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Question 1 - According to the sources Apple currently have equity capital on issue? Why do companies raise equity capital? What has happened to the Apple share price in 2019 and why has this happened?

Answer - Apple Equity Issue

The statement of Finance Chief of Apple, "Our first priority is always looking after the business and making sure we continue to grow and invest,". The statement had made clarity of intention of the company not to issue any equity share in the near future as the company has focused its attention on the improvement in the growth and investment. Apple has made its intention publically clear of ready to repurchase own shares for $100 billion worth by repaying cash to Apple's shareholders (Nicas, 2019).

Apple has announced that the company will repurchase the common stock with the cash outflows of $75 billion. Huge cash is in hands of Apple as at the end of the first quarter is $129.6 billion, which clearly shows the surplus cash and the same can be used to repay the shareholders over the period. Hence, Apple has equity capital issue in the present time and not in the near future on the basis of present intention (Owen, 2019).

Equity Capital Funding

High risk and high return are the main features of the equity capital whereas the low risk and low risk are best features of debt funding. Companies are interested in the issue of equity share for arranging to fund because of no obligation of repayment of the principal and return on the equity capital fund. Companies are free and have huge flexibility in using the equity capital for expanding their business activities (Armitage, 2005). The expansion of the business has no assurance of success so the use of equity capital is more flexible because of no issue of return on the invested fund in case of failure of the business. Equity capital is a permanent source of financing for business expansion without limitation of the repayment thereof. The dividend on equity is not mandatory so it provides flexibility for arranging sufficient funding for further growth and when excessive funding dividend can be paid (Armitage, 2005).

Apple Share Price in 2019

Apple Equity Issue.png

Apple's share market price movement is downward after the end of April which indicates downfall in the market price over the last six years. Main factors for downfall in the market price performance of the share are cut in the price of iPhone in China range of models including iPhone 8, iPhone 8 Plus and XR with the discount offering of 20% and battery replacements downing confidence and reputation among the customers. The price cut will down the profitability in 2019 between $5 billion to $9 billion from the original estimated profitability in 2019 (Spence, 2019). The company has expected battery replacements between 1 million and 2 million but actual battery replacements are around 11 million which are much more than the expected replacements showing the quality issue. Awkward designed battery case in new, XS, XR, and XS Max handsets is also an issue for downing the demand of Apple's product in the market. Therefore, the market price performance of Apple' share will down in 2019 (Spence, 2019).

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Question 2 - i) What are the FCFs for this project?

Answer - FCFs

Statement of Free Cash Flows


Year

Particulars

0

1

2

3

4

Revenue of New IphoneXI


$2,800,000

$2,800,000

$2,800,000

$2,800,000

Less: Decrease in sale revenue of Existing IPhoneX

-$1,000,000

-$1,000,000

-$1,000,000

-$1,000,000

Incremental Revenue (A)


$1,800,000

$1,800,000

$1,800,000

$1,800,000

Incremental Expenditures:






Variable Exp. (20% of Revenue)


-$360,000

-$360,000

-$360,000

-$360,000

Dep. Exp.


-$1,000,000

-$1,000,000

-$1,000,000

-$1,000,000

Total Incremental Expenditures (B)


-$1,360,000

-$1,360,000

-$1,360,000

-$1,360,000

PBT (A-B)


$440,000

$440,000

$440,000

$440,000

Tax (30% on PBT)


-$132,000

-$132,000

-$132,000

-$132,000

PAT


$308,000

$308,000

$308,000

$308,000

Add: Dep. Exp.


$1,000,000

$1,000,000

$1,000,000

$1,000,000

Incremental Operational Cash Flows


$1,308,000

$1,308,000

$1,308,000

$1,308,000

Capital Expenditures and Receipts:






Purchase of New Machinery

-$5,000,000





Working Capital

-$30,000





Resale of Machinery





$1,700,000

Working Capital Recovered





$30,000

FCFs

-$5,030,000

$1,308,000

$1,308,000

$1,308,000

$3,038,000

Discount Rate10%

1

0.909

0.826

0.751

0.683

Present Value (PV)

-$5,030,000

$1,189,091

$1,080,992

$982,720

$2,074,995

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ii) What is the NPV of this project?

Answer - NPV

Net Present Value

PV of all Cash Inflows

$5,327,797

Initial Capital Expenditure

$5,030,000

Net Present Value

$297,797

iii) State whether Apple should invest in this project and explain why or why not based on your calculations, research and sources 1-2.

Answer - Decision

The project of manufacturing a new IphoneXI has the net present value of $297,797 supporting positive NPV on the investment. Apple can accept the project because of positive NPV showing higher present value of cash inflows than the cash outflows present value. The investment in this project will increase the worth of investment in Apple. Apple can earn a higher return than the required return (Ehrhardt & Brigham, 2013). Therefore, Apple should make an investment in this project.

iv) Is funding this project with ordinary shares the cheapest way to finance? Why or why not? Imagine Apple could refinance using only bonds. Would this affect its NPV? Why or why not?

Answer - Bond Reissue

Ordinary shares investment has the highest risk due to no certainty of returning the invested fund and return on the invested fund in the form of a dividend. A company has no obligation to make dividend payment and no repayment of equity investment that presents high-risk investment. High risk entails high expected return. Therefore, the funding to this project with ordinary shares cannot be the cheapest way of financing rather it the highest costly way of financing to this project (Ehrhardt, and Brigham, 2013).

If Apple could refinance the same project by using only bonds financing, it would increase the NPV of the project, which is of the project financed by the ordinary share funding. The expected return on Bond will be lower than the expected return on ordinary share because of low risk in case of Bond. Bond has a secure and reliable return in the form of interest and fixed schedule of repayment of the investment fund in Bond. This source is highly secure so less risk which means lower discount rate as compared to the ordinary share required rate. Therefore, refinancing from a bond only will increase the NPV of the project.

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