Kaplan Business School: FINM4000 Assessment 2 - Amazon Finance Report

This finance report provides a comprehensive analysis of Amazon's financial performance, covering key areas such as working capital management, free cash flow, and investment strategies. The report begins by examining Amazon's superior working capital management, highlighting its negative cash conversion cycle (CCC) and the implications for funding new product development. It then explores the advantages and disadvantages of debt and equity financing, comparing Amazon's CCC in 2013 and 2018 and analyzing associated risks. The report also includes a bond valuation calculation and a holding period return calculation for Amazon stock. Furthermore, the report analyzes a hypothetical project involving 3000 new Amazon stores, including free cash flow projections, NPV calculations, and discounted payback period analysis. It assesses the project's feasibility, identifies weaknesses in the cash flow estimations, and provides a personal reflection on the learning experience, comparing it to a previous case study. The report concludes with a recommendation against undertaking the project due to concerns about the accuracy of the financial projections and a discounted payback period that exceeds the company's expectations.

FINANCE
AMAZON
STUDENT ID:
[Pick the date]

PART A
1) As per Source 2, Amazon’s CCC during 2013 was -30.6 days. In comparison, retailers
such as Costco and Walmart had managed to bring down their CCC to single digits but
still the figure remained positive. The above numbers clearly highlight that the working
capital management is superior for Amazon in comparison to the other retailers such as
Costco and Walmart. This is because lower the CCC, lesser would be the working capital
requirements for the company. The negative CCC in case of Amazon is primarily on
account of the credit period from suppliers which is significantly larger than the other
retailers such as Walmart. As a result, the working capital requirements of Amazon would
be lower in comparison to other retailers which tends to enhance the profitability
(Brealey,Myers and Allen,2014).
2) A negative CCC is important for a company which is innovating with new products. This
is because in case of a negative CCC, there would not be any requirement of external
working capital as the operations would be funded from the cash collected from
customers. In such an environment, the company can afford to deploy the additional cash
available for the development of new innovative products. If one of these products such as
Firestick does fail also, it does not impact the normal business operations which do not
require any external funding. On the contrary, the development of a successful product
would further enhance the cash flows of the company. If the CCC is positive, then
company would have external working capital requirements which would constrain the
ability of the company to invest in new products (Lasher, 2017).
3) If Amazon would not have the cash to fund new projects, then the two available
alternatives of funding would be through debt and issuance of stock. The key advantages
associated with the issue of debt are outlined below (Damodaran, 2015).
 There is no dilution of equity and hence the promoters are able to maintain control
over the company.
 The interest expenses tend to provide tax relief as the overall profits would reduce.
The key disadvantages associated with the issue of debt are outlined below.
 There are regular interest and repayment obligations which increase the associated
business risk.

 The debt covenants may restrict the flexibility with regards to expansion, assuming
incremental financing and sale of assets.
The key advantages associated with the issue of equity are outlined below (Parrino and
Kidwell, 2014).
 The money raised through equity does not need to be repaid back to the investors and
hence does not result in increased business risk.
 This tends to deleverage the balance sheet and improve the solvency position of the
company.
The key disadvantages associated with the issue of equity are outlined below (Petty et. al.,
2016).
 Stake sale or issue of additional equity would lead to dilution for promoters thereby
reducing their control over the company and decision making.
 Extent of money that can be raised through equity dilution is typically less as
compared to debt.
 Also, there is no tax shield offered through interest in case of debt.
4) In accordance with Source 1, the CCC for Amazon in 2018 was -23.6 days. The
comparable value in 2013 was -30.6 days (Amazon, 2018). While there has been a slight
increase in the CCC for Amazon in 2018 as compared to 2013, the pivotal point is that it is
still negative. This would imply that the company’s normal business operations do not
require external funding as they are essentially self –sustaining. This clearly highlights
that supplier relationships with Amazon continue to be quite healthy and long term. This is
the reason why the company is able to maintain a negative CCC. Typically for other retail
companies, the credit period from suppliers is lesser owing to which they have a positive
CCC. While the other retailers have matched Amazon in terms of collection period and
inventory turnover, but they still fail to achieve the efficiency with regards to suppliers.
This clearly indicates that the company has invested heavily in building the global supply
chain and long term relationships with various suppliers (Arnold, 2015).
5) The three most significant risks for Amazon are as follows (Amazon, 2018).

 The company faces intense competition not only from global online and offline
retailers but also from local retailers in various geographies that the company has
presence. This may adversely impact the financial performance of the company
going forward.
 The company continues to expand in new products, services, geographies and
technology which exposes the company to additional risk. This is a significant risk
factor as in the recent past there have been failed product innovations along with
failed foreign venture such as in China which have led to significant losses for the
company.
 The company has presence in host of countries which exposes the company to a
host of risks. Infact going forward, the company is expected a derive a larger part
of the revenue and profits from international operations owing to which these risks
would become more significant.
The above risks are unsystematic as these relate to the firm in specific and not essentially the
economy as a whole. This is especially true for the risk with regards to the international
business and expansion of the company which is a company centric factor. The higher
competition being faced is an industry level phenomenon and not limited to Amazon
(Damodaran, 2015).
6) Face value of bond = $1,000
Annual coupon rate = 4.5% p.a.
Annual coupon amount = (4.5/100)*1000 = $ 45
Time of maturity = 1 year
YTM = 5%
The current price of this bond would be the future cash flows discounted at YTM. The future
cash flows would include a coupon payment of $ 45 along with principal repayment of $
1,000 (Parrino and Kidwell, 2014).
Hence, current price of bond = ($45/1.05) + ($1,000/1.05) = $995.24

Based on the above computation, it can be concluded that bond at the end of 2019 is prices at
$ 995.24.
7) Opening price of Amazon stock as on June 2 ,2014 (since June 1 there was no trading) =
$312.59
Opening price of Amazon stock as on June 3,2019 (since June 1& June 2 were holidays) = $
1,760.01
As it has been assumed that no dividends have been paid, hence the holding period return
would arise on account of changes in the stock price of Amazon.
Holding period return = [(1760.01-312.59)/312.59]*100 = 463.04%
It is evident that the holding period return is quite phenomenal which highlights that the
investments which the company has done between 2014 and 2019 have been adding
significant value which is leading to rapid rise in the stock price over a short span of time.
PART B
1) The free cash flows generated by 3000 new Amazon stores over the next 10 years are
indicated in the table below (Molla, 2019).
Explanation
 Depreciation is non-cash expense but it is included since it provides a tax shield which
results in lower tax outflow.

 Since the book value of the capital investment on stores after 10 years is $0 but the salvage
value is $ 1bn, hence this would be gains which would attract a 30% tax rate.
 Depreciation computation = (Total investment/Useful life) = ($10bn/10) = $ 1bn
 Cash inflows are denoted by positive sign whereas cash outflows are indicated by negative
sign.
2) The NPV function available in Excel has been used to compute the NPV based on the
above free cash flows for the US Amazon stores. When the cost of capital is 5%, the NPV
of the project is estimated at $7.06 bn. On the other hand when the cost of capital is
increased to 12%, the NPV of the project decreases to $ 2.33 bn. Considering that the
venture is speculative in nature, hence the risk associated with the project is quite high.
This would imply that the expected returns on the project would also be higher. As a
result, 12% is a better estimation of the cost of capital for the given project (Petty et. al.,
2016).
3) The discounted payback period for the project is 7.37 years. This compares poorly with
regards to company’s expectations of recovering the complete investment in just 2 years.
In comparison, the expected time to recover the initial investment would be more than 7
years. Considering the significant amount of initial investment, it does not seem that the
company’s target of recovering the initial investment within two years is realistic. The
company should consider a higher discounted payback period than the current expectation
of 2 years (Lasher, 2017).
4) There are various weaknesses in the manner of estimation of cash flows for the given
project. The first issue pertains to the estimation of sales which do not alter from Year 1 to
Year 10. It is quite likely that the sales would not peak in the first year but in later years.
Additionally, the variable costs associated with the items sold is not represented in the
computations as only the staff costs along with other fixed costs have been taken into
consideration. Further, the tapering of the staff costs would also be gradual and not sudden
as has been envisaged in the predictions. On account of the above weaknesses, it is not
suitable to rely on the project analysis which has been conducted based on estimates
provided (Brealey,Myers and Allen, 2014).

5) The given project should not be undertaken by Amazon. This may be attributed to the
following reasons (Parrino and Kidwell, 2014).
 There are serious issues with the estimation of project cashflows. The cost of goods sold
has not been considered in the current estimates. At 12% cost of capital, the NPV is $2.33
billion. As a result, any addition of incremental costs or lowering of revenue estimates
could potentially lead to the NPV becoming negative.
 Also, the discounted payback period is significantly greater than the expectations of the
company and hence it may not be approved by the company.
PART 3: Personal Reflection
a) Class Case Study 1 had a significant influence on my answers in PART A. I went through
the various sources attached and made sure that for each of the questions, I refer to the
appropriate source only. Further, I read the relevant portion of the source repeatedly so as
to obtain the relevant information and then framed the same in answers. Further, if any
aspect of the information was not clear, I referred to the textbook for greater clarity on the
same. This enabled me to write relevant answers in PART A.
b) With regards to PART B, the process commenced with reading through the Source 4 in
order to understand about the stores. Then, an excel sheet was implemented based on the
information given in the question with regards to the project. Once the free cash flow was
estimated, then NPV was computed using Excel function followed by the computation of
discounted payback period. Once the excel sheet was complete, then the various
interpretation were done and finally the relevant answers were included in the report.
c) In case study 1, I did not pay much attention to the sources and instead focused on other
sources included internet. Further, I did not mark the key information provided in sources
owing to which I had to repeatedly read the source which was time consuming and
frustrating. Also, I did not write draft answers and instead submitted the first set of
answers without reviewing the same. With regards to case study 2, I intend to rectify these
shortcomings which would enable me to improve on my score.

References
Amazon (2018) Annual Report 2018, [online] Available at https://ir.aboutamazon.com/static-
files/0f9e36b1-7e1e-4b52-be17-145dc9d8b5ec [Assessed September 22, 2019]
Arnold, G. (2015) Corporate Financial Management. 3rd ed. Sydney: Financial Times
Management
Brealey, R.A., Myers, S.C. and Allen, F. (2014) Principles of corporate finance. 2nd ed. New
York: McGraw-Hill Inc.
Damodaran, A. (2015) Applied corporate finance: A user’s manual. 3rd ed. New York:
Wiley, John & Sons.
Lasher, W. R., (2017) Practical Financial Management. 5th ed. London: South- Western
College Publisher.
Molla, R. (2019), Amazon’s cashierless Go stores could be a $4 billion business by 2021, new
research suggests, [online] Available at https://www.vox.com/2019/1/4/18166934/amazon-
go-stores-revenue-estimates-cashierless [Assessed September 22, 2019]
Parrino, R. and Kidwell, D. (2014) ,Fundamentals of Corporate Finance,4th ed., London:
Wiley Publications
Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M., and Nguyen, H. (2016)
Financial Management, Principles and Applications. 6th ed. NSW: Pearson Education, French
Forest Australia.