Corporate Finance Assignment on Amazon

This Corporate Finance Assignment focuses on Amazon and its cost of capital. It discusses the reliance on debt and provides recommendations for the company. The assignment covers key financing issues and offers insights into Amazon's financial performance.

Corporate Finance Assignment
2019

Amazon
Executive Summary
Amazon.com Inc is a powerful player in the online retail and is popular for the continuous
sales and market share and that too at the expense of the profit. The current report revolves
around the company Amazon where the cost of capital is vividly described. The business uses
debt to a major extent and hence the cost of debt part is kept at the priority in the report. The
calculation has been provided where it is noted that the reliance on debt is high and hence
Amazon might face a challenging position in the upcoming future. Therefore, to combat such
a scenario, it is recommended to the company to have lesser reliance on debt.
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Contents
Introduction...........................................................................................................................................4
Key Financing Issue................................................................................................................................5
Conclusion:..........................................................................................................................................10
References...........................................................................................................................................11
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Introduction
Amazon was launched in the year 1995 and was founded by Jeff Bezos in the year 1994.
Amazon is the first company in the large group that started selling goods online. The
company is based in Seattle, Washington. The company initially sold books over the internet
and later it engaged in selling other items online such as electronics, gadgets, video games,
garments, DVDs, music and what not. Jeff Bezos was honored as Person of the Year by the
Times magazine in the year 1999 due to his immense contribution towards the
encouragement of digital shopping all over the world. Amazon.com labels itself as a
customer-centric organization. The company believes itself to be customer obsessed. The
entity highly believes that if the feedbacks and queries of its customers are ignored and left
unanswered then nothing can save the company from failing. The company also takes up new
challenges considering the same as opportunities.
The company highly values its customers and places them above all. Amazon expects
ownership from its personnel because it is of the opinion that in order to create and sustain
the brand value for an organization, there must be a prevalence of ownership and
responsibility in its employees. When the employees will develop a sense of ownership
towards the brand then they might passionately work for the company and think of the future
in a way that enhances the brand value of the same (Donius, 2010). The HR of the company
makes sure that the candidates hired by the same are admirable and knowledgeable. It is why
the recruitment process in the company is tough and getting a job in the same is a task in
itself.
The e-Commerce spending is expected to rise up to $5 trillion by the year 2020 which at
present is at $2.1 trillion. This means that there are strong probabilities for the Indian E-
commerce industry to have a promising future ahead of it owing to enhanced consumer
demand and a strong economy. However, there are several e-commerce industries that have
failed in their very first year despite such growth trends. Therefore, this calls for the need to
identify possible challenges associated with the e-commerce industry. The government laws
and regulations change from time to time and therefore, the same exposure a great risk on the
operations of an entity (Melville, 2013). Political unrest, economic recessions, taxations,
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regulations, and so on are the potential threats faced by Amazon that has a huge tendency to
impact its revenues and financial performance (Gowthrope, 2011).
Key Financing Issue
Amazon.com ranks number one in the online sale of customer products and services across
the globe. It is also the first ever company to sell its products online. The sudden boom in the
online industry is high due to Amazon.com. Most of the capital structure of the company
comprises of debts despite the fact that the shares of the same have enhanced by at least
150% in the previous 3 years. The company is also exposed to the risks pertaining to their
quench for expansion into international markets. This is because of the fact that there are
huge expenses involved with respect to establishing, developing and maintaining
international operations and websites for the company that is opting for international
expansion. In other words, the company will require to have more of debt and the same is
exposed to a lot of risks on account of business licensing, economic and political conditions,
international regulations on e-commerce, language and so on (Julia & Elizabeth, 2010.
Equity Capitalization
The company faces a lot of challenges with respect to optimization of data fulfillment. For
any e-commerce industry that is growing at a very fast pace, there exist risks related to the
optimization of returns and therefore, they must ensure that their equity is optimized. This is
because of the fact that this shall assist in the reduction of shipping costs arising out of the
fulfillment centers and will facilitate the formation of a strong bond with the shipping
companies. The balance sheet of an organization represents the amount of equity and debt
held by the same during the end of a financial year. Equity represents the investments of the
shareholders in an organization. In other words, equity signifies the overall interest of
shareholders in a going concern. It is the capital held by the company due to the investments
made by the shareholders of the same. It is calculated by means of adding the common stock
and retained earnings and thereafter, the derived amount is subtracted from the amount of
treasury stock. On December 2015 the stockholders’ equity of the company was around
$13.384 billion which consists a total retained earnings of $2.545 billion, additional paid-in
capital and common stock worth $13.399 billion, accumulated other comprehensive loss
worth $723 million and treasury stock worth $1.837 billion. The company has convertible
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securities worth 10 million and outstanding shares worth 474 million on 8 August 2016. The
market capitalization of Amazon is around $363.35 billion and the company is presently
trading for $766 per share.
Debt Capitalization
Debts are the obligations that a company owes to its creditors and suppliers (Mersland &
Urgeghe, 2013) Debts are classified into two segments. One being liabilities that take
maximum a year to mature that is current liabilities and the other are such liabilities that
mature in more than a year (Lapsley, 2012). It is important for a company to identify its
current liabilities as these have the potential to impact the solvency of an entity. On
December 2015, the current liabilities of Amazon.com amounted to $33.899 billion which
includes unearned revenues of $3.118 billion, accounts payable for $20.397 billion and
accrued expenses for $10.384 billion. The total liabilities of the company amounted to $52.06
billion that represents a 144% rise in the same since December 2012. Also, the long term debt
and other long-term liabilities of the company were at $8.235 billion and $9.926 billion
respectively.
Cost of Debt
Ever since the prevalence of global financial crisis in the year 2008, the accommodative
monetary policy of the Fed has made sure that the interest rates are maintained at lower
levels. This is why several companies have opted for issuance of bonds so as to enhance their
leverage. Amazon.com has written off around $8 billion in bonds at a median of 3.3% and a
weighted average interest rate of 3.44% since early 2009. The capital structure of the
company has, therefore, altered due to this sudden surge in the issuance of debt. Also, the
liquidity ratio and quick ratio of the company are reduced to 1.08 and 0.774 respectively
since December 2012. This signifies the issues faced by the entity in tackling its short term
debt obligations.
The debt to equity ratio has signalled an increment. The debt to equity ratio helps the
company in making comparisons between its equity capital and debts that a company owes to
its creditors. In other words debt to equity ratio is a comparison between the company’s
equity and its debts (Laux, 2014). It is a ratio between the equity owned by a company and
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debts owed by the same to its creditors. The debt to equity ratio of the company has increased
to 389% in the previous three years. The company had a debt to equity ratio of 336% as of
December 2012 which is very high as compared to its competitors’ ratio and industry average
as well (Macrotrends, 2018).
The company initiated a deal by issuing bonds worth $16 billion. This deal is one of the 20
largest deals on record and is also the fourth largest deal for the year 2017. Below is the table
reflecting the details of the bond issuance::
Amazon.com took up a lot of acquisitions out of which the acquisition of Whole Foods was
one that was completely debt funded. It was stated that though there is a significant rise in the
debts of a company yet the acquisition of Whole Foods depicts a bright and a positive future
of the same (Macrotrends, 2018). It was also stated that such statements are highly on the
basis of the company’s liquidity profile and cash flow generation and not on the basis of mere
assumptions. The company is very much into leveling up its operations by means of opting
for diversification with respect to new goods and services along with various acquisitions.
This makes the company prone to certain risks that can be fatal to its existence as well
(Divine, 2018).
Amazon is keen to position itself and for this purpose, it has to expose itself to various risks
that might be vulnerable to its well being as well. The company aims at more and more
expansion which ultimately increases the strain on its employees, management, financial
resources, operations, technical performance, and systems. If the growth is not dealt with
proper care then there are high possibilities for the company to impact its own reputation and
financial well being (Leo, 2011).
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Ever since the Baal rating was assigned in November 2012, the market capitalization has
boomed to $470 billion from $110 billion.
The WACC can be defined as the rate that is needed by the company to be paid to the
investors so that the finance can be done on the assets (Madura & Fox, 2011). The WACC is
defined as the cost of capital of the firm. Amazon assets are financed through equity and debt
and WACC can be defined as the average of the costs of the sources of finances, each being
weighted by respective situation. This is done by using the concept of WACC we can project
the interest that is needed to be paid for each dollar that is financed.
WACC = E/(E+D) * cost of equity + D/(E+D) * Cost of debt * (1- tax rate)
It is important that the weight of equity and the weight of debt needs to be computed. The
market value of equity is even commented to be the market capitalization. In the present
scenario, the market capitalization of Amazon stands at $907721.940 Mil. The book value of
debt is considered for the computation of D.
Going by the March 2019 status, Amazon’s Inc latest two-year average long term debt
scenario stands at 60 million and the latest two year average of long term debt and capital
lease obligation comprises of $38856.5 million. The total book value of the debt comprises of
$38856.5 million.
a. weight of equity = E / (E + D) = 907721.940 / (907721.940 + 38856.5) = 0.95
b. weight of debt = D / (E + D) = 38856.5 / (907721.940} + 38856.5) = 0.04
The interest expense of the financial year is being used divided by the last two year average
debt to reach to the simplified cost of debt. Till 2018 the interest expenses was $147 million
and the overall book value of debt appeared at $3885.6 million.
Hence cost of debt = 1417/38856.5 = 3.6468%
Further, tax rate was 15.415%
The WACC of Amazon
WACC = E/(E+D) * cost of equity + D/(E+D) * Cost of debt * (1- tax rate)
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= 0.959 * 12.91% + 0.041 * 3.6468% *(1-15.415%)
=12.51%
From the computation, it is clearly noted that the WACC of Amazon. Com INC is 12.51%.
Amazon.com Inc generates revenue on a grand basis on the money spent by it that leads to a
cost for the company (Bylund, 2018). A firm that wants to have positive returns on the
investment so that the future leads provides more wealth (Petty et. al, 2012).
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Conclusion:
Return on equity or ROE is an important mechanism that will help the business to flourish.
ROE is one of the parameters that help the company to attain a favorable position however,
without the presence of high debt is a lucrative option. Hence, Amazon should try to increase
its ROE without the usage of fo debt. The debt-equity ratio stands at 1.21 meaning that the
debt plays an important role. If the debt component is removed or reduced then it will help in
projecting good returns for the company. A high return on equity without debt will be fruitful
to the performance of the company. if two companies comprise of the same ROE then the
one with the lesser debt will be the choice.
The second important consideration is the operating cash flow that can be the best source
when it comes to the operating course of activities. The cash flow of Amazon increased from
$3.9 billion to $11.9 billion in the period ranging from 2011 to 2015. The company should
ensure strong sales so that it generates more revenue and hence will be able to repay the
debts. When the ongoing cash flow helps to support the debt obligations or capital
expenditure then it will be easier for the company to make further developments. The best
mechanism that Amazon can undertake in this scenario is to keep the accounts receivable low
and accounts payable high. This will lead to more operating cash flow and going by the
profile of the Amazon it can be said that the new accounts receivable or uncollected sales at a
low level and delayed some of the payments. For rapid growth and to design strategy
Amazon should look into the long term debt perspective and retire old debts. It should ensure
that the operating cash flow should be strong enough to meet the obligations of the debt.
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References
Bylund, A. (2018) Is Amazon.com, Inc. a Buy? . Available from:
https://www.fool.com/investing/2018/05/31/is-amazoncom-inc-a-buy.aspx [Accessed 15 May
2019]
Divine, J. (2018) Pros and Cons to Buying Amazon Stock. Available from:
https://money.usnews.com/investing/stock-market-news/articles/2018-03-28/amazon-com-
inc-amzn-stock [Accessed 15 May 2019]
Donius, B. (2010) Profit Maximization - Ethics = The ‘Goldman Standard, Available
from http://www.huffingtonpost.com/bill-donius/profit-maximization---
eth_b_553605.html [Accessed 25 May 2018]
Julia, S.K & Elizabeth C. R. (2010). Conflict Between Doing Well And Doing Good? Capital
Budgeting Case Study – Coors. Journal of Business Case Studies. 6(6), 123-130. Retrieved
from: https://www.ssoar.info/ssoar/bitstream/handle/document/36873/ssoar-2010-
graaf_et_al-The_good_cause__theoretical.pdf?sequence=1
Lapsley, I. (2012). Commentary: Financial Accountability & Management. Qualitative
Research in Accounting & Management. 9(3), pp. 291-292. Retrieved from
https://doi.org/10.1111/1468-0408.00081
Laux, B. (2014) Discussion of The role of revenue recognition in performance reporting.
Accounting and Business Research. [online]. 44(4), 380-382. Available from:
http://www.ccsenet.org/journal/index.php/ijbm/article/viewFile/4235/3672 [Accessed 17
May 2018]
Laux, B. (2014) Discussion of The role of revenue recognition in performance reporting.
Accounting and Business Research. [online]. 44(4), 380-382. Available from:
http://www.ccsenet.org/journal/index.php/ijbm/article/viewFile/4235/3672 [Accessed 24
May 2018]
Leo, K. J. (2011) Company Accounting. Boston:McGraw Hill
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Macrotrends. (2018) Amazon Long Term Debt 2006-2019 | AMZN. Available from:
https://www.macrotrends.net/stocks/charts/AMZN/amazon/long-term-debt [Accessed 15
May 2019]
Madura, R., & Fox, J. (2011). International financial management (2nd ed.). South Western
Mersland, R., & Urgeghe, L. (2013) International Debt Financing and Performance of
Microfinance Institutions. Strategic Change. 22, 36-47. Doi:10.1002/jsc.1919.
Petty, J. W, Titman, S., Keown, A. J., Martin, J. D., Burrow, M. and Nguyen, H. (2012)
Financial Management: Principles and Applications, 6th ed. Australia: Pearson Education
Australia.
Porter, G. and Norton, C. (2014) Financial Accounting: The Impact on Decision Maker.
Texas: Cengage Learning
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