lectures/HBA1 Finance/Session 17 - Apple

DCF Analysis 3 Main Steps

1. Identify cash flows available to all stakeholders (Free Cashflow)

$$FCFF=EBIT(1-t)+Dep.\&Amort.-Capex-IncreaseinNWC$$

2. Calculate the EV of the firm

$$EV=\text{PV of FCFF}+\text{PV of }T{V}_n=\frac{FCF{F}_1}{(1+WACC{)}^1}+\frac{FCF{F}_2}{(1+WACC{)}^2}+\cdots +\frac{FCF{F}_n}{(1+WACC{)}^n}+\frac{FCF{F}_n}{(1+WACC{)}^n}+\frac{FCF{F}_n(1+g)}{(WACC-g)}\times \frac{1}{(1+WACC{)}^n}$$

3. Calculate value of equity and price per share

$$V_{Equity}=EV-V_{\text{Net Debt}}=EV-(\text{Book Debt - Cash})$$

Analysis Step by Step

Calculating Weight of Debt and Equity

Recall the requirements for debt:

• Should be interest bearing
• Should be “permeant” or long-term, that is, not the debt has a long term, but that we can assume it’ll stay as an item on the balance sheet

For Equity amount, recall that we should always use market values when we can. Actually we should just always use it and never use book value. So we use shares outstand x share price.

So after calculating all these ratios and debt + equity amounts for all years. We now need to consider this question:

• Do we take an average of these values?
• Do we take the latest value?
• Or should we base it off our competitors
• Do we take a weighted average?
• Or maybe we should do a forecast

Generally in the course, we only consider the first three options. For this case, there is a very clear trend line, thus the average is not a good representation. Additionally, as there is a clear trend, taking the latest is not good either. It’s clear we’re moving, so let’s take our competitors numbers!

So let’s look, if we take our competitors numbers, we’ll average the two and use 18%. This is quite a big jump from our current 12.5%. We can say that Apple is trying to move towards this target capital structure to maximize firm value (CAPM). You can also say that 12.5% is plateauing here, and that this is their target structure. We’re not sure, moving forward we’ll choose 12.5% but we could have argued the other way.

Cost of Debt

Looking at comparable bonds, we want to find the Yield to Maturity using either the Excel Function - RATE or the YIELD function. We only look at the 30 year ones as we’re doing a valuation and want the longest time horizon.

In addition, we also take the 30 year US treasury bonds as our Risk-Free Rate.

Using these two, and averaging our 30 year YTMs, we calculate our Bond Spread. We find our cost of debt using our spread + the risk free rate.

Cost of Equity

We will use CAPM.

Calculating Beta

Should we use the beta given by Bloomberg? This one is a two-year beta range, but does a 5-year beta make more sense? Maybe a 10-year? Let’s calculate this by hand using the SLOPE function in excel. As also have the Adjusted Beta which, if we go with bloomberg, would be better for long run aggregates.

We found that they actually differ quite a bit, but as we know that beta changes with capital structure, we state that the more recent 2-year one is better than our 5 and 10 year estimates because we’ve been changing our capital structure more recently.

But what if we didn’t have our historical stock prices? Then the next best option would be to use our competitors. To do that, we need to unlever their beta using their capital structure, and then relever it using our capital structure for proper comparison (Levered Beta).

Terminal Value

Growth Rate

So, when thinking of the terminal growth, we often say that it trends towards the market average in the long run. This is good, but for a firm as large and big as APPLE, that has shown strong growth recently, we can argue that it should be at the upper range of market average 3%.