Running head: 1

Chad Small

BUS 650: Managerial Finance

Dr. Dana Leland

June 29, 2015

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A bookstore bests Wal-Mart on all fronts. This could be the headline for the giant online

retailer known as Amazon Inc. This company has roots as an online bookstore but over the

growth of internet, time, and capital changed to an organization never seen before. CEO Jeff

Bezos started the website in 1995, IPO occurred in 1997, trading at nine dollars a share, and by

1999 was trading at $209 a share (Saunders, 1999). An explosion not seen in the online retail

market place. Steadily over the next six years the company focus shifts from books over to all

retail items offering a wide array of retail items all online. Amazon describes itself as the earth’s

most customercentric company offering membership services, manufacturing technology, and a

server to store apps for consumers to use (Annual Report, 2014) In 2005 the company added

another innovative service known as Amazon Prime. A subscription service that allows the

member to receive free two shipping on items, and in the future years to come offered streaming

television service, prime music, prime pantry for perishable items, and eventually a one button

click on the website to order products (Frizell, 2015). The exclusivity of the membership was

promising as members continued to show loyalty to the company and purchased more products.

The anniversary of the prime membership occurred and hitting ten years marks time to complete

review of the financial health of this company and convince new investors to buy into the stock

price. For purpose of this corporate performance evaluation the annual statements will be

evaluated through pro forma review, ratio analysis, return on equity, DuPont System, and

economic value added to make recommendations to invest and also determine if the organization

can be a blue chip stock. To start the evaluation, a financial statement review is needed.

Financial Statement Review

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Additionally, the financial statement consists of a statement of cash flow, income

statement, balance sheet, and owner’s equity statement. To analyze these statements it is

important to apply techniques to understand them and those techniques are trend calculation and

common size statements. Of all the elements to the financial statement, cash flow is responsible

to show the cash made by Amazon in 2014 and 2013. It gives the company the ability to leverage

more debt when needed. Cash flow is calculated in two ways and are shown in Figure 2.

Figure 2

Initial Cash Flow = Project Cost + Sale Price + Tax Effect

And

EBT- Earnings before tax = Revenue (Sales) - Expenses – depreciation

TAX – Corporate Tax EBT x Tax Rate

Operating Cash Flow = EAT – Earnings after tax = EBT - TAX

Cash Flow 2014 2013 2012Net Income 241 274 39Cash From Operation 5899 574 2815Cash From Investing 5065 4276 3595Cash From Financing 4432 539 2259Long Term Debt Issued 6359 394 3378Long Term Debt Repaid 1933 1011 588Change in Cash 5899 574 2815

(Annual Report, 2014)

Secondly, using techniques of trend calculation and common size statements take a look at the

numbers from Amazon Inc. over the past few years. Table 1, Table 2, Table 3, and Table 4 show

all these statements for amazon.

Table 1

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Dollar Value 2014 2013 2012Revenue (in Mil) 88,988 74,452 61,093Calculating the Trend Value 88,988 74,452 61,093Beginning Year Balance 61,093 61,093 61,093

Trend Values1.45659

91.21866

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Dollar Value (In Mil) 2014 2013 2012COGS 62752 54181 45971Calculating the Trend Value 62752 54181 45971Beginning Year's Balance 45971 45971 45971

Trend Value1.36503

41.17859

1 1(Annual Report, 2014)

Table 2

Trend Income Statement 2014 2013 2012Revenue 88,988 74,452 61,093COGS 62,752 54,181 45,971Selling, General Admin 16,650 12,847 9,723R&D 9,275 6,565 4,564Other 133 114 159Net Income 178 745 676       Trend Balance Sheet      Inventory 8,299 7,411 6,031Current Assets 31,327 24,625 21,296Net Equipment 22,730 14,809 9,582Total Assets 54,505 40,159 32,555Current Liabilities 28,089 22,980 19,002Long-Term Debt 8,265 3,191 3,084Total Equity 10,741 9,746 8,192

(Annual Report, 2014)

Table 3 Trend Calculation

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Trend Income Statement 2014 2013 2012Revenue 1.457 1.219 1COGS 1.365 1.179 1Selling, General Admin 1.296 1.321 1R&D 1.413 1.438 1Other 1.167 0.717 1Net Income 0.239 1.102 1       Trend Balance Sheet      Inventory 1.120 1.229 1Current Assets 1.272 1.156 1Net Equipment 1.535 1.546 1Total Assets 1.357 1.234 1Current Liabilities 1.222 1.209 1Long-Term Debt 2.590 1.035 1Total Equity 1.102 1.190 1

Table 4 Common Size

Common Size      Trend Income Statement 2014 2013 2012Revenue 1 1 1COGS 0.71 0.73 0.75Selling, General Admin 0.19 0.17 0.16R&D 0.10 0.09 0.07Other 0.0015 0.0015 0.0026Net Income 0.002 0.010 0.011       Trend Balance Sheet      Total Assets 1 1 1Current Assets 0.57 0.61 0.65Net Equipment 0.42 0.37 0.29Inventory 0.14 0.15 0.00Current Liabilities 0.52 0.57 0.58Long-Term Debt 0.15 0.08 0.09Total Equity 0.20 0.24 0.25

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It can be seen that in 2014, revenue was significantly higher than in 2013. One of reasons for this

could be the number of new Prime subscribers and the cost of the membership also went up to

(NEFF, 2015). In the common size analysis there is a drop in current assets and equity went

down as well. One explanation for the current assets dropping is due to a highly popular item,

diapers, brand specific to Amazon were dropped from the site. Diapers are one of the top three

selling items on Amazon and after manufacturing the diapers and then pulling them from the site,

it will drop overall assets (Amazon Pulls Its Own Brand of Diapers from Site, 2015). This is a

look at some historical statements and giving a projection of how well Amazon will do in 2015 is

found in the Pro Forma Income Statement.

Pro Forma Income Statement

The Pro Forma Income Statement uses historical percent-of-sales method. From this, an

income statement and balance sheet can be generated to show the projections. Table 5 and Table

6 show the income statement and the balance sheet to project earnings of Amazon into 2015.

Table 5 (Income Statement)

  2014 2013 2012

2015 (Projected) Source

Revenue 88,988 74,452 61,093 97886.810% Growth

COGS 62,752 54,181 45,971 6674175 % Sales

Gross Margin 26236 20271 15122 31145.8 SubSelling, General Admin 16,650 12,847 9,723 8898.8

10% of Sales

R&D 9,275 6,565 4,564 1779.762% of sales

Other 133 114 159 889.881% of sales

Depreciation 4006 2634 1669 3205 GivenEBIT -74 435 389 530 SUBInterest Expense -210 -141 -92 -215 GivenTaxable Income 167 161 428 318 Sub

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Taxes 167 161 428 175 25%Net Income -241 274 -39 143 SubDividends 0 0 0 0 GivenRetained Earnings -241 274 -39 143 SUB

Table 6

Assets 2014 2015  Cash 17,416 21865.4 5% of sales

A/R 561210632.1

6 8% of salesInventory 8,299 13546.2 20% of sales

Total Current Assets 31,32746043.7

6 Sum

PPE 16967 17037Plus 30 and 40 of new asset

Total Assets 48294 63081 sumLiabilities / Equity      

A/P 1645920224.1

2 6 % of COGSAccrued Expenses 4507 6286.76 2 % of SalesCapital Leases 4224 5479.04 2% of SalesLong Term Debt 8265 8265 No Change

Total Liabilities 3345540254.9

2 SumCommon Stock 5 5 No Change

Retained Earnings 1949 22902013 to 2014 earnings retained

Total Liabilities and Equity 68864

82804.84  

The revenue stream expects to be at $97 billion with total assets equally $63 billion. The total

liabilities and equity expects to be at $82 billion. Amazon is set to have a combination of revenue

and assets that nearly doubles the liabilities. This company is on pace to be profitable.

Ratio Analysis

Calculating proportions to understand different parts of the Amazon business is the next

step in the valuation. A ratio analysis can consist of: Debt ratio, Liquidity ratio, profitability ratio,

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efficiency ratio, and measures of relative value or price to earnings ratio. This proportion helps to

determine where Amazon is at as far and can give some indication of performance for the

investor. See Figure 3 to see all the ratios.

Figure 3

Profitability

ROE = Net Income / Total Equity = 2014 ROE = $178,000,000 / 10,741,000,000 = 0.0166

Liquidity

Current Ratio = Current Assets / Current Liabilities = 31327/33455 = .936

Financial Leverage

Total Assets / Total Equity = 54505 / 10741 = 5.074

Asset management

Inventory Turnover = Cost of Goods Sold / Inventory = 62752 / 8299 = 7.561

Asset Turnover = Revenue / Total Assets = 88988 / 54505 = 1.633

Market Value

Price-earnings = Price per share / EPS (Net Income / Number of shares)

438.10 / (178 / 313) = 249.14

This is not the end all be all to determine return on equity. This figure is going to be used as part

of a bigger formula to determine the main goal wealth management. It is important to understand

why Amazon is doing so well in the market place and the way to show this is to apply the

Dupont System.

The DuPont System

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This is a system to determine the function ROE, return on equity. This tool is useful to

compare the wealth of a company to other competitors in the market. This function is part of

projecting future growth. The formula for the DuPont System is in Figure 4.

Figure 4

ROE = ROA x LEV = Net Profit Margin x Asset Turnover x Leverage.

Utilizing ratios of debt ratio a leverage ratio can be found. Figure 5 shows the leverage ratio

Figure 5

LEV = Total Assets / Total Equity

Or

2014 LEV = 54505/10741 = 5.074

Using Profitability ratio we can determine Net Profit Margin. Figure 6 shows NPM.

Figure 6

NPM = Net Income / Revenue = 178 / 88,988 = .002

Asset turnover is part of the efficiency ratio. In Figure 7 you can see the calculation for Amazon

and the 2014 asset turnover.

Figure 7

(2014) Asset Turnover = Revenue / Total Assets = 88988 / 54505 = 1.633

Once all three values are found then a function is generated. The function using the DuPont

System is (.002) times (1.633) times (5.074) equals (0.0166). This is similar to the original

formula given to find ROE. Knowing the ROE, this can be plugged into a sustainable growth

formula to determine growth. The sustainable growth formula is the function of ROE divided by

retention rate (Byrd, et. al., 2013). Retention rate is retained earnings (-241) divided by net

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income (-241) and for amazon that is equal to one. The fact that Amazon has yet to have a

dividend payout leads to this growth rate. It also shows they invest back into the business.

EVA

Concurrently, knowing how well an organization is growing wealth for investors is

important to gain more investors. Amazon itself can benefit by having management add

economic value to the organization and weather previous projects made money. EVA for Amazon

is shown in Table 7.

Table 7

DateAdj Close

Adj Close

Amazon

S&P Returns

Beta

6/11/2015 432.972108.8

60.51% 0.17%

1.21187

    CAPM

RF 3%R=RF+B(RM-RF)

RM 10% 0.1148309Ke   11.48

NOPAT  

Capital Charges      

EBIT 74 Equity 10,741 11.48%1233.06

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Tax -22.2Long Term Loan 8,265 10% 826.5

NOPAT -96.2      

2059.567

EVA2155.7

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To determine EVA, the Beta for Amazon must be found. This was done using historical data and

the S&P 500. Once known, the cost of capital can be determined. The cost for debt and equity

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can also be calculated and that is done using the WACC method. For this Table, the percent is

given but WACC could be used in the future. NOPAT, net operating profit after tax is needed to

determine EVA. This is provided as the earnings before tax and then tax is added at 30 percent.

Capital charges include equity and debt and a function is generated using the cost of capital and

the cost of debt. Once the cost is known the function of NOPAT minus the cost of capital equals

an EVA of -2155.77. The negative EVA explains that wealth is being destroyed by projects where

the value is less than the cost to do the project (Byrd, et. al., 2013, p. 11.5). Some of the reasons

why EVA is negative could be due to projects like Amazon Fresh, a fresh grocery delivery

service, only available in Seattle, WA but is expanding; resembles a similar online company

offering the same service in the early 2000s that shut down (Mintz, ). A second projects includes

spending millions on robotics and drones to have delivery for the future (Risen, 2013). Delivery

drones was a great idea until legal action occurred as in Conoy, Pennsylvania. This is the first

township to prohibit operation of remote controlled drones or non-tethered aircraft over property

not owned by operator and without permission of the property owner (Umble, 2013). Legislation

like this is going to prevent drone delivery and this project may need more evaluation.

Recommendations

Lastly, as an investor should you buy stock in Amazon? The answer lies in the analysis

presented. The cons from the analysis exist in the EVA, net income from 2014, COGS, Beta and

long term debt. The EVA analysis shows that there were several projects that did not acquire

more wealth for Amazon. Certain real world examples were given to prove these facts. Those

examples include Amazon Fresh and drone delivery service. The EVA calculation was -2155.77.

The net income from 2014 was down compared to recent years. This year posted a negative -241

million. The COGS was high for Amazon in 2014 but one of the reasons for this is due to

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Amazon is a retail business and will carry inventory at a cost. The Beta for Amazon is 1.2 which

means the organization is highly volatile to what the market is. If the stock market price lowers

Amazon will go right along with it. The long term debt increased for Amazon in 2014 as it

increased to 2.590 on the trend calculations. The pros from the analysis for Amazon are: revenue,

trend analysis for revenue, the pro forma balance sheet and income statement, sustainable growth

and DuPont calculation of the ROE, R&D, and zero dividend payout. The revenue for Amazon in

2014 was $88 billion dollars and the projections for 2015 from the pro forma balance sheet at 10

percent growth to $97 billion. Amazon exists sustainable growth as there is an even one from the

sustainable growth formula and the reason for that is because there is no dividend payout either,

Amazon reinvests back into itself. The focus on constant growth is a positive that can attract

investors. This is also supported by the trend analysis show R&D growth in 2014. Investors are

seeing large growth from this company that can offer innovation. It has already occurred in the

technology produced, the membership it sells, and the new ways to grow ecommerce. There is

more upside for the pros than the cons and those can be seen in the analysis. Yes, you should

invest in Amazon as it continues to show sustainable growth, investments into research and

development, and projected revenue continues to grow. Amazon, however is not a blue chip

stock at this point due to the fact it does not pay out dividends, once it does, this may change

(Kurson, 2002).

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References

Amazon Pulls Its Own Brand of Diapers from Site. (2015). Nonwovens Industry, 46(2), 14.

Annual Report. (2014). Amazon.com, Inc. Retrieved from

http://phx.corporate-ir.net/phoenix.zhtml?c=97664&p=irol-reportsAnnual

Byrd, J., Hickman, K., & McPherson, M. (2013). Managerial Finance. San Diego, CA:

Bridgepoint Education Inc

Frizell, S. (2015). How Amazon Just Posted its First Profit in Months. Time.Com, N.PAG.

Kurson, K. (2002). Where Have All the Blue Chips Gone?. Money, 31(13), 43.

NEFF, J. (2015). WALMART VS. AMAZON PRIME. Advertising Age, 86(11), 0006.

Mintz, J. (2007, Sep 03). Amazon fresh service delivers grocery basics. Oakland Tribune

Retrieved from http://search.proquest.com/docview/352214020?accountid=32521

Risen, T. (2013, 12). 2014: The year of robots at apple, google and amazon. U.S.News & World

Report, , 1. Retrieved from http://search.proquest.com/docview/1492138851?

accountid=32521

Saunders, R. (1999). Business the Amazon.com Way : Secrets of the World's Most Astonishing

Web Business. Dover, N.H.: John Wiley and Sons, Inc.

Umble, C. (2013, Mar 15). Conoy limits drones' air space. Intelligencer Journal / Lancaster New

Era Retrieved from http://search.proquest.com/docview/1316970004?accountid=32521