1. Financial Analysis, Planning and Forecasting Theory and Application
Chapter 24
Simultaneous-Equation Models for Financial Planning By
Cheng F. Lee
Rutgers University, USA
John Lee
Center for PBBEF Research, USA

2. Outline 24.1 Introduction 24.2 Warren and Shelton model
24.3 Johnson & Johnson (JNJ) as a case study
24.4 Francis and Rowell (FR) model
24.5 Feltham-Ohlson model for determining equity value
24.6 Combined forecasting method to determine equity value
24.7 Summary

3. 24.1 Introduction

4. 24.2 Warren and Shelton model
Table 24.1

5. 24.2 Warren and Shelton model
TABLE The Warren and Shelton Model (Cont.)
III. Financing the desired level of assets

6. 24.2 Warren and Shelton model
TABLE The Warren and Shelton Model (Cont.)

7. 24.2 Warren and Shelton model
Table 24.2

8. 24.2 Warren and Shelton model
TABLE List of unknowns and list of parameters provided by management (Cont.)

9. 24.2 Warren and Shelton model
TABLE FINPLAN input format (Cont.)

10. 24.2 Warren and Shelton model
Balance Sheet
24.2 Warren and Shelton model
TABLE 24.3
(Cont.)
Historical or
Base-Period
input:

11. 24.2 Warren and Shelton model
TABLE 24.3 (Cont.) Historical or Base-Period input:
Balance Sheet

12. 24.2 Warren and Shelton model
Income Statement
24.2 Warren and Shelton model
TABLE 24.3 (Cont.) Historical or Base-Period input:

13. 24.2 Warren and Shelton model
TABLE 24.3 (Cont.) Historical or Base-Period input:
Income Statement

14. 24.2 Warren and Shelton model
Statement of Cash Flows
TABLE 24.3 (Cont.)

15. 24.2 Warren and Shelton model
Retained Earnings Statement
24.2 Warren and Shelton model
TABLE 24.3 (Cont.)

16. 24.2 Warren and Shelton model
Retained Earnings Statement
24.2 Warren and Shelton model
TABLE 24.3 (Cont.)
The above data of financial statements is downloaded from the COMPUSTAT dataset. @NA represents data is not available.

17. 24.3 Johnson & Johnson (JNJ) as a case study
Data sources and parameter estimations
Procedure for calculating WS model

18. 24.3 Johnson & Johnson (JNJ) as a case study

19. 24.3 Johnson & Johnson (JNJ) as a case study
Procedure for Calculating WS Model
By using the data above, we are able to calculate the unknown variables below:
(1) Salest = Salest-1 (1 + GCALSt)
=  0.71
= 43,
(2) EBITt = REBITt-1  Salest
=  43,946.87
= 11,
(3) CAt = RCAt-1  Salest
=  43,946.87
= 28,073.26

20. 24.3 Johnson & Johnson (JNJ) as a case study
(4) FAt = RFAt-1  Salest
=  43,946.87
= 39,152.27
(5) At = CAt + FAt
= 28, ,152.27
= 67,225.53
(6) CLt = RCLt-1  Salest
=  43,946.87
= 13,
(7) NFt = (At – CLt – PFDSKt) – (Lt-1 – LRt) – St-1 – Rt-1 – bt{(1 – Tt)[EBITt –
it-1(Lt-1 – LRt)] – PFDIVt}
= (67, – 13, – 0) - (8,223.0 – 219.0) – 3,120.0 – 67,248.0 –
{( )(11, (8,223.0 – 219.0) – 0}
= -29,

21. 24.3 Johnson & Johnson (JNJ) as a case study
(12) itLt = i0(L0 – LRt) + ietNLt
= (8,223.0 – 219.0) NLt
= NLt
(8) NFt + bt(1-T)[iNLt + ULtNLt] = NLt + NSt
( )x(0.0671NLt NLt) = NLt + NSt
NLt = NLt + NSt
(a) NSt NLt = -29,817.99
(9) Lt = Lt-1 – LRt + NLt
(b) Lt = 8,223.0 – NLt
Lt – NLt = 8,004
(10) St = St-1 + NSt
(c) -NSt + St = 3,120.0
(11) Rt = Rt-1 + bt{(1 – Tt)[EBITt – itLt – ULtNLt] – PFDIVt}
= 67, {( ) x [11, – itLt NLt]}

22. 24.3 Johnson & Johnson (JNJ) as a case study
Substitute (12) into (11)
Rt = 67, x { x [11, – ( NLt) NLt]}
= 67, , NLt
(d) Rt = 72, NLt
(13) Lt = (St + Rt)Kt
Lt = St Rt
(e) Lt – St – Rt = 0
(b) – (e) = (f)
0 = (Lt – NLt – 4,326.90) – (Lt – St – Rt)
8,004 = St Rt – NLt
(f) – (c) = (g)
7,497 – 507 = (0.1625St – Rt – NLt ) – (-NSt + St )
7,497 = NSt - NLt Rt

23. 24.3 Johnson & Johnson (JNJ) as a case study
(g) – (d) = (h)
7,497 – x 72,
= (0.1625NSt – NLt Rt ) – (Rt NLt)
- 4, = NSt – NLt
(h) – (a) = (i)
0.1625NSt – NLt – (NSt NLt )
= - 8, ,440.78
NLt = / =
Substitute NLt in (a)
NSt ( ) = -29,817.99
NSt = -29,

24. 24.3 Johnson & Johnson (JNJ) as a case study
Substitute NLt in (b)
Lt = 8,223.0 – –
= 7,
Substitute NSt in (c)
29, St = 3,120.0
St =
Substitute NLt in (d)
72, = Rt ( )
Rt = 72,286.98
Substitute NLtLt in (12)…
it(7, ) = ( )
it =0.0671

25. 24.3 Johnson & Johnson (JNJ) as a case study
(14) EAFCDt = (1 – Tt)(EBITt – itLt – ULtNLt)- PFDIVt
= [11, – (0.0671)(7, ) ( )]
= 8,907.51
(15) CMDIVt = (1 – bt)EAFCDt
= (8,907.51)
= 3,868.53
(16) NUMCSt = X1 = NUMCSt-1 + NEWCSt
X1 = NEWCSt
(17) NEWCSt = X2 = NSt / (1 – Ust) Pt
X2 = - 29, / ( )Pt
(18) Pt = X3 = mtEPSt
X3 = 14.5(EPSt)

26. 24.3 Johnson & Johnson (JNJ) as a case study
(19) EPSt = X4 = EAFCDt / NUMCSt
X4 = 8, / NUMCSt
(20) DPSt = X5 = CMDIVt/ NUMCSt
X5 = 3, / NUMCSt
(A) = For (18) and (19) we obtain X3 = 14.5(8,907.51) / NUMCSt = 129,158.9/X1
Substitute (A) into Equation (24.17) to calculate (B)
(B) = -29, / [( ) x 129,158.9 / X1]
(B) = X1

27. 24.3 Johnson & Johnson (JNJ) as a case study
Substitute (B) into Equation (24.16) to calculate (C)
(C) = X1 = X1
(C) = X1 =
Substitute (C) into (B)…
(B) = X2 = x
(B) = X2 =
From Equation (24.19) and (24.20) we obtain X4, X5 and X3
X4 = 8, / =
X5 = 3, / =
X3 = 14.5(4.0548) = 58.79

28. 24.3 Johnson & Johnson (JNJ) as a case study
The results of the above calculations allow us to forecast the following information
regarding JNJ in the 2010 fiscal year ($ in thousands, except for per
share data):
Sales = $43,946.87
Current Assets = $28,073.26
Fixed Assets = $39,152.27
Total Assets = $67,225.53
Current Payables = $13,663.08
Needed Funds = ($29,817.99)
Earnings Before Interest and Taxes = $11,909.60
New Debt = $
New Stock = ($-29, )
Total Debt = $7,
Common Stock = ($26, )
Retained Earnings $72,286.98
Interest Rate on Debt = 6.71%
Earnings Available for Common Dividends = $8,907.51
Common Dividends = $3,868.53
Number of Common Shares Outstanding =
New Common Shares Issued = (577.54)
Price per Share = $58.79
Earnings per Share = $4.0548
Dividends per Share = $1.7610

29. 24.3 Johnson & Johnson (JNJ) as a case study

30. 24.3 Johnson & Johnson (JNJ) as a case study

31. 24.3 Johnson & Johnson (JNJ) as a case study

32. 24.3 Johnson & Johnson (JNJ) as a case study

33. 24.4 Francis and Rowell (FR) model
The FR model specification
A brief discussion of FR’s empirical results

34. 24.4 Francis and Rowell (FR) model

35. 24.4 Francis and Rowell (FR) model
TABLE List of variables for FR model.

36. 24.4 Francis and Rowell (FR) model
TABLE List of variables for FR model. (Cont.)

37. 24.4 Francis and Rowell (FR) model
TABLE List of variables for FR model. (Cont.)

38. 24.4 Francis and Rowell (FR) model
TABLE List of variables for FR model. (Cont.)

39. 24.4 Francis and Rowell (FR) model
TABLE List of equations for FR Model.

40. 24.4 Francis and Rowell (FR) model
TABLE List of equations for FR Model. (Cont.)

41. 24.4 Francis and Rowell (FR) model
TABLE 24.11
Transformation of
industry sales
moments to company
NIAT and EBIY moments

42. 24.4 Francis and Rowell (FR) model
TABLE 24.11
Transformation of
industry sales
moments to company
NIAT and EBIY moments
(Cont.)

43. 24.4 Francis and Rowell (FR) model
TABLE Transformation of industry sales moments to company NIAT and EBIY moments (Cont.)
(Cont.)

44. 24.4 Francis and Rowell (FR) model
TABLE Transformation of industry sales moments to company NIAT and EBIY moments (Cont.)
(Cont.)

45. 24.4 Francis and Rowell (FR) model
TABLE Transformation of industry sales moments to company NIAT and EBIY moments (Cont.)
(Cont.)

46. 24.4 Francis and Rowell (FR) model
TABLE Sector interdependence

47. 24.4 Francis and Rowell (FR) model
TABLE Variable interdependence within sector seven

48. 24.4 Francis and Rowell (FR) model

49. 24.5 Feltham-Ohlson model for determining equity value

50. 24.5 Feltham-Ohlson model for determining equity value
Operating Assets = Total Assets – Financial Assets
Operating Liabilities = Preferred Shares + Total Liabilities – Financial Liabilities
Financial Assets = Cash and Cash Equivalent + Investment and Advancements + Short-Term Investments
Financial Liabilities = Long-Term debt + Debt in Current Liabilities + Notes Payable
Net Operating Assets = Operating Assets – Operating Liabilities
Net Financial Assets = Financial Assets – Financial Liabilities

51. 24.5 Feltham-Ohlson model for determining equity value
The derived implied pricing function is

52. 24.7 Summary
Two simultaneous-equation financial planning models are discussed in detail in this chapter. There are 20 equations and 20 un­knowns in the WS model. Annual financial data from JNJ are used to show how the WS model can be used to perform financial analysis and planning. A computer program of the WS model is presented in Appendix 24B.
The FR model is a generalized WS financial-planning model. There are 36 equation and 36 unknown in the FR model. The two simultaneous-equation financial-planning models discussed in this chapter are an alternative to Carleton's linear-programming mode­l, to perform financial analysis, planning, and forecasting.