AMAZON WACC 1
BX2014 Principles of Finance
Assessment task 3: Business Report
Weighted Average Cost of Capital (WACC) Report
Amazon
Prepared for: Dr TY Thong
Prepared by: Siti Nazrana Nazeer Ahamed
Student ID- 13679698
Due date- 04/06/2021
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Table of Contents
Table of Contents ……………………………………………………………………………………………………. 2
Introduction ……………………………………………………………………………………………………………. 3
About Amazon ………………………………………………………………………………………………………… 3
WACC …………………………………………………………………………………………………………………….. 5
Cost of Equity ……………………………………………………………………………………………………….. 6
Cost of Debt ………………………………………………………………………………………………………….. 7
Capital Weights …………………………………………………………………………………………………….. 8
Calculation of the WACC………………………………………………………………………………………. 9
Gearing ratio …………………………………………………………………………………………………………. 10
Reflection and recommendation ……………………………………………………………………………. 12
Conclusion …………………………………………………………………………………………………………….. 12
References ……………………………………………………………………………………………………………… 13
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AMAZON WACC
Introduction
The Weighed Average Cost of Capital (WACC) is an essential financial precept widely
used in financial circles to test whether a return on investment can exceed or meet an asset, project,
or company’s cost of invested capital. The information below will expound on Amazon
Incorporation WACC
About Amazon
Amazon incorporation is a vast Internet-based enterprise that sells music, books, movies,
housewares, electronics, and other goods either directly or as middlemen between different
retailers and Amazon’s customers. It includes the Web services business that provides for renting
data storage and computing resources, so it is called cloud computing over the internet. It is a
considerable online presence such that in 2012, one percent of all internet traffic in North America
travelled in and out of Amazon data centers (Hall, 2020). The company also makes market-leading
e-book readers. Its promotion of these devices has led to dramatic growth in e-book publishing
and turned Amazon into a significant disruptive force in the book publishing market.
Jeff Bezos instituted the corporation. On the basis he had conducted, Bezos concluded that
books would be the most logical product initially to sell online. While Amazon famously started
as a bookseller, Bezos contended that the site was not merely a retailer of consumer produc ts. He
argued that the corporation was technological, whose business was simplifying online transactions
for customers. Despite the criticisms in the early stages of the development, Bezos argued that the
internet would be the most outstanding retail market globally. Amazon is known for its disruption
of well-established industries through technological innovation and mass scale. It is the world ‘s
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most prominent online marketplace, AI assistant provider, live-streaming platform, and cloud
computing platform. As measured by revenue and market capitalization.
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WACC
The Weighted Average Cost of Capital (WACC) represents its blended cost of capital
across all sources, including common shares, preferred shares, and debt. Its percentage of total
capital weighs the cost of each type of capital, and they are added together. WACC is also known
as the discount rate, where it assesses the value of an asset and determining whether a project is
feasible or not in the net present worth (Corporate Finance Institute [CFI], n.d.). The purpose of
the WACC is to find the average cost rate that a company must pay its debt and equity capital
borrowed from creditors and investors. Therefore, it reflects the overall return a company must
earn on its existing assets to maintain the value of its shares and the satisfaction of its shareholders
as well as creditors. This information can also be utilized in assessing investments that deal in the
same risk class as the company (Vartiainen et al. 2020)
The formula is calculated by summarising the corporation’s debt and equity weighed by
their capital structure and multiplying their costs. The procedure is outlined as follows:
???? = ( ?
? × ?? ) + {(
?
? × ??) × (1 − ?)}
in which
E: the market value of the company’s equity
D: market value of a company’s debt
V: Total market value of the company (E+D)
(E/V): Percentage of financing that is equity
(D/V): Percentage of financing that is debt
RE: Cost of Equity
RD: Cost of Debt
T: Corporate Tax rate
AMAZON WACC 6
Cost of Equity
To get the WACC for Amazon, one needs to look into the cost of equity. Cost of equity is
the total value of all company’s outstanding shares or stock measured by the market prices. It is
also the total value of all outstanding stock in the stock market as measured at a point in time. It
represents the rate of return that a shareholder expects to receive from an investment in business.
It is the cost that investors expect to be compensated, in exchange for the associated ownership
risk it takes in owing the stocks of the business. The cost of equity is computed by adding the
adjusted market risk premium by the risk-free rate and additional risk adjustments.
?? = ?? + ?? + ?? × (?? − ?? )
Where:
Rf: the risk-free rate
RA: Risk adjustments
??: Estimate of relevant Beta
(RM-RF): market risk premium
Adjusted market risk premium: (1.2 × 4.7%) = 5.64%
Cost of Equity: 5.64% + 2.50% + 0.25% = 8.39%
The cost of equity of 8.39% means that stockholders require a return on investment of
approximately 8.39%. It means that for every dollar they invest in Amazon, they require a return
of $0.0839.
Cost of Equity Selected Beta 1.2
Market Risk Premium 4.7%
Adjusted market risk premium 5.64%
Risk-free rate 2.50%
Additional risk adjustments 0.25%
Cost of Equity 8.39%
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Cost of Debt
Afterward, one needs to calculate the cost of debt. Total market value of debt is calculated
by the adding up the company’s contract amount consisting of commercial paper, bonds and
financial debt. A commercial paper is an unsecure short-term debt issued by a company to finance
its accounts receivable, inventories and other short-term liabilities. A bond refers to a security that
is issued by a government or a public company to raise capital. Bonds are of two types: short term
and long term. Short term bonds are those which can be redeemed in two years or less while long
term bonds mature in seven years or more until its redemption rate. It is the product of the selected
long-term debt and the tax rate. The computations are as follows:
Cost of debt:????? ???? × (1 − ??? ????)
Cost of debt: 4.5%*(1-19%) = 3.65%
The cost of debt is 3.65%. It means that for every dollar invested in Amazon, they require
a return of $0.036.
The cost of equity is lower than the cost of debt. This is brought about by reasons such as
ownership protection, fixed maturity rate, interest and tax deductions as well as callable feature.
In the case of ownership protection, issuing bonds does not change one’s ownership percentage in
the corporation unlike selling stock shares which dilutes one’s ownership percentage. This is
because the stockholders could band together and outvote on corporate matters unlike bondholders
who request investors to loan the company money. As far as fixed maturity rate is concerned,
bonds have a life span. This implies that they have a maturity date for paying the periodical interest
and repaying the original loan. On the other hand, a company must offer a substantial premium to
investors to convince them to sell back its shares which are kept forever when stock is issued to
these shareholders (Thompson, 2020).
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Capital Weights
As for interest and tax deductions, the interest tax expense on bonds is tax deductible and
therefore a company can reduce its taxable income by issuing bonds. On the other hand, dividends
paid to stockholders are not tax deductible. If the company can issue bonds at low interest rates,
then the interest deduction can make the debt costs quite low. Callability means reducing bonds
earlier than the actual maturity date. When interest rates fall, old bonds with an earlier interest rate
are called in so that the company can sell new bonds at a lower interest rate. The called bonds are
paid off based on their face value and the interest rates stop accumulating as of the callable date.
On the other hand, a company is entitled to paying dividends to its shareholders indefinitely after
selling shares. If it defaults on its payment, the shareholders can file a lawsuit against the
corporation (Thompson, 2020).
Cost of Debt Selected Long-term Debt 4.5%
Tax Rate 19.0%
Cost of Debt 3.65%
The debt and equity section of capital are as follows:
Debt % of capital: ?????? ?????
????? ??????? =
101,229
(101,229+1,684,193) = 5.7%
Debt % of Equity: ?????? ?????? ???????
????? ??????? =
1,684,193
(101,229+1,684,193) = 94.3%
(In Millions)
Amazon Debit $ 101,229
Amazon Market Capital $ 1,684,193
Debt % of capital 5.7%
Debt % of equity 94.3%
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Calculation of the WACC
Using the data above, one can calculate the WACC for the Amazon incorporation. The
information has been tabulated below:
WACC
Cost Estimates
Cost of Equity 8.39%
After-tax Cost of Debt 3.65%
Weights
Equity % of Capital 94.3%
Debt % of Capital 5.7%
WACC 8.121%
The calculation is as follows:
???? = (???? ?? ?????? ∗ ?????? ?????????? ?? ??????? ) + (????? ???? ?? ????
∗ ???? ?????????? ?? ??????? )
???? = (8.39% ∗ 94.3%) + (3.65% ∗ 5.7%) = 8.121%
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Gearing ratio
Gearing ratio is a type of ratio that measures how a firm’s day to day operations are
funded by a mix of owner’s funds i.e. equity and borrower’s funds i.e. debt. Companies with
higher gearing ratios are more likely to be affected by economic downturns. This is because
companies with higher leverage have higher amounts of debt as compared to equity. However,
companies with high gearing ratios do not necessarily signify that they are in poor financial
conditions; rather, they have a riskier financial structure than those with low gearing ratios
(Investopedia, 2017). The gearing ratios for Amazon incorporation are as follows:
???????? ????? = ????? ????
????? ?????? =
$227,791,000
$93,404,000 = 2.439
???? ????? = ????? ????
????? ?????? =
$227,791,000
$321,195,000 = 0.709
?????? ????? = ????? ??????
????? ?????? =
$93,404,000
$321,195,000 = 0.291
According to the above-mentioned figures, the leverage ratio is 2.439. This means that
for every $1 of shareholder’s equity, Amazon has $2.439 in debt. Normally, a debt to equity ratio
which is greater than 2.0 indicates a risky scenario for investors because this may result in
volatile earnings due to additional interest expenses that arise from issuing debt and if it is high,
then it may result in bankruptcy. Amazon’s equity value is much less than its debt which
suggests that its leverage ratio is very risky and that its capital structure is contributing to lower
rates of return (Investopedia, 2017). Debt ratio is the ratio that reflects what is the total value of
assets that a company must sell to pay its total debt. The overall debt ratio is 0.709 which means
that while Amazon has relied on a lot of debt, its assets is 1.41 times its total debt value. This
denotes that while the debt ratio is relatively stable, the company needs to cut back on its debt
financing to avoid higher chances of defaulting on its payments. Equity ratio is the ratio that
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denote what is the total value of assets that have been financed by equity. The overall equity ratio
is 0.291 which means that a large proportion of Amazon’s assets have been financed through
issuing debt. This suggests that Amazon is will meet more interest payments on its loans and that
it has sufficient cash for future product expansions and growth opportunities.
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Reflection and recommendation
The weights used are the accounting book values. It is because the values are present a
correct count of the information proved and the prices in the market keep fluctuating. The WACC
for Amazon incorporation is 8.121%. This means that the company needs to pay its investors an
average of $0,08 in every $1 funding. To convince more investors to finance Amazon, the
organization needs to be great. It also implies that the return on capital invested needs to be
observed (Ellerman, 2019). Moreover, the organization needs to reduce the debt entirely to
increase the shareholders’ value and even expand. The beta, which has been derived from yahoo-
finance, for the organization is 1.15, which is summarized as 1.2 as used in the table above. the
published beta is simplified and usable in the organization. Amazon should also consider channels
of decreasing debt. Debts carry along interest rates which lead to reduction in profits. Amazon may
be in the best interest of not sharing power to shareholders, but they should consider other methods
of raising finances and reduce debt.
Conclusion
WACC can be used as a hurdle rate against which to assess the performance of the
company. The information can be used in economic value-added calculations. Using the
information provided, investors can decide whether to invest in Amazon corporation.
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References
Corporate Finance Institute [CFI]. (n.d.). WACC. Retrieved from
https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-wacc-
formula/
Ellerman J. (2019). The Weighed Average Cost of Capital (WACC) and its implications for
Incentive Plan Design. Retrieved from https://www.paygovernance.com/viewpoints/the-
weighted-average-cost-of-capital-wacc-and-its-implications-for-incentive-plan-
design#:~:text=The%20weighted%20average%20cost%20of%20capital%20(WACC)%2
0is%20an%20important,capital%20(equity%20%2B%20debt).
Hall, M. (2020, April 9). Amazon.com. Encyclopaedia Britannica.
https://www.britannica.com/topic/Amazoncom
Investopedia (2017). Leverage ratio. Retrieved from
http://www.investopedia.com/terms/l/leverageratio.asp
Thompson J. (2020). Why Corporations Issue Bonds Rather than Stocks. Retireved from <
https://smallbusiness.chron.com/corporations-issue-bonds-rather-stocks-75530.html>
Vartiainen, E., Masson, G., Breyer, C., Moser, D., & Román Medina, E. (2020). Impact of
weighted average cost of capital, capital expenditure, and other parameters on future
utility‐scale PV levelised cost of electricity. Progress in photovoltaics: research and
applications, 28(6), 439-453.
