Capital Budgeting Analysis Johnson & essay

Download this essay in word format (.doc)

Note: Sample below may appear distorted but all corresponding word document files contain proper formatting

Excerpt from essay:

Approximately 19% of the short-term liabilities in the form of notes payable and other short-term debt.

The long-term liabilities consist of long-term debt and other miscellaneous liabilities. The debt portion of this represents approximately 39% of the total long-term liabilities. Johnson & Johnson has issued notes onto the market that mature in 2017, comprising the bulk of the long-term debt.

The calculate the market value capital structure of JNJ, we need to find estimates of the market value for their long-term liabilities and their equity. For short-term liabilities, we will assume that because the maturity is under one year, the market value and the book value will be sufficiently similar to one another.

As of market close on Friday August 1, 2008, Johnson & Johnson had 2818.19 million shares outstanding. The price of their stock was $68.61. This gives them a market capitalization for their equity of $191,918.91 million.

The market value of their long-term liabilities can be estimated based on the market value of their outstanding long-term debt, the 2017 note. This bond has a coupon of 5.55 and a maturity of 15-Aug-2017. This bond is currently priced at 105.61 on the open market. This price represents the net present value of those cash flows, both the interest and the principle.

JNJ also has another long-term bond on the market. This bond has a maturity of 15-Aug-2037. The coupon on this bond is 5.95%, and the price is 108.90. For the majority of JNJ's long-term debt, the "other long-term liabilities," we do not know the structure or nature. Therefore, we shall have to extrapolate the information from the marketed securities and apply it to the other long-term liabilities in order to achieve an estimate of the market value.

To do this, we will average the price of the two bonds on the market, to get an average price of 107.255. The securities would have been issued at par value, which is reflected in the book value. So the average price of the debt currently on the market represents the appreciation over the book value. This gives us a market value for the long-term debt of 107.255 * 18,299 = 19,626.59.

Therefore, the market value capital structure of Johnson & Johnson is as follows:


Short-Term Liabilities

Long-Term Liabilities

So we can see that the capital structure based on book value is much more heavily weighted towards equity. This reflects a couple of factors. One is that JNJ is not highly leveraged. They have only a couple of major public debt issues, which means that the majority of their liabilities both short-term and long-term flow from operations.

Another factor at play is the disparity between the balance sheet and the stock market valuation. The balance sheet stock issue is low, with the majority of the equity being retained earnings. The stock market, however, is basing its valuation based on expectations of future performance. Retained earnings only reflects past performance, since the profit needs to be earned before it can be translated to the balance sheet.

Weighted Average Cost of Capital

There are several components to the WACC of Johnson & Johnson. We will first compute the before-tax cost of debt, both short-term and long-term. For the short-term debt, we will use an estimate based on the 3-month non-financial CD rate. This is 2.21%.

We shall base the long-term cost of capital on the average yield to maturity of JNJ's two long-term debt issues. The 2017 issue has a YTM of 4.831%, and the 2037 issue has a YTM of 5.09%. The average of yield to maturity of these two issues is 5.09%.

Next, we shall determine the tax rate so that we may calculate the after-tax cost of short-term and long-term debt. This is an important consideration because interest expense comes off of the income statement before taxes are applied. Therefore, one must compare after-tax cost of debt vs. The cost of equity, which is not subject to tax deduction.

Corporate tax rates fluctuate each year for a variety of reasons. In the case of Johnson & Johnson, their income tax provision for 2007 was significantly lower than it was in the preceding five years, at 20.3%. This is compared with the provisions from the previous four years ranging from 23.2% to 33.6%. Therefore, it is reasonable to assume that the tax rate for JNJ is typically going to higher than the 2007 number. Since the numbers of 2003 and 2004 are far above what they have paid in the past three years, we will estimate their tax rate based on the past three years only. The average tax rate for the past three years has been 22.5%.

The after tax cost of debt is calculated as After-tax dost of debt = (before tax cost of debt) * (1 - tax rate)

When applied to the before-tax short-term cost of debt, the after-tax cost of short-term debt is 1.7127%. When applied to the before-tax cost of long-term debt, the after-tax cost of long-term debt is 3.944%.

To estimate the cost of equity, we can use several different models. The first we shall use is CAPM. The CAPM formula is as follows:

Ra = Rf + B (Rm-Rf), with JNJ being Ra.

The risk free rate is represented by a one-year government security. That rate is 2.32%. The market rate is represented by the average long-term return on the S&P 500 is approximately 7%. The beta for JNJ is 0.34. This gives us a CAPM calculation of:

Ra = 2.32 + (0.34)(7-2.32), which computes to a cost of equity for Johnson & Johnson of 3.9112%.

Another model is the discounted cash flow model. The DCF calculation is as follows:

(D/P)*(1+g)+g, where k is the discount rate, D is the dividend, P is the stock price, and g is the expected dividend growth rate. The current dividend is $1.84, and the current stock price is $68.61. The dividend growth over the past five years has been 15.3%, so a 3.06% average. Thus the DCF calculation is:

(1.84 / 68.61) * (1 +.0306) +.0306, which gives us a discount rate of 5.82%

The third method for calculating the cost of equity is bond yield plus risk premium. The bond yield we established as 5.09%. The risk premium on JNJ is reflected it its beta, and the risk-free bond rate is 2.21%. With a beta of 0.34, the risk premium is 0.75, so the cost of equity is 5.84% using this method.

The component cost of equity for Johnson & Johnson can be considered an aggregate of the costs of equity determined by these three methods, so 5.19%.

The weighted average cost of capital evaluates the relative costs of capital of short-term and long-term debt and the cost equity. Again, JNJ has no preferred shares. The weightings used are the market value weightings, and the debt costs of capital should be the after-tax costs of capital, since interest expense is a before-tax cash flow.


Market Value


Cost %


ST Liabilities

LT Liabilities

Shareholder's Equity

Therefore the WACC of JNJ is calculated as follows:

This gives us a weighted-average cost of capital for JNJ of 4.7568%.

Cash Flow Estimation

The first step in the cash flow estimation of the project is to calculate the applicable MACRS allowances. The project falls into the 7-year MACRS class, and the initial outlay is $120M. This gives us the following MACRS chart:

Outlay $120-Year 1-2 3-4 5-6 7-8 MACRS 0.1429 0.2449 0.1749 0.1249 0.0893 0.0892 0.0893 0.0446 Depreciation charge 17.15-29.39-20.99-14.99-10.72-10.70-10.72 5.35

The estimate the annualized cash flows, we need to determine the annual revenue stream, the annual variable cost stream, and the annual operating cost stream. These calculations are as follows:

Products Sold 800000 864000 933120 1007770 1088391 1175462 1269499 1371059 Price 200-200 200-200 200-200 200-200 Revenue (millions) 160-172.8 186.624-201.5539 217.6782 235.0925 253.8999 274.2119 VC 120-133.488-148.4921 165.1826 183.7491 204.4025 227.3773 252.9345 NOWC 19.2-20.736 22.39488 24.18647 26.12139 28.2111 30.46799 32.90543 net 20.8-18.576 15.73707 12.18489 7.807768 2.47892 -3.94541 -11.6281 vc increase factor 1.03 baseline vc 150-154.5 159.135-163.9091 168.8263 173.8911 179.1078 184.4811

To this information we then add the initial outlay, salvage value, and then account for the tax. This gives us the final cash flow chart:

Year 0-1 2-3 4-5 6-7-8 Outlay -120 Install -8 Revenue stream 20.8-18.576 15.737 12.184 7.807 2.478 -3.945 -11.628 Salvage 30 Net cash flow -128 20.8-18.576 15.737 12.184 7.807 2.478 -3.945 18.372 Tax 51.2 -8.32 -7.4304 -6.2948 -4.8736 -3.1228 -0.9912 1.578 -7.3488 Tax effect of depreciation 6.8592 11.7552 8.3952 5.9952 4.2864 4.2816 4.2864 2.1408 After tax flow -76.8-19.3392 22.9008 17.8374 13.3056 8.9706 5.7684 1.9194 13.164 tax = 40.00% WACC 4.7568% the timeline representation of these flows is as follows:

Capital Budgeting Analysis

The WACC I have calculated is 4.7568%. Applying this WACC to the cash flows calculated above, the net present value (NPV) of the project is:

After tax flow -76.8-19.33-22.9-17.83-13.3-8.97 5.76 1.91-13.16-Year 0-1 2-3 4-5 6-7-8 WACC 4.7568% Present Value -76.8-18.452 20.868 15.510 11.044 7.110 4.358 1.380 9.074 NPV…[continue]

Cite This Essay:

"Capital Budgeting Analysis Johnson & " (2008, August 04) Retrieved December 6, 2016, from

"Capital Budgeting Analysis Johnson & " 04 August 2008. Web.6 December. 2016. <>

"Capital Budgeting Analysis Johnson & ", 04 August 2008, Accessed.6 December. 2016,

Other Documents Pertaining To This Topic

  • Capital Project Analysis

    Capital Project According to the AMA, capital budgeting is "the decision-making process used by companies to evaluate long-term investments in large capital assets" (Hampton, 2011). Zeit (2013) makes the point that construction projects are included in the category of capital investment decisions, and that designers and architects are often involved. Reiter et al. (2000) argue that because of their size and critical strategic nature, "capital investment decisions are among the most

  • Capital Structure the Three Companies Selected for

    Capital Structure The three companies selected for this report are eBay, Clorox, and Darden Restaurants. eBay is an online auction website, acting as an intermediary between buyers and sellers. Clorox is described as being a manufacturer and marketer of consumer and institutional cleaning and household products. Some of its brands are the eponymous cleaners, Brita water filters, Burt's Bees and a variety of other brands as well. Darden Restaurants operates casual

  • Budgeting and Financial Planning Distinctions Between Budgeting

    Budgeting and Financial Planning Distinctions between budgeting & financial planning. The difference between budgeting and financial planning The difference between budgeting and financial planning Budgeting and financial planning are often used interchangeably in the speech of laypersons, when they are talking about the economic outlook of organizations. They are, however, very different processes, although the two are interrelated. One analogy is that of someone trying to maneuver the organization like a rowboat over a

  • Budgeting a School Budget Table

    Their insights can help to determine the longer term impact on them. Students were included because they can show how these cuts will affect them and offer ideas about ways to possibly offset them. Teachers can discuss how certain decreases will affect the quality of education and their ability to educate students. (Lunnenburg, 2011) (Olden, 2012) The people who are excluded from the budgetary process were selected because they can

  • Analysis of Quantitative Research the

    While the research paper could perhaps elaborate further on why some of the vehicles that interfere with librarian visitors are present, if considering that those vehicles identified are in fact problems, the paper does have a convincing design proposal. The design proposal of this report is very straightforward in purpose and procedure, and is complete in its scope. I found it particularly interesting that the solicitors outside the library were noted. This aids to a complete

  • Analysis American Airlines

    American Airlines: Analysis and Discussion American Airlines History (adopted from American Airlines, 2011) American Airlines was formed in 1934 through the consolidated act of American Airways Inc. And several airline subsidiaries that had been acquired by the Aviation Corporation between 1929 and 1930. Cyrus Smith Rowlett was elected president -- a position he held until his appointment as U.S. Secretary of Commerce in 1968. By 1940, American had become the leading domestic carrier

  • Johnson and Johnson Annual Report Review Financial

    Johnson and Johnson Annual Report Review Financial Report Review Company: Johnson and Johnson Consolidated Balance Sheets Total Assets: $121,347,000,000 Total Liabilities: $56,521,000,000 Total Shareholder's Equity: $64,826,000,000 Company's Retained Earnings: 85,992,000,000 Shares of common stock the company has been authorized to issue: 4,320,000,000 shares Shares the company has issued: 3,119,843,000 shares Cash (cash and cash equivalents): $14,911,000,000 Decrease in cash and cash equivalents during 2012: $9,631,000,000 F: Increase in cash and cash equivalents during 2011: $5,187,000 Consolidated Statement of Earnings Essentially, the term "consolidated" as used

Read Full Essay
Copyright 2016 . All Rights Reserved