Please help me answer these questions from the apple itv iinvestment project
' Estimate the after-tax incremental cash ows from the proposed iTV investment to Apple over the next 10 years. 0 If the project is terminated at the end of the 10th year, and both working capital and investment in other assets can be sold for book value at the end of that year, estimate the net present value of this project to Apple. Develop a net present value profile and estimate the internal rate of return for this project. The Apple iTV Project Apple Computer has had a very good run, both in terms of accounting prots and stock prices. Based largely on the success of the iPod, the iPhone and the iPad, the company has reported double digit growth in revenues and earnings over the last few years (see exhibit 1) and its stock price has reected this success (see exhibit 2). It has a substantial cash balance and a strong balance sheet (see exhibit 3 for balance sheet r information). However. Steve Jobs, CEO of Apple, is concerned that the halcyon days of the iPod are past and that potential challengers loom on the horizon (Sony, Zune etc.). Apple is considering entering the television market with an innovatively designed and technologically state-of-the art LCD television, called the iTV, aimed at the upper end of the market. You have been asked to collect the data to make the assessment and have come back with the following information: 1. R&D Expenses: Apple has already spent (and expensed) $ 200 million on research on the television technology and development of the commercial design. None of that money can be recouped at this stage, if Apple decides not to go ahead with the iTV. 2. Introductory Costs; If Apple decides to go ahead with the iTV, it will have to spend $2 billion up front gright now; to tie up suppliers, distributors and retailers, and as investment in infrastructure. The cost is depreciable over 10 years down to a salvage value of $ 200 million, and Apple expects to use straightline depreciation. 3. W: There were 30 million televisions sold in the United States in the most recent year and the market is expected to grow approximately 4% a year in the long term. Apple expects to gain a 2.5% market share next year if the iTV is introduced and increase that market share by 0.5% a year (3% in the second year, 3.5% in the third year etc.) to reach a target market share of 5% of the overall market by the sixth year. It expects to maintain that market share beyond year 6. 4. Pricing and Unit Costs: Apple expects to price its displays at $ 1,000 a unit next year and the price will keep pace with inflation after that. Based upon the costs of the material used in the iTV currently, Apple expects the production cost per unit to be $ 400 next year and grow at the ination rate thereafter. 5. Marketing Options and Costs: Apple plans to use two different retailing options. In the first, it will sell the iTV through other retailers (Amazon, Best Buy. WalMart) and pay the retailers a commission of 10% of the price per unit sold (The retailers will have to follow Apple's fixed price schedule no discounting allowed). In the second, it will sell the iTV through the Apple Stores around the country. To do the latter, it will have to spend $200 million up front in expanding and remodeling the stores; this expense will be depreciated straight line over the next 10 years to a salvage value of zero. It also will pay its sales people a commission of 5% of the price per unit for every unit sold at the Apple Stores. Apple expects to generate 80% of its revenues pay the retailers a commission of 10% of the price per unit sold (The retailers will have to follow Apple's fixed price schedule no discounting allowed). In the second, it will sell the iTV through the Apple Stores around the country. To do the latter, it will have to spend $200 million up front in expanding and remodeling the stores; this expense will be depreciated straight line over the next 10 years to a salvage value of zero. It also will pay its sales people a commission of 5% of the price per unit for every unit sold at the Apple Stores. Apple expects to generate 80% of its revenues from specialty retailers and 20% from Apple Store sales over the next 10 years. 6. Geographical breakdown: Apple expects to get 70% of its revenues for the iTV in in the United States, 20% of its revenues in China and 10% in Brazil, and it expects this revenue breakdown to be stable over time. Based on sovereign ratings, you have estimated an additional country risk premium of 1.05% for China and 3% for Brazil. 7. Production Facilities and Costs: Apple currently uses a manufacturing facility in Singapore to make computer displays. This facility has production capacity of 4 million units but it is under utilized, since Apple produced only 1,200,000 computer displays in the most recent year. While the computer display market is expected to k grow 15% a year for the next 10 years, Apple plans to use the excess capacity in the facility to produce the iTV. If the capacity limit is reached, Apple will have to invest a substantial amount to create a new facility of equivalent capacity (4 million units). The current estimate of the cost of expansion is $ 500 million, but this cost will grow at the ination rate. 8. G&A exmnses: Apple will allocate 10% of its existing general and administrative w to the new division. These costs total $ 500 million for the entire rm in the most recent year and are expected to grow 5% a year for the next 10 years. [_n m, it is expected that Apple will have an increase of $ 50 million in general and administrative costs next year when Apple iTV is introduced, and this amount will grow with the new division's dollar revenues after that. The latter cost is directly related to the new iTV division and will be charged to them fully, unlike the corporate G&A costs. 9. Advertising Exgnses: Apple spent $ 1 billion on advertising in the most recent year and expects this cost to increase 5% a year for the next 10 years, even if it does not invest in iTV. If the iTV is introduced, total advertising expenses are expected to be 12% higher than they would have been without the iTV division, each year from year 1 to year 10. 10. Working Capital: The iTV will create working capital needs, which you have estimated as follows: ' The sale of iTVs to retailers will create accounts receivable amounting to 5% nf rPlIPnIlF-u Purl": \"Par invest in iTV. If the iTV is introduced, total advertising expenses are expected to be 12% higher than they would have been without the iTV division, each year from year 1 to year 10. 10. Working Capital: The iTV will create working capital needs, which you have estimated as follows: ' The sale of iTVs to retailers will create accounts receivable amounting to 5% of revenues each year. ' Inventory (of both the input material and nished iTVs) will be approximately 10% of the variable production cost (not including depreciation, marketing costs, allocations or advertising expenses). - The credit offered by suppliers will be 6% of the variable production cost (not including depreciation, marketing costs, alloeations or advertising expenses). All of these working capital investments will have to be made at the beginning of each year in which goods are sold. Thus, the working capital investment for the first year will have to be made at the beginning of the rst year. 11. Side benets for iTunes store: If Apple goes ahead with the Apple iTV, the Apple iTunes stores will see revenues increase by $100 million next year (as new Apple iTV users buy movies at the store), and grow at the ination rate after that. The after-tax operating margin (after tax operating income] revenues) is 20% for all Apple iTunes I'CVCIIUC. 12. Risk Measures: The beta for Apple is 1.18, calculated using weekly returns over the last 2 years and against the S&P 500 Index (see exhibit 4). Apple currently gets about 50% of its revenues from computers, 40% from electronics and 10% from retail. The details of the beta calculation are included in Exhibit 4. Apple is currently rated A+, and A+ rated bonds trade at a default spread of 0.85% over the long-term US treasury bond rate. The current stock price for the rm is $ 350 and there are 920 million shares outstanding. 13. Debt Choices: Apple expects to nance the iTV division using the same mix of debt and equity (in market value terms) as it is using currently in the rest of its business. Apple's has no interest bearing debt but it has lease commitments for the future: Year Lease commitment 2011 $ 266 million 2012 $ 267 million 2013 $ 260 million 2014 $ 244 million 2015 $ 226 million w. 1 mam, Year Lease commitment 201] $ 266 million 2012 $ 267 million 2013 $ 260 million 2014 $ 244 million 2015 $ 226 million Beyond $ 826 million The lease payment for the most recent year is $271 million. 14. Taxes: Apple's effective tax rate is 30%, but its marginal tax rate is 40%. 15. Macro data: The current long-term bond rate is 3.5%, and the expected ination rate is 2%. You can use the implied equity risk premium of 5% as your equity risk premium for mature (AAA rated) markets. 16. Company information: You have collected information on other companies that are primarily or only in electronics in Exhibit 5. The data includes the betas of these companies and relevant information on both market values of debt and equity. You can assume a 40% tax rate for these rms, as well. (You can also assume that the debt includes the present value of operating leases). While you have not been able to collect similar company-specic information for audio/video retailers, you believe that an unlevered beta of 1.10 is appropriate for these rms. Questions on the Project 1. Accounting Return Analysis ' Estimate the operating income from the proposed iTV investment to Apple nua tka have 1n "an"
