McDonalds Project - Assumptions & Outline

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University of Pittsburgh *

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Finance

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Feb 20, 2024

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Semester Project Outline: Company: McDonalds Capital IQ Income statement, balance sheet, cash flow statement last 5 years: https://www.capitaliq.com/CIQDotNet/Financial/IncomeStatement.aspx? CompanyId=139488&fromSearchProfiles=true&statekey=ca269605769b4a8fb2dc5d70034ff278 https://www.linkedin.com/pulse/fast-food-market-regional-stats-trends-mxksf/ SEC 10K https://www.sec.gov/ix?doc=/Archives/edgar/data/63908/000006390823000012/mcd- 20221231.htm McDonald’s 10K https://www.annualreports.com/HostedData/AnnualReports/PDF/NYSE_MCD_2022.pdf Forecast Horizon: 5 years. This allows us to be confident in projected numbers, as well as not open the DCF to unknown events and risk further down the line past 5 years. A company like McDonalds has to constantly check their forecasts due to social trends such as healthy eating habits and such. This is also a well-established company, so there should not be much of a shock to revenues and earnings further than 5 years, so in order to keep the valuation precise we went with 5 years.

Assumptions: INCOME STATEMENT Growth Rate: Fast Food Industry expected to reach USD 896,967.34 million; The overall industry should witness significant compound annual growth rate 4.91% by 2031 according to analysts. We assume that since McDonald’s is a market leader and with room to expand (assuming they keep up with technological advancements, changing consumer demands, and adapting to government policies and regulations that act as catalysts for market growth), that their growth rate will be higher than the average. The past year their revenue grew by about 7.8% so to be conservative we are estimating and basing our forecast with 4% sales growth. Due to COVID, the revenues were irregular compared to past years, we expect the sales to start stabilizing as we transition from COVID. We are using the same sales growth for other revenue (Franchising, developmental licensees, leasing, and affiliates). Cost of Goods Sold: We assume that the cost of goods sold can be forecasted as a proportion/percentage of sales since the food supply cost does not seem to change much historically for McDonalds and the supply bought depends on sales. In the years leading up to COVID, McDonalds had COGS that was around 50-60% of revenue. For the 5 years prior to 2023, the average % of revenue was 47%. In order to account for pre-COVID and post COVID years, our group decided to go with a gradual increase from 45% up to 50% in the final forecasted year. We do not think it will rise as high as 60% again in the foreseeable future because the food industry has seen a lot of change after covid, and we do not expect levels to get that high again. Dividends: McDonalds pays a quarterly dividend and has increased its dividends for 15 consecutive years. More specifically, their dividend payout ratio was at a steady 70-80%, but when Covid occurred, the dividend payout ratio went down to 53% (2021). However, in 2022, it has bounced back to 67%, closer to its original, pre-Covid dividend payout ratio. McDonald’s stated that they will continue to increase their dividend payout ratio, so we assume they will continue to increase their ratio to its original amount pre-Covid, and then will remain at mainstay. So, assume a 4% increase every year until roughly 78%, then it remains constant (it is a long run number thereafter). Tax Rate: We are using the corporate tax rate of 21%. (Checked the income statement and calculated: provision for income taxes/income before provision for income taxes which resulted in 21% -> suggests no tax shields, so we are using the corporate tax rate as a constant.). McDonald’s seems content with paying this amount each year and doesn’t take advantage of many tax havens or cuts. Other Operating Expenses: There was a large impairment and others charge to write off goodwill and other long-lived assets from their carrying value to their fair value, as well as charges associated with strategic initiatives, such as refranchising and restructuring activities. In 2021 there were gains on the sale of McDonalds Japan stock which reduced the Company’s ownership in Japan by 14%. In 2022 there was $1.3 billion in charges relating to the sale in

Russia and a gain of 271 million in the Companys sale of its Dynamic Yield Business (Page 51 of 10-K). SG&A: We took the proportion of SG&A and sales, and took the average which SG&A was 10% of sales. The increases in price reflect higher costs for investments in restaurant technology, incremental costs related to strategic initiatives, the Company’s 2022 Worldwide owner/Operator convention and proxy contest, as well as the impact of inflationary cost pressures. “Management believes that analyzing SG&A expenses as a percent of systemwide sales is meaningful because these costs are incurred to support the overall McDonald’s business.” (Page 16 on 10-K) Depreciation: McDonalds based their depreciation percentage off of straight-line deprecation method, so we took an average of the percentage for the past years and used that percentage as the constant base for depreciation in our forecast each year. Interest expense: Interest expense is a percentage of operating income. Interest expenses decreased by 3% during Covid of 2021 and in the following year it increased by 2% (4% in constant currencies) (according to the 10-K). We calculated the average percentage in the past 5 years to be 13.5%, which is inflated due to Covid. We expect the proportion to lower to about pre-Covid times and stabilize around 10%. Interest and Investment Income: In 2022, interest income increased due to higher average interest rates. Since we forecasted that interest expense will be slightly lower than the average over the past 5 years, that means interest and investment income will stabilize to a lower level. We took interest and investment income as a percentage of operating income, where we made it slightly lower than the average since we did the same with interest expense (considering interest income fluctuates according to interest expense/interest rates). We decided to have it at a constant 0.15% of operating income, correlating with the logic. Income/(Loss) from affiliates: We assume McDonald’s proportionate share for the period of the net income (loss) of its investee, being unconsolidated subsidiaries and joint ventures, will be a percentage of operating income. We obtained that income/(loss) from affiliates as a percentage of operating income is an average of 1.6% (over the past 5 years), which we will keep constant in our forecast. Currency Exchange Gains (Loss): Since McDonalds conducts a lot of business internationally, we assume they will be buying/selling a normal amount of goods and services in foreign currency (pre-Covid numbers). We obtained that currency exchange gains (loss) as a percentage of operating income is an average of 0.5% (over the past 5 years), which we will lower to 0.1% considering year 2022 is inflated. Additionally, we made 2 out of the 5 forecasted years a negative percentage to take into account years there are positive returns (Lots of frequent business transaction in Europe, specifically France that we considered; Our logic is that all transactions will not be losses).

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Other Non-Operating Inc. (Exp.): We assume McDonalds will continue to have a normal amount of interest payments and one-time expenses related to the disposal of assets or inventory write-downs. Thus, we are expressing our forecast by taking other non-operating inc. (exp.) as a percentage of operating income from the past 5 years, averaging the percentage, and lowering the yield by 0.75% since year 2022 was an extreme case (1% -> 0.25% in our case), which is constant. Restructuring Charges: After looking at this section over the past 10 years, McDonalds has had a few expenses regarding restructuring. We assume McDonald's will close or shift production to a new location twice in the next 5 years based on its history. There was a 5-year stretch where McDonalds had restructuring charges (2014-2018), so we assume a lot of work has been done, and only unforeseeable events will cause them to relocate their plants or layoff their employees. We further wanted to take the 6 years from the past 10 that there were restructuring charges and average them out to obtain -179.1. We will assume -179.1 will be the next two restructuring charges. Gain (loss) on sale of investment: These are the gains on sales and purchases of businesses with its franchises. This only happened twice in the last 12 years, and this was during COVID. So, we are assuming this will probably not happen often, thus we aren’t including it in the forecast. Gain (loss) on sale of Assets: (Can be explained as “asset disposition and other (income) expense, net on page 51): This is the net gain or loss on assets such as property, provisions for restaurant closings, reserves for bad debt, asset write-offs due to restaurant reinvestment, and other miscellaneous. We assume that due to COVID, there were more asset write-offs and restaurant closings than a usual year. Through our research, we discovered McDonald’s plans to close more than 200 restaurant locations. We will assume through these shutdowns; McDonald’s will gain 50% of the time and lose 50% of the time. We took gain (loss) on sale of assets and divided by EBT excl. unusual items and averaged out those percentages from 2015- 2020 to obtain the constant number 2.10% (where it is negative 50% of the time (-2.10%) and positive 50% of the time (2.10%)). Income Tax expense: This is calculated by multiplying taxable income by the tax rate. We are using a tax rate of 21% which is the standard corporate tax rate. We averaged out the last 7 years and found that when you take income tax expense as a percentage of EBT incl. unusual items, it turns out to be about 21%.

Assumptions: Balance Sheet *For all contents calculated as percent of sales (everything in total assets and total liabilities), we took the last 5 years for each category and averaged the percentage out over those 5 years to obtain a constant percentage. Accounts Receivable: The receivable days vary according to our calculation: Average Accounts Receivable/Sales Revenue * 365, which we will use in this assumption for each forecasted year. We will perform the calculation: Receivable days/365*Total sales to obtain the accounts receivable amount. Inventory: The average Inventory was 52 the past 5 years. We used this to calculate inventory days. The Inventory days vary according to our calculation: Average inventory/COGS * 365, which we will use in this assumption for each forecasted year. We will perform the calculation: Inventory Days/365*COGS to obtain the inventory amount. Accounts Payable: The accounts payable days vary according to our calculation: Average Accounts Payable/COGS* 365, which we will use in this assumption for each forecasted year. We will perform the calculation: Accounts Payable days/COGS*365 to obtain the accounts receivable amount. Common Stock: Common stock has been stable and constant at 16.6 for the past 5 years, so we are keeping it constant as well in our forecast. Additional Paid in Capital: Found average added each year from the past 5 years (300) and added that each year to stay consistent. Retained Earnings: Previous Year retained earnings + Net Income – Dividends Paid Treasury Stock: Check equity schedule for formulas; Ending Treasury Stock values from equity schedule are formulated into balance sheet. Comprehensive Inc. And Other: Keep as constant Long-term Debt: Plug Figure

Assumptions: Statement of Cash Flows *For the most part, we took percentages of sales/liabilities on each item. Look at excel for in- depth explanation.

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