CONSTRUCTING A WINNING STRATEGYPharmaceutical companies have long been - PDF document

CONSTRUCTING A WINNING STRATEGYPharmaceu
CONSTRUCTING A WINNING STRATEGYPharmaceutical companies have long been the growth stocks of choice for many investors. Their income wassteady and climbing, their stocks grew in value, and their growth appeared limitless as the population aged.Stakeholders pushed them to grow through acquisition of competitors, and encouraged them to further mar-ket existing drugs and pursue new product development. All looked rosy. The high profit margins from suc-$12$1020022003Valuing EquityJ&J is currently riding high while many other pharmaceutical companies are struggling. Says MasonTenaglia, a drug-industry consultant, J&J is Òcasting a broader net for innovationÑitÕs not just blockbusterdrugs. TheyÕve held their value or grown, and the pure pharma plays that everyone thought could grow for-ever are the companies that have lost their luster.Ó (Supported by its more diversified operations and fueled by a steady increase in operating profits, J&JÕsstock price has climbed steadily since late 2003, as shown here:Despite the run-up in stock price, however, analysts remain bullish, continuing to rate the J&J stock a ÒBUY.Ócontinue to rise? How do accounting measures of performance and financial condition impact this price? Thismodule provides insights and answers to these questions. It explains how we can use forecasts of operatingprofits and cash flows in pricing equity securities such as that of J&JÕs stock.Sources: The Wall Street JournalFebMarAprMayJunJulAugSepOctNovDecNovDeceas70119_mod11.qxd 2/15/05 11:20 AM Page 3Module 11: Analyzing and Valuing Equity Securitiesflows from investing activities. That is, FCFF reflects increases and decreases in net operating workingNOPAT NOPATStated differently, free cash flows to the firm equal net operating profit that is not used to grow net oper-net operating assets are normally negative. The sum of the two (positive or negative) represents the netavailable for distribution to creditors and shareholders either in the form of debt repayments, dividends, orthe remainder of the companyÕs life. Generating such forecasts is not realistic. Consequently, practi

cing1.Forecast and discount FCFF for the
cing1.Forecast and discount FCFF for the 2.Forecast and discount FCFF for the post-horizon period, called 3.Sum the present values of the horizon and terminal periods to yield firm (enterprise) value.4.Subtract net financial obligations (NFO) from firm value to yield firm equity value.5.Divide firm equity value by the number of shares outstanding to yield stock value per share.To illustrate, we apply DCF to our focus company, . J&JÕs recent financialstatements are reproduced in Appendix 11A. Forecasted financials for J&J (forecast horizon 2004Ð2007and terminal period 2008) are in Exhibit 11.1. These forecasts are based on analystsÕexpectations re-garding J&JÕs future operating results and balance sheet for the next four years.The forecasts (in bold)are for sales, NOPAT, and NOA. These forecasts assume an annual 8% (analystsÕconsensus) salesrent periodÕs 17.24% net operating profit margin (NOPM) and its 1.57 net operating asset turnover(NOAT).When discounting FCFF, the appropriate discount rate (weighted average cost of capital (WACC)), respectively: WACC ) present value of FCFF in perpetuity (beyond the horizon period) is given by, is WACC, and those cash flows. The resulting amount is then discounted back to the present using the horizon period discount factor.We use a four-period horizon in the text and assignments to simplify the exposition and to reduce the computational burden. InNOPATtaxes; it excludes any interest revenue and interest expense and any gains or losses from financial investments. NOPATreflects NOPATand NOAare typically forecasted using the detailed forecasting procedures discussed in Module 10. This module uses theFCFFTrwgeas70119_mod11.qxd 2/15/05 11:20 AM Page 5Module 11: Analyzing and Valuing Equity SecuritiesHorizon Period20032004200520062007Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 41,862$45,211$48,828$52,734$56,953$58,092NOPAT* . . . . . . . . . . . . . . . . . . . . . . . . .7,2167,7938,4179,0909,81710,014NOA* . . . . . . . . . . . . . . . . . . . . . . . . . .26,73328,87231,18133,67636,37037,097Increase in NOA . . . . . . . . . .

. . . . . . . . .2,1392,3092,4952,69472
. . . . . . . . .2,1392,3092,4952,694727FCFF (NOPAT Increase in NOA) . . . . .5,6546,1086,5957,1239,2879,287(rw)t] . . . . . . . . .0.941270.885980.833940.78496Present value of horizon FCFF . . . . . . . .5,3225,4125,5005,591Cum present value of horizon FCFF . . . .21,825Present value of terminal FCFF . . . . . . . .171,932Total firm value . . . . . . . . . . . . . . . . . . . .193,757 . . . . . . . . . . . . . . . . . . .(136)Firm equity value . . . . . . . . . . . . . . . . . .$193,893Stock outstanding . . . . . . . . . . . . . . . . . .2,968Stock value per share . . . . . . . . . . . . . . .$ 65.33*2003 computations: NOPAT(1-[$3,111/$10,308]) NFO is negative when investments exceed borrowings (such as for J&J); in this case NFO is added, not subtracted (see footnoteThe bottom line of Exhibit 11.1 is the estimated J&J equity value of $193,893 million, or a per sharestock value of $65.33. Present value computations use a 6.24% WACC(cally, we obtain this stock valuation as follows:Compute present value of horizon period FCFF.computed from the forecasted 2004 NOPATless the forecasted increase in 2004 NOA. The presentSimilarly, the present value of 2005so on through 2007. The sum of these present values (cumulative present valueCompute present value of terminal period FCFF.(1.0624)4$9,287 million0.0624 0.02TerminalThe weighted average cost of capital (WACC) for J&J is computed as follows:is the expected return to the entire market. The expressionThe cost of debt capital is the 3.66% after-tax weighted average rate on J&J borrowings as disclosed in its footnotes (5.23%-tax weighted average rate on J&J borrowings as disclosed in its footnotes (5.23%30% effective tax rate of J&J]).WACC is the weighted average of the two returns. For J&J, 90% is weighted on equity and 10% on debt, which reflects therelative proportions of the two financing sources in J&JÕs capital structure: (90% eas70119_mod11.qxd 2/15/05 11:20 AM Page 6Module 11: Analyzing and Valuing Equity SecuritiesEXHIBIT 11.3Advantages and Disadvantages of DCF and ROPI Valuation ModelsModelAdvantagesDisadvantagesPerform

s Best¥ When financialstatements refle
s Best¥ When financialstatements reflect allreported off-balance-¥ Financial statements do not reflect all company assets,¥ Requires some knowledge of accrual accounting¥ Focuses on value drivers suchas profit margins and asset¥ Uses both balance sheet and¥ Reduces weight placed on¥ When the firm reports¥ When FCFF grows at arelatively constant rate¥ Cash investments in plant assets are treated as cash outflows,even when creating shareholder value¥ No recognition of value unless evidenced by cash flows¥ Computing FCFF can be difficult as operating cash flows areaffected byÑCutbacks on investments (receivables, inventories, plantÑTax benefits of stock option exercise; but likely aretransitory as they depend on maintenance of currentÑGAAP treats securitization as an operating cash flow¥ Popular and widely accepted¥ Cash flows are unaffected by¥ FCFF is intuitiveothers do not. Aquick review of selected models follows:number. That financial number varies across investors but is usually one of the following: net income, netsales, book value of equity, total assets, or cash flow. Companies are then compared with competitors ondraws on the financial reporting system to assign value. That is, eq-ties for several perceived shortcomings in GAAPprior to computing net asset value. This method is alsopredicts that equity valuation or stock values equal the present valueof expected cash dividends. This model is founded on the dividend discount formula and depends on thevelopment outlays, accounting rates of return, cash recovery rates, and real option models. Further, somechart price behavior over time and use it to predict equityRESEARCH INSIGHTImplementation of the ROPI model can include parameters to capture differences in growth opportuni-ties, persistence of ROPI, and the conservatism in accounting measures. Research finds differences in howsuch factors, across firms and over time, affect ROPI and changes in NOA. This research also hints thatinvestors do not understand the properties underlying these factors and, consequently, individual stocksare mispriced for short periods of time. Othe

r research contends that the apparent mi
r research contends that the apparent mispricing is due to anomitted valuation variable related to riskiness of the firm.eas70119_mod11.qxd 2/15/05 11:20 AM Page 12(Dollars in Millions)200320022001Sales to customers$41,862$36,298$32,317Cost of products sold12,17610,4479,581Gross profit29,68625,85122,736Selling, marketing and administrative expenses14,13112,21611,260Research expense4,6843,9573,591Purchased in-process research and development918189105Interest income(177)(256)(456)Interest expense, net of portion capitalized207160153Other (income) expense, net(385)29418519,37816,56014,838Earnings before provision for taxes on income10,3089,2917,898Provision for taxes on income3,1112,6942,230Net earnings$ 7,197$ 6,597$ 5,668At December 28, 2003 and December 29, 2002 (Dollars in Millions Except Share and Per Share Data)20032002Current assetsCash and cash equivalents$ 5,377$ 2,894Marketable securities4,1464,581Accounts receivable trade, less allowances for doubtful accounts $192 (2002, $191)6,5745,3993,5883,303Deferred taxes on income1,5261,419Prepaid expenses and other receivables1,7841,670Total current assets22,99519,266Marketable securities, non-current84121Property, plant and equipment, net9,8468,710Intangible assets, net11,5399,246Deferred taxes on income6922363,1072,977Total assets$48,263$40,556Liabilities and ShareholdersÕ EquityCurrent liabilitiesLoans and notes payable$ 1,139$ 2,1174,9663,6212,6392,059Accrued rebates, returns and promotions2,3081,761Accrued salaries, wages and commissions1,4521,181Accrued taxes on income944710Total current liabilities13,44811,449Module 11: Analyzing and Valuing Equity Securitieseas70119_mod11.qxd 2/15/05 11:20 AM Page 14Module 11: Analyzing and Valuing Equity Securities(Continued from previous page)(Continued)At December 28, 2003 and December 29, 2002 (Dollars in Millions Except Share and Per Share Data)20032002Liabilities and ShareholdersÕ Equity$ 2,955$ 2,022Deferred tax liability780643Employee related obligations2,2621,9671,9491,778ShareholdersÕ equityPreferred stockÑwithout par value (authorized and unissued 2,000,000 shares)ÑÃ

‘Common stockÑpar value $1.00 per share
‘Common stockÑpar value $1.00 per share (authorized 4,320,000,000 shares; issued 3,119,842,000 shares)3,1203,120Note receivable from employee stock ownership plan(18)(25)Accumulated other comprehensive income(590)(842)30,50326,57133,01528,824Less: common stock held in treasury, at cost (151,869,000 and 151,547,000)6,1466,127Total shareholdersÕ equity26,86922,697Total liabilities and shareholdersÕ equity$48,263$40,556(Dollars in Millions)200320022001Cash flows from operating activitiesNet earnings$ 7,197$6,597$5,668Adjustments to reconcile net earnings to cash flowsDepreciation and amortization of property and intangibles1,8691,6621,605Purchased in-process research and development918189105Deferred tax provision(720)(74)(106)Accounts receivable reserves6(6)99Changes in assets and liabilities, net of effects from acquisition of businessesIncrease in accounts receivable(691)(510)(258)Decrease (increase) in inventories39(109)(167)Increase in accounts payable and accrued liabilities2,1921,4201,401Increase in other current and non-current assets(746)(1,429)(270)Increase in other current and non-current liabilities531436787Net cash flows from operating activities10,5958,1768,864Cash flows from investing activitiesAdditions to property, plant and equipment(2,262)(2,099)(1,731)Proceeds from the disposal of assets335156163Acquisition of businesses, net of cash acquired(2,812)(478)(225)Purchases of investments(7,590)(6,923)(8,188)Sales of investments8,0627,3535,967(259)(206)(79)Net cash used by investing activities(4,526)(2,197)(4,093)Cash flows from financing activitiesDividends to shareholders(2,746)(2,381)(2,047)Repurchase of common stock(1,183)(6,538)(2,570)Proceeds from short-term debt3,0622,359338Module 11: Analyzing and Valuing Equity Securities(Continued from previous page)(Continued)(Dollars in Millions)200320022001Cash flows from financing activitiesRetirement of short-term debt$(4,134)$ (560)$(1,109)Proceeds from long-term debt1,0232214Retirement of long-term debt(196)(245)(391)Proceeds from the exercise of stock options311390514Net cash used by financing activities(3,863)(6,953)(5,251)Ef

fect of exchange rate changes on cash an
fect of exchange rate changes on cash and cash equivalents277110(40)Increase/(decrease) in cash and cash equivalents2,483(864)(520)Cash and cash equivalents, beginning of year2,8943,7584,278Cash and cash equivalents, end of year$ 5,377$2,894$3,758Q11-1.Explain how information contained in financial statements is useful in pricing securities. Are there somecomponents of earnings that are more useful than others in this regard? What nonfinancial informationQ11-2.In general, what role do expectations play in pricing equity securities? What is the relation betweensecurity prices and expected returns (the discount rate, or WACC, in this case)?Q11-3.MANAGERIAL DECISIONYou Are the Division ManagerCash flow is increased with asset reductions. For example, receivables are reduced by the following:¥Encouraging up-front payments or progress billings on long-term contracts¥Increasing credit standards to remove slow-paying accounts before sales are made¥Monitoring account age and sending reminders to past due customers¥Selling accounts receivable to a financial institution or special purpose entityAs another example, plant assets are reduced by the following:¥Selling unused or excess plant assets¥Forming alliances with other companies for special purpose plant asset requirements¥Owning assets in a special purpose entity with other companies¥Selling production facilities to a contract manufacturer and purchasing the outputMANAGERIAL DECISIONYou Are the Operations ManagerRNOA can be disaggregated into its two key drivers: NOPAT margin and net operating asset turnover.NOPAT margin can be increased by improving gross profit margins (better product pricing, lower costmanufacturing, etc.) and closely monitoring and controlling operating expenses. Net operating assetturnover can be increased by reducing net operating working capital (better monitoring of receivables,better management of inventories, extending payables, etc.) and making more effective use of plant as-sets (disposing of unused assets, forming corporate alliances to increase plant asset capacity, selling pro-ductive assets to contract produ

cers and purchasing the output, etc). Th
cers and purchasing the output, etc). The ROPI model effectively focusesandincome statement.eas70119_mod11.qxd 2/15/05 11:20 AM Page 16Module 11: Analyzing and Valuing Equity SecuritiesE11-14.Estimating Share Value using the DCFand ROPI ModelsAbercrombie &Õs sales, net operating profit after tax (NOPAT), and net operating assets (NOA)as of January 31, 2003:Horizon Period(In millions)2004200520062007Sales . . . . . . . . . . . .$1,708$1,879$2,067$2,274$2,501$2,551NOPAT . . . . . . . . . .203223246270297303NOA . . . . . . . . . . .8619471,0421,1461,2611,286Answer the following requirements assuming a discount rate (WACC) of 10.0%, common shares outstand-Estimate the value of a share of Abercrombie & Fitch common stock using the (1) discounted cashestimate compare with this closing price? What do you believe are some reasons for the difference?E11-15.Estimating Share Value using the DCFand ROPI Modelssales, net operating profit after tax (NOPAT), and net operating assets (NOA)as of January 29, 2004:Horizon Period(In millions)2005200620072008Sales . . . . . . . . . . .$35,436$36,499$37,594$38,722$39,884$40,682NOPAT . . . . . . . . .809833858884911929NOA . . . . . . . . . . .10,70511,02611,35711,69812,04912,290Answer the following requirements assuming a discount rate (WACC) of 6.5%, common shares outstand-Estimate the value of a share of AlbertsonÕs common stock using the (1) discounted cash flow (DCF)compare with this closing price? What do you believe are some reasons for the difference?E11-16.Identifying and Computing Net Operating Assets (NOA) and Net Financial Obligations (NFO)Current assetsCash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Accounts receivableÑnet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Investm

ents . . . . . . . . . . . . . . . . . .
ents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Property, plant and equipmentÑnet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .(Continued on next page)TerminalTerminal& Fitch (ANF)(ABS)Module 11: Analyzing and Valuing Equity Securities(Continued from previous page)Current liabilitiesShort-term borrowings and current portion of long-term debt . . . . . . . .Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Accrued payroll . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Accrued income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Common stock, par value $.01 per share . . . . . . . . . . . . . . . . . . . . . . . .Shares outstandingÑ2003: 784,117,360Shares outstandingÑ2002: 780,391,362Capital in excess of par value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Unearned compensation . . . . . . . . .
Unearned compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Accumulated other comprehensive income (loss) . . . . . . . . . . . . . . . . . .StockholdersÕ equityÑnet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Total liabilities and stockholdersÕ equity . . . . . . . . . . . . . . . . . . . . . . . .StockholdersÕequity.E11-17.Identifying and Computing Net Operating Profit afterTax (NOPAT) and Net Financial ExpenseYear Ended December 31 (Millions)20022001Net sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$16,332$16,054Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8,4968,749Selling, general and administrative expenses . . . . . . . . .3,7204,036Research, development and related expenses . . . . . . . .1,0701,084Other expense (income) . . . . . . . . . . . . . . . . . . . . . . . .Ñ(88)Total operating expenses . . . . . . . . . . . . . . . . . . . . . .13,28613,781Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3,0462,273Interest expense and incomeInterest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .80124Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .(39)(37)Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4187Income before income taxes and minority interest . . . . . .3,0052,186Provision for income taxes . . . . . . . . . . . . . . . . . . . . . . . .966702Minority interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6554Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 1,974$ 1,430Module 11: Analyzing and Valuing Equity Securities(Continued from previous page)Income Statement (Continued)Years Ended May 31, (In millions)20032002$1,471$ 1,321Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .(124)(144)Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . .(15)(22)(133)(16
. . . . . . . . . . . .(15)(22)(133)(161)Income Before Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1,3381,160Provision for Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .508435Income Before Cumulative Effect of Change in Accounting Principle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .830725Cumulative Effect of Change in Accounting for Goodwill, Net of Tax Benefit of $10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Ñ(15)$ 830$ 710Balance SheetCurrent AssetsCash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Receivables, less allowances of $151 and $149 . . . . . . . . . . . . . . . . . . . . .Spare parts, supplies and fuel, less allowances of $124 and $101 . . . . . . .Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Prepaid expenses and other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Property and Equipment, at CostAircraft and related equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Package handling and ground support equipment and vehicles . . . . . . . . .Computer and electronic equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Less accumulated depreciation and amortization . . . . . . . . . . . . . . . . . . . .Net property and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Other Long-Term AssetsGoodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Prepaid pension cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Intangible and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Total other long-term assets . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . .Total AssetsCurrent liabilitie
. . . . .Total AssetsCurrent liabilitiesCurrent portion of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Accrued salaries and employee benefits . . . . . . . . . . . . . . . . . . . . . . . . . .Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Long-Term Debt, Less Current Portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Other Long-Term LiabilitiesDeferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .eas70119_mod11.qxd 2/15/05 1:25 PM Page 21Module 11: Analyzing and Valuing Equity Securities(Continued from previous page)(Continued)Pension, postretirement healthcare and other benefit obligations . . . . . . .Self-insurance accruals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Deferred lease obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Deferred gains, principally related to aircraft transactions . . . . . . . . . . . . .Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Total other long-term liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Common stock, $0.10 par value; 800 million shares authorized; 300 million shares issued for 2004 and 299 million shares issued for 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Additional paid in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Accumulated other comprehensive loss . . . . . . . . . . . . . . . . . . . . . . . . . . .Less deferred compensation and treasury stock, at cost . . . . . . . . . . . . . . .Total common stockholders investment . . . . . . . . . . . . . . . . . . . . .

. . . .Total liabilities and shareholde
. . . .Total liabilities and shareholdersÕ investmentCompute net operating assets (NOA) and net financial obligations (NFO) for fiscal year-end 2004.StockholdersÕequity.Compute net operating profit after tax (NOPAT) and net financial expense (NFE) for fiscal yearNOPATForecast FedExÕsales, NOPAT, and NOAfor fiscal years 2005 through 2008 using the followingSales growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10%Net operating profit margin (NOPM) . . . . . . . . . . . . .7%Net operating asset turnover (NOAT) . . . . . . . . . . . .2.13and NOATassumptions above.(WACC) of 6.9%, common shares outstanding of 784 million, and net financial obligations (NFO) ofHow does your valuation estimate compare with this closing price? What do you believe are somereasons for the difference? What investment position is suggested from your results?P11-22.Forecasting and VYears Ended December 31 (In thousands)200320022001Net revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$4,624,274$4,090,970$3,406,786Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . .2,958,7082,673,1292,253,815Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1,665,5661,417,8411,152,971Financial services income . . . . . . . . . . . . . . . . . . . . . .279,459211,500181,545Financial services expense . . . . . . . . . . . . . . . . . . . . .111,586107,273120,272Operating income from financial services . . . . . . . . .167,873104,22761,273Selling, administrative and engineering expense . . . .684,175639,366551,743(Continued on next page)Davidson(HDI)Module 11: Analyzing and Valuing Equity Securities(Continued)December 31, (In thousands)2003Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 1Other prepaid expenses and receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1,786,919Total Current Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1Investment securities . . . . . . . . . . . . .

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. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .406,357Property and equipment, at costLand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .356,757Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2,662,023Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9,479,044Construction in progress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .792,923Less: accumulated depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7,008,941Net property and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6,281Intangible assets, net of amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4,089Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4,449,408Deferred income taxes, investments in joint ventures and other assets . . . . . . . . . . . . . . . . .1,197,474Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$26,715,342Current LiabilitiesShort-term borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ Trade accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1,754Salaries, wages and commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .625,525Other accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2,Dividends payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38Income taxes payable

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. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .158Current portion of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1,709,265Total Current Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3,452,329Post-employment obligations and other long-term liabilities . . . . . . . . . . . . . . . . . . . . . . . . .2,551,220ShareholdersÕ investment:Preferred shares, one dollar par, AuthorizedÑ1,000,000 shares, none issued . . . . . . . . . .ÑCommon shares, without par value, AuthorizedÑ2,400,000,000 shares; Issued at stated capital amountÑShares: 1,580,247,227 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3,034,054Common shares held in treasury, at costÑShares: 15,729,296 . . . . . . . . . . . . . . . . . . . . .$ (229,696)Unearned compensationÑrestricted stock awards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .(56,336)Earnings employed in the business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9,691,484Accumulated other comprehensive income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .632,752Total shareholdersÕ investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13,072,Total liabilities and shareholdersÕ investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$26,715Compute net operating assets (NOA) and net financial obligations (NFO) for year-end 2003. ShowShareholdersÕInvestment.Compute net operating profit after tax (NOPAT) and net financial expense (NFE) for 2003.Treat equity income from TAPPharmaceutical Products, foreign exchange loss, and otherNOPATForecast Abbott LaboratoriesÕsales, NOPAT, and NOAfor 2004 through 2007 using the followingSales growth11.30%Net operating profit margin (NOPM)14.53%Net operating asset turnover (