Heineken 2

This paper investigates a target share price for Apple, Inc. using the discounted cash flow model as the valuation technique and aims to provide an investment recommendation based on the comparison between the market price and the estimated target price. The foundation of the valuation approach is to forecast 10-year future cash flows based on their historical growth trends to estimate annual free cash flow to firm. These cash flows are discounted back to 2019 with the weighted average cost of capital to find the present value of the company. Under the guidelines of capital asset pricing model, this discount rate is estimated at 7.30%. The paper concludes a target price of $218.62, which is +12.78% above the market price as of 10/06/2019 and provides an in-debt analysis of the price sensitivity to the model’s assumptions that impacts Apple’s economic growth and its market position. This paper recommends investors a strong buy position based on the estimated target price, Apple’s latest strategic decisions, its strong bargaining power, and its liquidity management.

iii

Abstract ii Table of Contents iii List of Tables v List of Figures vi Introduction 1 Literature Review 2 Data 3 Free cash flow to firm 3 Earnings before interest and debt 3 Depreciation and amortization 3 Capital expenditures 3 Effective tax rate 4 Change in net working capital 4 Weighted average cost of capital 4 Cost of equity 4 Cost of debt 5 Perpetuity growth rate 6 Terminal value 7 Enterprise value and equity value 7 Methodology 8 Discounted cash flow model 8 Step 1: Forecasting cash flows 8 Step 2: Free cash flow to firm 10 Step 3: Discounted cash flows 11 Sensitivity Analysis 12 Internal justification 13 External justification 13 Results 14 Preliminary fundamental analysis 14 Forecasting cash flows 21 The discounted cash flow model 26 Sensitivity analysis 31 Conclusion 34 References 35 Abbreviations and acronyms 38 Appendix 39

Apple, Inc. is a California based technology company that is developing consumer electronics goods together with their accessories, computer software, media devices, third-party digital content and software applications (Apple Inc., 2018). The multinational company sells and delivers its products worldwide to retailers and wholesalers. Apple’s stock price is trading today, 10/06/2019, at $193.85 per share in the securities market under Nasdaq Stock Exchange (Yahoo Finance, 2019). This work aims to determine a target share price of Apple, Inc. by the end of 2019 using the discounted cash flow model1. The model is conducted by the forecasting free cash flow to firm based on historical trends. As a conclusion, an investment recommendation by comparing the target price to the current price is provided.

The financial assessment of the valuation technique is based on the discounted cash flow approach. First, the free cash flow available to the firm is forecasted for ten years including the terminal value, then the free cash flows are discounted back to the current year using the cost of capital to determine the present value of future cash flows. Long-term forecasting is based on the historical trends of sales growth and its ratio to other variables. Cash flows are estimated by applying the same historical growth trend to future cash flows assuming that the investment policy and capital structure of the company will remain the same. The discount rate is the weighted average of the cost of equity and the cost of debt. The cost of equity calculation is based on the capital asset pricing model (CAPM) and the cost debt depends on the default rate given by the credit rating agencies. The present value of all projected cash flows is the enterprise value of the company. The equity value, or the target price, is the residual value of the company once the net debt is paid to debt holders by liquidizing all cash and cash equivalent securities. Hence, after obtaining the target price, its sensitivity to the assumptions is analysed.

The work closely follows the business valuation techniques addressed by the “Business Analysis and Valuation” book (Palepu, et al., 2013) and the “Corporate Finance” book (Ross, et al., 2016). The financial information used in the assessment is based on the 2018 annual report and proxy statement to the shareholders that are provided by the company itself (Apple Inc., 2018). The Corporate Finance Institute’s guidelines are followed to provide the most trustworthy valuation techniques (CFI, 2019).

The Bloomberg Terminal is used as a data source of financial data to support assumptions that are taken for forecasting future cash flows and valuing the business (Bloomberg L.P., 2019). The Terminal provides standardized and financial statements which allow easy comparison between companies and industry benchmarks. Analyst reports and recommendations provided in Bloomberg Terminal are studied to provide a professional outlook.

Forecasts of the International Monetary Fund are used for macroeconomic data such as inflation and real GDP growth (IMF, 2019). Stock price movements and related up-to-date price data are downloaded from Yahoo Finance (Yahoo Finance, 2019). The yield of the 10- year U.S. treasury bonds is taken from Yahoo Finance to obtain the risk-free rate of return.

Online media resources such as highly reputable and trustworthy newspapers such as Financial Times, CNBC, Time Magazine and the Guardian Magazine are referenced to provide background information about Apple’s financial statement, its strategic decision and price curve.

This paper references the book “Investment Philosophies” (Damoran, 2012) for financial ratio calculation and technical assessment. Finally, the regression analysis technique is based on the methodology explained by the “Introductory Econometrics for Finance” book (Brooks, 2014).

The applied valuation approach to calculate Apple’s fair value is the discounted cash flow method (DCF), where forecasted future cash flows are discounted to the current year, 2019, to obtain the total present value of the company (Palepu, et al., 2013, p. 278). The methodology is based on a 10-year valuation technique starting from 27/09/2008 until 29/09/2018. Historical financial statements of Apple are analysed to build a foundation for forecasting. This section briefly explains the financial background of variables and addresses how to access them.

The valuation technique used in this work is based on the total cash available to the firm that is obtained from its operations and ready to distribute for internal purposes, paying off debt or returning to shareholders (Damoran, 2012, p. 109). It is the free cash flow from operating activities that is available to debt- and credit-holders when all fixed asset investments, net working capital and tax obligations are paid (Ross, et al., 2016, p. 32).

The DCF model focuses on the value generation from operating income, not from financing or investing income. Hence, the foundation of the model is estimating earnings before interest and debt (EBIT) that is generated by the sales of good and services and subtracted by the costs of goods sold (COGS) and the other operating expenses. These items are taken from the income statement of Apple.

Depreciation and amortization (D&A) are non-cash accountancy items from the cash flow statement under operating activities (Ross, et al., 2016, p. 25). It amounts to the cost of assets that are depreciating over time. The remaining asset value is the economic value of the asset that is used up (Ross, et al., 2016, p. 25).

Capital expenditures are payments to purchase fixed assets, machinery, equipment or tools to improve the operation. These are taken from the cash flow statement under “Payments for acquisition of property, plant and equipment”.

Tax expenses are other non-cash accountancy items from the balance sheet. A business is obliged to pay taxes from its income due to the corporate income tax. However, not only the income but also all value generating/destroying items in a company are subject to various type of taxes such as capital gain tax, dividend tax, payroll tax, property tax etc. Instead of considering every single tax item separately, the effective tax rate covers all tax expenses and computes their annual ratio to pre-tax income.

The 2017 U.S. corporate tax legislation under the President Trump administration reduced the corporate taxes from 35% to 21%, which also reduced overseas income tax to 15.5%, which allowed many multinational companies to reinvest in their operations using their overseas profit (CNBC, 2018).

Change in net working capital is a measurement of accountancy components that identify if the basic requirements of the business to run its daily operations are fulfilled at an adequate level (Palepu, et al., 2013, p. 194). These balance sheet items are the change in trade receivables, the change in payables to suppliers and the change in inventory. According to the Corporate Finance Institute, the calculation technique might slightly vary depending on the analysts’ perspective2.

The discounting rate with which present value of the company is calculated is the cost of capital

achieve extra returns (Ross, et al., 2016, p. 397). The cost of capital

𝑟𝑊𝐴𝐶𝐶

is a function of

the cost of equity (re), the market value of total equity (E), the after-tax cost of debt (rd) and the market value of total debt (D) (Palepu, et al., 2013, p. 335). The market value of the equity is the market capitalization of the stock in the equities market.

that the investors are paying to receive a minimum required rate of re(turn to )bear the risk and

The cost of equity (re) calculation method is derived from the capital asset pricing model (CAPM) that is the expected return-beta relationship of a security relative to its market. Its

2 https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-net-working-capital/

graphical representation is the Securities Market Line (Bodie, et al., 2014, p. 297). The expected return on an asset is expressed as a function of the equity beta 𝑒

(𝛽 )

10

premium 𝑟𝑝 = 𝐸(𝑟𝑀) − 𝑟𝑓and the risk-free rate of return (𝑟𝑓).

, the market risk

The risk-free rate of return is the historical daily average yield of 10-year U.S. government bonds from 20093 until 2018 (Palepu, et al., 2013, p. 334). The average risk-free rate is at 2.46% (Yahoo Finance, 2019). The 10-year maturity of government bonds are chosen exactly to match the forecasting period (Ross, et al., 2016, p. 400).

T(𝑟he)market risk premium (𝑟𝑝) is the extra return investors require from the market portfolio

𝑀

to bear the market wide risk above the risk-free rate of return (Palepu, et al., 2013, p. 334).

The market risk varies depending on the country and its macroeconomic state. Duff & Phelps, a global advisory expert company in valuation and corporate finance areas, recommends 5.5% for the U.S. market risk premium in 2018 (Duff&Phelps, 2019).

(𝛽 )𝑒

The equity beta, also called as the levered beta or the systematic risk is the non- diversifiable market-wide risk that indicates the impact of the market-wide risk on the equity’s return (Palepu, et al., 2013, p. 331). The market portfolio is usually the market index where the company is traded or where its headquarter is located. In Apple’s case, instead of the US benchmark S&P500 index, the tech-heavy index Nasdaq Composite Index, where Apple’s stocks are traded, is chosen. This allows investors to compare Apple within the technology industry and to observe its correlation to the market-wide risk that impacts technology firms the most.

Since the DCF model is based on after-tax cash flows, the cost of debt is calculated after-tax basis considering the tax-deductibility of interest expenses and the tax shield that is created (Palepu, et al., 2013, p. 334). Hence, the cost of debt is the sum of the risk-free rate and the credit default risk of the company after-tax. The credit default is the default rate at which a long-term corporate bond issued by a company, which is graded by the credit rating agencies depending on their ability to repay the debt (David, et al., 2002, pp. 47, 48). Credit rating

3 Year 2008 is bypassed due to the financial crisis in the United States in order to assess normal years.

agencies rate the potential risk of repayment of the debt by specific degrees and define the creditworthiness of the corporations by these rates over their lifetime. The spread is defined by the extra cost that the investor is paying to bear the default risk of the firm. The higher a firm is rated, the lower is the cost of debt and hence its interest rate is closer to the risk-free rate of return (Damoran, 2012, p. 50).

The credit default of the long-term corporate bonds of Apple are rated by the Moody’s agency at AA1 and by the Standard & Poor’s agency at AA+ (Bloomberg L.P., 2019). The AA1 level traded corporate bonds in the United States have in average a 1.00% spread (NYU Stern, 2019).

The perpetuity growth rate is the constant rate at which the terminal value of FCFF growing forever. It is assumed that in an economy, cash flows do not grow at a higher rate than the economies perpetuity growth rate. As a benchmark rate, the expected growth rate of the U.S. economy is taken (Damoran, 2012, p. 102). Herewith, the real GDP growth assumption by the International Monetary Fund is applied as the perpetuity growth rate.

IMF estimates the real GDP growth at 1.6% from 2022 to 2024 (IMF, 2019). After 2024 the growth rate of the US economy is hardly foreseeable and uncertain. Therefore, the expected perpetuity growth rate of the FCFF after 2029 is assumed to follow the same trend and remain stable at 1.6% as the IMF projections presume.

The terminal year is the last cash flow forecasting year that is covered in the DCF model. However, cash flows beyond the terminal year are generating value as well and are important to include in the valuation exercise. The terminal value is the estimated present value of all cash flows beyond the terminal year and they are assumed to be growing at a perpetuity growth rate (Damoran, 2012, p. 107).

The sum of all discounted cash flows determines the fair enterprise value of the company at the calculation date that is the date to which free cash flows to firm are discounted back. The enterprise value is defined as the asset value if the company had been financed 100% with equity (Palepu, et al., 2013, p. 347). However, in reality, there is the tax-shield advantage of debt that adds value to equity as a whole. As a result, the remaining equity value becomes the residual claim to shareholders once all debt is paid. The estimated equity value is the fair (target) value of the companies’ stocks that are driven by the cash flow structure of the company. The target price of a share is a benchmark value for the investor when compared with the market price. With the valuation approach, this paper introduces a target price that is driven by the fair value of the firm and compares it with the current trading price.

The following section introduces the techniques that are used for the valuation of Apple, Inc. following two sections: the first section explains how to obtain the target price of the company and the valuation method behind it. The second section examines how the assumptions are justified and assesses the sensitivity of the obtained target price to both external and internal assumptions.

The first step of the discounted cash flow model (DCF) is analysing historical 10-years of cash flows and forecasting them based on their growth trend or their ratio to the sales revenues. The second step is calculating the free cash flow to firm (FCFF). The last step is discounting FCFF to current year to obtain the present value of the company.

The forecasting future cash flows starts with analysing historical financial statements. The goal is to seek trends and consistent ratios to estimate future cash flows based on that conclusion. Below are the forecasting methods applied to obtain all necessary variables for the free cash flow calculation.

The foundation of the forecasting cash flow is sales revenues. First, the historical 10-year growth trend is analysed considering the business cycles, the U.S. economic growth and the recent strategies of the company. Second, the trend is extended to the future 10-years and additionally the growth rate of the terminal year is expected be exactly to equal as the U.S. economic growth forecasts.

to revenues margin is analysed to obtain the historical gross

profit margin of t𝐺h𝑟e𝑜c𝑠o𝑠m𝑝p𝑟a𝑜n𝑓y𝑖:𝑡 𝑚𝑎𝑟𝑔𝑖𝑛 = 𝑅𝑒𝑣𝑒𝑅𝑛𝑒𝑢𝑣𝑒𝑒𝑠𝑛−𝑢𝑒𝐶𝑠𝑂𝐺𝑆

(1)

The same gross margin interval of the past 10-years is kept as the benchmark projection of future predictions. Next, other operating expenses such as selling, general and administration expenses, research and development expenses and other operating expenses are summed up to compute their ratio to the cost of goods sold. As a result, EBIT is the gross profit subtracted by the other operating expenses and EBIT margin is simply the ratio of EBIT to the revenues. Hence, the following equation can be applied:

(2)

First, the ratio of depreciation and amortization expenses (D&A) to EBIT is calculated to obtain a benchmark ratio of how the future organic growth trend might evolve. Second, historical CapEx to D&A ratio is analysed, and the same ratio is applied to future estimations to maintain a similar performance. If the CapEx is higher than the D&A, meaning their ratio is greater than one (or 100%), the business can not only maintain its current state but can also invest in its fixed assets to improve production and its operating performance. However, the terminal year is the year at which the company is just expected to maintain organic growth and to follow the growth predictions of the economy, hence, the CapEx is assumed to be equal to the D&A in the terminal year in order to maintain a stable growth and replace all the equipment that is depreciating (Forensic Strategic Solutions, 2017).

The effective tax rate is the ratio of total tax expenses to the pre-tax income (Palepu, et al., 2013, p. 210). Since annual tax payment of the company varies depending on the state tax regimes, applied effective tax rate (t) for the future forecasts is set to the average of the past 10-years.

Applied methodology for calculating the change in net working capital (NWC) is based on the annual change in working capital followed by the methods of Corporate Finance Institute (CFI, 2∆01𝑁9𝑊): 𝐶 = ∆ 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 + ∆ 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠 − ∆ 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑝𝑎𝑦𝑎𝑏𝑙𝑒 (3)

The free cash flow to firm (FCFF) is the operating income after tax that is subtracted by the change in the net working capital (NWC), depreciation and the capital expenditures (Palepu, et al., 2013, p. 618):

Once, the FCFFs for every forecasting year are calculated, the next step is to estimate free cash flows beyond the terminal year, which is the terminal value.

The weighted average cost of capital is the discount rate at which all cash flows are discounted. It is calculated by weighting the cost of equity (re) to the market value of total equity (E) and the after-tax cost of debt (rd) to the market value of total debt (D) which is the sum of short-term and long-term debt (Palepu, et al., 2013, p. 335):

default spread above the risk-free rate (𝑟𝑓 + 𝑠𝑝𝑟𝑒𝑎𝑑) that the investor is seeking (Ernst &

The cost of debt (𝑟 ) is the after-tax rate (𝑡) of the cost of borrowing based on the additional𝑑

𝑑 𝑓 (6)

the investor is requiring to bear the market-wide systematic risk (𝛽𝑒) based on the market

Young, 2018):

The cost of equity (𝑟𝑒), on the other hand, is the extra return above the risk-free rate (𝑟𝑓) that

conditions (𝑟𝑝):

The systematic risk, also known as the equity beta or the levered beta, is the beta estimate of the regression analysis of the market benchmark Nasdaq composite index (CCMP: IND) and Apple’s stock index (AAPL: US). Hence, daily stock prices of both indices are downloaded from Yahoo Finance and their daily returns are calculated.

All returns are plotted on a scatter diagram as with the x-axis defining the daily price returns of the market portfolio and the y-axis is the daily price returns of Apple’s stock. The fittêd line

Alpha estimate (𝛼̂). Beta estimate is the covariance of Apples’ and Nasdaq’s price returns over

that describes all data the best is the regression line. It is a function of Beta estimate (𝛽) and

the variance of Nasdaq’s price return (Bodie, et al., 2014, p. 297):

𝛽̂ = 𝐶𝑜𝑣𝑉(𝑎𝑟𝐴𝑟𝑝(𝑝𝑟𝑙𝑁𝑒𝑎, 𝑠𝑟𝑑𝑁𝑎𝑎𝑞𝑠)𝑑𝑎𝑞)

(8)

The beta estimate indicates the sensitivity of the Apple’s stock to the market-wide risks. The alpha estimate is the intercept of the fitted line, that is expressed by the average of Apple’s and Nasdaq’s daily price returns (Brooks, 2014, p. 81):

(9)

The perpetuity growth rate is the expected growth rate of the U.S. economy as mentioned in

the present value of the cash flows at perpetuity in year 2029 yearend, that is the tenth

discounting year. Once all the discounting years are defined, the method is as follows (David,

et al., 2002):

𝐹𝐶𝐹𝐹

𝐹𝐶𝐹𝐹

𝑇𝑉

The present value of all discounted cash flows indicates the fair asset value of the enterprise based on the cash flows assumptions that were made. However, due to the tax advantage of interests, debt financing adds value to the firm. According to the pecking order theory of financing, debt holders are being paid before equity holders can claim their stake. Therefore, equity value is the total asset value subtracted by net debt and minority interest, which are non- equity claimants (Palepu, et al., 2013, p. 347):

Minority interests are payments that are made to the outside shareholders and not related to the economic value of the business (Palepu, et al., 2013, p. 349). The net debt is the sum of all interest-bearing debt subtracted by the cash and cash-equivalents. The reason is that the cash equivalent marketable securities can be quickly turned into cash and the remaining debt can be immediately paid off (Ross, et al., 2016, p. 56). In the end, net debt will be only the remaining portion of the debt that is not payable with the current liquidity of the company:

(13)

The reached equity value is expected to be at least equal to the market capitalization that is the selling price of the company’s equities at the secondary market, meaning the trading price of a single share multiplied by the number of outstanding shares (Ross, et al., 2016, p. 56). Thus, the purpose of the valuation is to obtain a target equity value that is derived from the fair enterprise value and to compare this to the market price.

After obtaining the target price, its sensitivity to the assumptions is an important measurement. This section examines sensitivity analysis in to two parts. Internal justification is the sensitivity

of the target price to performance-related “internal” assumptions and external justification is the sensitivity of the target price to market-wide “external” effects.

All variables are forecasted depending on their ratios related to revenues or COGS. Thus, it is important to justify the sensitivity of the target price to the growth assumptions of both variables. This work presents the good and bad case scenarios for the two core variables. The good-case scenario is when the annual growth of sales revenues is +1.00% faster and/or the annual growth of the costs is -1.00% lower than an expected “average” year. The worst-case scenario is when the annual growth of revenues is slower by -1.00% and/or the costs increase

+1.00% higher than expectations.

In this section, the market-wide external factors are examined. Two core variables have a crucial impact on the target price: the perpetuity growth rate and the weighted average cost

of capital (𝑟𝑊𝐴𝐶𝐶). ∓0.50% incremental change in the perpetuity rate is computed and the

impact on the target price is calculated. Similarly, ∓1.00% incremental change in the weighted

average cost of capital (𝑟𝑊𝐴𝐶𝐶) is applied and the DCF model is built multiple times to obtain

the target price. Lastly, the impact of the variables to the target price is illustrated in a matrix form.

Results are presented in four sections: the preliminary analysis of the 10-year historical financial statements, the 10-year forecast of future cash flows, the discounted cash flow model with the target price and the sensitivity analysis.

Analysing the past decade, Apple indicated fast revenue growth after the financial crisis with the highest annual revenue growth of 66.00% in 2011. However, reports indicate that Apple’s revenue growth has been slowing down since 2012. The extreme growth increase from 2010 to 2011 can be related to the post-financial crisis recovery period.

The net income margin increased slowly from 16.21% to 26.67% and stabilized up until 2018 at around 21.00%. The FCFF had bad performance in 2008 and 2009, assumingly due to the financial crisis and its ratio to sales stagnated at around 22.00% in the last 5 years. This level of FCFF to sales margin is kept stable for further forecasting of the future cash flows.

Profitability measures such as the return on equity (ROE) and the return on assets (ROA) follow the gross margin and the EBIT trends. ROE was 33.23% in 2008 and improved to 49.36% in 10 years, meaning the equity holder has 49.36% return on their investment to the common equity stocks.

The corporate effective tax rate between 2009 and 2018 had an average of 25.84%. Due to the high deviation in the effective tax rate, the forecasting is based on the 10-year average.

Apple has decided to pay dividends starting from 2012. The average dividend-payout ratio is at 14.41% annually.

Two main solvency ratios are analysed. The interest coverage ratio, that is EBIT over interest expenses and the net debt to EBITDA ratio. The interest coverage ratio has a 10-year average

of 62.15x, meaning Apple can cover its interest expenses 62.15 times with its income. Because Apple has more cash than its total debt, net debt indicates negative number. Although the interest coverage ratio has been falling, a negative net debt is an indication successful debt level, hence, there is no default risk observed.

The main reason for the high level of cash is Apple’s strength on cash and liquidity management. Apple’s current assets are on average 1.65 times of its current liabilities over the past 10 years (Ross, et al., 2016, p. 49) due to the current ratio. Working capital management has a tremendous impact on Apple’s strong liquidity. Apple’s cash conversion cycle (CCC) has been decreasing dramatically. A negative CCC means days payables outstanding are longer than receivables and inventory held. On a 10-year average, Apple has been receiving payments for its goods and services in 24.75 days, holding inventory only for 62.33 days and paying its suppliers in 87.42 days. In other words, Apple is financed by its supplier for approximately 3 months and can pool cash for its internal needs for -56.28 days. This indicates, on one hand, dominant bargaining power towards its supplier and persuasive sales strength towards its customers.

20

Apple’s stock price has increased +108.00% over the last 5 years, and +5.00% since 2018 June. The higher price was obtained at the beginning of October with $232.07 followed by a similar rise in the market portfolio. With the reduction of corporate tax rate early 2018, Apple was able to increase its cash level furthermore, which allowed Apple to reinvest in itself. In May 2018, Apple announced a $100.00 billion worth share buyback program to be implemented gradually starting from June (Time, 2018). With the buyback operations, Apple was able to use the excess cash so that shareholder could appreciate the value with the price jump. The rise in stock price continued until the beginning of October until the announcement of 25.00% additional tariffs on Chinese goods (Guardian, 2019). Added tariffs, affected Apple dramatically since many spare parts and components are produced in China. Analysts assume that the increase in tariff could add +14.00% to the COGS (Fortune, 2019). According to 2018 annual report, 19.56% of the total revenue came from Greater China (Apple Inc., 2018). An accordingly slowdown in sales in China will be unattractive for Apple’s shareholders.

22

The revenues are forecasted based on the preliminary analysis results. The slowdown in revenue growth has been adapted to future forecasts. The revenues of the terminal is set equal to the expected economic growth rate of 1.60%. As the US economy is expected to growth at 1.60% in 10 years, the growth of the revenues is assumed to be equal to the economic growth rate.

25

from 28/09/2009 until 30/09/2019

With Beta 0.97, Apple stays lower than the industry average for instance in the consumer electronics (1.19), the computer services (1.27), the semiconductor (1.34), and the software industries (1.46) (NYU Stern, 2019). Hence, the cost of equity is found as 7.80% using equation

The end of the year market capitalization in 2018 was $1,073,390.54 million and the market value of total debt $114,483 million (Bloomberg L.P., 2019). As a result, the debt-weight is found as 0.10 whereas the equity weight is 0.90. The cost of equity and the appropriate weight

𝑟

Once all FCFFs including the terminal value are obtained, they are discounted back to 2019 to obtain the present value of each year. Enterprise value, which is expressed in

using 𝑟𝑊𝐴𝐶𝐶

In Millions of USD except per share

30

311.26

362.89

0.00% 162.21

218.62

270.24

-1.00% 77.39

133.81

185.43

-1.00%

0.00%

1.00%

COGS growth

(% YoY)

Target price in USD

Target price upside/ downside

potential (%)

COGS growth

(% YoY)

1.00%

0.00%

-1.00%

1.00% 16.57%

42.38%

65.99%

0.00% -25.80%

0.00%

23.61%

-1.00% -64.60% -38.79% -15.18%

The market-related assumptions have a significant impact on the target price. The perpetuity growth rate, the risk-free rate, and the market premium depend on the U.S. economic state and the market conditions. Hence, all assumptions might overperform or underperform in the

Revenue growth (% YoY)

Revenue growth (% YoY)

future. Therefore, the sensitivity of the target price to ∓

0.50% incremental changes of the incremental changes in the discount rate is calculated. The

perpetuity growth rate and ∓1.00%

(%)

WACC (%)

4.30%

5.30%

6.30%

7.30%

8.30%

9.30%

10.30%

-0.40%

42.55%

15.74%

-3.03%

-16.88% -27.51% -35.93% -42.75%

0.10%

54.66%

23.14%

1.82%

-13.54% -25.13% -34.17% -41.43%

0.60%

70.04%

32.11%

7.52%

-9.70% -22.43% -32.21% -39.97%

1.10%

90.22%

43.22%

14.32%

-5.24% -19.35% -30.02% -38.35%

1.60%

117.86% 57.33%

22.56%

0.00%

-15.82% -27.53% -36.54%

2.10%

158.07% 75.85%

32.77%

6.25%

-11.72% -24.70% -34.52%

2.60%

221.91% 101.23% 45.73%

13.82%

-6.90% -21.45% -32.23%

3.10%

338.88% 138.12% 62.74%

23.20%

-1.15% -17.68% -29.62%

3.60%

622.58% 196.71% 86.04%

35.12%

5.81%

-13.24% -26.63%

The preliminary analysis indicates that despite a slow down in revenue growth, Apple’s 10- year gross margin average is at 39.20% with net income margin of 21.68%. On the liquidity side, Apple has a current ratio of 1.65 and a quick ratio of 0.99. Due to high levels of cash, Apple’s net debt to EBITDA ratio is negative with an average of -2.21 and the cash conversion cycle is around 56.28 days which is a sign of strong bargaining power and dominant market position.

Apple stocks are currently trading at $193.85 and the expected target price by 30/09/2019 is

$218.62 that is 12.78% upside price potential, according to the DCF model. The discount rate that is based on the weighted average cost of capital method is 7.30%. The perpetuity rate of future cash flows is assumed at 1.60%. The estimated target price is highly sensitive to the deviation of each assumption. +1.00% increase in the discount rate, reduces the target price by

-15.82% assuming that the perpetuity rate remains the same. -0.50% decrease in the perpetuity rate, drops the target price down by -5.24% if the discount rate is constant.

Business growth assumptions have a strong impact on the estimated target price as well. Two scenarios are investigated. First, if the revenues grow +1.00% faster than expectated and the COGS slow down by -1.00% annually, the target price rises up to $362.89 per share. Second, if the COGS’ growth rate increases +1.00% annually followed by a -1.00% fall on the revenues side, the estimated target price drops down to $77.39 per share.

Apple has announced to turn its focus towards services business and to not report the number of units sold in upcoming financial reports. This creates uncertainty about whether Apple wants to continue developing its long-time cash-cow products iPhone or Macbook and creates confusion about the intention of reducing the transparency of its’ sales. Despite all concerns, refocusing in the services area will help Apple to boost its revenue growth, to relief from tariff and trade, and to expand its business barrier-free even with possible sanctions. Considering its strong market position, bargaining power towards its supplier, updated market strategy and the state of the economy, Apple is currently underpriced by 12.78%. Therefore, this paper recommends investors a strong buy strategy.

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Filed).pdf

[Accessed 02 Jun 2019].

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Available at: Bloomberg Professional [Accessed 06 Jun 2019].

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Available at: bloomber.com [Accessed 15 Jun 2019].

Bodie, Z., Kane, A. & Marcus, A. J., 2014. Investments. 10th ed. New York: McGraw-Hill. Brooks, C., 2014. Introductory Econometrics for Finance. 3rd ed. Cambridge: Cambridge University Press.

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Available at: https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-net- working-capital/

[Accessed 10 Jun 2019].

Alpha estimate Equity beta Beta estimate

CapEx Capital expenditures

CAPM Capital asset pricing model

CCC Cash conversion cycle

COGS Cost of goods sold

D Market value of debt

D&A Depreciation and amortization

DCF Discounted cash flow model

E Market value of equity

EBIT Earnings before interest and tax

EBITDA Earnings before interest tax depreciation and amortization

FCFF Free cash flow to firm Perpetuity growth rate

GDP Gross domestic production

NWC Net working capital

Change in net working capital

PV Present value

Cost of debt Cost of equity

Risk-free rate of return Return on market portfolio Market risk premium

Weighted average cost of capital

ROA Return on asset

ROE Return on equity

Goodness of fit (R square)

t Effective tax rate

TV Terminal value

yoy Year-on-year

Weight of equity

Weight of debt Mean value of x Mean value of y

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Apple, Inc. (AAPL US) - Standardized Balance Sheet

Apple, Inc. (AAPL US) - Standardized Balance Sheet

Apple, Inc. (AAPL US) - Standardized Balance Sheet

Apple, Inc. (AAPL US) - Adjusted Income Statement