FINANCING AND PROJECT APPRAISAL ALTERNATIVES:
ANALYSIS OF APPLE COMPUTERS INCORPORATED
Table of Contents Page
Summary 1
Introduction
Fundamental Risks of the Business 2
Research Methods 3
Body of Analysis
Sources of Financing 4
Methods for Project Appraisal 7
Conclusion 11
Bibliography 12
Summary
This presentation is about Apple and how it could use available financing and project appraising alternatives to its advantage. The first section introduces the position of Apple relative to existing risks followed by discussion on how the information in this paper is organized and analyzed. The following section is the body that shows evaluations of different financing options available to Apple and how each benefit or risks the position of Apple based on its current risks. IN addition, project appraisal methods are also treated on the same way as financing. As a conclusion, Apple must not depend on a singular financing option because mixture of financing alternatives would provide the optimal capital structure while project appraisal techniques must be integrated.
Introduction
Fundamental Risks of the Business
The first consideration is the business risk that Apple confronts such as stagnation of its innovative structure and changes of leadership mindset and/ or abrupt changes of the leader itself. The latter issues are reflected by the decision of the firm to include to its portfolio non-high end markets and the health issues attached to Steven Jobs. Due to this, variances on earnings and increased investment risks had developed. In the contrary, Apple’s strategic re-utilization of existing software to create new set of technologies minimizes financial risk because resources are recycled. Alternatively, equity-based partnering to other companies and support from government authorities in research efforts of hi-tech firms ultimately diminishes leverage s issues.
High-tech firms are characterized by lower liquidity as most of their assets are tied-up with R&D efforts where their value is hard to estimate and is highly illiquid. To minimize liquidity risks, Apple assures that short-term assets have reduced maturity while long-term assets are applied with limits. Although the framework may not bear additional inflows from interest-bearing long-run investments, assets are relatively more transferable to cash equivalents. In addition, cross-border trades of Apple with emerging economies are applied with substantial spot exchange risks which can reduce price competitiveness. To resolve the issue, Apple enters futures/ forward contracts in the derivative market to address risks in fluctuations in exchange rates and interest rates.
As Apple is operating in difference political/ economic environments, its expansion and success is highly dependent on the level of support that governments provide to multinationals. This admonitions is concretized by the fact that Apple outsourcers, communicates and transacts with different global participants to complete its supply and value chains. As they are uncontrollable, political risks can be minimized by specialized insurance in which undoubtedly kept by big companies such as Apple. Lastly, credit risks are not really attached to Apple mainstream financial framework. Its distributors carry the substantial amount of debt from end-users where collaterals are inexistent. However, Apple also feels such practice that motivated the firm to create doubtful accounts to distributors depending on their debt history, profit/ growth and credit worthiness.
Research Methods
The data that are presented came from different sources such as journals, textbooks, news articles and online information. Information is analyzed based on the context of the risk confronting Apple presented in the introduction. Appropriate models for financing and investment decisions are summarized and highlighted their major differences with other types. Apple is seen as a case study because the researcher wanted to explore the different implications of certain financing and investment appraisal tactics that can be used by the company. The analysis is guided by the nature of high-tech industries and the position of Apple to address inherent risks that it confronts. The data is also carried as desk research due to existence of voluminous information online.
Body of the Analysis
Sources of Financing
Every form especially those who are listed in capital markets have the privilege to mix different financing sources from varying investors/ creditors from any part of the world. As for Apple, there are two major types of financing; namely, debt and equity. The former is defined as the act of raising funds through issuance of bonds while the latter is the act of internal funds. According to some theories, optimized capital structure can be attained when the cost of using the sources of financing is minimized while the value of the company is maximized. However, there are also issues of financial risks as high-reliance to debt will result to inability to pay interest obligations or paying the principal. With this conflicting statement Apple is expected to choose among the most lucrative sources of financing available.
One type of debt financing is seller financing which is characterized by ease of making the contract and Apple can immediately use the assets of the other party (i.e. operating plants). However, the downside is that Apple must comply with continuous amortization to prevent litigation of being incapacitated. As a result, there is less flexibility that will not be compatible with Apple’s current change in strategy because withdrawal from the contract due to detection of inability to achieve synergy is not an excuse to avoid default. Government-supported projects are also potential source of financing; however, most of them are for smaller business interests due to lack of access to necessary capital. Consequently, Apple’s projects are relatively huge and also require substantial financing which may only deter their application as the firm is qualified for worldwide capital market access due to global presence.
Commercial banks are also willing to extend credit to big companies as long as its financing fundamentals and growth prospects are healthy. This option can provide any requirement for huge financial needs of Apple which in accordance to the level of innovation it requires. However, there is conflict of interest when transacting with banks because the borrower and the creditor has both with profit-oriented goals. Specifically, bank requirements and limitations that the borrower must comply (i.e. smaller equity issues) can deter some of financing strategies from Apple. Also, screening for potential debtors may take a long time which is not strategic and can undermine speed-to-market. Alternatively, mezzanine financing can be tapped wherein banks will finance the project through less stringent and faster loans, however, with the requirement of ballooning equity interest attributable to banks. However, this strategy can substantially allocate the cash flows from the project to banks. As a result, the firm has minimal control over its growth direction.
In the contrary, equity financing is usually represented by initial public offerings (IPOs). As Apple is in its expansion and growth phase, this type of financing has high potential as the proven successes in the selected markets where the firm operates. IPOs give investors the opportunity to own part of the company through holding stock certificates and entail them to receive returns during profitable operations (i.e. dividends). The positive feature of IPO is the ability of the firm to grow and execute its plans without interference from the obligations from creditors that can hamper liquidity and disable growth prospects. Further, investors in stock markets are relatively plenty and more motivated than bond issuers because sock investors can gain on both short and long run periods compared to debt financing where maturity is more on the long-run side. However, Apple may loose control of the operations, receive hostile bids and being taken away. As a result, IPOs and succeeding issuances must be supported with rigid ownership planning and financial control.
The last option would be the retained earnings. As Apple see them as savings after paying debt and equity obligations, it can serve as useful financing mechanism to hedge the negative issues of debt/ equity. Using retained earnings, Apple can eradicate costs and risks of financing alternatives. The backside, however, is that the firm must not rely on retained earnings exclusively especially during intense rivalry. Several firms that actively participated in competition against major industry players ran-out of business because they cannot sustain the financial needs of such engagement. Undermining the use of debt/ equity mixture in the capital structure may show hostile approach of the firm to the willing creditors and investors. Investors/ creditors may feel that the use of retained earnings indicates the last stand of the company. As a result, notices for debt repayment will ensue due to anxiety wherein the competing firm can destabilize its strategy instantly.
As debt financing is cheaper than equity option due to the tax-deductible expenditure feature of the former, it can provide incentives for Apple. However, Apple will shoulder a commitment to pay without assurance of profit where equity financing can redeem its upper hand. With the use of equity, bankruptcy and being a target can be prevented. Debt can also threatened existing stockholders because external creditors are prioritized during asset allocation upon liquidation. As Apple is not a closed corporation and its shares are heavily traded in capital markets, loose of corporate control will be a small issue to consider compared to the benefits of equity financing which are largely IPOs in nature. The caution, however, must be applied in evaluating the possibility of unintended takeover from market manipulation. Due to this, finding the most appropriate capital structure for Apple must be applied with larger investment criteria like supporting theories on optimal capital structure and the nature of the projects it will invest in. The latter is discussed on the following section.
Methods for Project Appraisal
There are available techniques to evaluate the financing relevance of major projects. This will help Apple management to determine the appropriate capital structure (i.e. debt, equity or retained earnings) for its projects. First is the technique that highly supports the time value of money principle which is payback period. This technique adheres to the concept that the money that is received today is less risky and has higher value than the same amount of money that will be received in the future. Its strength is derived by its simplicity without requiring derivation of future values to current values. In addition, it is useful in appraising projects from the standpoint of a firm that will be acquired in pre-determined date in the future. As a result, the firm can optimize its operational existence by focusing on the years where the capital outlay will be recouped and profit will be realized. However, as it does not conform to present value computations, it diminishes time value of money concept. It is also regarded as subjective analysis to investment valuation due to substantial intervention of managerial influence for the purpose of accelerating the period of profiting from the project.
A more investor-focused alternative is offered by return on equity (ROE). This is a financial ratio that indicates how much equity holders are earning. With existing shareholder in mind, the cost of equity is intended to be reduced while returns of holders are intended to be maximized through dividends or other distributing in assets. When ROE would increase, it will imply efficient allocation of corporate funds on business areas that are growing. In the contrary, internal rate of return (IRR) is a more complicated investment measure than ROE. Its ultimate contribution to decision-making is to assure that the discount rate being used in net present value derivations are really equal to investor’s as well as the project’s expected return. Comparative analysis is also provided by IRR (i.e. expected return and required return) polishing the return outlook of holders. In addition, IRR utilizes discount rates in their maximum capacities because they are able to contrast two or more projects. The drawback is that these projects must have the same operational periods, discount rates, betas (i.e. measure of industry sensitivity) and the requirement that there must be apparent cash flows.
The advantage of using ROE is the comfort of using industry benchmarks. This can provide firms to have a guide in decision-making. However, ROE is tinted by accounting manipulation in the hope of attracting additional holders. For example, excessive writer-downs, repurchase of stocks and, even having large debts can increase ROE. In contrast, IRR can evaluate the costs and benefits of different projects which maximize investment selection process. As ROE deals with investment projects as a whole, IRR deals with piecemeal and more elaborate underlying of alternatives. The latter statement is tarnished by the inability of IRR to tackle combined project inflows and outflows of huge investments as it cannot protect its reliability posted by external/ market factors. Also, getting appropriate discount rate which is the cornerstone of IRR is tedious but with little assumptions necessary to operate IRR the former challenge can be undermined and conclude that IRR is relatively simple investment appraisal compared to highly-acclaimed NPV.
Net present value (NPV) can rationalized the risks attached to projects which require long-term periods before the payback is achieved. It is simply the sum of annual cash flows of the entity that is applied with discounting after profit is identified. Also, non-cash transactions are also brought back to the net income. In effect, the technique is focused on cash flows rather on financial statements. NPV is simple such as accept projects with positives NPVs and reject otherwise. To support identification, NPV tables and supporting data are existent. In the contrary, NPV does not offer tools to reduce capital outlay which can adversely affect the level of investment. Due to this, it is tagged as pure analytical framework and is not responsive. In effect, its effectives can only be obtained if it will be applied with other techniques that identify inefficiencies, value-creation methods, project stoppage and withdrawal for determining opportunities to minimize risks or maximize returns. NPV can supply the lacking of payback period about time value of money while the IRR’s historic approach on analyzing data give NPV upper hand in forecasting future returns and basis for sound decision-making.
The appraising framework of Apple could be bias on global operations making cross-border investments a noteworthy consideration. In this veil, ROE can measure equity and direct investments in host countries in a manner that above average returns are emphasized. Host companies (i.e. using the industry standard) can imply the nature of investor expectations and can be used by Apple to determine its operational performance to address. In the contrary, IRR can reduce external risks of the foreign operations (i.e. political, cultural, and economic). IRR is based on projects that from start-to-end Apple is assured that necessary actions such as to plan, monitor or evaluate performance. In this veil, ROE and IRR can provide information that are corporate-level and project-level in nature respectively. As a result, Apple can select between the two who addresses the nature of its risk-tolerance and corporate objectives. Lastly, NPV can aid in discounting while payback period can inject some valuable inputs from managers that can substantially uplift the credibility of ROE and IRR.
V. Conclusion
It is concluded that the firm will use different sources of financing to obtain optimal capital structure as well as use integrated appraisal framework depending on its current and future strategy. Partnering as a source of short-term competitive advantage can be lucrative to the high business risk and political risk of Apple particularly in cross-border operations. Consequently, ROE can be used for these host country operations. However, NPV and IRR can serve as maximizing tools for Apple to base its investment decision objectively while payback method can also used to give way to experienced decisions of managers. In the end, the dynamic environment of high-tech firms can change the emphasis of Apple regarding these sources or tools. But the rule is to align business strategy to the instrument to be utilized.
Bibliography
Books
Journals
Electronic Sources
Credit:ivythesis.typepad.com
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