Corporate Finance- Final Case
Section N3: Group F
IMBA Nov 2012
Haydar Olkan Erkan
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TABLE OF CONTENTS
KEY ASSUMPTIONS ................................................................................................................................................. 2
CAPITAL STRUCTURE ............................................................................................................................................ 4
DIVIDEND POLICY.................................................................................................................................................... 6
FIRM VALUATION.................................................................................................................................................... 7
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Established in post-war Germany in 1949 (in its current form) by Adolf Dassler, the adidas
Group has been synonymous with sports and sportswear for the last 60 years. The company
has been part of many significant sporting moments, including but not restricted to the 1954
and 1974 German victories in the football World Cup, the recently in news Boston and
Vancouver Marathons, and all World Cup and Euro Cup footballs since 1970.
The phenomenal growth of the company has been primarily off the back of clever sponsorships
of key athletes and teams, and also through the design of innovative new technologies. For
example, adidas was the first footwear brand to develop football boots with removable studs in
the 1954 World Cup, and more recently in 2005, the design of the first shoe with an in-built
microprocessor that can adjust itself as per the runner’s needs. Alongside this, their revenues
have been growing roughly at 11% year-on-year with the latest financial reports of 2012
showing Revenues of €14.9 billion and Net Income of €526 million.
Adidas Group counts amongst its brands the flagship “adidas marque”, “adidas Originals” and
“TaylorMade-Adidas” (golf range), amongst many others. In 2005, adidas acquired Reebok for
$3.8 billion, thus bringing it closer to its largest rival Nike in terms of Sales, and making it the
number two athletic shoemaker in the world. Apart from Nike, other competitors for adidas
include Puma, Deckers, Crocs and Callaway Golf (competing with adidas’ golf range –
The operating environment of adidas is the sportswear and fashion industry, which has seen
outstanding growth since the economic recession. Worth less than $200 billion in 2008, it is
projected to grow to $300 billion in 2017. This growth provides tremendous opportunities for
sportswear firms, both large and small, to expand and establish their business in this arena.
Most of the growth in this segment is provided for by the United States, Brazil, China and
Russia, who together account for 60% of the total growth. However, challenges for the industry
still remain in the form of market saturation in developing countries and the subdued economic
In the following report, we analyse the corporate structure of adidas AG, and look at the firm’s
Capital Structure, Dividend Policy and the Firm Valuation. We use our analysis to determine the
stock value of the firm and we compare that to the actual price at which the stock is trading.
Our future sales growth rests on three pillars: historical data (trends), analyst estimations and
adidas’ own expectations.
Historical Data - Analysing the last 10 years of sales data paves the way to estimate the future
based on the trend. The steady sales growth only shows two anomalies: one in 2006 and one in
2009. The first, a peak of sales of 50%, was due to the Reebok acquisition in 2006 and the
World Cup in Germany. Before the acquisition, the company was growing steadily between
2.5% to 3.5%. The 2009 anomaly has its roots in the effect of the global financial crisis, yet
surprisingly sales only decreased by a mere 3%. After the last anomaly the company growth
has been a staggering 11% year on year. Events such as the Football and Cricket World Cups,
the Euro Cup, etc. do affect the Adidas sales but the equal distribution in terms of the timing of
the events mute the effect.
1 Euromonitor International - http://go.euromonitor.com/ApparelWebinar2013_RegistrationPage.html
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Analyst Estimations – Estimations here vary widely. According to Deutsche Bank’s reports,
the company has strengthened its infrastructure and retail capabilities hence the future sales
growth of company will remain steady (11%). However, given that the core sales growth stems
from Russia, Latin America and China, currency risk is the main threat to growth, projected to
decrease to 4.7% for the next 5 years. On the other hand, Bloomberg predicts an average
growth of 4% and Reuters calls for a 7% range.
Adidas’ Expectations – Being optimistic about the world GDP growth and its positive influence
on their business, as well as the overall expansion of the global sporting goods industry, yet a
slightly negative currency translation to the top line, adidas’ prediction is a mid-single-digit
rate in 2013.
Drawing upon these three sources of input we decided to opt for a flat pro forma sales growth
of 11%, which corresponds to the average growth rate over the last few years. While this
estimate is higher than the analyst or Adidas estimations, we are confident that the continuing
recovery in the world economy will yield comfortable room to grow; especially from the
Emerging Markets that Adidas already operates in and will possibly expand to further.
Terminal Growth Rate
In order to calculate the Terminal Value of adidas at the end of our projections, we determine
the expected nominal potential GDP growth rate of all the markets that adidas operates in. We
do this by taking the following steps:
1. We take the six major regions listed in the adidas Financial Highlights, and work out
what proportion of total current sales are contributed by each region.
2. We find out the constituting countries of each region, and calculate the potential
nominal GDP growth rate of each country as per the below formula:
Nominal Potential GDP Growth = Labour Productivity Growth + Labour Force Growth +
3. We calculate the relative size of the GDP of each country in proportion to the total GDP
of the region, and use this to calculate how much of the regional growth will be
contributed to by each country.
4. By summing up each country’s contribution, we get an aggregate weighted average
nominal potential GDP growth rate for the region.
5. Next, we multiply the regional growth rates thus obtained to the proportional
contribution of the region to adidas’ growth. For example, Latin America contributes
10% of all adidas’ sale, and the region is projected to grow at 6.29%. Thus, we can
calculate the Latin American contribution to adidas’ growth as 0.63%.
6. Finally, we add up each region’s contribution in order to arrive at the final growth rate
for adidas AG.
The number we derived as per the above process was 4.2716%. The detailed calculations done
to arrive at this number can be seen in Exhibits 1 & 2.
Change in Net Fixed Assets (Depreciation & CAPEX)
An important part of the FCF calculations circulate around depreciation and CAPEX. We define
, where we assume no assets
are being disposed of. Over the last 10 years we can easily see that it grew steadily and strongly
correlated to sales (5.5-8% as can be seen in Exhibit 3). This correlation encourages us to apply
the same for our pro forma calculations. A growth in NFA from one year to another implies
CAPEX outstripping depreciation, and vice versa. (Exhibit 5 shows the calculation of for
the FCF estimations).
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Working Capital Requirements
Due to a lack of correlation to sales, we excluded cash from our working capital calculations.
Other Assets and Other Liabilities also haven’t been taken into consideration in the WC
calculation for the same reason. Hence we computed from .
(Exhibit 5 shows the calculations of for the FCF estimation).
Number of Shareholders
We assume that Adidas will not issue any new equity and keep its outstanding common shares
at 209.22m for the forecasted period.
Current Capital Structure
The capital structure is derived by looking at the market value of debt in comparison to the
market value of equity. In the case of Adidas, the total interest bearing debt, which is not part of
the working capital, is set at a book value of €1.487bn. Amongst the debt held, two bonds are
publically traded (499m @ €103.80 and 449m @ €125.52), which thus translates into an
overall market value of debt of €1.620bn (or D=10.32% of total value).
The market value of equity is a function of . With
209.2m shares and a share price of €67.33 at the end of 2012, the market value comes to
€14.085bn (or E=89.68% of total value). The firm value comes to €15.706bn.
Applying this, the WACC given the current capital structure is:
[( ) ] [ ]=[( ) ] [ ]
The Risk Free Rate – Despite its international operations, adidas is a Germany based company
and is listed in the DAX index (representing the German stock market). Two arguments speak
for the selection of the 30-Year Bund rate (2.383% 31Dec12) as the risk free component in our
calculations. First, being a very sizable German company that is of importance for the local
economy but also a local “champion”, government aid by Germany if needed is likely and thus
leaves the Bund rate as reference. Second, the funding that Adidas has drawn upon to date has
been drawn locally.
The Market Premium – In line with the risk free rate conversation, the comparison of Adidas
is against the DAX. Exhibit 6 shows the yearly returns from 1994-2012 of the DAX, the 30-Year
Bund, and the difference between the two. The resulting average spread of 5.24% constitutes
the market premium to investors for the extra risk of choosing equity investments over bonds.
The Equity Beta – The equity beta was derived through the regression of monthly Adidas
share prices and DAX values, from the last three
years. Using these values and the correlation
( ), the equity Beta,
given the current capital structure, is 0.67x.
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The Cost of Debt – The book value of interest bearing debt for 2012 came to €1.487bn,
whereas the interest expense amounted to €97m. The corresponding average interest rate
stands at 6.52%.
The Cost of Equity – The cost of equity is calculated via the CAPM (
). Since Adidas is a large Cap stock, we do not need to undertake a liquidity or small firm
The Tax Rate – The effective tax rate for 2012 is 38%, as per the income statement of adidas.
Optimal Capital Structure
Is adidas using its optimal capital structure at this point in time? In order to answer this
question, a look at varying D/E levels and the corresponding WACC and enterprise value levels
is required. Whichever capital structure allows minimizing the WACC and thus, maximising
enterprise value can be deemed optimal.
Exhibit 7 visualises the simulation results. By keeping the EBIT constant and defining the
terminal growth rate (see above section), the D/V level is set as variable. The numbers show
that the WACC is minimized and enterprise value is maximised with a 10% debt component.
This shows that the “current capital structure = optimal capital structure”. Interestingly, this is
higher than the debt level of its industry peers. While Puma’s current D/V level is 1.7% (with
no long term debt), Nike operates at 7.89% D/V level.
Looking at the simulation, it is apparent that as the debt percentage increases, the interest
coverage ratio goes down. This is due to the increasing interest expenses in comparison to the
steady EBIT. The lower the ratio drops, the more worried an investor will get.
The debt investor will require a higher premium to offset the higher default risk he is taking.
The debt rating serves as a proxy here to assess the size of the default premium. Exhibit 7
shows the historical premiums over the risk free rate associated with the respective rating (e.g.
AAA = Rf + 0.2%). The bankruptcy cost is another element to consider, as it is not fully
considered in the default premium, given it is firm specific. Derived by looking at the historical
volatility in EBIT versus interest payments of a firm, and thus the likelihood to cover those
payments, can be coupled with the bankruptcy cost (estimated at 20% of firm value) to
quantify what premium would be required. In the case of adidas we simplified our workings by
only including the default premium.
The equity investor, on the other hand, will also demand a higher premium given that common
equity holders get paid last (after bonds and preferred shares). The increase is reflected in the
growing cost of equity.
The current level of 10% debt creates a high level of financial flexibility for adidas. Thus, should
adidas need to spontaneously resort to additional leverage, in order to finance a positive NPV
project or respond to external factors, they are well positioned to do so.
Last but not least, the effective tax rate decreases from a 30% Debt/Value ratio onwards since
the interest payments outstrip EBIT. This results in a lower tax shield advantage and thus
makes debt less attractive.
Applying this, the WACC given the optimal capital structure is:
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The past history indicates a growing dividend per share. As per the Annual report, the target
dividend payout ratio of adidas is 40%. Dividend per share increased from 0.25 (Dec’ 03) to
1.35 (Dec’ 12) as shown in Exhibit 8.
Based on the above data and adidas AG’s own estimates for 2013 and 2014, the growth rate in
Dividend Per Share (DPS) is estimated as 25% based on an average of the last 3 years.
Using the estimated growth rate in DPS, the calculation for FCFE and Dividend payment is
calculated in Table 1.
Table 1: FCFE Calculation (shares & EUR million)
It can be seen that with the estimated growth rate of 25% in Dividend Per Share, adidas will
have sufficient cash flows to pay the dividends. However a larger portion of that amount comes
from the debt issued, which increased the firm’s leverage. The estimated payout ratio is also
higher than the current target payout ratio of 20-40% (Table 2).
Table 2: Payout Ratio (EUR million)
Looking at the sensitivity analysis on the growth rate in Dividend Per Share (Exhibit 9), to
maintain the payout ratio, the optimal growth in Dividend per share is determined as 5%.
Hence there is a need for adidas to slow down its dividend payment.
However if the firm decides to slow down the growth in Dividends Per Share, it could face some
challenges as detailed below.
Sticky Dividends - adidas has continuously raised its dividends year on year since 2001. The
shareholders of adidas have enjoyed a steady stream of dividend flows. While dividends are
known to be “sticky”, the successive raises have most likely also become “sticky”. Adidas’
financial leverage is only 10%, which means, it has the capacity to pay higher dividends should
it require. Nonetheless, it can’t continue to raise dividends indefinitely.
Clientele Effect - Shareholders expect a steady income source with adequate growth in
income. In the event of a slow/no growth, investors might simply sell and move on to other
companies that promise higher returns. Thus, adidas would favour continually increasing
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Floatation Cost – Whenever adidas proceeds to get funding, whether equity or debt, it will be
confronted with the cost it takes to float (mainly the cut of the financial institution take out).
Incurring any extra cost is unfavourable. In line with the pecking order theory that dictates
internal financing is preferred over debt financing, which in turn, trumps equity financing,
Table 1 illustrates that dividend financing is only possible through the debt increases (hence no
internal financing). Thus, adidas will face the flotation costs attached.
Transaction Costs – A decrease in the dividend payment would result in investors looking to
sell adidas stock. Whenever a buy/sell operation occurs, the investor needs to pay a transaction
cost (the broker’s spread). From adidas management’ perspective, who have the shareholder’s
“well being” as top priority, transactions costs are to be avoided. This translates into not
changing the course of dividends or the associated growth of them.
Agency Cost - Shareholders will expect management to run the company in order to increase
shareholder value, and as such, decrease the costs of available incentives like stock options,
performance bonuses, etc. and instead pass the benefit on to shareholders. Adidas would need
to consider the above expectations of shareholders while balancing dividend payouts with the
funding requirements in the future.
Asymmetry of Information – It is a fact that managers know more about the company than
investors. Any deviation in the dividend payment trend will therefore send signals to the
market. adidas dividends have been steadily increasing, hence a halt or reduction will send a
negative signal to investors who are left believing that the company does not have positive
future prospects. Share prices tend to fall as a consequence. In turn, a higher than expected
increase will send a strong positive signal and a share price increase is an observed
Dividend Yield - On Dec 2012 the dividend per share was 1.35 and the share price was 67.33.
This leads to a dividend yield of 2.01%. This means that out of the 5.89% return on equity,
dividends accounted for a 34% share. As such investors still draw the majority of their returns
from stock appreciation. This alleviates yet doesn’t resolve the associated problems of a
potential dividend cut.
To estimate the value of Adidas we looked at three different frameworks: 1.) The Discounted
Cash Flow Method 2.) The Dividend Discount Model and 3.) Comparables.
Discounted Cash Flow Method
The first step was to calculate the pro forma for adidas from 2013 to 2017. The most important
underlying driver was the growth rate, which was set at the historic level of 11% (reasons
stated under key assumptions). The remainder of the forecasted inputs was derived as a
historical percentage of sales. The exceptions were Shareholder’s Equity, which was a function
of previous equity and new retained earnings (net income less dividends), as well as long-term
debt, which served as the plug. Exhibits 3a/b & 4 show the full pro forma (Balance sheet &
By taking ( ) , we arrived at
the FCF for years 2013-2017. In 2017 the horizon value was computed and added to the 2017
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FCF. Once discounted by the WACC, the enterprise value of €26.386bn was derived. Taking out
the end 2012 market value of debt, as well as adding back non-operating cash, we get the
equity value: €26.893bn or €128.54 per share (209.22 million shares outstanding). Exhibit
11 shows the full overview of how these figures were derived.
Time Horizon – adidas has a long-standing history and has been around since 1949. We no
longer consider it to be in its growth stage and rather assume it to be in a stage of maturity.
This means that free cash flows are considered to be stable, which allows us to limit the
forecast period to five years. Beyond that time period, we apply the horizon value method.
Horizon value – We identified several different ways to estimate the horizon value:
Liquidation / Scrap value
First and foremost, adidas is a going concern, which eliminates the liquidation / scrap value
method. Second, we assume Adidas FCFs are bound to grow at the potential weighted growth
rate of the countries it operates in, in the long term. Hence our choice fell on the growing
perpetuity model. It is important to note that 96% of the discounted FCFs are generated by the
horizon value, which emphasises the need to run a sensitivity analysis regarding the terminal
growth rate we estimated.
Sensitivity Analysis – An important consideration is that our calculations for adidas are only
as good as the assumptions we make. While we believe adidas can grow in line with the
economic potential of the markets it operates in, it is worthwhile to stress test its perpetual
growth assumption of 4.27%. In addition, exogenous variables may result in cost of debt or
equity changes, or adidas may be forced to change its capital structure. The factors will affect
the WACC and should also be stress tested. Table 3 depicts the associated sensitivity analysis
and the resulting market value of equity that would be the outcome.
Table 3: Equity Value Sensitivity Analysis
Dividend Discount Model (DDM)
The DDM is based on the notion that shareholders receive a steadily growing dividend, forever.
The corresponding present value of this growing perpetuity should then yield the current
intrinsic price of the stock. In other words, all future cash flows to investors (all dividends)
discounted to the present at the cost of equity, should reflect what the stock is worth to the
investor. In the case of adidas that would be €152.67 per share; resulting in an equity value of
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Next Dividend D1 1.62 (Dec 31, 2013)
Growth rate (g) 4.27%
Return on Equity (r) 5.89%
Price/share = €152.67
No of outstanding shares = 209.22 million
Equity value = €31.941bn
Based on industry data collected, the following can be considered as comparable firms:
Table 4: Comparable Firm Snapshot
However, adidas can’t be compared directly to its competitors, as its size and scale are very
different from the two (Exhibit 10). We can see that the firm lies somewhat midway between
the two most identical competitors. Hence, we shall be using the average of the multiples for
the valuation using ratios.
For the purpose of valuation, the following ratios can be used:
Enterprise Value/ EBIT
Enterprise Value/ EBITDA
Enterprise Value/ Sales
However, in our opinion, Price/Sales is inconsistent since the numerator (price) relates to the
share price or equity component whereas the denominator (sales) relates to the both equity
and debt component. Hence we shall discard this ratio. For the rest, as discussed earlier, we
shall use the average of the data from the competitors.
The average of the multiples are given in the Table 5.
Table 5: Multiple Averages
Table 6 shows our valuation for Adidas using the above averages.
Ratios Nike Puma Average
Price / Earnings (x) 22.87 47.94 35.41
Enterprise Value / EBIT (x) 14.92 11.93 13.42
Enterprise Value / EBITDA (x) 13.23 9.73 11.48
Enterprise Value / Sales (x) 1.91 0.97 1.44
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Table 6: Adidas Valuation from Multiples
Our best guess for Equity value = €16.047bn (Averaged)
Based on our weighted valuation we believe the stock of adidas has an intrinsic value of
per share, as of 31.12.2012.
The actual stock market closing price of adidas on the same day was per share.
(Deviations in the underlying assumptions and calculations drive the difference)
We deployed three models to determine the enterprise value of adidas. Table 7 gives the
overview of the individual results, as well as the weighted valuation.
Table 7: Overview of Valuation Methods
DFCF – We give our discounted cash flow a 60% weight. First, the model underlies a more
through process in deriving enterprise value, largely due to the array of assumptions that are
taken along the way. Since all assumptions were crafted ourselves, based on the data and
approaches we used, we feel comfortable with the results. Second, the DFCF is firm specific to
adidas in our case. Third, we control several variables, which gives us more flexibility (and
hopefully accuracy) in the scope of the calculations. What prevented us from solely relying on
the DCFC was that we wanted to buffer and neutralize against an “own assumption bias”,
especially in light of deviating data regarding public sales growth estimates.
DDM – We gave the Dividend Discount Model a sole 10% slice. We feel that the model assumes
too much simplicity and has too much dependence on too few variables. While the horizon
growth rate (g) is the main driver in the equation, it is also the hardest to predict. In addition,
adidas’ dividend yield is not the main driver of return to equity holders and despite the steady
dividend growth in the last few years; it could easily adjust the number going forward. That
would change the outcome of the dividend growth model as it assumes steady growth.
Adidas Debt Equity Value
Price / Earnings (x) 35.41 18623.94
Enterprise Value / EBIT (x) 13.42 13344.02 1220.00 12124.02
Enterprise Value / EBITDA (x) 11.48 14446.22 1220.00 13226.22
Enterprise Value / Sales (x) 1.44 21434.05 1220.00 20214.05
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COMPS – We opted for a 30% allocation. Main argument against this approach is the fact that
other companies are simply different from us, even if in the same industry. Another supporting
justification for the low weight is the fact that comparable valuations lose ‘value’ if the industry
is over/undervalued. Yet we decided to include the average of the comps in order to reduce our
“own assumption bias”, as stated under the DFCF, which is only as good as the assumptions that
Finally, there are a few additional points to take into consideration. A fourth way to value a
company could have been to look at recent transactions, possibly of similar companies in the
same industry that took place. Yet for adidas we could find no useful information on this front.
Furthermore, it is important to separate between valuing a company for a minority and a
controlling stake. In the case of the latter we would most likely have to pay a premium over the
quoted share price to entice current shareholders to hand over their stake. In our case we are
valuing adidas from a minority stake view. Likewise, had adidas not already been publically
traded (lack of marketability) we would have had to apply roughly a 25% discount to the
enterprise value we calculated.
Last but not least, adidas is a multinational company so that an even more stringent approach
would have been to split the individual geographical regions into silos. Each individual silo
might then have its own WACC, corporate structure and future growth assumptions. Once each
silo has an enterprise value attached, a simple or weighted sum would give us, a possibly more
refined, overall adidas AG enterprise value. This approach however is a lot more complex and is
beyond the scope of the mission set out in this report.
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The content of this report has been prepared by Group F, N3 of IMBA Nov 2012. The report is based on
the publically available data, data from FactSet, Bloomberg, Yahoo Finance and Website of Adidas-AG.
The group has made certain assumptions as part of the valuation and made their best effort to validate
them to the extent possible. As a consequence. The findings of this report many not align fully with the
publically available results (intrinsic share price).
The report is prepared for academic purpose only and not to be used as a basis for any investment
related decisions. The contents of this report should not be published by anyone without the prior
consent of Group F, N3 of IMBA Nov 2012.
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Exhibit 1 – Calculation of Terminal Value Growth Rate
Exhibit 2 – Regional Breakdown of Terminal Value Growth Rate Calculations
EMERGING EUROPEAN MARKETS
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GREATER CHINA (China, Taiwan, Hong Kong, Macau)
* We don’t have data for Productivity Growth for China and no data in the World Bank database for Taiwan. We use actual growth rates
where possible and ignore Taiwan for its comparatively small size relative to China.
OTHER ASIAN MARKETS
* Data not available for Productivity Growth. We project past actual growth rates.
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Exhibit 3a – Pro Forma Balance Sheet (Assets)
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Exhibit 3b – Pro Forma Balance Sheet (Liabilities & Shareholder’s Equity)
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Exhibit 4 – Pro Forma Income Statement
Exhibit 5 – Calculation of and for the FCF Estimations
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Exhibit 6 – Adidas Equity Beta Calculation
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Exhibit 7 – Minimum WACC Calculation
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Exhibit 8 – Dividend per Share Increase
Financial year FY '10 FY '11 FY '12 FY '13E FY '14E
Growth rate 25% 35% 20% 25% 22%
Exhibit 9 – Dividend Growth Rate Sensitivity Analysis
Exhibit 10 – Adidas vs. its Comparable Competitors
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Exhibit 11 – FCF Calculations & Intrinsic Share Price Determination