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An1.

Investment
Analysis Case
Study
Names of Authors: Philip Taiwo and

Sef

This is a study on the proposed investment by
Apple on iTV to recommend whether or not to
go ahead with the investment.

8 6 Post tax cost of debt = 4.81 143. 1: 55 Cost of capital (post tax) = Cost of Equity x %age of equity + Post Tax Cost of Debt x %age of debt Cost of debt for Apple = Treasury rate + spread = 2% +2.000 i. The β for Apple is 0. Present Value of minimum lease payments Year Lease commitments Discount Factor PV Total Debt 1 2 3 4 5 6 195 0.55 * (9%-2%) = 5.55 Thus the cost of equity for Apple’s TV division will be : R = 2% + 0.78 613.5 2 191 0.An Investment Analysis Case Study Part 1 : Estimation of Cost of Capital Market Value of Equity : $ 90/share x 900 mn shares = $ 81. unlevered beta is computed using the following formula : Raw β /(1+(1-T)*DER) where DER is the net Debt equity Ratio of respective company and T is the marginal tax rate of 40% The average unlevered β is found to be 0.25% = 4.3 1 200 0.e.54.7 5 788 0. say 6% Total Debt i.25% Cost of equity = Rf + β * (Rm-Rf) The treasury bonds of 10 year duration are presently trading around 2%.85 161.55% Cost of Capital = 6% x 55/56 + 2.92 192.9%.95 but it is not relevant to the electronics (TV) division as Apple’s income mainly comes from IT industry.7 1 177 0.85%. Considering that Apple will have a debt equity ratio of 1:52. From the data given for the electronics companies. say 6% .88 176.55% * 1/56 = 5.000 million Thus the Debt to Market Value ratio is 1475: 81.25% *(1-40%) = 2.e.96 187.0 5 1475 209 0. the relevered beta works out to 0.

1.6 % The cost of equity for the company is 6%. . Accounting Return Analysis Estimation of Operating Income and ARR $ Million Year Revenue Cost of Sales Gross Proft Sales Commission Allocation of corporate G&A Costs Figures in 1 2 3 4 5 6 7 8 9 10 75 95 11 14 17 20 21 22 24 25 0 5 82 32 09 15 37 67 05 51 30 38 47 57 68 80 85 90 96 10 0 2 3 3 4 6 5 7 2 21 45 57 70 85 10 12 12 13 14 15 0 3 9 9 26 09 82 60 43 31 8 10 13 15 18 22 23 24 26 27 53 55 58 61 Operating Proft 50 12 0 21 9 64 12 6 31 8 79 13 2 42 7 95 13 9 54 9 64 11 4 14 6 68 4 67 13 4 15 3 83 3 70 14 2 16 1 88 6 74 15 1 16 9 94 2 78 16 0 17 7 10 02 81 17 0 18 6 10 66 Depreciation Interest 20 0 1 Proft before Tax 18 20 0 1 11 7 25 2 1 17 4 25 2 1 29 6 25 2 1 43 1 25 2 1 58 0 25 2 1 63 3 25 2 0 69 0 31 1 0 69 1 31 1 0 75 5 7 47 70 11 8 17 2 23 2 25 3 27 6 27 7 30 2 11 70 10 5 17 8 25 9 34 8 38 0 41 4 41 5 45 3 G&A Costs Advtg Costs Tax Operating Proft Average Accounting proft Total Investment ARR 25 1 33 06 7. Since ARR is 8% and more than the cost of equity. it is advisable to go ahead with the project on the basis of ARR.

6 0. The expected cost of capital is 6%.2.00 238 (22 3) 0.1 9.0 Net Working Capital PAT Add :Depreciation G&A Allocation* Interest Net cash accrual Terminal Value Net cashflows 3 - 4 - 5 - 6 - 7 - 8 (586) 9 - 16.7 40 3 10 - -1 58 93 166 247 336 368 402 441 220 32 220 33 272 35 272 36 272 38 272 40 272 42 272 44 33 1 47 331 49 1 1 1 1 1 1 1 0 0 0 238 297 38 4 45 7 53 7 641 674 710 77 1 821 741 (2. Since the last increase in capacity was only in year 8.6 18.5 -15.2 -8.7 0.56 2 0. no immediate investment is considered.6 -9.200) 1 - 2 (520) 3 - 4 - 5 - 6 - 7 - 8 (586) 9 - 10 - .8 0.179 mn Based on the above terminal value.1 -8. we fnd the terminal value as follows : P = E1/(k-g) = 821*(1+3%)/(6%-3%) = $ 28. As a going concern. a conservative growth rate 3% is assumed for a mature company in a mature industry like TV/electronics. the incremental cash-flows and valuation is given below Incremental Cashflows Year Investments Required 0 (2.9% 53 8 0. the iTV division will not have to incur any R&D or introductory costs after year 10.56 0.9% much above the cost of capital of approximately 8. For the purpose valuation.8%.9 0. 59 45 6 1.3 20.7 4 9 32 36 2 2 12.200) (520) Required -49. The cash accrual of the division has increased by an average of 6% in the last 3 years.25 0) 1. Incremental cash flows Figures in $ Million Incremental Cashflows Year 0 1 2 Investments (2.7 5 40 2 641 674 124 77 1 0. Using the dividend discounting model.63 PV Factor 4 0 7 Net Present -2250 225 -198 452 448 78 872 Value 1169 IRR NPV * Net of tax shield The above cash-flows indicate a positive NPV of $ 1169 million as well as an IRR of 12. Only the production capacity will have to be increased as and when required.89 38 45 4 7 0.5 -13.

56 456 34. the investment decision is recommended.63 0.999 Terminal value Net Cash flows (2.70 0.0 23 12. The IRR and NPV on the other hand have consistently shown that the project is viable even in the most adverse scenario tested above.6 % NPV ($ Mn) 16490 15.87 8 12. the viability improves even better with an NPV of $ 16.84 0.6 % 6.250) 238 (223) 384 457 538 641 674 124 771 PV Factor 1.89 0.490 mn and the IRR (post tax) to 34.67 0. we fnd that the project is viable based on all three parameters in the base case.562 28.96 6 The project viability is most sensitive to reduction in selling price.3 % 32.3% If we factor in the valuation of the business as a going concern.3%.9 % 30.00 0.59 322 362 402 452 448 Present Value -2250 NPV 16490 225 -198 IRR 78 29. 16193 .000 0.94 0.3 % Increase in product cost by 10% Reduction in price by 10% Reduction in peak market share from 5% to 4% IRR 34.3 % 4. Based on these two scenarios. Sensitivity Analysis : Sensitivity analysis is carried on the following key parameters : 1) Direct costs 2) Price 3) Market share The IRR and NPV using the terminal value based on valuation at the end of year 10 is given below : Scenario ARR Base Case 7.250) 238 (223) 384 457 537 641 674 124 771 1.Net cashaccruals (2.79 0.7 % 31. it is recommended that Apple should go ahead with the project. Recommendations: Based on the above analysis. In view of the same.75 0.5 % 5.