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.

An Investment Analysis Case Study

Part 1 : Estimation of Cost of Capital

Market Value of Equity : $ 90/share x 900 mn shares = $ 81,000 million

Thus the Debt to Market Value ratio is 1475: 81,000 i.e. 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% +2.25% = 4.25%
Cost of equity = Rf + * (Rm-Rf)
The treasury bonds of 10 year duration are presently trading around 2%. The
for Apple is 0.95 but it is not relevant to the electronics (TV) division as Apples
income mainly comes from IT industry. From the data given for the electronics
companies, unlevered beta is computed using the following formula :
Raw /(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 is found to be 0.54. Considering that Apple will have a
debt equity ratio of 1:52, the relevered beta works out to 0.55
Thus the cost of equity for Apples TV division will be :
R = 2% + 0.55 * (9%-2%) = 5.85%, say 6%
Total Debt i.e. Present Value of minimum lease payments
Year
Lease
commitments
Discount Factor
PV
Total Debt

195
0.96
187.0
5
1475

209
0.92
192.3
1

200
0.88
176.5
2

191
0.85
161.7
1

177
0.81
143.7
5

788
0.78
613.8
6

Post tax cost of debt = 4.25% *(1-40%) = 2.55%

Cost of Capital = 6% x 55/56 + 2.55% * 1/56 = 5.9%, say 6%

1. 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

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
7.6
%

The cost of equity for the company is 6%.

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.

2. Incremental cash flows

Figures in $ Million
Incremental Cashflows
Year
0
1
2
Investments
(2,200)
(520)
Required
-49.5
-13.5 -15.0
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
-

16.6

18.3

20.2

-8.1

-8.6

-9.1

9.7
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

238

297

38
4

45
7

53
7

641

674

710

77
1

821
741

(2,25
0)
1.00

238

(22
3)
0.89

38
45
4
7
0.8 0.7
4
9
32
36
2
2
12.9%

53
8
0.7
5
40
2

641

674

124

77
1
0.
59
45
6

1,56
2
0.56

0.9
0.7 0.6 0.63
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 12.9% much above the cost of capital of approximately 8.8%.
As a going concern, the iTV division will not have to incur any R&D or
introductory costs after year 10. Only the production capacity will have to be
increased as and when required. Since the last increase in capacity was only in
year 8, no immediate investment is considered.
The cash accrual of the division has increased by an average of 6% in the last 3
years. For the purpose valuation, a conservative growth rate 3% is assumed for a
mature company in a mature industry like TV/electronics. The expected cost of
capital is 6%. Using the dividend discounting model, we fnd the terminal value
as follows :
P = E1/(k-g) =

821*(1+3%)/(6%-3%) = $ 28,179 mn

Based on the above terminal value, the incremental cash-flows and

valuation is given below

Incremental Cashflows
Year
Investments
Required

0
(2,200)

1
-

2
(520)

3
-

4
-

5
-

6
-

7
-

8
(586)

9
-

10
-

Net cashaccruals

(2,250)

238

(223)

384

457

537

641

674

124

771

1,562
28,999

Terminal value
Net Cash flows

(2,250)

238

(223)

384

457

538

641

674

124

771

PV Factor

1.00

0.94

0.89

0.84

0.79

0.75

0.70

0.67

0.63

0.59

322

362

402

452

448

Present Value

-2250

NPV

16490

225

-198
IRR

78

29,000
0.56

456

34.3%

If we factor in the valuation of the business as a going concern, the viability

improves even better with an NPV of $ 16,490 mn and the IRR (post tax) to
34.3%. Based on these two scenarios, the investment decision is recommended.

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

7.6
%
6.3
%
4.5
%
5.3
%

Increase in product cost by

10%
Reduction in price by 10%
Reduction in peak market
share from 5% to 4%

IRR

34.3
%
32.9
%
30.7
%
31.6
%

NPV
($
Mn)
16490
15,0
23
12,87
8
12,96
6

The project viability is most sensitive to reduction in selling price.

Recommendations:
Based on the above analysis, we fnd that the project is viable based on all three
parameters in the base case. The IRR and NPV on the other hand have
consistently shown that the project is viable even in the most adverse scenario
tested above. In view of the same, it is recommended that Apple should go
ahead with the project.

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