Finance Case: Beta, Cost of Capital, Valuation
Deadline: 17:00 March 10, 2021
INSTRUCTIONS
Please follow the case instructions below.
• One case study group should contain 3 or 4 students.
• Write the name and student number of each group member on the front page.
• Submit your solutions as a pdf file in the Canvas case assignment before the deadline.
• Only one copy of the solutions needs to be submitted per case group. Any member can
submit but you are all responsible that this group member uploaded the solutions on
time.
• Solutions should be typed (i.e. not hand written)
• Solutions should include intermediate calculations and explanations so that we
understand how you ended up with the final result.
• Solutions should fit on a maximum of 3 single-sided pages A4 format.
• Only use the material provided on Canvas or the information found using specific
instructions in the case. So for instance do not add other information from internet
about the company involved.
• Submissions will be subject to a Turnitin plagiarism check. Remember plagiarism is a
serious offence and perpetrators will face sanctions.
Introduction
The goal of this assignment is to estimate the cost of capital (WACC) and to do a valuation
based on the WACC and APV method using the financial statements for Amazon.com, Inc.
Imagine that it is January 1st ,2021 and that you have to do this valuation. In part 1 we ask you
to estimate the Weighted Average Cost of Capital (WACC). In Part 2 you have to evaluate a
project.
Part 1: Calculation of Betas and WACC
Question 1
You are asked to estimate the equity beta of Amazon.com, Inc. Follow the procedure below to
get the data:
Collect Price information for Amazon.com, Inc. from Yahoo! Finance (finance.yahoo.com) as
follows:
- Enter the stock symbol of Amazon.com, Inc. (AMZN) On the page for that stock click
“Historical Data”.
- Enter as start date December 31, 2015 and as ending date December 31, 2020 to cover
the five-year period. Make sure to click “Weekly” next to the date to get the weekly
prices reported by Yahoo. Hit “Apply” and then download data into a spreadsheet.
- Open this spreadsheet and select the first column. Select “Data” on the menu bar and
select the data column and then select “text to columns” button. Choose delimited and
next, select as delimiters, comma and tab. Then select finish. Delete all columns
except Date and Adjusted Close.
1
-
Repeat the steps above in another worksheet for the index: S&P 500 (stock symbol:
GSPC) and copy in the same spreadsheet1.
Using this data, estimate the equity beta using weekly data for the 5-year period from 3112-2015 to 31-12-2020. Hint: do not forget to calculate weekly rates of return first!
Question 2
In Question 1 you estimated the beta which is a levered equity beta. To determine project risk,
we are more interested in the unlevered equity beta or asset beta. Please estimate the asset
beta of Amazon Inc. on December 31, 2020, based on the data from question 1 and
information from the balance sheet posted on Canvas for the year 2020 with the following
assumptions:
- Assume the debt beta equals 0
- Ignore the impact of taxes.
- Use the following equation as a proxy for the market value of debt based on information
from the balance sheet: Net Debt = (Short-term debt + Current portion of long-term debt
+ Long-term debt + non-convertible debt) – (Cash + Short-Term Investment).
- For your calculations, please use the balance sheet values stated in the excel sheet for
2020.
- Calculate the market value of equity separately
Question 3
Consider the balance sheet of Amazon.com, Inc. as of 31-12-2020. Amazon held $31,816bln
(excl. Capitalized Leases) of long-term debt. Assume that this long-term debt is in the form of
an A-rated bond with a yield to maturity of 5%. Analysts have estimated the recovery rate for
A-rated bonds to be 45%. Use the default probabilities table provided in chapter 12 of the
book (page 454, 5th edition) and calculate the cost of debt for Amazon in 2020. Use the
average default rate.
Question 4
Assume the relevant risk-free interest rate and market risk premium for 2020 to be 1% and
6%, respectively. What is the cost of equity, pre-tax WACC and after-tax WACC for
Amazon.com, Inc? Apply the leverage ratios for the firm in 2020, assume the tax rate is 28%
and the cost of debt for 2020 to be equal to the one you calculated in Question 3. For net debt
use the same proxy as in question 2 (Net Debt = (Short-term debt + Current portion of longterm debt + Long-term debt + non-convertible debt) – (Cash + Short-Term Investment).
Part 2: Valuation
For the following questions, please use a value of 6.05% for the pre-tax WACC and 6.00%
for the after-tax WACC (i.e. ignore the values you’ve calculated in part 1).
1
Compare the data you downloaded with the original data in the browser. Be sure to understand which units are
used and what is the decimal point symbol.
2
Question 5
The CEO of Amazon is currently (end of 2020) considering investing in a new project to
further expand to Asia. The project will last for 6 years. The development of the project will
take one year. It is expected that the project will raise the annual sales by $450mln in the first
year (at the end of 2021, t = 1) and that these additional sales will grow by 7% annually for
two years ( t = 2 and 3). Subsequently, the sales are forecasted to grow by 8% for the next two
years (t = 4 and 5) and will then remain stable for one more year (t = 6). Assume no further
impact from year 7 onwards. To develop the project, an initial R&D investment of $450mln
needs to be made and $200mln worth of equipment needs to be purchased (t = 0). Based on
the accounting rules, the R&D investments needs to be expensed directly. Additionally,
$145mln worth of equipment needs to be bought one year from now (t = 1). Both investments
in equipment are depreciated using the straight-line method in 5 years to a salvage value of
$0. The cost of goods sold is expected to be 40% of the sales and the operating expenses
(excl. depreciation) are estimated at $60mln per year (i.e. constant throughout the project).
Accounts receivable are assessed to be 21% of the sales, whereas the accounts payable and
inventory are 17% and 15% of the cost of goods sold, respectively. Assume no cash
requirements are needed for this project and that the investment in NWC is not recovered at
the end of the project. The corporate tax rate applicable for this project equals 21%. Assume
Amazon is not allowed to carry forward or carry back losses so losses will trigger positive
cash flows due to a reduction in taxes.
a) What are the Free Cash Flows for this new project? Make a table in which you present
your answers. Include the formula’s used.
b) What assumptions are needed to use WACC as a discount rate to calculate the value of
the project?
c) What is the NPV of the project using the WACC method?
Question 6
The management of Amazon decides to invest in the expansion to Asia as described in
Question 5. Amazon however decides to change the capital structure used for the project so
that it has a constant debt capacity of $300mln during the life of the project. Use a cost of debt
of 5% in this exercise. What is the NPV of the project in this situation according to the APV
method? Assume tax benefits have the same risk as the underlying debt. Why is this answer
different compared to the WACC method?
3