FIN 7100 Module 5 Final Investment Recommendation Paper Example

Johnson & Johnson, Merck and Prudential, but Not Campbell's: A $300,000 Recommendation Built on Risk, Return and Capital Structure

Student Name

Master of Business Administration (MBA), Thomas Edison State University

FIN-7100: Financial Management

Mentor Name

Month Day, Year

Johnson & Johnson, Merck and Prudential, but Not Campbell's: A $300,000 Recommendation Built on Risk, Return and Capital Structure

Recommendation in Brief

I recommend that the clients, a composite retired couple in Princeton, invest their $300,000 New Jersey sleeve as follows: about $126,000 (42 percent) in Johnson & Johnson, $105,000 (35 percent) in Merck and $69,000 (23 percent) in Prudential Financial, buying 475, 722 and 607 shares at September 30, 2026, prices. I recommend no position in The Campbell's Company. At current dividend rates the sleeve would pay about $8,400 a year, a 2.8 percent yield, and based on its history it would be expected to be noticeably less volatile than the stock market. This paper completes the final project begun with the proposal and interim report, adding valuation, debt policy and the imperfections of real markets to the risk and return analysis.

The Clients' Goals and Limits

The clients want income they can rely on, growth that keeps ahead of inflation, and smaller swings than the market, because they will draw on this money over the next fifteen to twenty years. They chose to hold New Jersey companies for personal reasons and accept that four candidates make a concentrated sleeve. The sleeve is a portion of a larger diversified portfolio, so its role is to add steady, dividend-paying companies, not to stand alone.

What the Risk and Return Analysis Showed

The interim report measured five years of monthly returns ending in September 2026. Johnson & Johnson had the best balance of return and risk, with a 14.3 percent average annual return, the lowest volatility at 17.5 percent and a largest decline of only 15.7 percent. Merck earned the most, 19.3 percent, but with 24.5 percent volatility and a 40 percent decline along the way. Prudential moved most with the market and earned 9.2 percent. Campbell's lost an average of 8.8 percent a year and fell 59 percent from its peak. Correlations among the four were low, so combining them reduced risk, as Markowitz's portfolio theory predicts.

The recommended mix of 42, 35 and 23 percent, applied to the same five years, would have returned 14.9 percent a year with 16.4 percent volatility, a beta of 0.36, a Sharpe ratio of 0.68 and a largest decline of 16.6 percent. History is not a forecast, so the next sections ask whether current prices and balance sheets support the same conclusion.

Valuation: What Each Price Assumes

Each company's required return came from CAPM, using adjusted betas, the 5.29 percent 10-year Treasury yield and a market premium of 5.5 percentage points, and used a 9 percent rate for Campbell's because its regression beta understates the risk of a heavily indebted company. I then asked what constant dividend growth rate makes the dividend discount model equal the market price (Berk & DeMarzo, 2020).

For the three recommended companies, the implied growth rates of 5 to 6 percent are demanding but in line with what each has achieved in dividends over the past decade, so none looks clearly cheap or clearly overpriced. Campbell's price assumes dividend growth of only about 1 percent, which might suggest a bargain. The capital structure analysis shows why it is not.

Capital Structure and Market Imperfections

Modigliani and Miller's results hold only in perfect markets. The textbook's integration of risk, return and capital structure asks what changes when taxes, distress costs, agency problems and dividend signals are added, and these imperfections decide the Campbell's question.

Campbell's debt is 55 percent of its market value, its operating income covers interest only 2.6 times, and its dividend of $1.56 exceeds its fiscal 2026 earnings of $1.31 a share. Andrade and Kaplan (1998) estimated that financial distress costs about 10 to 20 percent of firm value in the highly leveraged companies they studied, losses that fall on shareholders first. Campbell's is not in distress, but its expected distress costs are rising, and the value of its tax shields does not offset them. Its dividend raises a second imperfection. Miller and Modigliani (1961) showed that in a perfect market dividend policy does not affect value, but Brav et al. (2005) found that managers treat dividend cuts as a last resort because markets read them as bad news. A board facing a payout above earnings must choose between more debt, a cut that markets will punish, or asset sales. Each path hurts the shareholder who bought the stock for its yield, which is why the 7.9 percent yield is a warning rather than an offer.

The other three companies face imperfections of a different kind. Johnson & Johnson and Merck carry little debt for their size, with coverage of 34.6 and 16.5 times, so distress costs are remote, and their financial slack lets them absorb shocks. Their main risks are business risks: Johnson & Johnson's long-running talc litigation and competition for older drugs, and Merck's dependence on Keytruda, whose key patents begin to expire in 2028. Both companies have used their balance sheets to buy new products, which is the right use of flexibility but carries agency risk if managers overpay. Prudential's risks are tied to interest rates and markets, which explains its higher beta and required return; its higher yield compensates the clients for that.

Why Not Include a Small Campbell's Position?

The clients asked about keeping a small position for its income. A 5 percent position, $15,000, would add about $1,180 a year of dividends to the sleeve. Against that, the stock has a meaningful chance of a dividend cut, which would remove much of that income and likely send the price lower. The same $15,000 placed in Prudential adds about $740 from a company whose dividend is covered by earnings. Excluding Campbell's therefore costs the clients about $440 a year of income, a modest price for removing the sleeve's most fragile holding.

Taxes, Implementation and Review

The clients hold the sleeve in a taxable account, so qualified dividends and long-term gains will be taxed at favorable federal rates; the plan does not depend on tax effects but avoids short-term trading. Purchases should be made in three equal steps over six weeks to reduce the risk of buying at a short-term high.

The recommendation should be reviewed in four situations: if any holding grows beyond 45 percent of the sleeve; if Johnson & Johnson's litigation results in a settlement large enough to require borrowing; if Merck has not replaced a meaningful share of Keytruda's sales by 2028; or if Prudential cuts its dividend. Campbell's goes back on the list only once its borrowing drops under roughly three times EBITDA and its profits once more pay for the dividend.

Limitations

The analysis rests on five years of data, a period that included unusual interest rate and inflation shifts. Betas were estimated with error and adjusted by rule; the market risk premium is an assumption; and the dividend discount model is highly sensitive to its growth input. A four-stock sleeve remains concentrated, which is acceptable only because it sits inside a broader portfolio.

Conclusion

Integrating risk, return and capital structure changes the answer that yield alone would give. Johnson & Johnson, Merck and Prudential offer covered dividends, strong or adequate balance sheets and prices consistent with their growth histories, and together they formed a portfolio with lower volatility than the market over the past five years. Campbell's offers the highest yield but carries the most debt, an uncovered dividend and rising distress costs, so it is excluded. The recommended sleeve pays about $8,400 a year and has clear triggers for review.

References

Andrade, G., & Kaplan, S. N. (1998). How costly is financial (not economic) distress? Evidence from highly leveraged transactions that became distressed. The Journal of Finance, 53(5), 1443-1493. https://doi.org/10.1111/0022-1082.00062

Berk, J., & DeMarzo, P. (2020). Corporate finance: The core (5th ed.). Pearson.

Brav, A., Graham, J. R., Harvey, C. R., & Michaely, R. (2005). Payout policy in the 21st century. Journal of Financial Economics, 77(3), 483-527. https://doi.org/10.1016/j.jfineco.2004.07.004

Miller, M. H., & Modigliani, F. (1961). Dividend policy, growth, and the valuation of shares. The Journal of Business, 34(4), 411-433. https://doi.org/10.1086/294442