FIN301 Mod 5 SLP

Topics: Weighted average cost of capital, IPhone, Apple Inc. Pages: 6 (1544 words) Published: December 19, 2014
Introduction

Apple is a leading innovator in mobile device technology, which requires their customers to accept Apple’s (ever expanding) closed ecosystem. Originally, Apple’s closed ecosystem was not as widely accepted as Microsoft’s open ecosystem, but that has since changed. Now Apple provides a full range of apps, software and products that are interlinked and support their hardware seamlessly (unlike Microsoft products). When Apple releases a new product, the customer not only receives new hardware with more features (than the previous model), but also gets an expanding ecosystem with more interactive options to further enhance the user’s experience. Apple designs their hardware (software) to be used in close proximity with their customers in order to build trust and acceptance amongst their customers. The customers in turn purchase more products and services from Apple. This “perceived” relationship (through interactive software and hardware) is the business model Apple is using to build and retain their customer base. Weighted Average Cost of Capital (WACC) for Apple

The WACC calculation is a company’s cost of capital in which each category of capital is equally weighted. A firm should use WACC as the discount rate when calculating the Net Present Value (NPV) of any typical project. All capital sources such as common stock, preferred stock, bonds and all other long-term debt are included in this calculation. As the WACC of a firm increases, the beta and rate of return on equity increases, which is an indicator of a decrease in valuation and a higher risk. By taking the weighted average, we can see how much interest the company has to pay for every dollar it finances. For this calculation, we use the following formula: WACC = rD (1- Tc ) * (D/V) + rE * (E/V) = 11.09% We calculate the components of the WACC equation as follows:

rE = Cost of Equity
rD = Cost of Debt
E = Market Value of the firm’s equity
D = Market Value of the firm’s debt
V = E + D
E/V = Percentage of financing that is equity
D/V = Percentage of financing that is debt
Tc = Corporate Tax Rate

For rD, the firm's return on Debt:
From the Income Statement, we know the interest paid for the most recent fiscal year. Then from the Balance Sheet, we add the (short and long-term) debt for the TWO prior years. Dividing this figure by 2 gives a rough average for the debt outstanding for the prior fiscal year. Finally, by dividing the Interest Expense by the Average Debt, we arrive at an estimate for rD.

For Tc, the firm’s corporate tax rate:
From the INCOME STATEMENT, we add the prior 3-year’s “Income Tax Expense”, and divide this by the prior 3-year’s “Income before Tax”.

For D, the firm’s Total Debt; From E, the firm’s Market Capitalization and for V, the firm’s Enterprise Value: Total Debt, D, is calculated as the Short-Term + Long-Term debt listed on the BALANCE SHEET. The firm’s Market Cap is based on the intraday stock price of the firm at the time the query was run. The firm’s Enterprise Value is: Total Debt + Market Cap (or D + V)

For rE, the firm’s cost of equity:
Calculate using the CAPM (Capital Asset Pricing Model): Cost of Equity rE = rf + β (rM - rf) = 0.1124 rf = the Risk Free rate of return (currently assumed to be 3%) β = the firm’s Beta (AAPL: 1.03)

rM = the historical Market risk premium (currently assumed to be 11%) (Investopedia, 2014).

Key Statistics For:
Apple Inc. (AAPL)
Market Cap (intraday) 5:
617.24B
Beta:
1.03
Historical Market Returns rM:
11%
Risk Free Rate:
3%

(Apple, 2013)

Based on the WACC calculations above, we see that Apple pays 11.09% on every dollar it finances, or 11.09...

References: Investopedia. (2014). Weighted Average Cost of Capital (WACC). Retrieved from: http://www.investopedia.com/video/play/what-is-wacc/
Apple Inc. (2013). Form 10-K, Annual Report. Retrieved from:
http://files.shareholder.com/downloads/AAPL/3572582107x0x701402/A406AD58-6BDE-4190-96A1-4CC2D0D67986/AAPL_FY13_10K_10.30.13.pdf
Apple Press Info. (2014). Apple Reports Fourth Quarter Results. Retrieved from: http://www.apple.com/pr/library/2014/10/20Apple-Reports-Fourth-Quarter-Results.html
Rogowsky, M. (2014). Apple Pay is here and it’s going to be great: Why the skeptics have it
Wrong. Retrieved from: http://www.forbes.com/sites/markrogowsky/2014/10/20/apple-pay-is-here-and-its-going-to-be-great-why-the-skeptics-have-it-wrong/
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