5014_ASS 3 # DRAFT 1 # Financial Engineering to Enhance Shareholder Value # MBA # FLEXPAH CAPELLA

Running head: Financial Engineering to Enhance Shareholder Value 9

Financial Engineering to Enhance Shareholder Value Assessment 3

Apple vs. Samsung

Apple and Samsung have been competing for years through the Blackberry, Sidekick, Galaxy and First Generation IPhone. Both companies are known for their uniqueness, quality products and attention to detail while their followers are torn between different features and tricks one can do over the other they are still both neck and neck having a favorable competitive advantage and is strategically collaborated and designed to reach their markets. The rivalry between Apple and Samsung caused a massive blowup in 2018 with Apple winning a $539 Million lawsuit against Samsung but somehow they are depended on one another through structure, components, performance and influence.

Founded in 1976 by Steve Jobs, Steve Wozniak and Ronald Wayne, Apple Inc. operates in the consumer electronics, computer software and hardware retail Industry. Headquartered in California, with Apple Inc. being well known and innovative as it is and serving a number of markets all over the world whether it’s retail store, online store or wholesaler. Apple Products are recognized by their design, their hardware, their designs being made from scratch and their software (IOS) is uniquely their own brand and design that gives it core services. Apple Store, Apple Music, ITunes Store, IMessage, FaceTime, ICloud etc. distinction that no other brand has because integrating and designing the hardware to work for the software and for the software to work for the hardware is distinctive and suggests that Research and Development effortlessly worked hard so that Apple Products can be appealing to their consumers and consumers to come.

Founded in 1938 as a trading by Lee Byung-Chul. Entering into the electronics industry in the late 1960’s with diversity into a number of areas. Samsung has increased in electronics particularly within its mobile phones and semiconductors. Samsung consist of a number of branches within the brand name, making it unique and profitable all by itself. It believes that ethical management is not only a tool producing changes globally but also to build trust with its stakeholders whom they are committed to. Aiming to become one of the most ethical companies in the world, Samsung continues to train its employees and operate monitoring systems, while practicing fair and transparent corporate management. Samsung is committed to the process their 2020 vision is to create an Eco-friendly experience for every customer they encounter as well as lead them to Eco-friendly products and technology through innovative surprises.

This Assessment will use Apple Inc. as the target for further research within Financial Statements, 10K and 10Q, conducting a Financial Ratio Analysis using different forms of Ratios. The purpose of this Assessment will seek to entail a comparison with Apple Inc. and Samsung Electronics to strategize how to Financially Engineer Shareholder Value if the Stock Price were to rise. Once the Ratio results and research have been completed, the methods will be evaluated, examining its pros and cons using qualitative assessments. There is always Risk Management, however Apple and Samsung are the best companies to compare financially and globally because their competitive edge don’t only presume in the United States but also all over the world targeting markets they have built lasting relationships with, creating loyal customers, clients and consumers.

Financial Ratio Analysis

An Income Statement records the accounts of the Profit and Loss. Reported annually or quarterly it gives a description of a company’s income and expenses. Businesses used Income Statements to determine how healthy and stable they are.

Figure 1: Income Statement Millions (The Wall Street Journal 2018)

Revenue	29-Dec-2018	29-Sept-2018	30-Jun-2018	31-Mar-2018
Total Revenue	84,310,000	62,900,000	53,265,000	61,137,000
Cost Revenue	52,279,000	38,816,000	32,844,000	37,715,000
Gross Profit	32,031,000	24,084,000	20,421,000	23,422,000
Operating Exp
R&D	3,902,000	3,750,000	3,701,000	3,378,000
General	4,783,000	4,216,000	4,108,000	4,150,000
Total Op, Exp.	60,964,000	46,782,000	40,653,000	45,243,000
Income or Loss	23,346,000	16,118,000	12,612,000	15,894,000
Income B4 Tax	23,906,000	16,421,000	13,284,000	16,168,000
Income Tax Ex	3,941,000	2,296,000	1,765,000	2,346,000
Interest Exp.	890	868	846	79
Net Income	19,965,000	14,125,000	11,519,000	13,822,000
EPS	4.18	2.91	2.34	2.73

One of the main financial statements used in companies is called a Balance Sheet. Investors, Lenders and Top Managers all have assess to these types of statements. They are accurate using its effectiveness knows what information is included on it.

Figure 2: Balance Sheet (Millions) The Wall Street Journal (2018)

	29-Dec-2018	29-Sep-2018	30-Jun-2018	31-Mar-2018
Assets
Cash	140,828	131,339	115,761	130,053
Accounts Rec	36,981	48,995	26,367	22,408
Inventory	4,988	3,956	5,936	7,662
Prop. & Equip.	39,597	41,304	38,117	35,077
Liabilities
Accounts Pay.	44,293	55,888	38,489	34,311
Debt	11,969	11,964	11974	11,980
Shareholders	117,892	107,147	114,949	126,878

The cash transactions for specific time frames for incoming and outgoing are included on the Cash Flow Statement. While it is usually used to monitor the cash that goes out and the cash that comes in, it is important to reporting accurately as it also reflects the stability of the company.

Figure 3: Cash Flow (Millions) The Wall Street Journal (2018)

Operating	31-Dec-2018	30-Sep-2018	30-Jun-2018	31-Mar-2018
Net Cash Flow	26,690	19,523	14,488	15,130
Investing
Investing C F	5,844	(3,001)	3,947	28,710
Financing
Financial C F	(13,676)	(22,580)	(31,523)	17,568
Free Cash Flow	23,335	16,482	11,221	10,935

Ratio Analysis compares values within the company from year to year and against other companies in the industry, Liquidity Ratio such as Current Ratio (current assets divided by current liabilities) show the company’s ability to pay its short-term obligations on time. The Debt Ratio (total assets divided by total liabilities) shows how much of the company’s assets are provided by debt. A lower percentage shows a lower dependence on debt. The higher the percentage, the more risk the company has taken on. (Crawford, 2016). Still remaining to be seen Apple is said to be the most successful consumer Electronics Company in the world, however during their beginning stages there was doubt in the company becoming as successful as it is. Their brand is undeniable although their components are not made originally but they do have Supply Chain that is effectively causing efficiency in areas such as Gross Profit Margin.

“Profitability Ratios measures the efficiency with which the company turns business activity into profits.” (Kokemuller, 2016). Since 2015 Apple’s Growth Profit Margin has made a 2% progress, their Operating Margin decreased from 30% to 27% and its Profit Margin recovering from the 2% decrease in 2016. The Return on Equity (ROE) also decreased in the course of a three-year span from 2015 to 2017 from 45% to 36%. Certainly when taking risk and suffering loss there is always a bounce back, In 2018 Apple regained the increasing mobility and increased to 56%.

Figure 3: Stock Analysis on Net (2018)

2018	Operating Margin	Profit Margin	Return on Asset	Return on Equity
Apple	25.98%	22.72%	15.90%	50.41%
Samsung	22.38%	17.26%	14.66%	21.01%

Apple’s Profitability Ratios compared to Samsung, Apple’s Return on Equity is much higher causing the company to be more favorable. The measurement of the profitability over capital is the Return on assets and Return on Equity indicating that management is doing a great job maintaining and sustaining profits that is generated from every dollar that includes assets and equity.

Figure 4: Guru Focus 2018 & Stock Analysis on Net (2018)

Apple Inc.	2018	2017	2016	2015
Current Ratio	1.30	1.28	1.35	1.11
Quick Ratio	0.99	1.09	1.22	0.89
Cash Ratio	0.57	0.74	0.85	0.52

During 2016 to 2017 and 2017 to 2018 in Apple’s Liquidity Ratios there is a minor decrease in their Current Ratio but it progress over time. The higher the Quick Ratio, the better the company’s Liquidity position, because Apple’s Quick Ratio fluctuates at different time frames it generally suggests that the company is over-leveraged, struggling to maintain or grow sales, paying bills too quickly or collecting receivables too slowly.

Figure 5: Market Watch 2018

2018	Current Ratio	Quick Ratio	Cash Ratio
Apple Inc.	1.12	1.09	0.57
Samsung	2.22	1.85	1.24

Apple’s Liquidity movement compared to Samsung, Samsung’s results are presumably higher. Current Ratio forecasts quick sources of cash known as assets and marketable securities. It gives reassurance of how well the company is doing specifically when turning products into cash. Current Ratios varies depending on the industry, a healthy, more stabled and structured business ranks from 1 to 3, suggesting the financial obligations that must be fulfilled is highly capable because of Samsung’s Current Ratio reaching twice as much more than Apple. If a company is unable to pay off its debt at the time its due a Ratio below 1 is the reason. This is something to be notice of when deciding on strategies to increase the value of shareholders. The Quick Ratio for Samsung shows its company’s performance, the company is converting receivables into quick cash, it is growing by leaps and bounds and the company can fulfill their financial obligations with no restraints. Once again, Samsung’s Cash Ratio show’s that they are in a better position than Apple.

Identifying proper strategies and its components in order for any company to increase shareholder value effectively. Shareholders play a key role in any organization, they are as important as the business itself, they must always be briefed on any decisions before one is made. Management holds great responsibility in increasing stock and value prices. Organizations of this magnitude such as Apple must strategize to increase the cash flow to increase shareholder value to avoid any financial risk impact they may face.

Market Analysis

Apple, Inc. investment opportunities are provided through an exceptional long-term investment portfolio. Loyal customers and being internationally recognized is how their brand is built. “Their proprietary product line combined with customer loyalty will increase sales among their product line from their phones to their watches.” (Dalton, 2018). Apple continuously produces sales while demonstrating the ability to put into place consistent price increase through their product line. Their revenue stream continues to rise through Apple Cloud Services as it grows more and more. Forbes suggests Apple has the most valuable brand of any publicly traded company on the planet. It’s 2017 ranking held them valued at $170 Billion, investing in a company that is impenetrable when investing long-term is important. Powerful brands keeps loyal customers coming back, the powerful brand Apple holds will continue to increase revenue, dividends and shareholder equity while increasing their large customer base.

There has been some concern as the Smart Phone market is becoming competitive. Apple continues to lead the industry through successful innovation, although there was a decline in performance with the newest IPhone Model they production had to be cut by nearly 10%. Apple has a plan to reduce prices in order to increase sales across the world where sales have declined, specifically in China. Issues have been that Android Users aren’t transferring to IPhones and IPhone Users aren’t utilizing the opportunity to trade in causing the trade in value to decline. Reducing cost added more customers to Apple’s customers base, as millions took to the sale prices of the new IPhone Model in 2018. Apple will increase revenue as promised through unique sales in different products they plan increase pricing in a strategic method to fill in the gaps of trading the products with little to no value left on it.

Capital Expenditures - Apple has filed its related annual 10-K with the SEC. Total Capital Expenditures for 2018 came in higher than expected at $16.7 Billion, Mac Maker is predicting that 2019, Capital spending will decline compared to last fiscal year. The bulk of Apple’s Capital Expenditures are for product tooling and manufacturing infrastructure, in addition to data centers and other corporate facilities (Niu, 2018). Their current ecosystem would cause new plants, equipment or machinery to be an ineffective source of cash. There is also a new expansion in place to build a new corporate campus for technical support; they also plan to add 20,000 new jobs all across the United States by 2023. Advertising, Marketing and Campaign would be considered if the company found products that are not being sold over time. This would mean a strategic plan would have be in place in order for the product to get the market exposure and the campaign be effective because Apple customers already are aware of Apple and what their products entail, the goal would be to advertise on a different magnitude in order to see a return on investment and increase revenue.

Mergers and Acquisitions - “Apple Inc. has promised to spend $163 Billion in cash, leading to breathless speculation about large acquisitions. The company’s largest acquisition was headphone maker Beats Electronics Inc., for $3 Billion and the next largest was NEXT, the merger that brought Steve Jobs back to Apple.” (Bary, 2018). Apple wants to progress its News Platform as it has recently settled for an amount that was left unmentioned towards a Magazine Subscription, another goal is to grow its Apple Music Services as the Subscribers have doubled but there is room for new Subscribers. New Mergers and Acquisitions will always be an interest as they are always looking for ways to grow the business and capitalize not only in investments but also products and services.

Stock Repurchases – In 2018, the first six months of the year, $43.5 Billion of its own stock to repurchase the IPhone. The 5 largest stock buybacks have been recorded to be Apples according to the Standard & Poor’s 500 Stock-Index (Grocer, 2018). $1.5 Trillion tax cut was signed into law because of Apple’s spending on its own shares lowering the corporate tax rate to 21% from 35% that gave their overseas profits a huge break. Apple’s goal was for new workers and factories to be invested long-term by companies to bridge the economy. Stock Repurchases rise through legislation of Corporate America, Apple broke record among the companies in S&P 500 by purchasing an additional $100 Billion in stock.

Dividend Policy Change - “On May 1, 2018, Apple announced that it’s raising its quarterly dividend by 16%, from $0.63 to $0.73. This translates to an increase from $2.52 to $2.92, giving Apple Stock a dividend yield of 1.6%.” (Sparks, 2018). Apple’s 10% dividend increase rate between 2012 and 2017 of 16% gave them a raise that was out of the ordinary. The increased rate was due to recent corporate tax reform mentioned earlier. Apple’s plan to grow will also result in an increase in dividends now and in the future.

Reduction of Debt – Apple is seeking to become net cash neutral by reducing its cash, plans are to dispense dividends, continue to buyback stocks and increase mergers and acquisitions. Apple will also continue to freely and effectively provide for their shareholders long-term. The goal to clear debt is progressing however the strategy will still take time to see the efforts of their hard work. Apple uses its cash wisely resulting in increased shareholder value bringing cash and debt into influenced balance.

Expansion – The start of 2018 Apple announced to spend $1 billion on building a new campus that would focus around technical support, the company will train new employees to work in full capacity in engineering, finance, R&D, operations and sales. The company’s goal is to expand to other regions within the United States. “Over the next five years, Apple is planning to invest $10 Billion in domestic data center infrastructure, of which %4.5 Billion is expected to be spent within he next two years.” (Niu, 2018).

Introduction of New Products & Services - Apple’s innovation, research and development remains to be unique and effortlessly effective. Apple has some great things in store for their target markets and loyal base customers this year. Their plan to announce their suggested subscriptions for TV services, News Apps, new AirPods and the new Mac Pro. Apple’s issue is Apple Pay Services, many fail to utilize the access they have to it and it has not been doing well as it can because of the other services made available such as Cash App and Pay Pal. There are many that use it but there are also many that do not, about 16% of IPhone users use the service and or have made a purchase in the past year. Although secure, easy to use and set up Apple must still strategize to come up with a more appealing way for Apple Pay Services to grab the attention of its markets.

Recommendations

In order to increase shareholder value there must options to chose from. Each strategy must be pursued properly; the benefits in it will be increase and growth along with an effective stock price. The organization must evaluate these strategies by financial analysis and environmental scanning and work to keep them balanced. In any investment seeking to make increase and make an return on investment there will be advantages and disadvantages that each plan may come with but Apple balances its market change through hard work and stability. It is recommended to move forward knowing that in the process the strategies risk can take place at any time, change is inevitable and Apple must freely adjust and adapt if such a risk happens in the industry, in order to maintain that of the company’s market share. Expansion through Capital Expenditures can produce shareholder value. In a written article by Forbes, they suggests that Apple’s renewable energy and eco-friendly campus expansion will be reliable where ever the company decides to expand it.

Management has not worked to its full potential in helping to increase the value of shareholders. Stock options were introduced as compensation but the object was to have managers think and apply the idea with that of shareholders. But the risk came when they failed to motivate feeling as though the idea would fail and would not produce results. The company’s proven ability have already geared in the right direction, for years Apple Inc. demonstrated success in many if not all areas they have produced and invested in. Investors of Apple are certain within their ability to invest in value, capital isn’t what they need to be assured about they need to be reassured that they are not overpaying for what they have invested in. These ventures will take work, as things change the company must develop with the market industry for it is sure to change financially and strategically. Apple’s financial reports describes their financial ratio, it analyzes what project to use cash for and what capital budgeting project will provide a return on investment. Samsung, Apple’s competitor if using their data can benchmark where they stand, however, the factors to the organizations capital structure must be realized and considered within each strategy.

The company’s Product and Services are always expanding and finding new ways to advertise products. Increasing the unit price, the product price and selling more unit are proven factors of increase. The design is to generate more profit and profit generates more wealth. As the company continues to develop its innovation and supply chain, increase fixed cost utilization when the fixed cost are consolidated and rationalized, in addition, capital equipment’s production activity can also be consolidated, sharing the planning and resources as long as increased shareholder value is not lost.

Financing

The Weighted Average Cost of Capital (WACC) calculates an organizations cost of capital as each capital is weighted it is the average rate of return expected to give out to each investor that invests in a company. The financing of an organization are broke down into different parts, debt and equity, it is important for any company to know its Weighted Average Cost of Capital when investing in projects of the future, the lower the WACC of a company it becomes cheaper for that company to invest in projects. Data taken from Guru Focus suggests Apple’s WACC as of September 18, 2018 is 9.87% and as of today Apple’s WACC is 8.46% by using the calculation listed below.

WACC = E / (E+D) * Cost of Equity + D / (E+D) * Cost of Debt * (1- Tax Rate)

The Market Cap on Yahoo Finance is reported as $741.727 million. The average current debt is $19,610 million and the debt and capital obligation is $95,471 million, the total debt is $115,081 million. To further calculate:

Weight of Equity = E / (E+D) = 741.727(741.727 + 115,081) = .865

Weight of Debt = D / (E+D) + 115,081 / (741.727 + 115,081) = 0.13

Using the Capital Pricing Model to calculate the rate of return does the formula used to calculate Cost of Equity.

Cost of Equity = Risk - Free Rate of Return + Beta of Asset * (Expected Return of the Market – Risk – Free Rate of Return) To calculate use the 2.75% 10-year treasury constant maturity rate as the risk – free rate. Beta is represented by the sensitivity of the expected asset returns to the expected market returns, Apple Inc. is 1.11 calculated by a market premium of 6%.

Cost of Equity = 2.76% + 1.11 * 6% = 9.41%

Cost of Debt is calculated by using the last fiscal year the interest expense of Apple, which is $3,240 million, divided by the current two-year average debt getting the simplified cost, the book value debt is %115,081 million.

Cost of Debt = 3,240 / 115,081 = 2.82%

Tax Rate = 21.45%

WACC = E / (E+D) * Cost of Equity +D / (E+D) * Cost of Debt * (1- Tax Rate)

= 0.856 9.41% +0.13 2.81% (1-21.45%)

= 8.44%

Apple Inc. Weighted Average Cost of Capital is 8.44% and by calculating the data from the income statements the Return on Investment Capital is 34.64%. Consistently Apple generates huge returns on anything they invest in, the capital to invest is less than the amount it returns. Expectancy is generating higher returns on all future projects as it increases the shareholder value and adds more growth and dimension to the company.

References

(2018, December). Retrieved February 9, 2019, from https://quotes.wsj.com/AAPL/financials

(2018, December 28). Retrieved February 9, 2019, from https://www.gurufocus.com/stock/AAPL

(2018, September 18). Retrieved February 9, 2019, from

https://www.gurufocus.com/term/WACC/AAPL/WACC/Apple Inc

AAPL Balance Sheet | Apple Inc. Stock. (2018, January 09). Retrieved February 9, 2019, from https://finance.yahoo.com/quote/AAPL/balance-sheet?p=AAPL

Apple Inc. (AAPL) | Financials Analysis and Stock Valuation. (2018, December). Retrieved February 9, 2019, from https://www.stock-analysis-on,net.NASDAQ/Company/Apple-Inc

Bary, E. (2018, March 24). Three ways Apple could spend $163 Billion besides a big acquisition. Retrieved February 9, 2019, from https://www.marketwatch.com/story/three-ways-apple-could-spend-163-billion-besides-a-big-acquisition-2018-03-16

Crawford, C. (2016, October 26). Purpose of Financial Analysis. Retrieved February 9, 2019, from https://smallbusiness.chron.com/purpose-financial-analysis-59178.html

Dalton, H. (2018, May 03). Apple: Extraordinary Longevity – Apple Inc. (NASDAQ:AAPL Retrieved February 2019, from https://seekingalpha.com/article/4154617-apple-extraordinary-longevity

Grocer, S. (2018, August 01). Apple’s Stock Buybacks Continue to Break Records. Retrieved February 9, 2019, from https://www.nytimes.com/2018/08/01/business/dealbook/apple-stock-buybacks.html

Kokemuller, N. (2016, October 26). What Do Profitability Ratios Measure in the Evaluation of a Company? Retrieved February 9, 2019, from https://smallbusiness.chron.com/profitability-ratios-measure-evaluations-company-56032.html

Niu, E. (2018, December 13). Apple Details Domestic Expansion Plans. Retrieved February 9, 2019, from https://www.fool.com/investinf/2018/12/13/apple-details-domestic-expansion-plans.aspx

Niu, E. (2018, November 05). Apple Forecasts 2019 Capital Expenditures at $14 Billion. Retrieved February 9, 2019, from https://www.fool.com/investing/2018/11/05/apple-forecasts-2019-capital-expenditures-at-14-bi.aspx

Sparks, D. (2018, May 05). Apple, Inc.’s 16% Dividend Increase- What You Need To Know. Retrieved February 9, 2019, from https://finance.yahoo.com/news/apple-inc-apos-16-dividend-134600501.html

SSNLF Key Statistics – Samsung Electronics Co. Ltd. Financial Ratios – MarketWatch. (2018, January 19). Retrieved February 9, 2019, from https://www.marketwatch.com/investing/stock/ssnlf/profile

Weighed Average Cost of Capital (WACC). (n.d.). Retrieved February 9, 2019, from https://investinganswers.com/financial-dictionary.financial-statement-analysis/weighted-average-cost-capital-wacc-2905