 0.817 0.764 0.714 0.667 0.624 0.583 0.545PV of AEG $0.00 $0.01 $0.02 $0.02

Total PV of AEGContinuing (Terminal) Value gPV of Terminal Value $0.71 -0.08 -0.06 -0.04 -0.02 0 0.02 0.04Total PV of AEG $0.69 0.02 $93.45 $95.89 $99.96 $108.09 $132.49 N/

(0.0283) (0.0227) (0.0165) (0.009557) (0.001844)

($0.03) ($0.02) ($0.01) ($0.01) ($0.00)

($0.02)$1.30

A N/ACore EPS $1.57 0.03 $61.36 $62.73 $64.89 $68.76 $77.81 $123.02 N/AGrowth Adjust EPS Perp $2.25 0.04 $45.33 $46.20 $47.51 $49.69 $54.05 $67.14 N/ACapitalization Rate (perpetuity) 0.0697135 0.05 $35.73 $36.33 $37.19 $38.54 $40.98 $46.66 $75.08

0.06 $29.34 $29.77 $30.37 $31.27 $32.76 $35.75 $44.72Value Per Share 2005 $32.34 0.07 $24.80 $25.12 $25.55 $26.17 $27.15 $28.91 $33.02Value Per Share 2006 $33.26 0.08 $21.41 $21.65 $21.97 $22.41 $23.09 $24.21 $26.45

Ke 6.97% 0.09 $18.78 $18.96 $19.21 $19.54 $20.02 $20.77 $22.13G 0.04

Actual Price per share $34.36 0.01 0.01 0.01 0.01 0.01 -1

Ke


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Abnormal Earnings Growth Graph

AEG Future Growth Prediction

0.0000

0.0100

0.0200

0.0300

0.0400

0.0500

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

AEG

(0.0400)

(0.0300)

(0.0200)

(0.0100)

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Appendix E. Method of Comparables

2004EPS BPS DPS PPS

Kraft 1.87 17.54 0.75 35.61Sara Lee 1.59 3.71 0.75 46.08ConAgra 1.5 9.3 1.03 29.45

2005EPS BPS DPS PPS

Kraft 1.88 17.72 0.85 28.21Sara Lee 1.36 3.74 0.78 36.95ConAgra 1.35 9.38 1.07 20.28

Comparables (KFT) P/E Trailing P/E Forecast P/B D/P P/S PEG P/EBIT P/EBITDA M/BKraft's Price (2004) $19.04 $39.44 $136.64 $25.86 $27.54 $20.09 $35.11 $84.37 2.03$ Kraft's Price (2005) $15.01 $39.20 $106.67 $22.97 $22.68 $19.86 $29.47 $71.59 1.59$ Industry Avg. (2004) 24.31 21.09 7.79 0.029 1.46 0.341

0.147513.01 12.98 3.78

Industry Avg. (2005) 21.09 20.85 6.02 0.037 1.11 10.34 10.36 3.07

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1. Kraft Foods Inc. 2001-2005 10K (www.kraft.com) (www.edgarscan.pwcglobal.com)

2. Sara Lee 2001-2005 10K (www.saralee.com) (www.edgarscan.pwcglobal.com)

3. ConAgra Foods Inc. 2001-2005 10K (www.edgarscan.pwcglobal.com)

5. Sara Lee Value Line, November 3, 2006 (www.fidelity.com)

6. ConAgra Value Line, November 3, 2006 (www.fidelity.com)

7. Kraft S&P 500 Report, October 3, 2006 (www.fidelity.com)

4. Kraft Value Line, November 3, 2006 (www.ttu.edu)

8. Sara Lee S&P 500 Report, October 3, 2006

9. ConAgra S&P 500 Report, October 3, 2006

10. www.yahoo.finance.com

11. www.wsj.com

Resources

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Kraft Foods Inc. Equity Valuation and Analysis - Mark E. Moore

Documents

Transcript of Kraft Foods Inc. Equity Valuation and Analysis - Mark E. Moore