Finance Instrument and Markets - Desklib

This article provides an analysis of e-commerce companies like Amazon and eBay, theoretical price for share, valuation multiple/ratio and more in Finance Instrument and Markets. The article discusses the industry and company analysis of e-commerce in the US, theoretical price for share using dividend discount model, valuation multiple/ratio for evaluating whether the company is undervalued and overvalued, and more.

Running head: FINANCE INSTRUMENT AND MARKETS
Finance instrument and markets
Name of the student
Name of the university
Student ID
Author note

1FINANCE INSTRUMENT AND MARKETS
Table of Contents
Question 4..................................................................................................................................2
Answer (a)..............................................................................................................................2
Answer (b)..............................................................................................................................2
Answer (c)..............................................................................................................................5
Answer (d)..............................................................................................................................6
Reference....................................................................................................................................7

2FINANCE INSTRUMENT AND MARKETS
Part A
Question 4
Answer (a)
Industry and company analysis
E-commerce is regarded as selling and buying of services or products exclusively
using the electronic channels. E-commerce market in US has evolving constantly for over the
last decades. Retail e-commerce in US is expected to grow at fast space in future years and it
is expected that the sales will grow from 360 billion in 2016 to 638 billion in 2022. However,
Amazon is the most accepted in US. Amazon also ranked ahead of pack with regard to US e-
commerce sales in 2017 (Scarborough 2016). It generated dollars amounting to more than 54
billion through e-commerce sales. On the other hand, e-Bay is another successful online
retailer that is ranked among most popular e-commerce organization in US. Emerging in
1990, both Amazon as well as e-Bay assisted in expansion of global electronic sector.
Though both the companies are multinational corporations for e-commerce, e-Bay is
exclusively the market place for conducting the business whereas the Amazon is retailer as
well marketplace (eBay 2018). Initially, Amazon was formed as online bookstore however; it
expanded to superstore through selling the digital media and physical products. On the
contrary, e-Bay is transformed as online marketplace from just the collectibles.
However, Jet.com is new entrant in US e-commerce market and is providing
competitive prices that can become strong threat for Amazon. However, as brand loyalty for
Amazon is significantly strong with high engagement of consumer for 93% that means
consumers have strong trust for the brand and are likely to go for the repeat purchase from
Amazon. This can act as the barrier to new entrants in market (Turban et al. 2017). Further,
electronic products those are the major products for Amazon are comparatively costly in
Jet.com. Hence, in such situation Amazon has strong supply chain with low cost and threat
from new entrants may be reduced in this way (Ritala, Golnam and Wegmann 2014).
Answer (b)
Theoretical price for share can be computed through various ways. One of the ways is
computing through using the dividend discount model that uses the current dividend of the
stock and the expected dividend growth rate for determining theoretical current price of the

3FINANCE INSTRUMENT AND MARKETS
stock. This model of valuation is carried out on theory that the stock price of the company
shall be derived from present value of all future dividends. For computing the valuation of
mostly used equation is Gordon dividend growth model or dividend discount model. The
equation is –
P = D 1
r−g
Where, P determines the stock value on the basis of the dividends or it is the theoretical
valuation.
D1 determines the expected dividend for next year
r determines required rate of return
g determines the growth rate (Duncan et al. 2017)
Further, r = risk free rate + beta (market risk premium – risk free rate)
Amazon –
R = 3.01% + 1.81 (6% - 3.01%)
R = 3.01% + 5.4119 = 8.4219%

4FINANCE INSTRUMENT AND MARKETS
Share price for Amazon as per is $ 1450.89 per share. On the other hand, the share
price mentioned in the annual report is $ 0.01 per share (Annualreports.com 2018).
However, as the company never paid any dividend it is not possible to compute the
theoretical price of share through dividend discount model. Further, the company’s profit is
not stable and it is consistent in paying dividend. Further, since the main criteria for using the
FCFF model is that the company must be stable in profit earning aspect and consistent is
paying dividend, this model cannot be used.
[for the purpose of computing r, beta is taken from yahoo finance]
e-Bay –
R = 3.01% + 1.45 (6% - 3.01%)
R = 3.01% + 4.3355 = 7.3455%
Free cash flows for eBay are as follows –
For 2013 – 4317
For 2014 – 5055
For 2015 – 3365
For 2016 – 2200
For 2017 – 2480
Free cash flow is computed as follows –
Free cash flow for 2017 = cash flow from operation + capital expenses
= 3146 + (-666) = 2480
In the same way, other years FCFF are computed.
Growth rate on the basis of 5 years EBITDA growth rate = 0.3399 = 33.99%
Share price for Amazon as per is $ 40.58 per share.
However, as the company never paid any dividend it is not possible to compute the
theoretical price of share through dividend discount model. Further, the company’s profit is

5FINANCE INSTRUMENT AND MARKETS
not stable and it is consistent in paying dividend. Further, since the main criteria for using the
FCFF model is that the company must be stable in profit earning aspect and consistent is
paying dividend, this model cannot be used.
[for the purpose of computing r, beta is taken from yahoo finance]
Answer (c)
Valuation multiple/ratio for evaluating whether the company is undervalued and
overvalued
Method 1- Price to book ratio
Amazon
Price to book value ratio (P/B ratio) = stock price / book value per share (Kusmayadi,
Rahman and Abdullah 2018)
Book value per share = (total assets – total liabilities) / Number of share outstanding
Book value = (131310 – 103601) / 484.1072 57.23 = 57.24 per share.
Therefore, P/B ratio = 1450.89 / 57.24 = 25.35
P/B ratio of higher than 1 indicate that the stock of the company is overvalued. As the P/B
ratio for Amazon is 25.35, the stock is overvalued.
E-Bay
Price to book value ratio (P/B ratio) = stock price / book value per share
Book value per share = (total assets – total liabilities) / Number of share outstanding
Book value = (25981 – 17918) / 42 = 190.48 per share.
Therefore, P/B ratio = 40.58 / 190.48 = 0.21
P/B ratio of lower than 1 indicates that stock of the company is undervalued. As the P/B ratio
for Amazon is only 0.21, the stock is undervalued.
Method 2 – Price to earnings ratio
Amazon

6FINANCE INSTRUMENT AND MARKETS
P/E Ratio = Market value per share /earnings per share (Caballero, Farhi and Gourinchas
2017)
P/E ratio = 1450.89 / 4.93 = 293.29
P/E ratio of higher than 1 indicate that the stock of the company is overvalued. As the P/E
ratio for Amazon is 293.29, the stock is overvalued.
E-Bay
P/E Ratio = Market value per share /earnings per share
Market value per share = 40.58
However, as the company had net loss for the year ended 2017 it did not provide any earning
to the shares outstanding. Hence, P/E ratio will be invalid.
Answer (d)
Based on the analysis done in part (b) and (c) it can be stated that the company does
not pay any dividend to its shareholders. Further, the share of the company in the market is
overvalued. Moreover, bases on both prices to book value ratio as well as price earnings ratio
it is found that the shares of the company are overvalued. Therefore, based on the analysis the
investor shall not invest in the ordinary share of Amazon.

7FINANCE INSTRUMENT AND MARKETS
Reference
"Electronics, Cars, Fashion, Collectibles, Coupons And More | Ebay". 2018. Ebay.
https://www.ebay.com/.
Annualreports.com. 2018. [online] Available at:
http://www.annualreports.com/HostedData/AnnualReports/PDF/NASDAQ_EBAY_2017.pdf
[Accessed 13 Oct. 2018].
Caballero, Ricardo J., Emmanuel Farhi, and Pierre-Olivier Gourinchas. "Rents, technical
change, and risk premia accounting for secular trends in interest rates, returns on capital,
earning yields, and factor shares." American Economic Review 107, no. 5 (2017): 614-20.
Duncan, Jerome, Seth C. Anderson, Sherrell Price, and Cassandra Thomas. "The Gordon
Growth Model: A Teaching Case." Journal of Business Case Studies (Online) 13, no. 1
(2017): 23.
Kusmayadi, Dedi, Rani Rahman, and Yusuf Abdullah. "Analysis Of The Effect Of Net Profit
Margin, Price To Book Value, And Debt To Equity Ratio On Stock Return." (2018).
Ritala, Paavo, Arash Golnam, and Alain Wegmann. "Coopetition-based business models: The
case of Amazon. com." Industrial Marketing Management 43, no. 2 (2014): 236-249.
Scarborough, Norman M. Essentials of entrepreneurship and small business management.
Pearson, 2016.
Turban, Efraim, Jon Outland, David King, Jae Kyu Lee, Ting-Peng Liang, and Deborrah C.
Turban. Electronic commerce 2018: a managerial and social networks perspective. Springer,
2017.