Assignment #2: Johnson Controls Capital Investments ACC 560 Nadine Gilles December 2, 2012 Professor Linda Chess

Johnson Controls, Inc. follows a carefully an outlined capital budgeting process. There are many methodologies to supplement the traditional methods for evaluating the capital investments of Johnson Controls, Inc. The three traditional valuation methods, transaction, income, replacement cost, are appropriate for nearly all valuation analyses. However, over the past decade or so we have seen the growth of a new family of valuation methods based on future contingent events. This family of methods includes real options, binomial models, and Monte Carlo simulations. They are all based on decision tree models where the conditional events required for the IP to generate value are modeled explicitly. At the core of each of these methods is a two-step process: first, compute the probability of the favorable event occurring that will make the IP valuable, and second, compute the payoff if the favorable event occurs (usually using one of the traditional three methods described above). The real option method is based on the successful Fischer-Black valuation model for pricing options (calls and puts) of financial stocks. The basic premise behind the real option method is that an investment with an asymmetric payoff (i.e., a potentially large payoff and only limited losses) will have an increased value as the level of uncertainty, known as volatility, increases. Consequently, real option methods have been most useful where large capital investments are required with a highly uncertain and far away payoff. Monte Carlo simulations, named for the gambling games popularized at the Mediterranean resort, models a low probability payoff over multiple iterations. The binomial expansion method, or decision tree, is the most intuitive of these methods. In the binomial expansion the required events and decisions are modeled explicitly, each with...

Suggest a methodology to supplement the traditional methods for evaluating the capital investments of Johnson Controls in the emerging markets to reduce risk providing a rationale of how risk will be reduced. Johnson Controls, Inc. (JCI) was founded in 1885 by Warren Johnson, who was the inventor of the first electric room thermostat. This company was based out of Milwaukee, Wisconsin and is now a global leader in the building and automotive industries. It has more than 1300 locations worldwide, over 170,000 employees, and is traded on the New York Stock Exchange under the symbol JCI. The company is made up of three major sections: Building Efficiency, Automotive Experience, and Power Solution. They are innovative and committed to sustainability all while accelerating into the global market. A methodology that Johnson Controls, Inc could use to help in evaluating capital budget investments is the discounted payback method. This method could be very useful for this company especially with all its different business aspects. The discounted payback method is considered to be the period required to recover the initial cash investment in a project to equal the discounted value of expected cash inflows (Bhandari, 1986, p. 18). This is the approach where the present values of cash inflows are cumulated until they equal the initial investment. (http://www.answers.com/topic/discounted-payback-period) You see the discounted payback period takes into account the time value of money and the discounting of future cash flows which is similar to NPV method before it obtains the value for the payback period. Since Johnson Controls is a growing leader in Energy Savings Performance Contracting, it would be very sensible for management to use the discounted payback period, mainly because of the projects with the wind (turbine), photovoltaic solar, solar hot water systems, anaerobic biogas production systems

JOHNSON CONTROLS FINANCE PROJECT 1 1) Executive Summary Johnson Controls, Inc. (JCI) is based out of Milwaukee, Wisconsin and the company is made up of three major sections: Building Efficiency, Automotive, and Power Solution. The building segment is

was responsible for 37% of the total revenue for 2011. The automotive segment was responsible for 49% of Johnson Controls total revenue for 2011. The power solution segment was responsible for the small amount of the 2011 total revenue at only 14% (zacks.com). Stock Recommendations There are strong indicators that buying stock in Johnson Controls would be a good choice, however there are also some reasons against purchasing. The reasons for buying stock in Johnson Controls is that they anticipate growth in revenue by eight percent in the next year, and they have over 50% of market shares in the automotive seating business. Johnson Controls also has increased their cash dividend to $0.18 from $0.16 per share that was paid on January 3, 2012 to its shareholders. This was the last increase since December 2010. There are also indicators to not purchase the stock in Johnson Controls. The reasons not to buy the stock are that the company has had to decrease prices due to the large inventories and competition, and the cash flows for 2011 was down from $1.4 billion to $1.1 billion. The decline in the cash flows was due to the amount of inventory, lower deferred taxes, and higher accounts receivable. Johnson Controls debt has also increased due $1.7 billion from September 2010 to September 2011. The debt to capitalization ratio had increased from 25% to 32% (zacks.com). Additional areas of concern listed below: 1. There is the risk of increases in prices of key commodities such as: steel, aluminum, copper, & fuel. 2. Strong competition and pressure from automakers could force price reductions. 3. Total Debt has increased from last year 4. Free Cash Flow has decreased from last year 5. While earnings are strong,...