As a new junior analyst for a large brokerage firm, you are excited to demonstrate the skills you learned in college and prove that you are worth your attractive salary. Your first assignment is t o analyze Johnson & Johnson stock. Your boss recommends determining prices based on both the discounted free cash flow valuation method and the comparable P/E ratio method. You are a little concerned about your bosss recommendation because your finance pr ofessor explained that these two valuation methods can result in widely differing estimates when applied to real data. You are really hoping that the two methods will reach similar prices. Good luck with that!

a. Go to Reuters ( http://www.reuters.com ) and enter the symbol for Johnson & Johnson (JNJ) in the Search box, then select Johnson and Johnson. From the main page for JNJ, gather the following information, and enter it into a spreadsheet (For any missing informati on, you can use Yahoo Finance):

i. The current stock price

ii. The EPS (TTM)

iii. The number of shares of stock outstanding

iv. The industry P/E (TTM) ratio

b. Click the Analysts tab. On the Analyst page, scroll down to find the LT (Long - Term) Growth Rate and enter the Mea n value into your spreadsheet.

c. Go to Morningstar ( http://www.morningstar.com ) and enter JNJ into the Quote box.

d. Under Financials, click Income Statement. Copy and paste (or use the Export to Excel button to create a new file with the data) the most recent three years worth of income statements into a new worksheet in your existing Excel file. Repeat this process for both the balance sheet and the cash flow statement for Johnson and Johnson. Keep all the diff erent statements in the same Excel worksheet. Note: Make sure you are collecting annual data, rather than quarterly or interim data.

e. To determine the stock value based on the discounted free cash flow method:

i. Forecast the free cash flows. Start by using th e historical data from the financial statements downloaded from Morningstar to compute the three - year average of the following ratios:

1. EBIT/sales

2. Tax rate (income tax expense/income before tax)

3. Property plant and equipment/sales

4. Depreciation/property plant and equipment

5. Net working capital/sales

ii. Create an empty timeline for the next five years.

iii. Forecast future sales based on the most recent years total revenue growing at the LT growth rate from Reuters for the first five years.

iv. Use the average ratios compu ted in part (i) to forecast EBIT, property, plant and equipment, depreciation, and net working capital for the next five years.

v. Forecast the free cash flow for the next five years.

vi. Determine the horizon enterprise value for year 5 using a long - run growth r ate of 4% and a cost of capital for JNJ of 11%.

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

viii. Determine the stock price. Note that y ou need to subtract excess cash to find m arket value of equity. A common assumption among practitioner s is that the compan y would use cash in operation s as much as 2% of sales. Any extr a cash would then be classified as excess cash.

To calculate an estimate of JNJ price based on a comparable P/E ratio, multiply the industry average P/E ratio by JNJ EPS. g. Compare the stock prices produced by the two methods to the actual stock price. What recommendations can you make as to whe ther clients should buy or sell JNJ stock based on your price estimates? h. Explain to your boss why the estimates from the two valuation methods differ. Specifically address the assumptions implicit in the models themselves as well as the assumptions you mad e in preparing your analysis. Why do these estimates differ from the actual stock price of JNJ?