• Internal Code :
  • Subject Code : FINM4000
  • University : Kaplan University
  • Subject Name : Finance

Individual Assessment in Finance

Table of Contents

Overview: 

Part A: Company Financing 

1. Cash conversion cycle: 

2. Negative CCC for investing in new products: 

3. Financing options for Amazon: 

4. Cash conversion cycle of Amazon in 2018: 

5. Risks facing Amazon: 

6. Price of Amazon bond: 

7. Holding period return of Amazon stocks: 

Part B: Capital Budgeting 

1. Free cash flow for Amazon: 

2. NPV for the new AmazonGo stores: 

3. Discounted payback period for the project: 

4. Weakness of cash flow evidenced: 

5. Recommendations for Amazon: 

Part C: Personal Reflection 

References 

Overview:

A study would be conducted to have an understanding of the cash conversion cycle of the technological giant, Amazon delivering an insight into its working capital management system. The study would also discuss on the working capital and risk management scenario of that Amazon has been subjected to over the last few years. Besides company financing, there would also be discussion on capital budgeting factors of Amazon as it strives to launch the Go stores in the market. 

Part A: Company Financing

1. Cash conversion cycle:

Image showing cash conversion cycle for Amazon in 2018

Cash conversion cycle stands for determinant that shows the average time say in terms of days undertaken by the business to convert its investments in inventories and other assets into cash resources by means of sales (Damodaran, 2016). It is seen that in the year 2013, Amazon has a negative cash conversion cycle (CCC) of 28.65 days while its fellow technological counterpart like Apple as well has a negative CCC of 44.5 days. Again the retailers like Walmart and Costco has attained the excellent feat of bring down their CCC to single digits. The figures depict that Amazon is better-off than Apple owing to a lower CCC as Amazon has excellence in liquidating its resources efficiently as compared to the latter. 

The negative cash conversion cycle of Amazon reveals that the organisation is characterised with an efficient inventory management mechanism (Justin, 2014). It indicates that the organisation owing to its swiftness in managing the inventories are being able to collect its dues from the customers much earlier than the due date of its suppliers delivering a continuous flow of free cash resources in the organisation. 

2. Negative CCC for investing in new products:

A negative CCC indicates that the organisation strives to receive from its customers much before than it has to pay its suppliers. So it deliberates of a financing methodology through the suppliers without shelling out any interest on it. Contrarily, it would be better to have a positive CCC which stands for a balancing act by having timely receipt from the customers and paying off timely to the suppliers as well. Amazon is a giant organisation and could take the risk of delaying the suppliers’ payment so that it could come up with innovative projects (seekingalpha, 2015). But Amazon continuously pushing its CCC to a negative proposition might stress the relationship with its suppliers and this could disrupt its operation tending the company to look for alternative financing. 

3. Financing options for Amazon:

Amazon to fund its new projects take relevance of the financing options of free cash flow and cash conversion cycle:

Free cash flow –

Free cash flow (FCF) stands for the cash resources generated by the company after the sorts of cash outflows to support the business operations and maintenance of the capital resources (Fracassi, 2016). The advantage of having FCF is that the company could have an idea of raising the funds off business to invest in its upcoming business projects as in case of Amazon. But the disadvantage in having FCF in the foray is that it is entirely based on future projections while there has been no such real-tem benefit in investment. 

Cash conversion cycle –

Cash conversion cycle (CCC) determines the time gap prevailing between purchases of the inventories and paying off the suppliers against those purchases (Ehrhardt & Brigham, 2016). The advantage in having CCC as a financing option lies in having an interest-free funding options carrying negligible charge for its usage. Again, its disadvantage lies in the fact that too much delay in paying the suppliers could stress the business relationship with the company though Amazon being a giant organisation could expend such risk. 

4. Cash conversion cycle of Amazon in 2018:


5. Risks facing Amazon:The cash conversion cycle for Amazon in 2018 has been a negative figure of 28.99 or 29 days as compared to the negative figure of 28.65 days back in 2013. It indicates no such change in both the figures as in 2013 it was 28.65 days and 29 days in 2018 (Justin, 2014). But it is due to make an unprecedented impact on the relationship with the suppliers in the organisational scenario of Amazon as the company keeps on delaying the payments. The company withholds the suppliers’ payment to fund its projects leading to a negative CCC and this is plausible owing to the branding of Amazon and its credibility in having confidence of the suppliers.  

The significant risks faced by Amazon in 2018 are as follows:

  1. Fluctuation risks in operating outcome and growth rate – It is considered as a significant risk as in certain cases the company expends the amount without knowing the probability of its return in the dynamic business environment (Kim, et al., 2018). This is definitely an unsystematic risk because it is concerned with the business decisions undertaken by Amazon based on its market research and speculation for the future. 

  2. International exposure risks – Expanding into the international territory definitely strives to be a risky proposition to Amazon as it has to adhere by the sorts of economic, political, social and labour legislations as per the law of the land. It could be categorised as a systematic risk as the legislations applicable for conducting businesses in the attractive markets of China and India are under strict vigilance for international companies like Amazon (Ke, et al., 2011). 

  3. Breaching risks of intellectual property rights – Amazon being an innovative organisation need to protect its product and services from getting commercially exploited in a scenario where intellectual protection facilities are not available to each of its operating market (Scheers, 2016). So it is definitely an unsystematic risk for Amazon as it is related to its loss of business and violation of its brand value in the market. 

6. Price of Amazon bond:

Face value of bond (F) = $1,000

Annual coupon rate = 4.5%

Yield to maturity = 3% or 0.03

Coupon payment = $1,000 x 4.5% = $45 per period

T = 12 (2007 to 2019)

Present value of annual payments: 45/ (1.03)1 + 45/ (1.03)2 + 45/ (1.03)3 + 45/ (1.03)4 + 45/ (1.03)5 + 45/ (1.03)6 + 45/ (1.03)7 + 45/ (1.03)8 + 45/ (1.03)9 + 45/ (1.03)10 + 45/ (1.03)11 + 45/ (1.03)12 

= $447.93

Present value of face value: 1000/ (1.03)12 = $701.38

So, price of the bond in 2019 = $447.93 + $701.38 = $1,149.31

7. Holding period return of Amazon stocks:

Holding period return (HPR) = (Worth at the end of period – Initial worth) / Initial worth

Amazon stock price on 2nd June, 2014 – $308.84

Amazon stock price on 3rd June, 2019 – $1,692.69

So, HPR = ($1,692.69 – $308.84) / $308.84 = 448%

The HPR for the Amazon stock from June, 2014 to June, 2019 has been phenomenal having the figure of 448%. It is seen that the stock price jumped from $308.84 on 2nd June, 2014 to $1,692.69 on 3rd June, 2019. So an investor is poised to get 5 times of his investment during the aforesaid period having due potentiality to generate a suitable return on the stock investment of Amazon (Fracassi, 2016). 

Part B: Capital Budgeting

1. Free cash flow for Amazon:

The free cash flow table of Amazon (refer to the appendix) shows the company undertakes the business proposal to come up with 3,000 brand new cashier-less stores, AmazonGo at an investment worth of $4 billion having the potentiality to earn $4.5 billion annually (Molla, 2019). The table has been drawn keeping in mind the relevance of the associated costs and income potentiality for the upcoming 10 years and it is seen that Amazon is due to earn a potential revenue off this arrangement.  

2. NPV for the new AmazonGo stores:

NPV for the AmazonGo stores at a cost of capital of 5% comes around $963,666,686.50 indicating a positive figure to go ahead with the project. 

NPV for the AmazonGo stores at a cost of capital of 12% comes around ($2,135,422,037.49) indicating a negative figure tending the management to shelve the project. 

In this case, two plausible business scenario has been used wherein at the cost of capital rate of 12%, a negative NPV comes in while a positive NPV is being desired at the capital rate of 5%. So it implicates that the business venture of AmazonGo could sustain the market having a lower cost of capital tending the business to raise its fund for the business expending lower cost (Ehrhardt & Brigham, 2016). Therefore, having a lower cost of capital say 5% would be quite speculative for the business venture for AmazonGo to continue with its business plan. 

3. Discounted payback period for the project:

Discounted payback period indicates the profitability of the project to attain the break-even point using the time value of money (Lins, et al., 2017). The below table shows the discounted PBP for AmazonGo for 7.43 years which means that the business is found to take a longer time say more than 7 years to raise the investment for the business. It is seen that the company strives to have the PBP within the period of 2 years but owing to the current business scenario, the matter seems to be impossible. This is due to the fact that the business venture of AmazonGo is supposed to incur substantial expenditure for its operation and it would definitely attract a lower return in the initial phase of business.  

4. Weakness of cash flow evidenced:

The article by Molla (2019), shows that the business venture of AmazonGo would attract an initial investment of $3 billion but has potentiality to generate cash flows worth $1.5 billion annually. It shows that for the high-tech stores of AmazonGo, a fortune would be required but in the initial phase of business the cash flow would be slower as seen in a developing business case. It is based on pure estimation that such stores would generate around $1.5 billion annual sales but unless another ground-breaking innovation takes place, the Amazon scenario would not be an attractive proposition (Dyck, et al., 2019). 

5. Recommendations for Amazon:

After going through the business scenario certain recommendations could be proposed for Amazon for ensuring its business success, such as:

  1. The business project of AmazonGo need to be undertaken provided it implements a lower cost of capital.

  2. It is seen that AmazonGo having a lower cost of capital of 5% is being able to render a positive NPV ensuring business sustainability. 

  3. It would be better to negate the project if it uses the cost of capital at 12% as it would incur loss to the business.

  4. The desired PBP of 2 years could not be met but that does not deter the business project owing to a positive NPV. 

Part C: Personal Reflection

  1. Case study 1 has duly helped Part A of the assignment owing to the financial details of Amazon for working out the CCC for 2018. It helped the study to have a better understanding of the supplier relationship trend of Amazon in due course of business and compare the figure with that of 2013 as well. Then the case study showed proper insight of the risks that Amazon is exposed to have a simplistic understanding of the business scenario in which it operates.  

  2. Part B of the assignment has been quite calculative in nature as it was mainly concerned with the sorts of calculations like free cash flow, NPV and discounted payback period. The main notion of this part of the assignment has been investment appraisal and the same has been done quite minutely to undertake a feasible business decision.  

  3. I think Part 2 is quite progressive than Part 1 as it is concerned with the aspect of investment appraisal to decide whether the business venture of AmazonGo would be feasible or not. It is seen that the aspect of investment appraisal has given way to a futuristic cash flow trend for the business purpose. 

References

Damodaran, A., 2016. Damodaran on valuation: security analysis for investment and corporate finance. 324 ed. London: John Wiley & Sons.

Dyck, A., Lins, K., Roth, L. & Wagner, H., 2019. Do institutional investors drive corporate social responsibility? International evidence. Journal of Financial Economics, 131(3), pp. 693-714.

Ehrhardt, M. & Brigham, E., 2016. Corporate finance: A focused approach. London: Cengage learning.

Fracassi, C., 2016. Corporate finance policies and social networks. Management Science, 63(8), pp. 2420-2438.

Justin, F., 2014. Harvard Business Review. [Online]
Available at: https://hbr.org/2014/10/at-amazon-its-all-about-cash-flow
[Accessed 07 September 2019].

Ke, Y., Wang, S., Chan, A. & Cheung, E., 2011. Understanding the risks in China's PPP projects: ranking of their probability and consequence. Engineering, Construction and Architectural Management, 18(5), pp. 481-496.

Kim, K., Kim, M. & Qian, C., 2018. Effects of corporate social responsibility on corporate financial performance: A competitive-action perspective. Journal of Management, 44(3), pp. 1097-1118.

Lins, K., Servaes, H. & Tamayo, A., 2017. Social capital, trust, and firm performance: The value of corporate social responsibility during the financial crisis. The Journal of Finance, 72(4), pp. 1785-1824.

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
[Accessed 07 September 2019].

Scheers, L. v., 2016. MANAGING THE RISK OF OUTSOURCING THE IT FUNCTION AT COMPANIES. Risk Governance and Control: Financial Markets & Institutions, 6(3), pp. 12-25.

seekingalpha, 2015. Understanding Amazon's Cash Conversion Cycle. [Online]
Available at: https://seekingalpha.com/article/3528986-understanding-amazons-cash-conversion-cycle
[Accessed 07 September 2019].

 

 

 

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