As a new junior analyst for a large brokerage firm, your first assignment is to analyze Johnson & Johnson stock. Your boss recommends determining prices based onboththediscounted free cash flow...

As a new junior analyst for a large brokerage firm, your first assignment is to analyze Johnson & Johnson stock. Your boss recommends determining prices based onboththediscounted free cash flow valuationmethod and thecomparable P/E ratiomethod.

1. 
   

   Go to Reuters (http://www.reuters.com) and enter the symbol for Johnson & Johnson (JNJ) in the “Search Reuters” box, then select Johnson and Johnson. From the main page for JNJ, click “OVERVIEW” tab, gather the following information, and enter it into a spreadsheet:

   
   
   
   
   1. 
      

      The current stock price

      
      
   
   
   2. 
      

      The EPS (TTM, which means ‘trailing twelve months’)

      
      
   
   
   3. 
      

      The number of shares outstanding

      
      
   
   
   4. 
      

      TheindustryP/E ratio (TTM)

      
      
   
   
   
   


2. 
   

   Click the “ANALYSTS” tab. On the Analyst page, scroll down to find the LT (Long-Term) Growth Rate and enter it into your spreadsheet. (Feel free to choose one of the ‘Mean’, ‘High’, ‘Low’, or ‘1 Year Ago’ value.) This is thesalesgrowth rate projection for the upcoming5 years.

   
   


3. 
   

   Go to Yahoo Finance (http://finance.yahoo.com/) and type “JNJ” into the “Search” box. Under “FINANCIALS” of JNJ, choose “Income Statement” and “Annual Data” frequency. Copy and paste the most recentthreeyears’ worth of the following data items into your Excel file.

   
   
   
   
   1. 
      

      Total Revenue

      
      
   
   
   2. 
      

      Earnings Before Interest And Taxes

      
      
   
   
   3. 
      

      Income Before Tax

      
      
   
   
   4. 
      

      Income Tax Expense

      
      
   
   
   
   


4. 
   

   Now choose “Cash Flow” statement and “Annual Data” frequency, and repeat the same process for the three years’ worth of the following cash flow statement items:

   
   

1

1. 
   

   Depreciation

   
   


2. 
   

   Capital Expenditures(*Note that this item is listed as minus value to indicate it is cash

   
   

   outflows. Therefore, use theabsolutevalue for the ‘size’ of capital expenditures.)

   
   

5. 
   

   Now choose “Balance Sheet” and “Annual Data” frequency, and repeat the same process for

   
   

   the three years’ worth of the following balance sheet items:

   
   
   
   
   1. 
      

      Total Current Assets

      
      
   
   
   2. 
      

      Total Current Liabilities

      
      
   
   
   3. 
      

      Short/Current Long Term Debt

      
      
   
   
   4. 
      

      Long Term Debt

      
      
   
   
   5. 
      

      Cash And Cash Equivalents

      
      
   
   
   
   


6. 
   

   To determine the stock value based on thediscounted free cash flow method:

   
   
   
   
   1. 
      

      Based on the historical data from the financial statements downloaded from Yahoo Finance,compute the following ratios foreachof the three years and take theaverage:

      
      
      
      
      1. 
         

         EBIT-to-sales ratio (=Earnings Before Interest And Taxes/Total Revenue)

         
         
      
      
      2. 
         

         Tax rate (=Income Tax Expenses/Income Before Tax)

         
         
      
      
      3. 
         

         Depreciation-to-sales ratio (=Depreciation/ Total Revenue)

         
         
      
      
      4. 
         

         Capex-to-sales ratio (=Capita Expenditures/Total Revenue)

         
         
      
      
      5. 
         

         NWC-to-sales ratio (=[Total Current Assets–Total Current Liabilities]/ Total Revenue)

         
         
      
      
      
      
   
   
   2. 
      

      Forecast future (annual) salesfor the nextfiveyears, starting from the most recent year’s Total Revenue (Sales0) growing at the 5-year growth rate obtained from Reuter (in Question 2) foreachof the next five years.

      
      
   
   
   3. 
      

      Use theaverageratios computed in part (a) toforecast the following itemsforeachof the next five years:

      
      
      
      
      1. 
         

         EBIT (=Total Revenue each year × EBIT-to-sales ratio)

         
         
      
      
      2. 
         

         EBIT× (1-t) (=EBIT each year× (1- Tax rate))

         
         
      
      
      3. 
         

         Depreciation (=Total Revenue each year × Depreciation-to-sales ratio)

         
         
      
      
      4. 
         

         Capital expenditures (=Total Revenue each year × Capex-to-sales ratio )

         
         
      
      
      5. 
         

         Net working capital (=Total Revenue each year × NWC-to-sales ratio)

         
         
      
      
      6. 
         

         Increasein net working capital (=this year’s NWC−previous year’s NWC)

         
         
      
      
      
      
   
   
   
   

2

4. 
   

   Forecast the free cash flowforeachof the next five years using the free cash flow equation.

   
   


5. 
   

   Determine theterminal enterprise valueat the end of year 5 (EV5) using following equation and a long-run constant FCF growth rate of3%and a WACC of6%.

   
   

   EV5=FCF6=FCF5×(1+gFCF)rwacc−gFCFrwacc−gFCF

   
   


6. 
   

   Determine thecurrent enterprise value(EV0) of JNJ as the sum of present values of the five year free cash flows plus terminal enterprise value, i.e.:

   
   

   EV=FCF+FCF+FCF+FCF+FCF+EV123455

   
   

0(1+rwacc) (1+rwacc)2(1+rwacc)3(1+rwacc)4(1+rwacc)5

g. Find debt amount outstanding (=Short/Current Long Term Debt + Long Term Debt) and cash amount (Cash And Cash Equivalents) based on the most recent year’s financials. Determine thestock priceusing the following equation:

P=EV0−Debt0+Cash0
0Numberof sharesoutstanding-0

Note:Make sure to match units.

7. 
   

   To calculate an estimate of JNJ’s stock price based on acomparable P/E ratio, multiply the

   
   

   industry average P/E ratio by JNJ’s EPS.

   
   


8. 
   

   Compare the stock prices produced by the two methods to the actual stock price. Explain to your boss why the estimates from the two valuation methods may differ. Specifically address the assumptions implicit in the models themselves as well as the assumptions you made in preparing your analysis.