Johnson & Johnson Uses a Cost of Equity Case Study - Management Assignment Help

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Task:

PART I: Johnson & Johnson STOCK VALUATION (75 marks)

As a new analyst for a large brokerage firm, you are anxious to demonstrate the skills you learned in your MSc programme and prove that you are worth your attractive salary. Your first assignment is to analyse the Johnson & Johnson stock. Your boss recommends determining prices based on both the dividend-discount model and discounted free cash flow valuation methods. Johnson & Johnson uses a cost of equity of 8% and an after-tax weighted cost of capital of 7%. It expects 12% return on new investments. However, you are a little concerned because your finance professor has told you that these two valuation approaches can result in widely differing estimates when applied to real data. You are really hoping that these alternative valuation methods will reach similar prices.

1. Go to Yahoo! Finance (http://finance.yahoo.com) and enter the symbol for Johnson & Johnson (JNJ). From the main page for JNJ, gather the following information and enter it into an Excel spreadsheet:

a. The current stock price (last trade).

b. The current dividend amount.

2. From the “Key Statistics” page, gather the following information and enter it on the same spreadsheet:

a. The number of shares of stock outstanding.

b. The payout ratio.

3. From the “Analyst Estimates” page, find the expected growth rate for the next five years and enter it onto to spreadsheet.

4. Start Excel, create a new blank spreadsheet and select Data / From Web. In the New Web Query box, paste the URL for Johnson & Johnson’s “Income Statement” of the web page and press return. Use the little yellow and black arrow boxes to select the table containing the entire three years of income statements and import them. Repeat this process for both the balance sheet and cash flow statements for Johnson & Johnson. Keep all the different statements in the same Excel worksheet.

5. To determine the stock value based on the dividend-discount model:

a. Create a timeline in Excel for five years.

b. Use the dividend obtained from Yahoo! Finance as the current dividend to forecast the next five annual dividends based on the five-year growth ratio.

c. Determine the long-term growth rate based on Johnson & Johnson’s payout ratio (Eq. 9.12).

d. Use the long-term growth rate to determine the stock price for year five (Eq. 9.13).

e. Determine the current stock price based on the dividend-discount model (Eq. 9.14).

6. To determine the stock value based on the discounted free cash flow method: a. Forecast the free cash flows using the historical data from the financial statements downloaded from Yahoo!Finance, Bloomberg or Capital IQ to compute the three-year average of the following ratios:

i. EBIT/Sales and NI/Sales

ii. Tax Rate

iii. Property Plant and Equipment/Sales and Depreciation/Property Plant and Equipment

iv. Net Operating Working Capital/Sales

v. Net Borrowing/Sales

b. Create a timeline for the next seven years.

c. Forecast future sales based on the first five years and the long-term growth rate for years 6-7.

d. Use the average ratios computed in part (a) to forecast EBIT, property, plant and equipment, depreciation, and net working capital for the next seven years.

e. Forecast the free cash flow for the next seven years (Eq. 9.18).

f. Determine the horizon enterprise value for year 5 (Eq. 9.24).

g. Determine the enterprise value of the firm as the present value of the free cash flows

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