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PS4: Putting it all together

Corporate Finance – ECONS4280

2022

In this exercise, you will be acting as the CFO of Apple. You have a new project lined up, a project that looks very much like a typical Apple project. Your task is to decide if the project is worthwhile!

Note! Your task is numerical. You will not be solving this problem with pen and paper! You have two datasets that you should use:

• A list of forecasts of the cash flows pertaining to this project, produced by your team of analysts.

• A list of historical monthly returns for Apple stock and the S&P 500. Once you have these datasets, you should complete the following tasks:

1. Take a look at the forecasts from your analysts. Calculate the net cash flows of the project, and excluding the initial outlay in period 0, plot them, with time on the x-axis, and net cash flows on the y-axis. Comment on what you find.

• (Extra Credit, 1 point): What approach do you think your analysts took to come up with these forecasts?

2. To calculate the NPV of this project, we need to find the WACC for Apple. To do that, we need to know about Apple’s cost of raising debt, Apple’s cost of raising equity, and Apple’s debt to equity ratio. To find the cost of raising equity, we would need to know Apple’s β, and the market premium. Suppose we took the following guesses:

• The risk-free rate is 3%

• Apple can borrow at the risk-free rate.

• Apple’s β is 0.2.

• The market premium is 5.6%.

• Apple’s debt-to-equity ratio is 1.5

How good are these guesses? Are they reasonably close to the actual numbers for Apple? Would you use these numbers to estimate the WACC, or would you use alter- natives? You must justify your answers! Use evidence to support your arguments.

3. If you haven’t already, go to the data on Apple’s returns. Calculate the β . How close is this to our guess? How close is it to the reported β you can find online?

(Hint: Use Excel to plot the returns of Apple and the S&P 500, then insert a linear trendline. In the options, you can choose to ‘Display Equation’ . This should get you the number you’re after!)

4. Using your guesses, construct the WACC for Apple.

5. Now you have the WACC, compute the NPV of the project. Comment on what you find. Would you take on the project?

6. Suppose that your boss, the CEO, doesn’t like NPV. She prefers the Internal Rate of Return (IRR). What is the internal rate of return for this project? Does the project pass the internal rate of return rule?

7. Now, suppose you decide as part of your role as CFO, to reshuffle the debt-equity ratio at Apple. Suppose there are no corporate taxes. You manage to achieve a new debt-equity ratio of 3.

(a) What is the new WACC?

(b) Assuming that the cost of debt has not changed, what is the new cost of equity?