Question

​​​​​​For my Accounting project I need to answer the following questions:

1. Based on your analysis and company research would you, as a bank-lending officer, approve a 5-year loan for this company? If so, how much would you approve the loan for and for what purpose? Would you require security or collateral? Explain your reasoning. As a bank-lending officer, I would approve a 5 year short term loan for Johnson and Johnson.

2. Provide a recommendation as to whether an investor should buy, sell, or hold the stock of your company compared to the selected competitor. Your recommendation should be supported by an adequate explanation and reference to supporting analysis and ratios. Note that the quality of the arguments you provide in support of your position for (1) and (2) are more important than your final recommendation.

My company is Johnson and Johnson and all their information can be found below. I just need help answering these 2 questions.

• Return on Equity (Return on Owner's’ Investment)

  • Return on Equity = net income / shareholders’ equity

                                  = $1,300 / 60,160

                                  = 0.02

• Return on Assets (Return on Total Investment)

  • Return on Assets = net income / average total assets

                                  = $1,300/ [(157303+141208)/2]

                                  = 0.0087

• Earnings per Share

  • Earnings per Share = net income/ outstanding shares

                                     = 1,300/ 2,692

                           Basic = 0.48

                        Diluted = 0.47

• Net Profit Margin

  • Net Profit Margin = net income/ revenue

                                   = 1,300/ 76,450

                                   = 0.017

• Current Ratio

  • Current Ratio = current assets/ current liabilities

                             = 43,088/ 30,537

                             = 1.411

• Quick Ratio

  • Quick Ratio = (total current assets – inventory) / current liabilities

                           = (43,088 – 8,765) / 30,537

                           = 1.124

• Accounts Receivable Turnover

  • Accounts Receivable Turnover = net credit sales/ average accounts receivable

                                      = 76,450/ [(17,824 + 18,972)/2]]

                                      = 4.155

• Inventory Turnover

  • Inventory Turnover = cost of goods sold/ average inventory

                                      = 25,354/ [(8765+8144)/2]

                                      = 25,354/ 8454.5

                                      = 3.00

• Times interest earned

  • Times interest earned = income before interest and taxes/ interest expense

                                         = 17,673/ 960

                                         = 18.409

• Debt to Equity ratio

  • Debt to Equity ratio = total liabilities / total shareholders’ equity

                                       = 97,143/ 60,160

                                       = 1.615

• Price/Earnings (P/E) ratio (Use the market price as of the balance sheet date).

  • P/E ratio = share price (12.29.2017)/earning per share (diluted)

                     = 139.72/ 0.47

                     = 297.28

Answer 1

(1): As a bank-lending officer I will focus on J&J’s (Johnson and Johnson) credit related ratios (also known as leverage ratios) – times interest earned and debt to equity ratio. I will analyze these ratios together with other ratios to determine J&J’s financial health and on this basis the size and type of loan will be determined.

J&J’s times interest earned ratio is 18.409 and this means that the company can easily pay and cover its interest expenses. The figure is above 18 and this is a comfortable figure and implies that J&J can easily meet its interest burden even if its EBIT (i.e. profit before interest and taxes) suffer a substantial decline.

Secondly I will look at J&J’s debt to equity ratio. The company’s debt to equity ratio is 1.615 and this means that the company’s total debt is around 1.6 times its level of equity. Thus the company has a high level of debt in its books and hence the degree of protection that is enjoyed by its creditors is low.

Given the comfortable times interest earned ratio I will recommend a loan to J&J. The company’s liquidity also looks good with a strong current ratio of 1.411 and quick ratio of 1.124. However the company has high level of debt currently and hence I will not be in favor of granting it a long term loan. As such I will approve a short term loan up to a maximum period of 5 years and since the level of debt is already high for J&J I will require a security or collateral against the fixed assets of the company.

(2):J&J’s P/E ratio is 297.28 and this indicates that the stock of J&J is overvalued and is trading at a high premium. J&J’s main competitors are companies like Pfizer, Novartis, Bayer etc. P/E of Pfizer is 13.16, that of Novartis is 15.59 and that of Bayer is 34.46. This shows that J&J’s stock is very expensive and is commanding a high premium in the market. The high premium is not justified by the company’s profit margins – its RoE is 0.02 (or 2%) and RoA is 0.0087 (or 0.87%). Its net profit margin is 0.017 (or 1.70%). These numbers are nothing to write home about and as such J&J’s stock is clearly overvalued. Hence I will recommend a ‘sell’ on this stock.