becton, dickinson and company - texas tech...

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Becton, Dickinson and Company

Analysis Team

Trevor Willis [email protected]

Ryan Leblanc [email protected]

Stephen Bell [email protected]

Craig Spearman [email protected]

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Table of Contents

Executive Summary .............................................................................................. 7

Industry Analysis ............................................................................................ 8

Accounting Analysis ........................................................................................ 8

Financial Analysis, Forecast Financials, and Cost of Capital Estimation ................. 9

Valuations ...................................................................................................... 11

Company and Industry Analysis ........................................................................ 13

Company Overview ......................................................................................... 13

Industry Overview........................................................................................... 17

The Five Forces Model ....................................................................................... 19

Rivalry Among Existing Firms ........................................................................... 19

Industry Growth ................................................................................... 20

Concentration ...................................................................................... 21

Differentiation ...................................................................................... 21

Switching Cost ...................................................................................... 22

Economies of Scale ............................................................................... 22

Fixed and Variable Costs ........................................................................ 23

Excess Capacity ................................................................................... 24

Exit Barriers .......................................................................................... 26

Threat of New Entrants ................................................................................... 27


Channels of Distribution Access and Relationships .................................... 27

Legal Barriers and Regulation ................................................................. 28

Threat of Substitute Products ........................................................................... 29

Buyer’s willingness to Switch .................................................................. 29

Bargaining Power of Suppliers and Customers (Industry) ................................... 30

Bargaining Power of Suppliers ................................................................ 30

Bargaining Power ........................................................................ 31

Price Sensitivity ........................................................................... 32

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Bargaining Power of Customers .............................................................. 32

Relative Bargaining Power ............................................................ 33

Price Sensitivity ........................................................................... 33

Value Chain Analysis .......................................................................................... 34

Differentiation ................................................................................................ 35

Product Quality ..................................................................................... 35

Customer Service .................................................................................. 36

Brand Image ........................................................................................ 37

Innovation ............................................................................................ 37

Investment in R&D ................................................................................ 38

Cost Leadership .............................................................................................. 39


Efficient Production Lines ....................................................................... 40

Corporate Strategy Analysis .............................................................................. 41

Price ................................................................................................. 41

Quality ................................................................................................. 42

Innovation ................................................................................................. 42

Reputation ................................................................................................. 43

Accounting Analysis .............................................................................................. 44

Key Accounting Policies ..................................................................................... 45

Research and Development ............................................................................. 45

Pension Plans ................................................................................................. 46

Foreign Currency Management ......................................................................... 50

Accounting Flexibility ........................................................................................ 53


Pension Plans ................................................................................................. 55


Actual Accounting Strategy ............................................................................... 56


Pension Plans ................................................................................................. 56


Accounting Disclosure ....................................................................................... 57

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Pension Plans ................................................................................................. 58


Quantitative Analysis ......................................................................................... 59

Sales Manipulation Diagnostics ......................................................................... 60

Sales / Cash from sales ................................................................................... 60

Sales / Accounts Receivable ............................................................................. 61

Sales / Inventory ............................................................................................ 61

Expense Manipulation Diagnostics .................................................................... 65

Asset Turnover Ratio ....................................................................................... 65

CFFO / Operating Income ................................................................................ 66

CFFO / Net Operating Assets............................................................................ 67

Pension Expense / SG&A Expense .................................................................... 68

Total Accruals / Change in Sales ...................................................................... 69

Identify Potential “Red Flags” ........................................................................... 71

Undo Accounting Distortions ............................................................................. 73


Financial Analysis .............................................................................................. 75

Liquidity Ratio Analysis .................................................................................... 75

Current Ratio ........................................................................................ 76

Quick Asset Ratio .................................................................................. 77

Inventory Turnover ............................................................................... 78

Days Supply of Inventory ....................................................................... 79

Accounts Receivable Turnover ................................................................ 80

Days Sales Outstanding ......................................................................... 81

Working Capital Turnover ...................................................................... 82

Cash to Cash Cycle ................................................................................ 83

Profitability Analysis ........................................................................................ 84

Gross Profit Margin ................................................................................ 85

Operating Expense Ratio ....................................................................... 86

Operating Profit Margin ......................................................................... 87

Net Profit Margin ................................................................................... 88

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Asset Turnover ..................................................................................... 89

Return on Assets ................................................................................... 90

Return on Equity ................................................................................... 91

Capital Structure Analysis ................................................................................ 92

Debt to Equity Ratio .............................................................................. 93

Times Interest Earned ........................................................................... 94

Debt Service Margin .............................................................................. 95

Altman Z-Score ..................................................................................... 96

IGR ................................................................................................. 97

SGR ................................................................................................. 99

Financial Statements Forecast .......................................................................... 100

Income Statement .......................................................................................... 100

As Stated ............................................................................................. 102

Restated .............................................................................................. 104

Balance Sheet ................................................................................................. 107

As Stated ............................................................................................. 108

Restated .............................................................................................. 110

Statement of Cash Flows ................................................................................. 113

Estimating Cost of Capital ................................................................................. 117

Cost of Equity ................................................................................................. 117

Indirect Cost of Equity ..................................................................................... 120

Cost of Debt ................................................................................................. 120

Weighted Average Cost of Capital .................................................................... 122

Methods of Comparables ................................................................................... 122

Price / Earnings Trailing ................................................................................... 123

Price / Earnings Forecast ................................................................................. 124

Price / Book Value ........................................................................................... 125

Dividends / Price ............................................................................................. 126

P.E.G. ................................................................................................. 126

Price to EBITDA .............................................................................................. 127

Price to FCF ................................................................................................. 128

Enterprise Value to EBITDA ............................................................................. 129

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Intrinsic Valuation Models ................................................................................. 129

Discounted Dividends Model ............................................................................ 130

Discounted Free Cash Flows Model ................................................................... 131

Residual Income Model ................................................................................... 133

As Stated ............................................................................................. 134

Restated .............................................................................................. 134

Long-Run Residual Income Model .................................................................... 135

As Stated ............................................................................................. 137

Restated .............................................................................................. 137

Abnormal Earnings Growth Model ..................................................................... 138

As Stated ............................................................................................ 139

Restated .............................................................................................. 139

Appendices .............................................................................................. 141

Regression Output .......................................................................................... 141

Financial Ratios ............................................................................................... 143

Methods of Comparables ................................................................................. 147

Valuation Models ............................................................................................ 150

References ................................................................................................. 158

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Executive Summary

Investment Recommendation: Overvalued, Sell (6/1/2008)

Charts provided by moneycentral.msn.com

BDX ‐ NYSE (6/1/2008) 84.45 Altman Z‐Scores52 Week Range 2003 2004 2005 2006 2007Revenue 6,360M Initial 4.62 5.59 5.64 6.28 6.89

Market Capitalization 2,009M Restated 4.65 5.64 5.70 6.35 6.97Shares Outstanding 244,929T

Market Price(6/1/08) $84.45Initial Restated

Book Value Per Share 17.8% 19.1% Financial valuations Initial RestatedROE 23.0% 30.0% Trailing P/E 92.11 161.13ROA 13.0% 17.0% Forward P/E 72.42 93.92

P.E.G. 57.55 101.03Cost of Capital P/B 71.77 77.01Estimated (72 months) Adjusted R² Beta Ke P/EBITDA 80.94 96.713‐Month 19.2% 0.68 8.3% P/FCF 40.02 40.026‐Month 19.1% 0.68 8.3% EV/EBITDA 87.48 106.412‐Year 19.1% 0.68 8.3% D/P 130.55 130.555‐Year 19.0% 0.69 8.3%10‐Year 19.0% 0.69 8.3% Intrinsic Valuations

Discounted Dividends 23.50 23.50Indirect Ke 11.44% Free Cash Flows 111.35 111.35Published Beta 0.60 Residual Income 66.70 83.86Cost of Debt 4.90% LR RI N/A N/AWACC (BT) 7.80% A.E.G. 85.36 104.00

$72.15 ‐ $93.24

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Industry Analysis

BD (Becton, Dickinson and Company) is in the medical supply industry which is

part of the healthcare sector. They specialize in numerous products ranging from

needles and syringes to testing systems for cancer as well as sexually transmitted

diseases. Most companies in this field have many different business segments that

makes its almost impossible to find a direct competitor. However BD’s closest

competitors are: Boston Scientific Corporation, Baxter International and, C.R. Bard. Inc.

The medical supplies industry is highly competitive, and is constantly evolving.

Changes in technology, discoveries of new medical techniques, and increased

regulation, constantly change the dynamics of the industry. Firms in the medical

supplies industry compete on the basis of price, quality, innovation, reputation, and

service. Firms competing in the industry must focus their resources on product quality

and innovation, while at the same time maintaining a low-cost structure in order to be

profitable.

Accounting Analysis

The purpose of conducting an accounting analysis is to evaluate the extent to

which a firm’s accounting captures the fundamental reality of the business. By

identifying a firms accounting flexibility, and by determining how appropriate the firm’s

estimates and policies are, allows us to assess the level of distortion in their accounting

numbers. By identifying distortions, we can than adjust the firm’s accounting numbers

Rivalry Among Existing Firms

Threat of New Entrants

Threat of substitute products

Bargaining Power of Buyers

Bargaining Power of Suppliers

High

Low

High

High

Moderate

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using information in the firm’s footnotes and statement of cash-flows to undo these

accounting distortions, and receive a clearer view of the firm’s business activities.

The key accounting policies for firms in the medical supplies industry Include:

research and development, tight cost control in regard to pension liabilities, and

management of foreign currency risk. These policies have a direct effect on the key

success factors of the industry. Research and development represents a large expense

for Becton Dickinson, approximately 40% of net income. Since this is such a high

number, we capitalized this expense to get a better assessment of the firm’s business

reality.

The actual accounting strategy Becton Dickinson uses is fairly conservative.

When accounting for research and development, the SEC clearly states that it must be

expensed, leaving management little room to manipulate or distort those numbers. The

method the firm uses to record and manage their pension liabilities is consistent with

the industry, and offers no reason to suggest there has been any distortion by

management. The method the firm uses to manage currency risk and record the

activities from their derivative securities is consistent among the firms in the medical

supplies industry.

Becton Dickinson presents a good amount of disclosure on each key accounting

policy, without providing too much information that could possibly weaken their

transparency. The firm did not have any accounting “red flags” that would substantially

impact any of the firm’s key accounting policies. There was some questionable

accounting used to record pension liabilities. However, the amount of money in

question was too little to have a serious impact their financial statements.

Financial Analysis, Forecast Financials, and Cost of Capital Estimation

Financial analysis is a valuable instrument used by analyst to determine

how the firm is performing in comparison to the firm’s goals, strategies, and how they

match up with their competition. Ratio analysis takes certain items from the balance

sheet, income statement, or statement of cash flows and compares them to other

elements in the financial statements to draw information about how the company is

performing. This information is useful in evaluating the liquidity, profitability, and capital

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structure of the firm. Through ratio analysis, we are able to compare different line

items of the firm’s financial statements, to see how they relate to one another, and how

they matchup with their competition in the industry.

In terms of liquidity, Becton Dickinson is near the industry average. They showed

some concern with how fast they were turning their inventory into revenue, which

appeared to be slightly lower than the industry average. However, the majority of their

liquidity ratios were consistent with their competitors.

Becton Dickenson has done a good job managing their operating activities and

assets in order to efficiently generate profit for the firm over the past six years. The

low profits margins experienced in 2004, was a result of a few large expenses that did

not accurately reflect the firm’s ability to operate efficiently, and effectively manage

their assets. In relation to the industry, Becton Dickinson has performed exceptionally

well, and has maintained the most stability over the past six years in maintaining their

profit potential.

BDX’s capital structure remains consistent with its competitors in the medical supplies

industry. Since BDX finances most of their operations through equity rather than debt,

they have relatively no capital structure risk that would otherwise lead to default.

Although their debt service margin isn’t as high as analyst may like, their solid z-score

over the past 6 years allows them to stay strong in the industry without the eminent

danger of declaring bankruptcy.

Financial statements of companies allow investors to look into the activities of

the operations of the business. These financial statements serve many purposes. They

report the past performance of the company and could be used to determine success or

failure at any time. Many companies look at the past in order to go into the future.

The historical numbers can be a great learning tool for companies when trying to

forecast their future. We used that knowledge to forecast the next ten years for BDX.

We forecasted their income statement, balance sheet, and the statement of cash flows.

The income statement was the easiest to forecast with revenues being the back bone of

the forecasting process. The balance sheet was a little difficult to forecast, but we used

the asset turnover to link the balance sheet to the income statement. Since we felt

pretty comfortable with our forecasted income statement, this provided a pretty

accurate balance sheet. The statement of cash flows was the hardest to forecast. We

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used the average actual CFFO divided by sales to forecast the CFFO, which stands for

cash flows from operations. The main number on the statement of cash flows was the

forecasted dividends. The dividends played a huge role when forecasting retained

earnings on the balance sheet.

Cost of capital estimation was another valuable tool in the valuation process.

The cost of capital is the key ingredient in the valuation process. The cost of capital

includes the cost of equity and the cost of debt. We also had to compute the weighted

average cost of capital, aka WACC. We completed a regression analysis on the treasury

yields of the 3-month, 6-month, 2-year, 5-year, and 10-year. We used the regression

analysis to determine the beta for BDX. The beta we computed was .68 with an

explanatory power of 19%. We used that beta to compute a cost of equity of 8.3%.

After using a weighted average system of the liabilities, we computed a cost of debt

equal to 4.9%. Overall, we feel comfortable with our cost of capital because the

numbers are around the normal rates.

Valuations

The main purpose of any equity valuation is to value the firm and also to

determine if the stock price, as of a certain date, is over, under, or fairly valued. There

are two main methods of valuation, which include financial and intrinsic valuations.

Financial valuations use the method of comparables where an analyst will use the ratio

averages from the industry to estimate the share price for that firm. This price is then

compared to the observed share price to see if it is over, under, or fairly valued. The

intrinsic valuations are more complicated then the financial, but have much more

explanatory power because of the financial theory underlying them.

There were eight different methods of comparables that we used to value the

share price of BDX. These models were used to determine if the stock price was over,

under, or fairly valued. Three out of the eight, overstated the stock price. Four out of

the eight were fairly valued, but some were on the slightly overstated side. Only one of

the methods said that the stock price was undervalued and that one was dividends

divided by price. These methods had a range of share price from $40.02 to $130.55.

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There are many problems with these models that cause such a lack of consistency.

These numbers have little meaning, unless you use every firm in the industry.

The intrinsic valuations are harder to compute, but some of the models have a

high explanatory power. Also, some of these models are absolutely useless. The

discounted dividend and free cash flows model have an explanatory power of 5% and

15%, respectively. Both of these models are sensitive to growth rates and adjustments

to cost of equity. The free cash flows model is more sensitive than the discounted

dividends model when dealing with growth rates. The discounted dividends model

assumes that investors only buy based on dividends, which that isn’t the case most of

the times. If someone held on to the stock just for dividends, it would take years, even

decades to get your initial investment back. The models that aren’t as sensitive are the

most useful models.

The model that has the highest explanatory power is the residual income model.

This model has an explanatory power of over 50%. This model was a vital tool when

used to determine if the share price was over, under, or fairly valued. Another great

model is the abnormal earnings growth (A.E.G.) model. This model goes hand in hand

with the residual income model. The change in residual income per year is equal to the

annual abnormal earnings growth per year when using the same cost of equity. The

last model in the valuation process is the long-run residual income model. For many

firms this might be a good model to value a share price, but for BDX this model was

almost pointless. The main flaw in our long-run residual income model was the fact

that our growth rate was higher than our cost of equity, which in turn led to a negative

stock price. A negative stock price as everyone knows is impossible, making it hard to

value the stock of BDX. We had to restate the last three models in order to account for

the capitalization of research and development. Both the residual income model and the

A.E.G. model helped us determine that the share price of BDX was overvalued.

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Company and Industry Analysis

Company Overview

BD (Becton, Dickinson and Company) is a medical technology company that

serves healthcare institutions, life science researchers, clinical laboratories, industry and

the general public. BD manufactures and sells a broad range of medical supplies,

devices, laboratory equipment and diagnostic products. The company was started back

in 1887 when Maxwell W. Becton and Fairleigh S. Dickinson met on a sales trip. Months

later they decided to go into business together, sealing the deal with a handshake. In

1906, together they opened up the first medical manufacturing facility in the United

States. Since their first opening in East Rutherford, New Jersey, the company has

grown to be home to nearly fifty countries worldwide. BD more specifically classifies

their services in three different segments:

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First segment, BD Medical, which is a leading supplier of medical devices for many

countries. (www.bd.com)

Products/Services

• Needles, syringes and intravenous catheters for medication delivery

• Syringes and pen needles for the self-injection of insulin and other drugs used in the treatment of diabetes

• Refillable drug delivery devices provided to pharmaceutical companies and sold to end-users as drug/device combinations

• Surgical blades and regional anesthesia needles

• Critical care monitoring devices • Ophthalmic surgical instruments • Sharps disposal containers

Markets Served

• Hospitals and clinics • Physicians’ office practices • Consumers and retail pharmacies • Public health agencies • Pharmaceutical companies • Healthcare workers

In this first segment for BD the company is specializing in low end products such

as needles and syringes. For this section the company is competing on a commodity

basis. This is why the company built the first ever manufacturing facility in the U.S. to

produce needles and syringes. Also BD is responsible for supplying homes around the

world with products such as ACE bandages and thermometers.

Second, BD Diagnostics is a leading provider of products for the safe collection

and transport of diagnostic specimens and instruments for quick, accurate analysis

across a broad range of infectious diseases, including the growing problem of

healthcare-associated infections (HAIs).

(www.bd.com)

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Products/Services

• Integrated systems for specimen collection

• An extensive line of safety-engineered blood collection products and systems

• Plated media • Automated blood culturing systems • Molecular testing systems for

sexually transmitted diseases and HAIs

• Microorganism identification and drug susceptibility systems

• Liquid-based cytology systems for cervical cancer screening

• Rapid diagnostic assays

Markets Served

• Hospitals, laboratories and clinics • Reference laboratories • Blood banks • Healthcare workers • Patients • Physicians’ office practices • Industrial microbiology laboratories

This segment for BD is specializing in the transport and analysis of diagnostic

specimens. This means most of the products from this business segment are designed

for hospitals and laboratories use to perform multiply test on patients. The tests differ

from, cancer screenings and healthcare associated infections, to test systems for

sexually transmitted diseases.

Last, BD Biosciences is one of the world's leading businesses bringing innovative

tools to life scientists, clinical researchers and clinicians. Its customers are involved in

basic research, drug and vaccine discovery and development, biopharmaceutical

production, clinical trials, diagnostic testing and disease management. (www.bd.com)

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Products/Services

• Fluorescence activated cell sorters and analyzers

• Cell imaging systems • Monoclonal antibodies and kits for

performing cell analysis • Reagent systems for life sciences

research • Tools to aid in drug discovery and

growth of living cells and tissue • Cell culture media supplements for

biopharmaceutical manufacturing • Diagnostic assays

Markets Served

• Research and clinical laboratories • Academic and government

institutions • Pharmaceutical and biotech

companies • Hospitals • Blood banks

This last business segment for BD is focused around new innovation for drug and

vaccine discovery. It specializes in research and development of tools to help their

customers in basic research and disease management. This segment is designed for

scientists and clinical researchers.

Some of Becton, Dickinson’s competitors in the medical supply industry are (BSX)

Boston Scientific Corporation, (BAX) Baxter International and, (BCR) C.R. Bard. Inc.

These companies are close competitors compared to other companies in the medical

supply industry because they make and sell similar products such as catheters. However

like many other companies in this field it is nearly impossible to find a direct competitor

due to the fact they all produce and perform significantly different services.

BD has a market cap of 20.53 billion, and total assets given from the company’s

10-K as follows:

BDX 2003 2004 2005 2006 2007

Total Assets 5572.25

5752.58

6132.79

6824.52

7329.36

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BD has a stock value, as of June 1 2008, of 84.45. The stock price has increased

slowly ever since first entering the market in 1962. The graph below shows the stock

price for the last five years for Becton Dickinson.

Industry Overview

The medical supply industry is a highly competitive industry. There are

well over 10,000 different companies fighting for their piece of the market share. Some

compete by lowering cost of products such as needles and syringes, while others

compete by producing superior products such as tools to aid in drug discovery. This

industry has a low rate of new firms trying to grab part of the market share due to the

fact once a company is in the medical industry they must face multiple regulations such

as: (FDA) Food and Drug Administration, U.S. Department of Health and Human

Services, Department of Justice, and (CMS) Centers for Medicare and Medicaid. The

industry might have even harder regulations in the future “You can rest assured that

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when we finally win the battle for universal health care in this country” (WSJ June 3) if

the government goes to a universal health care for every American.

Another must for the medical industry is Research and Development, this is a

huge factor in this industry. If the company is not willing to spend the money for R&D

then they have no chance of growth. Companies that have a good R&D program are

the ones that continue to grab more market share while developing new patients.

The companies that are closest to BD in terms of services and market cap are

(BSX) Boston Scientific Corporation, (BAX) Baxter International and, (BCR) C.R. Bard.

Inc. We will be using these companies to benchmark BD as well as the industry.

Competitors BSX BAX BCR Market Cap 20.21 Billion 38.58 Billion 9.05 billion

The Industry segments are slightly different for all companies however they all

relate in one area and that is the segment of products and devises the companies make

to provide their customers in the development and research of disease management.

This includes treatment of cancer, diabetes and other diseases. In addition to treatment

the companies make tools and devises to help their customer in researching new

diseases such as software.

A different segment all four companies share is the collection and storage of

blood components. This includes the production of innovative products to store cells

and blood so they can be properly stored until time to be analyzed. The companies also

produce mass productions of syringes and tubing (catheters).

All companies have many other business segments that the other companies do

not perform. Such as Boston Scientific specializes in devices that use neurostimulation

to help chronic pain signals with electrical impulses. And Baxter specializes in

biosurgery. Since each company is producing over 10,000 products all around the world

there is many different business segments that each perform while its competitors do

not.

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Five Forces Model

The Five forces model is a framework that is used by analysts to determine the

competitive intensity and the profit potential of a particular industry. Analysts examine

the level of competition among existing firms, the threat of substitute products, and the

threat of new firms entering the industry, to determine the level of actual and potential

competition in the industry. The five forces model also examines the degree of

bargaining power buyers and suppliers have in the industry to further asses the

profitability potential of firms competing in the industry.

Rivalry among Existing Firms

The medical technology industry is highly competitive, and is constantly evolving.

Changes in technology, discoveries of new medical techniques, and increased

regulation, constantly change the dynamics of the industry. Firms in the medical

technology industry compete on the basis of price, quality, innovation, reputation, and

service. Firms competing in the industry must focus their resources on product quality

and innovation, while at the same time maintaining a low-cost structure in order to be

profitable.

Rivalry Among Existing Firms


Threat of substitute products

Bargaining Power of Buyers


High

Low

High

High

Moderate

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Industry Growth

The level of growth in an industry has an inverse relationship to the degree of

competition in the industry. Industries plagued with stagnant growth force competing

firms to fight for market share which often results in price-wars. However, firms in

industries experiencing rapid growth do not have to fight for market share. As the

industry increases, individual market share increases as well. The Medical technology

industry is experiencing normal growth, averaging approximately 13% per year.

Established firms have begun to diversify into more advanced medical supplies to

capture the growing demand and higher profit margins associated with that sector.

Along with diversification into new markets, established firms are also increasing the

scale of their operations, as well as their customer base through mergers and

acquisitions. The chart below illustrates the level of growth in the industry. We have

removed Boston Scientific from this data because of the firm’s high sales volatility which

tends to be inconsistent with the industry.

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Concentration

The industries concentration is determined by the number of firms competing in

that industry. The level of concentration in an industry can greatly affect a firm’s

control over prices and a firm’s competitive position. An industry that is highly

concentrated has only a few key players competing for market share, giving them

control over their prices. In contrast, an industry that has a low concentration of firms

competing in the industry has little or no control over their prices which usually leads to

intense price competition. The medical technology industry is fairly concentrated.

Established firms such as Becton Dickenson and Baxter International primarily focus

their efforts on providing a broad range of general medical supplies. Due to the

simplistic and disposable nature of these products, firms must be able to produce large

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quantities at a low cost in order to compete. Competing in this sector of the industry

requires a great deal of start-up capital. Due to this large entry barrier, the level of

concentration has remained fairly constant.

Differentiation

Firms in the medical technology industry focus heavily on product quality, and

innovation as a way of differentiating themselves from their competitors. Due to the

nature of the industry, buyers require high quality products, with minimal defects.

These buyers are usually large medical facilities, or government agencies, who look to

enter into long-term relationships with these companies. Therefore, firms in the

industry look to differentiate themselves by establishing an image based on quality and

service, while at the same time offering these products and services at a low price.

Switching Costs

If a firm’s products and services are very similar to other products and services

offered in the industry, customers tend to move from one company to the other on the

basis of price. Firms with low customer switching costs are faced with high price

competition and are less likely to produce high profit margins. Conversely, firms with

high customer switching costs are less likely to compete on price and often produce

higher profit margins. Switching costs tend to be low for buyers in the industry due to

the level of competition. However, buyers sometimes lock into contracts with these

firms, which can make it more difficult for them to switch.

Economies of Scale

A firm’s size also plays an important role in determining how well it can compete

in an industry. Larger firms have greater bargaining power over their suppliers, giving

them the ability to offer lower prices than smaller firms competing in the industry.

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Larger firms often prevent new firms from entering an industry as well as drive out

smaller existing firms that are unable to compete against larger firms low-cost

structure. Additionally, larger firms often possess greater intellectual capital as a result

of operating experience. Existing Firms in the medical technology industry pose a

significant barrier to enter the industry due to economies of scale. The high level of

price competition in the industry makes it hard to for smaller firms in the industry to

compete at the same level. However, due to changes in technology, and diversification

into other medical sectors, smaller companies are able to compete with certain product

lines through specialization.

The chart below shows the size of the major firms in the industry. The large

increase in Boston Scientifics Assets in 2006 and 2007 came from several large

acquisitions resulting from the firm specializing in high-tech medical supplies. These

acquisitions have greatly increased the scale of their operations. However, it appears

that Boston Scientific has had difficulty utilizing these acquisitions. During 2006 and

2007 Boston Scientific has produced negative net-income values due to large operating

expenses.

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Fixed/Variable Cost

The relationship between fixed and variable cost provides insight to the degree

of actual and potential competition in an industry. Firms with a high ratio of fixed cost

to variable cost are less flexible in moving from one industry to another. These types of

firms are more likely to engage in higher levels of price competition because of their

need to utilize capacity. However, firms that have low fixed cost to variable cost are

more flexible in moving from one industry to another. These types of firms have a

greater opportunity of leaving an industry when profits become undesirable. The

medical supplies industry has moderate ratios of fixed to variable cost. Firms in the

industry tend to have lower variable cost in relation to fixed cost, due to the type of

products they are manufacturing. The majority of firms in the industry manufacture

many different product lines, the majority of which are relatively cheap to manufacture.

Higher oil prices and other raw materials could pose a threat to firms in the industry,

since the majority of the materials used are made with plastic, rubber, and metal. The

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chart below shows the fixed to variable cost ratios of firms in the industry. Over the

past five years the industry has maintained a fairly constant fixed/variable cost ratio.

The slight increase in the industry average in 2006 and 2007 came from large

acquisitions made by Boston Scientific, which significantly increased their fixed assets

such as property, plant, and equipment.

(Fixed/Variable Cost Ratios)

2003 2004 2005 2006 2007 BSX 1.96 2.55 1.90 2.73 2.53 BCR 1.44 1.60 1.86 1.48 1.44 BDX 1.09 1.06 1.14 1.14 1.02 BAX 1.08 1.08 0.89 1.24 1.32 Industry Avg. 1.39 1.57 1.45 1.65 1.58

Excess Capacity

Excess capacity occurs when there is a buildup of inventories due to a lack of

customer demand or simply overproduction. When supply exceeds demand, firms

reduce prices in order to increase sales to eliminate the excess inventory. If industry

conditions become undesirable, firms with low exit barriers will sell off there inventories

and leave the industry. However, firms that face high exit barriers may have to endure

for a while. One way to measure how well companies are able to manage their

inventories is by calculating a firm’s inventory turnover. Inventory turnover measures

how efficient a firm is able to sell its products, and is calculated by dividing cost of

goods sold by the amount of inventory. The higher the ratio, the more efficient a firm is

at getting rid of excess capacity. Firms in the medical technology industry have

relatively low inventory turnover ratios in relation to other manufacturing industries due

to sizeable differences in the cost of production. The chart below shows how well firm’s

in the medical supplies industry manage their excess capacity. C.R Bard tends to

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slightly outperform everyone else in the industry, but for the most part they are fairly

close to each other, showing only a small amount of volatility.

(Inventory Turnover) 2003 2004 2005 2006 2007 BSX 3.42 3.59 3.32 3.23 3.23 BCR 3.89 4.21 4.00 3.42 3.53 BDX 2.96 3.38 3.38 3.19 2.92 BAX 2.35 2.62 2.99 2.73 2.46 Industry Avg. 3.16 3.45 3.42 3.14 3.04

Exit Barriers

Exit Barriers prevent companies from exiting the industry. Firms with high fixed

to variable cost ratios and specialized assets have a difficult time exiting the industry.

Firms in the medical technology industry face significant exit barriers. Smaller firms in

the industry who specialize in certain sectors would have the greatest difficulty leaving

the industry, due to their specialized equipment and knowledge. Larger, established

firms would also have a very difficult time leaving the industry. However, larger firms

who manufacture a larger range of products may have an easier time shifting into a

new industry.

Conclusion

The medical technology industry is highly competitive and constantly evolving.

The industry is showing moderate growth over the past five years, with some sectors

growing faster than others. Firms in the industry must focus their resources on

maintaining a low cost structure, and provide high quality products and services, and

commit to innovation in order to be successful. The industry is fairly concentrated with

an average number of firms controlling the majority of market share. As new

technology and regulation continues to shape the industry, established firms have

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looked to increase market share and customer base through mergers, acquisitions and

divestitures.


The threat of new firms entering and industry has an enormous impact on the

level of competition existing firms will face in the future. Established firms in the

medical technology industry faces little threat from new direct competitors. However,

smaller firms have been able to enter the industry and compete in certain sectors of the

industry through specialization. As technology changes and new profitable

opportunities arise in the industry, the threat of new entrants will also increase. For the

most part, established companies such as Becton Dickinson, Baxter International, and

Boston scientific face little threat from new direct competition due to the level of price

competition in the industry.

Economies of Scale

The greatest challenge new firms entering the industry face is competing on cost

with existing firms. Large firms in the industry have close relationships with their

suppliers and have substantial bargaining power, giving them a cost leadership

advantage over new and smaller firms. In order for a new firm to be successful, they

would have to heavily invest in capacity to increase their scale of operations. New firms

entering the industry are also disadvantaged by not being able to achieve economies of

scale, and by not having enough resources to devote to research and development. In

order effectively compete in the medical supplies industry firms must achieve

economies of scale.

Channels of Distribution Access and Relationships

A firm’s ability to efficiently distribute their products can have an enormous

impact on a firm’s ability to compete, especially in an industry experiencing high price

competition. Established Firms in the medical supplies industry distribute and market

their products through both independent sales representatives, independent distribution

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channels, as well as directly to consumers. Although, firms in the industry sell directly

to end-users, the majority of their products are distributed via some form of distribution

channel. For example, Becton Dickinson receives approximately 50 percent of their

sales from foreign operations, selling a wide variety of medical products to many

countries around the world. In order to reach all of their customers, they need to

maintain sufficient supplies of inventories at their distribution centers to satisfy the

needs of their buyers. Established firms in the medical supplies industry with long

standing relationships with distributers and suppliers pose a significant threat to new

firms. Companies such as Baxter International and Boston Scientific have been around

for more than 80 years, and sell to over 100 countries worldwide. The level of

experience and number of business relationships these firms have developed in the

industry poses an enormous obstacle for a new firm entering the industry.

Legal Barriers and Regulation

The medical supplies industry does not have any substantial legal barriers

preventing new firms from entering. However, the industry is subject to numerous

government regulations. In the medical supplies industry, firms are subject to

extensive regulation by numerous government agencies, both in the United States and

abroad. Firms in the industry are regulated even further by the center of Medicare and

Medicaid Services and by the Inspector General within the Department of Health and

Human Services as a result of supplying products and services to healthcare providers

that are reimbursed by federally funded programs (Baxter International 2007 10-K).

Conclusion

The medical supplies industry faces little threat from new entrants. The

industry’s concentration and large economies of scale pose the most significant barriers

for new firms entering the industry. In order for a firm to affectively compete in the

industry they must heavily invest in operating capacity, and research and development

to achieve economies of scale. New companies entering the industry must also be

aware of industry regulations and the large amount of patents that have been

established in the industry.

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Threat of Substitute Products

The threat of substitute products is another major determinant of the level of

competitive intensity in an industry. Industries with many companies offering similar

products are less likely to earn abnormal profits, and are more likely to compete on

price. Firms competing in the medical supplies primarily produce products that are

easily substituted by their competitors. This results in lower bargaining power for firms

and intensifies the competition amount existing firms. Since many of the buyers of

these products are large medical companies and government agencies, they are, for the

most part, at the mercy of their buyers.

Buyers’ Willingness to Switch

How comfortable a buyer is willing to substitute one product for another also plays an

important role in the level of competition in an industry. If the buyer is indifferent

between two products offered by different companies, the more firms in the industry

will compete on price. In the medical supplies industry buyers expect a certain level of

product quality and service. For the major firms competing in the industry buyers tend

to be close to indifferent about the different companies products and services.

Therefore the determining factor tends to be the price. Although buyers may be willing

to switch, they may be locked into a contract that would prevent them from switching

in the short run.

Conclusion

In the Medical supplies industry the threat of substitute products is high. Competing

firms sell close to identical products and offer close to identical services. Buyers of the

firm’s products tend to have substantial bargaining over firms in the industry, and have

led firms to adopt aggressive low cost methods of operating in order to compete.

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Bargaining Power of Suppliers and Customers (Industry)

When analyzing the dynamics of supplier and customer bargaining power in the

medical supplies industry, it becomes evident that there are many factors influencing

whether or not a company ultimately has leverage over the supplier and consumer.

When it is determined that a company does have leverage over customers and

suppliers, it can be assumed that the company will experience an increase in sources of

potential profits in relation to its competitors in the industry.

Some of these factors related to supplier bargaining power include, a firms

switching costs with relation to its suppliers, the amount of differentiation a firm’s

supplier has in relation to other suppliers in the industry, the importance or quality of

product a supplier produces, the number of suppliers available for substitution in the

market, and finally, the volume of product a firm purchases from a supplier.

On the other hand, factors that contribute to the customer bargaining power

include, a customer’s switching cost, in other words, what it costs to not do business

with the firm by switching to another. Also, the ability of a firm to differentiate itself

from competitors in the market, the number of customers/buyers in the given industry,

and the volume of purchases each buyer makes can also determine their power over a

company in a particular industry.

As the medical supply industry continues to grow at a rapid pace, companies are

being forced to compete in areas such as research and development, consumer safety,

and price in order to reduce the bargaining power of both the customers and the

suppliers, and therefore generate more profit for the firm.


A supplier’s power over a company in any industry depends on whether or not

that company can effectively bargain with the supplier. If the industry can squeeze

suppliers on price then they effectively have the bargaining power. They do this by

creating the need for a supplier to do business with them in order for the suppliers

company to stay alive. Because companies in the medical industry make such large

purchases, for example, metal or plastics, then the supplier inherently is in need of the

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industry. Therefore, the supplier’s need of the industry creates a potential source of

profits for the industry. Also, the amount of power a supplier has in an industry can

determine that industry’s pricing habits. For example, a supplier might have power due

to lack of substitutes for firms in the industry, thus making the industry more

dependent on the supplier.

Bargaining Power

Suppliers will have the highest degree of bargaining power when there are few

alternatives for firms to choose from. This means that suppliers can successfully charge

higher prices to companies without the fear of losing their business. However, when

there are a large number of firms containing an array of substitutes, suppliers will have

low bargaining power.

The suppliers in the medical supplies industry are companies that produce high

quality metals, plastics, and ceramics. BDX and its competitors rely on specialty metal

products from their suppliers in order to produce needles, syringes, and other medical

equipment that is used to save lives everyday. Plastic tubing and ceramics for other lab

equipment are also essential to this industry because if they can’t rely on quality raw

materials, they can’t expect to create a quality finished product.

With respect to the medical supplies industry, companies and their suppliers will

form somewhat of a symbiotic relationship. They become dependent of one another

because the medical supply companies only have a certain number of suppliers that will

fit their needs, and those suppliers can’t afford to not do business with the medical

supply companies because the volume of their purchases are essential for the suppliers

to stay in business.

Looking through a specialty metal suppliers perspective, they know that

companies will produce millions of needles/syringes a year, and they know that keeping

the industry’s business is absolutely essential to the prosperity of their own company.

More simply put, the industry has few alternatives to the supplier, and the supplier is in

absolute need of the industry.

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Price Sensitivity

Because the supplier needs the company’s business to stay alive, they will

consequently keep prices low in order to compete with other suppliers. In a price

sensitive industry such as the medical supply industry, firms maintain a competitive

edge by taking advantage of these lower prices offered to them by the suppliers.

Therefore, with regard to BDX’s medical supplies division, a cost leadership approach is

taken rather than a differentiation approach. Because supplier bargaining power is

moderate, and they can purchase supplies at relatively low costs, they can take

advantage of lower input costs and efficient production. BDX still wants to maintain a

quality product, but since they are producing something as typical as needles and

plastic tubing, a cost leadership approach seems more appropriate.

Conclusion

The supplier’s bargaining power over companies in the medical supplies industry

can be described as moderate because the mass amount of plastic, specialty metal, and

ceramic purchased by the industry is extremely essential to the supplier’s financial well

being. Companies in the industry must make prompt payments, and suppliers must

avoid high pricing as well as pay attention to producing a product of high quality in

order to maintain good standing with the industry. This system creates an equilibrium

that will deter the suppliers from making unreasonable or unjustifiable demands of

companies in the industry, and vice-versa.

Bargaining Power of Customers

In the medical supplies industry, products are sold to a wide array of consumers

such as hospitals, clinics, retail pharmacies, and physician offices. Governmental health

care programs such as Medicare also require the products and services of companies in

the medical supplies industry. Because there are so many customers in this industry,

and because of the volume of their purchases, bargaining power is high for the

customer. The safety and functionality of items being sold is also of great concern to

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companies in the industry because they want to make sure they maintain the trust of

doctors and their patients. If their product is seen as un-reliable or faulty, hospitals will

look for another supplier, which can be done at relatively no costs to them. Even

though a government agency or insurance company makes the final decision as to

whether a company’s product is purchased, the consumer’s input on the effectiveness

of the product will still be an important factor in that determination process.

Relative Bargaining Power

An industry generates power over customers by creating the need for its

product. If the consumer strongly requires the use of an industry’s product, then the

industry will be more inclined to control price level and charge a number more favorable

in their eyes. However, if customers have bargaining power over the industry, it will

force them to keep their prices low. Currently in the medical supplies industry, the

bigger companies own such a great portion of the market share that they are

somewhat able to set prices based on their large economies of scale.

However, this trend has started to shift with the emergence of “hospital buyer

groups.” These groups consist of hospitals which form a coalition in order to increase

their power over the big companies in the industry, ultimately achieving lower prices. In

the past, a single hospital or clinic wouldn’t have power to influence big companies

pricing decisions. But, as many hospitals and clinics band together forming somewhat of

a union, their power increases because of the industries increased reliance on doing

business with everybody involved in the coalition. This developing trend also has

companies in the medical supply industry worried about what the future will have in

store for their ability to control prices. If buyer groups become too large or attain too

much power, this could be very detrimental to a company like BDX, who bases its

competitive strategy heavily on price.

Price Sensitivity

The amount a customer is actually willing to pay for a product refers to their

price sensitivity. If the customer is relatively insensitive to an increase in price they will

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more than likely continue to buy the product. But, if they are sensitive to higher prices

then they will be more likely to search for a different alternative. As stated above,

customers (hospitals) in the medial supplies industry are becoming more sensitive to

price than ever before. The decision to use a specific company’s product in the industry

comes down to how reliable and innovative the product is in comparison to its

competitors, and how reasonably that company can compete on price. If a company in

the medical supplies industry can establish credibility with medical professionals, they

will be more likely to grow therefore creating economies of scale. The more efficient

they are in producing a product, the more they can cut prices. Again, lower prices will

help reinforce their relationships with the customer.

Conclusion

Judging by the highly competitive nature of the industry, medical supply

companies don’t have much power over their customers. Because quality of the product

is so essential to the customer, they will gladly seek out a suitable product if the one

being sold to them is not functioning correctly or safely. Also, with the growth of

hospital buyer groups, price has also become an important factor in the determination

of customer bargaining power. There are still some cases in which no alternatives for a

product are available to due to the nature of specialty, but for the most part there is

always some sort of alternative for the customer, especially in BDX’s case, seeing that

much of their sales are generated from products like needles and plastic tubing.

Therefore, the industry’s bargaining power over to customers is relatively low, and the

customer bargaining power over firms in the medical supplies industry is very high and

will continue to grow stronger.

Value Chain Analysis

The profitability of a firm is influenced not only by its industry structure, but also

by the strategic choices it makes in positioning itself in the industry. (Palepu & Healy) A

firm can choose between two types of competitive strategies: cost leadership and

differentiation. Firms that try to use the two strategies together are considered to be

“stuck in the middle.” (Palepu & Healy) These firms are expected to earn lower profits

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when compared to firms that choose one of the strategies. Many firms in this industry

are trying to differentiate their product from each other. The firms that differentiate

will lead to higher profits and better growth rates. Both competitive strategies are

discussed below.

Differentiation

In the medical supplies and equipment industry, each firm tries to find ways to

differentiate their products from the other firms. The firms that are going to be

successful in this industry need to achieve differentiation at a cost lower than the

customers are willing to pay. In the medical supplies and equipment industry, there are

many drivers to differentiation. They include product quality, customer service, brand

image, innovation, and investment in research and development.

Product Quality

In order to be profitable in the medical industry, firms need to have superior

product quality. Each firm has its own variety of products it makes, but all of the

products eventually go to every hospital in the world. Their products can help millions

of patients. The medical industry is getting more costly by the year. With the

upcoming election, this industry could take a major turn. Some people want the every

citizen in the United States to have medical coverage. This would eventually affect the

medical equipment industry because they have to make their products cheaper. They

have to try to save money, but they cannot take the product quality away. Product

quality is a very important success factor no matter what industry you are in. The

product quality has to be high in order to help the customers that need medical

attention.

Many firms in this industry provide ways of proving that their products are of

high quality. For example, BDX provides Quality Certificates for many products

certifying that these products have been manufactured and tested in accordance with

BD specifications. Firms, like BDX, assure their customers in some way that their

products are made with the highest quality material. Since this industry affects so many

people across the world, the FDA has set strict regulations on the products in this

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industry. Before any product can be released, the FDA requires every product has to go

through extensive clinical testing. This testing will assure that the product is safe and

efficient. Failure to meet the FDA regulations, will lead to the product being taken off

the market.

Everyone knows that mistakes are going to happened, but in this industry the

firms need to try to keep the mistakes at a minimum. Firms need to make sure their

product will last through the toughest procedures. For example, C. R. Bard (BCR)

recalled versions of a plastic patch implanted during hernia surgery, after learning the

devices could later break inside the patient and damage internal organs. (WSJ 3/16/07)

BCR recalled the products in order to avoid lawsuits in the future. By recalling the

products they saved money, even though it will cost them more R&D to improve the

plastic patch. Some firms on the other hand, recall products voluntarily because of

concerns of the product. Medtronic voluntarily recalled disposable products used during

heart surgery because of concerns about a coating of contaminated heparin. (WSJ

5/7/2008) This could also go under customer service. Even though they put the

product out in the market, they did the right thing by recalling it protecting potential

patients. Product quality is important in many different industries, but in the medical

supplies and equipment industry it is a key ingredient.

Product quality should be at the top of every firms list no matter what industry

they are in. The firms that provide the highest quality at a reasonable price will lead to

higher profits than originally thought.

Customer Service

In the medical supplies and equipment industry, there are many different

customers. They range from healthcare institutions, life science researchers, clinical

laboratories, and the general public. Since there are many different products in this

industry, many of them require attention when they stop working properly. Almost

every firm has a customer support hot-line where they can determine if they can fix the

problem over the phone. If the problem is more complex than originally thought, some

firms have their own technical support team. They travel out to the customer and help

fix the broken equipment. This should be part of a warranty if the customer originally

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bought warranty when they bought the equipment. Customers in every industry expect

great customer service when they buy or use a product. Firms that can provide the

more superior customer service can have the competitive advantage over the other

firms.

Brand Image

The name of a company is more than just a name. It is worth something to

every company. Every firm tries to improve their brand image through many ways.

The two main ways to improve their brand image is through advertising and social

responsibility. Firms advertise by sending sales representatives to hospitals, research

labs, and etc. That is one of the many ways firms advertise in this competitive industry.

Firms like BDX and BSX don’t really need to advertise like many other industries through

the use of the television. Another way to advertise their new products is by the internet

and health magazines.

Social responsibility is important to every firm within this industry. Medical costs

are on the rise, which in turn could lead to more people without the medical attention

they require. Boston Scientific is huge believer of helping the less fortunate. At BSX

they fund non-profit organizations in the communities where they live and work

throughout the United States. They are committed to supporting innovative and

replicable programming aimed at improving the lives of the economically

disadvantaged. Since 2002, BSX has donated more than $6 million to local charities.

(www.bostonscientific.com) Like BSX, almost every firm donates to a local charity.

They believe a little donation can go a long way. If firms help out more, the world will

turn into a better place.

Innovation

In the medical supplies and equipment industry, creativity and innovation are the

two key success factors. They provide the firm with developing a product that will help

the patients out in a way the other firms can’t. The firms that have the most innovation

will lead their way up to the top of the medical industry. For example, Abiomed Inc.

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invented a tiny heart pump that is threaded into the body through an artery to improve

blood flow in the sickest of patients. (WSJ 6/3/08) An invention like this will help the

world of medicine tremendously.

When a company invents a new product, they need to place a patent on it that

way the company can be protected if someone else invents a similar product. A patent

is the exclusive right granted by a government to an inventor to manufacture, use, or

sell an invention for a certain number of years. Amgen Inc. has used their research and

development to invent a new technology that would greatly help the medical industry.

Amgen Inc. harnessed gene-splicing technology to create medicines modeled on human

proteins -- including profitable blood-cell growth factors -- out of living cells. (WSJ

3/10/08) In the world of medicine today, firms are trying to put patents left and right

on as many products as possible. Firms do not always get their requested patent, but

the firms that get their patent will surely benefit from it.

Investment in R&D

In the medical supplies and equipment industry, almost every firm invests a good

size percentage of their sales into research and development. The more a firm invests

in R&D, the more likely that firm will get more market share and higher profits. Like

mentioned above, each firm invests a good percentage of their sales into R&D as shown

below:

R&D % Of Sales 2002 2003 2004 2005 2006 2007 BSX 11.8% 13.0% 10.1% 10.8% 12.9% 13.0% BCR 4.8% 4.3% 6.7% 6.4% 5.7% 6.2% BDX 5.2% 5.0% 4.8% 5.0% 5.3% 5.7% BAX 6.2% 6.2% 5.4% 5.4% 5.9% 6.7% Industry Avg. 7.0% 7.1% 6.8% 6.9% 7.5% 7.9%

As indicated in the table above, the industry average in R&D investment is 7.9%

in 2007. Boston Scientific (BSX) is the bigger investor with 13.0% of their sales going

into R&D. Boston Scientifics’mission is to improve the quality of patient care and the

productivity of health care delivery through the development and advocacy of less-

invasive medical devices and procedures. They have invested nearly $6 billion in new

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technologies over the past five years. (www.bostonscientific.com) In the recent years,

Boston Scientific has been the leading company is this competitive industry. Not all

good things last forever though, BSX has had two back to back years of net losses.

They might stop contributing so much to research and development in order to save

some money. A Becton and Dickinson (BDX) is the smallest investor with 5.7%. It is

probably true that the more R&D could lead into more innovated inventions, but it is

how you use your R&D. Just because BDX is the smallest investor, percentage wise,

they could be inventing the most innovated products in the market today.

GlaxoSmithKline has always been a big investor in R&D. Just recently they have used

that R&D through creating a new vaccine named Prepandrix that could provide

protection against the lethal H5N1 influenza virus in advance of a pandemic outbreak.

(WSJ 5/18/08) Research and development isn’t just a number on the financial

statements. It can lead to many profitable products in the market today.

Conclusion

There are many different firms within the medical supplies and equipment

industry. In order of a firm to have a competitive advantage within the industry, firms

need to find ways to differentiate them and their products from the others. Firms need

to focus on what makes them profitable in this industry. Some firms strive for product

quality, customer service, brand image, innovation, and investment in R&D.

Cost Leadership

Even though in the medical supplies and equipment industry it is mostly about

differentiating products from each other, some firms try to be the cost leader in the

industry. Cost leadership is often the clearest way to achieve competitive advantage.

There are many ways to achieve cost leadership, including economies of scale, efficient

production, tight cost controls, and product designs. In the medical industry though,

firms try to achieve economies and scale and have an efficient production line. The

medical industry as we have mentioned is big investors in R&D and since it is regarding

the medical industry, they are going to be more complex designs.

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Economies of scale

Economies of scale are about having a low cost. Firms in this industry achieve

economies of scale by ordering their raw materials at large quantities. When ordering in

large quantities it reducing the cost per unit. BD’s products, for example, manufactured

and sold worldwide including North America, Europe, Japan, Asia, South Latin America,

and North Latin America. (www.bd.com) Working outside the US, reduces cost

significantly because labor and the materials are cheaper in other parts of the world.

Many firms also have manufacturing plants in other countries beside the US like Mexico,

Asia, and Europe. The firm with the lowest cost, but still have a good quality product

will have an advantage over other firms.

Efficient Production Lines

Firms need to create an efficient production line in order to be successful. By

having an efficient production line, managers can save money which in turn save the

customers money. To be more efficient, managers need to look for ways to save

money. If a firm has an efficient, it will spend less time dealing with wasted materials

and more time investing into other ideas.

Conclusion

Even though in the medical supplies and equipment industry it is mostly about

who can differentiate their products from the other, cost leadership still plays a key

role. Firms need to focus on some elements within cost leadership to be successful.

Firms need to keep the costs low for themselves and the potential customers. They

also need to produce an efficient production line. The firm that tries to achieve cost

leadership will see profits unlike the other firms in this industry.

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BDX Corporate Strategy Analysis

In order to properly analyze how a firm functions, certain strategies must be

evaluated in order to determine what exactly gives them an advantage over

competitors. There are many ways in which BDX separates itself from other

competitors in the medical supplies industry. First, by competing on price, they ensure

that they will stay in favorable standing with customers, especially the all important

hospital buyer groups. Not only is price important to these customers, but quality will

also be a major aspect of BDX power in the industry. Next, a lack of innovation in this

industry can ultimately render a firm obsolete. Large investments in R&D are essential

for BDX to maintain any type of advantage over its competitors. Last but not least, a

firm’s reputation can also be a factor that will seal the deal with customers, or cause

them to choose a different firm. The Medical supplies industry is very differentiated;

therefore, anything that will set BDX apart from its competitors is vital to the company’s

success.

Price

BDX strives to be efficient in every aspect of its operations. Some of their main

units of production include simple needles and syringes. When producing products as

interchangeable as these, a fair price is essential to keep customers from switching to

another firm. Because BDX buys its raw materials such as metal and plastic in large

quantities, they are able to secure fairly low prices, which helps them to lower input

cost and maintain efficient production. Because of their relatively low bargaining power

over customers, they must maintain prices that are low enough to continue to attract

new customers, as well as keeping the current ones. According to BDX’s 10K, they

increased their volume of production by 8% in the last year. This increase in production

allows them to create greater economies of scale, therefore, becoming more efficient in

the process. The more efficient they become, the easier it is for them to compete on

price. Consequently, in the ever changing medical supplies industry where hospital

buyer groups are continuing to exert more power over firms, it is very important to

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increase efficiency in order to counteract the requirements of these groups to decrease

prices. If it costs a firm less to generate a product, cutting prices won’t be overly

detrimental.

Quality

In an industry as competitive as the medical supplies industry, BDX must ensure

that all of its products are of the utmost quality. Doctors, patients, clinics, and hospitals

depend on BDX producing a product that is safe and reliable at all times. Since “BDX

owns significant intellectual property, including patents, patent applications, technology,

trade secrets, know-how, copyrights, and trademarks,”(BDX 10K) this allows them to

stay on the cutting edge and produce products that will consistently accommodate

consumer needs along with ensuring to the consumer that all products are of high

quality. Also, according to BDX’s website, many of the products receive quality

certificates that ensure manufacturing and testing are up to the appropriate BDX

standards. These certificates are just one way BDX can guarantee a quality product to

the customer.

Innovation

The ability of a firm to stay ahead of the curve has a lot to do with how much

success they achieve compared to direct competitors in their industry. BDX strives for

innovation by consulting with many different agencies on how to be progressive in the

medical supplies industry. BDX “retains individual consultants to support its efforts in

specialized fields” (BDX 10K). Also, BDX “collaborates with certain universities, medical

centers, and other entities on research and development programs” (BDX 10K). In

2007, BDX spent approximately $360 million in the research and development sector.

This comprises of over 40% of their total revenues, which is a much higher percentage

than those of its competitors.

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Reputation

Sometimes a company is in an industry that is so competitive that factors other

than price or quality will determine whether or not a consumer will buy their products.

In the medical supplies industry sometimes a company’s image can play a major role in

determining its success. According to BDX’s website, ethisphere magazine named it

2007’s “World’s most ethical company.” The magazine examined over 5,000 companies

in 30 different countries on all levels of ethical integrity. BDX gained notoriety mainly in

the area of the treatment of its employees. For example, they offer better benefit plans

and more vacation days compared to their competitors. They also have taken great

strides recently in cutting down their carbon emissions from their manufacturing plants.

These steps taken to protect the environment coincide directly with the global “going

green” trend. If a supplier or customer is deciding whether or not to do business with

BDX, something like this might be the deciding factor that will propel BDX ahead of the

competition in the industry.

Conclusion

Although there are many ways in which a company can gain an advantage over

another company, BDX specifically concentrates in the areas of price, innovation,

quality, and reputation. By maintaining low prices they are able to continue good

relationships with large hospital buying groups. Because of their attention to detail in

the area of quality, patients and doctors can be sure that they are getting a reliable

product. In the medical supplies industry, the ability of a firm to differentiate itself from

its competitors has a great deal to do with their level of innovation. As a result, BDX

takes great care to stay ahead of the game with regard to its spending in the research

and development sector. Last, another factor often over looked when determining a

firm’s competitive advantage is their reputation. The more steps a company takes to

ensure the integrity of their name, the better standing they will usually find themselves

in the business community. By utilizing these key strategies, BDX has been able to

secure a significant amount of the market share and continues to see great success in

relation to its closest competitors.

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Accounting Analysis

The purpose of conducting an accounting analysis is to evaluate the extent to

which a firm’s accounting captures the fundamental reality of the business. By

identifying a firms accounting flexibility, and by determining how appropriate the firm’s

estimates and policies are, allows us to assess the level of distortion in their accounting

numbers. By identifying distortions, we can than adjust the firm’s accounting numbers

using information in the firm’s footnotes and statement of cash-flows to undo these

accounting distortions.

In order to perform a formal accounting analysis, six key areas of accounting

must be assessed. The first step in the process of a formal accounting analysis is to

determine a firm’s key accounting policies. These policies are derived from the firm’s

key success factors, and therefore provide the most relevant information in determining

how well that firm is able to compete in the industry. Once the firm’s key accounting

policies have been identified, the level of flexibility firm’s have over recording these

polices must be assessed. Firms with a high degree of flexibility over their key

accounting policies find it much easier to manipulate financial statements. For example,

item such as pension expenses and warranty liabilities are often manipulated to portray

more favorable earnings.

In contrast, firms may write down large impairments on “goodwill” when

investors expect poor performance, in order to look better in the coming quarter or

fiscal year. The next step in a formal accounting analysis is to determine the actual

accounting strategy of the firm, and compare it to their competitors accounting

strategies. This provides a good description of how companies in the industry handle

their accounting strategies and the level of disclosure they provide. We are looking for

consistency among these firms. A firm that uses different accounting strategies may

raise concern about the accuracy of their reporting. To further analyze the quality of

information and the level of disclosure it is important to calculate sales and expense

manipulation diagnostic ratios. These ratios provide transparency into the

reasonableness and quality of disclosure at a quantitative level through ratio analysis.

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If any “red flags” have been uncovered from this analysis we must undo these

distortions, and adjust our financial statements accordingly to reflect the fair value of

the activity.

Key Accounting Policies

A firm’s industry characteristics and competitive strategy decide what a

company’s key success factors and risks are. A firm’s key success factors are the factor

that add the most value to the firm, and enable them to effectively compete in their

industry. In order to determine how well these success factors and risks are being

managed by the firm, we need to analyze the firm’s accounting policies that affect the

firm’s key success factors. In the medical supplies industry, the key success factors are

research and development, tight cost control, and management of foreign currency risk.

The way in which management chooses to report this information and the amount of

information they choose to disclose can have an enormous impact on firm value.

Research and Development

One of the ways BDX strives to achieve a competitive advantage over other

medical supply companies is its extensive investment in the research and development

of new products. This means finding ways to be innovative with respect to new

products as well as improvement on already existing products. Therefore, feedback

from doctors and patients, as well as research contribution from numerous universities

help to indicate to the company which products need improvement or change in design.

According to BDX’s 10K, in 2007 they spent a total of $360 million on R&D, which

equates to approximately 5.6% of sales for that year. This number is up from 2006,

where $301 million was spent on R&D (which comprised of about 5.2% of sales). Also,

an expense not added to total R&D was that of acquired in-process research and

development, which refers to the acquisition of companies whose technology and or

products weren’t ready for introduction to doctors or clinics at the time BDX acquired

them. An example of this was BDX’s acquisition of Plasso Technology, Ltd on May 4,

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2007. Plasso is a “privately-held company that is developing the next generation of

surface-critical research tools utilizing functional coating technology for applications in

glycomics and cell culture”(BDX 10K). The acquisition of Plasso will most likely add a

significant amount of value to BDX. However, as stated earlier, it is not considered in

the $360 million listed in BDX’s research and development expenses. As a result, the

total accumulated cost of 2007’s research and development is $482 million. The table

below represents BDX’s actual investment in R&D.

(In Millions of Dollars)

Year Total R&D expense

Acquired in-process R&D

Actual Total R&D

% of Sales

2003 224 ----- 224 5.02% 2004 235 ----- 235 4.76% 2005 268 ----- 268 5.02% 2006 302 53 355 6.19% 2007 360 122 482 7.58%

Pension Plans

A pension plan is a steady income given to a person after retirement. Pensions

are typically payments made in the form of a guaranteed annuity. Pension plans are

saved up throughout the individual’s career. There are two types of pension plans.

The first one is called a defined contribution plan. The second type is called a defined

benefit plan. The main difference between these two plans is that the defined

contribution plan is based on what the individual contributes to the plan. Some

companies match or contribute less than the individual. The defined benefit plan rests

solely on the employer. It is very hard for companies to predict how long a pension

plan will pay. The length of the pension plans depends on how long the company

believes their employees will live after they retire. Some companies believe that to be

15 years and for others it might be longer. The amount of benefits paid during any

year can greatly affect the balance sheet. If the company understates pension

liabilities, the net income will be overstated. Overstating net income is becoming more

and more popular because some managers get stock bonuses. GAAP made companies

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report their pension plans as conservative as possible. There is some flexibility when it

comes to pension plans, but it is still closely monitored. Below is the defined benefit

pension plan disclosure for Becton, Dickinson and Company:

Change in benefit obligation: 2003 2004 2005 2006 2007Beginning obligation(thousands) 852,922 1,058,645 1,185,394 1,413,092 1,384,667Service cost 44,798 57,013 61,836 74,111 69,869Interest cost 54,072 62,825 66,837 71,997 75,728Plan amendments 894 761 195 86 (16,586)Benefits paid (49,891) (55,401) (57,818) (75,207) (97,671)Actuarial gain 129,493 46,726 164,161 (117,307) (63,519)Other, includes translation 26,357 14,825 (7,513) 17,895 41,942Benefit obligation at September 30 1,058,645 1,185,394 1,413,092 1,384,667 1,394,430

In the table above, it explains the changes in the benefit obligations for the past

5 years. Every item in the table looks pretty consistent from year to year. The benefit

obligation is growing, which makes sense because people might be retiring each year.

Besides the defined benefit plans, there are Other Post-Retirement Benefits. This can

include healthcare and life insurance plans. Other postretirement benefits are listed

below and calculated the same way as defined benefit pension plans:

Change in benefit obligation: 2003 2004 2005 2006 2007Beginning obligation (thousands) 222,374 255,106 263,678 281,197 255,726Service cost 3,159 3,510 3,657 4,164 4,386Interest cost 14,484 14,492 15,321 14,873 14,608Plan amendments - - - - - Benefits paid (15,449) (18,282) (22,279) (22,734) (25,411)Actuarial gain 30,538 35,621 20,820 (24,345) (11,818)Other, includes translation - (26,409) - 2,571 8,480Benefit obligation at September 30 255,106 263,678 281,197 255,726 245,971

When dealing with pension plans, companies have to disclose information about

future expected benefit payments. Companies estimate both future benefit and other

postretirement pension plans. Both of them are listed below in thousands of dollars:

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Expected Defined Benefit Payments

2008 81,738 2009 70,735 2010 75,948 2011 81,612 2012 89,059

2013-2017 522,634

Expected Other Postretirement Benefit Payments

2008 20,067 2009 20,378 2010 20,798 2011 20,907 2012 20,757

2013-2017 100,137

BDX estimates the next ten years when it comes to both types of plans. This is

usually how every company discloses expected benefit payments. By estimating the

future payments, there could be estimation errors. That is why BDX has to be careful

on how much they predict.

Also, BDX has an expected return on assets of 8%. This is around the industry

average. The healthcare industry return on assets rate is around 9% for 2007. BDX

uses the following asset allocations in order to get the higher return for their assets.

Asset

Allocations 2007 2006

Equity securities 64.5% 64.4%

Debt securities 33.1% 33.0%

Other 2.4% 2.6%

Total 100.0% 100.0%

The industry trend for asset allocation for the equity securities is between 60-70%. The

other 30-40% varies between companies. Some divided the remaining amount into

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many different types of investments. For BDX, debt securities include fixed-income

securities and the other would include cash. BDX’s investments are diversified in terms

of domestic and international equity securities, short-term and long-term securities,

growth and value styles, as well as small and large capitalization stocks.

BDX also has a voluntary defined contribution plan which they call a “Savings

Incentive Plan.” This plan is another way for employees to save more money for

retirement. BDX contributes 75% of the employee’s contribution and up to a maximum

of 4.5% of each employee’s eligible compensation. The cost of this plan was

$21,878,000 in 2007, $16,626,000 in 2006, and $6,905,000 in 2005. This plan has

definitely grown a lot in the past three years.

BDX does a superior job when it comes to disclosing pensions. The only item

that brings up some concern is the funding status of the pensions. Below is a table

from BDX’s 10k that shows the concern in thousands.

Pension Plans Funded status at September 30: 2006 2007 Unfunded benefit obligation (260,102) (98,261) Unrecognized net transition obligation (1,012) - Unrecognized prior service cost (credit) 6,193 - Unrecognized net actuarial loss 356,968 - Net amount recognized 102,047 (98,261)

Other Postretirement Funded status at September 30: 2006 2007 Unfunded benefit obligation (255,726) (245,971) Unrecognized net transition obligation - - Unrecognized prior service cost (credit) (12,920) - Unrecognized net actuarial loss 77,392 - Net amount recognized (191,254) (245,971)

The two tables each represent the funding status of pensions for BDX. This

brings up some concerns. The areas highlighted in blue represent certain unrecognized

items. The reason why this brings up concern is because the only reason why this

numbers exist is because changing of discount rates. Why are they not being

recognized? The green highlighted area is of great concern as well. In 2006, they are

recognizing it as an asset. In 2007, they are recognizing it as a liability. Why the

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sudden change in recording? Even though they bring up some concerns, it isn’t enough

of a concern to adjust the financials.

Conclusion

When it comes to pension accounting, BDX does a superior job at disclosure.

They follow the guidelines to pension disclosures very well. They provided the interest

rates that they used every year including the growth rate. BDX’s rates were not

unusually different compared to the industry. We compared BDX’s pension information

to its top three competitors, and the information was consistent in all four companies.

Last information to consider would be the fact that medical costs are rising. Usually the

older a person gets the more medical cost her or she will need. Both the benefit

pension plan and the other postretirement benefits need to follow the trend of rising

medical costs.

Foreign Currency Management

The management of foreign currency risk is vital to any company that does a

significant portion of their business activity in foreign countries. Accounting regulations

under GAAP require American companies to report their financial information in one

standard unit of measure, which the SEC states is US dollars. Since the value of the

dollar and other currencies are subject to change, this volatility poses a great deal of

risk to these companies. Firms competing in the medical supplies industry receive

approximately half of their sales from foreign operations, and manufacture and

distribute a substantial amount of their products in these foreign countries. As result of

conducting a large portion of their operations overseas, their ability to mitigate their

exposure to foreign currency risk has a significant impact on the value of the firm.

Becton Dickinson receives an average of 51% its sales from foreign operations, with the

largest amount coming from European, Japanese, and Canadian operations. The chart

below shows the percentage of sales received in different currencies.

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Becton Dickenson and their competitors reduce their exposure to currency

fluctuations though hedging, using derivative instruments. One common instrument

firm’s use is a forward currency contract. Companies purchase forward currency

contracts in the opposite position they are currently holding in the market. This allows

them to lock in exchange rates, and accurately predict their accounts receivables.

However, forward contracts prevent firms from exchanging at the future market rate

which could either be higher or lower than the contract rate, forcing firms to forgo an

opportunity loss. Another commonly used hedging instrument is currency options.

When entering into an option contract, these companies are usually purchasing a call

option which gives them the right but not the obligation to exchange currency at a

preset exchange rate. Currency options eliminate the opportunity loss associated with

futures contracts, while still providing the same degree of certainty. However, a

premium is paid in advance to receive this benefit. These instruments allow them to

predict with relative certainty the dollar value they will be receiving from foreign

operations.

Becton Dickenson and their competitors use a large amount of forward contracts

and currency options as a way to hedge their currency exchange risk. These derivative

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instruments are primarily used to hedge forecasted sales (i.e. accounts receivable) that

are denominated in foreign currencies. Gains or losses on these derivative instruments

are largely offset by the gains or losses on the underlying hedged transaction. Unlike

individual investors and other investment institutions, Becton Dickenson and their

competitors do not use these derivative instruments for trading or speculative purposes,

and the counterparties to these contracts are usually highly rated financial institutions.

Becton Dickinson and their competitors are not looking to profit from these contracts.

They are simply using these instruments to protect their business from economic

uncertainty. The chart below represents the fair value of the forward currency

contracts and currency options Becton Dickinson has entered into over the past five

years. This trend tends to be consistent with firms in the industry.

(In Thousands of Dollars)

The above graph shows the fair value of these contracts over the last five years.

The large fluctuation in 2005 resulted from market rates being higher than future

contract rates, resulting in an inverse relationship between the value of future and

option contracts. Future contracts decreased in value, while option contracts increased

in value. Over the past five years Beckon Dickinson has shown gains from foreign

currency transactions. These gains are recorded in the comprehensive income section

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in the firm’s financial reports. Although there was a steep decline in foreign currency

gains in 2005, this decline was offset by the company’s future and option contracts.

Gains and Losses in foreign Currency: (In Thousands of Dollars) 2003 2004 2005 2006 2007Becton Dickinson +5499 +2461 +135 +13795 +16391

Conclusion

Becton Dickinson and their competitors are exposed to a great deal of currency

exchange risk due to the scale of their operations in foreign markets. In order to

reduce this risk, firms purchase future and option contracts to hedge against

fluctuations in currency exchange rates. Becton Dickinson and their competitors are not

looking to profit from these contracts. Instead, they try to protect against increases and

decreases in the value of their forecasted revenue. Due to the amount of revenue these

firms produce from foreign operations, and the way these firms manage exchange rate

risk has an enormous effect on the firm’s value; making it a key accounting policy.

Accounting Flexibility

The next step in a company’s accounting evaluation process is determining the

level of flexibility a company has with regard to its key accounting policies. When

determining the overall value of a company, one of the key elements involved is the

accounting procedures a company uses in the development of its balance sheet, income

statement, and statement of cash flow. With regard to flexibility, managers can skew

certain numbers so that they appear to add more value to the firm than they actually

do. When this occurs, a company’s shareholders could be mislead as to how the

company is currently performing at that point in time. While managers do have a

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significant degree of flexibility for accounting policies such as pension and post-

retirement benefits, in areas such as technological research and development, they

remain constrained by certain methods proscribed by GAAP. A firm’s requirement to

expense all research and development rather than capitalizing it is an example of some

of the restrictions managers might face when deriving value in the technologically

competitive medical supplies industry. The following section is used as an indicator as

to how BDX and its competitors in the industry accurately report data to give a fair

representation of their financial statements.


With regard to R&D, there has always been debate between managers of a firm

and GAAP on whether the expense should be capitalized and amortized (in accordance

with the matching principle), or whether it should be recorded as an expense at the

time it occurred (in accordance with the reliability principle). Pertaining to the matching

principle, it can be argued by managers that extensive investment in a product’s

research and design may lead to revenues extending further than the period in which

they were initially recorded. Therefore, these expenses should be capitalized as assets

and amortized over a certain amount of time until the revenues are actually realized.

Yet, in 1972, the Financial Accounting Standards Board (FASB) came to the conclusion

that expenses should be written off at the time of their occurrence, rather that

capitalizing and amortizing them over a period of time. Nevertheless, although GAAP

generally allows little to no flexibility regarding the external accounting for R&D, it is still

possible to manipulate certain information wherever one may see fit do to so. For

example, an analyst may derive more value for a company if R&D is capitalized rather

than expensed when actually incurred. So we can conclude that although all companies

must expense R&D, capitalizing it may in fact provide a better grasp of the company’s

overall value in an industry such as the medical supplies industry because so much

value is placed on innovation and the ability of firms to differentiate themselves from

their competitors. The table below provides a representation of the effects of writing off

R&D as an expense rather than capitalizing it.

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Assets Liabilities Equity Revenues Expenses Net Income

U O U N O U

*U=understate O=overstate N=no effect

Pension Plans

As indicated earlier, pension plans are for employee’s retirement needs. The

amount of money spent on pension plans can significantly affect the balance sheet of

the firm by increasing or decreasing liabilities. Some firms understate their pension

plans on the liabilities section of the balance sheet in order for the firm to appear more

profitable. GAAP has set some guidelines when it comes to pension accounting. GAAP

wants companies to compute their accounting numbers as conservative as possible.

There is flexibility when it comes to pension accounting. Companies can adjust

the discount and growth rate without making it apparent to where it would be better for

them. The difference between 6% and 6.15% can provide the company with

overstating or understating the liabilities. This flexibility allows companies to better

describe their economic standing within the industry. In order to stay profitable in any

industry, companies need to stay around the same interest rates as their competitors.

BDX’s interest rates are right around the industries average rate, which means that they

are more than likely correcting stating their pensions.


The level of flexibility in managing foreign currency is relatively low. Managers

face strict guidelines under the SEC on how they are to account for foreign currency.

According to the SEC, firms have approximately two months to translate foreign

earnings into US dollars. There is little room for managers to manipulate the actual

value of foreign currency transactions. Although managers have little flexibility on how

they translate foreign currency, they do have some flexibility on the amount of

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disclosure they provide regarding risk management of foreign currency. Firms that

have not taken sufficient steps to hedge against foreign currency risk might use their

accounting flexibility to hide information regarding forward and option contracts from

shareholders.

Actual Accounting Strategy


The medical supplies industry is one that is highly competitive in the area of

technological advances and research and development. However, research and

development is not an accounting policy that has any flexibility according to GAAP’s

rules and regulations. Even though BDX prides itself on innovation, this does not always

appear to be evident in their financial statements. Although GAAP requires that all R&D

expenses be written off immediately, BDX’s R&D expense comprises approximately 40%

of their net income. This percentage is very high in comparison to its competitors,

which are generally in the 5-15% range. Therefore, in order for an analyst to derive a

fair value from the benefits of BDX’s research and development expense, it should be

capitalized and added as an asset on the balance sheet. Often times in this industry,

managers are tempted to modify their financials in order to lessen the strain of such

high expenses. This inflexibility in the area of recording research and development

could be detrimental to shareholders and stockholders because it undermines a

company’s true value. Any company in an industry where innovation is essential to

derive value will experience the same types of issues regarding the overstating of

expenses and the understating of assets.

Pension Plans

The amount of a company’s pension plan is determined by the amount of

employees. Each employee seeks benefits that they use for either health care or just

living expenses. Pension plans involve estimates when they calculate the future

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amounts. An increase or decrease in the discount rate can drastically alter the amount

of money expensed on the balance sheet.

Pension plans can be very costly to the companies and the investors as well. If a

company has a defined benefit plan, the company will have more expenses than a

company with a defined contribution plan just because of the set up of each. BDX has

a discount rate that is right around its competitors in the industry. After evaluating

BDX’s pension accounting, we would say that they are conservative. We would say that

because of the fact that their interest rates are right around the industry’s average. If

they wanted to be more conservative, they could have lower interest rates than their

competitors. If BDX is compared to some competitors, then BDX would seem

aggressive. C.R. Bard had a discount rate of 6.16% in 2007 and BDX had a rate of

6.35%. Compared to C.R. Bard, BDX looks more aggressive than it really is. We have

determined that C.R. Bard is the more conservative firm of the industry because the

other competitors in the industry are right around BDX.


Becton Dickinson’s strategy for accounting for foreign currency is appropriate for

the industry and is consistent with its competitors. Management’s key objective in

dealing with foreign exchange transactions is “to manage the impact of foreign

exchange rate and interest rate fluctuations on earnings” (Becton Dickinson 2007 10-K).

Management purchases these contracts for the sole purpose of hedging against

exchange rate fluctuations, and all of these transactions are recorded in the

comprehensive income statement. Once gains and losses on these transactions are

recognized, they are moved from comprehensive income to the income statement and

recorded as realized gains and losses for each fiscal year.

Accounting Disclosure

Qualitative disclosure refers to the relevance and importance of information firms

provide to investors and analyst through financial statements in their 10K. As discussed

earlier, managers have the ability due to accounting flexibility to make information easy

to understand or obscure depending on how they choose to disclose certain accounting

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procedures. The increased reliability of information to investors depends upon the

quality in which certain information is disclosed. However, ways in which a firm may

make it difficult for investors to confide in information include the poor quality of

disclosure or an excess of information designed to deter analyst from recognizing bigger

problems within the firm’s economic environment.


BDX‘s level of disclosure with regard to R&D isn’t very thorough. They don’t

provide information as far as the desegregation of R&D between the medical, diagnostic

and bioscience segments. They simply lump all R&D expenses into one category. This

makes it difficult to determine what money is actually spent in the product,

technological, or scientific aspects of the company. Therefore, one cannot determine

which segment might require the most R&D to create value for the firm. They do

provide additional information in their notes to financial statements, but this is mainly

dealing with the acquisition of new companies and the progress each acquisition is

experiencing in terms of FDA approval. Because they lack such breakdown, their level

of transparency is relatively low in the research and development sector. In comparison

to other firms in the industry, Boston Scientific provides a little more information in their

notes to financial statements as to how R&D expenses were derived, but they also fail

to desegregate certain expenses in their research and development activities. Baxter

on the other hand, does a better job of desegregating the R&D expenses into different

categories as well as providing further analysis in the notes to financial statements.

Pension Plans

BDX does a great job at disclosing information when it comes to pension

accounting. They provide tables of almost every dimension of pensions. It was very

easy to talk about their pensions because of their disclosure information. When it

comes to qualitative disclosures, BDX’s pension is definitely up to the industry

standards. We believe that they provide more than enough information to the investors

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and potential investors in the company. Like we said before, pension accounting

involves some estimates. BDX does a great job of sticking with the industry when it

comes to discount rates and growth rates. The amount of pension expense is going to

be different from company to company just because of the difference in the number of

employees.


Becton Dickinson provides an adequate amount of disclosure regarding their

foreign currency transactions. Their seemed to be an ample amount of information

regarding the firm’s future and option contracts, and the policies they used to record

those transactions. Management was very clear on their intensions in using future and

option contacts, and offered no evidence that would suggest these numbers or policies

have been manipulated.

Quantitative analysis

Quantitative analysis is performed to determine how the actual numbers in the

financial statements, such as the balance sheet and income statement relate to each

other. It also helps point out any accounting distortions the company may have in order

to overstate the company’s value. This is due to the fact that GAAP allows managers to

have flexibility in the way they report the financial statements. This means all investors

should pay close attention to the information disclosed by the company as well as

analysis.

The most efficient way to check for distortions is to compute sales and expense

manipulation diagnostics. Sales manipulation compares net sales to: cash from sales,

accounts receivable, inventory, unearned revenue, and warranty liabilities. While the

expense manipulation compares sales to assets, change in operating cash flows to

operating income as well as net operating assets, and pension and other employment

expenses to selling, general and administrative expense.

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Sales Manipulation Diagnostics

To conduct our sales manipulation diagnostics, we simply take the most recent

six years of financial information found in each company’s 10-K and compute some

ratios to better understand the financial position of the company. All ratios relative to

sales manipulation diagnostics are to help the investor point out any irregularities in the

company’s financial statement. These irregularities that stand out are called red flags.

The ratios are computed for all companies so the investor may also take a look at the

financial position of their competitors. This is important due to the fact you may find

what appears to be a red flag but in reality all companies in the industry are reacting

very similar, this is called an industry trend.

Net sales/Cash from sales

This ratio is computed by dividing sales by cash from sales. This number informs

the investor that the company’s sales are supported by their cash from sales. The

closer the ratio is to 1:1 the better. In some instances, it will not always be close to 1:1.

For example, sometimes firms sell goods to customers on credit which delays the

collection of cash from the sale.

Net sales/Cash from sales

When analyzing this data to determine if a firm is distorting its numbers, one must

compare the questionable firm’s ratio with competitors in the industry. If the unusual

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ratio is firm specific, further investigation may be necessary. Since BDX and all of its

competitors have a ratio close to one, none show signs of accounting manipulation with

the intent of misleading investors as to the actual condition of the business. The ratio is

not great to bankers who would like the ratio to be as high as two. However all

companies are above a ratio of one and should have no problem finding a lender.

Sales/Accounts Receivable

To determine this ratio we divide sales by accounts receivable. This tells the

investor if the sales are supported by accounts receivable. BDX is in the middle for this

ratio when it is compared to its competitors. The chart below shows the ratio for BDX

and its top three competitors.

Sales/Accounts Receivable

This graph shows the ratio of net sales divided by net accounts receivable. For

the year 2007 the ratio went down indicating there were more cash sales for BDX then

sales on account. There is no exact industry trend for this ratio. As you can tell, the

companies are not very similar. The two that would be closest would be C.R. Bard

(BCR) and Boston Scientific (BSX), implying they both use the same time frame for

collecting accounts receivable. Baxter’s ratio is consistent for the first three years and

then has a huge jump. This could indicate the firm has increased sales on account

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while slightly if not at all increasing sales from the previous year. From this ratio, there

seems to be no sales manipulation within BDX or its competitors.

Sales/Inventory

Net sales/Inventory ratio shows how much inventory supports the revenues of

each firm. An increase in sales or a decrease in inventory would lead to a higher ratio.

This ratio is better to be low, because it proves that the company needs to keep up with

fewer inventories which in turns could lead to higher profits. The chart below shows

the ratio for BDX and its top three competitors

Sales/Inventory

This graph shows the ratio of net sales divided by inventory. BSX is by far the

highest ratio out of these four companies. BAX is more efficient when it comes to

keeping inventory low per sales dollar. This indicates they use more of a “just in time”

policy regarding inventory. The worst would be BSX and then followed by BCR. BDX is

in the middle of the pack. Overall, there seems to be no sales manipulation within BDX

or its competitors

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Conclusion

In conclusion BDX, is not leading the industry in terms of ratios, however they

are still where they want to be. They have enough cash from sales to appear low risk to

lenders. Second, their accounts receivable have been slowly climbing except the decline

in the industry the last year. Last, their sales over inventory has stayed right at six for

the last six year which tell the investor they have found a form of selling inventory that

is stable and profitable. Most important the company has no red flags and we can

indicate that BDX has not tried to manipulate there financials to overstate the company.


BDX 2002 2003 2004 2005 2006 2007

Sales/Cash from Sales 1.23

1.21

1.20 1.19 1.18 1.21

Sales/Accounts Receivable 5.31 5.78 6.11 6.34 6.48 5.87

Sales/Inventory 5.77 5.75 6.68 6.88 6.55 6.05

Unearned Revenue N/A N/A N/A N/A N/A N/A

Warranty N/A N/A N/A N/A N/A N/A

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Baxter International

BAX 2002 2003 2004 2005 2006 2007

Sales/Cash from Sales 1.28 1.27 1.28 1.22 1.22 1.22


Sales/Inventory 4.62 4.23 4.45 5.12 5.02 4.83



C.R. BARD

BCR 2002 2003 2004 2005 2006 2007



Sales/Inventory 8.66 9.16 10.57 10.43 8.83 9.00



Boston Scientific

BSX 2002 2003 2004 2005 2006 2007



Sales/Inventory 12.01 12.37 15.62 15.03 11.43 11.53



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Expense manipulation diagnostics

We conduct the expense manipulation diagnostics just like we did the sales. We

will be taking the last six years of financial information and computing ratios to better

reflect the true position of the firm and its competitors. We will be looking for potential

red flags for all firms while using a graph to understand the industry trend. There

might be a significant increase for all firms indicating there is not misleading

information in the 10-K to make the company look more favorable, rather a spike in the

industry.

Asset Turnover Ratio

The asset turnover ratio is computed by dividing sales by assets. This ratio

demonstrates how well a company can use its assets to generate revenue. As sales

increase, assets should increase as well. This ratio indicates if the firm is properly

depreciating and writing off assets as well.

Asset Turnover Ratio

Over the last six years BDX has done well in this category with respect to its

competitors. In 2006 BSX’s asset turnover ratio fell significantly. Further analysis

indicates that their total assets in that year jumped from 8,000 (in millions) to 30,000

and their net sales have just slightly increased every year. The sudden increase in

assets is due to the fact that they acquired Guidant and had a huge increase in goodwill

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of 78%. These numbers are important to investors because a significant decrease in

asset turnover means there will be a significant decrease in profit. BDX seems to be

efficient in their use of assets and shouldn’t have to alter production in any way. The

steadiness of their line over time is evidence that they haven’t in any way tried to

overstate their assets in order to appeal to investors.

Cash Flow from Operations/Operating Income

This ratio is found by dividing the change in cash flow from operations by

operating income. In this industry, changes in this ratio are not that rare because of

major activities for the year or putting in a new form of operations. Operating income

with unjustified accruals will effect this ratio. The chart below shows the ratio for BDX

and its top three competitors.

CFFO/OI

This graph shows the change in cash flow from operations divided by operating

income. Of these four companies, the most consistent would be BDX and BCR because

they stay around one the entire six-year period. The two concerns that first jump out

are BSX and BAX. BSX is by far the worst company because of the dramatic drop in

their ratio. The reason why their ratio is so low is because for years 2006 and 2007

they had a net loss. A net loss in turn results in a negative operating income number.

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The loss comes from an increase in purchased research and development expense of

93%. Baxter’s ratio increase to above 2.00. After reviewing this graph, BSX raised a

“red flag,” but BDX and the rest of their competitors show no signs of expense

manipulation.

Cash Flow from Financing Operations/Net Operating Assets

This ratio is found by dividing change in cash flow from operations by net

operating assets. These net operating assets include fixed assets such as PPE (property,

plant and equipment). Computing this ratio gives a better understanding as to how well

the company’s net operating assets can generate cash.

CFFO/NOA

This ratio outlines how well a company can utilize its fixed assets. BDX’s low

ratio could imply that their fixed assets are high while their CFFO is low . If this problem

is not corrected it could pose a problem in the future for BDX. BCR’s ratios are steady

and for the most part higher than the other companies, which mean they have a higher

return on net operating assets. BSX’s has an increase in this ratio for year 2005 and we

found out they had a significant decrease in 2005 for asset turnover. This indicates to

the investor there might have been some manipulation and further investigation is

recommended. There really is no industry trend regarding this ratio because companies

are so different in terms of their operations and fixed assets. From the information

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provided in this graph, BDX shows no sign of adjusting its books in order to appear

more valuable.

Pension Expense/Selling, General, and Administrative

This ratio is found by dividing the pension expense by the selling, general and

administrative cost. This lets the investor know how much money the company is

spending to pay retired workers now and in the future. For this ratio, companies want

it to be low because if it is high than that means that the company is wasting money.

Also if the ratio is high, it could mean that the pension plan they selected is bad and

could get worse over time. The chart below shows the ratio for BDX and its top three

competitors.

Pension Expense/SG&A

This graph is shows the amount of pension expense divided by the selling,

general, and administrative expenses for each year. Every company has the same

trend except for they differ in the amount. The reason why BSX doesn’t have ratios for

2002 and 2003 is because they disclosed on their 10K that it wasn’t sufficient to

disclose. And the decrease in 2005 might be an attempt to understate expenses. The

leaders out of these four companies would be BCR and BSX. We would say that BCR is

better than BSX because of the fact that BCR is based on more years and overall the

ratio decreases. BDX and BAX aren’t as good at managing their pension expenses.

BDX slightly increases from 2002 to 2007 and BAX slightly decreases from 2002 to

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2007. From the pension disclosure talked about earlier and the graph above, we

determined that BDX and its competitors show no sign of expense manipulation.

Total Accruals/Change in Sales

This ratio is performed by dividing total accruals by change in sales. This ratio

would indicate if accruals are supported by sales. We would like to see a ratio of around

one.

Accruals/Change in Sales

As we can see from the graph BSX stops stating accruals in 2005 the same year

the asset turnover dropped significantly this is important because, a drop in accruals

could indicate the company understating expense. If the expense were understated

then operating income would be overstated. BDX is on a slight decrease and appears to

have accruals supported by change in sales indicating no manipulation.

Conclusion

In conclusion BDX shows no signs they have altered the financial statements to

increase the value of the firm. There are some issues an investor may want to further

investigate such as the low ratios indicating BDX may have to high of fixed assets.

They have had an insignificant decrease over the last six years, but could lead to

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problems in the future. BSX on the other hand has some ratios that should stand out to

an investor. The negative net income for the last two years is not what you want to see

for a company in the medical field. Furthermore capitalizing a huge amount of goodwill

compared to years before might be an indication of overstating their asset


BDX 2002 2003 2004 2005 2006 2007

Asset Turnover .79 .80 .86 .87 .84 .87

CFFO/OI 1.23 1.18 1.41 1.14 .94 1.03

CFFO/NOA .23 .25 .27 .28 .23 .23

Accruals/Change in Sales .70 .32 .70 .62 .46 .35

Pension/SG&A .08 .08 .09 .09 .10 .09

Baxter International

BAX 2002 2003 2004 2005 2006 2007

Asset Turnover .65 .65 .67 .77 .71 .74

CFFO/OI .78 1.13 2.28 .95 1.19 1.06

CFFO/NOA .18 .18 .17 .20 .26 .26

Accruals/Change in Sales .34 .62 1.65 1.98 1.57 .74

Pension/SG&A .12 .11 .12 .12 .12 .11

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C.R. BARD

BCR 2002 2003 2004 2005 2006 2007

Asset Turnover .90 .85 .82 .78 .87 .89

CFFO/OI 1.24 1.18 .67 .76 .84 .96

CFFO/NOA .85 .69 .63 .68 .58 .96

Accruals/Change in Sales .15 .09 .02 .01 .01 .14

Pension/SG&A .06 .05 .05 .05 .05 .05

Boston Scientific

BSX 2002 2003 2004 2005 2006 2007

Asset Turnover .66 .61 .69 .77 .25 .27

CFFO/OI 1.21 1.13 1.15 .93 -.63 -66.71

CFFO/NOA .66 .59 1.10 .49 .72 .32

Accruals/Change in Sales .45 .20 .20 .27 N/A N/A

Pension/SG&A N/A N/A .06 .07 .05 .05

Identify Potential “Red Flags”

The next step in accounting analysis section is to identify any potential “red

flags.” These indicators suggest that the analyst should examine certain items more

closely or gather more information on them. If the items in question show great

concern, then the financial statements would need to be restated.

Companies have more flexibility when it comes to classifying leases. There are

two types for which a company can classify a lease. There are capital and operating

leases. Capital leases allow the company to take direct ownership of the firm and its

equipment or buildings with leasing liabilities. Operating leases are leased properties

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which are returned at the end of the lease period. When a company uses operating

leases rather than capital leases, it isn’t recognizing all of the liabilities for that property.

Companies sometimes classify leases as operating in order to make their liabilities look

better.

BDX has many properties throughout the world. They are currently leasing 132

and own 53. They use the properties for their corporate offices and their three

business segments, which include Biosciences, Medical, and Diagnostic. They also use

some properties for all of the segments together. BDX has a total of $153 in operating

leases and the information per year is shown below.

Years Time Amount (millions) PV Factor PV 2008 1 46 0.9447 43.46 2009 2 30 0.8925 26.78 2010 3 29 0.8432 24.45 2011 4 16 0.7966 12.75 2012 5 16 0.7526 12.04

2013 and Thereafter 6 16 0.7110 11.38

Total $ 153 $ 131

BDX did not disclose the interest rate that they used for operating leases. We

used two different interest rates off of their interest rate table for 2009 and 2013. We

then took the average of those two interest rates and came up with an interest rate of

5.85%. If BDX was to classify their leases as capital, they would have to account for

$131 million of additional liabilities. Their total liabilities on their balance sheet are

around $2.9 billion. Comparing the two figures, we calculated that the $131 million

would only account for 5% of the total liabilities. Since it is only 5% of the total

liabilities, we do not need to restate the financial statements.

Another item that would be a “red flag” to some firms would be goodwill, but

goodwill for BDX was not that big of a concern. Goodwill accounted for 8% of total

liabilities which was below the required amount.

There are a couple more items that rise up questionable information for BDX.

Pensions draw up some concerns for the firm, but the information in question would not

reflect very much difference in financial statements. Another item in question would be

research and development. R&D accounts for 40% of their net income. If they

capitalized part of that each year, their financial statements would reflect better

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information. Since the percentage of net income is more than the standard, the

financial statements are going to have to be restated to show capitalization of R&D.

Undo Accounting Distortions

The last step in the accounting analysis would be to undo any accounting

distortions. If any “red flags” are found when reviewing BDX, the financials need to be

adjusted in order to show the correct information. By doing this, it will provide a

clearer picture of how the financial statements should appear. The only item that raised

a “red flag” was research and development.


Firms in the medical equipment and supplies industry, strive for research and

developments to help achieve higher profits. Firms in this industry need to be very

innovative with their R&D in order to stay in the market. As we talked about earlier,

R&D is a good part of each firm’s sales. Even though BDX’s had below industry average

in R&D as a percentage of sales, they still need to be mentioned. If a firm’s R&D

expense is greater than 10% of its net income, then the firm needs to capitalize 20% of

its R&D per year. BDX’s research and development accounts for 40% of their net

income, which is well above the required amount. Below is a table showing the

calculations for each year to find the capitalized amount in millions of dollars.

R&D

Expense Cap. Rate

Cap. Amount

2003 224.24 20% 44.852004 235.65 20% 91.982005 267.66 20% 145.512006 301.87 20% 205.882007 360.05 20% 277.89

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The table above shows R&D for the past five years. In order to find the

capitalized amount, we multiplied R&D expense by the capitalization rate and then

added the previous year. For 2003, it only includes 2003’s capitalization amount.

Now that we know the capitalized amount of R&D, we have to adjust the

financial statements to show the changes. Since we are capitalizing the expense, we

created an account titled Capitalized R&D in the asset section of the balance sheet. In

order to make the balance sheet balance we needed to deduct the amount after

deducting taxes from retained earnings. This information is shown below in millions of

dollars.

As indicated in the tables above, the balance sheet balances. The adjustment to

net income is added to retained earnings. Next is to adjust the income statement. We

deducted the capitalized amount from R&D expense. After capitalizing R&D, the

operating expense went down which lead to higher operating income. The net income

went up as well compared to the original financials. The income statement is shown

below in millions of dollars.

By capitalizing R&D expense at a rate of 20% per year, net income went up

every year in relation to the old net income.

Research and development expense 207,204 224,237 235,649 267,664 301,872 360,050 Capitalized R&D 41,441 86,288 133,418 186,951 247,325 319,335 Total Operating Expenses 1,194,967 1,319,352 1,513,698 1,467,610 1,556,013 1,765,252 Net Income 521,423 633,344 600,820 909,214 999,605 1,209,368

Retained Earnings (before adjustment) 3,507,349 3,950,592 4,264,778 4,805,852 5,345,697 5,995,787 Adjustment due to cap. of R&D 41,441 86,288 133,418 186,951 247,325 319,335 Retained Earnings (after adjustment) 3,548,790 4,036,880 4,398,196 4,992,803 5,593,022 6,315,122 Total Shareholders' Equity 2,522,299 2,983,242 3,201,281 3,470,903 4,083,529 4,681,292 Total Liabilities and Shareholders' Equity 5,070,424 5,658,541 5,885,997 6,319,762 7,071,850 7,648,700

Capitalized R&D 41,441 86,288 133,418 186,951 247,325 319,335 Total Assets 5,070,424 5,658,541 5,885,997 6,319,744 7,071,850 7,648,700

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Conclusion

By capitalizing their R&D expense at a rate of 20% per year, the balance sheet

and income statement were adjusted to account for the difference. Before this

adjustment, BDX’s expenses were overstated which in turn lead to understating their

income, equity, liabilities, and assets.

Financial Analysis

Financial analysis is a valuable instrument used by analyst to determine how the

firm is performing in comparison to the firm’s goals, strategies, and how they match up

with their competition. Ratio analysis takes certain items from the balance sheet,

income statement, or statement of cash flows and compares them to other elements in

the financial statements to draw information about how the company is performing.

This information is useful in evaluating the liquidity, profitability, and capital structure of

the firm. Through ratio analysis, we are able to compare different line items of the

firm’s financial statements, to see how they relate to one another, and how they

matchup with their competition in the industry.

Liquidity Ratio Analysis

The liquidity ratios are performed to show the investor how much credit risk is

involved in the company as well as the industry. What makes these ratios so important

is the fact that lenders will not lend to companies with high risk and low liquidity. This

means it is important to the future growth of a company to have a source of funds

available from a bank or lender. The most commonly used of the liquidity ratios are as

follows: Current Ratio, Quick Asset Ratio, Accounts Receivable Turnover, Days in

Accounts Receivable, Inventory Turnover, Days in Inventory, Working Capital Turnover,

and the Cash to Cash Cycle. While all these ratios help better our understanding of the

firm’s liquidity, the two ratios with accounts receivable and Inventory as well as the

cash to cash cycle are a way to measure operating efficiency. The current ratio as well

as the quick asset ratio measures the firm’s ability to afford current obligations. There

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could be a firm with a high ability to pay off short term debt, however they might be

holding to much cash that should be invested rather held onto for credit risk. All factors

affect the future growth of the company

Current Ratio

This liquidity ratio is calculated to show the firms relationship between current

assets and current liabilities. We divide the assets by the liabilities and this in return

shows how well the firm can pay off short term obligations. The obligations are paid

from cash, accounts receivable and other liquid assets.

As we can see from the graph all the companies end up around two at the year

2007. However BCR shoots up in 2005 and is still climbing in 2007. This is due to the

fact their current liabilities is the lowest it has been in the last six years while current

assets is the highest. The industry trend is right around two which is a good level for

this ratio. This is good because it means its current liabilities can be paid for from the

current assets.

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Quick Asset Ratio

This ratio is somewhat similar to the current ratio except it uses the most liquid

assets. This means that inventory is taken out of the equation since inventory can

sometimes not be turn into cash quickly. However this ratio is again to determine the

firm’s ability to pay off short term obligations.

The industry trend is ending up around one for year 2007. This is a good number

for this ratio since it means they have the assets needed to pay their current

obligations. Once again BCR has increased compared to the industry this is due to their

low current liabilities while maintaining a steady increase in liquid assets. BDX is on a

slight decrease but seems to be in no danger due to the fact they are above a ratio of

one.

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Inventory Turnover

This ratio is first calculated by dividing cost of goods sold by inventory. This

shows how well the company is efficient in terms of operating inventory. The investor

wants this number to be high because it tells how often inventory is turned into sales.

The graph shows that all the companies are relatively close and the industry

trend seems to be right around three in year 2007. BCR has the highest ratio that

would indicate the company is operating its inventory efficiently. BDX is right around

three, however it has been on a slight decrease. This might be from a decrease in sales

or the company is not running its inventory efficiently. It would be recommended to

check this ratio for the future since it will keep its steady decline if its inventory is not

operating efficiently.

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Day’s Supply of Inventory

This ratio is found by taking inventory turnover and dividing it by 365 days. This

gives the investor an idea of how many days it will take to turn the inventory into sales,

generating revenue.

We can see from the graph all the firms have been increasing in the last three

years. The is a good industry trend to have. The trend is saying that all the firms in this

particular medical field are turning inventory into sales quicker and more often. BCR

goes to the bottom after having the highest inventory turnover. This once again means

they are operating more efficient. BDX seems to be taking longer but is not to

significant that we should alarmed, yet.

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Account Receivable Turnover

Accounts receivable turnover simply tells us how many times the accounts

receivables are collected during the year. By dividing sales over accounts receivable we

construct each companies account receivable turnover. In this situation, you would

want the highest number possible for the ratio because this means you are quickly

being paid your accounts receivable.

From the graph we can see the industry trend is around six at year 2007. Since

the ratio is so close for all the firms, we could say their policy for collecting accounts

receivable is similar. BSX has dropped over the years indicating they may need to

change their operations for receiving accounts receivable. BDX is above where it started

in 2002 indicating they have gotten better at receiving credit.

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Days Sales Outstanding

Day’s sales outstanding are figured out by dividing 365 by the accounts

receivable turnover. The day’s sale outstanding needs to have the lowest number

possible to signify that the company is reducing the accounts receivable. This is

important because it means the company is receiving cash from accounts receivable

that were on credit.

From the graph we can see the industry trend is around sixty in year 2007. This

indicates all the companies are receiving cash from credit around the same speed. BDX

has dropped indicating maybe a better policy to receive cash from accounts receivable.

This is a good situation for the company to have accounts receivable increasing as well

as this ratio decreasing.

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Working Capital Turnover

Working capital turnover measures the sales generated from the working capital.

Working capital is found by taking current assets minus current liabilities. Then we

divided sales by the working capital. If working capital turnover is high, then the firm is

successfully producing sales from its investments in working capital.

From the graph we can see that over the last few years all the firms working

capital turnover has been significantly different. However for year 2007 they all have

landed around three. BCR seems to have a steady ratio they are comfortable with as

well as BDX. BSX had a huge decline coming to the very bottom in 2006 due to

increases in total assets which was from an increase in goodwill of $13,996 compared

to the previous year of $1,938. BDX seems to be on a positive slant indicating they are

starting to produce higher sales from working capital.

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Cash to Cash Cycle

The ratio is calculated by adding day’s supply of inventory and day’s sales

outstanding. The ratio indicates how long it takes the company to convert one dollar of

inventory into one dollar of revenue.

From this graph we can say the industry trend from 2005 has been a slight

increase. This might suggest the companies are starting to take longer in turning

inventory into revenue. The increase in time to receive the revenue is not so significant

to be alarmed. However if this continues to increase the companies would become less

liquid and gain more risk.

Conclusion

In conclusion we can say for the year 2007 all the companies are coming closer

in terms of liquidity. BDX does not have the best ratios showing liquidity however they

are right there in the industry trend which means they are where they need to be. The

only concern would be they are taking longer to turn a dollar of inventory into a dollar

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of revenue. This is important for many reasons, the most being time value of money.

The slower and later they receive cash from credit the less the money is worth to the

company. Another important reason we should pay close attention to their operating

efficiency is if they are starting to receive cash slower for their services they might have

a problem with who they are storing on credit. The customers on credit that are taking

longer might not have the cash to pay at all in the near future. However as of right

now BDX has no big concerns that the ratios show. They are still above a two on the

current ratio indicating they could turn their assets into cash to pay for their liabilities if

an emergency where to happen leaving them to pay for it themselves. Plus they are in

great shape to receive additional funds from lenders.

Profitability Analysis

Profitability analysis is used to assess a company’s ability to earn profits. Critical

factors that affect a company’s profitability are operating efficiency, asset productivity,

the rate of return on assets, and the rate of return on equity. These key factors are

assessed using seven financial ratios: gross profit margin, operating expense ratio,

operating profit margin, net profit margin, asset turnover, return on assets, and return

on equity. The first four ratios measure the operating efficiency of the firm, while the

last three measure the revenue productivity of the company’s resources. Profitability

analysis provides and understanding of how well a firm efficiently manages its

resources, and minimizes its cost in order to create profits. Boston Scientific tends to

be an outlier for the majority of these profitability ratios due to the high volatility of their

expenses, which have yielded negative operating income values in the last two years.

We have removed this firm from most of our analysis (starting with operating profit

margin) in this section because it provides little insight into the profit potential of the

industry.

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Gross Profit Margin

Gross profit margin is an indicator of the degree to which a company’s revenues

exceed costs associated with its sales. Gross profit margin is calculated by subtracting

a company’s cost of goods sold from its revenue, which equals the company’s gross

profit, and dividing the gross profit from total revenue. The Gross profit margin is

affected by how efficiently it manages its production processes, as well as the price

premium that a firm’s products or services receive in the market. A high gross profit

margin means that a company has more money left over to pay debt and help fund

future growth.

Becton Dickenson’s profit margins have remained fairly constant over the past six

years, which tends to be the norm for the industry. The firm’s cost-of-goods-sold have

grown an average of 8.5%, while growing their revenue at an average of 10% over the

past six years. Boston Scientific and C.R Bard have been able to capture slightly higher

profit margins than Becton Dickenson and Baxter International by diversifying a larger

portion of their operations into the medical technology industry which produces larger

profit margins for those product lines.

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Operating Expense Ratio

The operating expense ratio indicates how well a company manages its

operating costs in relation to the amount of sales revenue. This ratio is calculated by

dividing a firms selling and general administrative costs by their revenue. A company

that has a high operating expense ratio in relation to the industry has trouble

minimizing their operating costs. Having high selling and general administrative costs

can severely weaken a firm’s profits, and can be directly related to inefficiencies in the

firm’s operations. Becton Dickenson has done an excellent job maintaining their

operation costs in relation to the industry. The firms selling and general administrative

costs have averaged 25% of total sales over the past six years, growing in constant

proportion with sales each year.

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Operating Profit Margin

Operating profit margin describes the relationship between a firm’s operating

profit and net sales. This profitability ratio is calculated by dividing a firm’s operating

income by its sales revenue. Operating profit margin is a measurement of what

proportion of a company's revenue is left over after paying for variable costs of

production such as wages and raw materials (www.investopedia.com). A high

operating profit margin indicates a high level of efficiency in minimizing its operating

costs. Conversely, firms with low operating profit margins are burdened with high

operating costs due to inefficiencies in operations. If a company's margin is increasing

(decreasing), it is earning more (less) per dollar of sales.

Becton Dickenson has again shown stability in managing their operating

activities. The firm’s operating income has averaged 18% of net sales over the past six

years, which tends to be less volatile than the other firms in the industry. In 2006 and

2007 the firm has shown a slight decrease their operating profit margins due to an

increase in research and development expense and acquired-in-process R&D expenses.

In 2004 we had to make an adjustment to operating income due to a $100 million

litigation settlement that decreased the level of operating income. This type of rare

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expense gives a false reading of the firms operating profit margin, since it has no effect

on the operating efficiency of the company. The restated operating income produced

an increase in operating profit margin from 2004-2005, instead of a decline.

Net profit margin

Net profit margin shows the relationship between net income and sales, and is

calculated by dividing a firm’s net income by its net sales. Net profit margin calculates

a firms return on sales (how much is earned out of each sales dollar), and illustrates the

profitability of the firm’s operating activities. A high net profit margin indicates a high

level of efficiency in controlling operating costs. In contrast, a low net profit margin

indicates poor efficiency in controlling operating costs. Companies that are able to

increase their net margins over time will generally be rewarded with share price growth,

as it leads directly to higher levels of profitability (www.investopedia.com).

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Becton Dickenson’s net profit margin has remained fairly constant over the past

six years, with some slight variability in 2004. Becton Dickenson and Baxter

International both experienced a decline in net income due to higher than normal

expenses in 2004. Baxter international had a large impairment write off and a sizeable

restructuring expense that totaled close to 10% of net sales; while Becton Dickenson’s

slight decline was a result of a loss from discontinued operations which was close to

2.5% of net sales. C.R Bard on the other hand moved in the opposite direction due to

a large increase from continuing operations close to 19% of net sales, providing the

firm a much larger net income and share price. While this decline in 2004 had a

negative effect on Becton Dickinson’s share value, it quickly rose from a low $46.5 to a

high $59.96 per share in the early months of 2005.

Asset Turnover

Asset turnover measures the revenue productivity of the resources employed by

the firm, and is calculated by dividing sales by total assets. Asset Turnover shows how

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quickly a firm is converting its physical asset base into sales (www.Reuters.com). A

high asset turnover ratio indicates that a firm is effectively using its resources to

generate sales, while a low asset turnover ratio indicates that a firm is not effectively

using its resources to generate sales. “It also indicates pricing strategy: companies

with low profit margins tend to have high asset turnover, while those with high profit

margins have low asset turnover” (www.investopedia.com) .

Becton Dickenson has done well at affectively using its resources to generate

revenue, especially in the last three years. The firm’s asset turnover has stayed

relatively constant over the past six years. Toward the end of 2004 sales began to

increase a little more than the firm’s assets, causing a small spike in the firm’s asset

turnover ratio. Over the past six years Becton Dickinson has outperformed the industry

on average at generating sales from assets.

Return on Assets

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Return on Assets is a measure of profitability that shows the relationship

between a firm’s profits and the firm’s resources. This profitability ratio is calculated

by dividing net income by total assets, and is expressed as a percentage. A firm’s

return on assets shows how much return management has earned on all assets

available to it, from all sources (www.Reuters.com). A high percentage means a

company is successfully utilizing its assets to generate profits.

Becton Dickenson’s rate of return on assets shows some variability over the past

six years, showing a large decrease in 2004 followed by a large increase in 2005, and

then leveling off. The increase at the end of 2004 and beginning of 2005 was a result

of net income rebounding from large losses from discontinued operations during 2004.

During 2005 net income increased by 55%, while total assets increased only by 7%,

resulting in a larger rate of return on assets that more accurately described the

company’s ability to use its resources.

Return on Equity

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Return on Equity measures the profitability of the stockholders interest in total

assets, and is calculated by dividing net income by owner’s equity. The return on equity

shows the amount of profit a company generates with the money shareholders have

invested. A firm’s return on equity can be influenced by asset turnover, profit margins,

and a firm’s level of debt to equity. A higher ratio indicates that the firm is successful

at generating profits with the firm’s equity.

Becton Dickenson’s return on Equity is consistent with our other profitability

ratios using net income in the numerator. We see a sharp decline in 2004 and than a

sharp increase in 2005. After 2004 the firm tends to do a fair job at utilizing

shareholder’s equity to generate profits.

Conclusion

Becton Dickenson has done a good job managing their operating activities and

assets in order to efficiently generate profit for the firm over the past six years. The

low profits margins experienced in 2004 were a result of a few large expenses that did

not accurately reflect the firm’s ability to operate efficiently and effectively manage their

assets. In relation to the industry, Becton Dickinson has performed exceptionally well,

and has maintained the most stability over the past six years in maintaining their profit

potential.

Capital Structure Analysis

A firm’s capital structure ratios indicate how it finances its business activities

through its assets. In other words, it explains to investors where firms obtain the

money to finance their operations in order to achieve growth. The ratios involved in

capital structure analysis include the debt to equity ratio, times interest earned, and the

debt service margin. These ratios serve to indicate how effectively a firm uses its debt

to finance assets, as well as showing how equipped a firm is to handle its long-term

debt and its interest expense.

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Debt to Equity ratio

The debt to equity ratio is computed by dividing a company’s total liabilities by

its total owner’s equity. This ratio helps in determining a company’s financial leverage.

A company with a high debt to equity ratio is choosing to finance their growth primarily

with debt rather than equity. In other words, they are ok with having outside financing

institutions fund their expansion. Conversely, companies with a smaller debt to equity

ratio finance most of their company with equity rather than debt. Over the past 6 years,

BDX’s debt to equity ratio average is .86. However, their restated debt to equity ratio

average is .82. The difference in BDX’s restated ratio is due in part to its increase in

retained earnings because of the capitalization of R&D expense. BDX’s 6-year average

strikes somewhat of a median in relation to its competitors.

Baxter is on the high side with an average of 2.27. While this high of a ratio

might be common in some industries, judging by the rest of their competitors in the

medical supplies industry, this could be very risky for them. When a company finances

too much of its growth with debt, they are forced to bear a more detrimental interest

expense, which could ultimately lead to bankruptcy. BCR is on the low side with an

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average of .47. This means that they borrow less than half of the amount of equity they

have which is very conservative and shows that they really don’t pose any capital

structure risk. BDX’s 2007 debt to equity ratio of .68 means that for every equity dollar

they have, 68% of that dollar is debt. In general, their debt to equity ratio is consistent

with other firms in the medical supply industry which means that they don’t pose any

grave capital structure risk.

Times Interest Earned

According to investopedia.com, times interest earned illustrates how well a firm

is able to cover its debt obligations. This number is calculated by dividing a firm’s

income from operations by its interest expense. Stated in other terms, it indicates

exactly how many times a firm’s operating income can cover its interest expense. Since

interest rates are always susceptible to change, a company’s interest expense can be

described as being volatile. If they finance the majority of their activities with debt,

their financiers always have the option to boost interest rates, meaning that they will

have to work harder to cover their interest obligations. Because most companies in the

medical supplies industry finance their operations with equity rather than debt, they

usually don’t accrue much interest. Consequently, they don’t experience difficulty when

it comes to meeting their debt obligations.

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The average times interest earned for BDX and its competitors is between 10

and 30. In years 2006 and 2007 Boston Scientific had negative times interest earned

due to their interest expenses being negative for those years. BDX’s 2007 times interest

earned was 25.92 which remains consistent with its competitors in the medical supply

industry. Therefore, they don’t have to worry much about being able to meet their debt

obligations. The reason the average was higher for the restated times interest earned

for BDX was because their operating income went up once again due to the

capitalization of R&D expense.

Debt Service Margin

A firm’s debt service margin is useful to analysts because it indicates how much

their cash flows from operations are actually available to pay off their current portion of

long-term debt. This percentage is calculated by dividing the current year’s cash from

operations by the previous year’s current portion of long-term debt. Much like the times

interest earned ratio, the debt service margin is also very volatile. Since the

denominator (current portion of long-term debt) varies from year to year, the debt

service margin is likely to experience vast amounts of change.

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With regard to the debt service margin, the higher the ratio the better. The

higher number indicates a firms ease in paying off its current portion of long term debt,

which lowers their risk of defaulting on this debt. BCR was not included in this graph

because it was an outlier. Even though BDX’s debt service margin is relatively low in

comparison to its competitors, it’s still above one, which means they are able to cover

their current portions of long-terms debt, although not a sufficiently as their

competitors. Since their restated debt service margin failed to differ from their actual

debt service margin, there is no need to further analyze the effects of the capitalization

of R&D expense for this ratio.

Altman Z-score

The Altman Z-score is a multi-factor model that serves to indicate a firm’s

chances of going bankrupt. This number is very useful to lenders as it helps them to

determine who they will or will not lend money to. An Altman Z-score of less than 1.81

alerts lenders that the firm will have a high chance of going bankrupt (Palepu and

Healy). If a company chronicles a z-score between 1.81 and 2.67 they will then be red

flagged as a high risk firm and classified as undetermined. If their score is rated higher

than 3 it is generally a safe bet that they are not in jeopardy of going bankrupt.

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Consequently, firms want to strive for the highest z-score possible. BDX’s average z-

score for the last 6 years is 5.52; therefore, they have a low chance of default. With

respect to BSX, all of BDX’s competitors seem to be safe from bankruptcy due to their

high z-scores. BSX, however, is dangerously low in 2006 and 2007 and will have a 95%

chance of going bankrupt in the first year, and a 70% chance of going bankrupt in the

following 2 years. Although their score rose slightly from 2006 to 2007, they are still in

grave danger of having to declare bankruptcy.

Conclusion

BDX’s capital structure remains consistent with its competitors in the medical

supplies industry. Since BDX finances most of their operations through equity rather

than debt, they have relatively no capital structure risk that would otherwise lead to

default. Although their debt service margin isn’t as high as analyst may like, their solid

z-score over the past 6 years allows them to stay strong in the industry without the

eminent danger of declaring bankruptcy.

Internal Growth Rate

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The internal growth rate refers to the rate at which a company can grow its total

assets using only firm generated funds such as retained earnings. The internal growth

rate is a function of return on assets and the plowback ratio, the percent of net income

plowed back into the company as retained earnings. BDX has maintained a steady IGR

over the past 5 years except for 2004. Actually everyone but BCR, went down from

2003 to 2004. The reason why BCR was the only company, out of the four, to go up

was because their ROA for that year went up when everyone else’s went down. The

graph below shows BDX and their main competitors.

The chart above shows the IGR for BDX and their main competitors. Boston

Scientific is not included in this calculation because they had a net loss in 2006 and

2007 which greatly threw off the picture as a whole. As indicated before, BCR was the

only company to go up from 2003 to 2004. This was because their ROA went up

instead of down. Out of everyone, BDX was the only one that was pretty much the

same from year to year. Since we had to restate both the income statement and the

balance sheet, their IGR went down by a small margin at first and grew as time went

on. BAX went down from 2003 to 2004 and then they went up by an average of 2%

per year. This increase was due to an increase in ROA. BCR was very inconsistent

from year to year. Their ROA was the main reason because it also bounced from year

to year.

By studying IGR, we determined that IGR and ROA go hand in hand. If ROA

goes up then IGR goes up and vice-versa.

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Sustainable Growth Rate

Sustainable growth rate is the rate a firm can grow its assets with internal and

external financing. A company’s leverage is important to the computation of a

sustainable growth rate. By multiplying the internal growth rate with the term (1+ debt

to equity ratio), leverage is included and a sustainable growth rate can be concluded.

The graph below shows BDX and their main competitors.

The chart above shows the SGR for BDX and their main competitors. Boston

Scientific is not included in this calculation because they had a net loss in 2006 and

2007 which greatly threw off the picture as a whole. Since SGR uses IGR in its

calculation, it will look similar to the IGR chart, but will be somewhat different since the

debt to equity ratio is also used. As indicated earlier, the main reason why BCR went

up from 2003 to 2004 was because their ROA went up while everyone else’s went

down. BDX is the only consistent company from year to year. Both BAX and BCR jump

around from year to year. Since we had to restate both the income statement and the

balance sheet, their SGR went down by a small margin at first and grew as time went

on.

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SGR is a great tool used for forecasting and future analysis. The relative

predictability of the growth rate can be forecasted into the future and will help analysts

determine the health of the firm.

Financial Statements Forecast

Financial statements of companies allow investors to look into the activities of

the operations of the business. These financial statements serve many purposes. They

report the past performance of the company and can be used to determine success or

failure at any time. Another reason why financial statements are very important is

because analysts run ratios on them. As discussed in the previous section, there are

many different ratios. Most of the ratios can be divided into three areas: (1) liquidity,

(2) profitability, and (3) capital structure. To understand where the company is going,

analyst forecast the financial statements. When it comes to forecasting, it is best to

start by converting the financial statements in common size financial statements.

Common size means that each number is presented as a percentage of a whole. After

analysts have completed the common size statements, they look for trends in the

statements to help forecast each year. Forecasting is very difficult. A mistake made in

year 2010 is more costly to the company then the same mistake made in 2018.

Forecast numbers should be more correct within the first three years then. Many

different events can cause companies numbers to change. For example, there will be a

new president in January 2009. That could change some industries depending on

which nominee is elected. For BDX, we decided to forecast the next ten years in order

to see where they are going, in our opinion. Below we will discuss the income

statement, balance sheet, and the statement of cash flows.

Income Statement

The income statement is one of the most important tools when it comes to

forecasting. It is the easiest statement to forecast. In order to forecast any financial

statement, we first need to look at the past. The income statement shows expenses

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that the business may incur during the year and their revenues they gain. For BDX, we

looked at the past six years of income statements starting with 2002 and going through

2007. We put all six years into one spreadsheet and converted the information into the

common size income statement. After that we looked for trends and “red flags” that

would affect the forecast process. After looking over the income statement, we decided

to forecast sales, cost of goods sold, gross profit, expenses, operating income, and net

income. Since we restated our financials, we forecasted the same accounts for both,

but the numbers vary because of the restated amount. This is shown below and

discussed afterwards.

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Becton, Dickinson and CompanyCommon Size Income StatementsYears Ended September 30

(Thousands of dollars) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017OperationsSales Growth 12.7% 10.6% 8.2% 7.4% 10.8% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6%Revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%Cost of Products sold 51.7% 51.5% 50.7% 49.1% 48.7% 48.3% 47.9% 47.9% 47.9% 47.9% 47.9% 47.9% 47.9% 47.9% 47.9% 47.9%Gross Profit 48.3% 48.5% 49.3% 50.9% 51.3% 51.7% 52.1% 52.1% 52.1% 52.1% 52.1% 52.1% 52.1% 52.1% 52.1% 52.1%

Selling and administrative expense 25.4% 26.5% 26.6% 26.0% 25.2% 25.2% 25.4% 25.4% 25.4% 25.4% 25.4% 25.4% 25.4% 25.4% 25.4% 25.4%Research and development expense 5.2% 5.0% 4.8% 5.0% 5.3% 5.7% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5%Acquired in-process R&D 0.0% 0.0% 0.0% 0.0% 0.9% 1.9%Special Charges 0.5% 0.0% 0.0% 0.0% 0.0% 0.0%Litigation settlement 0.0% 0.0% 2.0% 0.0% 0.0% 0.0%Total Operating Expenses 31.2% 31.5% 33.4% 31.0% 31.4% 32.8% 32.5% 32.5% 32.5% 32.5% 32.5% 32.5% 32.5% 32.5% 32.5% 32.5%Operating Income 17.0% 17.1% 16.0% 19.9% 19.9% 18.9% 19.6% 19.6% 19.6% 19.6% 19.6% 19.6% 19.6% 19.6% 19.6% 19.6%Interest Expense -0.8% -1.0% -0.9% -1.0% -1.2% -0.7%Interest Income 0.0% 0.2% 0.3% 0.7% 1.0% 0.7%Other Income (expense), net -0.3% -0.1% -0.1% -0.1% -0.2% 0.0%

Income From Continuing Operations before Income Taxes 15.8% 16.2% 15.3% 19.4% 19.6% 18.9%Income Tax Provision 3.7% 3.7% 3.5% 6.1% 5.4% 5.5%Income From Continuing Operations 12.1% 12.4% 11.8% 13.3% 14.2% 13.5%Income (loss) from Discontinued Operations 0.0% -0.2% -2.3% 0.2% -1.1% 0.5%Net Income 12.1% 12.3% 9.5% 13.5% 13.1% 14.0% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5%Other Comprehensive Income (loss), Net of Tax Foreign currency translation adjustments 0.4% 4.6% 1.7% -0.3% 1.3% 3.9% Minimum Pension Liability adjustment -2.0% -0.2% -0.1% 0.1% 1.3% 0.0% Unrealized (loss) gain on investments 0.1% 0.2% 0.0% 0.0% 0.0% -0.2% Unrealized loss on cash flow hedges 0.0% -0.1% 0.0% 0.0% 0.0% 0.0%Other Comprehensive Income (loss), Net of Tax -1.5% 4.5% 1.5% -0.3% 2.7% 3.8%Comprehensive Income 10.7% 16.8% 11.0% 13.3% 15.8% 17.8%

Actual Income Statements Forecasted Income Statements

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Becton, Dickinson and CompanyConsolidated Statements of IncomeYears Ended September 30

(Thousands of dollars) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017OperationsRevenues 3,960,359 4,463,509 4,934,745 5,340,833 5,738,017 6,359,708 6,970,240 7,639,383 8,372,764 9,176,549 10,057,498 11,023,018 12,081,227 13,241,025 14,512,164 15,905,331 Cost of Products sold 2,049,475 2,296,637 2,500,362 2,622,427 2,793,265 3,071,921 3,338,745 3,659,264 4,010,554 4,395,567 4,817,541 5,280,025 5,786,908 6,342,451 6,951,326 7,618,654 Gross Profit 1,910,884 2,166,872 2,434,383 2,718,406 2,944,752 3,287,787 3,631,495 3,980,119 4,362,210 4,780,982 5,239,956 5,742,992 6,294,319 6,898,574 7,560,837 8,286,678

Selling and administrative expense 1,007,696 1,181,403 1,311,467 1,386,897 1,448,166 1,602,404 1,770,441 1,940,403 2,126,682 2,330,843 2,554,604 2,799,846 3,068,632 3,363,220 3,686,090 4,039,954 Research and development expense 207,204 224,237 235,649 267,664 301,872 360,050 383,363 420,166 460,502 504,710 553,162 606,266 664,468 728,256 798,169 874,793 Acquired in-process R&D - - - - 53,300 122,133 Special Charges 21,508 - - - - - Litigation settlement - - 100,000 - - - Total Operating Expenses 1,236,408 1,405,640 1,647,116 1,654,561 1,803,338 2,084,587 2,265,328 2,482,799 2,721,148 2,982,378 3,268,687 3,582,481 3,926,399 4,303,333 4,716,453 5,169,233 Operating Income 674,476 761,232 787,267 1,063,845 1,141,414 1,203,200 1,366,167 1,497,319 1,641,062 1,798,604 1,971,270 2,160,511 2,367,921 2,595,241 2,844,384 3,117,445 Interest Expense (33,243) (43,477) (44,832) (55,673) (66,046) (46,420) Interest Income - 6,928 15,225 36,421 59,296 46,221 Other Income (expense), net (13,766) (2,725) (4,792) (7,064) (8,762) 944 Income From Continuing Operations before Income Taxes 627,467 721,958 752,868 1,037,529 1,125,902 1,203,945 Income Tax Provision 148,115 167,028 170,364 325,009 310,792 347,778

Income From Continuing Operations 479,352 554,930 582,504 712,520 815,110 856,167

Income (loss) from Discontinued Operations 630 (7,874) (115,102) 9,743 (62,830) 33,866

Net Income 479,982 547,056 467,402 722,263 752,280 890,033 940,982 1,031,317 1,130,323 1,238,834 1,357,762 1,488,107 1,630,966 1,787,538 1,959,142 2,147,220 Other Comprehensive Income (loss), Net of Tax Foreign currency translation adjustments 16,472 207,107 83,522 (17,742) 77,396 250,411 Minimum Pension Liability adjustment (77,661) (9,248) (6,730) 4,494 77,086 3,159 Unrealized (loss) gain on investments 4,005 9,653 242 (1,112) 1,212 (10,643) Unrealized loss on cash flow hedges (380) (5,499) (2,461) (135) (1,307) (2,596) Other Comprehensive Income (loss), Net of Tax (57,564) 202,013 74,573 (14,495) 154,387 240,331 Comprehensive Income 422,418 749,069 541,975 707,768 906,667 1,130,364

Basic Earnings per Share:Income from Continuing Operations 1.85 2.17 2.30 2.83 3.30 3.50 Income (loss) from Discontinued Operations - (0.03) (0.46) 0.04 (0.25) 0.14 Basic Earnings per Share 1.85 2.14 1.85 2.87 3.04 3.63 3.84 4.21 4.61 5.06 5.54 6.08 6.66 7.30 8.00 8.77 Diluted Earnings per Share:Income from Continuing Operations 1.79 2.10 2.21 2.73 3.18 3.36 Income (loss) from Discontinued Operations - (0.03) (0.44) 0.04 (0.24) 0.13 Diluted Earnings per Share: 1.79 2.07 1.77 2.77 2.93 3.49

2002 2003 2004 2005 2006 2007Common Shares Outstanding (thousands) 258,016 254,497 252,011 251,429 247,067 244,929 244,929 244,929 244,929 244,929 244,929 244,929 244,929 244,929 244,929 244,929 Diluted Shares Outstanding 263,418 260,573 259,959 260,712 256,554 254,810 Market Price 28.40 36.12 51.70 52.43 70.67 82.05 Market Cap 7,327,654 9,192,432 13,028,969 13,182,422 17,460,225 20,096,424

Forecasted Income StatementsActual Income Statements

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Becton, Dickinson and CompanyCommon Size Income Statements (restated)Years Ended September 30

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017OperationsSales Growth 12.7% 10.6% 8.2% 7.4% 10.8% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6% 9.6%Revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%Cost of Products sold 51.7% 51.5% 50.7% 49.1% 48.7% 48.3% 47.9% 47.9% 47.9% 47.9% 47.9% 47.9% 47.9% 47.9% 47.9% 47.9%Gross Profit 48.3% 48.5% 49.3% 50.9% 51.3% 51.7% 52.1% 52.1% 52.1% 52.1% 52.1% 52.1% 52.1% 52.1% 52.1% 52.1%

0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Selling and administrative expense 25.4% 26.5% 26.6% 26.0% 25.2% 25.2% 25.4% 25.4% 25.4% 25.4% 25.4% 25.4% 25.4% 25.4% 25.4% 25.4%Research and development expense 5.2% 5.0% 4.8% 5.0% 5.3% 5.7%Capitalized R&D 1.0% 1.9% 2.7% 3.5% 4.3% 5.0%New R&D expense 4.2% 3.1% 2.1% 1.5% 1.0% 0.6% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0%Acquired in-process R&D 0.0% 0.0% 0.0% 0.0% 0.9% 1.9%Special Charges 0.5% 0.0% 0.0% 0.0% 0.0% 0.0%Litigation settlement 0.0% 0.0% 2.0% 0.0% 0.0% 0.0%Total Operating Expenses 30.2% 29.6% 30.7% 27.5% 27.1% 27.8% 28.0% 28.0% 28.0% 28.0% 28.0% 28.0% 28.0% 28.0% 28.0% 28.0%Operating Income 18.1% 19.0% 18.7% 23.4% 24.2% 23.9% 24.1% 24.1% 24.1% 24.1% 24.1% 24.1% 24.1% 24.1% 24.1% 24.1%Interest Expense -0.8% -1.0% -0.9% -1.0% -1.2% -0.7%Interest Income 0.0% 0.2% 0.3% 0.7% 1.0% 0.7%Other Income (expense), net -0.3% -0.1% -0.1% -0.1% -0.2% 0.0%Income From Continuing Operations before Income Taxes 16.9% 18.1% 18.0% 22.9% 23.9% 24.0%Income Tax Provision 3.7% 3.7% 3.5% 6.1% 5.4% 5.5%Income From Continuing Operations 13.2% 14.4% 14.5% 16.8% 18.5% 18.5%Income (loss) from Discontinued Operations 0.0% -0.2% -2.3% 0.2% -1.1% 0.5%Net Income 13.2% 14.2% 12.2% 17.0% 17.4% 19.0% 17.5% 17.5% 17.5% 17.5% 17.5% 17.5% 17.5% 17.5% 17.5% 17.5%Other Comprehensive Income (loss), Net of Tax 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Foreign currency translation adjustments 0.4% 4.6% 1.7% -0.3% 1.3% 3.9% Minimum Pension Liability adjustment -2.0% -0.2% -0.1% 0.1% 1.3% 0.0% Unrealized (loss) gain on investments 0.1% 0.2% 0.0% 0.0% 0.0% -0.2% Unrealized loss on cash flow hedges 0.0% -0.1% 0.0% 0.0% 0.0% 0.0%Other Comprehensive Income (loss), Net of Tax -1.5% 4.5% 1.5% -0.3% 2.7% 3.8%Comprehensive Income 11.7% 18.7% 13.7% 16.8% 20.1% 22.8%

Actual Income Statements (restated) Forecasted Income Statements (restated)

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Becton, Dickinson and CompanyCommon Size Income Statements (restated)Years Ended September 30

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017OperationsRevenues 3,960,359 4,463,509 4,934,745 5,340,833 5,738,017 6,359,708 6,970,240 7,639,383 8,372,764 9,176,549 10,057,498 11,023,018 12,081,227 13,241,025 14,512,164 15,905,331 Cost of Products sold 2,049,475 2,296,637 2,500,362 2,622,427 2,793,265 3,071,921 3,338,745 3,659,264 4,010,554 4,395,567 4,817,541 5,280,025 5,786,908 6,342,451 6,951,326 7,618,654 Gross Profit 1,910,884 2,166,872 2,434,383 2,718,406 2,944,752 3,287,787 3,631,495 3,980,119 4,362,210 4,780,982 5,239,956 5,742,992 6,294,319 6,898,574 7,560,837 8,286,678

Selling and administrative expense 1,007,696 1,181,403 1,311,467 1,386,897 1,448,166 1,602,404 1,770,441 1,940,403 2,126,682 2,330,843 2,554,604 2,799,846 3,068,632 3,363,220 3,686,090 4,039,954 Research and development expense 207,204 224,237 235,649 267,664 301,872 360,050 - - - - - - - - - - Capitalized R&D 41,441 86,288 133,418 186,951 247,325 319,335 New R&D expense 165,763 137,949 102,231 80,713 54,547 40,715

Acquired in-process R&D - - - - 53,300 122,133 Special Charges 21,508 - - - - - Litigation settlement - - 100,000 - - - Total Operating Expenses 1,194,967 1,319,352 1,513,698 1,467,610 1,556,013 1,765,252 1,951,667 2,139,027 2,344,374 2,569,434 2,816,099 3,086,445 3,382,744 3,707,487 4,063,406 4,453,493 Operating Income 715,917 847,520 920,685 1,250,796 1,388,739 1,522,535 1,679,828 1,841,091 2,017,836 2,211,548 2,423,857 2,656,547 2,911,576 3,191,087 3,497,431 3,833,185 Interest Expense (33,243) (43,477) (44,832) (55,673) (66,046) (46,420) Interest Income - 6,928 15,225 36,421 59,296 46,221 Other Income (expense), net (13,766) (2,725) (4,792) (7,064) (8,762) 944 Income From Continuing Operations before Income Taxes 668,908 808,246 886,286 1,224,480 1,373,227 1,523,280 Income Tax Provision 148,115 167,028 170,364 325,009 310,792 347,778 Income From Continuing Operations 520,793 641,218 715,922 899,471 1,062,435 1,175,502 Income (loss) from Discontinued Operations 630 (7,874) (115,102) 9,743 (62,830) 33,866 Net Income 521,423 633,344 600,820 909,214 999,605 1,209,368 1,219,792 1,336,892 1,465,234 1,605,896 1,760,062 1,929,028 2,114,215 2,317,179 2,539,629 2,783,433 Other Comprehensive Income (loss), Net of Tax Foreign currency translation adjustments 16,472 207,107 83,522 (17,742) 77,396 250,411 Minimum Pension Liability adjustment (77,661) (9,248) (6,730) 4,494 77,086 3,159 Unrealized (loss) gain on investments 4,005 9,653 242 (1,112) 1,212 (10,643) Unrealized loss on cash flow hedges (380) (5,499) (2,461) (135) (1,307) (2,596) Other Comprehensive Income (loss), Net of Tax (57,564) 202,013 74,573 (14,495) 154,387 240,331 Comprehensive Income 463,859 835,357 675,393 894,719 1,153,992 1,449,699

Actual Income Statements (restated) Forecasted Income Statements (restated)

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In the above tables, it shows both the actual income statements and forecasted. Also,

the common size income statements of both the actual and forecasted are there as well.

Since we had to restate BDX’s financials, the restated income statements are also provided

above.

The restated financials and the as stated financials are not the different. Everything

was computed the same way. Although they were computed the same way, some numbers

are a little different. We had to allocate more operating expenses because of capitalized R&D,

which in turn affected operating income and net income. This raised our growth rate of the

two by about 4% for each item. Other than that, everything was calculated the same way

because it wasn’t that big of a difference.

The whole forecasting process begins with sales. We predicted that the sales growth in

this industry was around 10%. For BDX, we came up with a 9.6% sales growth. This rate is

conservative since all the numbers are based off of sales. This growth rate was determined by

looking at the trends of past financial statements. Even though the sales growth rate varies

from 2002 to 2007, we believe that it will stay around 10%. The factors that we took into

account were the presidential election, the economy, and several other factors. Next to

forecast would be the cost of goods sold. When we looked at the cost of goods sold account

for the past six years. The amount is decreasing from year to year. This means that the

company is having better gross profits. We calculated that their cost of goods sold would be

around 47.9% of sales. In turn, that would lead to a gross profit of 52.1% of sales.

The next section in the income statement would be expenses. Both SG&A and R&D

expenses were consistent from year to year. We determined that they would stay at 25.4%

and 5.5% of sales respectively. Total operating expenses, however, were not the same from

as stated to restated. The as stated percentage was 32.5% of sales which allowed an addition

1.6% between the other expenses. The restated percentage was 28% of sales which allowed

an addition 3.6% between the other expenses. The difference in total operating expenses

was because of the capitalized R&D. After operating expenses, was operating income.

Operating income is calculated by taking gross profit and subtracting operating expenses. We

used that formula and calculated operating income that way. Last but not least, was to

calculate net income. On the as stated financials the net profit margin was consistently

around 13% - 14%. We decided to forecast the net profit margin at 13.5%. According to the

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analysts on Yahoo Finance, they forecasted net profit margin for the next five years to be

13.67%. Both numbers are within a small percentage of each other which means that both

numbers are pretty accurate.

Forecasting is very difficult. A short term error is more costly than the same error made

in the long run. Since this is true, 2008 is the most important year. Our fiscal year end is

September 30 of every year. Since September 30, two quarterly reports have been published.

We used those numbers and compared them to our forecasted numbers. After two quarters

of information, they had revenues of $3,452 million. If we multiply that by two we get $6,904

million for the year 2008, considering they had similar revenues for quarters three and four.

For 2008, we forecasted $6,970 for revenues. That is almost a 1% difference. Revenues are

the back bone of forecasting. With this number within 1% of the actual number, based on 2

quarters, we feel pretty confident that our forecasted numbers are accurate. Also if you

multiply the net income stated on the second 10-Q by two, you get net income of $1,095

million. Our forecasted net income for 2008 was $940 million. Just like revenues, this number

isn’t as close, but it is still around the actual numbers considering they had similar net incomes

for quarters three and four.

After forecasting all the income statements, all forecasted numbers were very

reasonable from year to year. Both the sales growth and the net profit margin were around

the industry’s average. Now that the income statement is completed, we now need to

forecast the balance sheet.

Balance Sheet

The next step in the forecasting process is the balance sheet. This is more difficult than

forecasting the income statement, but with the use of ratios which link the income statement

to the balance sheet it makes the analysis possible. In order to properly forecast the balance

sheet we created a common sized balance sheet and evaluated any industry and company

trends, so that there were no forecasting errors. Since we restated our financials, we

forecasted the same accounts for both, but the numbers vary because of the restated amount.

This is shown below and discussed afterwards.

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Becton, Dickinson and CompanyConsolidated Balance SheetsSeptember 30

(thousands of dollars) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017AssetsCurrent Assets Cash and equivalents 4.8% 9.3% 12.5% 17.0% 14.7% 7.0% Short-term investments 0.0% 0.0% 0.6% 1.4% 1.6% 2.2% Trade receivables, net 14.8% 13.9% 14.0% 13.7% 13.0% 14.8% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0% Inventories 13.6% 13.9% 12.8% 12.7% 12.8% 14.4% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5% Prepaid expenses, deferred taxes and other 4.8% 4.3% 4.9% 3.7% 4.6% 4.4% Assets held for sale 0.0% 3.5% 1.1% 0.0% 0.0% 0.0% Total Current Assets 38.1% 44.9% 45.9% 48.5% 46.7% 42.7% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5%Property, Plant and Equipment, Net 35.1% 32.9% 32.7% 31.5% 31.3% 34.1% 33.2% 33.2% 33.2% 33.2% 33.2% 33.2% 33.2% 33.2% 33.2% 33.2%Goodwill 9.8% 8.0% 8.2% 7.7% 8.3% 8.5% 8.8% 8.8% 8.8% 8.8% 8.8% 8.8% 8.8% 8.8% 8.8% 8.8%Core and Developed Technology, Net 5.6% 3.5% 3.3% 2.7% 3.6% 5.1%Other Intangibles, Net 2.5% 1.8% 1.6% 1.7% 1.3% 1.3%Capitalized Software, Net 5.6% 5.5% 4.9% 3.7% 2.8% 1.9%Other 3.2% 3.4% 3.3% 4.2% 6.1% 6.4%

Total Non-Current Assets 61.9% 55.1% 54.1% 51.5% 53.3% 57.3% 58.5% 58.5% 58.5% 58.5% 58.5% 58.5% 58.5% 58.5% 58.5% 58.5% Total Assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

LiabilitiesCurrent Liabilities Short-term debt 17.1% 4.6% 1.8% 7.2% 14.3% 7.0% Accounts Payable 8.8% 8.2% 7.7% 8.9% 8.2% 9.0% Accrued expenses 12.2% 13.4% 14.3% 15.4% 16.4% 16.2% Salaries, wages and related items 8.9% 9.7% 11.5% 11.6% 12.7% 14.7% Income taxes 2.1% 2.8% 3.2% 2.5% 1.2% 2.9% Liabilities held for sale 0.0% 0.9% 0.5% 0.0% 0.0% 0.0% Total Current Liabilities 49.0% 39.6% 39.1% 45.6% 52.7% 49.8% 49.5% 49.5% 49.5% 49.5% 49.5% 49.5% 49.5% 49.5% 49.5% 49.5%Long-Term Debt 31.5% 44.3% 43.6% 37.2% 32.0% 32.2%Long-Term Employee Benefit Obligations 15.4% 12.3% 13.9% 12.0% 9.1% 15.0%Deffered Income Taxes and Other 4.1% 3.9% 3.3% 5.2% 6.2% 3.0%

Total Non-Current Liabilities 51.0% 60.4% 60.9% 54.4% 47.3% 50.2% 50.5% 50.5% 50.5% 50.5% 50.5% 50.5% 50.5% 50.5% 50.5% 50.5% Total Liabilities 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Commitments and Contingencies

Shareholders' EquityESOP convertible preferred stock - $1 par value 1.5% 1.2% 1.0% 0.0% 0.0% 0.0%Preferred stock, series A - $1 par value 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Common Stock - $1 par value 13.4% 11.5% 10.8% 10.1% 8.7% 7.6%Capital in excess of par value 7.5% 8.9% 13.5% 18.8% 22.8% 25.8%Retained Earnings 141.4% 136.4% 139.0% 146.3% 139.3% 137.5% 138.0% 138.0% 138.0% 138.0% 138.0% 138.0% 138.0% 138.0% 138.0% 138.0%Unearned ESOP compensation -0.3% -0.1% 0.0% 0.0% 0.0% 0.0%Deffered Compensation 0.3% 0.3% 0.3% 0.3% 0.3% 0.3%Common Stock in treasury -45.9% -49.7% -59.2% -70.0% -70.3% -71.2%Accumulated other comprehesive income (loss) -17.9% -8.4% -5.5% -5.6% -0.8% 0.0% Total Shareholders' Equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%Total Liabilities and Shareholders' Equity

Actual Balance Sheet Forecasted Balance Sheet

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Becton, Dickinson and CompanyConsolidated Balance SheetsSeptember 30

(thousands of dollars) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017AssetsCurrent Assets Cash and equivalents 243,115 519,886 719,378 1,042,890 1,000,289 511,482 Short-term investments 1,850 - 32,119 86,808 106,386 158,040 Trade receivables, net 745,998 772,067 807,380 842,806 885,748 1,083,152 1,150,015 1,260,416 1,381,416 1,514,032 1,659,379 1,818,679 1,993,273 2,184,627 2,394,351 2,624,209 Inventories 686,219 776,220 738,778 775,949 875,738 1,051,959 1,108,943 1,215,401 1,332,080 1,459,959 1,600,115 1,753,727 1,922,084 2,106,604 2,308,838 Prepaid expenses, deferred taxes and other 240,048 239,983 279,985 226,861 317,092 325,933 Assets held for sale - 195,303 63,694 - - - Total Current Assets 1,917,230 2,503,459 2,641,334 2,975,314 3,185,253 3,130,566 3,408,972 3,736,233 4,094,912 4,488,023 4,918,873 5,391,085 5,908,629 6,475,858 7,097,540 7,778,904 Property, Plant and Equipment, Net 1,765,730 1,831,791 1,880,997 1,933,718 2,133,548 2,497,338 2,727,178 2,988,987 3,275,929 3,590,419 3,935,099 4,312,868 4,726,904 5,180,686 5,678,032 6,223,123 Goodwill 492,327 445,854 473,211 470,049 565,146 621,414 722,866 792,262 868,319 951,677 1,043,038 1,143,170 1,252,914 1,373,194 1,505,021 1,649,503 Core and Developed Technology, Net 283,166 193,238 188,541 165,381 244,811 374,779 Other Intangibles, Net 126,758 102,538 93,466 101,558 91,501 95,938 Capitalized Software, Net 284,109 305,536 283,918 229,793 189,355 142,738 Other 159,663 189,837 191,112 256,980 414,911 466,592

Total Non-Current Assets 3,111,753 3,068,794 3,111,245 3,157,479 3,639,272 4,198,799 4,805,418 5,266,739 5,772,345 6,326,491 6,933,834 7,599,482 8,329,032 9,128,619 10,004,966 10,965,443 Total Assets 5,028,983 5,572,253 5,752,579 6,132,793 6,824,525 7,329,365 8,214,390 9,002,972 9,867,257 10,814,514 11,852,707 12,990,567 14,237,661 15,604,477 17,102,507 18,744,347

Asset Turnover - 0.89 0.89 0.93 0.94 0.93 0.93 0.93 0.93 0.93 0.93 0.93 0.93 0.93 0.93 0.93

LiabilitiesCurrent Liabilities Short-term debt 434,642 121,858 49,289 206,509 427,218 207,634 Accounts Payable 224,645 219,804 206,941 252,262 243,602 266,993 Accrued expenses 310,238 358,931 384,936 439,894 490,425 481,429 Salaries, wages and related items 225,694 258,749 307,996 329,864 380,478 435,854 Income taxes 52,873 74,986 86,739 70,864 34,606 86,899 Liabilities held for sale - 25,114 14,181 - - - Total Current Liabilities 1,248,092 1,059,442 1,050,082 1,299,393 1,576,329 1,478,809 1,704,486 1,868,117 2,047,456 2,244,012 2,459,437 2,695,543 2,954,315 3,237,929 3,548,770 3,889,452 Long-Term Debt 802,967 1,184,016 1,171,506 1,060,833 956,971 955,713 Long-Term Employee Benefit Obligations 391,607 328,254 374,222 340,938 270,495 444,874 Deffered Income Taxes and Other 105,459 103,587 88,906 147,695 184,526 88,012

Total Non-Current Liabilities 1,300,033 1,615,857 1,634,634 1,549,466 1,411,992 1,488,599 1,442,211 1,293,674 1,130,878 952,453 756,899 542,573 307,671 50,218 (231,950) (541,206) Total Liabilities 2,548,125 2,675,299 2,684,716 2,848,859 2,988,321 2,967,408 3,146,697 3,161,790 3,178,333 3,196,465 3,216,336 3,238,116 3,261,986 3,288,147 3,316,821 3,348,246

Commitments and Contingencies - - - - - -

Shareholders' EquityESOP convertible preferred stock - $1 par value 37,945 34,448 31,142 - - - Preferred stock, series A - $1 par value - - - - - - Common Stock - $1 par value 332,662 332,662 332,662 332,662 332,662 332,662 Capital in excess of par value 185,122 257,178 414,515 615,846 873,535 1,125,368 Retained Earnings 3,507,349 3,950,592 4,264,778 4,805,852 5,345,697 5,995,787 6,701,524 7,475,011 8,322,754 9,251,879 10,270,201 11,386,281 12,609,506 13,950,159 15,419,516 17,029,931 Unearned ESOP compensation (7,847) (3,693) - - - - Deffered Compensation 8,496 8,974 10,222 10,280 11,134 12,205 Common Stock in treasury (1,137,583) (1,439,934) (1,816,756) (2,297,493) (2,698,016) (3,105,893) Accumulated other comprehesive income (loss) (445,286) (243,273) (168,700) (183,195) (28,808) 1,828 Total Shareholders' Equity 2,480,858 2,896,954 3,067,863 3,283,952 3,836,204 4,361,957 5,067,694 5,841,181 6,688,924 7,618,049 8,636,371 9,752,451 10,975,676 12,316,329 13,785,686 15,396,101 Total Liabilities and Shareholders' Equity 5,028,983 5,572,253 5,752,579 6,132,793 6,824,525 7,329,365 8,214,390 9,002,972 9,867,257 10,814,514 11,852,707 12,990,567 14,237,661 15,604,477 17,102,507 18,744,347

Actual Balance Sheet Forecasted Balance Sheet

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Becton, Dickinson and CompanyConsolidated Balance Sheets (Restated)September 30

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017AssetsCurrent Assets Cash and equivalents 4.8% 9.2% 12.2% 16.5% 14.1% 6.7% Short-term investments 0.0% 0.0% 0.5% 1.4% 1.5% 2.1% Trade receivables, net 14.7% 13.6% 13.7% 13.3% 12.5% 14.2% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0% 14.0% Inventories 13.5% 13.7% 12.6% 12.3% 12.4% 13.8% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5% 13.5% Prepaid expenses, deferred taxes and other 4.7% 4.2% 4.8% 3.6% 4.5% 4.3% Assets held for sale 0.0% 3.5% 1.1% 0.0% 0.0% 0.0% Total Current Assets 37.8% 44.2% 44.9% 47.1% 45.0% 40.9% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5%Property, Plant and Equipment, Net 34.8% 32.4% 32.0% 30.6% 30.2% 32.7% 33.2% 33.2% 33.2% 33.2% 33.2% 33.2% 33.2% 33.2% 33.2% 33.2%Goodwill 9.7% 7.9% 8.0% 7.4% 8.0% 8.1% 8.2% 8.2% 8.2% 8.2% 8.2% 8.2% 8.2% 8.2% 8.2% 8.2%Core and Developed Technology, Net 5.6% 3.4% 3.2% 2.6% 3.5% 4.9%Other Intangibles, Net 2.5% 1.8% 1.6% 1.6% 1.3% 1.3%Capitalized Software, Net 5.6% 5.4% 4.8% 3.6% 2.7% 1.9%Capitalized R&D 0.8% 1.5% 2.3% 3.0% 3.5% 4.2%Other 3.1% 3.4% 3.2% 4.1% 5.9% 6.1%

Total Non-Current Assets 62.2% 55.8% 55.1% 52.9% 55.0% 59.1% 58.5% 58.5% 58.5% 58.5% 58.5% 58.5% 58.5% 58.5% 58.5% 58.5% Total Assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

LiabilitiesCurrent Liabilities Short-term debt 17.1% 4.6% 1.8% 7.2% 14.3% 7.0% Accounts Payable 8.8% 8.2% 7.7% 8.9% 8.2% 9.0% Accrued expenses 12.2% 13.4% 14.3% 15.4% 16.4% 16.2% Salaries, wages and related items 8.9% 9.7% 11.5% 11.6% 12.7% 14.7% Income taxes 2.1% 2.8% 3.2% 2.5% 1.2% 2.9% Liabilities held for sale 0.0% 0.9% 0.5% 0.0% 0.0% 0.0% Total Current Liabilities 49.0% 39.6% 39.1% 45.6% 52.7% 49.8% 49.5% 49.5% 49.5% 49.5% 49.5% 49.5% 49.5% 49.5% 49.5% 49.5%Long-Term Debt 31.5% 44.3% 43.6% 37.2% 32.0% 32.2%Long-Term Employee Benefit Obligations 15.4% 12.3% 13.9% 12.0% 9.1% 15.0%Deffered Income Taxes and Other 4.1% 3.9% 3.3% 5.2% 6.2% 3.0%

Total Non-Current Liabilities 51.0% 60.4% 60.9% 54.4% 47.3% 50.2% 50.5% 50.5% 50.5% 50.5% 50.5% 50.5% 50.5% 50.5% 50.5% 50.5% Total Liabilities 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Commitments and Contingencies

Shareholders' EquityESOP convertible preferred stock - $1 par value 1.5% 1.2% 1.0% 0.0% 0.0% 0.0%Preferred stock, series A - $1 par value 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Common Stock - $1 par value 13.2% 11.2% 10.4% 9.6% 8.1% 7.1%Capital in excess of par value 7.3% 8.6% 12.9% 17.7% 21.4% 24.0%Retained Earnings (before adjustment) 139.1% 132.4% 133.2% 138.5% 130.9% 128.1% Adjustment due to cap. of R&D 1.6% 2.9% 4.2% 5.4% 6.1% 6.8%Retained Earnings (after adjustment) 140.7% 135.3% 137.4% 143.8% 137.0% 134.9% 138.0% 138.0% 138.0% 138.0% 138.0% 138.0% 138.0% 138.0% 138.0% 138.0%Unearned ESOP compensation -0.3% -0.1% 0.0% 0.0% 0.0% 0.0%Deffered Compensation 0.3% 0.3% 0.3% 0.3% 0.3% 0.3%Common Stock in treasury -45.1% -48.3% -56.8% -66.2% -66.1% -66.3%Accumulated other comprehesive income (loss) -17.7% -8.2% -5.3% -5.3% -0.7% 0.0% Total Shareholders' Equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%Total Liabilities and Shareholders' Equity

Actual Balance Sheet (restated) Forecasted Balance Sheet (restated)

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Becton, Dickinson and CompanyConsolidated Balance Sheets (Restated)September 30

(thousands of dollars) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017AssetsCurrent Assets Cash and equivalents 243,115 519,886 719,378 1,042,890 1,000,289 511,482 Short-term investments 1,850 - 32,119 86,808 106,386 158,040 Trade receivables, net 745,998 772,067 807,380 842,806 885,748 1,083,152 1,188,348 1,302,430 1,427,463 1,564,500 1,714,692 1,879,302 2,059,715 2,257,448 2,474,163 2,711,682 Inventories 686,219 776,220 738,778 775,949 875,738 1,051,959 1,145,907 1,255,915 1,376,482 1,508,625 1,653,453 1,812,184 1,986,154 2,176,825 2,385,800 2,614,836 Prepaid expenses, deferred taxes and other 240,048 239,983 279,985 226,861 317,092 325,933 Assets held for sale - 195,303 63,694 - - - Total Current Assets 1,917,230 2,503,459 2,641,334 2,975,314 3,185,253 3,130,566 3,522,604 3,860,774 4,231,409 4,637,624 5,082,836 5,570,788 6,105,584 6,691,720 7,334,125 8,038,201 Property, Plant and Equipment, Net 1,765,730 1,831,791 1,880,997 1,933,718 2,133,548 2,497,338 2,818,084 3,088,620 3,385,127 3,710,099 4,066,269 4,456,631 4,884,467 5,353,376 5,867,300 6,430,561 Goodwill 492,327 445,854 473,211 470,049 565,146 621,414 696,033 762,852 836,086 916,350 1,004,319 1,100,734 1,206,405 1,322,219 1,449,152 1,588,271 Core and Developed Technology, Net 283,166 193,238 188,541 165,381 244,811 374,779 Other Intangibles, Net 126,758 102,538 93,466 101,558 91,501 95,938 Capitalized Software, Net 284,109 305,536 283,918 229,793 189,355 142,738 Capitalized R&D 41,441 86,288 133,418 186,951 247,325 319,335 Other 159,663 189,837 191,112 256,980 414,911 466,592 Total Non-Current Assets 3,153,194 3,155,082 3,244,663 3,344,430 3,886,597 4,518,134 4,965,599 5,442,296 5,964,757 6,537,374 7,164,961 7,852,798 8,606,666 9,432,906 10,338,465 11,330,958 Total Assets 5,070,424 5,658,541 5,885,997 6,319,744 7,071,850 7,648,700 8,488,203 9,303,071 10,196,166 11,174,998 12,247,797 13,423,586 14,712,250 16,124,626 17,672,590 19,369,159

Current Ratio 0.88 0.87 0.91 0.91 0.90 0.90 0.90 0.90 0.90 0.90 0.90 0.90 0.90 0.90 0.90

LiabilitiesCurrent Liabilities Short-term debt 434,642 121,858 49,289 206,509 427,218 207,634 Accounts Payable 224,645 219,804 206,941 252,262 243,602 266,993 Accrued expenses 310,238 358,931 384,936 439,894 490,425 481,429 Salaries, wages and related items 225,694 258,749 307,996 329,864 380,478 435,854 Income taxes 52,873 74,986 86,739 70,864 34,606 86,899 Liabilities held for sale - 25,114 14,181 - - - Total Current Liabilities 1,248,092 1,059,442 1,050,082 1,299,393 1,576,329 1,478,809 1,164,177 778,150 355,064 (108,639) (616,857) (1,173,864) (1,784,343) (2,453,429) (3,186,747) (3,990,463) Long-Term Debt 802,967 1,184,016 1,171,506 1,060,833 956,971 955,713 Long-Term Employee Benefit Obligations 391,607 328,254 374,222 340,938 270,495 444,874 Deffered Income Taxes and Other 105,459 103,587 88,906 147,695 184,526 88,012 Total Non-Current Liabilities 1,300,033 1,615,857 1,634,634 1,549,466 1,411,992 1,488,599 1,187,696 793,870 362,237 (110,834) (629,319) (1,197,578) (1,820,391) (2,502,993) (3,251,125) (4,071,078) Total Liabilities 2,548,125 2,675,299 2,684,716 2,848,859 2,988,321 2,967,408 2,351,874 1,572,020 717,300 (219,472) (1,246,175) (2,371,442) (3,604,734) (4,956,422) (6,437,872) (8,061,541)

Commitments and Contingencies - - - - - -

Shareholders' EquityESOP convertible preferred stock - $1 par value 37,945 34,448 31,142 - - - Preferred stock, series A - $1 par value - - - - - - Common Stock - $1 par value 332,662 332,662 332,662 332,662 332,662 332,662 Capital in excess of par value 185,122 257,178 414,515 615,846 873,535 1,125,368 Retained Earnings (before adjustment) 3,507,349 3,950,592 4,264,778 4,805,852 5,345,697 5,995,787 Adjustment due to cap. of R&D 41,441 86,288 133,418 186,951 247,325 319,335 Retained Earnings (after adjustment) 3,548,790 4,036,880 4,398,196 4,992,803 5,593,022 6,315,122 7,770,160 9,364,881 11,112,695 13,028,300 15,127,803 17,428,858 19,950,814 22,714,878 25,744,292 29,064,530 Unearned ESOP compensation (7,847) (3,693) - - - - Deffered Compensation 8,496 8,974 10,222 10,280 11,134 12,205 Common Stock in treasury (1,137,583) (1,439,934) (1,816,756) (2,297,493) (2,698,016) (3,105,893) Accumulated other comprehesive income (loss) (445,286) (243,273) (168,700) (183,195) (28,808) 1,828 Total Shareholders' Equity 2,522,299 2,983,242 3,201,281 3,470,903 4,083,529 4,681,292 6,136,330 7,731,051 9,478,865 11,394,470 13,493,973 15,795,028 18,316,984 21,081,048 24,110,462 27,430,700 Total Liabilities and Shareholders' Equity 5,070,424 5,658,541 5,885,997 6,319,762 7,071,850 7,648,700 8,488,203 9,303,071 10,196,166 11,174,998 12,247,797 13,423,586 14,712,250 16,124,626 17,672,590 19,369,159

Actual Balance Sheet (restated) Forecasted Balance Sheet (restated)

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In the above tables, it shows both the actual balance sheet and the forecasted. Also,

the common size balance sheets of both the actual and forecasted are there as well. Since we

had to restate BDX’s financials, the restated balance sheets are also provided above.

The first item on the balance sheet to forecast is total assets. This number is like sales

on the income statement. Total assets are used as a back bone to forecast the rest of the

asset section. In order to forecast the total assets for 2008, we needed to forecast sales for

2009. After the sales in 2009 were forecasted, we divide the sales by the asset turnover. The

asset turnover is used to link the income statement and the balance sheet. The asset turnover

for the as stated financials was .93. The asset turnover for the restated financials was .90.

The reason why the numbers are different is because there are more assets on the restated

financials. In order to calculate the total assets in 2017, we needed to forecast the sales in

2018.

After the total assets have been computed, we determined what percentage of total

assets current and non-current were. Since, the restated financials weren’t that significantly

different we used the same percentages on both restated and as stated. We determined that

BDX carried more non-current assets than current assets. Both of them varied from year to

year. We determined the current assets to be 41.5% of total assets for the next ten years

because it was around the average for the past six years and also because there was a

miniature trend. Since the current assets were 41.5%, non-current assets had to be 58.5% of

total assets. This percentage was right around the trend for the non-current assets. After we

computed all the totals, we computed the inventory, accounts receivables, PP&E, and goodwill.

All of these percentages were very consistent from year. They were all within a couple of

percentages from the year before. Because of the consistency, they were very easy to

forecast. We computed the percentages to be inventory of 13.5%, accounts receivables of

14.0%, PP&E of 33.2%, and goodwill of 8.8% for as stated and 8.2% for restated. Goodwill

was the only account that was greatly different than the as stated amount so we lowered the

percentage to account for the additional asset, aka capitalized R&D. Now that we have the

asset section done, the total assets number is also now the total liabilities and stockholders’

equity.

After we computed the asset section, we computed the stockholders’ equity section.

Since the balance sheet is harder to forecast, the asset and stockholders’ equity section are

not as distorted as the liability section. The only item that we forecasted in this section was

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the retained earnings. On the common size balance sheet, the retained earnings looks very

troubling. The only reason why it is over 100% is because there are going to other accounts

that will have negative balances and it will balance back down to 100%. The ending balance of

retained earnings was calculated as beginning balance plus net income minus dividends for the

year. Since this was the only item that was forecasted in this section, the total stockholders’

equity was calculated the exact same way.

The last section on the balance sheet to compute is the liabilities section. Since the

asset and stockholders’ equity need to be more accurate than the liabilities section, this

section will be a little distorted. The way it will be distorted will be non-current liabilities could

be negative in the later years. BDX’s liabilities section is pretty much 50-50 between current

and non-current. We forecasted the current liabilities at 49.5% and the non-current liabilities

at 50.5%.

After forecasting all the balance sheets, all forecasted numbers were very reasonable

from year to year. Now that the balance sheet is completed, we now need to forecast the

statement of cash flows.

Statement of Cash Flows

The statement of cash flows is by far the most difficult to forecast. The

statement of cash flows provides valuable information to potential investors. This financial

statement breaks down the cash flows into three sections. These sections include cash flows

from financing, operating, and investing activities. Since the degree of difficulty is high, the

amount of forecasting is very small. This is shown and discussed below.

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Consolidated Statements of Cash FlowsYears Ended September 30

2002 2003 2004 2005 2006 2007Operating ActivitiesNet Income 57.9% 60.6% 42.4% 59.2% 68.1% 72.0%(Income) loss from discontinued operations, net -0.1% 0.9% 10.4% -0.8% 5.7% -2.7%Income from continuing operations, net 57.8% 61.5% 52.8% 58.4% 73.8% 69.3%Adj to income from continuing operations Depreciation and amortization 35.8% 37.2% 32.4% 31.3% 36.4% 35.7% Share-based compensation 0.0% 0.0% 0.2% 5.8% 9.8% 8.7% Pension contributions -13.3% -12.4% -3.4% 0.0% 0.0% 0.0% Deferred income taxes 7.0% 0.7% -2.8% 5.2% -9.8% -9.3% Losses on investments 4.0% 0.5% 0.4% 0.0% 0.0% 0.0% Acquired in-process R&D 0.0% 0.0% 0.0% 0.0% 4.8% 9.9% Non-cash special charges 0.8% 0.0% 0.0% 0.0% 0.0% 0.0% Change in operating assets and liabilities Trade receivables, net 3.7% 3.5% -1.4% -2.8% -1.8% -9.5% Inventories 2.7% -5.5% 2.0% -4.7% -9.0% -10.3% Prepaid Expenses, deferred taxes and other -0.1% 1.0% -0.9% -0.1% -11.1% -2.0% Accounts Payable, taxes and other liab. -0.1% 7.3% 9.0% 8.8% 9.1% 8.3% Pension obligation 0.0% -5.2% 4.4% -4.8% -5.9% -1.8% Other, net 1.6% -0.2% 0.8% 2.9% 3.6% 1.0%Net Cash Provided by Continuing Operating Activities 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Investing ActivitiesCapital expenditures 71.6% 74.4% 67.2% 83.1% 58.3% 54.6%Capitalized software 22.8% 18.6% 9.9% 5.0% 2.9% 2.2%Change in short-term investments -0.9% -0.6% 7.9% 11.5% 2.4% 3.0%Purchases of long-term investments 1.0% 1.3% 2.6% 0.3% 1.2% 0.4%Acquisitions of businesses, net of cash acquired 0.0% 0.0% 6.1% 0.0% 29.5% 33.3%Proceeds from discontinued operations 0.0% 0.0% 0.0% -16.3% 0.0% -2.0%Other, net 5.6% 6.3% 6.2% 16.5% 5.7% 8.4%Net Cash Provided by Continuing Investing Activities 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Financing ActivitiesChange in short-term debt 6.0% 110.7% 11.1% -30.5% -35.5% 16.7%Proceeds of long-term debt -1.2% -140.1% 0.0% 0.0% 0.0% 0.0%Payments of debt 3.1% 2.2% 4.3% 20.3% 0.2% 13.9%Repurchase of common stock 71.6% 121.2% 88.8% 106.7% 131.2% 62.0%Issuance of common stock -12.2% -30.0% -34.2% -24.0% -43.2% -18.0%Excess tax benenfit from compensation plans 0.0% 0.0% 0.0% -7.9% -14.8% -7.6%Dividends paid 32.8% 36.1% 30.1% 35.3% 62.1% 33.0%Net Cash Provided by Continuing Financing Activities 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Discontinued Operations: Net cash provided by operating activities Net cash used for investing activities Net cash used for financing activitiesNet Cash Provided by Discontinued OperationsEffect of exchange rate changes on cashNet (Decrease) Increase in Cash and EquivalentsOpening Cash and equivalentsClosing Cash and Equivalents

Actual Statement of Cash Flows

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Consolidated Statements of Cash FlowsYears Ended September 30

(thousands of dollars) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017Operating ActivitiesNet Income 479,982 547,056 467,402 722,263 752,280 890,033 940,982 1,031,317 1,130,323 1,238,834 1,357,762 1,488,107 1,630,966 1,787,538 1,959,142 2,147,220 (Income) loss from discontinued operations, net (630) 7,874 115,102 (9,743) 62,830 (33,866) Income from continuing operations, net 479,352 554,930 582,504 712,520 815,110 856,167 Adj to income from continuing operations Depreciation and amortization 296,576 335,759 357,224 382,669 402,332 441,341 Share-based compensation - - 2,466 70,199 108,613 107,706 Pension contributions (110,325) (112,132) (37,468) - - - Deferred income taxes 58,372 5,921 (31,345) 63,769 (108,285) (115,489) Losses on investments 32,777 4,116 4,918 - - - Acquired in-process R&D - - - - 53,300 122,133 Non-cash special charges 6,526 - - - - - Change in operating assets and liabilities Trade receivables, net 31,086 31,450 (15,854) (34,332) (19,977) (117,048) Inventories 22,610 (49,854) 22,534 (57,371) (99,505) (126,863) Prepaid Expenses, deferred taxes and other (419) 8,596 (10,028) (897) (122,496) (24,965) Accounts Payable, taxes and other liab. (498) 65,500 99,447 107,929 100,636 102,996 Pension obligation - (47,382) 48,045 (58,842) (64,971) (22,119) Other, net 13,226 (1,987) 9,182 35,105 39,416 12,189 Net Cash Provided by Continuing Operating Activities 829,283 902,933 1,102,726 1,220,749 1,104,173 1,236,048 1,394,048 1,527,877 1,674,553 1,835,310 2,011,500 2,204,604 2,416,245 2,648,205 2,902,433 3,181,066

CFFO/Sales 0.21 0.20 0.22 0.23 0.19 0.19 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2

Investing ActivitiesCapital expenditures (255,705) (259,218) (265,718) (315,840) (457,067) (556,394) Capitalized software (81,376) (64,782) (39,190) (18,992) (22,454) (22,334) Change in short-term investments 3,054 1,975 (31,298) (43,775) (18,633) (30,167) Purchases of long-term investments (3,397) (4,399) (10,149) (1,171) (9,672) (3,881) Acquisitions of businesses, net of cash acquired - - (24,251) - (231,464) (339,528) Proceeds from discontinued operations - - - 62,051 - 19,971 Other, net (19,902) (21,987) (24,628) (62,566) (44,656) (85,922) Net Cash Provided by Continuing Investing Activities (357,326) (348,411) (395,234) (380,223) (783,946) (1,018,255) (229,840) (261,809) (286,943) (314,489) (344,680) (377,769) (414,035) (453,783) (497,346) (545,091)

Financing ActivitiesChange in short-term debt (18,756) (319,608) (56,509) 157,103 121,563 (121,102) Proceeds of long-term debt 3,827 404,683 Payments of debt (9,543) (6,386) (21,682) (104,522) (828) (100,790) Repurchase of common stock (223,961) (349,998) (449,930) (549,999) (448,882) (450,124) Issuance of common stock 38,069 86,618 173,606 123,494 147,796 130,679 Excess tax benenfit from compensation plans - - - 40,594 50,609 55,118 Dividends paid (102,459) (104,148) (152,376) (182,236) (212,431) (239,810) (235,246) (257,829) (282,581) (309,709) (339,441) (372,027) (407,741) (446,885) (489,786) (536,805) Net Cash Provided by Continuing Financing Activities (312,823) (288,839) (506,891) (515,566) (342,173) (726,029)

Discontinued Operations: Net cash provided by operating activities - - (1,063) (3,954) (27,773) 4,388 Net cash used for investing activities - - (1,601) (528) (2,580) - Net cash used for financing activities - - (62) (15) - - Net Cash Provided by Discontinued Operations 2,038 (1,003) (2,726) (4,497) (30,353) 4,388 Effect of exchange rate changes on cash (186) 12,091 1,617 3,049 9,698 15,041 Net (Decrease) Increase in Cash and Equivalents 160,986 276,771 199,492 323,512 (42,601) (488,807) Opening Cash and equivalents 82,129 243,115 519,886 719,378 1,042,890 1,000,289 Closing Cash and Equivalents 243,115 519,886 719,378 1,042,890 1,000,289 511,482

Actual Statement of Cash Flows Forecasted Statement of Cash Flows

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In the above tables, it shows both the actual statement of cash flows and the

forecasted. Also, the common size statement of cash flows of the actual are there as well.

The statement of cash flows was not required to restate, so it isn’t shown.

In order to forecast the cash flows from operations we found the most consistent ratio

to be the Cash Flows from Operations/Sales to be the most reliable and steady. This allowed

us to forecast the future CFFO for the next ten years. The ratio was pretty consistent

throughout the six years. We determined that a ratio of .2 would work well. Next, we took the

sales from 2008 and multiplied this number by the average ratio to get the cash flows from

operations in 2008. We used this formula to forecast the cash flows from operations for the

next ten years. The net income was the same number as forecasted earlier on the income

statement.

The next section to forecast was the cash flows from investing activities. There were a

couple of ways to forecast this amount. We choose to take the difference in plant, property,

and equipment to determine cash flows from investing activities.

The last section to forecast was the cash flows from financing activities. The only

account we needed to forecast was dividends. Forecasting dividends was very important.

Dividends are needed to forecast retained earnings which in turn forecasts stockholders’

equity. We noticed that BDX paid a consistent 20% of their net income each year to

dividends. This worked out very well for us. To forecast the next ten years of dividends, we

multiplied net income by 20%.

Conclusion

After forecasting the future financial statements of BDX, it allows us to see that they

will continue to grow steadily within the industry average. This also provides valuable

information as to how the company’s current activities will affect their long term position in the

industry. We expect their sales to grow at a rate of 9.6% per year. We believe that rate is

very reasonable and around the industry average. After all of the forecasting, we believe that

BDX will continue to grow and be a leader in this highly competitive industry.

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Estimating Cost of Capital

Cost of Equity

The cost of equity is the minimum rate of return that investors require for purchasing

stock for the company. When financing a company, there are two types of people. There are

the shareholders and people who lend money to the company. When a company goes out of

business, the company pays off their debt first and if they have any money left then that

money goes to the shareholders. Since the shareholders get paid last, their required risk

needs to be higher in order for them to potentially not lose any money. So, the higher the

cost of equity, then the higher rate of return.

One way to calculate the cost of equity is to use the Capital Asset Pricing Model, also

known as CAPM. This formula is derived by using the risk-free rate (U.S. Treasury Yield), beta

(Unsystematic Risk), and the market risk-premium (Market Risk – Risk Free Rate).

To calculate our cost of equity for BDX, we first had to find the treasury yields, which

we gathered from the St. Louis Federal Reserve website. These yields included the 3 month, 6

month, 2 year, 5 year, and 10 year. In order to achieve an accurate treasury yield, we

decided to use different lengths. An accurate treasury yield, will lead to a more accurate beta.

Besides the risk free rate and beta, we also had to find the market return, which we calculated

by using S&P 500’s prices and BDX’s stock history for the past six years. Both of these prices

were taking at the beginning of the month for all years. By calculating the change in price

from month to month, we were able to calculate the monthly return. Using this monthly

return, we were then able to calculate the market risk premium.

After we had all the data we needed, next was to run a regression on the data. In

order to estimate an accurate beta we had to use different amounts of months. We decided

to run regression over a 24, 36, 48, 60, and 72 month time periods to estimate beta. We ran

the regression on the 3 month, 6 month, 2 year, 5 year, and 10 year using the month time

periods. Then we compared the results from all the different tables. When choosing our beta

that best represents the unsystematic risk of the firm, we had to analyze the explanatory

power of the regressions, also know as the adjusted R². A higher explanatory power means

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that the firm’s percent of variation in expected return can be explained by the percent of

variation in the market risk premium.

After running all of these regressions, we looked at each beta and determined which

had the highest explanatory power. We concluded that the best beta in every regression was

the 72 month time period. The best one out of those was the 3 month treasury yield at 72

months. The results of the regressions are shown below.

3-Month

Months Beta Adj R²

72 0.68 0.192

60 0.62 0.09

48 0.72 0.13

36 0.59 0.07

24 0.13 -0.04

6-Month

Months Beta Adj R²

72 0.68 0.19

60 0.62 0.09

48 0.72 0.13

36 0.59 0.07

24 0.13 -0.04

2-Year

Months Beta Adj R²

72 0.69 0.19

60 0.62 0.09

48 0.72 0.13

36 0.60 0.07

24 0.14 -0.04

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5-Year

Months Beta Adj R²

72 0.69 0.19

60 0.62 0.09

48 0.72 0.13

36 0.60 0.07

24 0.14 -0.04

10-Year

Months Beta Adj R²

72 0.69 0.19

60 0.62 0.09

48 0.72 0.13

36 0.60 0.07

24 0.14 -0.03

Above are the results of the regressions for each of the treasury yields. As you can tell

by the tables, each table is almost the same, but some numbers might be different by a

percentage. This is the results that we expected. The highest explanatory power is the same

between the different treasury yields. As we mentioned earlier, the beta we choose was the

beta from the 3-month treasury yield at 72 months. When it comes to financial analysis, there

are usually a couple of analysts for every company. For example, on Yahoo Finance they run

the same figures as we do, but we do not know how well they analyze. After there analysis,

they came up with a beat of .6. This number is .1 of our number. This information ensures us

that we estimating beta correctly and that this beta will now be used to calculate our cost of

equity.

Now that we know our beta, we need to calculate our cost of equity (Ke). In order to

calculate the cost of equity, we used CAPM. We determined that the risk free rate used in this

equation was 3.88% and the market risk premium was 7%. After plugging all the numbers

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into the equation, we came up with a raw Ke of 8.7%. We then had to adjust it for the firm

size and the industry. After all the adjustments, our Ke came out to be 8.3% with a lower

bound of 6.41% and an upper bound of 10.94%. The upper and lower bounds are a estimate

of where the cost of equity should be.

Indirect Cost of Equity

After calculating the cost of equity, we needed something to compare it to in order for

us to feel comfortable to use it. One way to come up with a comparison Ke is to use the

indirect method, also known as the backdoor method. This method uses the book value of

equity per share (P/B), return on equity (ROE), and our forecasted earnings growth rate. The

data and calculations are shown below.

Indirect Ke P/B 4.03P/B-1 3.03ROE 0.17G 0.096 (P/B -1)*g 0.29ROE + (P/B-1)*g 0.46Ke 11.44%

Even though our indirect Ke of 11.44% is higher than our upper bound of 10.94%, we

still believe that Ke is still 8.3%. Indirect Ke is just used as a comparison and the actual Ke is

lower than the indirect Ke.

Cost of Debt

The cost of debt (Kd) is the rate at which firms borrow money from banks and other

lenders. To find the cost of debt, we used a weighted average formula and took the weight of

each liability, which is the dollar amount over the total liabilities, and multiplied it by the

appropriate interest rate. Most of the interest rates were found in the company’s 10-K

accounting notes. Like we said earlier, the cost of debt is lower than the cost of equity

because debt holders get paid before shareholders. BDX’s total liabilities for 2007 were

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approximately $2,967 million and our cost of debt came out to be 4.9%, which is reasonable

because our cost of equity is 8.3%. All of the calculations are shown below.

Shown above are the calculations for the cost of debt. Most of the interest rates are

given in the 10-K. We had to calculate the long-term debt interest rate. BDX provided the

interest rates on all of their debt. We took the weighted average of each of those rates to

come up with the 6% interest rate on long-term debt. We used a higher interest rate for

salaries and benefit obligations because those liabilities were required for our business. We

used the risk free interest rate for taxes because the government always gets their taxes and

we knew that BDX would have to pay them. The interest rate for short-term debt was

provided in the 10-K. We used a low interest rate for accrued expenses and accounts payable

because we knew that those for debts that BDX needed to do business. After all of these

calculations, we believe that the cost of debt of 4.9% is appropriate considering all of the

other rates.

Liabilities 2007 Weight Rate Weighted

Rate Current Liabilities

Short-term debt

207,634 0.070

0.052 0.004

Accounts Payable

266,993 0.090

0.021 0.002

Accrued expenses

481,429 0.162

0.021 0.003

Salaries, wages and related items

435,854 0.147

0.064 0.009

Income taxes

86,899 0.029

0.039 0.001

Total Current Liabilities

1,478,809

Long-Term Debt

955,713 0.322

0.060 0.019

Long-Term Employee Benefit Obligations

444,874 0.150

0.064 0.010

Deferred Income Taxes and Other

88,012 0.030

0.039 0.001

Total Non-Current Liabilities

1,488,599

Total Liabilities

2,967,408 Kd: 0.049

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Weighted Average Cost of Capital (WACC)

The weighted average cost of capital is the weighted sum of the cost of equity and the

cost of debt. It is also the average rate at which a firm will pay for its financed assets. There

are two types of weighted average cost of capital, one before tax, and one after tax. The

calculations are shown below.

MVD/MVA Cost of

Debt Tax Rate MVE/MVA

Cost of Equity WACC

WACC (BT) 0.13 4.9% 0 0.87 8.3% 7.8%WACC (AT) 0.13 4.9% 28.9% 0.87 8.3% 7.7%

The information above shows the WACC both before and after tax. The before tax

WACC was 7.8% and the after tax WACC was 7.7%. The tax rate was provided on BDX’s

2007 10-K. As you can tell, there is not that much difference between the two. Since free

cash flows are after tax, we used the before tax WACC for all other calculations.

Methods of Comparables

As stated earlier, the method of comparables is used to evaluate a firm’s financial

performance in relation to its direct competitors in the industry. This method allows investors

to match BDX’s performance with that of Boston Scientific, Baxter, and C.R. Baird, as well as

any other competitors in the medical supplies industry. For the purpose of arriving at a truer

industry average, we have included Stryker Corporation (SYK) and Alcon Incorporated (ACL) to

these comparables. When the subject firm is compared to other firms in the industry, they can

either be deemed as overvalued or undervalued. However, this model may not be adequate

because it doesn’t do a fair job of identifying firms’ key value drivers. For example, if a

company is holding a valuable asset that does not fit into one of these models, the firm could

be deemed as being overvalued, which would be inaccurate. We will use this method in order

to compare BDX’s share price of $84.45 on June 1, 2008, to that of its direct competitors in

the medical supplies industry. When determining whether or not BDX is over or undervalued

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compared to the industry, its suggested share price must fall within 15% of the published

(actual) share price.

Model Suggested Price Compared to Actual

Price

P/E Trailing 92.11 Fairly valued

P/E Forward 72.42 Fairly valued

P/B 71.77 Overvalued

P.E.G. 57.75 Overvalued

P/EBITDA 80.94 Fairly valued

P/FCF 40.02 Overvalued

EV/EBITDA 87.48 Fairly valued

D/P 130.55 Undervalued

June 1- Valuation Date 84.45

Price/Earnings Trailing

P/E (trailing) EPS PPS P/E PPS BDX 3.63 84.45 23.26 92.11BDX (restated) 6.35 84.45 13.30 161.13BSX - BAX 23.62BCR 24.28SYK 24.53ACL 29.07

Average 25.38

The Price to Earnings Trailing ratio is calculated by dividing a firm’s current price per

share closed on the valuation date by current period’s earnings per share. The numbers in the

above table come directly from Yahoo finance as of June 1, 2008. If a firm’s numbers vary too

124 | P a g e

much from the industry, they would be considered an outlier and should be left out. BDX’s P/E

ratio is not figured in with the above industry average because the purpose of this step is to

value them in relation to other competitors in the industry.

After analysis of this ratio, it is determined that BDX’s stock price is fairly valued

because their suggested PPS is $84.45, and their current PPS is $92.11. Since the current PPS

is within approximately 8% of the suggested price, our 15% error tolerance is easily satisfied.

With regard to BDX’s restated ratio, EPS was very high due to the fact that R&D expense was

capitalized resulting in net income to drastically increase. This increase in net income caused

their restated P/E trailing ratio to be very undervalued. Although this method can be used as a

tool in the valuation process, it cannot be the only source to derive a company’s true value.

With regard to classic financial theory, this ratio is somewhat imperfect due to the fact that

both inputs are backward looking, rather than looking forward into the future.

Price/Earnings Forecast

P/E (forecast) EPS PPS P/E BDX 3.84 84.45 21.99 72.42BDX (restated) 4.98 84.45 16.96 93.92BAX 17.20BSX 19.55BCR 17.54SYK 18.16ACL 21.85

Average 18.86

Next, in an attempt to counteract the previous ratio, we will analyze the forecasted

price to earnings ratio. This ratio deals with our earnings per share from the first year of

forecasted earnings. It is computed by dividing our first year of forecasted earnings by the

firm’s number of shares to common stock outstanding. In order to make the transformation

from total equity to EPS easier, we will choose to ignore any share issues or repurchases that

companies may be encountering. As stated previously, BDX does not factor into the industry

average because it would adjust the average to be more like BDX’s numbers, which would

defeat the purpose of this valuation ratio. After calculating the industry average P/E of BDX’s competitors, BDX’s comparable PPS

is derived by multiplying this number by one year into the future. BDX’s comparable PPS is

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72.42, which compared with their suggested PPS of 84.45, is approximately 14% lower. This

means that their suggested PPS just barely meets the 15% higher or lower requirement in

relation to the actual PPS. With regard to BDX’s restated ratio, the forecasted numbers used to

arrive at EPS only changed a small percentage and didn’t cause the firm to be under or

overvalued. This ratio is a good sign that BDX’s forecasted price to earnings ratio and their

earnings per share ratio are fairly accurate in their predicted values. Once again, because this

model only serves to value a firm in the short run, we must also place equal emphasis on the

other remaining models to achieve true market value.

Price to Book Value Ratio

P/B BPS PPS P/B

BDX 17.81 84.45

4.74 71.77

BDX (restated) 19.11 84.45

4.42 77.01BAX 5.64BSX 1.29BCR 4.88SYK 4.31ACL N/A

Average 4.03

The Price to Book Ratio is very important when it comes to valuing a company because

is compares overall value to the book value of equity. Initially, we divide our current price per

share by the book value per share. Next, we multiply our book value per share by the average

industry price to book ratio to derive the stock price. BDX’s actual PPS is 71.11, which is

slightly under our 15% error tolerance, meaning that BDX is overvalued with regard to its P/B

ratio. However, BDX’s restated ratio is fairly valued because of the extra equity added from the

capitalization of R&D.

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Dividends/Price

D/P DPS PPS D/P BDX 0.98 84.45 0.012 130.55BDX (restated) 0.98 84.45 0.012 130.55BAX 0.013BSX - BCR 0.007SYK 0.002ACL 0.008

Average 0.008

The Dividend/Price ratio, also known as the dividend payout ratio, is calculated by

dividing the dividends per share by the price per share. Next, divide the dividend per share by

the industry average to derive PPS. BDX’s computed share price was 133.55, which is a

difference of 54%, making BDX very undervalued with respect to the dividend payout ratio.

BDX’s restated ratio is the same because the capitalization of R&D had no effect on dividends

or price. This large variation between BDX’s comparable PPS and suggested PPS once again

explains how share prices can be misleading when it comes to establishing true value for a

firm.

P.E.G Ratio

P.E.G. P/E Growth Rate P.E.G.2 BDX 23.26 9.60% 1.32 57.75BDX (restated) 13.30 9.60% 1.39 101.03BAX 1.49BSX 1.64BCR 1.40SYK 1.20ACL 1.67

Average 1.48

In order to calculate the Price to earnings growth (P.E.G.) ratio we must use the current

price per share, forecasted earnings per share, and the average five year growth. To find the

price per share we use the average P.E.G ratio for the industry and multiply it by the average

127 | P a g e

growth rate and earnings per share. Using this model, we calculated BDX’s comparable price

to be $57.75, which is about 26% lower than our suggested share price. Once again, since

this fails to meet our 15% error tolerance, we can say with certainty that BDX is overvalued

with regard to the comparable model. However, BDX’s restated share price is $101.03 which is

undervalued. This is undervalued due to the P/E ratio being lower. The P/E ratio is lower

because BDX’s earnings per share increased because of the capitalization of R&D. Yet again,

we see how a firm’s numbers can be misleading and should undergo further analysis in order

to derive a fair market value.

Price to EBITDA

P/EBITDA PPS EBITDA P/EBITDA

BDX 84.45 6.67 12.66 80.94

BDX (restated) 84.45 7.97 10.60 96.71

BAX 61.10 4.64 13.16

BSX 13.29 1.48 8.98

BCR 91.20 6.40 14.26

SYK 74.72 1.77 N/A ACL 143.04 2.18 N/A

Average

12.13

We calculate the price to EBITDA ratio by dividing price per share by EBITDA, which

stands for earnings before interest, taxes, depreciation, and amortization. Because this

number represents a firm’s earnings before interest or depreciation, we can conclude that this

represents a cash flow to the firm. The lower the number the better because a low number

illustrates the close relationship between a firm’s market price and its generated value. This

ratio also conveys to the analyst how the cash earnings from operations uphold the market

value of equity, or market capitalization rate. Using this method of comparables, we have

calculated BDX’s comparable share price to be $80.94 which is just about 3% lower than the

suggested share price, and therefore, within our tolerance level. This would lead us to believe

that BDX is fairly valued with respect to this model. Also, BDX’s restated ratio is within the

15% error tolerance interval making it fairly valued as well.

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Price/FCF

P/FCF PPS FCF(per share) P/FCF2 BDX PPS BDX 84.45 0.89 94.89 40.02BDX (restated) 84.45 0.89 94.89 40.02BAX 61.1 3.11 19.65BSX 13.29 0.31 42.87BCR 91.20 4.23 21.56SKY 74.72 1.63 45.84ACL 143.04 2.97 48.16

Average 35.62

This method compares a firm’s market price to its level of annual free cash flow, and is

calculated by taking the price per share and dividing it by the firm’s free cash flows. A firm’s

free cash flows are calculated by adding their operating cash flows and investing cash flows.

Once we calculate Becton Dickinson’s P/FCF and the P/FCF of their competitors, we can than

derive an industry average using the P/FCF of their competitors. We than multiplied the

industry average P/FCF by Becton Dickinson’s FCF, and derived a share price of 40.02. By

comparing our derived share price of $40.02 with Becton Dickinson’s current share price of

$84.45, we see a substantial difference. The method of comparables does not provide an

appropriate estimate of the firm’s share price, since our Price/FCF is substantially larger than

everyone else in the industry.

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Enterprise Value/EBITDA

EV/EBITDA EV EBITDA EV/EBITDA

BDX 22,394,310

1,633,676

13.71

87.48

BDX (restated) 22,394,310

1,953,011

11.47 106.41

BAX 13.25BSX 11.78BCR 13.09SKY 13.41ACL 21.08

Average 14.52

This method uses the firm’s enterprise values. Enterprise value is similar to

a market cap and can be thought of as a “take over price” (investopedia.com).

Enterprise value equals the market value of equity plus the value of liabilities, minus cash and

cash equivalents (MVE+ Value of Liabilities – (Cash and equivalents)), and is a useful tool in

estimating the value of the firm. This is a non GAAP measure and has a possibility of

distortion. EBITDA was taken from the company’s most recent 10-K. This method is done by

multiplying the industry average (based on EV/EBITDA) by the EBITDA, then subtracting back

liabilities, cash, and cash equivalents as stated on the most recent balance sheet. The model

produces a price of $106.41 which shows that the company is once again overvalued.

Intrinsic Valuation Models

The intrinsic valuation models more accurately reflect the value of the firm when

comparing these models to the method of comparables. The intrinsic models include more

theory based assumptions while the method of comparables is looking at historical

information. The intrinsic models include the discounted dividends, discounted free cash flow,

residual income, long-run residual income, and abnormal earnings growth. Since we had to

restate BDX’s financials, we restated all the models except for free cash flows and discounted

dividends model to account for the capitalized R&D. The reason why we did not restate the

free cash flows model was because we did not restate the statement of cash flows. The

reason why we did not restate the discounted dividends model was because the amount of

130 | P a g e

dividends was the same for as stated and restated. We understand that the numbers would

be different because net income is what drives part of the statement of cash flows, but it

wasn’t required to restate the statement of cash flows. We will discuss and shown the

computations for each model down below.

Discounted Dividends Model

The discounted dividends model is the least accurate model of the intrinsic valuation

models. It is nearly impossible to value a company based on forecasted future dividends

because dividends are subject to change regularly and extremely tough to forecast with

reasonable accuracy in the long run. Also, the payback period is unrealistic. If the dividend

yield is 2% per year, and you invested $50 in the company, it would take 25 years to recover

your initial investment. Not very many people are going to hold on to a stock for 25 years just

to recover their initial investment. This model uses estimated future dividends on a per share

basis, which we forecasted by taking 20% of net earnings and dividing by the number of

shares outstanding, and uses the DPS to estimate the company’s share price.

After calculating the firms DPS, we needed to discount the forecast DPS for 2008

through 2017 back to 2007. The appropriate discount rate for the discounted dividends model

is cost of equity, Ke. The reason why Ke is the appropriate discount rate is because dividends

are paid to shareholders, who in turn, require a high cost of capital.

After we calculate the present value of the year-by-year DPS, we then had to calculate

the present value of the terminal value perpetuity, which starts in 2018. After looking over the

trend of DPS, we calculated the DPS in 2018 to be 2.38. We then divided the 2.38 by the

discount rate minus the growth rate. Now the terminal value perpetuity is in year 2017

dollars. In order to get the present value of the terminal value perpetuity, we multiplied it by

the present value factor for 2017, which was 0.45.

Now that we know the present value of the year-by-year and terminal value perpetuity,

the sum of those numbers is equal to the share price on September 30, 2007. We are valuing

the company as of June 1, 2008. So, we multiplied the model price by 1+Ke then rose to

8/12. The 8/12 represents the amount of months needed to get from September to June.

The sensitivity analysis of the discounted dividends model is shown below.

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For the discounted dividends model, we used a Ke of 8.3%. The 6.4% and 10.9%

represents the lower and upper bounds. Using our initial Ke and a zero percent growth, we

computed a share price of 23.50 compared to the observed share price on June 1, 2008 of

84.45. Like we mentioned earlier, this model is the least accurate of the models. From this

model, the stock price of BDX is extremely overvalued. This is just one of the many models.

The discounted free cash flow model is next.

Discounted Free Cash Flows Model

The next intrinsic model would be the discounted free cash flows model. This model

involves the present value of the forecasted future free cash flows and the present value of

the perpetuity. The growth rate is used to when finding the present value of the perpetuity. A

high growth rate leads to a higher share price. We used a lower growth rates because if the

rate was over 3% then the share price was too high. In order to find out how much free cash

flow were we took cash flows from operating activities (CFFO) and added cash flows from

investing activities (CFFI). If CFFI was a positive number, then we would have to subtract it

instead of adding it. In order to find the present value, when need to use the appropriate

discount rate. The discounted free cash flows model is the only model that uses WACC before

tax rather than Ke. We use the WACC before tax because net income is already taxed and it is

included in cash flow from operations. This avoids double taxation. As stated earlier, our

WACC before tax is 7.8%. The sensitivity analysis is shown below and also discussed.

G0.00 0.02 0.04 0.06 0.08

Ke 0.064 31.63 41.10 66.37 344.26 n/a0.070 28.57 35.80 52.68 137.06 n/a0.075 26.40 32.28 44.87 91.03 n/a0.083 23.50 27.82 36.17 59.04 386.800.090 21.40 24.78 30.86 45.06 116.050.100 18.93 21.38 25.45 33.60 58.04 0.109 17.12 18.99 21.94 27.30 40.05

Overvalued < $71.78Fairly Valued is within 15% of share price

Undervalued > $97.12

Observed Share Price = 84.45

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The table above shows the sensitivity analysis for the discounted free cash flows model.

After we find the present value of the free cash flows year by year, we take the sum of them.

We then add the present value of year by year cash flows and add the present value of the

perpetuity to it. Those two numbers are equal to the market value of assets. In order to find

the market value of equity, we subtracted the book value of liabilities from the market value of

assets. Then we divided the market value of equity by the number of shares outstanding,

which equals the model share price as of September 30, 2007. Since we are valuing the

company as of June 1, 2008, we needed to get the time consistent price. We multiplied the

model price by 1+WACC and then rose that to 8/12 in order to get the price up to June 1.

This model is highly sensitive to changes in the growth rate and therefore displays little

usefulness in determining the firm’s value of equity. The only way we could a share price that

would be fairly valued is if we had a high cost of equity and a low growth rate. As you can tell

by the table, every other number would make BDX’s stock extremely undervalued.

After analyzing the sensitivity analysis, BDX’s stock is overvalued when using a low cost

of equity. If we used a high cost of equity and a zero or 1% growth rate, then the stock is

fairly valued. Overall, the observed share price is under valued. This model is more accurate

G0.00 0.01 0.02 0.03 0.04

Ke 0.062 148.60 169.30 199.87 249.55 344.38 0.068 132.51 148.57 171.33 206.05 265.59 0.073 121.18 134.37 152.53 179.14 221.88 0.078 111.35 122.30 137.03 157.88 189.72 0.085 99.60 108.18 119.39 134.68 156.77 0.095 85.93 92.14 100.01 110.31 124.34 0.101 79.08 84.27 90.74 99.03 110.04

Overvalued < $71.78Fairly Valued is within 15% of share price



133 | P a g e

than the discounted dividends model, but still there are better and more accurate models.

The next model would be the residual income model.

Residual Income Model

Out of all the models so far, the residual income model is by far the most reliable. It

has an explanatory power of more than 50%. The discounted dividends model has an

explanatory power around 5% and the discounted free cash flows model has an explanatory

power around 10% to 15%. One of the main benefits of this model is that the sensitivity in

this model is much lower than that of the discounted dividends model and the free cash flow

model.

The residual income model allows us to value the company based on the current book

value of equity plus the present value of the value added by the firm. This value can either be

added or destroyed by the firm. To figure out if the firm added or destroyed value, we

needed to find their annual normal income, which is also known as the “benchmark.” The

benchmark is calculated as the previous year’s book value of equity times the appropriate

discount rate, which for this model is the cost of equity. After we found the benchmark,

residual income is the difference in the net income and the annual normal income

(benchmark). If net income is higher than the benchmark, the residual income is positive and

the firm added value to the company and if it is negative, they destroyed value. After we

found the residual income for every year, we multiplied each year by the present value factor.

For the present value factor, we used the cost of equity since we are dealing with income and

equity. We then took the sum of the year by year residual incomes.

After we had the present value of the residual incomes, we had to discount the terminal

value of the perpetuity back to 2007. Our residual income had a very predictable trend. In

order to keep the trend going, we multiplied 2017’s residual income by 1.15. By doing this, it

would adjust the perpetuity whenever we adjusted the cost of equity. In order to get the

perpetuity back to present value we divided the residual income in 2018 by Ke minus the

growth rate and then multiplied that by the present value factor for 2017. We now know the

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present value of the perpetuity. Next, we took the book value of equity at the end of 2007

added the sum of the year by year present value of residual income and also added the

present value of the perpetuity. This number represents the market value of equity as of

September 30, 2007. In order to get the model price, we divided it by the number of shares

outstanding, which were 244,929. Since we are valuing the company as of June 1, 2008, we

needed to get the time consistent price. We then multiplied the model price by 1+Ke and

then rose that to 8/12 in order to get the price up to June 1. Since we had to restate BDX’s

financials, we had to restate the residual income model as well. The way we computed the

share prices are the same way for both tables. We used the same cost of equity and the same

growth rates. The numbers are different however because net income was higher for the

restated model. The tables below show the sensitivity analysis for the residual income model.

These tables are the result of everything we have discussed so far.

G0.0 -0.1 -0.2 -0.3 -0.4 -0.5

Ke 0.064 98.03 66.32 58.63 55.16 53.19 51.92 0.070 86.09 61.28 54.85 51.89 50.20 49.09 0.075 77.74 57.46 51.93 49.35 47.85 46.88 0.083 66.70 51.97 47.65 45.58 44.37 43.58 0.090 58.85 47.71 44.26 42.57 41.58 40.92 0.100 49.81 42.39 39.92 38.69 37.94 37.45 0.109 43.31 38.25 36.47 35.56 35.00 34.63

Observed Share Price = 84.45Overvalued < $71.78

Fairly Valued is within 15% of share priceUndervalued > $97.12

GKe 0.0 -0.1 -0.2 -0.3 -0.4 -0.5

0.064 124.26 83.08 73.10 68.60 66.04 64.390.070 108.85 76.63 68.27 64.44 62.23 60.800.075 98.08 71.73 64.55 61.20 59.25 57.990.083 83.86 64.71 59.09 56.41 54.84 53.800.090 73.75 59.27 54.78 52.59 51.29 50.430.100 62.13 52.48 49.26 47.65 46.69 46.040.109 53.79 47.20 44.87 43.68 42.96 42.48


Fairly Valued is within 15% of share price


Restated

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The tables above represent the sensitivity analysis for both as stated and restated

models. We conducted the sensitivity analysis of the residual income model to see how

manipulating the range of variables would affect the intrinsic value of BDX. We adjusted the

growth rates and the cost of equity to determine how the price varies with different values.

Using our initial Ke of 8.3% and a zero percent growth rate, BDX’s stock was slightly

overstated in both the as stated and restated models. For the residual income model, we used

negative growth rates instead of the positive growth rates like some of the other models. The

reason why the growth rates are negative is because in the long run, the residual income

should be zero in order to restore equilibrium.

After analyzing the sensitivity analysis, BDX’s stock is overvalued when using a high

cost of equity. If we used a low cost of equity and a zero percent growth rate, then the stock

is fairly valued in the as stated table. However, if we used the same guidelines for the

restated table, the share price would be understated. Overall, the observed share price is

overvalued. Like we mentioned earlier, this model’s explanatory power is significantly higher

than the discounted dividends model and free cash flows model combined. We are now

starting to consider that BDX’s stock price as of June 1, 2008 is overvalued, but we can use a

couple more models to come to a better conclusion.

Long-Run Residual Income Model

The long-run residual income model is generated by using our forecasted book value of

equity, average return on equity, and a forward earnings growth rate. We fist found our

forecasted average return on equity, which is generated by taking net income divided by the

previous year’s book value of equity. Our forecasted return on equity started off high and

decreased as the years went by. We computed a forecasted return on equity of 17% for the

as stated financials. For the restated financials, we forecasted a return on equity of 15%. Our

forward earnings growth rate, as mentioned earlier, was forecasted at 9.6%. We used the

following formula to get the market value of equity:

MVE = BVE * (1+((ROE-Ke)/(Ke-g)))

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This formula is the main drive to this model. After we found the market value of equity

we divided by the number of shares outstanding. Just like every other model, this model price

is as of September 30, 2007. Since we are valuing the company as of June 1, 2008, we

needed to get the time consistent price. We then multiplied the model price by 1+Ke and

then rose that to 8/12 in order to get the price up to June 1. We then adjusted the cost of

equity, growth rate, and return on equity to end up with three different sensitivity analysis

tables. These tables are shown below both for the as stated and restated models.

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ROE0.12 0.13 0.14 0.15 0.16 0.17 0.18

Ke 0.064 n/a n/a n/a n/a n/a n/a n/a0.070 n/a n/a n/a n/a n/a n/a n/a0.075 n/a n/a n/a n/a n/a n/a n/a0.083 n/a n/a n/a n/a n/a n/a n/a0.090 n/a n/a n/a n/a n/a n/a n/a0.100 122.20 173.12 224.03 274.95 325.87 376.78 427.700.109 37.80 53.56 69.31 85.06 100.81 116.57 132.32

G0.078 0.084 0.09 0.096 0.102 0.108 0.114

Ke 0.064 n/a n/a n/a n/a n/a n/a n/a0.070 n/a n/a n/a n/a n/a n/a n/a0.075 n/a n/a n/a n/a n/a n/a n/a0.083 290.25 n/a n/a n/a n/a n/a n/a0.090 121.46 222.67 n/a n/a n/a n/a n/a0.100 66.65 84.01 122.2 274.95 n/a n/a n/a0.109 47.56 54.06 64.67 85.06 140.42 860.06 n/a

G0.078 0.084 0.09 0.096 0.102 0.108 0.114

ROE 0.120 169.31 n/a n/a n/a n/a n/a n/a0.130 209.63 n/a n/a n/a n/a n/a n/a0.140 249.94 n/a n/a n/a n/a n/a n/a0.150 290.25 n/a n/a n/a n/a n/a n/a0.160 330.56 n/a n/a n/a n/a n/a n/a0.170 370.88 n/a n/a n/a n/a n/a n/a0.180 411.19 n/a n/a n/a n/a n/a n/a



RestatedROE0.14 0.15 0.16 0.17 0.18 0.19 0.2

Ke 0.064 n/a n/a n/a n/a n/a n/a n/a0.070 n/a n/a n/a n/a n/a n/a n/a0.075 n/a n/a n/a n/a n/a n/a n/a0.083 n/a n/a n/a n/a n/a n/a n/a0.090 n/a n/a n/a n/a n/a n/a n/a0.100 208.75 256.19 303.64 351.08 398.53 445.97 493.410.109 64.58 79.26 93.94 108.61 123.29 137.97 152.65

G0.078 0.084 0.09 0.096 0.102 0.108 0.114

Ke 0.064 n/a n/a n/a n/a n/a n/a n/a0.070 n/a n/a n/a n/a n/a n/a n/a0.075 n/a n/a n/a n/a n/a n/a n/a0.083 345.58 n/a n/a n/a n/a n/a n/a0.090 144.61 270.36 n/a n/a n/a n/a n/a0.100 79.36 102.00 151.82 351.08 n/a n/a n/a0.109 56.63 65.64 80.34 108.61 185.36 n/a n/a

G0.078 0.084 0.09 0.096 0.102 0.108 0.114




138 | P a g e

The tables above show the sensitivity analysis for the long-run residual income

model. We found this model very useless. It provided no extra information about the

valuation of BDX’s stock. The reason why there are so many non-applicable are because the

growth rate was higher than our cost of equity. This led to negative stock prices, which isn’t

possible.

After reviewing all of the sensitivity analysis tables, it is almost impossible to judge

whether the stock is over or under valued. The only possibility way the stock would be fairly

valued is if we would us a high Ke and keep the return on equity and growth rate the same.

We still believe that the stock price of BDX is overvalued even after this model. The last

model is the abnormal earnings growth model (A.E.G.).

Abnormal Earnings Growth Model (A.E.G.)

The abnormal earnings growth model is one that is firmly grounded in financial

theory. The A.E.G. model is based on a forward price to earnings per share ratio. The

abnormal earnings are equal to the forecasted net incomes, plus dividend reinvestment

earnings, minus the “benchmark” or normal income.

The A.E.G. model is different than the rest of the models. Most models start with

the first forecasted year. This model actually begins in the second forecasted year. We start

in the second year because we need a set of forecasted income and dividends. If we started

in the first year, we would be using actual numbers. The A.E.G. model starts off with net

income at the top. Net income is used to determine the benchmark earnings of the next year.

But before that, comes the drip income. The drip income is calculated as the previous year’s

dividends multiplied times the cost of equity. After we have calculated the drip income, we

need to calculate the cumulative dividend income, also known as CDI. CDI is a very easy

number to calculate. It is the net income for the year plus the drip income for the year. The

annual A.E.G. is calculated as the year’s net income minus the year’s “benchmark” earnings.

One way to verify the A.E.G. is to calculate the change in residual income from year to year.

The two numbers should match in every year as long as the same cost of equity is used.

After we found the annual A.E.G., we multiplied each year by the appropriate

present value factor. We then took the sum of those numbers and those numbers are in year

2008 dollars. This is only one part to the core. Our annual A.E.G. was consistently growing

139 | P a g e

from year to year so we multiplied the last year’s annual A.E.G. by 1.1 in order to calculate the

terminal value of the perpetuity. Like the residual income model, this model also uses

negative interest rates. We divided the perpetuity by Ke minus the growth rate. Now the

perpetuity is in year 2017 dollars. We then multiplied the perpetuity by the present value

factor for 2017 and added the number to the core. The core consists of the first’s forecasted

net income plus the sum of the present value of the annual A.E.G. and plus the present value

of the perpetuity. This number represents the total adjusted earnings for 2008. We divided

the total adjusted earnings by the cost of equity in order to get it in year 2007 dollars.

We now know the model market value of equity. We then divided the model market

value of equity by the number of shares in order to get the model price per share. Just like

every other model, we needed to get this to be time consistent. We multiplied the model price

by 1+Ke then rose to 8/12. This price is now as of June 1, 2008. We completed a sensitivity

analysis and the table below shows that for the as stated and restated financials.

G0 -0.1 -0.2 -0.3 -0.4

Ke 0.064 152.73 115.24 106.15 102.06 99.730.070 125.03 98.89 92.11 88.99 87.210.075 107.14 87.69 82.39 79.91 78.480.083 85.36 73.24 69.69 67.99 66.990.090 71.19 63.24 60.77 59.57 58.860.100 56.22 52.05 50.65 49.96 49.540.109 46.39 44.26 43.50 43.12 42.89



G0 -0.1 -0.2 -0.3 -0.4

Ke 0.064 189.08 144.18 133.30 128.40 125.610.070 154.02 123.24 115.27 111.60 109.490.075 131.42 108.93 102.80 99.94 98.280.083 104.00 90.49 86.53 84.64 83.530.090 86.20 77.76 75.14 73.86 73.110.100 67.49 63.55 62.24 61.58 61.190.109 55.25 53.69 53.14 52.86 52.69



Restated

140 | P a g e

The two tables above represent the sensitivity analysis for the as stated and restated

financials. The two tables are somewhat similar. The restated table shows higher prices

which in turn results in more undervalued prices compared to the observed price. When using

our initial Ke and a zero percent growth rate, the price was fairly valued compared to the

observed price on the as stated model. The as stated model was slightly undervaluing the

price.

After studying the sensitivity analysis of the A.E.G. model, we have determined that

this model states the share price as fairly valued compared to the observed share price.

Conclusion

We have now discussed all of the valuation models. We figured out that the

discounted dividends model was the least accurate out of all the models with an explanatory

power of around 5%. The free cash flows model was a little more accurate with an

explanatory power around 10% to 15%, but the model was very sensitive to the growth rates.

The residual income model was by far the most accurate model with an explanatory power of

over 50%. The long-run residual income model looks like a very good model, but for BDX this

model provided no extra information because some of the growth rates would be higher than

the cost of equity. This would lead to negative share prices, which everyone knows is

impossible. The abnormal earnings growth model provided more great information when it

came to the stock price. It was very similar to the residual income model, which that is a

good sign of accurate results.

Overall, we believe that the stock price of BDX is overvalued. The reason why we

believe that it is overvalued is because of the residual and A.E.G. models. Both models

provided great knowledge for us to lead to this conclusion.

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Appendices

Regression

3-Month

6-Month

SUMMARY OUTPUT

Regression StatisticsMultiple R 0.451294209R Square 0.203666463Adjusted R Square 0.190290270Standard Error 0.047285671Observations 72

ANOVAdf SS MS F Significance F

Regression 1 0.040029638 0.040029638 17.9028658 6.9284E-05Residual 70 0.156515425 0.002235935Total 71 0.196545063

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Intercept 0.010751007 0.005576181 1.928023466 0.057909431 -0.000370334 0.021872349X Variable 1 0.685864712 0.162097823 4.231177826 6.9284E-05 0.362570804 1.009158621

SUMMARY OUTPUT





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2-Year

5-Year

SUMMARY OUTPUT





SUMMARY OUTPUT





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Current Ratio2002 2003 2004 2005 2006 2007

BDX 1.54 2.36 2.52 2.29 2.02 2.12BDX (restated) 1.54 2.36 2.52 2.29 2.02 2.12BAX 1.33 1.45 1.40 1.23 1.93 1.98BSX 1.31 1.35 1.26 1.78 2.29 1.82BCR 2.39 2.07 2.70 1.97 3.92 4.41

Quick Asset Ratio2002 2003 2004 2005 2006 2007


Inventory Turnover2002 2003 2004 2005 2006 2007


10-Year

Financial Ratios

SUMMARY OUTPUT




Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Intercept 0.011064566 0.005575254 1.984585044 0.051111464 -5.49276E-05 0.022184059X Variable 1 0.685140386 0.162099213 4.226673131 7.03964E-05 0.361843705 1.008437068

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Days Supply Inventory2002 2003 2004 2005 2006 2007


Receivables Turnover2002 2003 2004 2005 2006 2007


Days Sales Outstanding2002 2003 2004 2005 2006 2007


Working Capital Turnover2002 2003 2004 2005 2006 2007


Working Capital Turnover (Days)2002 2003 2004 2005 2006 2007


Cash to Cash Cycle2002 2003 2004 2005 2006 2007


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Gross Profit Margin2002 2003 2004 2005 2006 2007


Operating Expense Ratio2002 2003 2004 2005 2006 2007


Operating Profit Margin2002 2003 2004 2005 2006 2007

BDX 0.17 0.17 0.16 0.20 0.20 0.19BDX (restated) 0.18 0.19 0.19 0.23 0.24 0.24BAX 0.17 0.13 0.05 0.15 0.17 0.19BSX 0.21 0.20 0.28 0.15 -0.38 0.00BCR 0.17 0.16 0.25 0.26 0.20 0.26

Net Profit Margin2002 2003 2004 2005 2006 2007

BDX 0.12 0.12 0.09 0.14 0.13 0.14BDX (restated) 0.13 0.14 0.12 0.17 0.17 0.19BAX 0.10 0.10 0.04 0.10 0.13 0.15BSX 0.13 0.14 0.19 0.10 -0.46 -0.06BCR 0.12 0.12 0.18 0.19 0.14 0.18

Asset Turnover2002 2003 2004 2005 2006 2007

BDX 0.89 0.89 0.93 0.94 0.93BDX (restated) 0.88 0.87 0.91 0.91 0.90BAX 0.72 0.69 0.70 0.82 0.77BSX 0.78 0.99 0.77 0.95 0.27BCR 1.01 0.98 0.88 0.87 0.97

Return on Assets2002 2003 2004 2005 2006 2007

BDX 0.11 0.08 0.13 0.12 0.13BDX (restated) 0.12 0.11 0.15 0.16 0.17BAX 0.07 0.03 0.07 0.11 0.12BSX 0.11 0.19 0.08 -0.44 -0.02BCR 0.12 0.18 0.17 0.12 0.18

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Return on Equity2002 2003 2004 2005 2006 2007

BDX 0.22 0.16 0.24 0.23 0.23BDX (restated) 0.25 0.20 0.28 0.29 0.30BAX 0.30 0.11 0.26 0.32 0.27BSX 0.19 0.37 0.16 -0.84 -0.03BCR 0.18 0.16 0.22 0.22 0.16

Debt to Equity Ratio2002 2003 2004 2005 2006 2007


Times Interest Earned2002 2003 2004 2005 2006 2007

BDX 20.29 17.51 17.56 19.11 17.28 25.92BDX (restated) 21.54 19.49 20.54 22.47 21.03 32.80BAX 19.52 9.57 3.41 11.65 17.29 12.73BSX 14.19 15.15 24.59 10.76 -6.78 -0.03BCR 16.75 17.86 32.61 37.19 23.35 48.51

Debt Service Margin2002 2003 2004 2005 2006 2007

BDX 2.08 9.05 24.77 5.35 2.89BDX (restated)BAX 12.72 9.15 7.49 15.48 40.44BSX 8.94 3.26 0.74 11.83 133.43BCR 292.89 16.70 4013.00 1.10 #DIV/0!

Altman's Z-Score2002 2003 2004 2005 2006 2007


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IGR2002 2003 2004 2005 2006 2007

BDX 8.8% 5.7% 9.4% 8.8% 9.5%BDX (restated) 10.4% 7.9% 12.4% 12.5% 13.7%BAX 4.2% 0.2% 4.2% 8.1% 6.8%BCR 8.6% 15.0% 14.2% 9.5% 15.2%

Dividend Payout Ratio2002 2003 2004 2005 2006 2007

BDX 0.21 0.19 0.33 0.25 0.28 0.27 BDX (restated) 0.20 0.16 0.25 0.20 0.21 0.20 BAX 0.45 0.40 0.93 0.38 0.26 0.41 BCR 0.29 0.28 0.16 0.16 0.21 0.15

SGR2002 2003 2004 2005 2006 2007

BDX 0.18 0.11 0.18 0.16 0.17BDX (restated) 0.21 0.15 0.23 0.23 0.24BAX 0.18 0.01 0.16 0.24 0.16BCR 0.14 0.24 0.21 0.14 0.20

Methods of Comparables

Valuation Ratios Actual Calculation

Upper 15% 97.12Lower 15% 71.78# of Shares Outstanding 244,929

P/E (trailing) EPS PPS P/E PPSBDX 3.63 84.45 23.26 92.11BDX (restated) 6.35 84.45 13.30 161.13BSX 0.00BAX 23.62BCR 24.28SYK 24.53ACL 29.07Average 25.38

P/E (forecast) EPS PPS P/EBDX 3.84 84.45 21.99 72.42BDX (restated) 4.98 84.45 16.96 93.92BAX 17.20BSX 19.55BCR 17.54SYK 18.16ACL 21.85Average 18.86

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P/B BPS PPS P/BBDX 17.81 84.45 4.74 71.77BDX (restated) 19.11 84.45 4.42 77.01BAX 5.64BSX 1.29BCR 4.88SYK 4.31ACL N/A

Average 4.03

D/P DPS PPS D/PBDX 0.98 84.45 0.012 130.55BDX (restated) 0.98 84.45 0.012 130.55BAX 0.013BSX - BCR 0.007SYK 0.002ACL 0.008

Average 0.008

P.E.G. P/E Growth Rate P.E.G.BDX 23.26 9.60% 1.32 57.75BDX (restated) 13.30 9.60% 1.39 101.03BAX 1.49BSX 1.64BCR 1.40SYK 1.20ACL 1.67

Average 1.48

P/EBITDA PPS EBITDA P/EBITDABDX 84.45 6.67 12.66 80.94BDX (restated) 84.45 7.97 10.60 96.71BAX 61.10 4.64 13.16 BSX 13.29 1.48 8.98 BCR 91.20 6.40 14.26 SYK 74.72 1.77 N/AACL 143.04 2.18 N/A

Average 12.13

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P/FCF PPS FCF(per share) P/FCFBDX 84.45 0.89 94.89 40.02BDX (restated) 84.45 0.89 94.89 40.02BAX 61.1 3.11 19.65BSX 13.29 0.31 42.87BCR 91.20 4.23 21.56SKY 74.72 1.63 45.84ACL 143.04 2.97 48.16

Average 35.62

EV/EBITDA EV EBITDA EV/EBITDABDX 22,394,310 1,633,676 13.71 87.48 BDX (restated) 22,394,310 1,953,011 11.47 106.41BAX 13.25BSX 11.78BCR 13.09SKY 13.41ACL 21.08

Average 14.52

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Valuation Models Discounted Dividends Model

Discounted Dividends Approach WACC(BT) 0.078 Kd 0.049 Ke 0.083Perp

Relevant Valuation Item 0 1 2 3 4 5 6 7 8 9 10 112007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

DPS (Dividends Per Share) 0.96 1.05 1.15 1.26 1.39 1.52 1.66 1.82 2.00 2.19 2.38PV Factor 0.92 0.85 0.79 0.73 0.67 0.62 0.57 0.53 0.49 0.45PV annual dividend 0.89 0.90 0.91 0.92 0.93 0.94 0.95 0.96 0.98 0.99

PV YBY div 9.36 GTV Perp 12.92 0.00 0.02 0.04 0.06 0.08 28.67

Ke 0.064 31.63 41.10 66.37 344.26 n/a9/30/07 model price 22.28 0.070 28.57 35.80 52.68 137.06 n/aTime Consistent Price 23.50 0.075 26.40 32.28 44.87 91.03 n/a

0.083 23.50 27.82 36.17 59.04 386.80 0.090 21.40 24.78 30.86 45.06 116.05 0.100 18.93 21.38 25.45 33.60 58.04

Observed Share Price (6/1/08) $84.45 0.109 17.12 18.99 21.94 27.30 40.05 Initial Cost of Equity 0.083Perpetuity Growth Rate (g) - Overvalued < $71.78



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Free Cash Flows Model

Discounted Free Cash Flow WACC(BT) 0.078 Kd 0.049 Ke 0.083

0 1 2 3 4 5 6 7 8 9 10 112007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Cash Flow From Operations (Millions) 1,394,048 1,527,877 1,674,553 1,835,310 2,011,500 2,204,604 2,416,245 2,648,205 2,902,433 3,181,066 Cash Flow From Investing Activities (229,840) (261,809) (286,943) (314,489) (344,680) (377,769) (414,035) (453,783) (497,346) (545,091) FCF Firm 1,164,208 1,266,068 1,387,610 1,520,821 1,666,819 1,826,834 2,002,210 2,194,422 2,405,087 2,635,975 2,866,863

PV Factor 0.93 0.86 0.80 0.74 0.69 0.64 0.59 0.55 0.51 0.47PV FCF each year 1,079,971 1,089,480 1,107,672 1,126,167 1,144,972 1,164,090 1,183,527 1,203,289 1,223,382 1,243,809 Total PV of YBY FCF 11,566,359 TV Perpetuity 17,343,023 36,754,660.06

GMV of Assets (9/30/07) 28,909,382 0.00 0.01 0.02 0.03 0.04

Ke 0.062 148.60 169.30 199.87 249.55 344.38 Book Value of Liabilities 2,967,408 0.068 132.51 148.57 171.33 206.05 265.59

0.073 121.18 134.37 152.53 179.14 221.88 Model Estimated Total MVE 9/30/07 25,941,974 0.078 111.35 122.30 137.03 157.88 189.72 Divide by shares 244,929 0.085 99.60 108.18 119.39 134.68 156.77 Model Share Price 9/30/07 105.92 0.095 85.93 92.14 100.01 110.31 124.34

0.101 79.08 84.27 90.74 99.03 110.04

Time Consistent Price 111.35

Observed Share Price 84.45WACC(BT) 0.078Growth Rate 0

Overvalued < $71.78




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Residual Income (As Stated and Restated)

All Items in Thousands of Dollars Change in RI 31,758 34,807 38,148 41,811 45,824 50,224 55,045 60,329 66,121

0 1 2 3 4 5 6 7 8 9 10 Perp2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Net Income (Thousands) 940,982 1,031,317 1,130,323 1,238,834 1,357,762 1,488,107 1,630,966 1,787,538 1,959,142 2,147,220 Total Dividends (Thousands) 235,246 257,829 282,581 309,709 339,441 372,027 407,741 446,885 489,786 536,805 Book Value Equity (Thousands) 4,361,957 5,067,694 5,841,181 6,688,924 7,618,049 8,636,371 9,752,451 10,975,676 12,316,329 13,785,686 15,396,101

Annual Normal Income (Benchmark) 362,042 420,619 484,818 555,181 632,298 716,819 809,453 910,981 1,022,255 1,144,212 Annual Residual Income 578,940 610,698 645,505 683,653 725,464 771,289 821,512 876,557 936,887 1,003,008 1,153,459 pv factor 0.923 0.853 0.787 0.727 0.671 0.620 0.572 0.528 0.488 0.451YBY PV RI 534,571 520,679 508,176 496,961 486,938 478,020 470,127 463,183 457,121 451,876

GBook Value Equity (Thousands) 4,361,957 0.0 -0.1 -0.2 -0.3 -0.4 -0.5

Total PV of YBY RI 4,867,651 Ke 0.064 98.03 66.32 58.63 55.16 53.19 51.92 Terminal Value Perpetuity 6,260,939 0.070 86.09 61.28 54.85 51.89 50.20 49.09 13,897,096 MVE 9/30/07 15,490,547 0.075 77.74 57.46 51.93 49.35 47.85 46.88 divde by shares 244,929 0.083 66.70 51.97 47.65 45.58 44.37 43.58 Model Price on 9/30/07 63.25 0.090 58.85 47.71 44.26 42.57 41.58 40.92 time consistent Price 66.70 0.100 49.81 42.39 39.92 38.69 37.94 37.45

0.109 43.31 38.25 36.47 35.56 35.00 34.63 Observed Share Price (6/1/08) $84.45Initial Cost of Equity 0.083Perpetuity Growth Rate (g) 0




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All Items in Thousands of Dollars Change in RI 35,383 38,779 42,502 46,582 51,054 55,956 61,327 67,215 73,667

0 1 2 3 4 5 6 7 8 9 10 Perp2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Net Income (Thousands) 1,219,792 1,336,892 1,465,234 1,605,896 1,760,062 1,929,028 2,114,215 2,317,179 2,539,629 2,783,433 Total Dividends (Thousands) 235,246 257,829 282,581 309,709 339,441 372,027 407,741 446,885 489,786 536,805 Book Value Equity (Thousands) 4,681,292 5,665,839 6,744,901 7,927,554 9,223,742 10,644,363 12,201,365 13,907,838 15,778,133 17,827,976 20,074,604

Annual Normal Income (Becnhmark) 388,547 470,265 559,827 657,987 765,571 883,482 1,012,713 1,154,351 1,309,585 1,479,722 Annual Residual Income 831,245 866,627 905,407 947,909 994,492 1,045,546 1,101,502 1,162,829 1,230,044 1,303,711 1,499,268 pv factor 0.923 0.853 0.787 0.727 0.671 0.620 0.572 0.528 0.488 0.451YBY PV RI 767,539 738,883 712,785 689,053 667,512 647,996 630,356 614,452 600,156 587,350

GBook Value Equity (Thousands) 4,681,292 Ke 0.0 -0.1 -0.2 -0.3 -0.4 -0.5

Total PV of YBY RI 6,656,082 0.064 124.26 83.08 73.10 68.60 66.04 64.39Terminal Value Perpetuity 8,137,978 0.070 108.85 76.63 68.27 64.44 62.23 60.80 18,063,465 MVE 9/30/07 19,475,352 0.075 98.08 71.73 64.55 61.20 59.25 57.99divde by shares 244,929 0.083 83.86 64.71 59.09 56.41 54.84 53.80Model Price on 9/30/07 79.51 0.090 73.75 59.27 54.78 52.59 51.29 50.43time consistent Price 83.86 0.100 62.13 52.48 49.26 47.65 46.69 46.04

0.109 53.79 47.20 44.87 43.68 42.96 42.48Observed Share Price (6/1/08) $84.45Initial Cost of Equity 0.083Perpetuity Growth Rate (g) 0




Restated

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Long-Run Residual Income (As stated and restated)

Observed Share Price (6/1/2008) $84.45 ROE# of Shares Outstanding 244,929 0.14 0.15 0.16 0.17 0.18 0.19 0.2

Ke 0.064 n/a n/a n/a n/a n/a n/a n/aROE 0.170 0.070 n/a n/a n/a n/a n/a n/a n/aKe 0.083 0.075 n/a n/a n/a n/a n/a n/a n/aG 0.096 0.083 n/a n/a n/a n/a n/a n/a n/aBVE per share 17.81 0.090 n/a n/a n/a n/a n/a n/a n/a

0.100 208.75 256.19 303.64 351.08 398.53 445.97 493.41MVE per share (101.37) 0.109 64.58 79.26 93.94 108.61 123.29 137.97 152.65Time Consistent Price (106.91) G

0.078 0.084 0.09 0.096 0.102 0.108 0.114Ke 0.064 n/a n/a n/a n/a n/a n/a n/a

Upper Bound $97.12 0.070 n/a n/a n/a n/a n/a n/a n/aLower Bound $71.78 0.075 n/a n/a n/a n/a n/a n/a n/a

0.083 345.58 n/a n/a n/a n/a n/a n/a0.090 144.61 270.36 n/a n/a n/a n/a n/a

MVE = BVE * (1+((ROE-Ke)/(Ke-g))) 0.100 79.36 102.00 151.82 351.08 n/a n/a n/a0.109 56.63 65.64 80.34 108.61 185.36 n/a n/a

G0.078 0.084 0.09 0.096 0.102 0.108 0.114




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Observed Share Price (6/1/2008) $84.45 ROE# of Shares Outstanding 244,929 0.12 0.13 0.14 0.15 0.16 0.17 0.18

Ke 0.064 n/a n/a n/a n/a n/a n/a n/aROE 0.150 0.070 n/a n/a n/a n/a n/a n/a n/aKe 0.083 0.075 n/a n/a n/a n/a n/a n/a n/aG 0.096 0.083 n/a n/a n/a n/a n/a n/a n/aBVE per share 19.11 0.090 n/a n/a n/a n/a n/a n/a n/a

0.100 122.20 173.12 224.03 274.95 325.87 376.78 427.70MVE per share (79.39) 0.109 37.80 53.56 69.31 85.06 100.81 116.57 132.32Time Consistent Price (83.73) G

0.078 0.084 0.09 0.096 0.102 0.108 0.114Ke 0.064 n/a n/a n/a n/a n/a n/a n/a

Upper Bound $97.12 0.070 n/a n/a n/a n/a n/a n/a n/aLower Bound $71.78 0.075 n/a n/a n/a n/a n/a n/a n/a

0.083 290.25 n/a n/a n/a n/a n/a n/a0.090 121.46 222.67 n/a n/a n/a n/a n/a0.100 66.65 84.01 122.2 274.95 n/a n/a n/a0.109 47.56 54.06 64.67 85.06 140.42 860.06 n/a

G0.078 0.084 0.09 0.096 0.102 0.108 0.114




Restated

156 | P a g e

A.E.G. (As stated and restated)

(thousands) WACC(BT) 0.0788 Kd 0.049 Ke 0.083

0 1 2 3 4 5 6 7 8 9 102007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Net Income 940,982 1,031,317 1,130,323 1,238,834 1,357,762 1,488,107 1,630,966 1,787,538 1,959,142 2,147,220 Total Dividends 235,246 257,829 282,581 309,709 339,441 372,027 407,741 446,885 489,786 536,805 Drip Income 19,525 21,400 23,454 25,706 28,174 30,878 33,843 37,091 40,652 Cumulative Dividend Income 1,050,842 1,151,723 1,262,288 1,383,468 1,516,281 1,661,844 1,821,381 1,996,233 2,187,872 Normal (Benchmark) Earnings 1,019,084 1,116,916 1,224,140 1,341,657 1,470,456 1,611,620 1,766,336 1,935,904 2,121,751 Annual AEG 31,758 34,807 38,148 41,811 45,824 50,224 55,045 60,329 66,121 72,733 PV Factor 0.92 0.85 0.79 0.73 0.67 0.62 0.57 0.53 0.49PV AEG 29,324 29,676 30,032 30,393 30,758 31,127 31,501 31,879 32,261 Change in Residual Income 31,758 34,807 38,148 41,811 45,824 50,224 55,045 60,329 66,121

Core to the Perpetuity 940,982 Total PV of AEG added to Core 276,952 AEG TV Perp 427,561 876,303 Total Adjusted Earnings 1,645,495 GCapitlaization Rate 0.083 0 -0.1 -0.2 -0.3 -0.4Model MVE (8/30/2007) 19,825,242 Ke 0.064 152.73 115.24 106.15 102.06 99.73Divide by shares 244,929 0.070 125.03 98.89 92.11 88.99 87.21

0.075 107.14 87.69 82.39 79.91 78.48Model Price (8/30/2007) 80.94 0.083 85.36 73.24 69.69 67.99 66.99Time Consistent Price 85.36 0.090 71.19 63.24 60.77 59.57 58.86

0.100 56.22 52.05 50.65 49.96 49.54Observed Share Price $84.45 0.109 46.39 44.26 43.50 43.12 42.89Cost of Equity 0.083 Perpetuity Growth Rate (g) 0



157 | P a g e

(thousands) WACC(BT) 0.0788 Kd 0.049 Ke 0.083

0 1 2 3 4 5 6 7 8 9 102007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Net Income 1,219,792 1,336,892 1,465,234 1,605,896 1,760,062 1,929,028 2,114,215 2,317,179 2,539,629 2,783,433 Total Dividends 235,246 257,829 282,581 309,709 339,441 372,027 407,741 446,885 489,786 536,805 Drip Income 19,525 21,400 23,454 25,706 28,174 30,878 33,843 37,091 40,652 Cumulative Dividend Income 1,356,417 1,486,633 1,629,350 1,785,768 1,957,202 2,145,093 2,351,022 2,576,720 2,824,085 Normal (Benchmark) Earnings 1,321,035 1,447,854 1,586,848 1,739,185 1,906,147 2,089,137 2,289,695 2,509,505 2,750,418 Annual AEG 35,383 38,779 42,502 46,582 51,054 55,956 61,327 67,215 73,667 81,034 PV Factor 0.92 0.85 0.79 0.73 0.67 0.62 0.57 0.53 0.49PV AEG 32,671 33,063 33,460 33,862 34,268 34,679 35,096 35,517 35,943 Change in Residual Income 35,383 38,779 42,502 46,582 51,054 55,956 61,327 67,215 73,667

Core to the Perpetuity 1,219,792 Total PV of AEG added to Core 308,560 AEG TV Perp 476,358 976,315 Total Adjusted Earnings 2,004,710 GCapitlaization Rate 0.083 0 -0.1 -0.2 -0.3 -0.4Model MVE (8/30/2007) 24,153,132 Ke 0.064 189.08 144.18 133.30 128.40 125.61Divide by shares 244,929 0.070 154.02 123.24 115.27 111.60 109.49

0.075 131.42 108.93 102.80 99.94 98.28Model Price (8/30/2007) 98.61 0.083 104.00 90.49 86.53 84.64 83.53Time Consistent Price 104.00 0.090 86.20 77.76 75.14 73.86 73.11

0.100 67.49 63.55 62.24 61.58 61.19Observed Share Price $84.45 0.109 55.25 53.69 53.14 52.86 52.69Cost of Equity 0.083 Perpetuity Growth Rate (g) 0



Restated

158 | P a g e

References

• Becton Dickinson 10-K and Annual Report

• Becton Dickinson 10-Q 2008

• Boston Scientific 10-k and Annual Report

• C.R. Bard 10-k and Annual Report

• Baxter International 10-K and Annual Report

• Palepu & Healy

• www.bd.com

• www.wsj.com

• www.bostonscientific.com

• www.crbard.com

• www.baxter.com

• www.investopedia.com

• www.moneycentral.msn.com

• www.google.com

• www.yahooo.com

• www.reuters.com

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