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Apple iTV: “ My ” Analysis, Not necessarily “ the ” analysis

Apple iTV: “ My ” Analysis, Not necessarily “ the ” analysis. Aswath Damodaran. Executive Summary. On a stand-alone basis, this project is a good project (but only barely)

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Apple iTV: “ My ” Analysis, Not necessarily “ the ” analysis

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  1. Apple iTV: “My” Analysis,Not necessarily “the” analysis Aswath Damodaran

  2. Executive Summary • On a stand-alone basis, this project is a good project (but only barely) • The average return on capital, in the finite life case, is 22.35%, partly because of very high returns in later years. This is higher than the cost of capital of 15.25%. • The net present value of the cash flows on iTV, using a cost of capital of 15.25% • Is $ 478 million, under the finite life assumption of a of 10 years. Adding the present value of increased sales in the iTunes stores increases it to $1.77 billion • Is $1.66 billion, under the assumption of an infinite life. Adding the present value of increases sales in the iTunes stores increases it to $ $4.0 billion. • The IRR is above 16% in both cases and exceeds the cost of capital. • I would accept the investment.

  3. Cost of Capital iTV and iTunes

  4. Your findings on iTV cost of capital Lowest: 12.06% Highest: 15.66% Median: 15.25%

  5. Apple iTV: Operating Income

  6. Some Thoughts on Operating Income... • There are a number of allocation mechanisms that can be used to compute operating income, and the return on capital is affected by decisions on allocation. • Your choices on depreciation have profound effects on return on capital. Using a more accelerated depreciation method would raise your return on capital substantially. • Note that the operating income is computed after marginal taxes (Why?) and does not include the tax savings due to interest expenses (Why?)

  7. Apple iTV: Return on Capital Average ROC on just iTV = 35.65% ROC included iTunes = 37.55% Aggregate ROC on just iTV = 22.35% ROC with iTunes = 23.94% BV of capital = Undepreciated portion of original investment + 20% of Capacity Expansion + Non-cash Working capital

  8. Your findings on Return on Capital Lowest: -1.51% Highest: 66.28% Average: 22.49% Median: 21.40%

  9. Apple iTV: After-tax Cash Flows

  10. Observations on Expansion Capacity • To analyze what happens to capacity, we considered the two scenarios - with Apple iTV versus without Apple iTV. • If you invest in Apple iTV, you run out of capacity in year 4. • If you don’t invest in Apple iTV, you run out of capacity in year 10. Assumed straight line depreciation over 20 years In year 10, Incremental depreciation = $5,306,040/20 – $5,975,463/20 = -$33,471

  11. Apple ITV: NPV and IRR • Cost of capital for iTunes cash flows • Unlevered beta for iTunes = 1.10 • Levered beta for iTunes 1.1057 • Cost of equity for iTunes= 3% + 1.1057 (6.92%) = 10.65% • Cost of capital for iTunes = 10.65% (.9914) + 2.4% (.0086) = 10.58%

  12. Your findings on NPV – Finite Life Lowest: -$,8561 m Highest: $15,955 m Average: $1,143 m Median: $725 m

  13. Apple iTV: Longer Life The basic trade off You replace salvage value with a much larger terminal value, but your cash flows during the next 10 years will be lower to allow the project to keep going.

  14. Observations on Infinite Life & Capital Maintenance • You cannot extend the project life without putting money back to preserve existing investments. In the earlier years, I allow the capital maintenance to be less than depreciation but as the assets age, the depreciation schedule kicks up and reflects inflation. Thus, to replace the assets that are depleted in year 8 (captured in the depreciation in that year of $1,807 million), I assume that capital maintenance has to be $ 2,117 million…. ($1,807 million *1.028) • None of the assets are salvaged in this case, since the project continues forever.

  15. Terminal Value and NPV Calculations • Value of iTV in year 10 = CF in year 11/( Cost of capital - g) = $5,637(.1525 - .02) = $ 42,542 million • Value of ITunes in year 10 = CF in year 11/( Cost of capital – g) = $ 239/(.1058 - .02) = $ 2,843 million Use Solver or Goal seek for IRR

  16. NPV – Longer Life Lowest: -$2,678 m Highest: $68,475 m Average: $12,953 m Median: $11,100 m

  17. Consistency in growth and investment assumptions

  18. The final decision… • My rationale for investing in iTV • While the NPV is only mildly positive, it is over and above a high risk-adjusted cost of capital. • Apple has (or should have) no capital rationing constraints; the company has $ 140 billion in cash. • Over the last decade, Apple has consistently found ways to get unexpected synergies in its other products. • This investment in the electronics business may provide an option to expand into other electronic products – gaming stations (for example). • Of the 50 groups (with summary sheets): • 47 suggested accepting the investment, most because the longer life analysis yielded such a high NPV. • 2 suggested rejecting the investment • 1 made a conditional statements about acceptance

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