1. Investments 3033-003
Fernando Garcia
Discount Rate & Valuation of
AboutOracle,Inc.
Co-Founder&Executive Chairman:LawrenceJ. Ellison
CEO: Mark Hurd & SafraA. Catz
Oracle Corporation wasfoundedin1977 and isheadquarteredinRedwoodCity,California.
The company licensesitsOracle Databasessoftware to customers,which isdesignedto
enable reliable andsecure storage,retrieval,andmanipulationof variousformsof data.The
companyalsoprovidesarange of servicesinthree primarylayersof the cloud:Software asa
Service,PlatformasaService,andInfrastructure asa Service. Itoffersarange of software for
mobile computingtoaddressthe developmentneedsof businesses;and Java,a software
developmentlanguage.
Capital Asset Pricing Model
n order to determine the valuation of
Oracle (ORCL) I will calculate the
discount rate to value ORCL. In order
to determining the discount rate I will use
CAPM equation whose inputs include the
Risk free rate, Market Risk Premium, and
the Beta, in this following order.
CAP-M (Ke = Rf + MRP * Beta)
So lets begin with the Risk Free Rate…
Risk Free Rate
The risk free rate, which plays a critical role
on the yield rate of the 10-year Treasury,
has been low. The current rate is at 1.84%
(as of April 28, 2016 next release is on May
2nd) but historically tends to stay below 2%.
In my opinion, the only right thing to do is
to normalize the rate because of many
reasons. The Fed decisions are rarely
known, but according to the Musing on
Markets article, it is said that it seems the
Fed has an implicit message that lower risk
free rates are good for the economy and
the markets. They also say that the
normalized risk free rates are generally
computed by looking at the past average
10-year Treasury rate over the last 30 years,
which you can see below (starting at Jan.
1986-2016)
I

2. Principles of Investments
have been relatively dropping. They are
correct, but in the article they state and
argue that it is the wrong approach and I
beg to differ. The only reason why I do not
agree is because, although they may be
right, I rather be safe than sorry in this
occasion. With also the interest rates not
being the same as before the 4%
normalized risk free rate rather than the
actual low rate you may not get the value
you expect for your risky assets but it saves
you from the cyclical ups and downs of the
economy with risk free assets. I feel that it
is not a way that it should always be
because your returns will not have much
growth and may affect the risk premium for
risky asset classes, but I feel it is good to
have some assets with normalized risk free
rates just to be safe in your portfolio. You
could also compare these rates to those of
a Aaa and Baa corporate bond yield for the
past 10 years. Although, Aaa is the best
quality of a bond and Baa is a medium-
grade quality you could see that entering
2010 both bonds’ yield dropped and are
artificially low. Therefore, with my opinion
and
argument on normalized risk free rates I will
use a normalized 10-year Treasury. With my
chart up above, I too, believe that long term
the 10-Year Treasury has yielded 1% below
the expected nominal GDP growth.
According to my chart below (Conference
Board forecast) I will assume GDP will be 2%
since the job growth over the past months
have been pretty disappointing and the fall
of oil prices this year affecting the oil and
gas job market I believe it will be; 1%
productivity growth and 1% labor growth
making Real GDP 2% minus 1% equaling
1%. Using the Components of Nominal GDP
Growth by Decade as a reference and after
the downward months we’ve recently had I
assume the Federal Reserve to raise

3. Principles of Investments
interest rates, which I believe will increase
from the 2.1% inflation in 2015 to 2.4%.
Therefore, agreeing with Ron Sweet’s
theory equation my risk-free rate equal
3.4% and my Nominal GDP equal 4.4%. So
now, that leads us to determining our
Market Risk Premium…
Market Risk Premium
For the Market Risk Premium I will be using
the Implied Approach, which makes the
MRP correlate with my risk free rate. With
the Implied Approach, Expected Return on
Stocks will equal to the Current Dividend
Yield plus the Expected Earnings Growth of
the U.S. The Current Dividend yield of the
market is at 2.1% and Expected Earnings
Growth to be 4.4%. My estimated
Productivity Growth being 1% plus 1%
Labor Growth plus 2.4% inflation. Making
my long-term growth in earnings or
Expected Return on Stocks equal 6.5%
(2.1% + 4.4% = 6.5%).
MRP = Expected Return Stocks – Risk
Free Rate
Market Risk Premium: .065 - .034 = 3.1%
Now, for the final piece of the equation,
Beta…
Beta
I will be discussing and determining the four
components of Oracle’s beta.
1. Revenue Sensitivity
2. Operating Leverage
3. Financial Leverage
4. History
1. Revenue Sensitivity
Oracle is a technology company which
makes its stock a tech stock. Tech stocks
generally tend to have high beta’s (>1)
making it a cyclical stock. Since it is cyclical
it will not hold up well in a recession due to
it being vulnerable to the economy but will
do good in a recovering economy.
2. Operating Leverage
Oracle has a relative low fixed cost and as
you can see in the chart below its Net and
Gross Margin are below than that of the
average S&P 500 as well, making them
steady. Which makes me believe beta is
right at 1 or very slightly above.
3. Financial Leverage
Gross Margin Standard Deviation (%) S&P 500 ORCL UN Equity Rank
Median 3.53 1.78 22.6%
90 Precentile 13.56
10th Percentile 1.06
Net Margin Standard Deviation (%) S&P 500 ORCL UN Equity Rank
Median 5.37 1.78 14.3%
90 Precentile 57.38
10th Percentile 1.41

4. Principles of Investments
Oracle’s debt is slightly below average.
Making me believe that the beta is very
close or around 1.
4. History
History implies that beta rose well above 1
ever since the aftermath of the financial
crisis in ’08 and has stayed at 1 or well
above. Comparing my chart with that of
Zach Mueller, oracle has shown a trend in
the latest year of a beta in between 1.10 to
1.20. I will go with the long term trend and
forecast that beta is 1.18.
I will be using the CAP-M equation to
determine the discount rate of Oracle.
CAP-M (Ke = Rf Rate + MRP * Beta)
= .034 + .031 * 1.18 = .0767 or 7.67%
Now we will be using the discount rate we
calculated to determine the value of Oracle.
Debt to Equity S&P 500 ORCL UN Equity Rank
Median 52.58 51.40 49.1%
90Precentile 258.49
10th Percentile -

5. Principles of Investments
In this paper I will determine the valuation
of Oracle using three valuation models. The
Gordon Growth Model, Capitalized Earnings
Model, and the H Model. But first, in order
to find an answer to these models we must
first find the inputs of our stock, Oracle. The
inputs consist of the stocks Dividend 0
(ttm), Earnings Per Share (EPS) 0 (ttm),
Long-term Growth Rate, Inflation
Assumption, Short-Term Growth Rate, and
the time period for getting from short-term
to long-term growth. Now, let’s start with
finding these inputs…
Inputs for the
Valuation of Oracle
The Dividend 0 (ttm) and EPS 0 (ttm) for
Oracle, according to yahoo finance, is .60
and 2.07. The Long-term Growth Rate for
Oracle I assume should be the same
calculation for the function of the US
economy or Nominal GDP growth which is
4.4%. Mainly because it is the direction
Oracle will be heading depending on the
economy, in which I believe will be positive,
because it is a tech company and being in
this generation technology is enhancing
more and more every day. With the
software that Oracle could provide to all the
different sectors because every job now a
day uses technology, this could mean
positive growth for Oracle. Since I
concluded that inflation will be 2.4% in the
near future for Nominal GDP growth I will
use that as my inflation assumption. The
Short-term growth rate consists of three
things; the PEG Ratio Approach, Sustainable
Growth, and the Historical Growth. To
calculate the PEG ratio, it consists of a
formula that is, PE Ratio/PEG Ratio which
should equal expected Short-term growth.
For Oracle the PE ratio equals 19.22, PEG
ratio equals 2.27, and if you divide those
two it will equal to a short-term growth of
8.5%. To get a Sustainable Growth you must
multiply Return on Equity by Retention,
where Retention equals 1 minus dividends
divided by Earnings Per Share. When you
solve that out, from our previous input
dividends equals .60 and our EPS equaled to
2.07. Now, if you divide those two and
subtract by 1 you will receive 71%. So now,
we look at our ROE on yahoo finance which
is, 19.51% and you multiply that by our
retention we just calculated and should
receive a Sustainable Growth of 14%. Now
for our historical growth as you can see in
our graph the EPS have had a drastic drop in
the 90’s but have stayed fairly consistent
during the 2000’s, so I’m going to say that
our Short-Term Growth is 10%.
Now for our last input, which is the time
period for getting from Short-Term to Long-
Term Growth. I believe that since it is like I

6. Principles of Investments
have stated before, a technological
company, there are many competitors out
there such as leading leaders which consist
of companies such as Google, Apple, Dell,
and so forth. With U.S. competing against
other countries such as China and Japan for
leading technological companies Oracle has
a lot of competition out there and they are
rapidly expanding but they must come up
with a software that will set them apart to
put Oracle above all competitors. So with
that, I forecast that Oracle’s Long-Term
growth will be about 14 years. Making their
H equal 7. Now that we have all of our
inputs and data of the Article we can start
with our 3 different models. Let’s start first
with the Dividend Discount Model…
Dividend Discount Model: Value = (Div0 * (1
+ LT Growth)) / (ke – LT Growth)
(.60 * (1 + .044)) / (.0767 - .044) = $19.16
Next, the Capitalized Earnings Model…
Capitalized Earnings Model: Value = (EPS0 *
(1 + Inflation)) / (ke – Inflation)
(.0207 * (1 + .024)) / (.0767 - .024) = $.40
Lastly, our H model…
H Model: Value = (Div0 * (1 + LT Growth) +
Div0 * H * (ST – LT)) / (ke – LT)
(.60 * (1 + .044) + .60 * 7 * (.10 - .044)) /
(.0767 - .044) = $26.35
Oracle currently trading for: $39.86
So, to conclude I recommend that Oracle is
a strong buy due to it pricing lower than the
current price and the positive trend it may
have in the future.