Johnson Controls Capital Investment Paper
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). …show more content…
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 their own probabilities. An important aspect of building a binomial expansion is to ensure all potential alternatives and scenarios.
Each of these alternative methods should be used with care. The intuition behind each of these is often difficult for the reader of the valuation analysis to follow, and clarity in the purpose and approach of the valuation is always a prime objective of any analysis. Despite the technical complexity of these methods, they require extreme care in building models that are a highly sensitive to changes in underlying assumptions and parameters.
For instance, when using a real option or Monte Carlo model, it is always best to create a detailed binomial decision tree to ensure that all potential outcomes have been incorporated into the analysis. With the increased importance of IP in the business world and the increasing sophistication of valuation techniques, these alternative methods will become increasing useful tools to value IP in the future.
The potential impact of inflation on planned capital investments in China are that the impact of inflation on individuals and businesses depends in part on whether inflation is anticipate or unanticipated. Inflation leads to a rise in the prices. There are savers use to reduce the savings in any bank at the time of inflation. The reason for this is at the time of inflation the interest rate of deposit decreases because of the decrease in the value of the money. Therefore the investors and the savers use to deposit less in the bank account to avoid this. Companies like Johnson Controls, Inc. would probably have kept keep cash money on hand rather than deposit money in the bank.
Inflation would also leads to rise in the price of wages as the workers demand more at the time of crisis of price as the value of the money decreases the price of every things specially the daily necessities increase. Inflation also leads to rise in the price of wages as the workers demand more at the time of crisis of price as the value of the money decreases the price of every things specially the daily necessities increase.
This knowledge may impact management’s decisions because when the capital starts to flow out, it could cause a collapse in asset prices and exchange rates. The financial panic as caused in the past foreign creditors to call in loans and then depositors withdrew their funds from the banks. This magnifies the illiquidity of the domestic financial system and forces a round of costly asset liquidations and price deflation.
Modifications that would be made would in evaluating the projects in North America would be in the assessment of the projects.
Often, assessment objectivity is difficult to do internally and requires an outside perspective, as the answers may not always be apparent. An outside perspective would engage Johnson Controls Inc. to help them in their efforts to conduct an independent evaluation of the markets and the internal capabilities they needed to be successful in those markets. The resulting analysis would help them identify a key capability that has been overlooked. Success in the new markets would not hinge on simply delivering the U.S.-coveted brands, but in securing exclusive licenses for the same or similarly-positioned brands overseas. In order for the retailer to achieve success in the new markets it would need to find the right suppliers for those
markets.
Successful global expansion also hinges on execution and possessing the right skills and resources. Determining a retailer's available capital and talent will help it identify the degree of flexibility and/or limitations it may have in developing an executable expansion strategy.
Sensitivity analysis provides Johnson Controls, Inc. with the information about the sensitivity of the project to a particular change in any of the variables of projection. For example, how much the NPV increases or decreases due to a change in the selling price of the project or cost of manufacturing or fixed cost or rate of depreciation or any other factor. We have to compute NPV at purchase prices and also NPV at after change prices. Net difference is taken as sensitivity effect. Otherwise only PV of changes can be calculated. The principle followed is that the project should be accepted if the total benefit from the project is greater than its total costs.
Sensitivity analysis can help management focus on where opportunities lie for improving cash flow or profitability. They can then take a hard look at the historical range of variables that will help us understand the benefit or opportunity of achieving an incremental value above or below those used to prepare the cash flow or P&L projections. The sensitivity analysis can help the company identify uncertainties critical to planning and decision-making. It would help assess if price and peak market share are the dominating uncertainties or unit costs. Determining the most important variables is critical to building a manageable Supertree decision tree model.
References
Ligy V. K (2009) retrieved from: - http://www.fibre2fashion.com/industry-article/7/670/activity-based-costing-a-tool-for-decision-making8.asp
Don Lambert (2007) retrieved from: -http://www.focusedmanagement.com/knowledge_base/articles/fmi_articles/middle/abcserv.htm
Robert S. Kaplan (2005) retrieved from: http://hbswk.hbs.edu/item/4587.html
Stapleton, Steve. "Global Retail Spotlight On: Johnson Controls, Inc.". Global Retail Spotlight Archives. Trade Dimensions International, Inc. Retrieved November 13, 2011 from http://www.plainvanillashell.com/archivegrs.asp?id=977.
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). …show more content…
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 their own probabilities. An important aspect of building a binomial expansion is to ensure all potential alternatives and scenarios.
Each of these alternative methods should be used with care. The intuition behind each of these is often difficult for the reader of the valuation analysis to follow, and clarity in the purpose and approach of the valuation is always a prime objective of any analysis. Despite the technical complexity of these methods, they require extreme care in building models that are a highly sensitive to changes in underlying assumptions and parameters.
For instance, when using a real option or Monte Carlo model, it is always best to create a detailed binomial decision tree to ensure that all potential outcomes have been incorporated into the analysis. With the increased importance of IP in the business world and the increasing sophistication of valuation techniques, these alternative methods will become increasing useful tools to value IP in the future.
The potential impact of inflation on planned capital investments in China are that the impact of inflation on individuals and businesses depends in part on whether inflation is anticipate or unanticipated. Inflation leads to a rise in the prices. There are savers use to reduce the savings in any bank at the time of inflation. The reason for this is at the time of inflation the interest rate of deposit decreases because of the decrease in the value of the money. Therefore the investors and the savers use to deposit less in the bank account to avoid this. Companies like Johnson Controls, Inc. would probably have kept keep cash money on hand rather than deposit money in the bank.
Inflation would also leads to rise in the price of wages as the workers demand more at the time of crisis of price as the value of the money decreases the price of every things specially the daily necessities increase. Inflation also leads to rise in the price of wages as the workers demand more at the time of crisis of price as the value of the money decreases the price of every things specially the daily necessities increase.
This knowledge may impact management’s decisions because when the capital starts to flow out, it could cause a collapse in asset prices and exchange rates. The financial panic as caused in the past foreign creditors to call in loans and then depositors withdrew their funds from the banks. This magnifies the illiquidity of the domestic financial system and forces a round of costly asset liquidations and price deflation.
Modifications that would be made would in evaluating the projects in North America would be in the assessment of the projects.
Often, assessment objectivity is difficult to do internally and requires an outside perspective, as the answers may not always be apparent. An outside perspective would engage Johnson Controls Inc. to help them in their efforts to conduct an independent evaluation of the markets and the internal capabilities they needed to be successful in those markets. The resulting analysis would help them identify a key capability that has been overlooked. Success in the new markets would not hinge on simply delivering the U.S.-coveted brands, but in securing exclusive licenses for the same or similarly-positioned brands overseas. In order for the retailer to achieve success in the new markets it would need to find the right suppliers for those
markets.
Successful global expansion also hinges on execution and possessing the right skills and resources. Determining a retailer's available capital and talent will help it identify the degree of flexibility and/or limitations it may have in developing an executable expansion strategy.
Sensitivity analysis provides Johnson Controls, Inc. with the information about the sensitivity of the project to a particular change in any of the variables of projection. For example, how much the NPV increases or decreases due to a change in the selling price of the project or cost of manufacturing or fixed cost or rate of depreciation or any other factor. We have to compute NPV at purchase prices and also NPV at after change prices. Net difference is taken as sensitivity effect. Otherwise only PV of changes can be calculated. The principle followed is that the project should be accepted if the total benefit from the project is greater than its total costs.
Sensitivity analysis can help management focus on where opportunities lie for improving cash flow or profitability. They can then take a hard look at the historical range of variables that will help us understand the benefit or opportunity of achieving an incremental value above or below those used to prepare the cash flow or P&L projections. The sensitivity analysis can help the company identify uncertainties critical to planning and decision-making. It would help assess if price and peak market share are the dominating uncertainties or unit costs. Determining the most important variables is critical to building a manageable Supertree decision tree model.
References
Ligy V. K (2009) retrieved from: - http://www.fibre2fashion.com/industry-article/7/670/activity-based-costing-a-tool-for-decision-making8.asp
Don Lambert (2007) retrieved from: -http://www.focusedmanagement.com/knowledge_base/articles/fmi_articles/middle/abcserv.htm
Robert S. Kaplan (2005) retrieved from: http://hbswk.hbs.edu/item/4587.html
Stapleton, Steve. "Global Retail Spotlight On: Johnson Controls, Inc.". Global Retail Spotlight Archives. Trade Dimensions International, Inc. Retrieved November 13, 2011 from http://www.plainvanillashell.com/archivegrs.asp?id=977.