Procter & Gamble

Equity Valuation & Analysis

As of November 1, 2007


Raider Investments Group
Brian Hooper
Tyler Yenzer
Nathan Yosten
Dustin Bradford

Brian.D.Hooper@ttu.edu
Phillip.T.Yenzer@ttu.edu
Nathan.Yosten@ttu.edu
Dustin.Bradford@ttu.edu

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Table of Contents
Executive Summary
Business & Industry Analysis
Company Overview
Industry Overview
Five Forces Model
Rivalry Among Existing Firms
Threat of New Entrants
Threat of Substitute Products
Bargaining Power of Buyers
Bargaining Power of Suppliers
Key Success Factors
Firm Competitive Advantage Analysis
Future Competitive Analysis
Accounting Analysis
Key Accounting Policies
Potential Accounting Flexibility
Actual Accounting Strategy
Quality of Disclosure
Qualitative Analysis of Disclosure
5
10
11
13
13
18
20
22
24
24
28
30
31
33
35
36

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Quantitative Analysis of Disclosure
Sales Manipulation Diagnostics
Expense Manipulation Diagnostics
Potential Red Flags
Undo Accounting Distortions
Financial Analysis
Liquidity Analysis
Profitability Analysis
Capital Structure Analysis
IGR/SGR Analysis
Financial Statement Forecasting
Cost of Equity Estimation
Valuation Analysis
Multiples Valuation
Discounted Free Cash Flow Model
Discounted Dividends Model
Residual Income Model
Long-Run Return on Equity Residual Income Model
Abnormal Earnings Growth Model
Credit Analysis
40
41
44
49
49
50
63
72
76
79
83
86
95
96
98
100
103
106

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Analyst Recommendation
Appendix
Regression Analysis
Income Statement
Balance Sheet
Statement of Cash Flows
Cost of Equity/WACC
Multiples Valuation
Discounted Dividends Model
Discounted Free Cash Flows Model
Residual Income Model
Long-Run Return on Equity Residual Income Model
Abnormal Earnings Growth Model
Altman Z-Score
References

107
109
121
122
124
126
127
128
129
130
131
132
133
134

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Executive Summary
Share data
Observed NYSE:PG share
price as of 11/1/2007
52-week range
Shares Outstanding
Market Capitalization
Percent owned by insiders
Percent owned by
institutions
Book value per share

Key 2007 financial data:
Revenue
Net Earnings
Return on Equity
Return on Assets


$68.59
$61.03-$71.83
3,159 m
$216.7 b
3.83%
58.7%
$21.13
$76,476 m
$10,340 m
15%
7%
Valuation estimates

Multiples valuation
Trailing P/E
Forward P/E
P/B
D/P
PEG
P/EBITDA
P/FCF
EV/EBITDA

Intrinsic Valuations
Discounted Dividend
Discounted FCF
Residual Income
LR ROE
AEG



$69.01
$56.47
$307.10
$37.55
$89.49
$469.93
$69.39
$65.79

$126.83
N/A
$41.87
$33.11
$118.34

Published beta 0.92
K
d
6.26
WACC
bt
8.61%
Altmans Z-Score
2003 2004 2005 2006 2007
4.6 3.76 3.44 2.67 2.89
Cost of Capital Estimation
r
2
Beta K
e

3-month 0.2862 0.9358 11.15%
1-year 0.2854 0.9337 11.20%
2-year 0.2847 0.9313 11.08%
5-year 0.2839 0.9305 11.03%
7-year 0.2838 0.9306 11.10%
10-year 0.2839 0.931 11.24

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Industry Analysis
Procter & Gamble (NYSE: PG) started from humble beginnings as a small soap
and candle company in 1837, and has since grown into a multinational corporation with
hundreds of product lines. The company is the largest firm in the personal products
industry of the consumer goods sector. Top competitors for Procter & Gamble include
J ohnson & J ohnson (NYSE: J NJ ), Kimberly-Clark Corp. (NYSE: KMB), Colgate-Palmolive
Co. (NYSE: CL), Avon Products, Inc. (NYSE: AVP), and Unilever (LSE: ULVER.L).
The personal products industry is highly competitive. Top companies must rely
on brand recognition and product innovation to gain market share. The industry is
analyzed thoroughly using the five factor model. The first factor in the model evaluates
rivalry of existing firms. The collective result is that rivalry is high. The next factor
looks at the threat of new entrants, and reveals that substantial barriers exist which
keep the threat of new entrants low. Next is threat of substitute products, which shows
that brand recognition will keep customers loyal, but readily available comparable
products make the threat moderate. Analysis of the bargaining power of buyers reveals
that buyers have moderate power because retailers need to carry certain products at
certain prices to draw customers, in other words, the buyers (retailers) and suppliers
(personal products firms) are equally reliant on each other. Bargaining power of
suppliers reveals that suppliers have less power the bigger the buying firm is.
Certain key success factors must be present to be successful in creating value in
the personal products industry. While these factors vary from firm to firm, none of the
top companies rely on a pure cost leadership or pure differentiation strategy.
Prevalent cost leadership strategies include economies of scale and lowering the costs
of inputs. Differentiation strategies include superior product variety, brand building,
innovation, and superior customer service. Analysis of Procter & Gambles ability to
achieve a competitive advantage reveals that they have been very successful and can

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remain successful if they stay on top of research and development and maintains good
relationships with buyers.
Accounting Analysis
Procter & Gamble has six parts that sums up their companies accounting
analysis. These six parts are: key accounting policies, accounting flexibility, accounting
strategy, disclosure, potential red flags, and accounting distortions. Its main job is to
help an investor see if its company is doing well or if there is a potential problem in the
near future. Most of the accounting information came from Procter & Gamble as well
as other competitors in the industrys 10Ks.
Procter & Gamble is considered a flexible company because of the amount of
judgment decisions they allow their management to make. One of the main reasons
they are flexible is because they allow their companies management to make their
decisions on goodwill. This is a potential red flag area because goodwill is a huge part
of P&Gs company every since the Gillette acquisition. They are keeping it constant
instead of over or understating it so there was no manipulation. They are also a
company who is very transparent. This means they disclose more information than
most public companies. In their 10ks they have a detailed analysis of each section of
their company. This means they have a break up of different categories (cash & credit
sales), and segmented reporting (Baby care, Beauty, Household, etc.) for investors or
auditors to see. Due to their high disclosure, their flexibility through GAAP would be
obvious if there was a red flag. There were three ratios in the analysis that were a
concern when analyzing for potential red flags. However each of the three were
examined carefully, and it was determined there was no manipulation in the companies
accounting analysis.
Valuations
After all of the analysis of the industry, the firm, its accounting policies, and
financials, we can now do a valuation of Procter & Gamble. Several different valuations

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will be used to compute the per share price of the company. This per share price
compared to the actual per share price will advocate if the company is fairly valued,
overvalued, or undervalued.
The earnings multiples valuation is the quickest and easiest way to value a
company. Eight different ratios were used to determine the value. There was no
dominant valuation in this model to tell if it was fairly valued, overvalued, or
undervalued. There was a big variance in the per share prices, which made this method
of valuation very inaccurate and shows that it should not be the only form of valuation
for a firm.
Several different valuations were used to value Procter & Gamble. The
discounted free cash flow model uses expected future free cash flow models to arrive at
a per share price of -$274.17. Since this number is negative it is invalid and cannot be
used to value the company.
The discount dividend model calculates the price per share as the sum of each
of the next ten years expected dividends discounted back to the present value, added
to the terminal value of the perpetuity. This method gives us an undervalued per share
price of $126.83.
The residual income valuation model discounts residual earnings, which are
earnings in excess of normal earnings. The estimated share price of this model was
$41.87, overvalued.
The abnormal earnings growth model values a firm using forecasted earnings,
dividends, dividend reinvestment plan (DRIP), core earnings and normal earnings. Tying
these numbers together gives us a per share price of $118.34, which suggests that
Procter & Gamble is undervalued.



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Financial Analysis, Forecast Financials, and Cost of Capital Estimation
Liquidity, profitability, and capital structure ratios are all tools used by analysts
when looking at a firm. A firms performance can be assessed when the ratios are
compared against ratios from previous years and ratios of other firms in the industry.
Then, analysts will utilize the ratios in forecasted the firms future financial performance.
Regressions are used to estimate a Beta for the firm which is then used to find a cost of
equity using the capital asset pricing (CAPM) model. The weighted average cost of
capital (WACC) is then used to determine an appropriate cost of capital for the firm.
Procter & Gamble is a fairly liquid company. All of their liquidity ratios, except
the current ratio, quick ratio, and working capital turnover, are in line with or above the
industry average. They actually lead the industry in accounts receivable days. They
have good profitability as well despite being below the industry average. All profitability
analysis shows either steady or growing profitability. Although they are below the
industry average, Procter & Gamble is gaining on their competition year by year.
However, capital structure analysis shows that Procter & Gambles ability to pay debt is
has declined. Their debt service margin has experienced a downward trend in recent
years. As a matter of fact, there were not enough cash flows last year to support the
current portion of debt due.
Financial forecasts were then developed for the next ten years using a basic
assumption of a ten percent growth rate in sales per year. The assumption was also
made that past ratios would be a good indicator of future ratios. The ratios discussed
above were utilized in this process to develop a reasonable estimate of Procter &
Gambles future performance.

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Company Overview
In 1837, Procter & Gamble (NYSE: PG) was started as a soap and candle
company out of Cincinnati, OH. Procter & Gamble has since grown to become the
largest consumer goods product company in the world, with $68 billion in sales
worldwide for fiscal year 2006. Corporate headquarters are still in Cincinnati, and they
maintain 39 manufacturing facilities in 23 states, as well as 105 manufacturing facilities
in 41 other countries (P&G 2007 10-K). Procter & Gamble manufacturing facilities
produce personal health care products, house and home care products, health and
wellness products, baby and family care products, and pet care and nutrition products.
These products have made Procter & Gamble a recognized global leader in the
development, manufacture and marketing of some of the worlds most trusted, quality,
leadership brands including Pampers, Tide, Ariel, Always, Whisper,
Pantene, Mach3, Bounty, Dawn, Pringles, Folgers, Charmin, Downy,
Lenor, Iams, Crest, Oral-B, Actonel, Duracell, Olay, Head & Shoulders,
Wella, Gillette, and Braun (www.pg.com). Procter & Gamble boasts over 300
brands being sold in as many as 160 countries (P&G 2007 10-K). Procter & Gamble
acquired many of these brands because of a preexisting solid consumer base.
With global operations employing 138,000 worldwide, it has been necessary for
Procter & Gamble to develop two training schools for senior managers (P&G 2007 10-
K). One is an advanced leadership school for senior managers. It targets the 135
general managers from different branches of the Procter & Gamble global division.
The other is an executive leadership program aimed at the highest-level managers in
the company.
Procter & Gamble strives to provide branded products and services of superior
quality and value that improve the lives of the worlds consumers (www.pg.com). This
commitment would not be possible without progressive breakthroughs in research and
development. Each year, Procter & Gamble increases funding on research and
development, currently around $2 billion total expenditure for fiscal year 2007. The

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company employs more than 7,500 scientists and holds more than 24,000 active
patents worldwide (P&G 2007 10-K). This focus on innovation and technology has put
Procter & Gamble as an industry leader.
Procter & Gambles vast customer base spans drug stores, high-frequency
stores, membership stores, grocery stores, and mass merchandisers. Because of the
broad array of products through a wide customer base, Procter & Gamble benefits with
being industry leader in sales and market capitalization. Figure 1 shows total assets
grew significantly, helped especially by the Gillette merger in 2005. Net sales received
a bump also, but adjusted sales growth shows no significant gains from the acquisition.
Fig. 1: Total Assets, Net Sales, Sales Growth, and Stock Prices (*In Millions)
2003 2004 2005
2006
2007
Total Assets* $43,706 $57,048 $61,527
$135,695
$138,014
Net Sales* $43,377 $51,407 $56,741
$68,222
$76,476
Sales Growth 6% 6% 6%
6%
5%

Procter & Gamble is categorized in the household and personal products industry of the
consumer goods sector. Procter & Gambles major competitors, also in the personal
products industry, include Kimberly-Clark Corp., Colgate-Palmolive Co., Avon Products,
Inc, and Unilever. Another major competitor, although not primarily in the personal
products industry, is J ohnson & J ohnson .
I ndustry Overview
The household and personal products industry is a highly competitive industry.
Most companies in competition with Procter & Gamble are focused to only one or two
different sub-industries of the personal products industry. Procter & Gambles major

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competitors, such as Kimberly-Clark Corp, Colgate-Palmolive Co., J ohnson & J ohnson,
Avon Products Co., and Unilever, are also diversified into many sub-sectors. Most of
these sub-sectors of the personal products industry are largely made up of
manufacturing through chemical processing or paper processing. Suppliers of the
chemicals are numerous, although price fluctuation may occur if availability is limited.
According to Procter & Gambles 10K filing, we may or may not pass on the change,
depending on the magnitude and expected duration of the change.
The companies in the personal products industry rely on brand recognition and
product innovation to build their customer base. Product innovation is a key step to the
corporate strategy for long-term growth of Procter & Gamble. This core philosophy is
what has caused Procter & Gambles stock climbing 65 percent higher today than it was
five years ago (See Fig. 2). The top competitors stock prices have only gained
between 14 and 60 percent. Not shown in the chart is Unilever, with a 17 percent gain
over the same period.
Fig. 2: Stock prices for P&G and top competitors over the last 5 years

Moneycentral.msn.com

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The Five Forces Model
In every industry, there is a model that can be used to identify the strategy,
profitability, and power of particular companies. This model is called the five forces
model. This gives an analysis of companies for competing and personal uses. The five
forces model consists of two major parts. The first part of the model consists of rivalry
among existing firms, threat of new entrants, and threat of substitute products. This
part measures how much actual and potential competition there is. The second major
part is between the bargaining power of buyers and the bargaining power of suppliers.
These two measure the power a company has or does not have over the buyers and
suppliers. In using this model, we will be able to identify these valuable parts of
Procter & Gamble.
Personal Products Industry
Rivalry Among Existing Firms High
Threat of New Entrants Low
Threat of Substitute Products Moderate
Bargaining Power of Buyers Moderate
Bargaining Power of Suppliers Low

Rivalry Among Existing Firms
Industry Growth
The growth in this industry has been moving up on a yearly average. Every
year, the industry seems to steadily increase its annual sales revenue (see figure 3).
Given this information, price wars are expected to happen. To be able to survive, these
companies have to manage decisions by getting rid of every expense that is not
needed. In 2005, the industry grew 8.14 percent. In 2006, the industry grew 11.87
percent. That is a 3.73 percent change in industry growth from 2005 to 2006. A major
portion of that was from Procter & Gambles purchase of Gillette. Because of Procter &

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Gambles purchase of Gillette in 2006 sales grew by 20.23 percent. This is a 9.85
percent increase from the 2005 sales growth of 10.37 percent. A companys historical
growth rate can be used when trying to forecast future sales. The industrys growth is
due to the rise in demand over the last five years. There has been a demand and will
always be a demand for these types of products. The consumers have to use these
products because they are a part of everyday life, which leads to the reason for the
sales growth.
Figure 3: Sales Growth Over the Past Five Years


Concentration
There is a high amount of concentration in this industry. All of the companies in
the personal products industry have to compete on price. Since most of these goods
are not commodities, it allows them to compete less on the price. This industry has
some specific goods people are willing to pay for, and other goods that they are only
willing to pay for the cheaper product. It is in these companies best interest to focus
on the specialty products by putting as much quality in them as possible. Companies
Source: PG, J NJ , KMB, CL, and AVP 10k's;
Unilever financials

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also need to focus less on quality and more on price reduction when looking at non-
brand specific products.
Differentiation and Switching Costs
Many of the products offered in the personal products industry are of the same
quality and price, meaning that switching costs are relatively low. A switching cost is
the cost that the consumer encounters while changing from one product to another.
Many consumers will buy similar products based on which one is the cheapest, giving
them a low switching cost. For a company to be successful, it must differentiate its
products from its competitors products. A company can do this by creating brand
names and slogans that consumers will become familiar with, much like Procter &
Gamble has done with Duracell, Crest, and many of its other brand name products
(www.pg.com).
Scale/ Learning Economies
Fig. 4: Total Assets over the Last Five Years

In order for a company to be competitive and profitable, it must be a giant in the
personal products industry. The size of a firm can determine how successful it is going
to be. Having a large firm allows a company to attract more customers than a small

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firm would by name recognition and perceived value. In addition, large companies
have the ability to reduce costs and bring down prices, making it difficult for new
entrants to compete. To facilitate, figure 4 shows Procter & Gamble (PG) and J ohnson
& J ohnson (J NJ ) have the largest number of assets, making them the biggest
companies in the consumer goods market. Therefore, these companies are also the
leaders in this market.
Ratio of Fixed to Variable Costs
Analysis of the ratio of fixed to variable costs gives insight into how well a
company is utilizing its facilities. A firm with a high ratio of fixed to variable costs is
either not making efficient use of its existing capacities, or is having trouble selling
product. A firm with a low ratio of fixed to variable costs is making more efficient use
of its existing capacities. Different industries have different normal fixed-variable
costs ratios, so a ratio close to 1:1 may not be desirable or even achievable. In order
to calculate the ratio, fixed costs, which are general, selling, and administrative
expenses, are divided by variable costs, which are the costs of products sold.
Fig. 5: Ratios of Fixed to Variable Costs over the Past Five Years.
Figure 5 shows the average ratio of fixed to variable costs for Procter & Gamble over 5
years is 0.64. J ohnson & J ohnsons ratio over the same period averages 1.18, while
Kimberly-Clarks is only 0.25. Colgate-Palmolive averaged 0.75. The industry average
2002 2003 2004 2005 2006 Avg.
Procter & Gamble 0.60 0.60 0.66 0.66 0.66 0.64
J ohnson & J ohnson 1.17 1.16 1.20 1.23 1.16 1.18
Kimberly-Clark 0.26 0.25 0.25 0.25 0.25 0.25
Colgate-Palmolive 0.72 0.74 0.76 0.76 0.79 0.75
Avon Products 1.17 1.20 1.22 1.23 1.33 1.23
Unilever 0.75 0.70 0.60 0.63 0.64 0.67
Industry Average 0.79

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is 0.79, but since historical figures do not vary much suggests that firms either find it
difficult to change or it is not financially detrimental to keep the current state.
Objective interpretation of the averages would suggest Kimberly-Clark is making the
most efficient use of its resources, while Avon is making the least efficient use.
Excess Capacity
Excess capacity occurs when a firm is not producing as much as it could be
producing. This results in wasted money due to fixed costs. In this situation, a firm
would decrease price to spark demand. This effectively solves the problem of excess
capacity by increasing production. Figure 5 also allows for the interpretation of excess
capacity. Without investigating into alternate causes for the high ratio, Avon would be
a candidate for decreasing price to increase demand. Procter & Gamble and Colgate-
Palmolive would probably be considered to be at an acceptable capacity. Kimberly-
Clark may be considered to be at a very efficient capacity.
Exit Barriers
When a firms operating costs exceed revenue for a long enough period, the firm
may go out of business. In certain industries, barriers may make exiting the market
difficult and often they are forced to stay in business. Contract cancellation costs with
suppliers, asset write-off expenses, or regulations that must be followed are all costly
exit barriers. One large potential barrier to exit for the personal products industry is the
expense of writing-off assets. Much of the equipment is highly specialized chemical
processing equipment which may be difficult to sell or remove. The costs associated
may be more than the company wants to put on its balance sheet.
Conclusion
With a high industry concentration, relatively low switching costs, large
economies of scale benefits, and possible high exit costs, rivalry among existing firms in
the personal products industry tends to be high.

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Threat of New Entrants
The personal products market is a relatively difficult market to penetrate due to
the high degree of concentration. A highly concentrated market makes it difficult for
new entrants to succeed because there are only a few major companies in the industry
that are very competitive. Large companies in the personal products industry have a
huge competitive advantage over new entrants because of their size and experience.
The first companies entered the personal products industry as early as the 1830s,
giving them many years of experience and knowledge to be able to create barriers that
a new entrant would have to overcome to be successful. These barriers include
economies of scale, distribution access, and legal issues.
Economies of Scale and First Mover Advantage
A firms economy of scale can also give them a competitive advantage over new
entrants. The ability to increase production can drive down input costs, giving you
economies of scale. Increasing production is something that can only be done if your
firm is large enough to do so. A firm must have large amounts of assets to be able to
produce goods on a larger scale, making it hard for new entrants to compete with
production costs and price. For example, Procter & Gamble (PG) and J ohnson &
J ohnson (J NJ ) have to highest amount of total assets in the industry with amounts of
$138 Billion and $75 Billion (PG and J NJ 10-K). This allows these two companies to
dominate the consumer goods market, giving new entrants a disadvantage at
competing on cost, quantity produced, and price. Large firms in the consumer goods
market also have the first mover advantage. The first mover advantage lets the first
companies in the industry create different standards and agreements. The first ones in
the industry can regulate it; make it extremely difficult for a firm to enter their market.
For example, a first mover in the personal products industry would have an advantage
because they would be able to register patents, develop market share, get over the
learning curve, and gain reputation over companies that would enter the industry later.


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Distribution Access and Relationships
Access to existing distribution channels can be a substantial barrier that new
entrants would have to face in order to enter the industry. Supermarkets and other
retail stores have a limited amount of shelf space available for consumer goods. This
shelf space is usually used up by the big firms that have existing relationships with the
customer, making it difficult for new entrants to obtain the required room for their
products. A preexisting relationship is important in the personal products industry
because it allows the producer to negotiate pricing and discounts with the buyer. Brand
recognition is also a factor. If a company does not have brand recognition, they will not
be able to get their product distributed as well as a large company would. Without
distributor relationships and brand recognition, a new company will not have much
success upon entering the consumer goods market.
Legal Barriers
Legal barriers can also make it hard to enter the personal products industry. A
new entrant has many regulations, laws, patents, and copyrights that they have to
abide by when they are entering into an industry. The personal products industry is
Fig. 6: Intangible Assets for 2006 Source: PG, J NJ , KMB, CL, ULVR, & AVP Balance Sheets
very research-intensive. This produces many patented products that cannot be copied
by newcomers. For example, as figure 6 shows, market leaders Procter & Gamble (PG)
and J ohnson & J ohnson (J NJ ) have $33.6 billion and $15.4 billion in intangible assets,
Firm Intangible Assets (in millions) (2006)
Procter & Gamble $33,626
J ohnson & J ohnson $15,412
Kimberly-Clark $821
Colgate-Palmolive $0
Avon $80.4
Unilever $6,312.21(Converted from Euros)

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which includes copyrights, patents, trademarks, and goodwill (PG and J NJ balance
sheets). This much money invested in intangible assets shows that these two industry
leaders have many innovative ideas that they are protecting from being used by any
other company that wants to enter their market.
Conclusion
There are many different barriers in the personal products industry that a new
entrant would have to overcome to enter. The large companies have a huge
competitive advantage over new entrants that leave new entrants with little success in
gaining any market share. With established economies of scale, access to distribution,
relationships, and legal barriers in the favor of existing firms in the industry, a new
entrant would little success in competing. This almost eliminates the threat of a new
entrant in the personal products industry.
Threat of Substitute Products
The threat of substitute products is the customers (retail stores) willingness to
switch to a different product that is similar to yours. In the personal products market,
the threat of substitute products is always present. There are always substitutes
available for every different kind of product in the personal products industry, creating a
mild threat of substitute products. However, there are some factors in considering a
product to be a substitute. The relative price and performance of the substitute product
must be close to the original product to be considered as a substitute. In addition,
customers willingness to switch is a factor in considering a substitute for a product.
Relative Price and Performance
In the personal products industry, price is usually perceived as value. Many of
the name brand items, like Tide laundry detergent, Crest toothpaste, and Bounty paper
towels are often at a higher price than a generic brand of the same items would be.
This is because customers believe these name brands have more value than a lesser-
known brand, allowing them to pay a premium on these items. Often, the brand names

21

also have a higher performance than a generic or lesser-known brand would, due to
research and design on brand name products. Many hours are spent on research and
design in big companies so that they can make their products even better for the
customer. This usually results in an increase in performance so that the customer will
benefit more from buying their product. Therefore, the threat of substitute products
depends on the customers wants and needs. If they want better performance at a little
higher price, they can buy the brand names; or, if a customer is willing to give up a
little performance for a lesser price, generic and lesser known brands are what they
choose.
Buyers Willingness to Switch
Buyers willingness to switch is a critical part of the threat of substitute products.
In the personal products market, the buyers willingness to switch is usually low. A
buyer (retail store) of personal products usually has good relationships with their
suppliers, making them partial to their products. For example, Wal-Mart sells all of the
products from companies in the personal products industry, which means that they
have a good buyer/seller relationship. This relationship developed by the popular and
well-known brand names that come out of the companies in the industry. If a company
in this industry did not have familiar names, they would not have much shelf space, if
any, in retail stores like Wal-Mart. Since the buyers (retail stores) have good
relationships with the well-known companies in the personal products industry, they are
unlikely to switch to a different product offered by someone else trying to compete in
this industry.
Conclusion
Substitute products in the personal products industry are readily available by
much smaller and different firms, but due to brand name recognition and developed
relationships, it is not likely that a buyer will switch products. The added benefit, due to
the higher price, is usually enough to keep customers happy with the brand name

22

products. Therefore, the threat of substitute products in the personal products market
is low, due to the high concentration of the industry.
Bargaining power of Buyers
Bargaining power is the ability to influence the setting of prices
(http://www.photopla.net/wwp0503/buyer.php). It is based on the relationship
between the firm and the buyer. The main question in this part of the five factor model
is who has the power over whom? In this case, the retailers are the buyers and
Procter & Gamble is the firm. Obviously, the source with the most power will be able to
control the other. If the company has the most power then they will be able to raise
prices and most likely be the only source around. If the buyer has the most power then
the company will have to lower its costs and add a lot more expenses to its list.
Switching costs
The cost of these customers switching from Procter & Gamble to J ohnson &
J ohnson would be low in certain products. This is because most of these products on
the shelf are close to the same price. However, the quality they would receive would
be less in most cases. J ohnson & J ohnson would have similar quality to Procter &
Gamble, but the other smaller competitors could not compete with the price and
quality. This is not an industry to get started in if you are small because these huge
companies already have a major head start on you. A large company in this industry
could switch to another large company if it was the last resort.
Differentiation
There is a lot of differentiation when comparing Procter & Gamble products and
the products of other competitors in the industry. According to their 10k, Procter &
Gamble has narrowed their range to three different subjects; these subjects are beauty,
household care, and health and well-being. All of these areas have been differentiated
accordingly. Procter & Gamble has some of the best product names and quality in
retailer stores and pharmacies around the world. With new ideas coming up every

23

year, it gives them an advantage when dealing with retailers. Recently, they had a
breakthrough with Crest toothpaste. The new product was called Crest Pro Health and
was a huge success. It had more than $100 million in sales in the first year. Most of
Procter & Gambles brands have different product lines to offer, much like this one.
This product differentiation gives them more power when dealing with retailers.
J ohnson & J ohnson is very similar in the way that they have a lot of brand power and
quality in their products.
Price Sensitivity
Procter & Gamble is very differentiated, and because of this, it has to be less
price sensitive. In this industry, like most, the best option is to sell at the price desired.
If companies can do this then they have power when dealing with buyers (retailers).
Some of these retailers are Wal-Mart, HEB, Walgreen, etc. Buyers want the best
products on their shelves. These large retailers are forced to keep their own costs
down. Compromising with them more will help to put more products on the shelf. The
companys brand image can also help your business in a competitive industry. With the
advertising and high quality expected in Procter & Gambles brands, retailers will be
convinced that these products will create profits for them. If the product is a small part
of the buyers costs, they are less likely to look elsewhere for a better price.
Importance of Product for Costs and Quality
In the personal products industry, it is very important to have brand power and
quality. If one is lacking it will be very difficult to start a new company and compete
with others. All of the top companies in the personal products industry are greatly
helped by already having the best brand names. These companies have more
bargaining power with customers because their superior products demand a premium
price.



24

Bargaining Power of Suppliers
Our suppliers are valued partners in the success of our business. Our
relationships with them must be characterized by honesty and fairness. Suppliers are
selected on a competitive basis based on total value, which includes quality, service,
technology, and price (Sustainability guidelines for Supplier Relations, 2007 P&G 10-K).
Bargaining power of suppliers involves the relationship between the firm and the
suppliers. When there are fewer companies, the supplier is able to have more control
over a firm in this industry. Procter & Gamble has many sustainability guidelines that
must be followed in order to be involved with their suppliers. Some of these guidelines
are legal compliance, human rights, employment practices, forced labor, and child
labor. Most of the companies in this industry have guidelines like these because they
are ethical companies who want to do the right thing. Supplier diversity is a
fundamental business strategy at P&G (www.pg.com). Since Procter & Gamble has
this option, this allows them to be more diversified. This also allows them to have
some power over their suppliers. If one of the suppliers is trying to raise prices, they
can just go to another. A great portion of a companys success in this industry depends
on brand name. These suppliers know this, which leaves them with some power.
Suppliers have to provide good materials for people to see the quality. There are a few
companies in this industry that can manage and compromise with suppliers like Procter
& Gamble. Because of their large size and name, these companies are not only able to
get whom they want, but they can also control prices. This is a big plus for these
companies in this industry.
Key Success Factors for Value Creation
In order to be successful in the personal products industry, a company must
employ a mix between differentiation and cost leadership strategies. Customers in the
industry have come to expect high quality products at relatively low prices; therefore, a
company will not survive in the industry with a straight cost leadership or a strait
differentiation approach. According to Procter & Gamble, there are five areas that are

25

critical to winning in consumer products (www.pg.com). These five areas are
consumer understanding, brand building, innovation, go-to-market capability, and scale.
Colgate-Palmolive Co., one of Procter & Gambles major competitors, also cites strength
of brand, innovation, and cost control as factors for success in the personal products
industry (www.colgate.com). Neither strategy outlined here is true differentiation or
cost-leadership; however, more emphasis is placed on the differentiation strategies.
Cost Leadership Elements
The personal products industry has high rivalry among existing firms and a low
threat of new entrants. Therefore, companies in the personal products industry must
be able to utilize economies of scale in order to be successful. The manufacturing
process incurs high fixed costs that need to spread out over as many units as possible.
By driving down per unit costs, the final products can be sold at lower prices in the
market enabling firms to compete on price. Beating competitors on price is a common
tool in gaining market share against the existing firms. In addition, having such a
large-scale production process makes it difficult for new entrants to succeed. In order
to compete effectively in the industry on price, a new firm would have to jump straight
in with a huge capital investment that would allow them to mass-produce. This is
difficult for new firms to do; therefore, a new firms costs tend to be higher than an old
firms costs. This will result in higher selling prices making it less attractive to
consumers. If a firm is not large enough to increase production to a level that will
facilitate low per unit costs, it simply will not survive.
Firms must also be able to lower their input costs. Colgate-Palmolive Co.
expressed concern over rising input costs in their 2006 10-K. Increases in the prices of
their raw material commodities can have an adverse affect on their profit margins
especially when they are unable to pass these expenses on to consumers by increasing
prices (www.colgate.com). If a company were to try to pass these expenses on to
consumers through price increases, customers would simply switch to a competitors
product. There is a good degree of brand loyalty in the personal products industry;

26

however, even consumers who prefer one brand to another can only tolerate small
price increases. Therefore, effective management of input costs will allow a company
to maintain low prices and a good competitive advantage in the personal products
industry.
Differentiation Elements
Despite using a mix of cost-leadership and differentiation methods, the personal
products industry does lean more heavily towards differentiation. Firms spend a lot of
time and money trying to make their products stand out from the rest. Consumer
understanding is key in order to differentiate a product. The first thing a firm must do
is figure out exactly what it is that the consumer wants. Firms do this through the
utilization of market research and tests. The results of these tests will let firms know
where demand lies. They will then gear their research and development to satisfy
these consumer demands.
Personal products companies must also provide a superior product variety. Firms
in this industry have numerous products and product lines. The main reason for this is
that different consumers want different results out of the same product. For example,
some toothpastes are aimed at cavity protection while others are targeted for
whitening. Most personal products have different varieties in order to satisfy different
needs. If a firm cannot match a product with a customers need, the customer will turn
to a competing firms product that does address their need.
Brand building in the personal products industry plays a big role in a companys
success. Brand building seeks to increase the product's perceived value to the
customer and thereby increase brand franchise and brand equity
(www.wikipedia.com). When a company is able to deliver a consistent product for an
extended period, they begin to develop a trust with consumers. At this point, a
companys brand itself will increase in value allowing a premium to be charged for its
brand. This increases margins that eventually lead to higher profits.

27

Innovation is the single most important strategy in the personal products
industry. Personal products companies are constantly announcing new products and
improvements, and consumers have come to expect them. When these new products
are released, older products may be rendered obsolete. If a company cannot innovate
and keep up with competitors, their own products will quickly become outdated.
Demand for such products will drop until they eventually become extinct. An example
of product evolution can be seen with razors. Razors were originally single blade
instruments. Now they have evolved into instruments with upwards of four blades.
There are also electric razors. Razors are just one example of a personal product that
has changed through innovation. Successful personal products companies must have
the innovative capabilities to improve upon all their existing products. Figure 7 shows
an overall increase in research and development spending over the last two years by
the four major players in the personal products industry.
Figure 7: Research and development expenses
0
2000
4000
6000
8000
10000
12000
Millions of
Dollars
2004 2005 2006
Year
Research and Development Expenses
Johnson & Johnson
Proctor and Gamble
Colgate-Palmolive
Kimberly Clark
Avon
Unilever
Industry

Competitors in the personal products industry must also be successful at getting
their product to market. They must effectively manage their products supply chains
and distribution channels. In order to accomplish this, they need to have some power
over buyers. This gives them the ability to distribute their products to wherever they
see fit at the price they see fit. If a retail store has the power to dictate which of a
Figures, in millions of dollars, obtained from
2006 financial statements for each company.

28

firms products will ultimately get shelf space and at what price, the firm is not able to
manage the exposure of its own products. In such a case, the retail store is not acting
in the best interests of the firm. Therefore, companies in the personal products
industry need to have some bargaining power over buyers in order to move their
products through the supply chain at a profitable price.
The final element of the differentiation strategy that companies in the personal
products industry must utilize is superior customer service. Products provided in this
industry are indeed personal. Therefore, companies must make every effort to
maximize the satisfaction of their customers. People use these products everyday, and
in doing so, develop an attachment to them. A trust is then formed between the
manufacturer and the consumer. It is the responsibility of the manufacturer to
maintain that trust. If firms do not effectively manage relationships with consumers,
consumers will then turn to another firm. At this point, it is very difficult to regain the
trust of a consumer.
Conclusion
Creating the right mix between cost-leadership and differentiation strategies is
essential to last in the personal products industry and to create value for the firm. Most
firms will favor differentiation; however, cost-leadership must be addressed as well.
Consumers in this industry do desire a certain quality of products, but they will switch
to a lower cost provider if prices are too high. The personal products industry is very
research intensive; therefore, constant innovation is necessary in order to survive.
Finally, firms in the industry must offer a good variety of products while building a good
brand image and maintaining good customer service.
Competitive Advantage Analysis
The personal products industry, as stated above, contains many entrance, exit,
and legal barriers. This allows established firms to look forward into the future instead
of constantly worrying about new entrants into the industry. This has also allowed them

29

to be more efficient in the research and development aspect of the firm. It has been
shown that in the personal products industry it is necessary to perform intense research
and development in order to stay ahead of the competitors. For example, Procter &
Gamble steadily increased their research and development investment from year to
year. In addition, they have also made many acquisitions, such as The Gillette
Company in 2005, in order to provide a global advantage in the personal grooming
sector of the personal products industry. Research and development is extremely
important in the personal grooming sector. This can be seen when thinking how just
ten years ago there was no such thing as the Gillette Mach 4, or such high
performance shaving gels and creams as the ones being produced today by Procter &
Gamble. The personal products industry is technologically advanced; therefore, major
players in the industry have had to become extremely efficient and competitive while
keeping the prices low and new entrants virtually non-existent. In addition, Procter &
Gamble has been able to rely heavily on feedback from their consumers, in order to
provide them with functional, yet aesthetically pleasing products. Providing better
customer service is just one way Procter & Gamble has implemented and succeeded
with their differentiation strategies in the industry.
Through maintaining strong relationships with their retailers, Procter & Gamble
has also been able to hold on to vital shelf space, and prime brand recognition. These
intangible assets are extremely important, and if lost, could be detrimental to the firm.
In the personal products industry, it is often noted that the brand sells itself. For
example, consumers often times will automatically buy a certain brand due to history
and satisfaction with that particular brand or product. This is the case only if the
product is reasonably priced. This is where solid relationships with buyers come in to
play. In the personal products industry, the connection between the consumer and
manufacturer is the retailer whom sells the product. Therefore, as long as Procter &
Gamble can maintain their firm relationships with its buyers, they can continue to
dominate the market share in the personal products industry by producing quality,
differentiated products at a reasonably low price.

30

Future Competitive Advantage
Procter & Gamble has long been known for their expansion and global research.
In fact, P & G now sells its products in more than 13,000 cities and towns in China
alone, and that number is sure to grow even larger in the years to come
(CNN.Money.com). Procter & Gamble was even recently named the #10 most admired
company in the world by Fortune Magazine, as well as being placed in the top ten in
total sales from the time period of 1999 2007. Although corporate segment net sales
decreased $235 million in 2007, this can be attributed to high transaction costs from
the acquisition of The Gillette Company, and higher interest expenses (P&G.com). Yet,
Procter & Gamble recorded an increase of 18% in their operating cash flows in 2007
and this can be attributed to higher net earnings as well as the acquisition of The
Gillette Company (P&G.com). Since Procter & Gamble acquired Gillette, it has seen an
increase in their Razors and Blades net sales by 49%. This is shown in figure 8 below.
Figure 8: Sales growth of Procter & Gamble by segment
Beauty Health
Care
Fabric &
Homecare
Family
Care
Razors &
Blades
Net Sales Growth 9% 14% 11% 6% 49%

Overall, in the future you can look for Procter & Gamble to make huge strides. Due to
their enormous size and ability to turn profits (12% increase in 2007), it is almost a
given that Procter & Gamble will do well in this industry for years to come
(Fortune.com). Also, the constant dedication to research and development continues to
be a high priority for Procter & Gamble. Though many of these activities and costs will
not be realized in the coming year, Procter & Gamble believe this to be a demonstration
of their commitment to the future and the satisfaction of its consumers. With their long
history of achievements and dedication to the factors presented above, success is sure
to come for Procter & Gamble.

31

Identification of Key Accounting Policies
Analysis of a companys formal accounting practices starts with identifying key
accounting policies. These key accounting policies are those that help achieve a
companys key success factors discussed previously. The degree of success a company
enjoys directly relates to their ability to successfully implement certain key accounting
policies. Procter & Gamble cites its key success factors as being consumer
understanding, brand building, innovation, go-to-market capability, and scale (2007
P&G 10-K). Analysis of key accounting policies involves assessing the amount of
disclosure the company is willing to give about how they achieve their key success
factors.
Five years ago, Procter & Gamble reportedly owned 12 brands earnings over a
billion dollars in revenue each (2002 P&G 10-K). This number has grown to 23 billion-
dollar brands, with 18 expected to hit the billion-dollar mark in revenue within the next
few years (2007 P&G 10-K). Nearly doubling the amount of billion-dollar brands owned
was not accomplished just by building these brands from the ground-up, many were
acquired through the Gillette, Wella, and Hutchison acquisisions. Focus on brand
building through acquisitions may result in increases to the Goodwill line item on the
balance sheet. Purchased goodwill is the difference between the fair market value of
the net tangible and identifiable intangible assets and the purchase price of the
acquired business (Kieso, Weygandt, &Warfield, 2007). Procter & Gambles purchase
of Gillette resulted in $35.3 billion in goodwill recorded on the balance sheet. As stated
in their 2007 10-K filing, Procter & Gamble does not amortize goodwill, management
assesses it yearly and records impairment if they feel it is necessary.
Procter & Gamble invests an increasing amount of money every year in
innovation through research and development. Both the 10-K and the annual report to
shareholders liberally emphasize the amount of research and development required to
keep the firm growing. All research and development expenses are charged to
Research and Development Expense on the income statement as part of selling,

32

general, and administrative expenses. Expensing research and development (instead of
debiting an asset account) is a requirement of GAAP because of the uncertainty of the
results of the research and development (Kieso, Weygandt, & Warfield, 2007). When
research and development results in a useful product and is patented, the legal fees
associated are debited to intangible assets and amortized for the useful life. This is the
procedure Procter & Gamble uses, and states so in their 2007 10-K filing.
With products sold in over 180 countries, 18 of which generated over a billion
dollars in sales last year, Procter & Gamble must be concerned with the risks involved
(2007 P&G 10-K). Procter & Gamble claims to use direct netting to get rid of settlement
risk, risk involving the exchange of currency (2007 P&G 10-K)
(http://www.riskglossary.com/link/netting.htm). Interest rate exposure is lessened
through hedging the interest rates of certain debts in foreign interest rates to reduce
volatility in currency exchange rates. Procter & Gamble uses forward contracts and
options with less than 18-month maturities to curb short-term changes in currency
exchange rates. Since Procter & Gamble also manufactures products in countries
around the world, commodity prices can fluctuate due to economic, political, or
environmental factors. Fixed-price contracts, as well as swaps, options and futures
contracts, are used to reduce exposure to these issues.
Another key accounting policies refers to the disclosure associated with pension
plans and other post-employment benefit plans. Procter & Gamble claims that
contractual commitments associated with pension funding is not currently
determinable (2007 P&G 10-K). They do, however, project near-future expense
variables based on many different assumptions: discount rate; expected salary
increases; certain employee-related factors, such as turnover, retirement age and
mortality; expected return on assets and health care cost trend rates (2007 P&G 10-K).
U.S. GAAP policies are followed in expensing the costs, including a recent addition to
policy, disclosure of under/over funded status.


33

Accounting flexibility
A firms accounting flexibility is based on how a company allows their managers
to make decisions in accordance with GAAP. Procter & Gamble considers three items to
be important. These items are employee benefits, goodwill, and revenue recognition.
Both show how Procter & Gamble illustrates a large or small amount of their flexibility in
its accounting policies. The least flexible is revenue recognition because of the strict
GAAP standards and the required amount of accounting. The other two show a lot of
flexibility by using judgment calls and estimations in their accounting policies.
Goodwill
In 2005, Procter & Gamble purchased Gillette to take their company to the next
level. After they purchased Gillette the companys goodwill skyrocketed from 19.816
billion to 55.306 billion. In 2007, it remained steady at an amount of 56.552 billion. Of
the amount of goodwill in 2007, 35.3 billion were from the purchase of Gillette. The
overall amount of goodwill is expected to remain steady unless there is another huge
purchase or sell. Procter & Gamble does not amortize their goodwill, but they do test it
annually for impairment. They also treat other intangible assets in a similar manner as
they do their goodwill. The reason they are a flexible company is that they allow the
management of their company to make judgment decisions when they are evaluating
economic and operating changes. This is putting a lot of trust in your management by
letting them make decisions outside of what is required. When impairing their goodwill
they use forecasts in growth rates and cost of equity. This causes even more judgment
calls by managers. Other companies in this industry such as J ohnson & J ohnson and
Kimberly-Clark use similar techniques. Kimberly-Clark recorded goodwill in 2006 of
2860.5 million. That is around 16.7 percent of its total assets. In 2006, J ohnson &
J ohnson reported goodwill as 18.9 percent. In the previous year, they reported
goodwill at 10.2 percent. Overall Procter & Gamble and other companies in the industry
show that they are flexible through the amount of decisions they allow their
management to make.

34

Employee Benefits
Procter & Gamble has a lot of benefits, most being post-employment. These
benefits are pensions, specific benefit plans, and other post employment benefit plans.
These Other benefit plans are mainly health care and life insurance based. As far as
their accounting decisions, they are very flexible because you have to be able to
estimate expected salary raises, discount rates, and employee related factors. These
factors are all different because not every employee has the same health. Some
employees are obviously going to cost more to insure than others are. There are many
factors that play into employee benefits. All these factors increase a companys
flexibility because it enables them to make independent decisions aside from what is
required. They also comply with GAAP through certain ways. They defer the difference
between the actual results and their own assumptions up to 10%. Anything over 10%
is expensed in the next year. It is evident that Procter & Gambles employee benefits
are flexible because of the assumptions the company allows management to make.
Revenue Recognition
Of these three, revenue recognition is the least flexible and uses more required
accounting than judgment calls. The reason they do this is that there is not much
judgment needed. Everyone follows a basic strategy. Procter & Gamble recognizes its
revenue when the title has been passed to new owner. This is standard procedure for
all companies in this industry. Another procedure that is involved with revenue
recognition is how they deal with product discounts and returns. They use another
standard industry norm of reducing sales in the time the product is purchased. As said
before there is little if any room for flexibility in revenue recognition. It is standard to
follow the industry norm and record at the time of acquisition.
Conclusion
Although Procter & Gamble is reasonably flexible, they also give a lot of
disclosure through their 10k and annual reports. The reason they are reasonably

35

flexible is because of their high flexibility in goodwill and employee benefits and their
low flexibility in revenue recognition. Again, in this industry there is a lot of flexibility
given to the managers. The reason is that their KAPS allow them to make more
judgment calls rather than follow straight out of the book. So not only do they follow
GAAP requirements but also make adjustments when needed.
Accounting Strategy
Companies generally have to follow the GAAP Guidelines while disclosing
financial information in their annual reports. However, it is much better if some
information about results, trends, and insight used by the management could be
provided to the investors. This not only builds trust for the company but also enables
investors to make sound investment decisions. Procter & Gamble uses the Managers
Discussion and Analysis section in the annual report to discuss the financial results
which include several non GAAP financial measures used by them. Along with this, they
have also provided the comparable GAAP measures in their discussion. It is quite clear
that Procter & Gamble is an aggressive company because of excessive amount of
information they provide. By doing this, they are signaling to investors that they are a
high disclosure company that not only show what GAAP requires but they stretch the
limits. For example, Procter & Gamble segment reporting consists of three global
business units which are beauty and health, household care, and Gillette. In each of
these three global business units, Procter & Gamble categorizes their seven reportable
segments under U.S. GAAP. Those are beauty, healthcare, fabric and home care, pet
health, snacks and coffee, baby and family care, blades and razors, and finally Duracell
and Braun. An example of disaggregating is the companys choice to split credit sales
and cash sales. This also allows investors to see a more detailed part of their company.
When compared to a low disclosure firm the roles are completely reversed. A low
disclosure firm on the other hand only provides to investors what GAAP requires of
them. They do not provide any additional information. Procter & Gamble is considered
a very aggressive company not only because of their high disclosure, but also because
they always show an increase in reported earnings. Each year as shown in figure 9,

36

their reported earnings have grown. They are also proud to show that they give a lot of
dividends and pensions. Their companys motto is Procter & Gamble is designed to
grow (P&G Annual Report). Their transparency is just another factor that shows their
aggressiveness. Either Procter & Gamble can manipulate reported earnings to show a
high income, or they can reduce it to pay a smaller amount of taxes. In 2006, they
overstated their assets to possibly make the company look better. However, they will
have to pay a lot more for taxes. As shown this accounting strategy is very aggressive.
Sustaining Growth (FIGURE 9)
P&Gs performance in fiscal 2006 continues the consistent growth
we have delivered in the first half of the decade. Since 2001:
Net sales have increased 12% per year. Organic sales
have increased 6% per year. Total sales have grown from
$39 billion to $68 billion.
Earnings per share have grown an average of 12% per year.
Free cash flow has grown to nearly $9 billion per year,
totaling more than $35 billion over the past five years.
Procter & Gamble is a company which goes to great lengths to disclose its
companys information. Through their disclosure comes their aggressive strategy. After
researching their financial statements and annual reports it was determined their
industrys competitors disclose large amounts of information. It was also determined
that according to their key accounting policies they are considered an aggressive
company. Nevertheless, this leads a potential investor to think that they can be trusted
because of their high transparency.
Qualitative Analysis
Qualitative analysis is a useful tool in determining the overall transparency and
decision usefulness of the reported financial statements. In order to allow outsiders to

37

get a good picture of a companys performance, the company must release adequate
information. However, disclosure must also be at a level that does not harm a firms
competitive advantage. Incentives are always present that tempt managers to bias
company reports; therefore, an in-depth look at those reports must be taken in order to
ensure the accuracy of reported information.
The first area that needs to be evaluated is the companys overall level of
disclosure. Procter & Gamble does a good job disclosing financial information. The
notes to their financial statements give a good explanation for everything put into the
financial statements. They dont leave analysts guessing where the numbers came
from. If anything seems out of the ordinary, it is addressed either in the notes to the
financial statements, or in the management discussion and analysis. For example, in
2006 Procter reported a 19 percent increase in selling, general, and administrative
expenses. In comparison to other years, this is a large jump. If no other disclosure
were given, this increase would signal a red flag to analysts. However, the
management discussion and analysis section of Procter & Gambles 2007 10-K goes on
to explain how this large increase resulted from the acquisition of Gillette
(www.pg.com). This good level of disclosure is also consistent throughout the industry.
Dis-aggregation of financial information is also important in order to obtain an
accurate picture of a companys performance. If a company lumps items on financial
statements together, analysts cannot be sure how to allocate the data to individual
business activities. The line items on Procter & Gambles financial statements are
somewhat aggregated; however, in the notes to their statements, line items are further
broken down. One example of this is Procter & Gambles reporting of long-term debt.
Long-term debt is shown as one line item on the 2007 balance sheet. However, note 5
of the 10-K filing dis-aggregates all the long-term debt into individual liabilities complete
with interest rates and due dates (www.pg.com). Figure 10 shows the dis-aggregation.



38

Figure 10: Dis-aggregation of long-term debt notes
J une 30 2007 2006
LONG-TERM DEBT
3.50% USD note due October 2007 $ 500 $ 500
6.1 3% USD note due May 2008 500 500
Bank credit facility expires J uly 2008 4,537 19,555
4.30% USD note due August 2008 500 500
3.50% USD note due December 2008 650 650
6.88% USD note due September 2009 1,000 1,000
Bank credit facility expires August 2010 1,830 1,857
3.38% EUR note due December 2012 1,882 1,779
4.50% EUR note due May 2014 2,016
4.95% USD note due August 2014 900 900
4.85% USD note due December 2015 700 700
4.1 3% EUR note due December 2020 806 763
9.36% ESOP debentures due 2007-2021
(1)
968 1,000
4.88% EUR note due May 2027 1,344
6.25% GBP note due J anuary 2030 1,001 917
5.50% USD note due February 2034 500 500
5.80% USD note due August 2034 600 600
5.55% USD note due March 2037 1,400
Capital lease obligations 628 632
All other long-term debt 3,657 5,553
Current portion of long-term debt (2,544) (1,930)
23,37 35,976
(www.pg.com)
This method of reporting is much more transparent than the single line item on the
balance sheet, and it better depicts Procter & Gambles long-term debt. The rest of the
personal products industry practices similar dis-aggregation methods in reporting.
When a company with multiple segments reports financial information, it needs
to be reported by individual segments. This allows analysts to assess the performance
of each segment of the company. Some segments will out perform others; however, if
there is no individual segment disclosure, there is no way to determine which segments
are the strongest and which are the weakest. Procter & Gamble does report their
financial results based on segments. This breakdown can be found in the notes to
financial statements. For instance, note 12 of Procter & Gambles 2007 10-K breaks
down performance by segment (www.pg.com). Figure 11 from note 12 shows global
segment results.


39

Figure 11: Global segment results
Before-Tax Depreciation
&
Capital
Global Segment Results
Net
Sales
Earnings
Net
Earnings
Amortization
Total
Assets

Expenditure
s
BEAUTY AND HEALTH
BEAUTY 2007 $ 22,981 $ 4,794 $ 3,492 $ 577 $ 14,470 $ 641
2006 21,126 4,359 3,106 535 13,498 577
2005 19,721 3,977 2,752 535 11,494 535
HEALTH CARE 2007 8,964 2,148 1,453 279 7,321 189
2006 7,852 1,740 1,167 234 7,644 162
2005 6,078 1,210 811 161 2,536 112

HOUSEHOLD CARE
FABRIC CAREAND
HOMECARE
2007 18,971 4,156 2,793 453 7,649 654
2006 17,149 3,553 2,369 435 6,928 567
2005 15,796 3,186 2,129 391 6,845 647
BABY CARE AND
FAMILY CARE
2007 12,726 2,291 1,440 671 7,731 769
2006 11,972 2,071 1,299 612 7,339 739
2005 11,652 1,924 1,197 580 7,272 684
SNACKS, COFFEE AND
PET CARE
2007 4,537 759 477 164 2,176 141
2006 4,383 627 385 159 2,122 150
2005 4,314 714 444 162 2,197 142

GILLETTE GBU
(1)

BLADES AND
RAZORS
(1)
2007 5,229 1,664 1,222 657 24,160 210
2006 3,499 1,076 781 489 24,575 271
2005
DURACELL AND
BRAUN
(1)
2007 4,031 588 394 194 6,998 135
2006 2,924 400 273 155 7,384 108
2005

CORPORATE 2007 (963) (1,690) (931) 135 67,509 206
2006 (683) (1,413) (696) 8 66,205 93
2005 (820) (1,030) (410) 55 31,183 61

TOTAL COMPANY 2007 76,476 14,710 10,340 3,130 138,014 2,945
2006 68,222 12,413 8,684 2,627 135,695 2,667
2005 56,741 9,981 6,923 1,884 61,527 2,181
(www.pg.com)

40

This level of segmentation disclosure is consistent with that the rest of the personal
products industry.
Conclusion
On an absolute basis, Procter & Gamble exercises a high quality of disclosure.
Their 10-K information provides in-depth notes and management discussion and
analysis that discuss any foggy aspects of the reported financial information. This is
done by dis-aggregating single line items found on the financial statements as well as
breaking down results by segments. On a relative basis, Procter & Gamble reports with
about he same disclosure as its competitors. Overall, the personal products industry
practices high disclosure. The tables presented above are not exclusive to Procter &
Gamble. 10-K reports produced by J ohnson & J ohnson, Kimberly-Clark, and Colgate-
Palmolive all had dis-aggregated reports as well as segmented reports.
Quantitative Analysis
Quantitative Analysis is the financial analysis technique that seeks to understand
behavior by using complex mathematical and statistical modeling, measurement and
research (investopedia.com). This tool will be used to compare sales manipulation
diagnostics and expense manipulation diagnostics. Since there is flexibility in
accounting, a company could manipulate their revenue and expenses in a fiscal year,
which could alter their actual performance. Any inconsistence in a corporations
numbers could throw up a red flag to investors. A thorough analysis of these ratios
can show how accurate or inaccurate the quality of disclosure is from a company. In
the following paragraphs, we will compare sales manipulation diagnostics, which
includes net sales compared to cash from sales, net accounts receivable, unearned
revenues, warranty liabilities, and inventory. We will also compare expense
manipulation diagnostics, which compares sales to assets, changes in operating cash
flows to operating income and net operating assets, and pension and other employment
expenses to selling, general, and administrative expenses.

41

Sales Manipulation Diagnostics
Analyzing the sales of a company over a period can show if there are any
distortions to the accounting during those years. Also, comparing these numbers to
their competitors can also show if there are any manipulations of their accounting.
Sales manipulation diagnostics will be used in the following paragraphs for the personal
products industry.
Net Sales/ Cash From Sales

Net sales divided to cash from sales is an important ratio because it shows the
amount inventory sold on credit. An ideal ratio is 1:1. This ideal ratio can be reached,
but it is very hard to maintain due to the high amount of sales on credit. Sales on credit
cause a delay in the amount of cash received, which causes this ratio to be higher than
1:1. It is normal to be slightly higher than a 1:1 ratio in the personal products industry.
Procter & Gambles ratio has fluctuated from around 1:1 to 1.02:1 in the past five
years. This alternating ratio shows that there were higher amounts of sales on credit
one year, but the next year the cash from the sales was received. Therefore, this ratio
shows that the net sales and cash from sales reported are believable.


42

Net Sales/ Accounts Receivable

Comparing net sales to net accounts receivable shows us a companys accounts
receivable turnover. Accounts receivable turnover is the effectiveness of a company
collecting debts. As seen in the above graph, all companies have fairly steady net sales
to net accounts receivable ratios. Procter & Gamble has the most fluctuation from 14.28
percent to 11.54 percent, but this number has steadily decreased over the past five
years. The decrease in this ratio, however, is not significant enough to cause a red
flag because there are no sharp increases or decreases over time. A higher ratio
means that the company is more efficient in collecting its accounts receivable. Upon
analyzing this ratio, we believe that net sales are supported by accounts receivable and
that Procter & Gamble are not manipulating their sales.






43

Net Sales/ Inventory

Net sales compared to inventory will show how a companys inventory turnover.
Inventory turnover is the measure of how well a company can turn inventory into sales. Each
company in this industry has maintained steady net sales to inventory ratios over the past five
years. From 2003 to 2006, J ohnson & J ohnsons ratio increased, meaning that more sales were
generated with the inventory that they had. Then in 2007 there was almost a 2 percent
decrease, meaning that fewer sales were generated. Procter & Gamble has had a ratio of
between 11 percent and 12 percent over the past five years. Since there is little fluctuation in
this ratio, there is no reason to believe that Procter & Gamble has manipulated net sales with
respect to inventory.
Conclusion
Using sales manipulation diagnostics for companies in the personal products
industry has shown that some companies have more distortion than others do.
Investors should still be extremely careful in examining a company and be very cautious
if any distortions are found. Procter & Gamble was, overall, consistent in its accounting.
However, this does not mean that Procter & Gamble has no distortion at all. The
financial statements and annual reports should still be examined thoroughly before any
important decisions are made.

44

Expense Manipulation Diagnostics
Analyzing the expenses of a company over a period can also show if there are
any distortions to the accounting during those years. Comparing these numbers to their
competitors can show if there are any manipulations of their accounting as well.
Expense manipulation diagnostics will be used in the following paragraphs for the
personal products industry.
Asset Turnover

Asset turnover is generated by comparing sales to total assets. This ratio shows
the amount of sales produced for every dollar of assets produced. All the firms in the
industry, except Procter & Gamble, have maintained a steady asset turnover ratio over
the past five years. The industry leader is Avon, which means that they are efficient in
producing sales with the assets that they have. Procter & Gambles ratio had a
substantial decrease from 2005 to 2006. This would normally raise a red flag for the
company, meaning that assets were understated substantially. However, the sharp
decrease in asset turnover for Procter & Gamble was a result of the acquisition of The
Gillette Company on October 1, 2005. This acquisition increased Procter & Gambles
assets by $74 billion in this year. From 2006 to 2007, Procter & Gambles asset turnover

45

ratio rose slightly due to the increase in sales from the Gillette acquisition, and will
continue to increase in years to come.
Cash Flows from Operating Activities/ Operating Income

The ratio of cash flows from operating activities compared to operating income
shows how operating income is supported by cash flows. In the personal products
industry, each company maintained a low and relatively steady ratio with an average of
around one over the past five years, with the exception of Unilevers spike in 2005.
Procter & Gambles ratio fell roughly 0.4 percent from 2003-2005. A drop in cash
caused this decrease in the ratio from operating activities in 2005 while operating
income was steadily increasing. This drop in cash from operations was due to the initial
operating expenses of the Gillette acquisition. Operating cash flows increased in 2006
by 31 percent due to the benefit of acquiring Gillette (PG 10K). This caused the ratio to
become steady for the next two years. Upon analyzing this ratio, it shows us that cash
from operating activities is supported by operating income for Procter & Gamble.

46

Cash Flow from Operating Activities/ Net Operating Assets


The ratio of cash flows from operating activities to net operating assets shows how
operating revenue is generated for every dollar in net operating assets that the
company has. The higher the ratio, the more revenue a company has from its fixed
assets. As the graph shows, J ohnson & J ohnson is the industry leader in this area,
producing $1.05 in revenue, on average, with each dollar in net assets. Procter &
Gamble is on the middle of the industry and has an average ratio of around 0.65 that
has had little fluctuation over the past five years. Even though Procter & Gamble is
among the top in the industry based on cash flow from operations data, they have a
lower CFFO/NOA ratio due to the very large amount of fixed assets that they have
compared to others in the personal products industry.

47

Pension Expense/ SG&A

The pension expense to selling, general, and administrative expense ratio shows
how much money is being spent on retirees compared to the rest of SG&A expenses.
Pension expense is a part of SG&A expenses. As a result, this ratio should be relatively
low so that pension expense is only a portion of SG&A expenses. All companies in the
personal products industry have maintained a low ratio over the past five years. Procter
& Gambles ratio has relatively small change, if any, during this time period. This is
because both pension expense and selling, general, and administrative expenses are
increasing at about the same rate.

48

Other Employment Expenses/ SG&A

The ratio of other employment expenses to selling, general, and administrative
expenses shows how much is spend on other employee benefits, except for pension
funds, compared to all SG&A expenses. Other employee benefits in a company can
include life, dental and health insurance, retirement programs, and even family
benefits, and is included in SG&A. This ratio should remain relatively stable over time
because the expenses should typically increase or decrease collectively. An increase in
this ratio means that more is being spent on other employment expenses compared to
SG&A. Procter & Gamble has had little fluctuation over the past five years in this ratio.
Conclusion
Using the quantity of disclosure method has shown that some companies in the
personal products industry have more distortion than others. However, these distortions
could be caused by changing their accounting policies, managers, or methods. Even if
these changes explain the distortions in accounting, investors should still be very careful
in examining the company. Procter & Gamble was, overall, consistent in its accounting.
However, this does not mean that Procter & Gamble has no distortion at all. The

49

financial statements and annual reports should still be examined thoroughly before any
important decisions are made.
Potential Red Flags
Whenever analysts come across questionable financial reporting, they will red
flag it for further analysis. This is where biased and tampered financial reports will be
exposed. One potential red flag discussed above was with the other employment
expenses to selling general and administrative expenses ratio. Procter & Gamble
reported a small decrease from 2003 to 2005 while the rest of the industry remained
fairly flat. Although the move differed from that of the rest of the industry, it was small
enough to be ignored and is considered to be insignificant. One ratio that displayed a
broad range over the last five years was total accruals to change in sales. However,
the rest of the industry reported very sporadic results here as well. Therefore, there is
no evidence of manipulation here. The last ratio that presented a possible red flag was
cash flows from operations to operating income. This ratio did have a fair decrease
from 2003-2005; however, it never jumped outside the range of the rest of the
industry. Therefore, this is not an example of accounting manipulation.
The fact that Procter & Gamble does not amortize their goodwill does signal a
red flag. Goodwill is a very large item on the balance sheet and it was reported in 2007
as $56.552 billion dollars. If Procter & Gamble amortizes their goodwill in order to
better match revenues with expenses, their financial statements would look much
different.
Undo Accounting Distortions
Whenever an item within a companys financial disclosures is believed to be
materially misstated, analysts must go back and restate the numbers in order to obtain
a more accurate picture of the company. If Procter & Gamble were to take their
goodwill of $56.552 billion stated in 2007 and amortize it over the next five years, they
would report $11.310 billion in amortization expense per year over that period. Total

50

assets would decrease by $11.310 billion per year as well. Net earnings for 2007 were
only $10.340 billion. Therefore, Procter & Gamble must have at least a 3.4 percent
increase in net sales during 2008 just to break even, all else equal. They must attain
over a 22 percent increase in sales in order to maintain just the same level of net
earnings. Historically, growth has not been this high. This makes positive net earnings
over the amortization period highly unlikely. Looking at the company this way is
completely different than what Procter & Gamble themselves presents. Without
goodwill amortization, Procter & Gamble is a healthy growing company. If goodwill is
amortized, net earnings drastically decreases, and they appear to be struggling to make
profits.
Financial Analysis
The financial analysis is comprised of three different types of ratios. These types
of ratios are liquidity, profitability, and capital structure. Within these three categories
are different types of ratios that they correspond to. By looking at each companys
financial statements, you are able to implement these ratios. The three different types
of financial statements you look at are the income statement, balance sheet, and the
statement of cash flows. Each statement is needed to calculate these ratios. Once you
have made the calculations for all the ratios for each company, you are able to move on
to the next step. This consists of putting them together and comparing them. Based
on this, you are able to see where each company stands in the industry with its
competitors.
Liquidity Analysis
The Liquidity analysis is a measure of its companys liquidity. It is divided up into
two sections, which are short-term and long-term. These short-term ratios are Current
ratio and Quick asset ratio. The long-term ratios are; Accounts receivable turnover,
Days supply of inventory, Inventory turnover, Days sales outstanding, and Working

51

Capital turnover. These ratios are most helpful in measuring companies short and long-
term obligations.
Current Ratio
Current Ratio is defined as Current Assets divided by Current liabilities. This ratio
indicates whether a company can meet its short-term debt requirements. The more
current assets you have the higher the ratio. In this case, a high ratio is desireable. It
is said that if your current ratio goes below one, there could be a potential problem.
The reason is because your current liabilities have exceeded your current assets and
you are therefore unable to compensate for your debt.
2001 2002 2003 2004 2005 2006
Current Ratio

Procter & Gamble 0.96 1.23 0.77 0.81 1.22
J ohnson & J ohnson 2.30 1.68 1.71 1.96 2.49 1.20
Kimberly-Clark 0.94 1.06 1.13 1.09 1.03 1.05
Colgate-Palmolive 1.04 1.02 1.00 1.01 0.95
Avon 1.04 1.39 1.56 1.17 1.31
Unilever 0.70 0.78 0.74 0.72 0.68
AVG 1.62 1.08 1.21 1.19 1.21 1.07


52

Current Ratio
0
0.5
1
1.5
2
2.5
3
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

In the chart above Procter & Gamble is tied at fourth with an average current
ratio of one. In 2003 and 2006, it is at a favorable rate above one, however two out of
five years if not good enough. They are below the industry average and must be more
consistent. Throughout the past 6 years, J ohnson & J ohnson has had the best current
ratio out of all six companies. They have maintained a steady ratio above one and in
years 2001 and 2005, they have jumped above two. In 2006, it decreased to the level
where all the other companies were. It is still in a favorable position though. The
industry average current ratio is fairly steady, which Procter & Gamble is slightly below
in most years. J ohnson & J ohnson and Avon are the only two companies above the
industry average. Unilever came in last with an average of a 0.72 current ratio. Also
below the industry average was Colgate-Palmolive with an average of 1.0. It is
imperative that Procter & Gamble maintains a more consistent ratio of above 1.0 to be
looked at as more favorable.
Quick Acid Ratio (Acid Test)
The Quick Acid Ratio is defined as cash, securities, and accounts receivable all
divided by current liabilities. This ratio shows whether a company can meet its debt
obligations with its most liquid assets. If your company is greater than one, then you
are able to compensate for your debt with your most liquid assets. Other assets such as
inventories are not in this equation because they are not available to be converted into
cash within a very short time period.

53


2001 2002 2003 2004 2005 2006
Quick Acid Ratio

Procter & Gamble 0.53 0.75 0.45 0.49 0.68
J ohnson & J ohnson 1.57 1.12 1.20 1.42 1.83 0.67
Kimberly-Clark 0.85 0.96 0.97 0.95 0.91 0.94
Colgate-Palmolive 0.61 0.61 0.60 0.60 0.58
Avon 0.59 0.78 0.85 0.68 1.06
Unilever 0.39 0.44 0.45 0.38 0.37
AVG 1.21 0.70 0.79 0.79 0.82 0.72

Quick Acid Ratio
0.00
0.50
1.00
1.50
2.00
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

The industry average is right below 1.0 and like the previous ratio J ohnson &
J ohnson is the only company that exceeds its expectations. Their average is 1.30,
which is the highest on the chart. However, like the current ratio test in 2006 their
ratio dropped substantially to 0.67, which is slightly below the industry average of 0.72.
In second is Kimberly-Clark with an average of 0.93. These two are the only ones

54

above the industry average. In third is Avon with an average of 0.79. Most of these
companies have similarities with their own current ratio. Procter & Gamble came in fifth
and is below the industry average with an average of 0.58. In every year, they are
below the industry average. In 2004 and 2005, they are at an unfavorable state. They
need to start moving in a more favorable direction and get up to the industry average.
Accounts Receivable turnover
Accounts receivable turnover is defined as sales divided by accounts receivable.
This ratio measures the amount of times in a year a company collects its account
receivables. The higher receivable turnover a company has the more effective that
company will be. If the company has a lower turnover, this can indicate a possible
collection problem.
2001 2002 2003 2004 2005 2006
A/R Turnover

Procter & Gamble 13.02 14.28 12.66 13.56 11.92
J ohnson & J ohnson 6.98 6.72 6.37 6.93 7.21 6.12
Kimberly-Clark 7.95 6.60 7.17 7.40 7.57 7.17
Colgate-Palmolive 8.11 8.10 8.02 8.70 8.03
Avon 11.06 12.24 12.78 12.72 12.39
Unilever 8.74 9.09 9.77 9.61 10.40
AVG 7.47 9.04 9.54 9.59 9.90 9.34


55

A/R Tur nover
0.00
5.00
10.00
15.00
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

In every year Procter & Gamble lead the industry in accounts receivable turnover
with an average of 13.09. Leading the industry is obviously very favorable to investors.
Procter & Gambles A/R turnover did move up and down, but not too drastically and
never were they unfavorable. P&G never came below the average, and actually, they
stayed 2-3 points above each year. They need to continue what they are doing by
moving in a favorable manner. The industry average was right above 9.0 from 2002-
2006, and Avon and Unilever were the only two that consistently stayed above that
average. The three companies that did not meet the industry average were Colgate-
Palmolive, Kimberly-Clark, and J ohnson & J ohnson. However, all three stayed at a very
consistent rate and didnt have a lot of volatility. This shows consistency in these three
companies even though they are below the Industry average.
Days Sales outstanding (A/ R Days)
Days sales outstanding is equal to 365 days divided by the Accounts Receivable
turnover. This is the number of days it takes to collect the accounts receivable during a
year. Obviously you want this number to be very low. The reason is that you want to
be able to collect your A/R as fast as possible. A high number gives you the exact
opposite, which means your money will be worth less. A dollar is worth more today
than tomorrow. This is the reason you want a low number.


56

2001 2002 2003 2004 2005 2006
A/R Days

Procter & Gamble 28.03 25.56 28.84 26.92 30.63
J ohnson & J ohnson 52.29 54.29 57.32 52.66 50.65 59.63
Kimberly-Clark 45.94 55.33 50.88 49.33 48.24 50.93
Colgate-Palmolive 44.98 45.05 45.52 41.94 45.43
Avon 33.00 29.81 28.56 28.70 29.46
Unilever 41.79 40.17 37.35 37.99 35.11
AVG 49.12 42.90 41.47 40.38 39.07 41.87

A/R Days
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

The industry average in the Days Sales Outstanding was normally in the low
40s. In correlation to accounts receivable turnover, Procter & Gamble is obviously in
first again. They show a favorable and steady average of 28.00 days from 2002-2006.
The highest point was in 2006 at 30.63 and its low point was in 2003 at 25.56. They
are the industry leaders and continue to show it through their ratios. As shown before
in the A/R turnover, the other companies in the industry that were below the average

57

were Avon and Unilever. They also beat the industry average every year. This ratio
shows them moving in a favorable position. All the leaders in this industry were
somewhat steady. However, the three companies that did poorly compared to the
industry average were J ohnson & J ohnson and Kimberly-Clark. Their biggest change
from one year to the next was 9 days. That is a large amount when looking at the
number of times it turns over throughout a year.
Inventory Turnover
Inventory Turnover is defined as cost of goods sold divided by inventory. This
measures the amount of times inventory is sold during the year. Another way of
putting it is how many times you stock your shelves each year. A high turnover is good
for companies because you are making more products and sales that will create profit
for your company. A low turnover does the exact opposite, it prolongs the making and
selling of a companys products.
2001 2002 2003 2004 2005 2006
Inventory Turnover

Procter & Gamble 6.07 6.08 5.70 5.57 5.27
J ohnson & J ohnson 3.20 3.16 3.39 3.60 3.54 3.08
Kimberly-Clark 5.67 5.97 5.91 5.99 6.18 5.82
Colgate-Palmolive 6.29 6.20 5.61 6.07 5.49
Avon 3.97 4.03 3.96 3.91 3.81
Unilever 5.34 5.08 5.04 4.76 5.29
AVG 4.44 5.13 5.12 4.98 5.01 4.79


58

Invent or y Tur nover
0.00
2.00
4.00
6.00
8.00
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

The industry average in Inventory Turnover was slightly below 5. The industries
low point was in 2001 with 4.44 and its high point was in 2002 with 5.13. The three
companies in this section that consistently stayed above the industry average were
Colgate-Palmolive, Kimberly-Clark, and Procter & Gamble. All three of these companies
are consistently moving in a favorable manner. Unilever fell below during 2005 with a
4.76, but is still above average the other 4 years. Procter & Gamble had an average of
5.74. From 2004-2006 it has slightly decreased each year, but is still in a favorable
position since it is above industry average. The leader was Colgate-Palmolive with 5.93
and right behind was Kimberly-Clark with 5.92. The only two that were below average
and are moving in an unfavorable manner were J ohnson & J ohnson and Avon.
Days Supply Inventory (Inventory Days)
Days supply of inventory is equal to 365 days divided by the inventory turnover.
This represents the number of days it takes to sell the inventory throughout the year.
A low number is desired because it tells you how long your product is sitting on the
shelves, and you obviously want to sell products as fast as possible. A high number
shows that there could be a potential problem in the selling of your products. It could
also be that your products are no longer attractive to customers.



59

2001 2002 2003 2004 2005 2006
Inventory Days

Procter & Gamble 60.10 60.01 64.05 65.56 69.32
J ohnson & J ohnson 113.98 115.40 107.56 101.42 103.14 118.52
Kimberly-Clark 64.34 61.14 61.81 60.90 59.07 62.72
Colgate-Palmolive 58.04 58.84 65.01 60.16 66.48
Avon 92.02 90.63 92.17 93.38 95.68
Unilever 68.30 71.91 72.38 76.72 68.96
AVG 89.16 75.83 75.13 75.99 76.34 80.28

Inventory Days
0.00
20.00
40.00
60.00
80.00
100.00
120.00
140.00
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

In the days supply of inventory turnover, you want a low number of days. For
example in this illustration, the company with the lowest number of days is Kimberly-
Clark with an average of 61.66. Following closely behind is Colgate-Palmolive and
Procter & Gamble. Procter & Gamble has an average of 63.81 and is fairly steady.
However, it is moving in an unfavorable way. It starts in 2002 at 60.10 and ends at
2006 at 69.32. Each year it is still below the industry average, which is good, but must

60

do something to change its path to a favorable direction. The highest company with
days supply of inventory is J ohnson & J ohnson with and average of 110.00. This is
very unfavorable and they are well above the average days each year.
Cash to Cash Cycle
This cash to cash cycle is computed by taking days sales outstanding and adding
it to days supply of inventory. This cycle shows you how long it takes a company to sell
a product and collect the cash on that product. The faster this cycle turns the more
liquid your company is. This means a low number is desired. You, as a company, want
as many turns in a year as possible.
2001 2002 2003 2004 2005 2006
Cash to Cash Cycle

Procter & Gamble 88.13 85.57 92.89 92.48 99.95
J ohnson & J ohnson 166.27 169.69 164.88 154.08 153.79 178.15
Kimberly-Clark 110.28 116.47 112.69 110.23 107.31 113.65
Colgate-Palmolive 103.02 103.89 110.53 102.10 111.91
Avon 125.02 120.44 120.73 122.08 125.14
Unilever 110.09 112.08 109.73 114.71 104.07
AVG 138.27 118.73 116.59 116.36 115.41 122.14


61

Cash to Cash Cycle
0
50
100
150
200
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Pamolive
Avon
Unilever
AVG

The industry average of cash to cash cycle ranged anywhere from 138 days to
116 days. Once again Procter & Gamble lead the industry with an average of 92 days.
No other company in this industry came below 100 days throughout the past six years.
This graph shows that they are the most favorable company. However, in 2002, their
cycle was 88 days and in 2006, it was almost 100 days. To continue to be the industry
leader they must bring their cycle back down. Other companies who consistently bean
the yearly industry average were Kimberly-Clark, Colgate-Palmolive, and Unilever. The
company with the worst cash to cash cycle was J ohnson & J ohnson. They averaged an
amount of 164 days throughout these six years. This is very unfavorable for one of the
top companies in this industry.
Working Capital Turnover
Working capital turnover is calculated as sales divided by working capital.
Working capital is equal to current assets minus current liabilities. This ratio shows a
companies growth and its liquidity. It also analyzes money and sales used in operations
of expanding the company. The higher the working capital turnover the better off a
company is. This reason is simple because it is shows that a company is adding a high
amount of sales to the cash it uses for these sales.

62


2001 2002 2003 2004 2005 2006
Working Capital
turnover

Procter & Gamble -74.79 15.16 -10.22 -12.05 15.70
J ohnson & J ohnson 3.10 4.64 4.38 3.54 2.68 13.98
Kimberly-Clark -52.05 56.16 27.00 35.51 113.43 65.96
Colgate-Palmolive 114.41 181.88 1076.46 750.65 -67.80
Avon 84.49 10.94 8.54 19.23 11.06
Unilever -8.07 -11.61 -10.60 -9.03 -9.04
AVG -24.48 29.47 37.96 183.87 144.15 4.98

Working Capital Turnover
-200.00
0.00
200.00
400.00
600.00
800.00
1000.00
1200.00
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

Procter & Gamble is very volatile in this graph. In 2002, it starts very
unfavorable and then bounces from positive to negative each year. It is however,
moving in a favorable manner because it starts at -74.79 in 2002 and ends in 2006 at
15.70. The smoothest company in this chart is J ohnson & J ohnson with an average of

63

5.93. Perhaps the most interesting thing about this graph is the 2004 Colgate-
Palmolive turnover. It jumps to 1076.46, which is a very large number. This is going to
cause the industry average to be higher than it should actually be simply because of
Colgate-Palmolives turnovers in years 2004 and 2005. If they were taken out of the
chart, there would be a more realistic industry average in 2004 &2005.
Conclusion
Looking at Procter & Gambles liquidity ratios it is safe to say that they are a
liquid company. Its current ratio, quick ratio, and working capital turnover were below
average, but every other liquidity ratio was above the industry average. They also lead
the industry in some of these ratios. Procter & Gambles accounts receivable turnover
and accounts receivable days lead the industry. They also had a third place stand in
inventory turnover, but were very close to Colgate-Palmolive who was the leader.
Overall, P&Gs numbers show that they are a fairly liquid company.
Profitability Analysis
The purpose of profitability analysis is to examine a firms operating efficiency,
asset productivity, return on assets, and return on equity. All of these are measures of
how well a company is utilizing its resources. Operating efficiency is measured by gross
profit margin, operating expense ratio, operating profit margin, and net profit margin.
Asset productivity is measured with the asset turnover ratio, and return on assets and
return on equity are measured with the rate of return on assets and the rate of return
on equity respectively.
Gross Profit Margin
Gross profit margin is calculated by taking a firms gross profit (sales minus cost
of goods sold) and dividing it by sales. This ratio measures how much is left over from
each dollar of sales after product costs are taken out. If this ratio is growing, cost of
goods sold (COGS) is shrinking relative to sales. This frees up more sales revenue to

64

be used in other areas of the business or to be retained for future benefit; therefore, a
high ratio here is desired.
2001 2002 2003 2004 2005 2006
Procter & Gamble 0.48 0.49 0.51 0.51 0.51
J ohnson & J ohnson 0.70 0.71 0.71 0.72 0.72 0.72
Kimberly-Clark 0.36 0.35 0.34 0.34 0.32 0.30
Colgate-Palmolive 0.55 0.55 0.55 0.54 0.55
Avon 0.60 0.61 0.62 0.61 0.60
Unilever 0.50 0.50 0.49 0.49 0.49
AVG 0.53 0.53 0.53 0.54 0.53 0.53

Gross Profit Margin
0
0.2
0.4
0.6
0.8
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

Since 2002, Procter & Gamble has grown its gross profit margin from 0.48 to 0.51. This
trend is favorable both as a company and relative to the industry. They industrys gross
profit margin has remained constant allowing Procter & Gamble to move up closer to
the industry average. Therefore, Procter & Gamble is gaining relative to the industry.

65

However, in the personal products industry over the last five years as a whole, COGS
sold has not increased or decreased relative to revenues.
Operating Expense Ratio
The operating expense ratio is calculated by dividing selling, general and
administrative expenses by sales. This ratio directly measures how a firm is controlling
operating expenses relative to sales. Because low expenses are preferred, a low
operating expense ratio is preferred.
2001 2002 2003 2004 2005 2006
Procter & Gamble 0.31 0.31 0.32 0.32 0.32
J ohnson & J ohnson 0.35 0.34 0.34 0.34 0.34 0.33
Kimberly-Clark 0.16 0.17 0.17 0.17 0.17 0.18
Colgate-Palmolive 0.33 0.33 0.34 0.34 0.36
Avon 0.47 0.31 0.32 0.32 0.32
Unilever 0.40 0.31 0.32 0.32 0.32
AVG 0.26 0.34 0.30 0.30 0.30 0.31

Oper at ing Expense Rat io
0.00
0.10
0.20
0.30
0.40
0.50
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG
Over the last five years, Procter & Gamble has maintained a steady operating expense

66

ratio of about .32 or 32% with no significant change. The rest of the industry has
maintained this steady pace as well. Therefore, both Procter & Gamble and the
personal products industry as a whole have done well in keeping their operating
expenses consistent relative to sales.
Net Profit Margin
Net profit margin is computed by taking a companys net income and dividing it
by sales revenue. This ratio incorporates all of a companys expenses in order to come
up with net income. With this ratio, bigger is better. Companies want net income as
large as possible relative to sales; however, this ratio will not be as large as gross profit
margin due the incorporation of all expenses into net income.
2002 2003 2004 2005 2006
Procter & Gamble 0.11 0.12 0.13 0.12 0.13
J ohnson & J ohnson 0.18 0.17 0.17 0.20 0.21
Kimberly-Clark 0.13 0.12 0.12 0.10 0.09
Colgate-Palmolive 0.14 0.14 0.13 0.12 0.11
Avon 0.47 0.47 0.47 0.48 0.53
Unilever 0.08 0.07 0.07 0.07 0.10
AVG 0.19 0.18 0.18 0.18 0.20



67

Net Profit Margin
0.00
0.10
0.20
0.30
0.40
0.50
0.60
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

Since 2002, Procter & Gamble has increased their profit margin from 0.11 or 11 percent
to 0.13 or 13 percent. This is a favorable increase of about 18 percent. Therefore,
Procter & Gamble has done well in controlling expenses. Over the past five years, they
have risen above both Colgate-Palmolive and Kimberly-Clark with this particular
profitability measure.
The overall operating efficiency of Procter & Gamble has slightly increased since
2002. Their gross profit margin and operating expense ratio maintained pace with the
industry while net profit margin had a significant increase and passed two competitors.
This is indicative of better implementation of cost controls within the company and an
increasingly efficient operation.
Asset Turnover
Asset turnover is computed by dividing sales by total assets. This ratio measures
how well a company is using is assets to generate revenues. Year to year increases in
this ratio are favorable and would indicate that a company is better utilizing assets to
create revenues.

68


2001 2002 2003 2004 2005 2006
Procter & Gamble 0.99 0.99 0.90 0.92 0.50
J ohnson & J ohnson 0.84 0.90 0.87 0.89 0.86 0.76
Kimberly-Clark 0.89 0.85 0.84 0.89 0.98 0.98
Colgate-Palmolive 1.31 1.32 1.22 1.34 1.34
Avon 1.85 1.89 1.85 1.69 1.66
Unilever 1.14 1.12 1.01 0.97 1.07
AVG 0.87 1.17 1.17 1.13 1.13 1.05

Asset Turnover
0.00
0.50
1.00
1.50
2.00
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

From 2002 to 2005, Procter & Gambles asset productivity slightly decreased and
Kimberly-Clark passed them. In those four years, Procter & Gamble did not do well
both year to year as a company and relative to the industry. The industry average fell
as well; however, it did not fall as much as Procter & Gambles. From 2005 to 2006,
their asset turnover ratio was nearly cut in half. This would generally signal a red flag;
however, this large decline was due the acquisition of Gillette. The addition of all

69

Gillettes assets into this ratio in 2006 had a significant impact on Procter & Gambles
asset turnover. Still, Procter & Gamble was having steady declines in this area well
before the acquisition of Gillette. They were already near the bottom of the industry in
2005 and the trend suggests that even without the Gillette acquisition, Procter &
Gamble was headed for last place anyway. Therefore, Procter & Gamble has done a
poor job utilizing assets to generate revenues.
Return on Assets
Return on assets (ROA) is a measure of how well a company uses assets to
generate net income. This computed by dividing net income by total assets. Here,
higher ratios are desired; however, they will not get as high as the asset turnover ratio,
because net income will always be a smaller numerator than sales.
2002 2003 2004 2005 2006
Procter & Gamble 0.13 0.15 0.12 0.14
J ohnson & J ohnson 0.17 0.18 0.17 0.19 0.19
Kimberly-Clark 0.11 0.11 0.11 0.09 0.09
Colgate-Palmolive 0.18 0.19 0.15 0.16
Avon 0.20 0.24 0.20 0.10
Unilever 0.07 0.07 0.07 0.10
AVG 0.14 0.15 0.16 0.14 0.13



70

Return on Assets
0.00
0.05
0.10
0.15
0.20
0.25
0.30
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

Procter & Gamble has experienced a slight increase in ROA from 0.13 or 13 percent in
2003 to 0.14 or 14 percent in 2006. This was about an 8 percent increase. Relative to
the industry they have done even better surpassing both Avon and the industry
average. Hence, Procter & Gamble has done well in maintaining a steady ROA while
the industry on average fell.
Return on Equity
Return on equity (ROE) is a measure how profitable a company is relative to
capital raised by owners. ROE is calculated by taking net income and dividing it by
owners equity. With this ratio, bigger is better.

71


2002 2003 2004 2005 2006
Procter & Gamble 0.38 0.40 0.40 0.50
J ohnson & J ohnson 0.27 0.32 0.30 0.32 0.29
Kimberly-Clark 0.30 0.30 0.27 0.24 0.27
Colgate-Palmolive 3.70 1.60 1.07 1.00
Avon -5.21 2.28 0.89 0.60
Unilever 0.64 0.45 0.36 0.49
AVG 0.29 0.02 0.88 0.55 0.53

Ret ur n on Equit y
-6.00
-4.00
-2.00
0.00
2.00
4.00
6.00
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

Procter & Gamble has experienced a 32 percent increase in ROE since 2003. They have
been very profitable in this area year to year. However, Relative to the industry they
have done even better. If Avons negative ROE is thrown out of the graph as an outlier,
the industry average in 2003 is about 1.06. Therefore, the industry is on a downward
trend while Procter & Gamble is moving up.

72

Conclusion
Procter & Gamble has managed to maintain either steady or growing profitability
all but one of these measures. Therefore, they have done well with profitability on year
by year basis. They do typically fall under the industry average; however, they are
making gains relative to the industry.
Capital Structure Analysis
Capital structure analysis will reveal to analysts how much of a companys capital
is debt financed and how much is equity financed. It will also show whether a company
is capable of paying its debt. The three ratios used in this analysis are debt to equity,
times interest earned, and debt service margin.
Debt to Equity
Debt to equity is calculated by dividing total liabilities by total owners equity.
This ratio will reveal whether more debt or equity is used to finance assets.
2001 2002 2003 2004 2005 2006
Procter & Gamble 1.98 1.70 2.30 2.52 1.16
J ohnson & J ohnson 0.59 0.79 0.80 0.68 0.52 0.79
Kimberly-Clark 1.66 1.77 1.48 1.57 1.93 1.80
Colgate-Palmolive 19.23 7.43 5.96 5.30 5.48
Avon -27.06 8.65 3.37 5.00 5.63
Unilever 8.01 5.41 4.07 3.72 2.30
AVG 1.13 0.79 4.25 2.99 3.17 2.86


73

Debt t o Equit y Rat io
-30.00
-20.00
-10.00
0.00
10.00
20.00
30.00
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

Debt to equity for Procter & Gamble has fluctuated with an overall decrease since 2002.
This trend shows that Procter & Gamble has begun to finance assets more and more
with equity than debt. On the other hand, the industry has on average chosen to
finance capital with debt rather than equity.
Times Interest Earned
Times interest earned measures a companys ability to pay in its interest on debt.
It is calculated by dividing income from operations by interest expense. Here, a higher
ratio demonstrates a better ability to pay interest on debt.
2001 2002 2003 2004 2005 2006
Procter & Gamble 11.07 14.00 15.62 12.55 11.84
J ohnson & J ohnson 50.85 59.31 48.08 65.98 230.91 208.73
Kimberly-Clark 13.44 14.71 16.29 17.64 14.34 11.17
Colgate-Palmolive 14.10 17.45 17.73 16.29 13.61
Avon -22.84 -50.38 -93.11 -68.39 -17.19
Unilever -4.71 -7.04 -8.40 -10.05 -17.01
AVG 32.15 11.94 6.40 2.58 32.61 35.19

74


Times Int erest Earned
-150.00
-100.00
-50.00
0.00
50.00
100.00
150.00
200.00
250.00
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

Procter & Gambles times interest earned has fluctuated since 2002 with a slight
increase. On average, their times interest earned has been about 13. Because J ohnson
& J ohnsons times interest earned was so much higher than everyone else in the
industry, Procter & Gamble fell below the industry average in 2004 and 2006. However,
if J ohnson & J ohnson is removed as an outlier from the table, Procter & Gamble would
be near the top of the industry in times interest earned.
Debt Service Margin
Debt service margin measures whether a firm is able to meet long-term debt
obligations. This calculated by taking cash flows from operations in one year and
dividing it by the current portion of long-term debt in the previous year. Higher ratios
are desired in this instance to insure the ability to pay off debt.

75


2002 2003 2004 2005 2006
Procter & Gamble 2.33 4.31 1.05 0.99
J ohnson & J ohnson 14.47 5.00 9.74 42.14 21.33
Kimberly-Clark 17.56 2.40 3.44 1.90 2.11
Colgate-Palmolive 5.40 5.62 3.89 5.00
Avon 1.23 3.62 17.32 0.90
Unilever 0.72 0.96 0.99 0.86
AVG 16.02 2.85 4.62 11.22 5.20

Debt Servi ce Margi n
0.00
10.00
20.00
30.00
40.00
50.00
2001 2002 2003 2004 2005 2006
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
AVG

Procter & Gambles debt service margin has shrunk from 2.33 in 2003 to 0.99 in 2006.
This demonstrates a decreasing ability to meet long-term debt obligations. During
2006, there were not enough cash flows to support the portion of debt due. This trend
is well below the industry average indicating an even poorer performance relative to the
industry.

76

Conclusion
In analyzing Procter & Gambles capital structure, a downward trend can be seen
in their ability to pay their debts. Although their times interest earned has had slight
increases, their debt service margin has declined substantially. This indicates a problem
in paying off debt with cash flows.
I nternal Growth Rate
Internal growth rate (IGR) is a measure of a companys capability to increase its
assets with only retained earnings. If a company is able to finance growth internally, it
will have no need to take on additional debt. To compute IGR, the dividend payout
ratio must be known. The dividend payout ratio is equal to dividends paid divided by
net income. The dividend payout ratio is then subtracted from one and this figure is
multiplied by ROA to arrive at the IGR.
2002 2003 2004 2005 2006
Procter & Gamble 0.07 0.09 0.07 0.08
J ohnson & J ohnson 0.11 0.11 0.10 0.12 0.12
Kimberly-Clark 0.07 0.07 0.06 0.04 0.04
Colgate-Palmolive 0.12 0.11 0.08 0.08
Avon 0.14 0.16 0.13 0.03
Unilever 0.03 0.00 0.01 0.02
Average 0.09 0.09 0.07 0.06


77




Since 2003, Procter & Gambles IGR has fluctuated with no upward or downward trend.
Therefore, their ability to grow internally has remained steady. Because the rest of the
industry has declined over this time, Procter & Gamble has had relative gains in IGR
surpassing both Avon and the industry average.
Sustainable Growth Rate
Sustainable growth rate (SGR) is a measure of a companys capability to grow
without borrowing money. It calculated by dividing dividends by equity. This ratio is
then added to one and multiplied by the IGR. Higher SGRs are more favorable and
allow companies to grow without increasing their debt burdens.
IGR
0.0000
0.0500
0.1000
0.1500
0.2000
2003 2004 2005 2006
Year
Procter & Gamble
J ohnson & J ohnson
Kimberly-Clark
Colgate-Palmolive
Avon
Unilever
Average

78


2002 2003 2004 2005 2006
Procter & Gamble 0.09 0.12 0.09 0.09
J ohnson & J ohnson 0.13 0.13 0.12 0.14 0.14
Kimberly-Clark 0.08 0.08 0.07 0.05 0.04
Colgate-Palmolive 0.23 0.20 0.13 0.12
Avon 0.33 0.28 0.22 0.04
Unilever 0.04 0.00 0.01 0.02
Average 0.11 0.15 0.13 0.11 0.08
SGR
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
2003 2004 2005 2006
Year
Procter & Gamble
J ohnson & J ohnson
Kimberly Clark
Colgate-Palmolive
Avon
Unilever
Average

Procter & Gambles SGR has fluctuated since 2003 between 0.09 and 0.012, with no
upward or downward trend. Therefore, their SGR has remained fairly stable. On the
other hand, the industry average has dropped and Procter & Gamble actually rose
above it. Therefore, Procter & Gamble has done well relative to the industry.

79


Forecasts of Financial Statements
Part of the prospective analysis of a company is trying to get a glimpse of what is
likely to happen in the future years, in short-term and long-term. The published
financial statements of a company can be analyzed to hopefully provide reasonable
assumptions for what to expect in the future. These forecasts are important to base
judgments about whether or not the company can make loan payments on time, a
crucial insight for a prospective investor. While these forecasts are only based upon
public information and are subject to asymmetrical information and other errors, the
trend and benchmark analyses will help minimize the impacts of the errors on our
valuation.
Methodology
In forecasting Procter & Gambles financial statements, the previous six years
worth of 10-K reports from Procter & Gamble, as well as supplemental information from
the financial statements of Procter & Gambles top competitors were used. Data was
available from the first quarterly report of 2008 to aid in forecasting. First, we
forecasted the income statement, which centralized around the growth rate of net
sales. We then focused on the balance sheet. The balance sheet forecasts how
changes in assets, debt, and equity will change to support the growth rate of net sales.
Liquidity ratios such as the current ratio, inventory turnover, and receivables turnover,
as well as asset turnover ratios helped forecast the balance sheet. Then, we used
ratios linking the income statement forecasts to the statements of cash flows were used
to predict cash flows. The forecasted statements are located in the appendix.
Income Statement
The first financial statement to be forecasted is the Income Statement. We
created a common-size income statement to show every line item as a percentage of
net sales. Then we calculated the growth of net sales over the past 5 years. This helps

80

in the forecasting of net sales, which is the central line item that all other line items
relate to. Procter & Gamble experienced double-digit growth in 2004, 2005 and 2006,
which was directly associated with the acquisition of Gillette. Pre-acquisition growth
rate was already a healthy 7.8 percent. The growth rate for 2007 shows a slowing;
however, the assumption is that Procter & Gamble will still achieve an annual growth
rate of 10 percent. This assumption considers a first quarter 2008 reported sales
growth of 8 percent and a 12.3 percent sales growth rate expected from analysts at
Yahoo! Finance. Announcements of possibly selling off the Folgers and Duracell brands
have also been considered. In considering long-term sales growth it was important to
recognize that Procter & Gambles foreign sales account for a growing percentage of
net sales, and some developing markets like China, are growing exponentially.
Other line items have stayed roughly the same over the past 5 years, even with
the acquisition of Gillette. We suspect a fair assumption for cost of products sold to
remain steady at roughly 49 percent of net sales, and selling, general and
administrative expenses at 31 percent of net sales. Since net earnings have slowly
increased as a percentage of net sales to 13.52 percent in 2007, but we assume sales
growth will slow, in the future we will assume net earnings will be around 13 percent of
net sales.
Balance Sheet
The balance sheet forecast has to reflect growth in income statement items, as
well as utilize ratio analyses that reflect Procter & Gambles business choices. The
creation of a common-size balance sheet enables us to relate each line item to the
balances of each section. The first section forecasted is the asset section. The asset
turnover ratio for 2006 and 2007 dropped significantly while sales increased. We used
an asset turnover ratio of 0.60, which is slightly higher than the previous two years
averages, but lower than the average of the past 5 years. Accounts receivable was
forecasted using the five year average accounts receivable turnover of 0.1283. We
forecasted inventories using an assumed inventory turnover ratio of 5.5, which is just

81

below the five-year average and just above 2007 data. Total current assets were
forecasted assuming they would be around 19% of total assets, which is slightly higher
than the past two years but lower than the 5 year average. Property, Plant and
Equipment, Goodwill, and Trademarks were forecasted in the same manner assuming
17%, 40%, and 20% of total assets, respectively. Other Noncurrent Assets was just
forecasted using the excess balance.
The next section of the balance sheet we forecasted was the equity section.
First, Retained Earnings were forecasted using the previous years retained earnings,
adding the forecasted net earnings, and subtracting forecasted dividends paid.
Dividends paid are forecasted on the Statements of Cash Flows, which have historically
grown at a smooth 10-12% per year. Total Equity was then forecasted by adding the
change in retained earnings to the previous total equity balance. According to Procter
& Gambles 2007 10-K, money was borrowed to fund a share repurchase. This share
purchase was completed in 2007 and we assume they will hold onto these shares
indefinitely. A substantial amount of stock was issued in 2006, which grew additional
paid-in capital. We were unable to find a reason for the stock issue, or plans for the
proceeds, so we cannot accurately forecast whether the additional paid-in capital
account will decrease in the future. We believe some may be used to lower liabilities
balances from share repurchase debt.
The liabilities section was forecasted by subtracting the total equity from total
liabilities and equity. Current liabilities was forecasted assuming a current ratio of 0.85,
which is inbetween the 2007 and 5 year average ratios.
Statement of Cash Flows
Forecasting the statements of cash flows involves trying to forecast cash flows
from operating activities as accurately as possible. This involves finding ratios linking
the previously forecasted income statement to the statements of cash flows. We
looked for trends using CFFO/Sales, CFFO/NI, and CFFO/OI ratios. The CFFO/OI ratio
offered the best trend so we used it to forecast CFFO for the next ten years. The 2006

82

and 2007 data was similar at 0.86 and 0.87, respectively, so we used 0.87. The
projected numbers were then crosschecked against the averaged CFFO/Sales of 2006-
2007 data, which was stable. The resulting forecast was very close to the results of the
CFFO/OI forecast, so we are confident with our projections. We have forecasted CFFI
based on our assumed growth rates of noncurrent assets. The six years prior were
volatile due to the acquisition of Gillette and the sell-off of some investment securities,
but our expectations are for a smooth next ten years. By adding the forecasted CFFO
and CFFI, we were able to predict the free cash flows to the firm, which shows that
Procter & Gamble will have increasing free cash flows to use. CFFF was not forecasted,
but we found a historical growth rate for Dividends Paid of between 10-12 percent, so
we grew conservatively at 10 percent.
Conclusion
The forecasts for the next ten years of Procter & Gamble appear to be stable.
The Gillette acquisition was a major growth in the company, which poised the
overwhelming industry leader into a bright future. Even the share repurchase in 2006
and 2007 suggests Procter & Gamble thinks its stock is undervalued. As economies
around the world improve, Procter & Gamble will grow its customer base, and our
forecasts predict it to be inevitable.

83

Cost of Equity
The cost of equity, K
e
, is what we expect our returns to be for the current year.
To find the cost of capital for Procter & Gamble we use the capital asset pricing model,
or CAPM. In order to use CAPM, we have to find the necessary components of the
equation, which includes the risk free rate, Procter & Gambles beta, and the market
risk premium. We had to run regression analysis over 72 month, 60 month, 48 month,
36 month, and 24 month periods to find Procter & Gambles beta. Regression was ran
over these time periods to give us several different betas so we can look at beta
stability and be able to choose the best possible beta for our company. To find an
estimate for our risk free rates, we used the St. Louis Federal Reserve website to get
past Treasury bill rates.
In our regression analysis, we used 3 month, 1 year, 2 year, 5 year, 7 year, and
10 year Treasury bill rates. Regression was ran over these time periods to find out
during what time period the company has changed the most structurally. This also
shows the investor horizon. The investor horizon is the length of time a sum of money
is expected to be invested (investorwords.com). After analyzing the results, we found
that the 3 month Treasury bill rate gave us our best result for beta. The 3 month T-bill
rate was the best result because it gave us the highest adjusted R
2
with 28.62 percent
with the 36 month regression. This explains that Procter & Gamble has structurally
changed in the past 36 months compared to any other time. Also, the 3 month T-bill
shows that Procter & Gamble is better to be viewed as a short term investment, which
is the investor horizon. The adjusted R
2
gives us the best explanatory power for Procter
& Gamble, which gives us a beta of .9358 and a risk free rate of 5.16 percent. The beta
we calculated is very close to the published beta for Procter & Gamble, which is .92.
The beta of the company was very stable over the 72 month, 60 month, 48 month, 36
month, and 24 month periods and had little fluctuation at all. This shows that Procter &
Gambles performance follows the performance of the economy pretty closely over time.
To find our market risk premium we used the 1926-2005 period of returns from the
Standard and Poors 500 indexes (Business Analysis & Valuation textbook). This gave us

84

6.8 percent for our market risk premium. Next, we subtracted a .4 percent size
premium from this number because Procter & Gamble has a very large market value,
leaving us with a market risk premium of 6.4 percent. Putting all of this information into
the CAPM equation, we were able to find our cost of equity, or K
e
, to equal 11.15
percent.
Regression Analysis
3 Month Rate 72 Months 60 Months 48 Months 36 Months 24 Months
RF 5.16% 5.16% 5.16% 5.16% 5.16%
R
2
-0.0059 -0.0048 -0.0004 0.2862 0.2176
Beta 0.1809 0.3170 0.5506 0.9358 0.8698
K
e
6.32% 7.19% 8.68% 11.15% 10.73%

1 Year Rate 72 Months 60 Months 48 Months 36 Months 24 Months
RF 5.22% 5.22% 5.22% 5.22% 5.22%
R
2
-0.0058 -0.0044 0.0003 0.2854 0.2163
Beta 0.1825 0.3212 0.559 0.9337 0.8671
K
e
6.39% 7.28% 8.80% 11.20% 10.77%

2 Year Rate 72 Months 60 Months 48 Months 36 Months 24 Months
RF 5.12% 5.12% 5.12% 5.12% 5.12%
R
2
-0.0056 -0.004 0.0013 0.2847 0.2157
Beta 0.1837 0.3266 0.5705 0.9313 0.8645
K
e
6.30% 7.21% 8.77% 11.08% 10.65%

5 Year Rate 72 Months 60 Months 48 Months 36 Months 24 Months
RF 5.07% 5.07% 5.07% 5.07% 5.07%
R
2
-0.0054 -0.0033 0.0028 0.2839 0.2146
Beta 0.1856 0.3347 0.5892 0.9305 0.8627
K
e
6.26% 7.21% 8.84% 11.03% 10.59%

7 Year Rate 72 Months 60 Months 48 Months 36 Months 24 Months
RF 5.14% 5.14% 5.14% 5.14% 5.14%
R
2
-0.0053 -0.0031 0.0033 0.2838 0.2144
Beta 0.1864 0.3373 0.595 0.9306 0.8625
K
e
6.33% 7.30% 8.95% 11.10% 10.66%

10 Year Rate 72 Months 60 Months 48 Months 36 Months 24 Months

85

RF 5.28% 5.28% 5.28% 5.28% 5.28%
R
2
-0.0053 -0.003 0.0037 0.2839 0.2141
Beta 0.1873 0.3394 0.5997 0.931 0.8624
K
e
6.48% 7.45% 9.12% 11.24% 10.80%
Weighted-Average Cost of Debt
Procter & Gambles weighted average cost of debt is 6.23 percent on a before
tax basis, and 4.38 percent on an after tax basis. To get the weighted average we had
to come up with several interest rates used for our liabilities. For trades payable and
accrued expenses and other current liabilities, we used a three-month non-financial
commercial paper rate of 4.63 percent (http://research.stlouisfed.org). For long term
debt and current maturities of long term debt we used a rate of 5 percent found in
Procter & Gambles annual 10-K report. The rates of 29.7 percent for taxed payable,
5.25 percent for deferred taxes, and 6.3 percent for other noncurrent liabilities were
also found in the annual 10k report. We chose this percentage for other noncurrent
liabilities because it was the rate for other post employment benefits, which makes up
the companys other expenses.
In order to calculate the weighted-average cost of debt we took all of Procter &
Gambles liabilities and computed a weighted average of each line item based on the
percentage of total liabilities. Next, we multiplied these percentages by the
corresponding interest rate to come up with our value added weight. Adding the results
up gave us our weighted average cost of debt before taxes. Multiplying this answer by
1 minus the tax rate gave us our weighted average cost of debt after taxes.
Weighted Average Cost of Capital
Now that we have our cost of equity and weighted average cost of debt, we are
able to compute our weighted average cost of capital. To get our weighted average
cost of capital, or WACC, we must plug in information into the WACC formula, which is
WACC
bt
= (V
e
/V
f
)*K
e
+ (V
d
/V
f
)*k
d;
where V
e
is the market value of the firms equity, V
d
is
the market value of the firms liabilities, V
f
is the market value of the firms equity and
liabilities together, K
e
is the cost of equity, and K
d
is the cost of debt. Plugging all the

86

necessary information into the WACC formula, we get a before tax WACC of 8.61
percent and an after tax WACC of 6.05 percent using 1 minus the tax rate.


87

Valuations
After all of the analysis of the industry, the firm, its accounting policies, and
financials, we are now ready to do a valuation of Procter & Gamble. Several different
valuations will be used to compute the per share price of the company. This per share
price compared to the actual per share price will advocate if the company is fairly
valued, overvalued, or undervalued. The valuation methods to be used to value Procter
& Gamble are the earnings multiples model, the discounted dividends model, the free
cash flows model, the residual income model, the long-run residual income model, and
the abnormal earnings growth model.
Earnings Multiples Valuation
PG Share Price
Trailing P/E 69.01
Forward P/E 56.47
P/B 307.10
D/P 37.55
PEG 89.49
Price/EBITDA 469.93
Price/FCF 69.39
Enterprise Value/EBITDA 65.79

The earnings multiples valuation is the quickest and easiest way to value a firm.
Unlike the other valuation methods, the earnings multiples valuation does not require
detailed multi-year forecasts (Business Analysis and Valuation text). This valuation
method uses eight different ratios calculated for Procter & Gamble and its competitors:
J ohnson & J ohnson, Kimberly-Clark, Colgate-Palmolive, Avon, and Unilever. These ratios
are calculated for each firm to come up with an industry average. The firms that
produce numbers far from the average are known as outliers and are left out of the
industry average. This average is used to determine if Procter & Gamble is fairly valued,
undervalued, or overvalued. An assumption of 20% +/- will be used to determine a fair

88

valuation of Procter & Gamble. This gives an allowed variance of between 54.87 and
82.31 for the company to be fairly valued. Although this valuation is a quick and easy
way to value a firm, it is highly inefficient. This valuation is inefficient because it values
the company based on the industry average, even though not many firms, if any,
operate at the industry average. As a result, the valuation of the firm is very inaccurate
and does not give a result that one should rely on for a realistic valuation. The results
of the earnings multiples valuation follows.
Trailing Price/ Earnings
PPS EPS
P/E
Trailing
Industry
Average
PG Share
Price
Johnson
&
Johnson 65.17 3.55 18.36 21.08 69.01
Kimberly-
Clark 70.89 4.07 17.42
PG EPS:
3.27
Colgate-
Palmolive 76.29 3.16 24.14
Avon 39.93 1.331 30.00
Unilever(i
n EUROs) 2481 160 15.51

To get the trailing price to earnings ratio for the companies in the industry we
took the trailing P/E ratio for each competitor from yahoo finance. These ratios were
added together then divided by five (the number of competitors in the industry) to get
our average P/E trailing ratio of 21.08 for the industry. This average was then multiplied
by Procter & Gambles EPS of 3.27, found in the annual 10k, to compute the share price
of $69.01. The actual share price at November, 1 2007 was $68.59. According to this
method, Procter & Gamble is fairly valued based on our assumption that 20% +/- the
actual price per share is a fair valuation.



89

Forward Price/ Earnings
PPS
P/E
Forward
Industry
Average
PG Share
Price
Johnson
&
Johnson 65.17 15.33 17.06 56.47
Kimberly-
Clark 70.89 15
PG EPS:
3.31
Colgate-
Palmolive 76.29 20.85
Avon 39.93 NA
Unilever(i
n EUROs) 2481 NA

The Forward price to earnings method is calculated by dividing the share price as
of November 1, 2007 by the forecasted earnings per share. For Procter & Gambles
competitors, the forward P/E ratio was found using yahoo finance. An average of these
ratios was then taken to compute the industry average of 17.06. Avon and Unilever
were not a part of the average because there was not a forward P/E ratio available for
these companies. Procter & Gambles forecasted earnings per share of 3.31 was taken
and multiplied by the industry average to give us a share price of $56.47. This method
suggests that Procter & Gamble is fairly valued.








90

Price/ Book
PPS BPS P/B
Industry
Average
PG Share
Price
Johnson &
Johnson 65.17 15.66 4.16 14.53 307.10
Kimberly-
Clark 70.89 14.71 4.82
PG BPS:
21.13
Colgate-
Palmolive 76.29 3.57 21.36
Avon 39.93 1.44 27.79
Unilever(in
EUROs) 2481.00 3.93 631.73

The price to book ratio is computed by using the price per share at the
November 1 price and the book value of equity per share from the most recent 10k for
Procter & Gamble, and from yahoo finance for its competitors. Once the P/B ratio is
found for each competitor in the industry, an average is taken. Unilever was left out of
this average because it was an outlier in the industry. This average is then multiplied by
Procter & Gamble BPS of 21.13, taken from the 10K, to come up with a share price of
$307.10. We compare this to our actual share price of 68.59 and see that when using
this method Procter & Gamble is extremely undervalued. The per share price is so high
because there is a lot of variation in the P/B ratio for the industry and the average ratio
of 14.53 is a lot higher than the real ratio of 4.16 for Procter & Gamble. There is no firm
that operates at a ratio near the average. This shows the inefficiency in using this
model.






91

Dividend/ Price
PPS DPS D/P
Industry
Average
PG Share
Price
Johnson &
Johnson 65.17 2.40 0.04 0.035 37.55
Kimberly-
Clark 70.89 3.10 0.04
PG DPS:
1.33
Colgate-
Palmolive 76.29 1.80 0.02
Avon 39.93 1.80 0.05
Unilever(in
EUROs) 2481.00 69.93 0.03

This method is used by taking the dividends per share and dividing it by the price
per share for all of Procter & Gambles competitors to give us our D/P ratio. The D/P
ratio for Procter & Gamble was found by dividing DPS by PPS (taken from the 10K),
while the competitors D/P ratio was taken from yahoo finance. An average of the
competitors ratios was taken to give us our industry average of .035. Next, Procter &
Gambles DPS of 1.33 was divided by the industry average to give us our share price of
$37.55. Comparing this per share price to our actual share price of $68.59, it is
suggested that Procter & Gamble is overvalued.








92

P.E.G. Ratio
PPS EPS PEG
Industry
Average
PG Share
Price
Johnson
&
Johnson 65.17 3.55 1.71 2.105 89.48
Kimberly-
Clark 70.89 4.07 2.17
PG EPS:
3.27
Colgate-
Palmolive 76.29 3.16 2.11
Avon 39.93 1.33 2.43
Unilever(i
n EUROs) 2481.00 160.00 NA

The PEG ratio takes a companys PE ratio and divides it by the estimated
earnings growth rate for that company. The PEG ratio for Procter & Gambles
competitors was taken from yahoo finance. To find a share price for Procter & Gamble,
we took an average of the competitors PEG ratios, which came out to 2.105. This
average did not include Unilever because there was not an available PEG ratio for them.
Next, we multiply the average of 2.105 by Procter & Gambles estimated earnings
growth rate of 13 percent. The result was then multiplied by our EPS of 3.27 (10K) to
give us our share price of $89.48. Comparing this price to our actual share price of
68.59 shows that Procter & Gamble is undervalued.







93


Price/ EBITDA
PPS EBITDA P/EBITDA
Industry
Average
PG Share
Price
Johnson &
Johnson 65.17 17.45 3.73 26.34 469.93
Kimberly-
Clark 70.89 3.50 20.25
PG
EBITDA:
17.84
Colgate-
Palmolive 76.29 3.06 24.93
Avon 39.93 1.18 33.84
Unilever(i
n EUROs) 2481.00 6.50 381.93

This method uses the price per share and earnings before interest, taxes,
depreciation, and amortization to compute the P/EBITDA ratio. Price per share is the
price as of November 1, 2007. EBITDA for Procter & Gamble was found in the 2007
10K, while it was found for the competitors on yahoo finance. Dividing PPS by EBITDA
gave us the P/EBITDA ratio for each company. The P/EBITDA ratios were averaged
together to give us an industry average of 26.34. The outliers in this area were J ohnson
& J ohnson and Unilever, so they were not computed in the average. Next, the average
was multiplied by Procter & Gambles EBITDA (10K) of 17.84 to give us our share price
of $469.93. When this price is compared to our actual share price of 68.59, it is
suggested that Procter & Gamble is significantly undervalued. The number is so high
because the EBITDA of the competitors being averaged is drastically lower than that of
Procter & Gamble, causing the P/EBITDA ratio to be much higher. Again, this shows
how this method is unreliable and inaccurate.




94


Price/ Free Cash Flows
PPS FCFPS
Price/FCFP
S
Industry
Average
PG Share
Price
Johnson &
Johnson 65.17 -1.94 -33.65 20.02 69.39
Kimberly-
Clark 70.89 3.39 20.94
PG FCFPS:
3.47
Colgate-
Palmolive 76.29 1.64 46.56
Avon 39.93 3.29 12.13
Unilever(in
EUROs) 2481.00 5666.00 0.44

To calculate the Price/ Free Cash Flows ratio, we found free cash flows of Procter
& Gamble from the annual 10-K report and for its competitors from yahoo finance. Free
cash flows are just the sum of cash flow from operations and cash flow from investing.
For the competitors in the industry, the free cash flows found on yahoo finance were
averaged together to create an industry average of 20.02. J ohnson & J ohnson was not
computed in this average because they were an industry outlier in this area. For Procter
& Gamble, free cash flows were computed to be $10,959 and on a per share basis to be
3.47. Next, the industry average and Procter & Gambles free cash flows per share are
multiplied together to get the share price of $69.39. This price suggests that Procter &
Gamble is fairly valued.







95




Enterprise Value/ EBITDA

PPS

EBITDA EV/EBITDA
Industry
Average
PG Share
Price
Johnson &
Johnson 65.17

17.45 10.85 11.65 65.79
Kimberly-
Clark 70.89

3.5 9.33
PG EVPS:
5.647
Colgate-
Palmolive 76.29

3.06 13.85
Avon 39.93

1.18 15.61
Unilever(in
EUROs) 2481.00

6.5 8.63

Enterprise Value to EBITDA is calculated by dividing enterprise value by earnings
before interest, taxes, depreciation, and amortization. Enterprise Value and EBITDA for
Procter & Gamble was found in the companys annual 10K report and was found for the
rest of the industry from yahoo finance. For Procter & Gamble, enterprise value was
calculated by adding market value of equity to the value of liabilities, and then
subtracting cash and financial investments. Enterprise value was then divided by
EBITDA to computer the EV/EBITDA ratio. An average of this ratio was taken to
compute the industry average of 11.65. Next, Procter & Gambles enterprise value per
share of 5.647 (10k) was multiplied by the industry average to compute the share price
of $65.79. This model suggests that Procter & Gamble is fairly valued.
Conclusion
In using the earnings multiples valuation model, it is very hard to tell what the
valuation of Procter & Gamble is. Four of the methods used claimed that the company
was fairly valued; three claimed it was undervalued, and one claimed it was overvalued.

96

With this much variation in the valuations, it is clear that this model is not a reputable
way of valuing a company. The earnings multiples valuation model values companies
based on inaccurate measures and assumes that all companies in an industry operate
at the same level, when in fact they do not at all. Even though this method of valuation
has been used for some time now, other valuation methods must be used to get a more
accurate valuation.
Discounted Free Cash Flow
The discounted free cash flow valuation method uses expected future free cash
flows to arrive at an estimated price per share. The estimated price per share is the
present value of the future free cash flows. In order to use this method, a companys
cash flows from operations (CFFO), cash flows from investing (CFFI), book value of
liabilities, and shares outstanding must be known. First, subtract the firms CFFI from
their CFFO. This results in annual free cash flows. This cash flow must then be
discounted back to its present value using WACC(BT) as the discount rate. We
performed this operation for each year forecasted and added all of them together. A
perpetuity is used for years beyond our forecast. Because we forecasted 10 years out,
our perpetuity will start in year 11 with an estimated annual free cash flow of $29 billion
dollars. The value of this perpetuity at year 10 equals the annual cash flow divided by
the difference in before tax WACC and the growth rate. Based on our forecasts, will
assume an growth rate of 0.10 will continue. In our case, the value of the perpetuity in
year 10 will be:

$29,000 million / (.0861-0.10) = -$2086330.94 million

This total must then be discounted back to its present value using the present value
factor for year 10 assuming a WACC(BT) of .0861. This comes out to -$913450.59

97

million. This figure is then added to the total present value of cash flows in year one
through ten of $118,599.02 million to arrive at a total present value of -$794851.6
million. We must then subtract the book value of liabilities in order arrive at the value
of just the equity. This comes out o be -$866105.6 million. This is divided by the
number of shares (3,159 million) to arrive at a per share value of -$274.17. Since this
is a negative share price, we cannot use this model to value Procter & Gamble.
Growth Rate
0 0.025 0.05 0.1 0.12
0.0361 212.52 628.65 N/A N/A N/A
0.0561 120.49 199.43 925.45 N/A N/A
WACC(BT) 0.0761 77.62 106.98 192.59 N/A N/A
0.0861 63.88 83.67 130.86 N/A N/A
0.0961 53.12 67.02 95.99 N/A N/A
0.1161 37.43 44.93 58.08 207.04 N/A
Overvalued
Fairly Valued Actual Share Price November 1, 2007 $68.59
Under Valued


The discounted free cash flow model is highly sensitive. Our initial WACC(BT) was
.0861, and our initial growth rate was zero. Small changes in either of these inputs
produce large changes in the companys value and portray different pictures of the firm.
All boxes marked N/A represent negative results that were thrown out.
Discounted Dividends Valuation Model
Many investors value dividends as another way to achieve a desired return on
their investment. By assuming that a company that has historically paid dividends will

98

continue to pay them, we can achieve an expected value for the stock based upon what
dividends we expect the company to pay in the future. This model is known as the
discounted dividends model. As previously discussed, dividends for Procter & Gamble
have historically grown at 11-12 percent, and we took a conservative estimation of 10
percent growth for the next ten years. Since it is difficult to forecast a growth rate
beyond 10 years, we performed a sensitivity analysis to consider different growth rates
in the perpetuity, as well as different costs of equity in case of future variation. The
model states that the price per share is the sum of each of the next ten years expected
dividends discounted back to the present value, added to the terminal value of the
perpetuity. The terminal value is calculated by taking the expected dividend in year 11
and dividing it by the cost of equity minus the growth rate of the perpetuity. This
calculation is:
3.65/(0.1115-0.10) = $32.75
The resulting value is in year 10 dollars and must be discounted back to present year
dollars. Adding this value to the present value of the forecasted dividends results in an
estimated price of $24.32. This results in a current expected share price of $126.83.
Our sensitivity analysis shows that this model is very sensitive to terminal value errors
in our estimated cost of equity and projected growth rates. If we underestimated the
cost of equity by just 2 percent, the stock price changes from very undervalued to very
overvalued, with a price of $46.58. If we overestimated the growth rate by just 5
percent, the same result occurs.
Growth Rate
0 0.025 0.05 0.1 0.12
0.0715 41.38 55.46 102.31 N/A N/A
0.0915 30.88 37.32 51.51 N/A N/A
Ke 0.1015 27.25 31.87 40.97 969.4 N/A
0.1115 24.32 27.72 33.9 126.83 N/A
0.1315 19.87 21.84 25.03 46.58 107.66
0.1515 16.69 17.9 19.72 28.66 40.17
Overvalued

99

Fairly Valued Actual Share Price November 1, 2007 $68.59
Under Valued

Residual Income
Residual income has one main objective and that is to value a companys stock
price. What it does is measure the cost of equity of a companys performance. Another
way of putting it is it predicts a companys return. An important fact about residual
income is it can either be positive or negative. If its positive it adds value to the firm
and vice versa if negative. Either way there is an equilibrium that RI is constantly trying
to get back to. This equilibrium is at zero.
First, we recorded Procter & Gambles book value of equity each year by taking
net earnings and subtracting it from dividends paid. Then we added the previous years
BVE to get each year ending BVE. We then found our benchmark earnings by taking
the previous years ending book value of equity and multiplying it with the cost of
equity. The next step was to find the residual income. You simply take the difference
of actual earning and benchmark earnings. We also found the perpetuity of residual
income from year 11 and on. This perpetuity was 9562. This will be used to find the
PV of terminal value perpetuity. However this is an inaccurate residual income. To get
an accurate RI you must first calculate the present value multiple. Then multiply each
years RI by that particular years multiple. This gives you an accurate Residual income
for each year forecasted. As said before in the paragraph above the residual income
must eventually move towards equilibrium of 0. This is shown through the PV of
residual income graph. Slowly but surely each year it decreases a small amount. This
causes a negative growth rate in the perpetuity. The next step was to find the total PV
of annual residual income. You simply take the sum of each years accurate residual
income from 2008 to 2017. Procter & Gambles total sum was 31125.34. From the
previous perpetuity in the middle of the paragraph of 9562 we found the continuing
terminal value perpetuity. We took the perpetuity and divided that number by the cost
of equity minus growth rate. Using the continuing terminal value of perpetuity we

100

found the PV of terminal value perpetuity. The equation is simply the continuing
terminal value of perpetuity multiplied by the year ten present value factor. For the
second to last step in finding the residual income you must find the estimated price per
share. The final step is simply finding the time consistent price. To calculate the price
per share you add the total PV of residual income, the PV of terminal value perpetuity,
and the initial book value of equity all together. You then divide that number by the
total number of shares. To get the time consistent price you take the non time
consistent price and multiply it to 1 plus the cost of equity all raised to the .33 power.
The reason we did this is because Procter & Gambles end of the year is J une 30
th
. The
price date was set at November 1
st
which is a total of 4 months apart. If you divide the
4 months by 12 months you get .33. Procter & Gambles standard time consistent price
is 41.87 at an 11.15 percent K
e
and 0.0005 growth rate. With a time consistent price of
$41.87 and an observed share price of $68.59 it is evident that Procter & Gamble is
overvalued.
The sensitivity of this model is quite small as you can see. If you go down to -
2.5% in growth there is not a huge change in price. If you increase the cost of equity
past 11.15% there is not a large difference in price. You can also see the same pattern
if you decrease the cost of equity. A positive growth rate would be necessary to
achieve a desirable stock price.
Growth Rate
-0.0005 -0.025 -0.05 -0.1 -0.12
0.0715 64.52 59.05 55.74 52.01 51.06
0.0915 51.15 48.18 46.21 43.81 43.17
Ke 0.1015 46.11 43.85 42.3 40.35 39.82
0.1115 41.82 40.08 38.84 37.25 36.8
0.1315 34.91 33.82 33.02 31.93 31.61
0.1515 29.59 28.88 28.33 27.57 27.34

101

Overvalued
Fairly Valued Actual Share Price November 1, 2007 $68.59
Under Valued
Long Run ROE Residual Income
The long run ROE residual income uses growth rate, cost of equity, and return
on equity to determine the most accurate price. The intrinsic price to book value is
used in this model. It is also a perpetuity that is based off the previous residual income
model. Normally when the word perpetuity comes to mind, inaccurate is the first thing
thought because of the forecasting involved. However, this is an accurate model. Here
is the equation used to calculate:
=BVEo * (1+ (ROE-Ke) / (Ke-g))
all of the variables are know, so
=66760(1+(0.1668-0.1115)/(0.1115-0.0036)
Then we divide the result, $100,978.27, by the number of shares, 3159, to get an
estimated share price of $33.11. This means that according to this model, the observed
share price of $65.89 is severely overvalued. Analysis of the sensitivities of the three
variables will help us to decide how believable the results are. Each of the tables uses
two of the three items in the equation. In each table, one item is held constant and the
other two are fluctuated.






102



In the first table growth and ROE are both fluctuated. The cost of equity is held
constant. It was determined that the price is overvalued unless there is a growth rate
of 10 percent. Even then the ROE must be fairly high at 13 percent to get a fair valued
price.
Growth rate
-0.05 0 0.05 0.1
0.1 20.33 19.63 17.8 0
ROE 0.13 24.4 25.52 28.48 57.11
0.1668 29.39 32.75 41.58 127.16
0.18 31.18 35.34 46.27 152.29
Undervalued
Fairly valued
Overvalued









103


In the second table the cost of equity and ROE are fluctuated. The growth rate
is held constant. With a constant growth rate there is basically no chance of a fair
valued price unless your cost of equity is cut down past 8 percent. In this table you can
see that even with cost of equity being at 8.15 percent the ROE must be at 18 percent
to get a fair valued price. Again, an 18 percent ROE is very high so there must be a
large drop in the cost of equity to have a fair price. It should possibly be cut in half.
Ke
0.0815 0.1015 0.1115 0.1315
0.1 26.84 21.49 19.56 16.6
ROE 0.13 35.2 28.18 25.64 21.76
0.1668 45.45 36.38 33.11 28.1
0.18 49.12 39.33 35.79 30.37
Undervalued
Fairly valued
Overvalued








104


In the last table the cost of equity and the growth rate are fluctuated. The ROE
is held constant. In this table there must be a 5 percent growth and a 10.15 percent
cost of equity to get a fair valued price. At Procter & Gambles 11.15 percent cost of
equity the only way they will receive a fair or undervalued price is at 10 percent growth.
This is very unlikely to consistently grow year by year at this rate. Every other situation
below a 5 percent growth will lead them with an overvalued price.
g
-0.05 0 0.05 0.1
0.0815 35.76 44.4 80.43 N/A
Ke 0.1015 31.23 35.87 49.5 971.95
0.1115 29.39 32.75 41.58 127.16
0.1315 26.3 27.93 31.56 46.7
Undervalued
Fairly valued
Overvalued

After analyzing these three charts it was determined that the long run ROE
residual income tables are overvalued. In order for a fair or undervalued price there
must be at least a 5 percent to 10 percent growth rate. Cost of equity also needs to be
cut in half, and ROE needs to be close to 16 percent.
Abnormal Earnings Growth
The abnormal earnings growth (AEG) model values a firm using forecasted
earnings, dividends, dividend reinvestment plan (DRIP), core earnings and normal

105

earnings. This model is tied to the residual income model, because changes in residual
income equal abnormal earnings growth.
For the AEG model, we must first calculate our DRIP income. This is done by
multiplying forecasted dividends in 2008 by one plus the cost of equity (Ke). This
results in DRIP income for year 2009. With the AEG model, all figures are discounted
back to year one of the forecasts. This figure is then added to forecasted earnings to
arrive at the cumulative dividend earnings. From there, subtract normal earnings to get
abnormal earnings growth. Normal earnings are equal to net earnings in the previous
year multiplied by one plus Ke. At this point, AEG should be equal to residual income.
This check is shown below.

2009 2010 2011 2012 2013 2014 2015 2016 2017
Abnormal Earnings
Growth 390 430 472 520 572 629 692 761 837
Change in Residual
Income 390 430 472 520 572 629 692 761 837


Next, AEG is discounted back to year one using K
e
as the discount rate. This operation
is to be carried out for each year forecasted. A perpetuity is utilized for each year
beyond our forecasts. We assume abnormal earnings growth to be $800 million for
each year starting in 2018. The value of this perpetuity in 2017 is AEG divided by Ke
minus the growth rate.

$800 million / (.1115-0.10) = $69,565.22 million


106

This figure must then be discounted back to 2008 using K
e
as the discount rate.
The resulting value is $26,866.24 million. This is then added to the present value of
AEG from 2009 to 2017 of $3,033.95 million to arrive at a total present value of
$29,900.2 million. Then, add the present value of AEG to core earnings to get total
average earnings of $40,240.2 million. Core earnings are equal to forecasted earnings.
Total average earnings are then divided by the capitalization rate to arrive at the value
of the firms equity. The capitalization rate is equal to K
e
. Once the value of equity is
known, it can be divided by shares outstanding to reach a per share price, $118.34.
The per share price must then be grown four months in order to be compared to the
actual observed share price on November 1, 2007.

Growth Rate
0 0.025 0.05 0.1 0.15
0.0715 101.3 115.93 164.61 5.77 49.27
Ke 0.0915 66.65 71.97 83.71 N/A 30.33
0.1015 55.81 59.28 66.13 764.79 22.92
0.1115 47.48 49.83 54.1 118.34 15.73
0.1315 35.68 36.86 38.76 51.61 N/A
0.1515 27.88 28.52 29.48 34.19 352.77
Overvalued
Fairly Valued Actual Share Price November 1, 2007 $68.59
Under Valued

According to the AEG model, Procter & Gamble is undervalued with an initial Ke
of .1115 and a growth rate of 0.1. The value derived from the model is $118.34 per
share. The AEG model is sensitive to changes in the inputs of Ke and the growth rate.

107

Small changes produce different views of the firm. If we underestimated our cost of
equity just 2%, the estimated value drops almost $70. A growth rate estimation error
of just +/- 5% would also change the estimation from very undervalued to overvalued.

108

Credit Analysis
Procter & Gambles credit worthiness was calculated by using the Altman Z-score
model. This model combines five different ratios to see how likely a company is to go
bankrupt (www.investopedia.com). The lower the ratio, the higher the risk of
bankruptcy is for the company. A score that is lower than 1.2 means that the company
has a very high risk of bankruptcy; while a score above 2 or 3 means that there is a low
risk of bankruptcy for the company (Moore lecture notes). The formula for the Altman
Z-score is:



Altman Z-score
2007 2006 2005 2004 2003
Z-Score 2.89 2.67 3.44 3.76 4.60

Mark Moore Lecture

109

According to the Altman Z-score formula, Procter & Gamble has a current credit
score of 2.89. Although Procter & Gambles z-score has decreased each year from 2003-
2006, it has maintained a low bankruptcy risk and has since increased in 2007.
Analyst Recommendation
The comprehensive product of the preceding research and analysis is the overall
recommendation to buy. We believe that Procter & Gamble is poised for growth which
is not fully captured by the observed stock price.
We carefully researched information about Procter & Gamble as well as the top
five competitors and learned exactly what it takes for these firms to grow and succeed.
We discovered that the personal products industry is highly concentrated and requires
firms use combinations of cost leadership and differentiation to compete effectively.
Even with such high concentration and high competition, Procter & Gamble has grown
to the largest firm in the industry.
Our accounting analysis revealed that Procter & Gamble offers a high degree of
disclosure in their annual filings. We acknowledged that goodwill is an inflated number,
but do not think it is a material misstatement because it is a result of the purchase of
Gillette, which was an ambitious and successful acquisition. Sales manipulation
diagnostics revealed no problems in revenue recognition.
Financial analysis revealed Procter & Gamble is substantially more liquid than the
industry average. This will allow for less of a credit risk and therefore, a lower cost of
equity. Procter & Gamble is below industry average on many of the profitability
analyses, but trends show growth. IGR and SGR calculations showed steady growth
rates. The forecasted financial statements showed steady revenue growth above
industry average, as well as smoothly increasing dividend distributions. Procter &
Gambles estimated cost of equity was fairly low which reflects a favorable beta, which
indicates low risk.

110

The multiples valuation models provided expected prices mostly fairly valued, but
several that showed favorably that Procter & Gambles stock is undervalued. We found
a good trend in the growth rate of dividends, which provided a very large estimated
price in the discounted dividends model. The residual income and long run return on
equity residual income models both showed overvaluation, but the AEG model then
showed undervaluation.
With an observed price of $68.59, we dont believe the firm to be greatly
undervalued, but believe this would be a solid investment with steady growth that the
market currently doesnt completely reflect.

111

Appendix
3 Month Regression
SUMMARY OUTPU 72 Month

Regression Statistics
Multiple R 0.090692635
R Square 0.008225154
Adjusted R
Square -0.0059
Standard Error 0.069538651
Observations 72

ANOVA
df SS MS F
Significance
F
Regression 1 0.002807253 0.002807253 0.580535781 0.448662002
Residual 70 0.338493682 0.004835624
Total 71 0.341300935

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.003380604 0.008240123 0.410261323 0.682867257
-
0.013053803 0.019815011
-
0.013053803 0.019815011
X Variable 1 0.1809 0.237365501 0.761928987 0.448662002
-
0.292554902 0.654266213
-
0.292554902 0.654266213

SUMMARY OUTPU 60 Month

Regression Statistics
Multiple R 0.110664532
R Square 0.012246639
Adjusted R
Square -0.0048
Standard Error 0.075228629
Observations 60

ANOVA
df SS MS F
Significance
F
Regression 1 0.004069703 0.004069703 0.719111747 0.399921509
Residual 58 0.328242105 0.005659347
Total 59 0.332311808

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept
-
0.000780499 0.010084603
-
0.077395135 0.938575589
-
0.020967024 0.019406026
-
0.020967024 0.019406026
X Variable 1 0.3170 0.373834694 0.848004568 0.399921509
-
0.431297909 1.065324966
-
0.431297909 1.065324966

SUMMARY OUTPU 48 Month

Regression Statistics
Multiple R 0.144547713
R Square 0.020894041
Adjusted R
Square -0.0004

112

Standard Error 0.081460599
Observations 48

ANOVA
df SS MS F
Significance
F
Regression 1 0.00651397 0.00651397 0.98163625 0.326978413
Residual 46 0.305248142 0.006635829
Total 47 0.311762112

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept
-
0.003760318 0.012155145
-
0.309360198 0.758444541
-
0.028227355 0.020706719
-
0.028227355 0.020706719
X Variable 1 0.5506 0.555758906 0.99077558 0.326978413
-
0.568052286 1.66931699
-
0.568052286 1.66931699



3 Month Regression
SUMMARY OUTPU 36 Month

Regression Statistics
Multiple R 0.55370299
R Square 0.306587002
Adjusted R
Square 0.2862
Standard Error 0.030896767
Observations 36

ANOVA
df SS MS F
Significance
F
Regression 1 0.014350491 0.014350491 15.03282759 0.000459737
Residual 34 0.032456747 0.00095461
Total 35 0.046807237

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.006187956 0.005324093 1.162255506 0.253225367
-
0.004631902 0.017007815
-
0.004631902 0.017007815
X Variable 1 0.9358 0.241350012 3.877219054 0.000459737 0.445284631 1.4262491 0.445284631 1.4262491

SUMMARY OUTPU 24 Month

Regression Statistics
Multiple R 0.501575233
R Square 0.251577715
Adjusted R
Square 0.2176
Standard Error 0.031389567
Observations 24

ANOVA
df SS MS F
Significance
F

113

Regression 1 0.007286497 0.007286497 7.395169585 0.012520622
Residual 22 0.021676708 0.000985305
Total 23 0.028963205

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.00640522 0.006752795 0.94852879 0.353164188
-
0.007599219 0.02040966
-
0.007599219 0.02040966
X Variable 1 0.8698 0.31985207 2.719406109 0.012520622 0.206475083 1.533140266 0.206475083 1.533140266









1 Year Regression
SUMMARY
OUTPUT 72 Month

Regression Statistics
Multiple R 0.091640253
R Square 0.008397936
Adjusted R
Square -0.0058
Standard Error 0.069532594
Observations 72

ANOVA
df SS MS F
Significance
F
Regression 1 0.002866223 0.002866223 0.592834094 0.443915948
Residual 70 0.338434711 0.004834782
Total 71 0.341300935

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.003416616 0.008233788 0.414950702 0.679447041
-
0.013005156 0.019838389
-
0.013005156 0.019838389
X Variable 1 0.1825 0.236988162 0.769957203 0.443915948
-
0.290187236 0.65512872
-
0.290187236 0.65512872


114

SUMMARY
OUTPUT 60 Month

Regression Statistics
Multiple R 0.112249006
R Square 0.012599839
Adjusted R
Square -0.0044
Standard Error 0.075215178
Observations 60

ANOVA
df SS MS F
Significance
F
Regression 1 0.004187075 0.004187075 0.740116031 0.393165995
Residual 58 0.328124732 0.005657323
Total 59 0.332311808

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept
-
0.000743658 0.010061246
-
0.073913087 0.94133387
-
0.020883429 0.019396114
-
0.020883429 0.019396114
X Variable 1 0.3212 0.373316716 0.860299966 0.393165995
-
0.426110234 1.06843895
-
0.426110234 1.06843895

SUMMARY OUTPUT 48 Month

Regression Statistics
Multiple R 0.146910819
R Square 0.021582789
Adjusted R Square 0.0003
Standard Error 0.081431942
Observations 48

ANOVA
df SS MS F
Significance
F
Regression 1 0.006728696 0.006728696 1.014708521 0.319047057
Residual 46 0.305033416 0.006631161
Total 47 0.311762112

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept
-
0.003680221 0.01211878
-
0.303679205 0.762741681
-
0.028074059 0.020713617
-
0.028074059 0.020713617
X Variable 1 0.5590 0.554924157 1.007327415 0.319047057
-
0.558014059 1.675994692
-
0.558014059 1.675994692


1 Year Regression
SUMMARY
OUTPUT 36 Month

Regression Statistics
Multiple R 0.553007734

115

R Square 0.305817554
Adjusted R
Square 0.2854
Standard Error 0.030913904
Observations 36

ANOVA
df SS MS F
Significance
F
Regression 1 0.014314475 0.014314475 14.97847849 0.000468992
Residual 34 0.032492762 0.000955669
Total 35 0.046807237

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.006357791 0.005316488 1.195862939 0.240023842
-
0.004446612 0.017162194
-
0.004446612 0.017162194
X Variable 1 0.9337 0.241241144 3.870203934 0.000468992 0.443391437 1.423913411 0.443391437 1.423913411

SUMMARY
OUTPUT 24 Month

Regression Statistics
Multiple R 0.500397859
R Square 0.250398018
Adjusted R
Square 0.2163
Standard Error 0.031414296
Observations 24

ANOVA
df SS MS F
Significance
F
Regression 1 0.007252329 0.007252329 7.348908508 0.012762739
Residual 22 0.021710876 0.000986858
Total 23 0.028963205

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.006492734 0.006749557 0.961949608 0.346529556
-
0.007504991 0.020490458
-
0.007504991 0.020490458
X Variable 1 0.8671 0.319846274 2.710887033 0.012762739 0.203746546 1.530387686 0.203746546 1.530387686







116



2 Year Regression
SUMMARY OUTPUT 72 Month

Regression Statistics
Multiple R 0.092439115
R Square 0.00854499
Adjusted R Square -0.0056
Standard Error 0.069527438
Observations 72

ANOVA
df SS MS F
Significance
F
Regression 1 0.002916413 0.002916413 0.603304532 0.439936804
Residual 70 0.338384522 0.004834065
Total 71 0.341300935

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.003455367 0.008227827 0.419961034 0.675800172
-
0.012954516 0.019865249
-
0.012954516 0.019865249
X Variable 1 0.1837 0.236500432 0.776726807 0.439936804
-
0.287989007 0.655381457
-
0.287989007 0.655381457

SUMMARY
OUTPUT 60 Month

Regression Statistics
Multiple R 0.11420029
R Square 0.013041706
Adjusted R
Square -0.0040
Standard Error 0.075198346
Observations 60

ANOVA
df SS MS F
Significance
F
Regression 1 0.004333913 0.004333913 0.766414305 0.384939757
Residual 58 0.327977895 0.005654791
Total 59 0.332311808

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept -0.00072865 0.010042902
-
0.072553755 0.942410853
-
0.020831702 0.019374402
-
0.020831702 0.019374402
X Variable 1 0.3266 0.373053986 0.875450915 0.384939757
-
0.420158226 1.073339133
-
0.420158226 1.073339133

SUMMARY
OUTPUT 48 Month

117


Regression Statistics
Multiple R 0.150084015
R Square 0.022525211
Adjusted R
Square 0.0013
Standard Error 0.081392715
Observations 48

ANOVA
df SS MS F
Significance
F
Regression 1 0.007022507 0.007022507 1.060037289 0.308590057
Residual 46 0.304739605 0.006624774
Total 47 0.311762112

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept
-
0.003667606 0.012094975
-
0.303233857 0.763078867
-
0.028013528 0.020678316
-
0.028013528 0.020678316
X Variable 1 0.5705 0.55409783 1.029581123 0.308590057 -0.5448524 1.685829733 -0.5448524 1.685829733


2 Year Regression
SUMMARY OUTPUT 36 Month

Regression Statistics
Multiple R 0.552386096
R Square 0.305130399
Adjusted R Square 0.2847
Standard Error 0.030929201
Observations 36

ANOVA
df SS MS F
Significance
F
Regression 1 0.014282311 0.014282311 14.93004376 0.000477406
Residual 34 0.032524926 0.000956615
Total 35 0.046807237

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.006389583 0.005317458 1.201623578 0.237812756
-
0.004416792 0.017195957
-
0.004416792 0.017195957
X Variable 1 0.9313 0.241021551 3.86394148 0.000477406 0.441478447 1.421107889 0.441478447 1.421107889

SUMMARY
OUTPUT 24 Month

Regression Statistics
Multiple R 0.499765467
R Square 0.249765522
Adjusted R
Square 0.2157
Standard Error 0.031427546
Observations 24

118


ANOVA
df SS MS F
Significance
F
Regression 1 0.00723401 0.00723401 7.324165491 0.012894366
Residual 22 0.021729195 0.000987691
Total 23 0.028963205

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.006427994 0.006760749 0.950781221 0.352044728
-
0.007592942 0.02044893
-
0.007592942 0.02044893
X Variable 1 0.8645 0.319437524 2.706319547 0.012894366 0.20202714 1.52697289 0.20202714 1.52697289









5 Year Regression
SUMMARY
OUTPUT 72 Month

Regression Statistics
Multiple R 0.093502962
R Square 0.008742804
Adjusted R
Square -0.0054
Standard Error 0.069520501
Observations 72

ANOVA
df SS MS F
Significance
F
Regression 1 0.002983927 0.002983927 0.617394023 0.434668996
Residual 70 0.338317008 0.0048331
Total 71 0.341300935

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.00355139 0.008216178 0.432243604 0.666893024
-
0.012835259 0.01993804
-
0.012835259 0.01993804

119

X Variable 1 0.1856 0.236252965 0.785744248 0.434668996
-
0.285557267 0.656826083
-
0.285557267 0.656826083

SUMMARY
OUTPUT 60 Month

Regression Statistics
Multiple R 0.116864859
R Square 0.013657395
Adjusted R
Square -0.0033
Standard Error 0.075174887
Observations 60

ANOVA
df SS MS F
Significance
F
Regression 1 0.004538514 0.004538514 0.803097146 0.373873465
Residual 58 0.327773294 0.005651264
Total 59 0.332311808

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept
-
0.000630603 0.009998063
-
0.063072482 0.949925654
-
0.020643899 0.019382694
-
0.020643899 0.019382694
X Variable 1 0.3347 0.373477612 0.896156876 0.373873465 -0.41290213 1.08229119 -0.41290213 1.08229119

SUMMARY
OUTPUT 48 Month

Regression Statistics
Multiple R 0.155010943
R Square 0.024028392
Adjusted R
Square 0.0028
Standard Error 0.081330107
Observations 48

ANOVA
df SS MS F
Significance
F
Regression 1 0.007491142 0.007491142 1.132518655 0.292793314
Residual 46 0.30427097 0.006614586
Total 47 0.311762112

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept
-
0.003579332 0.012045414
-
0.297153076 0.767687417
-
0.027825493 0.020666829
-
0.027825493 0.020666829
X Variable 1 0.5892 0.553666775 1.064198597 0.292793314
-
0.525261992 1.703684803
-
0.525261992 1.703684803


5 Year Regression

120

SUMMARY
OUTPUT 36 Month

Regression Statistics
Multiple R 0.551731072
R Square 0.304407176
Adjusted R
Square 0.2839
Standard Error 0.030945292
Observations 36

ANOVA
df SS MS F
Significance
F
Regression 1 0.014248459 0.014248459 14.87917012 0.000486418
Residual 34 0.032558778 0.000957611
Total 35 0.046807237

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.006467649 0.005315669 1.216713937 0.232091987
-
0.004335091 0.017270388
-
0.004335091 0.017270388
X Variable 1 0.9305 0.241222399 3.857352734 0.000486418 0.440256987 1.420702773 0.440256987 1.420702773

SUMMARY
OUTPUT 24 Month

Regression Statistics
Multiple R 0.498758494
R Square 0.248760035
Adjusted R
Square 0.2146
Standard Error 0.031448599
Observations 24

ANOVA
df SS MS F
Significance
F
Regression 1 0.007204888 0.007204888 7.284916966 0.013106261
Residual 22 0.021758317 0.000989014
Total 23 0.028963205

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.006413466 0.006768344 0.947567936 0.353642465
-
0.007623221 0.020450153
-
0.007623221 0.020450153
X Variable 1 0.8627 0.319640578 2.699058533 0.013106261 0.199834647 1.525622614 0.199834647 1.525622614






121





7 Year Regression
SUMMARY
OUTPUT 72 Month

Regression Statistics
Multiple R 0.093887236
R Square 0.008814813
Adjusted R
Square -0.0053
Standard Error 0.069517976
Observations 72

ANOVA
df SS MS F
Significance
F
Regression 1 0.003008504 0.003008504 0.622524355 0.432774996
Residual 70 0.338292431 0.004832749
Total 71 0.341300935

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.003594506 0.008211793 0.437724869 0.662933418
-
0.012783398 0.01997241
-
0.012783398 0.01997241
X Variable 1 0.1864 0.23620169 0.789002126 0.432774996
-
0.284725775 0.657453047
-
0.284725775 0.657453047

SUMMARY
OUTPUT 60 Month

Regression Statistics
Multiple R 0.117702766
R Square 0.013853941
Adjusted R
Square -0.0031
Standard Error 0.075167397
Observations 60

ANOVA
df SS MS F
Significance
F
Regression 1 0.004603828 0.004603828 0.814817012 0.370433561
Residual 58 0.327707979 0.005650138
Total 59 0.332311808

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept
-
0.000574813 0.009978397 -0.05760574 0.954260682
-
0.020548744 0.019399118
-
0.020548744 0.019399118
X Variable 1 0.3373 0.373645795 0.902672151 0.370433561 - 1.085212967 - 1.085212967

122

0.410653661 0.410653661

SUMMARY
OUTPUT 48 Month

Regression Statistics
Multiple R 0.156529089
R Square 0.024501356
Adjusted R
Square 0.0033
Standard Error 0.081310398
Observations 48

ANOVA
df SS MS F
Significance
F
Regression 1 0.007638594 0.007638594 1.155370507 0.2880336
Residual 46 0.304123518 0.006611381
Total 47 0.311762112

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept
-
0.003518539 0.012024223
-
0.292620893 0.771127842
-
0.027722044 0.020684966
-
0.027722044 0.020684966
X Variable 1 0.5950 0.55357466 1.074881625 0.2880336 -0.51926075 1.70931521 -0.51926075 1.70931521


7 Year Regression
SUMMARY
OUTPUT 36 Month

Regression Statistics
Multiple R 0.551627134
R Square 0.304292495
Adjusted R
Square 0.2838
Standard Error 0.030947843
Observations 36

ANOVA
df SS MS F
Significance
F
Regression 1 0.014243091 0.014243091 14.87111288 0.000487862
Residual 34 0.032564146 0.000957769
Total 35 0.046807237

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.006528082 0.005312393 1.228840194 0.227569353
-
0.004267999 0.017324164
-
0.004267999 0.017324164
X Variable 1 0.9306 0.241324001 3.856308193 0.000487862 0.440190348 1.421049094 0.440190348 1.421049094

SUMMARY
OUTPUT 24 Month

123


Regression Statistics
Multiple R 0.498521956
R Square 0.248524141
Adjusted R
Square 0.2144
Standard Error 0.031453537
Observations 24

ANOVA
df SS MS F
Significance
F
Regression 1 0.007198056 0.007198056 7.275724203 0.013156447
Residual 22 0.021765149 0.000989325
Total 23 0.028963205

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.006432712 0.006767471 0.950534107 0.352167426
-
0.007602164 0.020467587
-
0.007602164 0.020467587
X Variable 1 0.8625 0.319755356 2.697355038 0.013156447 0.199361702 1.525625737 0.199361702 1.525625737









10 Year Regression
SUMMARY
OUTPUT 72 Month

Regression Statistics
Multiple R 0.094336242
R Square 0.008899326
Adjusted R
Square -0.0053
Standard Error 0.069515012
Observations 72

ANOVA
df SS MS F
Significance
F

124

Regression 1 0.003037348 0.003037348 0.628546493 0.430567886
Residual 70 0.338263586 0.004832337
Total 71 0.341300935

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.003631191 0.008208259 0.442382638 0.659576236
-
0.012739665 0.020002048
-
0.012739665 0.020002048
X Variable 1 0.1873 0.236243155 0.792809241 0.430567886
-
0.283876353 0.658467865
-
0.283876353 0.658467865

SUMMARY
OUTPUT 60 Month

Regression Statistics
Multiple R 0.118377151
R Square 0.01401315
Adjusted R
Square -0.0030
Standard Error 0.075161329
Observations 60

ANOVA
df SS MS F
Significance
F
Regression 1 0.004656735 0.004656735 0.824313933 0.367678922
Residual 58 0.327655072 0.005649225
Total 59 0.332311808

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept
-
0.000518544 0.009960345
-
0.052060895 0.958659064
-
0.020456341 0.019419252
-
0.020456341 0.019419252
X Variable 1 0.3394 0.373836336 0.90791736 0.367678922
-
0.408902225 1.087727224
-
0.408902225 1.087727224

SUMMARY
OUTPUT 48 Month

Regression Statistics
Multiple R 0.157747882
R Square 0.024884394
Adjusted R
Square 0.0037
Standard Error 0.081294433
Observations 48

ANOVA
df SS MS F
Significance
F
Regression 1 0.007758011 0.007758011 1.173893778 0.284249145
Residual 46 0.304004101 0.006608785
Total 47 0.311762112

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept -0.0034454 0.012003082
-
0.287042901 0.775368535 -0.02760635 0.020715551 -0.02760635 0.020715551
X Variable 1 0.5997 0.553489901 1.083463787 0.284249145
-
0.514431104 1.713803632
-
0.514431104 1.713803632

125




10 Year Regression
SUMMARY OUTPUT 36 Month

Regression Statistics
Multiple R 0.551649138
R Square 0.304316771
Adjusted R
Square 0.2839
Standard Error 0.030947303
Observations 36

ANOVA
df SS MS F
Significance
F
Regression 1 0.014244227 0.014244227 14.87281824 0.000487556
Residual 34 0.03256301 0.000957736
Total 35 0.046807237

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.006606458 0.005307461 1.244749346 0.221735785 -0.0041796 0.017392516 -0.0041796 0.017392516
X Variable 1 0.9310 0.241398246 3.856529299 0.000487556 0.440379151 1.421539665 0.440379151 1.421539665

SUMMARY OUTPUT 24 Month

Regression Statistics
Multiple R 0.498257102
R Square 0.24826014
Adjusted R Square 0.2141
Standard Error 0.031459061
Observations 24

ANOVA
df SS MS F
Significance
F
Regression 1 0.007190409 0.007190409 7.265442974 0.013212829
Residual 22 0.021772796 0.000989673
Total 23 0.028963205

Coefficients
Standard
Error t Stat P-value Lower 95% Upper 95%
Lower
95.0%
Upper
95.0%
Intercept 0.006472477 0.006764368 0.956848829 0.349041087
-
0.007555963 0.020500917
-
0.007555963 0.020500917
X Variable 1 0.8624 0.319934988 2.695448566 0.013212829 0.198863753 1.525872857 0.198863753 1.525872857



126







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129

Common Size Balance Sheets
CURRENT ASSETS
Cash and cash equivalents 0.084 0.135 0.096 0.104 0.049 0.039
Investment securities 0.005 0.007 0.007 0.028 0.008 0.001
Accounts receivable 0.076 0.070 0.071 0.068 0.042 0.048
Inventories 0.000 0.000 0.000 0.000 0.000 0.000
Materials and supplies 0.025 0.025 0.021 0.023 0.011 0.012
Work in process 0.008 0.007 0.006 0.006 0.005 0.003
Finished goods 0.052 0.052 0.050 0.053 0.030 0.035
Total Inventories 0.085 0.083 0.077 0.081 0.046 0.049
Deferred income taxes 0.013 0.019 0.017 0.018 0.012 0.013
Prepaid expenses and other current assets 0.036 0.034 0.032 0.031 0.021 0.024
TOTAL CURRENT ASSETS 0.298 0.348 0.300 0.330 0.179 0.174
PROPERTY, PLANT AND EQUIPMENT
Buildings 0.111 0.108 0.091 0.086 0.043 0.046
Machinery and equipment 0.441 0.417 0.341 0.332 0.185 0.199
Land 0.014 0.014 0.011 0.010 0.006 0.006
0.566 0.539 0.444 0.428 0.235 0.252
Accumulated depreciation (0.238) (0.239) (0.196) (0.195) (0.097) (0.110)
NET PROPERTY, PLANT AND EQUIPMENT 0.327 0.300 0.247 0.233 0.138 0.142
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill 0.269 0.255 0.344 0.322 0.408 0.410
Trademarks and other intangible assets, net 0.060 0.054 0.075 0.071 0.249 0.244
NET GOODWILL AND OTHER INTANGIBLE ASSETS 0.329 0.309 0.419 0.393 0.656 0.653
OTHER NONCURRENT ASSETS 0.045 0.043 0.034 0.044 0.026 0.031
TOTAL ASSETS 1.000 1.000 1.000 1.000 1.000 1.000
Liabilities and Shareholders' Equity
CURRENT LIABILITIES
Accounts payable 0.081 0.102 0.091 0.086 0.067 0.080
Accrued and other liabilities 0.197 0.200 0.193 0.171 0.132 0.135
Taxes payable 0.053 0.068 0.064 0.051 0.046 0.047
Debt due within one year 0.138 0.079 0.208 0.260 0.029 0.169
TOTAL CURRENT LIABILITIES 0.469 0.449 0.557 0.568 0.275 0.431
0.000 0.000 0.000 0.000 0.000 0.000
LONG-TERM DEBT 0.414 0.417 0.316 0.293 0.494 0.328
DEFERRED INCOME TAXES 0.040 0.051 0.057 0.066 0.170 0.169
OTHER NONCURRENT LIABILITIES 0.077 0.083 0.071 0.073 0.061 0.072
TOTAL LIABILITIES 1.000 1.000 1.000 1.000 1.000 1.000
SHAREHOLDERS' EQUI TY
Convertible Class A preferred stock, stated value $1 per share (600
shares authorized) 0.119 0.098 0.088 0.085 0.023 0.021
Non-Voting Class B preferred stock, stated value $1 per share (200
shares authorized) --- --- --- --- --- ---
Common Stock, stated value $1 per share (10,000 shares authorized;
issued: 2007--3,989.7, 2006--3,975.8) 0.095 0.080 0.147 0.142 0.063 0.060
Additional paid-in capital 0.182 0.181 0.140 0.180 0.920 0.884
Reserve for ESOP debt retirement (0.098) (0.081) (0.074) (0.072) (0.020) (0.020)
Accumulated other comprehensive income (0.172) (0.124) (0.089) (0.090) (0.008) 0.009
Treasury stock, at cost (shares held: 2007--857.8, 2006--797.0) --- --- --- --- (0.544) (0.581)
Retained earnings 0.874 0.846 0.788 0.756 0.567 0.626
TOTAL SHAREHOLDERS' EQUITY 1.000 1.000 1.000 1.000 1.000 1.000
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY


130


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131


Common Sized Statements of Cash Flows
2002 2003 2004 2005 2006 2007
CASH AND CASH EQUI VALENTS, BEGINNING OF YEAR
OPERATING ACTI VI TI ES
Net earnings 56.21% 59.61% 69.23% 79.77% 76.34% 76.96%
Depreciation and amortization 21.87% 19.57% 18.51% 21.71% 23.09% 23.30%
Share-based compensation expense --- --- --- 6.04% 5.14% 4.97%
Deferred income taxes 5.02% 0.72% 4.43% 6.50% -0.98% 1.88%
Change in accounts receivable 1.24% 1.87% -1.70% -0.99% -4.61% -5.43%
Change in inventories 2.05% -0.64% 0.60% -7.42% 3.37% -2.90%
Change in accounts payable, accrued and other liabilities 8.83% 10.76% 6.68% -1.16% 2.02% -2.03%
Change in other operating assets and liabilities -1.27% 2.05% -0.94% -5.74% -4.47% -1.17%
Other 6.03% 6.06% 3.19% 1.30% 0.09% 4.41%
TOTAL OPERATI NG ACTIVITI ES 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
I NVESTI NG ACTIVITI ES
Capital expenditures 24.56% 108.73% 19.95% 93.36% 365.34% 118.61%
Proceeds from asset sales -3.32% -10.49% -2.27% -22.13% -120.82% -11.32%
Acquisitions, net of cash acquired 80.04% 4.48% 73.70% 24.49% -23.42% 19.81%
Change in investment securities -1.29% -2.71% 8.62% 4.28% -121.10% -27.10%
TOTAL I NVESTING ACTI VITIES 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
FINANCI NG ACTIVI TI ES
TOTAL FINANCI NG ACTIVITIES
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
CHANGE I N CASH AND CASH EQUIVALENTS
CASH AND CASH EQUI VALENTS, END OF YEAR

132

Cost of Capital Estimation


2007 %of TL Interest Rate Value Added Weight
CURRENT LIABILITIES
Accounts payable

5,710 0.0801 4.63 0.371028995
Accrued and other liabilities

9,586 0.1345 4.63 0.622886855
Taxes payable

3,382 0.0475 29.70 1.40968086
Debt due within one year

12,039 0.1690 5.00 0.844794678
TOTAL CURRENT LIABILITIES

30,717 0.4311
LONG-TERM DEBT

23,375 0.3281 5.00 1.640258792
DEFERRED INCOMETAXES

12,015 0.1686 5.25 0.88526609
OTHERNONCURRENT
LIABILITIES

5,147 0.0722 6.30 0.45507761
TOTAL LIABILITIES

71,254 1.0000
Weighted Average Cost of Debt Before Taxes: 6.228993881
Ke 11.15% Weighted Average Cost of Debt After Taxes: 4.378982698
WACC=(Ve/Vf)*Ke+(Vd/Vf)*Kd(1-t)
WACC=((66760/138014)*11.15+(71254/138014)*6.23)(1-.297)
WACC
at
6.0528
WACC
bt
8.6099

133


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