• beta: The retail average beta of 0.83 is used in this valuation, adjusted for Debt risk though the beta increases to 1.01. This is an example why we have to convert operating lease expenses to debt to highlight a company's true risk.
• The return on capital would look a lot better if it wasn't for the operating lease to debt conversion. We use the ROC as calculated after adjustments to debt and earnings as is done here
• Growth is expected to continue it's trend to decline for about three years. It will probably take that amount of time to consolidate stores and shrink store sizes. It's doubtfull they'll get their merchandising fixed before that time, though that's the only think that can really help them turn things around in the near term.
• Adjustments to earnings, debt and cash flow evaluations are made below

To get there we estimate free cash flows to firm first by making a number major adjustments to earnings;
• We capitalize research and development, accrual accounting requires that R&D be expensed as it occurs, but we recognize and appreciate that results from R&D creates growth. We treat it the same as all other investments by capitalizing it.
  values in Millions

  R&D asset lifetime5 years

  R&D expense$0

  R&D amortized$0

  R&D asset value$0
  The R&D asset value is used to adjust the book value of equity, this in turn is used in the return on equity calculations.
• True one time charges muddle the growth picture of a stock because they tend to have a significant effect on profit but not earnings from operations. Valuations depend on our ability to predict future earnings growth, to get there we remove one time expenses from earnings.
• The marginal tax rate is used to determine the taxes that aught to have been paid. Corporations have a number of ways to defer the taxes they pay, these deferments can have a significant impact on stated earnings. Eventually though they have to be paid causing another significant impact on earnings. In order to avoid these oscillations to earnings we use the marginal tax rate to determine the amount paid for taxes.
• The other major adjustment to earnings that is made is by accounting for off-balance sheet item such as operating leases. Operating leases are treated as Operating expenses where they should be treated as financial expenses that have the same obligations as debt. Our second major adjustment therefore is in converting operating leases to their debt equivalent.
  Operating lease expenses and debt adjustment in (Millions)

  Current year$1,098

  Year one$1,006

  Year two$853

  Year three$642

  Year four$449

  Post year four$1,430

  Total$5,478

  Debt value$3,254

  Depreciation$651

  Debt Adjustment

  + Debt$50

  + Value of operating lease debt$3,254

  = Debt (Adjusted)$3,304

• Days inventory outstanding This metric measures how many days worth of inventory the company has in it's warehouse. It is measured as following DIO = (Inventory/Cost of sales) * 365.
• Days payable outstandingPayables are the moneys owed to creditors such as the providers of the raw materials or service providers. Days payable outstanding is a measure of how long the company takes to pay its creditors. it is calculated as follows: DPO = (Accounts Payable/ Cost of sales )*365.
• Days sales outstanding Sales are revenues, receivables are uncollected sales made on credit. A company has to collect sales as quickly as possible so it can use that money to create more products. This value is estimated as following: (Receivables / Revenues) * 365 or ( receivables/ Average sales per day).
• Cash conversion cycle. This metric measures how quickly in days a company can produce a product from raw materials, sell it to a customer and collect those sales, it is estimated in the following way: CCC = DIO + DSO - DPO. a good way to measure how effective management is at making money is by looking at the cash conversion cycle over time. Warning flags are an increase of Inventory (can't sell product) and Receivables (can't collect on the goods sold on credit)

• Current ratio The current ratio is a financial ratio that measures a companies ability to pay it's short term liabilities. When short term liabilities exceed short term assets the current ratio will be less than one and this indicates that a company may have problems meeting it's short-term obligations. It is calculated as follows: Current Ratio = Current Assets / Current Liabilities
• Acid test or quick ratioT he acid test measures a companies ability to pay it's short term obligations quickly using cash and near cash. It is calculated as follows: Acid Test = (Cash + Investments) / Current Liabilities
• Acid test (liberal) The more liberal version of the acid test allows a company to collect receivables and other assets except for inventory. Acid test (liberal) = (Current Assets - Inventory) / Current Liabilities
• Debt to equity ratio The debt to equity ratio shows the proportion of debt and equity used to finance a company's assets. Debt and equity are both adjusted to account for Operating leases and R&D as described above. The debt to equity ratio is calculated by dividing Debt by Equity.
• Interest coverage ratio The interest coverage ratio measures a firms ability to meet it's interest payments, it is calculated as follows: Interest coverage ratio = EBIT (adjusted) / Interest payment
• Fixed charges coverage ratio Fixed charges include interest payments and operating lease expenses for this year it is calculated as follows. EBIT (adjusted) / (interest payment + operating lease expense)

The Gap a global specialty retailer operating retail and online stores selling casual apparel, accessories, and personal care products for men, women and children under the Gap, Old Navy, Banana Republic, and Piperlime brands. They operate stores in the United States, Canada, the United Kingdom, France, Ireland, and Japan. They also have franchise agreements with unaffiliated franchisees to operate Gap and Banana Republic stores in Asia, Europe and the Middle East. Under these agreements, third parties operate or will operate stores that sell apparel, purchased from us, under our brand names. In addition, U.S. customers may shop online at www.gap.com, www.bananarepublic.com, www.oldnavy.com, and www.piperlime.com.

The Gap design most of their products, which are manufactured by independent sources, and sell them under their brands:

Gap. Founded in 1969, Gap stores offer an extensive selection of classically styled, high quality, casual apparel at moderate price points. Products range from wardrobe basics such as denim, khakis and T-shirts to fashion apparel, accessories, personal care products for men and women, ages teen through adult, and maternity apparel. They entered the children’s apparel market with the introduction of GapKids in 1986 and babyGap in 1989. These stores offer casual apparel and accessories in the tradition of Gap style and quality for children, ages newborn through pre-teen. They launched GapBody in 1998 offering women’s underwear, sleepwear, loungewear, yoga gear, and personal care products. They also operate Gap Outlet stores, which carry a similar line of products.

Old Navy was launched in 1994 to address the market for value-priced family apparel. Old Navy offers broad selections of apparel, shoes and accessories for adults, children and infants as well as other items, including personal care products, in an innovative, exciting shopping environment. Old Navy also offers a line of maternity wear.

Banana Republic. Acquired in 1983 with two stores, Banana Republic now offers sophisticated, fashionable collections of dress-casual and tailored apparel, shoes and accessories for men and women at higher price points than Gap. Banana Republic products range from apparel, including intimate apparel, to personal care products. They also operate Banana Republic Factory Stores, which carry a similar line of products.

We also offer products that are designed and manufactured by branded third parties in our online shoe store:

Piperlime. They launched Piperlime in October 2006. Piperlime offers customers an assortment of the leading brands in footwear for women, men and kids, as well as tips, trends and advice from leading style authorities.