Nordstrom, Inc.

Equity Valuation and Analysis

Valued at November 1, 2006
Carissa Laughlin: carissa.l.laughlin@ttu.edu Adam Hix: ahix18@cox.net Kristie Lee: kristie.lee@ttu.edu Kirk Florez: kflo6216@aol.com Zac Holley: zachary.s.holly@ttu.edu Steven Kratzer: stkratzer@hotmail.com

Table of Contents

Nordstrom, Inc.
Table of Contents Executive Summary Business/Industry Analysis Five Forces Model Accounting Analysis Ratio Analysis Forecasting Valuation Analysis Appendices Appendix A Appendix B Appendix C Appendix D References 45 50 55 59 66 2 3 5 8 15 22 37 38

Executive Summary
Nordstrom, Inc
Investment Recommendation: Overvalued, Sell
JWN-NYSE 52 Week Range Revenue (2005) Market Capitalization Shares Outstanding Dividend Yield 3-mo Avg Daily Trading Volume Percent Institutional Ownership Book Value per Share ROE ROA Est. 5-yr EPS Growth Rate Cost of Cap Est. Ke Estimated 5-year 3-year 1-year Published Kd WACC R2 .1520 .1529 .1543 $46.30 $31.77-50.79 $7.72B $12.42B 685,934,000 .90% 2,735,950 96% 7.76 11% 26% 3% Beta 1.31 0.13 0.13 1.82 Ke 7.69% 7.69% 5.01% 5.03% 5.29% 5.39% EPS Forecast FYE 1/28 EPS 2005(A) $2.03 2006E $2.09

Nov 1
2007E $2.15 2008E $2.22

Ratio Comparison Trailing P/E Forward P/E Forward PEG M/B

Nordstrom 22.81 22.15 7.38 .64

Industry 48.24 28.55 3.94 .57

Valuation Estimates
Actual Current Price Ratio Based Valuations P/E Trailing P/E Forward PEG Forward Dividend Yield M/B Enterprise Value Intrinsic Valuations Discounted Dividends Free Cash Flows Residual Income Abnormal Earnings Growth Long Run Residual Perpetuity $46.30 22.81 22.15 7.38 .91 .64 3.65 $7.31 $3.47 $41.79 $19.92 $(3.60)

Nordstrom has established itself as a high-end apparel retailing company. It derives its revenue from the sale of high-quality clothing, shoes, cosmetics, and accessories. Nordstrom is one of the leading fashion specialty retailers in the United States to date and has one hundred fifty-six stores spread out through twenty-seven states and is continuing to expand. Although the majority of Nordstroms profits are brought in by their retail stores they have also extended their business into a credit segment, a direct internet sector, and multiple boutiques. Nordstrom has founded itself upon excellent customer service and an unmatched reputation. Its main competitors are Saks, Dillards, and Neiman Marcus. Nordstroms accounting policies are moderate and very well disclosed; they leave no room for any potential red flags to be raised. Nordstroms transparent accounting policies show that the managers have confidence in the firm and its ability to perform. No distortion is used in their statements proving the firms high integrity standards. Upon completion of Nordstroms ratio analysis it is apparent that there should be no concerns as to how Nordstrom compares to its competition. In most cases Nordstrom was either average or stood above the competition. There were very few cases where Nordstrom fell behind in its market. After evaluating Nordstroms past performance we forecasted their financials for the next ten years. We predicted that Nordstrom would grow at an average of six percent per year. This is shown through increasing sales and expansion of new stores.

Business/Industry Analysis
Overview of Nordstrom, Inc. Nordstrom was incorporated in 1946, but began its operations in 1901 as a shoe store in downtown Seattle, Washington. Nordstrom generates revenues from its credit segment, which consists of a wholly-owned federal savings bank that offers Nordstrom VISA credit and debit cards and a private label card. Nordstrom also profits from its Faconnable boutiques located in France, Portugal, Belgium and the U.S. The remaining revenues are brought in by the retail store segment; the stores specialize in high quality apparel, shoes, cosmetics, and accessories. Nordstrom also sells direct via the internet at www.nordstrom.com. Though Nordstrom offers a variety of men and childrens apparel, womens fashion represents nearly one-third of total sales (Nordstrom 10-K). Nordstroms corporate offices are located in Seattle, Washington. Their distribution centers are located in Portland, Oregon; Dubuque, Iowa; Ontario, California; Newark, California; Upper Marlboro, Maryland; and Gainesville, Florida. The direct order center is located in Cedar Rapids, Iowa; and the Nordstrom Credit, Inc. and Nordstrom Federal Savings Bank are located in a leased office building in Denver, Colorado. Nordstrom maintains 156 retail stores in 27 states, and they plan to open thirteen new stores and remodel or relocate 18 existing stores over the next three years (Nordstrom 10-K). The apparel industry is a highly competitive market; Nordstrom competes with other national, regional, and local retail and departments stores. Nordstroms top competition comes from retail stores that sell similar lines of apparel such as Neiman Marcus, Saks Fifth Avenue, Dillards, and other high-end fashion retailers. Nordstroms net sales, net earnings, total assets, and net income have been vastly increasing over the past four years (from 2002-2005). As shown in table 1, net sales have been increasing at an average of 8.52 percent; and total assets have been increasing at an average of 4.82 percent over the past five years. Neiman Marcus net assets have been increasing at a rate of 6.28 percent and total assets have increased by 10.94 percent, as shown in table 2. As table 3 shows, Saks Fifth Avenues net sales

and total assets have been decreasing each year with the exception of 2004 at an average of 2.31% percent and 6.19 percent, respectively. As illustrated in table 4, Dillards net sales and total assets decreased at a rate of 1.86 percent and 6.29 percent, respectively. With respect to net sales and total assets, on average, Nordstrom is growing at a more rapid rate compared to its top competitors, as shown in tables 1 through 4. Table 1: Nordstrom, Inc. Net Sales and Total Assets Year 2001 2002 2003 2004 2005 Net Sales $5,607,687,000 $5,944,656,000 $6,448,678,000 $7,131,388,000 $7,772,860,000 % Change in Net Sales --6.01% 8.48% 10.59% 9.00% Total Assets $4,084,356,000 $4,185,269,000 $4,569,233,000 $4,605,390,000 $4,921,349,000 % Change in Total Assets --2.47% 9.17% 0.79% 6.86%

Table 2: Neiman Marcus Net Sales and Total Assets Year 2001 2002 2003 2004 2005 Net Sales $3,015,534,000 $2,948,332,000 $3,080,353,000 $3,524,771,000 $3,821,924,000 % Change in Net Sales --(2.22%) 4.48% 14.43% 8.43% Total Assets $1,785,870,000 $1,907,546,000 $2,034,430,000 $2,617,648,000 $2,660,660,000 % Change in Total Assets --6.81% 6.65% 28.67% 1.64%

Table 3: Saks Fifth Avenue Net Sales and Total Assets Year 2001 2002 2003 2004 2005 Net Sales $6,581,236,000 $6,070,568,000 $6,055,055,000 $6,437,277,000 $5,953,352,000 % Change in Net Sales --(7.76%) (0.26%) 6.31% (7.52%) Total Assets $5,050,611,000 $4,595,521,000 $4,579,356,000 $4,709,014,000 $3,850,725,000 % Change in Total Assets --(9.01%) (0.35%) 2.83% (18.23%)

Table 4: Dillards Net Sales and Total Assets Year 2001 2002 2003 2004 2005 Net Sales $8,154,911,000 $7,910,996,000 $7,598,934,000 $7,528,572,000 $7,560,191,000 % Change in Net Sales --(3.00%) (3.94%) (0.93%) 0.42% Total Assets $7,199,309,000 $7,074,559,000 $6,675,932,000 $5,691,581,000 $5,516,919,000 % Change in Total Assets --(1.73%) (5.63%) (14.74%) (3.07%)

Five Forces Model

For each industry there are competitive forces that, when analyzed, show the profitability potential in that given industry. For firms to attempt to create profits in any market, they must consider five main forces: rivalry among existing firms, threat of new entrants, threat of substitute products, bargaining power of buyers, and bargaining power of suppliers. Knowing where a particular company stands in relation to the industry using these five forces is a valuable determinant of how profitable that company will be. Rivalry Among Existing Firms Nordstrom, Inc. is a fashion specialty retailer that offers a selection of apparel, shoes, cosmetics and accessories for women, men and children. This specialty fashion industry has experienced steady growth over the past few years. The other directly competitive firms in this industry are Bloomingdales, Macys, Dillards, Saks Fifth Avenue, and Neiman Marcus. Nordstrom Inc. holds a fair market share in this industry at 12.95 Billion. The federated department stores inc. holds a 22.13B market share. This is a bit misleading because the Federated Dept. Stores Inc is made up of many department stores that are not highly competitive with Nordstrom (http://finance.yahoo.com). All of the companies that are competitive in this industry have taken advantage of todays technological advances such as the internet for more marketing and sales growth. Nordstrom is no different, in order to keep up with the ever changing fashion environment Nordstrom has expanded their products online and through other retail stores as well. The company offers its products through multiple retail channels, including its Full-Line Nordstrom stores, its discount Nordstrom Rack stores, its Faconnable boutiques, its catalogs, and on the Internet at www.nordstrom.com (www.moneycentral.msn.com). Maintaining current stores and expanding into new locations is important to Nordstroms future growth in order to help gain even more of a position in this market. The high-end apparel and fashion industry is a highly competitive market; and firms in this industry must be differentiated to distinguish themselves.

Threat of New Entrants The economies of scale in the specialty retail industry are quite large. The threat of any new entrant competing in this industry is seemingly very low. All of the companies in this industry have a very formidable first mover advantage. Many of the competitors in this industry already have working relationships with many of their suppliers and any new competitor will have a tough time cracking into the dealer network in order to establish themselves as any sort of threat. For example, Nordstrom is the exclusive retailer for the Facconable line of clothing and you can only purchase their products at Facconable stores or Nordstrom. The other competitors in this industry have similar relationships with other fashion specific designers and it would be hard for new entrants to gain the licensing, and marketing to gain any sort of meaningful share in this industry. The stores that are competing in this industry already have a high reputation and steady customer base, therefore making it difficult for new entrants to gain market share. Threat of Substitute Products Threat of substitution affects the marketing strategy of all companies involved in this industry. The threat of substitution in this industry would be outlets malls or other labels creating off-brand products that are seemingly the same but made of cheaper materials therefore sold at a much cheaper price. Also with the advance of the internet, shoppers can shop online and buy directly from certain designers that supply these retailers instead of buying from Nordstrom, Bloomingdales or other retailers. Threat of substitute products is high because many stores sell off-brand merchandise, therefore making it cheaper and more appealing to the average consumer. Bargaining Power of Buyers Price sensitivity is a major factor when buyers purchase items in this industry. Buyers in this industry have a very good idea of exactly what they want because they only sell name-brand merchandise. In the high-end industry many consumers shop in these stores solely based on certain brands, this makes the bargaining power of the buyers relatively low. In other cases, many brands strive to sell their merchandise in high-end stores making bargaining power of the buyers in this case moderately high. 9

Overall as an industry average bargaining power is moderate because of brand image being a high influence. Bargaining Power of Suppliers Suppliers have a moderate amount of power over the buyers in this industry because of the designer labels they carry. The department stores need to keep a solid inventory of their major brands in order to meet customer demand. Suppliers know that there are a limited number of stores that are able to carry and sell their brand at a premium cost. In the apparel and high-end fashion industry the stores need to sell certain brands. In the same sense, suppliers need their merchandise sold at a premium, therefore they need high-end stores to buy their products. Since there are so few retailers in this specialty retail industry suppliers hold a moderate amount of bargaining power for their products and are able to set a reasonable price. In the retail and apparel industry, after analyzing the five forces, the results can be concluded as shown in table 5. Table 5: Competitive Forces Analysis Competitive Force Rivalry Among Existing Firms Threat of New Entrants Threat of Substitute Products Bargaining Power of Buyers Bargaining Power of Suppliers Conclusion High Low High Moderate Moderate

As table five shows the retail industry is a low to moderate competitive market. For this reason, Nordstrom has chosen a differentiated strategy to distinguish itself within its market. Value Chain Analysis The apparel and retail industries have a high level of competition; consequently firms in this market need a successful strategy that allows them to create profit. Nordstrom, Inc. competes with various other high-end retail and apparel stores as well

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as common retail stores; therefore it must employ differentiated qualities to distinguish itself from other stores. In the retail and apparel industry various firms have different approaches to create profit. Some retail stores such as Macys and Dillards supply similar products at a lower price than high-end retailers such as Nordstrom. Others, such as Neiman Marcus and Saks Fifth Avenue, offer similar, if not the exact same, products as Nordstrom at around the same cost. In the high-end retail market, firms must use a differentiated strategy to create value within the industry. Customers in this market are willing to pay a premium for the unique products these high-end retailers provide. These stores are known for their superior customer service and overall betterquality in store shopping experience; they are much more elegant than other retail stores. The brand names in these high-end stores are well known and have a premium attached to them. The product quality and variety in this industry is outstanding and differentiates these stores from others. Nordstrom utilizes several strategies to create and maintain its value. Nordstrom relies on its high quality products and superior customer service to attract and uphold its customers. Nordstrom positions itself in the industry as a high end retailer by selling top of the line products with an exceptional brand image that customers are willing to pay extra for. After a product is sold, the employees of Nordstrom will do nearly anything to satisfy customers after the actual point of sale. This is included in the superior customer service that consumers have come to expect from the company. Nordstrom creates value by the differentiation of its product compared to competitors products by offering a unique and quality product while providing top of the line service. In order for companies to sustain a profitable position in an industry, they must differentiate themselves from competitors, and Nordstrom is successful in doing so. Nordstrom Competitive Advantage Analysis The success of a financial entity is structured by an assortment of distinct strategies and differentiations. Most notably, a firms competitive advantage distinguishes an enterprise from contending firms within the industry. There exist two basic components in which firms focus on to establish a competitive advantage over 11

competitors. Cost leadership and differentiation are two of the most generic approaches towards obtaining market dominance. In our case, Nordstrom has utilized differentiation in order to establish themselves as the front runner in their industry. Erik Nordstrom, President of Stores, has illustrated this tactic by stating the following, In simple terms, fashion is what sells. With compelling merchandise and unyielding commitment to customer service, we can be the retailer customers trust. President Nordstrom clearly demonstrates Nordstroms competitive advantage by focusing on customer service, product quality, and continuous improvement. Nordstrom has maintained this unique reputation from their establishment in 1901 to the present day and beyond. Nordstrom developed a strong competitive advantage foundation in the early 20th century and has adapted to changing environments and market conditions to sustain their success. Nordstrom has set the bench mark in the retail sector through customer service and product quality. In the recent past, Nordstrom had been facing increasing challenges sustaining their competitive advantage over significant competitors. Historically, Nordstroms customer service driven approach accounted for earnings nearly double that of competitors. On the other hand, recently competing specialty stores along with the expanding online retailing sector have threatened Nordstroms sustained market advantage. Nordstrom originally began to develop additional retail outlets to counter emerging competitors which resulted in declining market value and share price. These results prompted Nordstrom to return to their core competencies of superior customer service and product quality. Nordstrom re-committed their business approach to ensure that they were second to none in terms of the service provided for customers and the quality of their product offerings. Nordstrom possesses a distinct and reputable image that effectively differentiates them from their competitors. Nordstrom is known throughout the retail sector as the distant leader in customer service. Nordstrom regards their customers as extended family and treats them as such. In addition, Nordstrom utilizes devoted sales associates for serving customers in an array of fashions. They possess the most liberal return policy that is highly regarded among customers. Also, sales associates will call in 12

orders for merchandize not on hand free of charge. Recently, Nordstrom has improved their largest strength of customer service by implementing personal shopping sales associates who research customers and personally assist with their shopping needs. In comparison to its largest competitor, Macys, Nordstrom has implemented a distinct shopping experience to once again separate themselves from competition. For example, Nordstrom knows what clothes certain customers prefer when they walk through the door. A sales associate will keep a list of customers along with their preferences in order to lead them directly to the department that compliments their style. Nordstrom is a leader in customer retention and ranks highest in shopping atmosphere. Nordstrom represents the pinnacle in serving their largest asset, their customer base. Secondly, Nordstrom prides itself in offering quality products to compliment their highly regarded customer service approach. Nordstroms product offerings are not only of the best quality available, but are also presented in a fashion appealing to customers. The reputation Nordstrom has built in the industry has sustained their success for over a century. Nordstroms further expects to enhance their company philosophy in the future by implementing additional differentiation tactics that will continue their market dominance in highly volatile economy. In order to maintain their status in the retail industry, Nordstrom plans to implement additional competitive advantage differentiation strategies. Nordstrom must effectively respond to changes in the retail industry. To further enhance customer service, Nordstrom has focused on direct retailing through their online shopping experience. They strive to offer the most effective multi-channel relationship with their customers by offering the same in store benefits through online and catalog shopping. Nordstrom is exhausting substantial investment in their online business to reflect their uncanny in-store customer service. In comparison, Nordstrom is also utilizing effective strategy to maintain their high quality product offering by adapting to recent retail fashion changes. Nordstrom strives to continually offer the largest assortment of high quality products through market research and adaptation. Nordstrom uses various key factors that enable the company to be a successful retail chain. Using a differentiated strategy requires Nordstrom to compete based on 13

the high status level its customers expect. To measure their accounting policies, evaluating the firms success factors, risks, and competitive strategy are highly important. To do this the firm has to identify and evaluate the estimates and polices they use. Nordstroms most essential accounting policies used to be successful as a differentiated retail store involve: ability to respond to the business environment and fashion trends, inventory management, impact of competitive market forces, multichannel integration, and designer.

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Nordstrom Accounting Policies

Ability to Respond to the Business Environment and Fashion Trends Nordstroms sales and operating results all depend on their ability to predict and react to future changes in the fashion industry and consumer demands. Any delays in realizing the most recent fashion trends and customer demands would cause Nordstrom to lose a portion of its customer base. Maintaining todays ever-changing fashion trends is a must for any clothing retailer, not doing so can break a company. Customer demands also influence the products that a store needs to carry. Not appealing to these demands is also fatal to a company. Weather and other hazards, economic conditions such as a recession, and consumer confidence are all factors that affect Nordstroms customer spending. Nordstrom discloses the information about this key factor in the footnotes and also in the description of business parts of the 10-K. Inventory Management Nordstrom maintains appealing, fresh merchandise for its consumers. They must be able to predict demand on products to have the best merchandise inventory possible. Having to much of a product can lead to over stock which eventually leads to markdowns and a loss of profit. Having not enough of a product will lead to customers having to go elsewhere to purchase a product and possibly causing a customer to lose faith in the Nordstroms name losing their business for good. Nordstrom analyzes its past demands to predict future demands, for this reason Nordstrom orders more merchandise in the second quarter because of its annual sale and in the fourth quarter because of holiday shopping. This ensures that a healthy inventory level is maintained. Nordstrom uses the first-in, first-out (FIFO) method of inventory calculation. Inventory management can be flexible because there are several different ways to report it and also several ways to distort the accounting numbers when it comes to inventory. Nordstrom discloses its inventory accounting policies very clearly in the footnotes of its 10-K and leaves no room for distortion possibilities. Nordstroms accounting policies compared to its competitors in dealing with inventory are fairly similar. Information

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about Nordstroms inventory can be found on the balance sheet and supplementary information can be found in the description of business and footnotes. Impact of Competitive Market Forces With several retail stores consolidating, such as Foleys and Macys, changes have occurred among venders as well as customers. This broadens Macys customer base giving them an advantage. With such consolidating, the future venders might prefer to partner up solely with a company that has such a large customer base. This causes Nordstrom to have to respond to environmental changes in a timely manner to not loss the edge. If they do not then they could lose customers to the competition, lose venders, and lose profit because of higher markdowns, and declining same store sales. This factor is flexible because firms in the industry could disclose as little or as much as they deem necessary. Qualitative information can be found in the description of the business. Multi-Channel Integration Nordstroms goal is to create a more integrated, consistent merchandise offering for its customers. This can be done by shopping in the Full-line stores, on the internet, or through Nordstroms catalogs. In 2005 Nordstrom initiated the integration and now in 2006 they are starting to migrate the Direct inventory system into the Full-line stores. This will create a one-company view of the inventory resulting a more seamless merchandise offering and experience for the customer. This will allow one stop shopping for the customers making it more convenient and efficient. This provides superior customer service. This process will continue to be implemented through 2008. This factor is found in the description of the business in the 10-K Designer Nordstroms womens designer clothing is a strong seller and contributes to the inspirational nature of Nordstroms brand. The goal is to offer a complete designer selection in at least one store for every market that Nordstrom serves. Nordstrom is enhancing and aligning its designer offering throughout all of the major merchandise categories. Having these designers being offered at only particular high-end stores

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gives Nordstrom an advantage. This allows Nordstrom to offer a superior product variety and quality. Nordstrom discloses this factor in the description of the business. Table 6: Key Success Factor Analysis Key Success Factor Ability to Respond to the Business Environment and Fashion Trends Inventory Management Impact of Competitive Market Forces Multi-Channel Integration Designer Quality of Disclosure High High Moderate Low High Flexibility Not Flexible Flexible Flexible Not Flexible Flexible Aggressive/ Conservative N/A Moderate Moderate N/A Moderate

Accounting Strategy Analysis Nordstrom, Inc. has fairly moderate accounting standards that could be somewhat distorted. Nordstroms net income is slightly higher relative to the industry, although not enough to be alarming; this shows that Nordstrom uses a more moderate strategy when it comes to its accounting policies. As far as accounting standards go, Nordstrom uses similar basic standards as other firms in the industry. Management and select employees of Nordstrom receive stock options which may lead to intentional accounting distortion to increase these benefits. Also, top managers receive bonuses based on how profitable the company is and how much growth there is within the company from year to year which would be another incentive to distort the numbers. Although distortion would be beneficial to management, the standards used by Nordstrom to account for stock issued to employees seem well disclosed and straight forward. Compared to the accounting policies and estimates used in the past five years, Nordstrom has not significantly changed any of its accounting standards, except the few changes made to Nordstroms leasing accounting policies in 2004. Nordstroms leasing policies were changed from recording net rent expense once operations started

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to Nordstrom recording net lease expense once the property was leased. This change in leasing policy resulted in a charge of $7,753 recorded in the fourth quarter of 2004. Estimates such as returns are based on past returns and performance and have not altered much in recent years. Nordstroms uses its historical data to estimate future performance for the use of the inventory account. Inventory is ordered on a larger scale for the second and fourth quarter because these are two of Nordstroms reported busiest times due to their Annual Sale and the holiday shopping season. Since the increase in inventory is based on past sales, there have been no significant write offs of inventory. Other estimates such as returns are also based on past returns and performance and have not altered much in recent years. The estimates and assumptions used in Nordstroms financial statements seem to be reasonably calculated and are not considered distortions. There have been no noticeable forth quarter changes that would cause concern. Nordstroms accounting policies and estimates seem to have no significant distortions. The changes in policies are well recorded and explained in the footnotes, leaving no concern about their accounting policies. The changes in policies, accounting standards and estimates all seem to be legitimate. There are no major changes from quarter to quarter in looking at the 2005 quarterly reports. Quality of Disclosure The manner in which Nordstrom discloses their financial information to the public is of extremely high quality. Nordstrom exceeds their expectation of providing customers and shareholders with an adequate explanation for nearly every element of their finances. After the presentation of each financial statement, Nordstrom provides a detailed clarification concerning each component listed in a manner that could be easily interpreted by the common inquirer. The letter to shareholders commences with multiple high points that had occurred in 2005 deemed as good news. Total sales increased 8.3% to $7.7 billion, resulting in a focus to strategically exceed $8 billion in sales moving into 2006. The way the company strives to achieve this is broken down in two sections: Maximizing womens apparel and a seamless shopping experience. The letter also goes in to great depth 18

concerning expansion opportunities, focusing on the fact that Boston is the last major U.S. metropolitan market where Nordstrom is not present. Nordstrom will open four stores in this area by 2010. Not only does it appear that Nordstrom reported all relevant information in their 10 K annual report, they provide a detailed explanation for the cause of the numbers disclosed. Nordstroms decrease in interest expense, net in 2004 was due to the reduction in our average outstanding debt, partially offset by the increase in the prepayment costs. The fourth quarter report provides an in depth account concerning net earnings. After stating an increase of $190.4 million, compared with $140.0 million in 2004, it is justified by same-store sales increasing 5.8%. Specifically the same-store sales of cosmetics, accessories, and mens apparel merchandise improved drastically. Nordstrom separates their Financing, Operating, and Investing activities in to three different sections, as well. Inventory, revenue recognition, allowance for doubtful accounts, and leases are all additional subheadings detailing how each is recognized by the company. In addition, Nordstrom illustrates how the majority of their numbers were calculated that are present on the various financial statements. Overall, Nordstrom adequately discloses its accounting qualities and financial statements in a manner that is easily understood and does not exclude any relevant information to the outside user in their financial notes. Potential Accounting Practice Red Flags Nordstrom continues to thrive in the retail market due to their efforts in sustaining competitive advantage and effective financial positioning. Nordstrom represents the pinnacle in the retail fashion industry, and their accounting and financial disclosure parallels this stellar image. Erik Nordstrom, President and CEO, has made a strong effort to divulge in their yearly reports a consistent effort towards informing both current and potential investors. Nordstrom presents their financial statements and disclosures with full concern to the public and pays special attention towards corporate integrity. Nordstrom goes the extra mile to inform investors and financial statement viewers of additional financial information outlets including their own renovated web page to www.sec.com where they may find additional financial filings. Nordstrom emulates a disclosure transparency that is far above that of their competitors illustrating 19

their ethical business practices. Any questions or concerns raised by viewing Nordstroms financials are addressed and discussed in the footnotes. Illustrated through sales and core expense manipulation diagnostics, Nordstrom shows a minimal amount of volatility in their primary ratio analysis. Nordstrom has experienced steady positive growth over the past five years (2001-2005) due to continuing sales momentum and ongoing operations improvements. In addition, Nordstrom is continually expanding opening seven new major retail outlets in 2005 alone. These factors have all led to consistent financial gains avoiding apparent abnormal peaks and troughs in their financials. Theyre accounting preference was consistent having Deloitte & Touche L.L.P. audit their financial statements in recent years. The relationship between net sales and accounts receivable steadily increased reflecting growth and an increase in earnings. Additional sales and core expense manipulation diagnostics follow this trend. One exception is when the cash flow from operations and operating income ration increased by 62% from 2001 to 2002 (1.33-2.16); see tables 7-1 and 7-2. One note described a portion of the blame on Nordstrom implementing a new perpetual inventory system during 2002. In addition to these ratios, Nordstrom demonstrated a consistent comparison between their reported income and tax income. Nordstrom chose to writeoff large assets using the straight-line depreciation method consistent throughout recent financial statements. Nordstrom did not fail to once again reflect their industry prestige in the manor they present their financial information. Nordstrom effectively communicates their activities with their investors and are relatively free of unpredictable or unexplainable transactions. Table 7-1: Sales and Core Expense Manipulation Diagnostics Year 2001 2002 2003 2004 2005 Sales/AR 7.66 8.06 8.49 11.04 12.08 Sales/Inv 5.85 6.34 6.77 7.76 8.08 Sales/TA 1.53 1.39 1.57 1.55 1.57 CFFO/OI 1.33 2.16 1.19 1.1 1.06 PP&E/Pens Exp 6.81 7.06 6.76 6.45 6.16

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Table 7-2: Sales and Core Expense Manipulation Diagnostics

14 12 10
2001

8 6 4 2 0
Sales/AR Sales/Inv Sales/TA Ratio CFFO/OI PP&E/Pens Exp

2002 2003 2004 2005

Undo Accounting Distortions After evaluating all relevant financial data for Nordstrom Inc, we have concluded that the financial reports have displayed no apparent accounting distortions. After reviewing the 10-k and 10-q it is very apparent that Nordstrom is very transparent with their financial information and seem not to try to distort any of the information provided in their financial reports. They provide all the information in a very clear manner and adhere to all the current GAAP standards. Any irregularities that may appear on their financial reports are clearly explained in all their footnotes which helps give you knowledge on any questions you may have on their financial reporting. Therefore, Nordstroms financial information does not need to be adjusted or corrected.

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Ratio Analysis
There are several ratios that, when analyzed, can make reasonable estimates for future performance of a company. These ratios can also show where a firm stands within its industry by comparing them to competitors, calculating an industry average and then comparing the firm to the industry. The ratios can be broken down into three main groups: liquidity ratios, profitability ratios, and capital structure ratios. The liquidity ratios refer to the companys assets compared to its financial obligations and the ability to sustain adequate resources for the near future. Overall with regards to liquidity ratios, the higher the number the better; but a firm does not want the ratios to be too high because that would mean they were not using their resources to their full potential. The next set of ratios is profitability ratios that show the future profit potential of a firm. The last set of ratios, capital structure ratios, is based on a firms liabilities and equity. These ratios show how a firms assets are financed. Tables 8 through 12 show these ratios for Nordstrom, three of its top competitors, and for the industry.

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Table 8: Nordstrom Ratio Analysis (2001-2005) 2001 Liquidity Ratios: Current Ratio Quick Asset Ratio Inventory Turnover Days Supply Inventory Receivables Turnover Days Sales Outstanding OCF Ratio Working Capital Turnover Profitability Ratios: Gross Profit Margin Operating Expense Ratio Net Profit Margin Asset Turnover Return on Assets Return on Equity Capital Structure Ratios: Debt to Equity Times Interest Earned Debt Service Margin Sustainable Growth Rate: Nordstroms Liquidity As table 8 shows, with regards to the liquidity ratios, Nordstrom is comfortable in its near-cash assets when compared to its future obligations. Nordstrom has been able to maintain a healthy overall liquidity in the past five years. One aspect that has been steadily getting better each year is receivables turnover, which refers to how well the firm manages its receivables; and therefore also days sales outstanding has been steadily decreasing which means the firm is collecting receivables on a more timely basis. Nordstroms Profitability Upon evaluation of the operating efficiency, which takes into consideration the gross profit margin, the operating expense ratio, and the net profit margin, Nordstrom did increasingly well. The gross profit margin is steadily increasing, which is a positive 1.91 0.91 3.86 94.56 7.66 47.65 0.48 6.41 0.34 0.32 0.02 1.53 0.03 0.08 1.93 2.1 3.02 4.50% 2002 2.17 1.23 4.24 86.08 8.01 45.57 0.45 5.09 0.33 0.31 0.02 1.39 0.03 0.09 2.08 1.94 22.2 5.70% 2003 2.36 1.28 4.42 82.58 10.08 36.21 0.68 5.36 0.35 0.29 0.04 1.57 0.06 0.18 2004 1.92 1.23 4.97 73.44 11.05 33.03 0.44 5.79 0.36 0.28 0.05 1.55 0.08 0.22 2005 1.77 1.18 5.11 71.42 12.08 28.51 0.19 6.17 0.37 0.27 0.07 1.57 0.11 0.26

1.99 1.57 1.35 3.67 7.12 16.2 1.94 5.51 2.66 14.40% 19.10% 23.40%

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effect; the operating expense ratio is steadily decreasing, which is also constructive; and the net profit margin has been increasing, which also is a positive result. By evaluating the rest of Nordstroms profitability ratios, the asset turnover, return on assets, and return on equity, Nordstrom once again is upward looking. Nordstroms asset turnover has stayed stable over the past five years; and its returns on assets and equity have been greatly increasing in the past five years. Analyzing Nordstroms past profitability ratios shows that in the future, Nordstrom should continue being profitably. Nordstroms Capital Structure Nordstroms capital structure ratios make it clear as to how they finance their assets. Nordstroms average debt to equity ratio was 1.78 which means for every dollar of owners equity, there is 1.78 dollars of liabilities; this number over the past five years has fluctuated, but has somewhat increased. The times interest earned for Nordstrom had high fluctuation, but the number increased over the past five years, which is a positive result. This number is a coverage measure, and shows that Nordstrom has been able to cover its interest expense with its operating income. The last capital structure ratio, the debt service margin, measures how well the cash flows from operations cover the installments due on long-term debt. As the table shows, Nordstrom was able to cover its installments on long-term debt by at least 1.94 dollars and by most 22.2 dollars. In general, Nordstroms capital structure ratios also proved to be positive for Nordstrom from 2001-2005. Tables 9 through 12 show Nordstroms top competitors and how they performed from 2001-2005 based on the same ratios.

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Table 9: Dillards Ratio Analysis (2001-2005) 2001 Liquidity Ratios: Current Ratio Quick Asset Ratio Inventory Turnover Receivables Turnover OCF Ratio Working Capital Turnover Profitability Ratios: Gross Profit Margin Operating Expense Ratio Net Profit Margin Asset Turnover Return on Assets Return on Equity Capital Structure Ratios: Debt to Equity Times Interest Earned Debt Service Margin 3.24 4.34 2.91 6.21 0.91 6.10 1.04 0.26 0.005 1.19 0.001 0.02 1.77 0.06 2.11 2002 3.03 4.20 2.95 6.10 0.66 7.21 1.05 0.28 0.02 1.17 0.01 0.03 1.62 0.51 1.53 2003 3.53 4.22 2.85 5.09 0.49 6.89 1.06 0.27 0.003 1.13 0.001 0.004 1.91 1.83 1.59 2004 2.19 4.05 2.89 5.18 0.53 7.48 1.08 0.28 0.03 1.32 0.02 0.05 1.47 0.93 2.66 2005 1.87 3.51 2.78 5.4 0.32 7.54 1.03 0.26 0.02 1.36 0.02 0.05 1.40 1.28 2.31

Table 10: Saks Fifth Avenue Ratio Analysis (2001-2005) 2001 Liquidity Ratios: Current Ratio Quick Asset Ratio Inventory Turnover Receivables Turnover OCF Ratio Working Capital Turnover Profitability Ratios: Gross Profit Margin Operating Expense Ratio Net Profit Margin Asset Turnover Return on Assets Return on Equity Capital Structure Ratios: Debt to Equity Times Interest Earned Debt Service Margin 2.24 0.61 3.04 1.42 0.48 6.17 0.35 0.23 0.0001 1.33 0.0001 0.001 1.04 0.77 0.88 2002 2.41 0.77 2.84 1.37 0.35 5.26 0.37 0.23 0.005 1.28 0.005 0.01 1.04 1.84 9.33 2003 2.11 0.61 2.59 1.25 0.49 5.62 0.38 0.25 0.01 1.30 0.016 0.03 1.02 1.83 5.10 2004 2.15 0.58 2.64 1.23 0.37 5.77 0.38 0.25 0.01 1.36 0.013 0.03 1.30 1.73 2.25 2005 1.95 0.99 4.64 1.24 0.22 7.45 0.37 0.25 0.01 1.55 0.005 0.01 0.95 2.22 0.31

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Table 11: Neiman Marcus Ratio Analysis (2001-2005) 2001 Liquidity Ratios: Current Ratio Quick Asset Ratio Inventory Turnover Receivables Turnover OCF Ratio Working Capital Turnover Profitability Ratios: Gross Profit Margin Operating Expense Ratio Net Profit Margin Asset Turnover Return on Assets Return on Equity Capital Structure Ratios: Debt to Equity Times Interest Earned Debt Service Margin 2.20 0.81 2.71 155 0.27 6.02 0.06 0.26 0.04 1.66 0.06 0.11 0.89 12.93 1.65 2002 2.21 0.82 2.82 145.6 0.41 5.01 0.07 0.27 0.03 1.52 0.05 0.09 0.80 11.85 1.63 2003 2.40 0.94 2.94 140.2 0.31 4.29 0.07 0.27 0.03 1.50 0.05 0.09 0.82 13.86 2.03 2003 2.68 1.92 2.79 48.85 0.43 5.60 0.50 0.26 0.01 1.31 0.02 0.04 1.25 5.84 2.91 2004 2.43 1.41 3.19 5.83 0.07 3.50 0.09 0.23 0.06 1.35 0.08 0.14 0.86 21.88 52.8 2004 2.26 2.01 2.91 4.08 0.32 5.58 0.52 0.25 0.03 1.34 0.04 0.07 1.21 8.18 19.24 2005 2.83 1.66 3.38 126.67 1.37 3.45 0.11 0.242 0.05 1.14 0.07 0.13 0.63 34.25 84.50 2005 2.22 2.05 3.60 44.44 0.64 6.15 0.50 0.25 0.03 1.44 0.03 0.06 0.99 12.58 29.04

Table 12: Industry Average (2001-2005) 2001 2002 Liquidity Ratios: Current Ratio 2.56 2.55 Quick Asset Ratio 1.92 1.93 Inventory Turnover 2.89 2.87 Receivables Turnover 54.21 51.02 OCF Ratio 0.55 0.47 Working Capital Turnover 6.10 5.83 Profitability Ratios: Gross Profit Margin 0.48 0.50 Operating Expense Ratio 0.25 0.26 Net Profit Margin 0.02 0.02 Asset Turnover 1.39 1.32 Return on Assets 0.02 0.02 Return on Equity 0.04 0.04 Capital Structure Ratios: Debt to Equity 1.23 1.15 Times Interest Earned 4.59 4.73 Debt Service Margin 1.55 4.16

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Upon completion of analysis concerning Nordstrom and its competitors, past performance as well as future expectations can be derived. Through thorough ratio analysis, it becomes visible that Nordstrom once again out performs its competitors in liquidity and profitability and stands out above the industry average in many of the valuation criteria. Nordstrom presents consistency and improvement over the past five years, illustrated by smooth ratio increments, and possible most notably, in the sustainable growth rate. Nordstrom has performed admirably when compared to their direct competitors. With a consistently increasing sustainable growth rate from 20012005, we can conclude that volatility is not a concern for Nordstrom, rather increasing growth and market share. Indices such as this will greatly influence our choice of forecasting models as well as future predictions. Most importantly, no red flags were detected that illustrated signs of business stress or recession. Nordstrom is clearing a remarkable path with the future only looking brighter for this top notch company. Nordstrom is making every dollar work for them while improving their operating efficiency in a manner that once again distinguishes Nordstrom amongst the ever increasing market. The following fifteen charts compare Nordstroms ratios to its three competitors and to the industry average. Liquidity Ratios: Current Ratio The current ratio shows how much assets a firm has to cover their liabilities and evaluates liquidity. As shown in chart 1 below, Nordstrom is a slight amount below the industry average. Although Nordstrom is below the industry average, its current ratio is not the lowest in the industry. It is positive for the current ratio to grow, but it could become a negative aspect if the current ratio was so high that not all current assets were being used to their full potential to make future economic benefit.

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Chart 1: Current Ratio

4 3.5 3 2.5 2 1.5 1 0.5 0 2001 2002 2003 Yea 2004 2005

Nordstrom Dillard's Saks Neiman Marcus Industry

Quick Asset Ratio The quick asset ratio is a measure of how cash and assets nearest to cash can cover a firms liabilities. Nordstrom is again below the industry average line, but so is every other firm other than Dillards. Without Dillards quick asset ratio in the mix, the industry average would be more closely related to that of Nordstroms. As chart 2 shows, Nordstroms quick asset ratio is close to that of Saks Fifth Avenue and Neiman Marcus. Chart 2: Quick Asset Ratio
5 4 Value 3 2 1 0 2001 2002 2003 Year 2004 2005 Nordstrom Dillard's Saks Neiman Marcus Industry

Inventory Turnover Inventory turnover shows how efficient a firm can keep its inventory turning at a steady flow from the manufacturer to the store and out to the consumer. When it comes to inventory turnover, the higher the better because this means the firm is getting its inventory out to consumers at a more efficient pace. As chart 3 shows,

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Value

Nordstroms inventory turnover is far higher than all three competitors and the industry average. This is an excellent position for Nordstrom to be in compared to its competitors and the industry. Chart 3: Inventory Turnover
6 5 Value 4 3 2 1 0 2001 2002 2003 Years 2004 2005 Nordstrom Dillard's Saks Neiman Marcus Industry

Receivables Turnover A firms receivable turnover is the same type ratio as the inventory turnover, except the receivable turnover ratio has to do with how efficient a firm is at collecting its receivables. The faster a firm can collect its receivables, the better; and chart 4 shows that Nordstroms receivables turnover is well above that of Saks Fifth Avenue and Dillards. Neiman Marcus receivables turnover was well outside any reasonable average and therefore was left out of the chart; for the same reason, the industry average was left out as well. Compared to Nordstroms other two reasonable competitors, Nordstrom once again outperforms the competition. Chart 4: Receivables Turnover
14 12 10 8 6 4 2 0 2001 2002 2003 Years 2004 2005

Nordstrom Dillard's Saks Neiman Marcus Industry

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Value

The OCF ratio for the four stores and industry is all very similar. With regards to this ratio value, Nordstrom is neither above nor below the industry. Chart 5: OCF Ratio
1.5 Nordstrom Value 1 0.5 0 2001 2002 2003 Years 2004 2005 Dillard's Saks Neiman Marcus Industry

Working Capital Turnover The working capital turnover of a firm refers to a firms sales compared to its working capital (its current assets minus its current liabilities) and is the last measure of liquidity. Nordstroms working capital turnover is similar to that of its competitors. For this reason, the ratio is closely related to the industry average as shown below in chart 6. Chart 6: Working Capital Turnover
8 6 Value 4 2 0 2001 2002 2003 Years 2004 2005 Nordstrom Dillard's Saks Neiman Marcus Industry

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Profitability Ratios: Gross Profit Margin The gross profit margin is the first profitability ratio and measures gross profit as a percentage of sales. This ratio is also a measure of a firms operating efficiency. For the most part, the higher this number, the better. As chart 7 shows, the four stores all have quite a different average ratio, but Nordstroms gross profit margin is very similar to Saks Fifth Avenues. Neiman Marcus ratio is very low and Dillards ratio values are extremely high, causing the industrys average to be a slightly higher value than that of Nordstroms. Nordstroms gross profit margin has been steady over the past five years, and is average compared to the industry. Chart 7: Gross Profit Margin
1.2 1 Value 0.8 0.6 0.4 0.2 0 2001 2002 2003 Years 2004 2005 Nordstrom Dillard's Saks Neiman Marcus Industry

Operating Expense Ratio The operating expense ratio illustrates a firms selling and administrative expenses compared to its sales. A decreasing ratio value has a positive impact on the firm. As chart 8 shows, Nordstroms operating expense ratio has been steadily decreasing over the past five years. The other three competing firms have similar ratio values; therefore the industry average is in close proximity to the other values in the chart. Nordstroms ratio value is not the best or lowest in the industry, but they are showing positive change by decreasing this value.

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Chart 8: Operating Expense Ratio

0.35 0.3 0.25 0.2 0.15 0.1 0.05 0 2001 2002 2003 Years 2004 2005

Nordstrom Dillard's Saks Neiman Marcus Industry

Net Profit Margin The net profit margin of a company measures its net income divided by its sales. This is another operating efficiency ratio and an increasing ratio shows growth. As chart 9 shows, Nordstroms net profit margin over the past five years has been steadily growing, putting it well above the industry average. Neiman Marcus has a net profit margin similar to Nordstroms, but the other two competitors are below Neiman Marcus and Nordstrom, as well as the industry average. Any drop in the net profit margin is significant considering that a one percent drop can mean a huge decrease in net income when the numbers are in the multi-millions. In this category, Nordstrom definitely outperformed its competition. Chart 9: Net Profit Margin
0.08 0.06 Value 0.04 0.02 0 2001 2002 2003 Years 2004 2005 Nordstrom Dillard's Saks Neiman Marcus Industry

Asset Turnover The asset turnover ratio is a measure of how well a company is utilizing its assets to create future benefit and of how productive a firms assets are. Asset

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Value

turnover assesses asset utilization; therefore, bigger is better, meaning more utilization. In the high-end apparel industry, as shown below, all of the firms and therefore the industry average are all very similar in value. On average, Nordstroms asset turnover value has been stable over the past five years. Chart 10: Asset Turnover
2 1.5 Value 1 0.5 0 2001 2002 2003 Years 2004 2005 Nordstrom Dillard's Saks Neiman Marcus Industry

Return on Assets The return on assets ratio is a comprehensive measure of profitability, taking into account how a firms assets and profits are used to create future profit. This ratio is also positive when increasing; and as chart 11 illustrates, Nordstrom has done an extraordinary job at increasing its return on assets from 2001-2005. The ratio value of Nordstrom is well above the industry average in every year and above every competitor in years 2003-2005. Chart 11: Return on Assets
0.12 0.1 Value 0.08 0.06 0.04 0.02 0 2001 2002 2003 Years 2004 2005 Nordstrom Dillard's Saks Neiman Marcus Industry

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Return on Equity The return on owners equity is a profitability measure and is influenced by the affiliation between a firms debt and its owners equity. Return on equity is calculated by dividing net income by owners equity. An increase in this ratio value would be linked to an increase in profits. Nordstrom clearly has a higher return on equity than its competitors in years 2002-2005. This shows that Nordstrom, with regards to this ratio, is likely to be more profitable than its competitors, and the industry.

Chart 12: Return on Equity

0.3 0.25 Value 0.2 0.15 0.1 0.05 0 2001 2002 2003 Years 2004 2005 Nordstrom Dillard's Saks Neiman Marcus Industry

Capital Structure Ratios Debt to Equity The debt to equity ratio is the first of three capital structure ratios. This value is derived by dividing a firms total liabilities by its total owners equity. As a firms debt grows larger, this ratio value in turn increases. This ratio value is an important factor in considering a firms credit risk. As this value decreases, there is less leverage within the firm. As chart 13 shows, Nordstroms debt to equity ratio value starts out relatively high compared to the industry and competition, but then steadily decreases after 2001 and is more in line with the industry for the remaining four years.

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Chart 13: Debt to Equity

2.5 2 Value 1.5 1 0.5 0 2001 2002 2003 Years 2004 2005 Nordstrom Dillard's Saks Neiman Marcus Industry

Times Interest Earned Times interest earned is calculated by dividing operating income by interest expense. Because this ratio value is a coverage measure, an increase has a positive impact on the firm. Nordstrom is similar to the industry average and its competition, with the exception of Dillards. Nordstroms times interest earned has steadily increased over the past five years (chart 14), which shows that their coverage of interest expense is increasing. Chart 14: Times Interest Earned
40 30 Value 20 10 0 2001 2002 2003 Years 2004 2005 Nordstrom Dillard's Saks Neiman Marcus Industry

Debt Service Margin Finally, the debt service margin is a measure of how well a firms cash flow from operations can cover its current portion of its long-term debt; therefore this ratio value is also a coverage measure and has a positive impact when increased. With the exception of Neiman Marcus unusually high results which should not be included in the

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industry average, Nordstrom did relatively similar to its other competition. In 2002, Nordstroms debt service margin was unusually high, but overall, it had around the same coverage as the market.

Chart 15: Debt Service Margin

100 80 Value 60 40 20 0 2001 2002 2003 Years 2004 2005 Nordstrom Dillard's Saks Neiman Marcus Industry

After analyzing each individual ratio and comparing Nordstrom to three of its competitors and the industry average, it is apparent that there are no concerns with the accounting for the components of these ratios. Nordstrom was consistently somewhat similar to its competitors and the industry average. In most of the above charts comparing the ratios, Nordstrom outperformed the competition. In its industry Nordstrom is apparently a leader in utilizing its capital to create value for the firm and creating profits. (Numbers derived from Edgarscan.pwcglobal.com)

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Forecasting
To accurately predict the future performance of a firm, the past financials must be analyzed. Using the ratios and analysis examined in the last section, Nordstroms financial statements can be forecasted quite accurately. Financial Statement Forecasting Methodology In order to predict an accurate forecast for Nordstroms Income Statement, Statement of Cash Flows, and Balance sheet a sustainable growth rate is needed. After examining Nordstroms past performance and computing past growth rates on Nordstroms financial, we were able to come up with an average growth rate of six percent. We used this six percent growth rate to calculate the financial statement line items for the next fifteen years. Nordstrom is continually experiencing growth as a company and although Nordstrom has been growing more rapidly than six percent per year in the past five years, a six percent growth rate is reasonable because the industry does not support a much higher growth rate. Balance sheet The balance sheets forecast supports the income statement in reinforcing continuous growth. As Nordstrom expands through the years, assets will continue to grow along with liabilities. This is so because of the cost of new stores and larger inventories. (See appendix B-I) Income Statement Growth is apparent in the forecasted Income statement. The percentages in the common size income statement show no obvious change. (See appendix B-III) Cash Flows The cash flows statement shows that net cash flow is slowly rises while net income is increasing relatively well. Overall Nordstrom is gradually increasing in all aspects. (See appendix B-V)

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Valuations Analysis
This section explains how we used the various methods of valuation to value Nordstrom. We will comparables method, discounted dividends, free cash flows, abnormal earnings growth, long-run residual income perpetuity, and residual income method to determine a value of the firm. Cost of Capital (See appendix C) Cost of Equity We calculated the cost of equity using the CAPM method, or capital asset pricing model. The formula for CAPM is: Ke=Rf+(rm-rf). In order to find beta for the firm, we took the five year stock price history of Nordstrom and the S&P 500. We also found the risk free returns from the St. Louis Federal Reserve website. We found the market risk premium by subtracting the monthly S&P 500 returns by the risk free returns. We then determined beta by taking slope of the firms returns and the market risk premium and got a beta of 1.31. We then plugged all the values into the CAPM formula to come up with a Ke of 7.69%. This value is somewhat low and will have an effect on the valuation models. Cost of Debt The cost of debt was calculated by averaging the weighted averages of the long term debt and the current debt. First, all long term debt items were assigned a weighting based on each individual items percentage of the total long term debt. This weighting was multiplied by each items interest rate listed in the 10-K or from the St. Louis Fed. These weighted interest rates were totaled to get an average long term debt rate of 5.931%. The same method was used to determine the average of each item of current debt to come out to 5.914%. These to interest rates were averaged to get a cost of debt (Kd) of 5.923%. Weighted Average Cost of Capital Using the cost of equity and cost of debt, we found the weighted average cost of capital using the formula:

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WACCBT=VD/VF (Kd) + VE/VF (Ke) and

WACCAT=VD/VF (Kd-T) + VE/VF (Ke)

Where: WACCBT= Weighted Average Cost of Capital before taxes WACCAT= Weighted Average Cost of Capital after taxes VD= Value of debt VF= Value of firm VE= Value of equity Kd= Cost of debt Ke= Cost of equity T= Tax rate Table 13: Weighted Average Cost of Capital Weighted Average Cost of Capital
WACC Before Tax WACC After Tax

2,828,668/4,921,349(.05923) +2,092,681/4,921,349(.07694)=.0668 6.68% Intrinsic Valuations

2,828,668/4,921,349(.05923)(1-.377) +2,092,681/4,921,349(.07694)=.0539 5.39%

(Valuation Models Spreadsheets can be found in the Appendix) Discounted Dividends We calculated the Discounted Dividends valuation by first forecasting dividends growth and the discounting them back to 2005 using the Ke. Nordstrom has paid dividends around 30 cents per share for the last five years and have slowly grown every year to 33 cents per share in 2005; therefore, we forecasted a dividend growth of 3% per year. After all of these calculations we valued Nordstrom at $7.31 per share. Nordstroms stock is currently trading at the price of $46.30. According to our valuation Nordstrom is overvalued by a large margin. We think this method is not an accurate way to value Nordstrom because the company pays low dividends.

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Table 14: Discounted Dividends Sensitivity Analysis

Sensitivity Analysis
0 Ke 0.04 0.05 0.06 0.07 0.08 $10.74 $8.50 $7.02 $5.96 $5.18 g 0.01 $13.37 $9.95 $7.91 $6.55 $5.58 0.03 $34.45 $17.21 $11.46 $8.59 $6.86 0.05 ($28.78) $0.00 $29.22 $14.71 $9.87

As you can see from the sensitivity analysis, the cost of equity would have to fall below 4% in order to get close to Nordstroms actual trading price. Discounted Free Cash Flows The discounted free cash flows method is calculated similarly to discounted dividends. We forecasted future free cash flows to the firm with a 6% growth rate and discount them back using the weighted average cost of capital. We total the discounted cash flows, then add a terminal perpetuity and discount it back to 2005. This gives us the value of the firm; we then subtract the book value of debt in order to get the value of equity. We take the value of equity and divide it by the total shares outstanding to get a value of $3.47 per share. This value is also significantly lower than the current trading price of $46.30. This method is also not a good method to value Nordstrom because cash flows to the firm over the past five years have had inconsistent changes making it hard to get an accurate growth rate. We chose 6% growth rate because it was steady and consistent with average growth of net sales over the past five years. Also the cost of equity maybe low, causing the weighted average cost of capital to be low.

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Table 15: Discounted Free Cash Flows Sensitivity Analysis

Sensitivity Analysis
g 0.01 WACC 0.02 0.04 0.0539 0.07 0.1 $4.60 $3.57 $2.95 $2.33 $1.36 0.03 $4.85 $3.79 $3.16 $2.52 $1.52 0.06 $5.23 $4.13 $3.47 $2.80 $1.77 0.1 $5.74 $4.58 $3.89 $3.19 $2.10

This sensitivity analysis supports the above statements. As the WACC decreases and growth rate increases, the price increases closer to the actual trading price. Residual Income The residual income model uses the book value of equity per share, the dividends per share, and the earnings per share to value the firm. We used the book value of equity per share of 2005 and used that as the book value for 2006. We then added the forecasted earnings per share and subtracted the forecasted dividends per share to get the ending book value of equity for 2006. We then repeated the process to forecast all the way out to 2015. Next, we took the ending book value of equity and multiplied it by the Ke to get the normal income. We subtracted the normal income from the earnings per share and came up with the residual income. The residual income was then discounted back and totaled and then added to the book value of equity per share and the present value of the perpetuity to get a value of $41.79. This is the closest valuation to the actual price per share of $46.30. Table 16: Residual Income Sensitivity Analysis
Sensitivity Analysis 0 Ke 0.04 0.05 0.07 0.08 0.1 $55.10 $45.58 $34.59 $31.12 $26.21 g 0.01 $66.75 $52.26 $37.59 $33.33 $27.56 0.03 $155.86 $83.82 $47.30 $39.83 $31.10 0.05 ($105.22) $0.00 $74.10 $53.58 $36.75

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This sensitivity analysis shows that lower cost of equity and higher growth rates increase the value. The method seems to be the most accurate way to value Nordstrom. Long-run Residual Income Perpetuity The long-run residual income perpetuity takes the book value of equity in year 0 added to the book value of equity in year 0 multiplied by the value of return on equity subtracted by the Ke divided by Ke subtracted by the growth rate. The formula looks like: P0=BVE0+ BVE0(ROE-Ke/Ke-g) This was figured for every year for ten years and the amounts were averaged together. Our cost of equity is 7.69%, book value of equity is 7.76, our average return on equity came out to 15.27%, and our average growth came out to 12.86%. This method valued Nordstrom at ($3.60). This value is well below the actual trading value of $46.30. This method is not a good way to value this company. Again a low cost of equity caused and undervalue of the actual price. Table 17: Long-run Residual Income Perpetuity Sensitivity Analysis Sensitivity Analysis
0.1 ($5.11) ($9.20) ($19.96) $23.01 $11.50 g 0.12 ($2.77) ($4.36) ($7.08) $0.00 $15.25 0.1342 ($1.57) ($2.31) ($3.40) ($13.72) $33.58 0.15 ($0.52) ($0.72) ($0.99) ($2.41) ($7.22)

Ke

0.01 0.05 0.0769 0.12 0.14

ROE

0.1 0.12 0.1593 0.2 0.24

0.1 $0.00 ($6.73) ($19.96) ($33.65) ($47.11)

g 0.12 $3.60 $0.00 ($7.08) ($14.42) ($21.63)

0.1342 $4.63 $1.92 ($3.40) ($8.92) ($14.34)

0.15 $5.31 $3.19 ($0.99) ($5.31) ($9.56)

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ROE

0.1 0.12 0.1593 0.2 0.24

0.01 $2.14 $0.89 ($1.57) ($4.11) ($6.61)

Ke 0.05 $3.15 $1.31 ($2.32) ($6.07) ($9.76)

0.0769 $4.63 $1.92 ($3.40) ($8.93) ($14.35)

0.12 $18.72 $7.76 ($13.77) ($36.06) ($57.97)

0.14 ($45.45) ($18.84) $33.70 $87.57 $140.77

This sensitivity analysis shows that higher cost equity creates a higher return on equity and therefore bringing the value closer to the actual price. Abnormal Earnings Growth The abnormal earnings growth is based on the earnings per share and the reinvested dividends. The forecasted earnings per share are added the to the reinvested dividend which is the previous years dividends multiplied by the cost of equity. This gets the cumulative dividends earnings. Then the earnings per share is multiplied by one plus the cost of equity to get the normal earnings. The difference of cumulative dividends earnings and the normal earnings equals the abnormal earnings growth. The AEG are discounted back to 2005 and totaled and added to the base year earnings per share to get the total average earnings per share perpetuity. This is then divided by the cost of equity. Nordstroms came out the $19.92. This is also significantly lower than the actual price of $46.30. This is caused by having negative abnormal earnings growth each year. Table 18: Abnormal Earnings Growth Sensitivity Analysis

Sensitivity Analysis
0 Ke 0.04 0.05 0.07 0.08 0.1 $37.00 $27.49 $17.03 $13.93 $9.78 g 0.01 $40.34 $29.94 $18.51 $15.12 $10.59 0.03 $47.84 $35.45 $21.84 $17.79 $12.42 0.05 $56.59 $41.86 $25.71 $20.91 $14.53

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This sensitivity analysis shows that a higher growth rate gets the value closer to the actual price. The method is better than discounted dividends, free cash flows, and long run residual income perpetuity, but the residual income method seems to be the best method of valuing Nordstrom. Nordstrom Z-Score A firms Z-score is a discriminate analysis model. This model can be valuated by the formula: Z-Score = 1.2 [Working Capital/Total Assets] + 1.4 [Retained Earnings/Total Assets] + 3.3 [Earnings Before Interest and Taxes] + 0.6 [Market Value of Equity/Book Value of Liabilities] + 1.0 [Sales/Total Assets] Nordstroms past five years z-scores are shown in table ***: Table 19: Nordstroms Z-scores Nordstrom z-score 2002 2.5798 2003 2.5220 2004 2.8311 2005 2.7029 2006 3.0566

If the z-score is below 1.81, it is considered a worse off company; a score between 1.81 and 2.67 is moderate, and a z-score of above 2.67 is considerate a high quality company. As table 19 shows, Nordstroms z-score has been well above the healthy level of 2.67.

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Appendix APPENDIX A:
Core Financial Ratios Current Ratio 2001 2002 2003 2004 2005 Quick Asset Ratio 2001 2002 2003 2004 2005 Inventory Turnover 2001 2002 2003 2004 2005 Nordstrom 1.91 2.17 2.36 1.92 1.77 Dillards 3.24 3.03 3.53 2.19 1.87 Saks 2.24 2.41 2.11 2.15 1.95 Neiman Marcus 2.20 2.21 2.40 2.43 2.83 Industry Average 2.56 2.55 2.68 2.26 2.22

Nordstrom 0.91 1.23 1.28 1.23 1.18

Dillards 4.34 4.20 4.22 4.05 3.51

Saks 0.61 0.77 0.61 0.58 0.99

Neiman Marcus 0.81 0.82 0.94 1.41 1.66 Neiman Marcus 2.71 2.82 2.94 3.19 3.38

Industry Average 1.92 1.93 1.92 2.01 2.05 Industry Average 2.89 2.87 2.79 2.91 3.60

Nordstrom 3.86 4.24 4.42 4.97 5.11

Dillardss 2.91 2.95 2.85 2.89 2.78

Saks 3.04 2.84 2.59 2.64 4.64

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Receivables Turnover Nordstrom 2001 7.66 2002 2003 2004 2005 8.01 10.08 11.05 12.08

Dillardss 6.21 6.10 5.09 5.18 5.40

Saks 1.42 1.37 1.25 1.23 1.24

Neiman Marcus N/A N/A N/A N/A N/A

Industry Average 3.81 3.73 3.17 3.21 3.32

OCF Ratio 2001 2002 2003 2004 2005 Working Capital Turnover 2001 2002 2003 2004 2005

Nordstrom 0.48 0.45 0.68 0.44 0.19

Dillardss 0.91 0.66 0.49 0.53 0.32

Saks 0.48 0.35 0.49 0.37 0.22

Neiman Marcus 0.27 0.41 0.31 0.07 1.37

Industry Average 0.55 0.47 0.43 0.32 0.64

Nordstrom 6.41 5.09 5.36 5.79 6.17

Dillardss 6.10 7.21 6.89 7.48 7.54

Saks 6.17 5.26 5.62 5.77 7.45

Neiman Marcus 6.02 5.01 4.29 3.50 3.45

Industry Average 6.10 5.83 5.60 5.58 6.15

46

Gross Profit Margin 2001 2002 2003 2004 2005 Operating Expense Ratio 2001 2002 2003 2004 2005

Nordstrom 0.34 0.33 0.35 0.36 0.37

Dillardss 0.32 0.32 0.34 0.32 0.33

Saks 0.35 0.37 0.38 0.38 0.37

Neiman Marcus 0.33 0.32 0.33 0.34 0.35

Industry Average 0.33 0.34 0.35 0.35 0.35

Nordstrom 0.32 0.31 0.29 0.28 0.27

Dillardss 0.26 0.28 0.27 0.28 0.26

Saks 0.23 0.23 0.25 0.25 0.25

Neiman Marcus 0.26 0.27 0.27 0.23 0.24

Industry Average 0.25 0.26 0.26 0.25 0.25

Net Profit Margin 2001 2002 2003 2004 2005

Nordstrom 0.02 0.02 0.04 0.05 0.07

Dillardss 0.005 0.02 0.003 0.03 0.02

Saks 0.0001 0.005 0.01 0.01 0.01

Neiman Marcus 0.04 0.03 0.03 0.06 0.05

Industry Average 0.02 0.02 0.01 0.03 0.03

47

Asset Turnover 2001 2002 2003 2004 2005 Return on Assets 2001 2002 2003 2004 2005

Nordstrom 1.53 1.39 1.57 1.55 1.57

Dillardss 1.19 1.17 1.13 1.32 1.36

Saks 1.33 1.28 1.30 1.36 1.55

Neiman Marcus 1.66 1.52 1.50 1.35 1.41 Neiman Marcus 0.06 0.05 0.05 0.08 0.07

Industry Average 1.39 1.32 1.31 1.34 1.44 Industry Average 0.02 0.02 0.02 0.04 0.03

Nordstrom 0.03 0.03 0.06 0.08 .011

Dillardss 0.001 0.01 0.001 0.02 0.02

Saks 0.0001 0.005 0.016 0.013 0.005

Return on Equity 2001 2002 2003 2004 2005

Nordstrom 0.08 0.09 0.18 0.22 0.26

Dillardss 0.02 0.03 0.004 0.05 0.05

Saks 0.001 0.01 0.03 0.03 0.01

Neiman Marcus 0.11 0.09 0.09 0.14 0.13

Industry Average 0.04 0.04 0.04 0.07 0.06

48

Debt to Equity 2001 2002 2003 2004 2005 Times Interest Earned 2001 2002 2003 2004 2005 Debt Service Margin 2001 2002 2003 2004 2005

Nordstrom 1.93 2.08 1.99 1.57 1.35

Dillardss 1.77 1.62 1.91 1.47 1.40

Saks 1.04 1.04 1.02 1.30 0.95

Neiman Marcus 0.89 0.80 0.82 0.86 0.63

Industry Average 1.23 1.15 1.25 1.21 0.99

Nordstrom 2.10 1.94 3.67 7.12 16.2

Dillardss 0.06 0.51 1.83 0.93 1.28

Saks 0.77 1.84 1.83 1.73 2.22

Neiman Marcus 12.93 11.85 13.86 N/A N/A

Industry Average 4.59 4.73 5.84 1.33 1.75

Nordstrom 3.02 22.2 1.94 5.51 2.66

Dillardss 2.11 1.53 1.59 2.66 2.31

Saks 0.88 9.33 5.10 2.25 0.31

Neiman Marcus 1.65 1.63 2.03 N/A N/A

Industry Average 1.55 4.16 2.91 2.46 1.31

49

APPENDIX B:
Actual and Forecasted Financials

Numbers in Thousands 2001 Total Current Assets Total Noncurrent Assets Total Assets Total Current Liabilities Total Liabilities Total Shareholder's Equity Total liabilities and Shareholder's Equity 2,057,111 1,994,068 4,051,179 950,138 2,736,691 1,314,488 4,051,179

Actual Balance Sheet

2002 2,088,028 2,023,879 4,111,907 885,145 2,739,043 1,372,864 4,111,907 2003 2,524,843 2,044,390 4,569,233 1,122,559 2,935,224 1,634,009 4,569,233 2004 2,572,444 2,032,946 4,605,390 1,341,152 2,816,396 1,788,994 4,605,390 2005 2,874,157 2,047,192 4,921,349 1,623,312 2,828,668 2,092,681 4,921,349

I. Actual and Forecast Balance Sheet

Forecast Balance Sheet

2006 3,046,606 2,170,024 5,216,630 1,720,711 2,998,388 2,218,242 5,216,630 2007 3,229,403 2,300,225 5,529,628 1,823,953 3,178,291 2,351,336 5,529,628 2008 3,423,167 2,438,238 5,861,405 1,933,391 3,368,989 2,492,417 5,861,405 2009 3,628,557 2,584,533 6,213,090 2,049,394 3,571,128 2,641,962 6,213,090 2010 3,846,270 2,739,605 6,585,875 2,172,358 3,785,396 2,800,479 6,585,875 2011 4,077,047 2,903,981 6,981,028 2,302,699 4,012,520 2,968,508 6,981,028 2012 4,321,669 3,078,220 7,399,889 2,440,861 4,253,271 3,146,618 7,399,889 2013 4,580,970 3,262,913 7,843,883 2,587,313 4,508,467 3,335,416 7,843,883 2014 4,855,828 3,458,688 8,314,516 2,742,551 4,778,975 3,535,541 8,314,516 2015 5,147,177 3,666,209 8,813,387 2,907,105 5,065,714 3,747,673 8,813,387

50

II. Pro-Forma Actual and Forecast Balance Sheet Pro-Forma Actual Balance Sheet
2001 Total Current Assets Total noncurrent Assets Total Assets Total Current Liabilities Total Liabilities Total Shareholders Equity Total Liabilities and Shareholders Equity 50.8 49.2 100% 23.5 44.1 32.4 100% 2002 50.80% 49.20% 100% 21.50% 45.10% 33.40% 100% 2003 55.30% 44.70% 100% 24.60% 39.70% 35.70% 100% 2004 55.90% 44.10% 100% 29.10% 32.10% 38.80% 100% 2005 58.4 41.60% 100% 33% 24.50% 42.50% 100%

Pro-Forma Forecast Balance Sheet

2006 58.40% 41.60% 100% 33% 24.50% 42.50% 100% 2007 58.40% 41.60% 100% 33% 24.50% 42.50% 100% 2008 58.40% 41.60% 100% 33% 24.50% 42.50% 100% 2009 58.40% 41.60% 100% 33% 24.50% 42.50% 100% 2010 58.40% 41.6 100% 33% 24.50% 42.50% 100% 2011 58.40% 41.6 100% 33% 24.50% 42.50% 100% 2012 58.40% 41.6 100% 33% 24.50% 42.50% 100% 2013 58.40% 41.6 100% 33% 24.50% 42.50% 100% 2014 58.40% 41.6 100% 33% 24.50% 42.50% 100% 2015 58.40% 41.6 100% 33% 24.50% 42.50% 100%

51

III. Actual and Forecasted Income Statement

Amounts in thousands 2001 Net Sales Cost of sales and related buying and occupancy costs Gross profit Selling, general and administrative expenses Operating Income Interest expense, net other income including finance charges, net earnings before income tax expense income tax expense net earnings 5,239,241 (3,836,961) 1,402,280 (1,399,568) 172,712 (79,258) 125,259 123,152 (123,489) 102,458

Actual Income Statement

2002 5,944,656 (3,970,022) 1,974,634 (1,783,210) 191,424 (81,921) 139,289 195,624 (141,548) 142,589 2003 6,448,678 (4,215,446) 2,233,132 (1,899,129) 334,003 (90,952) 155,090 398,141 (155,300) 242,841 2004 7,131,388 (4,559,388) 2,572,000 (2,020,233) 551,767 (77,428) 172,942 647,281 (253,831) 393,450 2005 7,722,860 (4,888,023) 2,834,837 (2,100,666) 734,171 (45,300) 196,354 885,225 (333,886) 551,339

Forecast Income Statement

2006 8,186,232 (5,181,304) 3,004,927 (2,226,706) 778,221 (48,017) 208,135 938,339 (353,919) 584,419 2007 8,677,405 (5,492,183) 3,185,223 (2,360,308) 824,915 (50,899) 220,623 994,639 (375,154) 619,485 2008 9,198,050 (5,821,714) 3,376,336 (2,501,927) 874,409 (53,953) 233,861 1,054,317 (397,664) 656,654 2009 9,749,933 (6,171,016) 3,578,916 (2,652,042) 926,874 (57,190) 247,892 1,117,576 (421,523) 696,053 2010 10,334,929 (6,541,277) 3,793,651 (2,811,165) 982,486 (60,622) 262,766 1,184,631 (446,815) 737,816 2011 10,955,025 (6,933,754) 4,021,270 (2,979,835) 1,041,436 (64,259) 278,532 1,255,709 (473,624) 782,085 2012 11,612,326 (7,349,779) 4,262,547 (3,158,625) 1,103,922 (68,114) 295,244 1,331,051 (502,041) 829,010 2013 12,309,066 (7,790,766) 4,518,299 (3,348,142) 1,170,157 (72,201) 312,958 1,410,914 (532,164) 878,751 2014 13,047,609 (8,258,212) 4,789,397 (3,549,031) 1,240,366 (76,533) 331,736 1,495,569 (564,093) 931,476 2015 13,830,466 (8,753,705) 5,076,761 (3,761,973) 1,314,788 (81,125) 351,640 1,585,303 (597,939) 987,364

52

IV. Pro-Forma Income Statement Actual Pro-Forma Income Statement

2001 Net Sales Cost of sales and related buying and occupancy costs Gross profit Selling, general and administrative expenses Operating Income Interest expense, net other income including finance charges, net earnings before income tax expense income tax expense net earnings 100% 73.20% 26.80% 26.70% 3.30% 1.50% 2.40% 2.40% 2.40% 1.90% 2002 100% 67% 33% 29.90% 3.20% 1.40% 2.30% 0.30% 2.40% 2.40% 2003 100% 65.40% 34.60% 29.40% 5.20% 1.40% 2.40% 6.20% 2.40% 3.80% 2004 100% 63.90% 36.10% 28.30% 7.70% 1.10% 2.40% 9.10% 3.60% 5.50% 2005 100% 63.30% 36.70% 27.20% 9.50% 0.59% 2.50% 11.50% 4.30% 7.10%

Forecast Pro-Forma Income Statement

2006 100% 63.30% 36.70% 27.70% 9.50% 0.59% 2.50% 11.50% 4.30% 7.10% 2007 100% 63.30% 36.70% 27.70% 9.50% 0.59% 2.50% 11.50% 4.30% 7.10% 2008 100% 63.30% 36.70% 27.70% 9.50% 0.59% 2.50% 11.50% 4.30% 7.10% 2010 100% 63.30% 36.70% 27.70% 9.50% 0.59% 2.50% 11.50% 4.30% 7.10% 2011 100% 63.30% 36.70% 27.70% 9.50% 0.59% 2.50% 11.50% 4.30% 7.10% 2012 100% 63.30% 36.70% 27.70% 9.50% 0.59% 2.50% 11.50% 4.30% 7.10% 2013 100% 63.30% 36.70% 27.70% 9.50% 0.59% 2.50% 11.50% 4.30% 7.10% 2014 100% 63.30% 36.70% 27.70% 9.50% 0.59% 2.50% 11.50% 4.30% 7.10% 2015 100% 63.30% 36.70% 27.70% 9.50% 0.59% 2.50% 11.50% 4.30% 7.10%

53

V. Actual and Forecasted Statement of Cash Flows

in thousands

Net Income Cash from Operations Cash from Investments Cash from Financing Net Cash Flow

2001 $124,688 $488,510 ($370,573) $137,007 $254,944

Actual Statement of Cash Flows 2002 2003 2004 $90,244 $242,841 $393,450 $390,514 ($489,150) ($130,952) ($229,588) $599,282 ($309,597) ($73,657) $216,028 $606,346 ($110,033) ($475,971) $20,342

2005 $551,399 $776,232 ($292,093) ($382,106) $102,033

2006 584,483 822,806 309,619) 405,032) 108,155

Forecasted Statement of Cash Flows 2007 2008 2009 2010 $619,552 $656,725 $696,129 $737,896 $872,174 $924,505 $979,975 $1,038,774 ($328,196) ($347,887) ($368,761) ($390,886) ($429,334) ($455,094) ($482,400) ($511,344) $114,644 $121,523 $128,814 $136,543

2011 $782,170 $1,101,100 ($414,340) ($542,025) $144,736

2012 $829,100 $1,167,166 ($439,200) ($574,546) $153,420

2013 $878,846 $1,237,196 ($465,552) ($609,019) $162,625

2014 $931,577 $1,311,428 ($493,485) ($645,560) $172,383

2015 $987,472 $1,390,113 ($523,094) ($684,294) $182,726

VI. Pro Forma Statement of Cash Flows

percentage of net income

Net Income Cash from Operations Cash from Investments Cash from Financing Net Cash Flow

2001 100.0% 391.8% -297.2% 109.9% 204.5%

Actual Statement of Cash Flows 2002 2003 2004 100.0% 100.0% 100.0% 432.7% -542.0% -145.1% -254.4% 246.8% -127.5% -30.3% 89.0% 154.1% -28.0% -121.0% 5.2%

2005 100.0% 140.8% -53.0% -69.3% 18.5%

2006 100.0% 140.8% -53.0% -69.3% 18.5%

Forecasted Statement of Cash Flows 2007 2008 2009 100.0% 100.0% 100.0% 140.8% 140.8% 140.8% -53.0% -53.0% -53.0% -69.3% -69.3% -69.3% 18.5% 18.5% 18.5%

2010 100.0% 140.8% -53.0% -69.3% 18.5%

2011 100.0% 140.8% -53.0% -69.3% 18.5%

2012 100.0% 140.8% -53.0% -69.3% 18.5%

2013 100.0% 140.8% -53.0% -69.3% 18.5%

2014 100.0% 140.8% -53.0% -69.3% 18.5%

2015 100.0% 140.8% -53.0% -69.3% 18.5%

54

55

APPENDIX C
Cost of Capital I. Cost of Debt
Numbers in Thousands Long Term Debt Schedule 2005 300,000 300,000 250,000 96,027 75,406 16,495 (7,821) 1,030,107 (101,097) 929,010 2006 300,000 300,000 250,000 72,633 22,811 (11,050) 934,394 (306,618) 627,776 2006 Percent of total 32.11% 32.11% 26.76% 0.00% 7.77% 2.44% -1.18% 100.00% Weighted Rate 1.55% 2.23% 1.50% 0.00% 0.60% 0.12% -0.07% 5.93%

Private Label Securitization, 4.82%, due 2006 Senior debentures, 6.95%, due 2028 Senior notes, 5.625%, due 2009 Notes payable, 6.7%, due 2005 Mortgage payable, 7.68%, due 2020 Other Fair market value of interest rate swap Total long-term debt Less current portion Total due beyond one year

Rate 4.82% 6.95% 5.63% 6.70% 7.68% 4.80% 5.63%

Source 10-K 10-K 10-K 10-K 10-K St.Louis Fed 10-K

Current Liabilities Accounts payable Accrued salaries, wages and related benefits Other current liabilities Income taxes payable Current portion of long term debt Total current liabilities Average interest rate on long term debt Average interest rate on current debt Average interest rate of debt (Kd) Tax rate Effective tax rate 482,394 287,904 354,201 115,556 101,097 1,341,152 5.931% 5.914% 5.923% 2003 39.00% 2004 39.20% 2005 37.70% 540,019 285,982 409,076 81,617 306,618 1,623,312

2006 Percent of total 33.27% 17.62% 25.20% 5.03% 18.89% 100.00%

Rate 5.97% 6.08% 5.84% 5.28% 5.93%

Source St. Louis Fed 10-K St. Louis Fed St. Louis Fed 10-K

Weighted Rate 1.99% 1.07% 1.47% 0.27% 1.12% 5.91%

55

56

II. Risk Free Return Data

Date Close Dividends JWN Returns 47.35 42.3 0.105 37.455 34.3 36.5 0.105 36.935 38.33 39.18 0.105 38.105 41.72 37.4 0.085 36.965 34.65 34.32 0.085 33.665 37.01 67.97 0.085 61.125 50.83 55.38 0.065 53.825 48.25 46.73 0.065 43.815 43.18 38.24 0.119385 0.129355 0.091983 -0.06027 -0.01178 -0.03639 -0.02169 0.028212 -0.08665 0.115508 0.011768 0.066811 0.009615 0.019456 -0.09038 -0.4555 0.111984 0.202538 -0.08216 0.02889 0.115544 0.032527 0.06653 0.014706 0.129184 0.028095 Close S&P Returns 0.031508 0.024566 0.021274 0.005086 8.66E-05 -0.03092 0.012156 0.011096 0.000453 0.025467 -0.00095 0.035186 -0.01774 0.006949 -0.01122 0.035968 -0.00014 0.029952 -0.02011 -0.01912 0.018903 -0.02529 0.032458 0.038595 0.014014 0.009364 mkt premium 0.0276 0.0207 0.0173 0.0009 -0.0041 -0.0351 0.0081 0.0072 -0.0034 0.0218 -0.0046 0.0315 -0.0213 0.0036 -0.0147 0.0327 -0.0033 0.0267 -0.0234 -0.0226 0.0158 -0.0284 0.0295 0.0357 0.0112 0.0066 Riskfree annual Monthly Risk Free 0.00391 0.00389 0.00402 0.00420 0.00423 0.00417 0.00408 0.00393 0.00381 0.00363 0.00366 0.00371 0.00361 0.00334 0.00343 0.00332 0.00314 0.00321 0.00333 0.00348 0.00314 0.00309 0.00300 0.00294 0.00279 0.00280

2-Oct06 1-Sep06 1-Aug06 3-Jul-06 1-Jun06 1-May06 3-Apr06 1-Mar06 1-Feb06 3-Jan06 1-Dec05 1-Nov05 3-Oct05 1-Sep05 1-Aug05 1-Jul-05 1-Jun05 2-May05 1-Apr05 1-Mar05 1-Feb05 3-Jan05 1-Dec04 1-Nov04 1-Oct04 1-Sep04

47.35 42.3 37.35 34.3 36.5 36.83 38.33 39.18 38 41.72 37.4 36.88 34.65 34.32 33.58 37.01 67.97 61.04 50.83 55.38 53.76 48.25 46.73 43.75 43.18 38.24

1377.94 1335.85 1303.82 1276.66 1270.2 1270.09 1310.61 1294.87 1280.66 1280.08 1248.29 1249.48 1207.01 1228.81 1220.33 1234.18 1191.33 1191.5 1156.85 1180.59 1203.6 1181.27 1211.92 1173.82 1130.2 1114.58

10/1/2006 9/1/2006 8/1/2006 7/1/2006 6/1/2006 5/1/2006 4/1/2006 3/1/2006 2/1/2006 1/1/2006 12/1/2005 11/1/2005 10/1/2005 9/1/2005 8/1/2005 7/1/2005 6/1/2005 5/1/2005 4/1/2005 3/1/2005 2/1/2005 1/1/2005 12/1/2004 11/1/2004 10/1/2004 9/1/2004

4.69 4.67 4.82 5.04 5.07 5.00 4.90 4.72 4.57 4.35 4.39 4.45 4.33 4.01 4.12 3.98 3.77 3.85 4.00 4.17 3.77 3.71 3.60 3.53 3.35 3.36

56

2-Aug04 1-Jul-04 1-Jun04 3-May04 1-Apr04 1-Mar04 2-Feb04 2-Jan04 1-Dec03 3-Nov03 1-Oct03 2-Sep03 1-Aug03 1-Jul-03 2-Jun03 1-May03 1-Apr03 3-Mar03 3-Feb03 2-Jan03 2-Dec02 1-Nov02 1-Oct02 3-Sep02 1-Aug02 1-Jul-02 3-Jun02 1-May02 1-Apr-

37.13 43.9 42.61 40.55 35.63 39.9 39.14 39.3 34.3 34.5 30.49 24.81 26.07 21.11 19.52 18.65 17.33 16.2 17.01 18.04 18.97 20 19.92 17.94 19.33 18.9 22.65 24.62 23.46

0.065

37.195 43.9 42.61

-0.15273 0.030275 0.049378 0.13963 -0.10702 0.017987 -0.00267 0.145773 -0.00738 0.133322 0.22894 -0.05015 0.237328 0.081455 0.04385 0.079054 0.069753 -0.05041 -0.05432 -0.04902 -0.05387 0.006526 0.110368 -0.0743 0.025397 -0.16556 -0.08169 0.051364 -0.04245

1104.24 1101.72 1140.84 1120.68 1107.3 1126.21 1144.94 1131.13 1111.92 1058.2 1050.71 995.97 1008.01 990.31 974.5 963.59 916.92 848.18 841.15 855.7 879.82 936.31 885.76 815.28 916.07 911.62 989.82 1067.14 1076.92

0.002287 -0.03429 0.017989 0.012083 -0.01679 -0.01636 0.012209 0.017276 0.050765 0.007129 0.054961 -0.01194 0.017873 0.016224 0.011322 0.050899 0.081044 0.008358 -0.017 -0.02741 -0.06033 0.05707 0.086449 -0.11002 0.004881 -0.079 -0.07246 -0.00908 -0.06142

-0.0006 -0.0374 0.0147 0.0089 -0.0196 -0.0187 0.0097 0.0147 0.0480 0.0044 0.0523 -0.0146 0.0151 0.0138 0.0094 0.0488 0.0786 0.0060 -0.0194 -0.0300 -0.0629 0.0545 0.0840 -0.1125 0.0021 -0.0822 -0.0759 -0.0128 -0.0653

8/1/2004 7/1/2004 6/1/2004 5/1/2004 4/1/2004 3/1/2004 2/1/2004 1/1/2004 12/1/2003 11/1/2003 10/1/2003 9/1/2003 8/1/2003 7/1/2003 6/1/2003 5/1/2003 4/1/2003 3/1/2003 2/1/2003 1/1/2003 12/1/2002 11/1/2002 10/1/2002 9/1/2002 8/1/2002 7/1/2002 6/1/2002 5/1/2002 4/1/2002

3.47 3.69 3.93 3.85 3.39 2.79 3.07 3.12 3.27 3.29 3.19 3.18 3.37 2.87 2.27 2.52 2.93 2.78 2.90 3.05 3.03 3.05 2.95 2.94 3.29 3.81 4.19 4.49 4.65

0.00289 0.00308 0.00328 0.00321 0.00283 0.00233 0.00256 0.00260 0.00273 0.00274 0.00266 0.00265 0.00281 0.00239 0.00189 0.00210 0.00244 0.00232 0.00242 0.00254 0.00253 0.00254 0.00246 0.00245 0.00274 0.00318 0.00349 0.00374 0.00388

0.055

40.605 35.63 39.9

0.055

39.195 39.3 34.3

0.055

34.555 30.49 24.81

0.05

26.12 21.11 19.52

0.05

18.7 17.33 16.2

0.05

17.06 18.04 18.97

0.05

20.05 19.92 17.94

0.05

19.38 18.9 22.65

0.045

24.665 23.46

57

02 1-Mar02 1-Feb02 2-Jan02 3-Dec01 1-Nov01 1-Oct01 4-Sep01 1-Aug01 2-Jul-01 1-Jun01 1-May01 2-Apr01 1-Mar01 1-Feb01 2-Jan01 1-Dec00 1-Nov00 2-Oct00 1-Sep00 1-Aug00 3-Jul-00 1-Jun00 1-May00 3-Apr00 1-Mar00 1-Feb00 31-Jan00

24.5 25.46 25.3 20.23 18.93 14.1 14.45 20.05 22.5 18.55 18.53 18.39 16.28 18.45 20.39 18.19 16.06 16.44 15.56 18 17.5 24.12 25.12 27.81 29.5 21.31 22 0.04 0.045 0.045 0.045 0.045 0.045 0.045 0.045 0.045

24.5 25.505 25.3 20.23 18.975 14.1 14.45 20.095 22.5 18.55 18.575 18.39 16.28 18.495 20.39 18.19 16.105 16.44 15.56 18.045 17.5 24.12 25.165 27.81 29.5 21.35 22

-0.0394 0.008103 0.250618 0.06614 0.345745 -0.02422 -0.28092 -0.10689 0.212938 -0.00135 0.01006 0.129607 -0.11976 -0.09294 0.120946 0.129463 -0.02038 0.056555 -0.13771 0.031143 -0.27446 -0.04153 -0.09511 -0.05729 0.381733 -0.02955

1147.39 1106.73 1130.2 1148.08 1139.45 1059.78 1040.94 1133.58 1211.23 1224.38 1255.82 1249.46 1160.33 1239.94 1366.01 1320.28 1314.95 1429.4 1436.51 1517.68 1430.83 1454.6 1420.6 1452.43 1498.58 1366.42 1394.46

0.036739 -0.02077 -0.01557 0.007574 0.075176 0.018099 -0.08172 -0.06411 -0.01074 -0.02504 0.00509 0.076814 -0.0642 -0.09229 0.034637 0.004053 -0.08007 -0.00495 -0.05348 0.060699 -0.01634 0.023934 -0.02191 -0.0308 0.09672 -0.02011

0.0328 -0.0243 -0.0192 0.0039 0.0719 0.0148 -0.0852 -0.0679 -0.0147 -0.0290 0.0010 0.0728 -0.0681 -0.0964 0.0306 -0.0003 -0.0848 -0.0098 -0.0584 0.0556 -0.0215 0.0187 -0.0275 -0.0360 0.0913 -0.0257

3/1/2002 2/1/2002 1/1/2002 12/1/2001 11/1/2001 10/1/2001 9/1/2001 8/1/2001 7/1/2001 6/1/2001 5/1/2001 4/1/2001 3/1/2001 2/1/2001 1/1/2001 12/1/2000 11/1/2000 10/1/2000 9/1/2000 8/1/2000 7/1/2000 6/1/2000 5/1/2000 4/1/2000 3/1/2000 2/1/2000 1/1/2000

4.74 4.30 4.34 4.39 3.97 3.91 4.12 4.57 4.76 4.81 4.93 4.76 4.64 4.89 4.86 5.17 5.70 5.78 5.93 6.06 6.18 6.30 6.69 6.26 6.50 6.68 6.58

0.00395 0.00358 0.00362 0.00366 0.00331 0.00326 0.00343 0.00381 0.00397 0.00401 0.00411 0.00397 0.00387 0.00408 0.00405 0.00431 0.00475 0.00482 0.00494 0.00505 0.00515 0.00525 0.00558 0.00522 0.00542 0.00557 0.00548

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59

APPENDIX D
Valuation Models I. Discounted Dividends Discounted Dividends Evaluation
Years from valuation date Dividends per share Present value factor Present value of future dividends Total present value of forecast future dividends Continuing (Terminal) value (assume no growth) Present value of continuing (terminal) value Estimated value per share Actual price per share Cost of equity Growth rate 2005 0.33 1 2006 0.34 0.929 0.316 2 2007 0.35 0.862 0.302 3 2008 0.36 0.801 0.289 4 2009 0.37 0.743 0.276 5 2010 0.38 0.690 0.264 6 2011 0.39 0.641 0.253 7 2012 0.41 0.595 0.242 8 2013 0.42 0.553 0.231 9 2014 0.43 0.513 0.221 Terminal 0.45 9.58671 10 2015 0.44 0.477 0.211

Termina 0.45

2.393 0.45 4.920 7.312 Ke $46.30 7.69% 0.03 0.04 0.05 0.06 0.07 0.08

Sensitivity Analysis
0 $10.74 $8.50 $7.02 $5.96 $5.18 g 0.01 $13.37 $9.95 $7.91 $6.55 $5.58 0.03 $34.45 $17.21 $11.46 $8.59 $6.86 0.05 ($28.78) $0.00 $29.22 $14.71 $9.87

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II. Discounted Free Cash Flows

2005 $776,232 ($292,093) (Amounts in thousands of dollars except per share data) 2006 2007 2008 2009 2010 $822,806 $863,946 $907,144 $952,501 $1,000,126 ($306,698) 516,108 0.949 489712.8 ($322,033) 541,914 0.900 487900.6 ($338,134) 569,009 0.854 486095.1 ($355,041) 597,460 0.811 484296.2 ($372,793) 627,333 0.769 482504.1 2011 $1,050,132 ($391,433) 658,699 0.730 480718.6 2012 $1,102,639 ($411,004) 691,634 0.692 478939.6

Cash Flow from Operations Cash Provided (Used) by Investing Activities Free Cash Flow (to firm) discount rate (5.39% WACC) Present Value of Free Cash Flows Total Present Value of Annual Cash Flows Continuing (Terminal) Value (assume no growth) Present Value of Continuing (Terminal) Value Value of the Firm (end of 2005) Book Value of Debt and Preferred Stock Value of Equity (end of 2005) Estimated Value per Share Earnings Per Share Dividends per share Book Value Per Share Actual Price per share WACC after tax Growth Rate

4,743,437 828,042 464,792 5,208,229 2,828,668 2,379,561 $3.47 2.03 0.32 7.76 $46.30 5.39% 6.00% WACC 0.02 0.04 0.0539 0.07 0.1

Sensitivity Analysis
g 0.01 $4.60 $3.57 $2.95 $2.33 $1.36 0.03 $4.85 $3.79 $3.16 $2.52 $1.52 0.06 $5.23 $4.13 $3.47 $2.80 $1.77 0.1 $5.74 $4.58 $3.89 $3.19 $2.10

Terminal 2014 2015 2016 $1,157,771 $1,215,659 $1,276,442 ($431,554) ($453,132) ($475,789) 726,216 762,527 800,653 828,042

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III. Residual Income Residual Income

1 2005 Beginning BE (per share) Earnings Per Share Dividends per share Ending BE (per share) Ke "Normal" Income Residual Income (RI) Discount Factor Present Value of RI BV Equity (per share) 2005 Total PV of RI (end 2005) Continuation (Terminal) Value PV of Terminal Value (end 2005) Estimated Value (2005) 2.03 0.32 7.76 7.69% 2006 7.76 $2.09 $0.33 9.52 2 2007 9.5213 $2.15 $0.34 11.34 3 2008 11.3354 $2.22 $0.35 13.20 0.17 2.05 0.801 1.64 4 5 Forecast Years 2009 2010 13.204 15.1286 $2.28 $2.35 $0.36 $0.37 15.13 17.11 0.18 2.11 0.743 1.57 0.18 2.17 0.690 1.50 6 2011 17.111 $2.42 $0.38 19.15 0.19 2.24 0.641 1.43 7 2012 19.1528 $2.50 $0.39 21.26 0.19 2.30 0.595 1.37 8 2013 21.256 $2.57 $0.41 23.42 0.20 2.37 0.553 1.31 9 2014 23.4221 $2.65 $0.42 25.65 0.20 2.44 0.513 1.25 10 2015 25.653 $2.73 $0.43 27.95 0.21 2.52 0.477 1.20

7.76 13.59 2.45 20.44 $41.79

0.16 0.17 1.93 1.99 0.929 0.862 1.79 1.71 ValuePercent 18.57% 32.51% 48.92% 100.00% Ke

Sensitivity Analysis g 0 0.01 0.04 0.05 0.07 0.08 0.1 $55.10 $45.58 $34.59 $31.12 $26.21 $66.75 $52.26 $37.59 $33.33 $27.56

39.84 0.03 0.05 ####### $0.00 $74.10 $53.58 $36.75

Actual Price per share Growth

$46.30 3%

$155.86 $83.82 $47.30 $39.83 $31.10

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IV. Long Run Residual Income Perpetuity Long Run Residual Income Perpituity
change In RI 1 2005 Beginning BE (per share) 2.03 Earnings Per Share 0.32 Dividends per share 7.76 Ending BE (per share) 7.69% Ke 1% Forecast Growth Rate ROE Growth in BE Actual Price per share Average ROE Average Growth in BVE LR Res Inc Perp Value $46.30 15.27% 12.86% ($3.61) 2006 7.76 $2.05 $0.32 9.49 (0.05) 2 2007 9.4871 $2.07 $0.33 11.23 (0.03) 3 2008 11.231 $2.09 $0.33 12.99 (0.02) (0.02) 4 5 Forecast Years 2009 2010 12.9933 14.7727 $2.11 $2.13 $0.33 $0.34 14.77 16.57 (0.01) 6 2011 16.57 $2.15 $0.34 18.39 (0.01) 7 2012 18.3851 $2.18 $0.34 20.22 (0.01) 8 2013 20.2185 $2.20 $0.35 22.07 (0.01) 9 2014 22.07 $2.22 $0.35 23.94 (0.01) 10 2015 23.94 $2.24 $0.35 25.83

26.42% 22.26%

21.83% 18.39%

18.62% 15.69%

16.26% 13.70%

14.44% 12.17%

13.00% 10.95%

11.84% 9.97%

10.87% 9.16%

10.06% 8.47%

9.37% 7.89%

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Sensitivity Analysis
Ke 0.01 0.05 0.0769 0.12 0.14 0.1 ($5.11) ($9.20) ($19.96) $23.01 $11.50 0.01 $2.14 $0.89 ($1.57) ($4.11) ($6.61) g 0.12 ($2.77) ($4.36) ($7.08) $0.00 $15.25 Ke 0.05 $3.15 $1.31 ($2.32) ($6.07) ($9.76) 0.1342 ($1.57) ($2.31) ($3.40) ($13.72) $33.58 0.0769 $4.63 $1.92 ($3.40) ($8.93) ($14.35) 0.15 ($0.52) ($0.72) ($0.99) ($2.41) ($7.22) 0.12 $18.72 $7.76 ($13.77) ($36.06) ($57.97) 0.14 ($45.45) ($18.84) $33.70 $87.57 $140.77 ROE 0.1 0.12 0.1593 0.2 0.24 0.1 $0.00 ($6.73) ($19.96) ($33.65) ($47.11) g 0.12 $3.60 $0.00 ($7.08) ($14.42) ($21.63) 0.1342 $4.63 $1.92 ($3.40) ($8.92) ($14.34) 0.15 $5.31 $3.19 ($0.99) ($5.31) ($9.56)

ROE

0.1 0.12 0.1593 0.2 0.24

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64

V. Abnormal Earnings Growth

2001 0.78 0.18 2002 0.93 0.10 0.014 0.94 0.84 0.10 2003 0.89 0.205 0.008 0.90 1.00 (0.10) 2004 1.41 0.24 0.016 1.43 0.96 0.47 2005 2.03 0.32 0.018 2.05 1.52 0.53

EPS DPS DPS invested at Ke (Drip) Cum-Dividend Earnings Normal Earnings Abnormal Earning Growth (AEG) PV Factor PV of AEG Core EPS Total PV of AEG Continuing (Terminal) Value PV of Terminal Value Total PV of AEG Total Average EPS Perp (t+1) Capitalization Rate (perpetuity) Value Ke g

2.03 (0.541)

(0.541) 1.489 0.07694 $19.35 7.69% 0.03

Actual Share Price - Nov 1, 2006

$46.30

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1 2006 2.09 0.33 0.025 2.12 2.19 (0.07) 0.929 (0.066)

2 2007 2.15 0.34 0.025 2.18 2.25 (0.07) 0.862 (0.063)

3 2008 2.22 0.35 0.026 2.24 2.32 (0.07) 0.801 (0.060)

4 5 Forecast Years 2009 2010 2.28 2.35 0.36 0.37 0.027 0.028 2.31 2.38 2.39 2.46 (0.08) (0.08) 0.743 0.690 (0.057) (0.055)

6 2011 2.42 0.38 0.029 2.45 2.53 (0.08) 0.641 (0.053)

7 2012 2.50 0.39 0.029 2.53 2.61 (0.08) 0.595 (0.050)

8 2013 2.57 0.41 0.030 2.60 2.69 (0.09) 0.553 (0.048)

9 2014 2.65 0.42 0.031 2.68 2.77 (0.09) 0.513 (0.046)

10 2015 2.73 0.43 0.032 2.76 2.85 (0.09) 0.477 (0.044)

Sensitivity Analysis
0 Ke 0.04 0.05 0.07 0.08 0.1 $37.00 $27.49 $17.03 $13.93 $9.78 g 0.01 $40.34 $29.94 $18.51 $15.12 $10.59 0.03 $47.84 $35.45 $21.84 $17.79 $12.42 0.05 $56.59 $41.86 $25.71 $20.91 $14.53

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Works Cited

1. Nordstroms Inc. 10-K. PriceWaterhouseCoopers Technology Center. 29th January 2005. PriceWaterhouseCoopers. November 2006. http://edgarscan.pwcglobal.com 2. Investor Relations. Nordstrom Inc 2006. November 2006. www.Nordstrom.com 3. Industries. Yahoo Finance 2006. http://finance.yahoo.com 4. Bernard; Healy; Palepu. (2004). Business Analysis & Valuation: Using Financial Statements, Third Edition. Ohio: Southwestern.

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