Finance Project on Canon Inc.

July 1

2011

Company Introduction & Background

Canon Inc. is a Japanese multinational corporation that specializes in the manufacture of imaging and optical products, including cameras, camcorders, photocopiers, steppers and computer printers. Its headquarters are located in ta, Tokyo, Japan. The name Canon began in 1947 after the company Kwanon changed its name. In 1934 Kwanon began with a prototype for Japans first-ever 35 mm cameras with a focal plane shutter. It was named 'Kwanon by Goro Yoshida after the Buddhist bodhisattva Guan Yin, known in Japanese as Kannon. Canon is a manufacturer of business and consumer imaging products which includes printers, scanners, binoculars, compact digital cameras, film and digital SLR cameras, lenses and video camcorders. The Business Solutions division offers print and document solutions for small and medium businesses, large corporations and governments. These include multi-functional printers, black and white and color office printers, large format printers, scanners, black and white and color production printers, as well as software to support these products. Canon products still includes medical, optical and broadcast products, including ophthalmic and x-ray devices, broadcast lenses, semiconductors, digital microfilm scanners, and Handy Terminal Solutions.

Overview of Annual Report

The first part of this investigation involves an evaluation of the Canons report and the key factors for success. The first thing is necessary to consider how the company has performed in recent years. Below table provides an overall review of the organizations performance in recent years. The data clearly suggests that Canon has made notable progress toward developing market share, revenues and profitability.

2006 Net sales Cost of sales Gross profit % of sales

2007

2008

2009

2010

4,156,759 4,481,346 4,094,161 3,209,201 3,706,901 2,096,279 2,234,365 2,156,153 1,781,808 1,923,813 2,060,480 2,246,981 1,938,008 1,427,393 1,783,088 49.6% 50.1% 47.3% 44.5% 48.1%

Operating expenses Operating profit % of sales Other income (deductions) Income before income taxes % of sales Net income attributable to Canon Inc. % of sales

1,353,447 1,490,308 1,441,934 1,210,338 1,395,536 707,033 756,673 496,074 217,055 387,552 17.0% 12,110 16.9% 12.1% 6.8% 2,300 10.5% 5,311

11,715 (14,927)

719,143 768,388 481,147 219,355 392,863 17.3% 17.1% 11.8% 6.8% 10.6%

455,325 488,332 309,148 131,647 246,603 11.0% 10.9% 7.6% 4.1% 6.7%

Specifically, the organization set the specific goal of obtaining 30 percent of the world market in earlier stage. But the current state of achieving this objective suggests that even though Canon has not been able to maintain a 30 percent market share in the industry, it has overcome competitor Xerox to become second only to Hewlett Packard. Canon recognized that the formula for success being used by Xerox was not the same formula which it wanted to pursue in the development of its organization. The process of developing particular core competencies for operations, Canon was able to maximize its internal capabilities and uses proper resources to benchmark and become a market leader. The unique concept acquired by HP made canon to double check with their internal capabilities because their operations, sales & profits are drastically moving downwards.

The Business Environment

The analysis states most significant factor that directly effects on their business. These factors are categories into four factors which are mentioned below: Economic -foreign exchange currency rates -economic downturns -Hewlett-Packards influence -competitive environment -economic downturn effect on products Political -outside influence on employees creating disputes regarding payments -logistics efficiencys impact -environmental laws and regulations adapting to other countries policies documentation Socio-culture -public image of reputation -the growing photo sharing market -growing popularity of HD usage technological -limit in number of chosen suppliers -growing demand of HD ready cameras -rear and front facing cameras

-increase in number of -competition among counterfeit Canon products similar businesses

After considering various important external factors Canon faces, it can be determined as Canon is not at too much of a risk in related to external factors. However, some of Canons external factors like dependency of suppliers, logistics, Hewlett Packard & etc are subject to sudden change, which may cause damage to Canons operations if Canon is unprepared. Most of these direct damages done will likely be temporary. In case of Canons logistics systems malfunction and argument occurs, operations are likely to return to normal in a short time, considering time and money invested into them. However, long term damage may be done if malfunctions and disturbances become recurrent in result Canons brand image will be damaged, potentially losing a customer base. Logistics is incredibly important because it is the mean for Canon to distribute its products for sale to other countries. But because Canon has such a large customer base, with customers from all over the globe, problems with logistics from Canons headquarters to one specific country might not necessarily cause significant harm to Canon; since Canon has operations with many other countries. Canons dependency on a variety of countries does not

only reduce risks in logistics, but with many other factors as well. Problems with local lawsuits, policies may only harm one of Canons operating locations. In many cases, Canons operations in other countries can operate as usual. This significantly reduces the risks Canon will run into in its business operations. Additionally, the current economic state is fairly stable, and Canon is not yet prone to immediate damage due to an occurring economic downturn.

Analysis of operating Results & Financial position

Financial Ratio: It designed to reveal the strength and weaknesses of a company as with other companies in the same industry, and to show whether financial position has been improving or deteriorating over time. The analysis talks about how Canon Inc performing every year and how does it benchmark with its major competitor Xerox Inc.

Canon Ratio's Ratio Current Ratio Quick Ratio Average collection period Inventory turnover Total Asset turnover Debt Ratio Debt Equity Ratio Gross Profit margin Net Profit Margin Return on Assets Return on Equity EPS P/E ratio price/cash flow market/book Book value 2008 1.57 1.18 51.27 8.07 1.03 0.33 0.49 0.55 0.07 0.077 0.11 2.75 10.98 5.21 12.76 2.37 2009 1.74 2.09 63.30 8.59 0.83 0.30 0.43 0.54 0.04 0.03 0.10 1.15 40.64 11.9 19.90 2.34 2010 1.59 1.94 54.89 9.63 0.93 0.33 0.50 0.55 0.06 0.06 0.09 2.48 17.85 8.41 16.64 2.66

The analysis starts with Canons current ratio that includes current assets i.e. cash, marketable securities, accounts receivable and inventories in the numerator and current liabilities consist of account payable, short-term notes payable, long term debt, accrued taxes and other accrued

expenses in the denominator. The standard current ratio rate is 2:1. The Canons ratio is 1.57, 1.74 and 1.59, which is not up to the mark because current liabilities are rising faster than current asset and its liquidity position is relatively weak and in result they should raise their current assets. Liquidity ratio shows the relationship of a firms cash and other current assets to its current liabilities. The Canons liquidity ratio i.e. quick ratio is 1.18, 2.09 & 1.94 which is above the standard rate i.e. 1:1. It states that the companys liquid asset is trading well in active market and hence can be converted into cash at the going market place. Average collection period is used to appraise account receivable and it is calculated by dividing accounts receivable by average daily sales to find out the number of days sales that are tied up in receivables. The Canons average collection period is 51.27, 63.30 & 54.89 i.e. that the customers, on the average, are not paying their bills on time. The time period taken by the customers is not bearable by the company because they have clear their debts too. Inventory turnover ratio is defined as sales divided by inventories. The Canons inventory turnover ratio is 8.07, 8.59 & 9.63; this states improper flow of inventory because the company might actually holding obsolete goods which are not worth towards their stated value.\ Total asset turnover ratio measures the turnover of the entire firms asset; it is calculated by dividing sales by total assets. The Canons total asset turnover ratio is 1.03, 0.83 & 0.93. in the year 2008, canon is doing really well because it is generating a sufficient volume of business over its total assets investment and rest of the years its doing not great but bearable because the ratio is covered by increasing. Debt ratio is money raised by the company from outsiders for financing its activities like purchase of fixed assets, acquisitions & etc. Debt ratio shows the amount of debt in comparison to the total assets of the company & it measures the percentage of funds provided by creditors. The Canons debt ratio is 0.33, 0.30 & 0.33 which is good for the company because it is below its standard i.e. < 0.50.

Debt Equity ratio is the ratio of borrowed capital to the equity capital. The Canons debt equity ratio is 0.49, 0.43 & 0.50 which shows that the company is almost equally financed by debt & equity, as debt equity ratio is nearing to average of 0.5. Gross profit margin is a profit from operating activities. It is arrived at by deducting the direct expenses from revenue. The Canons gross profit margin is 0.55, 0.54 & 0.55 which tells that the company earning more than 50% of gross profit from its sales. Net profit margin is profit after providing for all the expenses like selling and administration, depreciation, taxes & etc. it is a distributable profit of the company. The Canons net profit margin is 0.07, 0.04 & 0.06 which shows a good profit margin among the industry. Return on assets is the ratio of net income to total assets measures the return on total assets after interest & taxes. The Canons return on assets ratio is 0.077, 0.03 & 0.06 which is lower than its standard i.e. 0.078. These low returns arise from companys low basic earning or high interest costs resulting from its above-average use of debt. Return on equity is the ratio of net income to common equity; measures the rate of return on common stockholders investment. The Canons return on equity is 0.11, 0.10 & 0.9 which is less than the industry standard i.e. 15.11, but it is far better than return on asset. It is somewhat better result is due to the companys greater use of debt.

0.2500

0.2000

0.1500

ROE ROA

0.1000

Series1

0.0500

0.0000 1 2 3

Comparison to Industry Benchmarks

Comparison is done for benchmarking with a group of companies to see whether the company is using its resource effectively and generating high profit than its competitor. Companies / 2010 Canon Inc Xerox Inc HP Inc Asset turnover 0.93 0.7 0.01 D/E Ratio 0.50 0.58 0.53 G/P Margin 0.55 0.36 0.093 N/P Margin 0.06 0.02 0.069 0.06 0.19 0.07 0.09 .048 0.21 2.48 0.43 1.14 ROA ROE EPS P/E Ratio 17.85 22.79 14.36

The comparison starts with asset turnover ratio between the companies, canon is really doing well with its total asset compared to Xerox and HP i.e. 0.93 with 0.7 and 0.01 because utilization of asset is good compared to Xerox and HP. As you can see Canon Inc is tackling well with debt and it is up to the mark with their industrial average compared to Xerox and HP, this ratio willhelp them in benchmarking by properly utilizing their resources. As you look upon their operating profits, canon is doing well compared with Xerox & HP because Canon is generating higher profits from its operating activities than Xerox & HP. According to the net profits, HP is generating higher profit after tax than Canon & Xerox because they have control over their expenses. HPs return on asset is acceptable according to its standards than Canon and Xerox because they have low returns on asset which is not even acceptable on the basis of industrial standard. Return on Equity may be the most important, or the bottom line, because it directly reflects the return of the investment. In our case HPs return on equity is the highest return on equity in the industry than Xerox & Canon. As you focus on earning per share, the Canon is has higher earnings per share than its competitor i.e. Xerox & HP. P/E ratio shows the willingness of the investors to pay based on the reported profits generated. In this case, Xerox has highest price earnings ratio compared to Canon & HP i.e. 22.79 compared to 17.85 & 14.36. Looking upon the overall analysis with major and minor competitor i.e. HP & Xerox, Canon has benchmarked with his competitors and earned a huge market share in the electronic industry. This gave them an opportunity to generate huge and have a change to diversify their product line.

Valuation of the company

Capital Asset Pricing Model
1) CAPM

RF= 8.27 t-bond Rm= closing stock price - opening price for the particular year/ opening price of that year * 100 Beta = 1.11 growth rate=ROE (1- dividend payout ratio) 2008 11.62(10.4439)=6.46 2010 9.32(1-0.4439)=5.18

RM calculation 2008 -25.33 2009 34.72 2010 18.24

CAPM= Risk free rate + beta ( market return - risk free rate) 2008 2009 8.27+1.11( (25.33) - 8.27) 8.27+1.11(34.72-8.27) 8.27+1.11 (-33.6) 37.62 8.27+(-36.96) 28.29

2010 8.27+1.11(18.24-8.27) 19.33 overall 8.27+1.11(9.218.27) 9.31

therefore, the fundamental value = D0 (1+g)/rs-g 110(1+5.18)/19.33-5.18 679.8/14.15 48.04

2) DCF 2008 Short term long term total debt Average Rd= interest expenses/average debt Rd=
61,000

2009
52,301

2010
88,773

93,000

52,763

50,933

154,000 132,923

105,064

139,706

0.27

27%

Effective Tax Rate 2008 Income before Tax Tax Expenses Rate Average tax rate
5,293,000

2009
2,356,248

2010
4,843,881

1,769,000

903,614

1,728,130

33.42 35.82

38.35

35.68

Cost of common stock D 2010 dividends payout/outstanding shares

1.21

Rc=

D2010 (1+g)/Price 2010 1.21(1+5.18)/51.34 7.477/51.34 14.56 139706

32,621,687

Total debt= common Stock=

32761393

Wd We WACC=

0.004 0.995735651 wdrd(1-t)+wcrc .004*0.27(1-35.82)+.99*14.56 =0.001(0.6418)+14.41 = 14.41 2008 22715000

14,930,000

3) free cash flow operating working capital net PP&E total operating capital New Investment in working capital NOPAT 2010= Free Cash Flow=

2009 21674407
13,639,669

2010 26267542
14,819,900

37645000

35314076

41087442 3132531 3163999 31467.5

4) value of operation Vop= FCF 2010 (1+g)/WACC-g 31467.5(1+5.18)/14.41-5.18 194469.15/9.23 21069.24 5) valuation of share value of the operation Less: value of debt value of equity divide by number of shares price per share

32,761,393

139,706
32,621,687

667035 48.91

Conclusion
Company Canon Inc Value of operation 32761393 Calculated price 48.91 Market price 47.59

Through the analysis of all the above data, we could roughly reach the conclusion that the stock of Canon Inc is underpriced and little point of difference in the price makes lot of difference in terms of volume of the stock. Recommendation So far as our recommendation goes, there are many factors which may lead to movements in the stock price of the company. So we recommend to stockholders that to hold the stock because the market is growing as per the experts opinion which may rise in the stock price. If people are interested in buying the stock we would recommend them to buy the stock References www.canon.com/investorsrelation www.centralconrol.com/canon(CAJ) www.Forbes.com/canonhighlights/financial www.wikipedia.com/canon(CAJ) *All the competitors data are taken from the external sources and all the calculation are shown in the Excel file.