Conversion Cycle Article 2022

Running Head: Corporate Finance
Finance
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Corporate Finance
Contents
Part A: Company Financing..................................................................................................................1
1) Amazon’s Cash Conversion Cycle as Compared to Other Retailers in 2014 and its Working
Capital Management..........................................................................................................................1
2) Significance of Negative Cash Conversion Cycle for a Company wanting to experiment with
Investing in New Products that could Fail or Succeed.......................................................................1
3) Financing Options available with Amazon except Cash: Advantages and Disadvantages.........2
i. Debt Financing...........................................................................................................................2
ii. Issue of stocks............................................................................................................................2
4) Amazon’s Cash Conversion Cycle in 2014 and 2018................................................................3
5) Three Significant Risks faced by Amazon in 2018....................................................................3
6) Bond Price in 2019....................................................................................................................4
7) Holding Period Return...............................................................................................................4
Part B: Capital Budgeting......................................................................................................................5
1) Free Cash Flows Generated by Amazon’s 3000 new stores over the 10 years..........................5
2) NPV............................................................................................................................................5
(i) A WACC of 12%..................................................................................................................5
(ii) A WACC of 5%...................................................................................................................5
3) Payback Period..........................................................................................................................5
4) Weaknesses of Cash Flows Estimated in the Article..................................................................6
5) Decision Regarding Opening 3000 new AmazonGo Stores........................................................6
Part C: Personal Reflection....................................................................................................................7
References:............................................................................................................................................8
Appendix...............................................................................................................................................9

Running Head: Corporate Finance
Part A: Company Financing.
1) Amazon’s Cash Conversion Cycle as Compared to Other Retailers in 2014
and its Working Capital Management
It is very necessary for any business to have a good amount of cash for carrying out its
business operations effectively and meet the urgent liabilities or any other type of liabilities.
There is a metric called cash conversion cycle (CCC) which shows the time taken by the
company to convert its investment into inventory and then to cash. In any business, firstly the
cash is converted to inventory, then accounts receivable and at the end back to cash (Chron,
n.d.). CCC is calculated by adding inventory turnover days and days of sales outstanding and
finally days of payable outstanding are subtracted. In 2014, Amazon experienced a negative
cash conversion cycle which stood at -30.6 days whereas other retailers like Walmart and
Costco which are considered to be super-efficient had their CCC in single digits (Fox, 2014).
Amazon’s negative cash conversion cycle shows that the company is able to generate revenue
from the customers much before it needs to pay the due amount to suppliers for inventories
among many other things. In other words, the company is financing its daily operations and
working capital needs using the borrowed amount from suppliers and the best part is
company is not even required to pay interest on it. Therefore, negative cash conversion cycle
of Amazon speaks about the strong management team which is managing the working capital
amazingly well.
2) Significance of Negative Cash Conversion Cycle for a Company wanting to
experiment with Investing in New Products that could Fail or Succeed
Earlier, it was believed that the companies operating in low- tech industries has the capability
to generate more cash than the companies operating in any other industry. It was believed so
because low-tech industries have faithful (addicted) customers. The examples of low tech
industries include tobacco, groceries, gaming etc.
Now, the myth has been broken by Amazon which operates in often- fickle markets but still
is a cash machine. All these cash are being utilised by the company to finance its increasing
growth. The company is utilising the borrowed amount from suppliers to finance its new
experiments. By new experiments we mean, Amazon is using the suppliers’ money to invest
in new products. For example, Amazon launched Amazon Fire phone which did not go well
in the market and failed. However, company learned from its mistakes and continue with
1

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more such experiments. All this has become easy because Amazon is having negative CCC
and therefore it is able to use the suppliers’ money for investing in new products on which it
is not even required to pay the interest amount.
3) Financing Options available with Amazon except Cash: Advantages and
Disadvantages
There are two options available with Amazon except cash whose advantages and
disadvantages for the company are being discussed below:
i. Debt Financing
Debt financing is financing option used by the companies for meeting the working capital
needs and capital expenditures. The company use this option by selling debt instruments like
bonds, notes or bills to institutional investors or individual who are referred as the creditors of
the company (Funding Post, n.d.).
Amazon is generating a huge net profit every year and therefore has to pay a great sum of tax
too. Amazon can opt for debt financing for funding its projects as it would help the company
in many ways. The amount paid by the business to repay the loan is considered as business
expense and is eligible for tax deduction. Therefore, if Amazon opts for debt financing in
future it can enjoy the tax benefits which would further reduce net tax obligation of the
company and increase its net profit. If Amazon will opt for debt financing it enjoys benefit of
tax deductions and would ultimately lower the interest rates. For example, Amazon takes a
debt on 10% interest rates and the government taxes the company at 30%. In this case, the
company will have an advantage of taking this debt as it can have its deduction at the time of
paying tax. Since, Amazon is having a strong cash position it will be able to make EMI
payments on time. This would build the credit score of the company which can be beneficial
at the time of meeting an urgent liability using debt financing.
On the other side, there are certain disadvantages of debt financing because of which Amazon
should restrict itself from opting the debt financing. If Amazon uses the debt financing to
fund any new project it has to make sure that the project generates an acceptable level of cash
flow by the time it would require to repay the creditors. In case, it fails to do so it would
impact the goodwill of the company as well as the company’s credit score.
ii. Issue of stocks
The company can also raise funds by issuing stocks of the company in the stock market.
Stocks of the company represent ownership in the company (Walters, 2019).

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Amazon can choose to issue company’s stocks for financing its new projects. Amazon can
think of issuing stock for funding its projects as it would help the company to get an
additional amount along with the present cash without any liability (Walters, 2019) to pay
any fixed amount such as interest. Amazon is a company which believes in launching
innovative products so issuing stocks to other qualified business people could help the
company in deriving new ideas from them.
Though, issuing stocks can prove to be dangerous for the founder and original owners of
Amazon as issuing stocks means giving a part of the company. The company pays dividends
to its shareholders but it is not liable to do so. However, if Amazon fails to pay dividends to
its stockholders it would hurt the company’s reputation and ultimately lower the stock price
of the company.
4) Amazon’s Cash Conversion Cycle in 2014 and 2018
In 2014, Amazon had a negative cash conversion cycle of -30.6 days (Fox, 2014) which went
up to -29 days in the year 2018.
As compared to 2014, Amazon’s efficiency to collect cash from its customers much before
paying out to suppliers has gone up by 5.22% in the year 2018. This increase in the cash
conversion cycle of Amazon shows the increasing efficiency of the company in managing its
working capital. It also depicts that Amazon still believes in investing the suppliers’ funds
into new projects and learning from failures to come out with a highly innovative products.
5) Three Significant Risks faced by Amazon in 2018
The three major risks discussed in Amazon’s Annual report 2018 are as follows:
(i) Amazon’s products and services deals in a highly competitive market where some of the
competitors have greater brand equity, capital resources, large customer base etc. the
competition for Amazon can become tougher due to new business models, entry of new
competitors backed with good level of capital, new and advanced technologies etc.
Since, this risk is inherent and unique to the company's industry, it is an unsystematic
risk.
(ii) Amazon holds cash and cash equivalents and other marketable securities in foreign
currencies like Euros, Yen, and Pounds etc. If US Dollar strengthens as compared to
currencies in which Amazon have held the marketable securities and cash equivalents, it
would lower their balances and this is how company will be exposed to the risk of
foreign exchange. Since, this risk is the result of changes in interest rates, trade activities

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of different countries, exports and imports of different countries etc., it is a systematic
risk.
(iii) Amazon has a wide customer base and therefore it has to manage their personal
information. Also, company has a wide operation wherein company processes, keeps
and transfers a good amount of data. These customers’ information and company’s
personal data exposes company to the risk of loss, misuse and other security breaches
which could adversely affect the company in a variety of ways. Since, this risk is
inherent and unique to the company; it is an unsystematic risk (Amazon, 2018).
6) Bond Price in 2019
Purchase Price $1,046.93
Selling Price $995.24
7) Holding Period Return
If the shares of Amazon would have been purchased in June 2014 and sold in the beginning
of June 2019, the approximated holding period return would have been 448% and annualised
holding period return would have been 41% (Yahoo Finance, n.d.). This shows that most of
the investments made by Amazon in different projects have turned out to be profitable. The
company’s profitability has increased the trust of the company’s investors and even attracted
new investors and therefore raised the share price of Amazon for the past 5 years.

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Part B: Capital Budgeting
1) Free Cash Flows Generated by Amazon’s 3000 new stores over the 10
years
Year Free Cash Flows
0 -10000000000
1 2085000000
2 2085000000
3 2085000000
4 2085000000
5 2085000000
6 2242500000
7 2242500000
8 2242500000
9 2242500000
10 3242500000
2) NPV
(i) A WACC of 12%.
WACC 12%
NPV $ 2.42 billion
Table: Calculations are done in the excel file.
(ii) A WACC of 5%.
WACC 5.00%
NPV $ 7.24 billion
Table: Calculations are done in the excel file.
Since, it is a speculative venture there is higher risk involved in the project and because of the
high riskiness Amazon should consider 12% as cost of capital. Following 12% cost of capital
over 5% cost of capital would show the conservative approach followed by the company. No
doubt, considering 12% cost of capital has lowered free cash flows generated by the project
but still NPV of the project has turned out to be positive which shows the project’s
potentiality to generate profit in future (Rey, 2019).
3) Payback Period
The calculated payback period of project AmazonGo Stores has turned out to be four years
and nine months (approx.).

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However, the payback period estimated by Amazon is just 2 years and the life span of the
project is 10 years. Company’s expectation to recover the initial amount in 2 years does not
seems to be realistic because it is near to impossible to recover the project’s initial amount in
just 20% time of project’s total life span (Rey, 2019).
4) Weaknesses of Cash Flows Estimated in the Article
RBC has taken their own purchases at Go stores for estimating the order size at new
AmazonGo stores. The analysts at RBC also considered the average number of visitors for
arriving at average revenue figure of AmazonGo in a year.
In the estimation of cash flows there exist various risks which have not been considered in the
article like changes in the consumer behaviour, revenue figures, purchases etc.
We cannot completely rely on these calculated cash flows for calculating NPV, IRR, Payback
period or any other such analysis. It would be better to carry out the sensitive analysis for
estimating the cash flows.
5) Decision Regarding Opening 3000 new AmazonGo Stores
Amazon can go ahead with the project of building new 3000 AmazonGo stores because its
NPV has turned out to be positive considering both 5% and 12% cost of capital. This means
that there are high chances of the project to generate profit for the company even when the
higher cost of capital is considered. Also, as per the estimated payback period the company
would able to recover the initial investment in less than 50% of the total life span of the
project which is considered to be ideal. However, it would be better to estimate cash flows
using sensitive analysis for getting a clear idea about the profitability of the project.

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Part C: Personal Reflection
a) In case study 1 there was a proper discussion carried out on the topics like working
capital management, cash conversion cycle, bond price calculation and holding period
return calculation. Also, the formulas to calculate Cash conversion cycle, bond price and
holding period return were discussed. With this knowledge about the theories and
formulae it was really easy to complete Part A of the assignment.
b) Firstly, I read the case study properly to find out the figures like initial outlay, variable
cost, fixed cost, depreciation, tax rate, etc. and these were used to prepare cash flow
statement with the help of which I arrived at the free cash flows generated and finally
calculated NPV for two different cost of capital. Later on, with the estimated cash flows
of the project I calculated the Payback period.
c) At the time of preparing for Case Study 2, I would prefer reading more about the topics
and concepts that will be further discussed. It will surely help me to get clarity on the
key areas with the help of which I will be in a position to complete the project in a more
proper and professional manner.

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References:
Amazon, (2018). Amazon Annual Report 2018. Accessed 23 August 2019:
https://ir.aboutamazon.com/static-files/0f9e36b1-7e1e-4b52-be17-145dc9d8b5ec
Chron. (n.d.). How Is the Cash Conversion Cycle Calculated & Interpreted?.Accessed 23
August 2019: https://smallbusiness.chron.com/cash-conversion-cycle-calculated-interpreted-
81332.html
Fox, J. (2014). At Amazon, It’s All About Cash Flow. Accessed 23 August 2019:
https://hbr.org/2014/10/at-amazon-its-all-about-cash-flow
Funding Post. (n.d.). Definition of debt financing. Accessed 23 August 2019:
http://www.fundingpost.com/glossary/debt-financing.asp.
Rey, J.D. (2019). Amazon’s cashierless Go stores could be a $4 billion business by 2021, new
research suggests. Accessed 23 August 2019:
https://www.vox.com/2019/1/4/18166934/amazon-go-stores-revenue-estimates-cashierless
Walters, S. (2019). Advantages & Disadvantages of Issuing Stock or Long-Term Debt
Accessed 23 August 2019: https://yourbusiness.azcentral.com/advantages-disadvantages-issuing-
stock-longterm-debt-15530.html
Yahoo Finance, (n.d.). Amazon.com, Inc. (AMZN). Accessed 23 August 2019:
https://finance.yahoo.com/quote/AMZN/