Amazon is an American company based in Seattle, Washington. Their primary operations are e-commerce, cloud computing, and digital streaming. In recent years, the company has focused on other aspects, such as artificial intelligence. The CEO of the company is Jeff Bezos, and the ticker symbol is AMZN. At the moment, the stock price of Amazon is $3,222.90. There is a total of 1,298,000 employees of Amazon in their different offices across the globe. Among the services that are being offered in Amazon include the personalization of shopping services. Amazon is among the five most prominent companies in the world. Among the key competitors include Apple, Microsoft, and Google. The company was formerly referred to as Cadabra, Inc. and was founded in the year 1994. Their products include Kindle, Fire Tablet, Echo, and Fire OS. Their operating income is US$ 22.9 Billion as of the 2020 financial year. The net assets to the company sum up to US$ 21.331 billion. Amazon started in a garage where the main component being sold was books. The venture later expanded to the sale of electronics devices, video games, and pieces of furniture. The company is known for being well-established through various technological innovations and the sale of mass products.
Financial Risk
Amazon has grown into one of the largest companies globally both in the sales that they make and the capitalization in the market sphere. However, the colossal size of the company comes with several financial risks, which are unique. The main financial risk in Amazon is the increasing competition in stocks. Also, other risks that are being encountered include uncertainty in profit generation and growth or revenue. There has been an increase in the amount of revenue for the company since it went public in 1997 (Zeis, 2018). A key outcome is that most of the investors became optimistic about the company’s level of performance. However, the growth has equally contributed to investors’ ability to overlook the organization’s unwillingness to generate profits that are sustained and will be suitable for the proper functioning of the company both in the short and long run (CNN Business, 2020). The stock of Amazon is likely to depreciate, resulting in the financial risk of reduced profits, and they can suffer from bankruptcy. In the process, it is possible that the financial risk can lead to receivership taking place in the organization. There is an assumption that the performance of the futures market will be satisfactory. The speculation is not reasonable since there is a fiscal risk arising. The stocks of Amazon have been made very volatile, exposing some investors to the fluctuations taking place in the market.
Cost of Capital
The cost of capital represents the company’s funds. From the investor’s point of view, the cost of capital is the rate required on a portfolio organization’s securities. Weighted Average Cost of Capital (WACC) entails a combination of capital from distinct sources. Some of the familiar sources include common shares, expected shares, and the debt of the organization. The cost of capital for Amazon stands at 11.38%. The value can be used to determine the point of breakeven if the cost of capital is less than the WACC amount. Therefore, there is a high chance that Amazon will experience much more losses in the future (CNN Business, 2020). The cost of the capital range is meager, and it will not work investing in Amazon if they maintain the current cost of capital. However, with an increased cost of capital, investing in the organization will be feasible both at the moment and in the future. In situations where there is a loss in the cost of capital, the future cash flow for Amazon is likely to be much higher since the WACC can be discounted (Wang and Ng, 2008). More so, the cost of debt in the organization is likely to be less expensive than the amount of risk posted on the equity value. While determining the WACC, Amazon needs to consider the organization’s needs, primarily that which will be used in the establishment of different projects and other financial activities.
While using the cost of capital, there is no limitation on the amount of debt present in Amazon. The value of debt is significant because it will affect the increase of interest payments, earnings that have been generated from volatility, and the risk of the company undergoing bankruptcy (Reilly and Brown, 2011). An increase in the value of the cost of capital will lead to a reduction in the market value for Amazon, and the evaluation process is likely to be more effective for the company. A key focus will be on using sufficient equity that will mitigate the risk likely to be encountered if Amazon does not pay all its debts on time. Lastly, the cost of capital has put into consideration the cash flow of the organization. In recent years, there has been consistency in the cash flow, ensuring that Amazon can cater for more obligations and there is an increase in the optimal capital structure. It is possible to obtain the value as a percentage of the cost of capital for Amazon.
Risk Reward
Amazon is one of the leading online retailers. Their risk rewards strategy focuses on taking a risk to gain at the end. In economics and finance, risk preference is the tendency that entails selecting an action that has a much higher variance in terms of monetary value relative to another option that has a much lower outcome (Wang and Ng, 2008). However, the expected value for each of the options will be the same. There are three types of risk preferences including risk-averse, neutral, and loving. The risk preference for the investment portfolio strategy will be neutral (Lumen Learning, 2018). That implies that there is an indifference in making an investment decision. The focus will not be on a high or low-risk alternatives. Instead, there is an evaluation of all the available options to determine the most effective strategy. The risk taken by the company has been paying off, especially recently during the COVID-19 pandemic, where there has been an increase in the revenue and sales for Amazon. The company is a risk-taker, and the rewards have been beneficial.
Capital Assents Pricing Model (CAPM)
The CAPM formula is as follows.
Capital Assets Pricing Model = Risk Free Rate of Interest + Sensitivity (Expected Return of the Market – Risk Free Rate of Interest
= 2.5% + (1.20 * 11.0) = 11.9%
The rate of return determined is higher than the current rate of equity provided by a financial analyst while determining the constant growth. The difference in the required rate of return is a small margin. However, the difference is very significant. It provides information on the volatility of assets in the company. A higher rate of return determined in the regular growth examination implies that it has more volatile assets than several other companies in the same line of operation.
Stock Price for low-end dividend growth rate
Stock Price = 0.12/ (0.1-0.009) = 1.31
Stock Price for high-end dividend growth rate
Stock Price = 0.12/ (0.1- 0.031) = 1.74
The value of the current stock price for Amazon is in between the high and low–end values. The low-end constant value is below the current stock price per share. The high-end constant value is above the current stock price per share for Amazon. The constant high-end value indicates that the current stock price per share is undervalued. That implies that it is overrated compared to that of other companies (Simpson, 2014). The constant low-end value indicates that the stock price value for the company is undervalued. That implies that the value is underrated than that of other companies in the same line of business as Amazon.
Strategies using the Modern Portfolio Theory
Modern Portfolio Theory is a practical method used in the selection of investments to maximize the overall returns. One of the strategies that Amazon can consider is to invest in high returns and reduce risk if diversification of their portfolio. When there is an optimal capital structure, then the best combination of debt and equity has been considered. The strategy’s focus is to increase the effectiveness of market capitalization for market value at the end (Finkle and Mallin, 2010). Also, it will be possible for Amazon to use the plan to minimize its cost of capital. The finances that have been allocated towards the debt will lead to the production of the least cost due to the deductible nature of taxes from Amazon (Zeis, 2018). Higher debt is not good since it increases the risk of shareholders in the portfolio and the expected returns on equity.
References
CNN Business (2020). Retrieved from https://money.cnn.com/quote/forecast/forecast.html?symb=AAPL. Accessed 17 May 2021.
Finkle, T. A., & Mallin, M. L. (2010). Steve Jobs and Apple, Inc. Journal of the International Academy for Case Studies, 16(7), 31.
Lumen Learning. (n.d.-cc). Understanding bonds. In Boundless finance. Portland, OR: Author. Retrieved from https://courses.lumenlearning.com/boundless-finance/chapter/understanding-bonds/.
Reilly, F. K. & Brown, K. C. (2011). Investment Analysis and Portfolio Management (with Thomson One – Business School Edition and Stock-Trak Coupon). USA: Cengage Learning.
Simpson, T. D. (2014). Financial markets, banking, and monetary policy. Hoboken, NJ: Wiley.
Wang, X. & Ng, C. (2008). New Retail Versus Traditional Retail in E-commerce: Channel Distribution, Price Competition, and Consumer Recognition. Annals of Operation Research, 1-17.
Zeis, M. (2018). Empirical Analysis of Dynamic Pricing on the “Amazon.de” Marketplace. Berlin School of Economics and Law, Pp. 1-52.
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