J. C. Penney Company, Inc. Equity Valuation and Analysis As of ...

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Potential Accounting FlexibilityA firm provides financial statements in order to give investors theinformation they need to make informed decisions regarding its investmentswithin the firm. This information should be relevant, reliable, and consistent.Flexibility within GAAP allows financial statement preparers the opportunity topresent their company’s financial information in a more informative, qualitativeway. This flexibility, however, can cause some information in a company’sfinancial reports to be distorted, making it seem more appealing to potentialinvestors. Some of the ways in which J. C. Penney has flexibility within GAAP arediscussed below.Operating vs. Capital LeasesOne of the main accounting policies that J. C. Penney has flexibility in iswhether to classify its leases as either operating or capital. With an operatinglease, the owner of the building or property only leases out the right to use it foroperating a business. When the lease term is up, the lessee can either returnthe property or renew his or her lease for an extended amount of time. Sinceownership does not transfer from the lessor to the lessee, the rent expenses areonly reflected on the income statement (as operating expenses) and not on thecompany’s balance sheet. When these expenses are not listed on the balancesheet, the company’s assets and/or liabilities can be significantly understated.This in turn causes the firm’s expenses to be understated, the net income to beoverstated, and the firm’s retained earnings to be overstated. When theretained earnings of a company are overstated, it appears more profitable than ittruly is. When a firm appears to be highly profitable, shareholders are moreinclined to invest in the business.Capital leases, on the other hand, do affect the firm’s balance sheet.They are listed as both a liability (lease payments) and an asset (additions toPPE). This is because the lessee assumes risks (e.g. taxes, payments) and also47
acquires certain benefits associated with ownership (e.g. depreciation, deductionof interest expenses). Since these expenses are recognized sooner than laterwhile using capital leases, most departmental retail firms opt to use operationalleases instead. However, since the obligation amounts of both of these types ofleases are relatively low for J. C. Penney, the company has a lot of flexibilitywhen choosing which type of lease to apply to its financial reports.PensionsPensions, or post-retirement benefit packages, represent a significantfinancial liability for a firm. Flexibility within GAAP allows from many companiesto overstate their earnings therefore making adjustments for pension expenses.Companies determine how much they will have to spend in the future onretirement packages based on their employee base. These assumptions includethings like the overall age and expected retirement dates of their existingemployees. When a final number is decided on, the rates are discounted backusing the time value of money so that they have a present value for these futureexpenses. The lower the discount rate, the higher the company’s assets becausethere is less money going into this type of expense. With increased assets, thereis typically a higher rate of return for the firm. Reporting a higher rate of returnon assets means a higher profit and therefore a greater percentage paid out asdividends to the investors. Fortune Magazine states that “a reasonable rate ofreturn on pension assets is between 6 and 7 percent.” J. C. Penney hasmaintained a limit around this reasonable rate. Therefore, they have flexibilitywith regard to what discount rate they utilize and still be within a normal range.ConclusionFlexibility within the generally accepted accounting procedures allowsfirms to report their financial information to their investors in more detail.However, firms can utilize this flexibility to distort and manipulate their financialstatements in order to make their company appear more profitable than they48
Page 1 and 2: J. C. Penney Company, Inc. Equity V
Page 5 and 6: Industry AnalysisIn 1902, James Cas
Page 7 and 8: Financial Analysis, Forecast Financ
Page 9 and 10: Business & Industry AnalysisCompany
Page 11 and 12: Industry OverviewThe retail industr
Page 13 and 14: Five Forces ModelThe Five Forces Mo
Page 15 and 16: ConcentrationThe level of concentra
Page 17 and 18: capable of offering lower prices th
Page 19 and 20: If a firm wishes to shut down, it m
Page 21 and 22: Legal BarriersMany industries have
Page 24 and 25: These costs include issues such as
Page 26 and 27: Bargaining Power of SuppliersThe de
Page 28 and 29: The relative bargaining power of th
Page 30 and 31: Competitive StrategiesIn order to a
Page 32 and 33: Department stores have to focus on
Page 34 and 35: The Big PicturePlayers in this indu
Page 36 and 37: Lower Input CostsJ. C. Penney is at
Page 38 and 39: in the last five years. This trend
Page 40 and 41: convenient for different consumers
Page 42 and 43: transactions have been improperly s
Page 44 and 45: Penney does state in its annual rep
Page 46 and 47: Operating and Capital LeasesOperati
Page 50 and 51: truly are. J. C. Penney, however, h
Page 52 and 53: Qualitative Analysis of DisclosureT
Page 54 and 55: we can see why targeting the strong
Page 56 and 57: manipulation diagnostics for J. C.
Page 58 and 59: Net Sales/Net Accounts ReceivableNe
Page 60 and 61: Net Sales/Unearned Revenue1200Net S
Page 62 and 63: Below is a chart of sales manipulat
Page 64 and 65: As for the industry, all the compan
Page 66 and 67: Pension Expense/SG&APension Expense
Page 68 and 69: Below is a chart of all expense man
Page 70 and 71: discount rates in respect to pensio
Page 72 and 73: Financial Analysis, Forecast Financ
Page 74 and 75: paying off their short-term obligat
Page 76 and 77: ecause many firms in this segment o
Page 78 and 79: Penney’s inventory turnover is in
Page 80 and 81: ConclusionAnalysis through liquidit
Page 82 and 83: operating efficiency because the fi
Page 84 and 85: Return on AssetsReturn on Assets0.1
Page 86 and 87: Capital Structure AnalysisWhen look
Page 88 and 89: however, in 2006, J. C. Penney show
Page 90 and 91: Sustainable Growth RateSustainable
Page 92 and 93: average of only years 2005 and 2006
Page 94 and 95: (reported in millions)Annual Income
Page 96 and 97: We then began to look at the equity
Page 98 and 99:
Common Size Balance Sheet 2002 2003
Page 100 and 101:
(numbers in millions)Statement of C
Page 102 and 103:
ConclusionOverall, it appears that
Page 104 and 105:
Inc. We set these averages equal to
Page 106 and 107:
Price to BookPPS BPS P/B IndustryAv
Page 108 and 109:
Price Earnings GrowthPPS EPS PEG In
Page 110 and 111:
y J. C. Penney’s EBITDA. Then we
Page 112 and 113:
Regression Analysis3 Month Rate 72
Page 114 and 115:
Intrinsic ValuationsIntrinsic valua
Page 116 and 117:
amount in the eye’s of shareholde
Page 118 and 119:
This particular stock price in our
Page 120 and 121:
esidual income or converge. Future
Page 122 and 123:
To find our long run return on equi
Page 124 and 125:
Sensitivity AnalysisGrowth Rates0 -
Page 126 and 127:
for this large difference between s
Page 128 and 129:
Analyst RecommendationAfter careful
Page 130 and 131:
AppendixLiquidity RatiosCurrent rat
Page 132 and 133:
Capital Structure RatioDebt to equi
Page 134 and 135:
SUMMARY OUTPUT3 Month Regression72
Page 136 and 137:
SUMMARY OUTPUT6 Month Regression72
Page 138 and 139:
SUMMARY OUTPUT2 Year Regression72 M
Page 140 and 141:
SUMMARY OUTPUT5 Year Regression72 M
Page 142 and 143:
SUMMARY OUTPUT10 Year Regression72
Page 144 and 145:
Cost of Equity 0.1361Estimated Pric
Page 146 and 147:
Discount Dividends Model0 1 2 3 4 5
Page 148 and 149:
Residual Income Model WACC(AT) 0.07
Page 150 and 151:
Z-Score AnalysisZ-Score=1.21.43.320
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J. C. Penney Company, Inc. Equity Valuation and Analysis As of ...

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