Problem 1. The purpose of this problem set is to value the company Amazon.com Inc. (Amazon), i.e. to estimate the intrinsic value (price) per share of the company.

Here is the basic information that you will need, which is also available from Yahoo! Finance (all numbers in millions):

Year 2014

Revenues 88,988

EBIT 99

EBIT as % of revenues 0.11%

Taxes (unlevered) 32

Tax rate 32%

Net Income (unlevered) 67

Net Capex 147

Goodwill 3,319

Property and Equipment (PP&E) 16,967

Depreciation 4,746

as % of previous year's Property Equipment 43%

Capex 4,893

NWC -12,355

NWC as % of revenues -14%

In addition, we will use the following assumptions:

• Revenue grows at 20% for the 1st year (2014 to 2015), 18% for the 2nd year (2016), and then growth rate declines 1% each year over 8 years till 2024 (hence 17% in 2017, 16% in 2018, ... , and 10% in 2024)
• Revenue increase = 70 times Net Capex (current year), e.g., in 2015 the net capex is 88988*0.2/70 = 254.3, and so on
• Depreciation = 40% of (previous year) PP&E
• Goodwill stays the same as that in 2014
• EBIT is 1.0% of sales (revenues)
• Tax rate is 32%
• NWC is -14% of sales
• Terminal growth rate of the free cash flows (post-2024) is 10%

Some extra information that you will need for the cost of capital and intrinsic value calculations:

• Debt (long-term debt; there is no short-term/current long-term debt): 8265 million
• Equity (market cap): 310470 million
• Shares outstanding: 468.76 million
• Cost of debt: 3.5%
• Beta: 1.49
• Risk-free rate (10 year): 2.24%
• Market risk premium: 6%
• Cash: 14557 million
• Total debt (there are no other liabilities): 8265 million

1. a)By following the same steps as we did for the Walmart case (i.e. do forecasts for the next 10 years and then apply the terminal value), estimate the intrinsic value (price per share) of Amazon at the end of fiscal year 2014.
2. b)Compute Amazon's market price per share based on the given information. Comparing it to the intrinsic price you just calculated, is Amazon overvalued or undervalued, and by how much (in percentage terms)?
3. c)Here is a very recent article from The Motley Fool talking about Amazon's share price:
4. "...According to analyst firm Pacific Crest, Amazon's tremendous run isn't over. The analyst firm recently opened coverage of the company with a 12-month price tag of $800..."
5. Now let us change our model's assumption on the market risk premium so that we can reach an intrinsic price level of 800. How do you have to change the market risk premium to get an intrinsic price of 800?
6. What is the intuition behind the size of the change (i.e. why is it big or small)? [Please make your answer as succinct as possible.]
7. d)Could Amazon's capital structure (i.e. its leverage ratio) be justified by anything that we have learned so far from the lectures? [Please make your answer as succinct as possible.]