MBA_Finance-(BUSA 5099)_Individual Assignment 1_(EVA-Apple Comp)_2000!04!26 (Final)

Finance (BUSA 5099)

MBA P/T (2009-2011 intake)

Individual Assignment 1

Apple’s Computers Financial Performance

Economic Value Added (EVA)

Kirill A. Oussov (Student No. 397580)

Word Count: 1,100

Submission Date: April 26, 2010

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Table of Contents

Table of Contents ......................................................................................................................................... 2

1. Introduction to EVA (Economic Value Added) ..................................................................................... 3

1.1. General Overview ......................................................................................................................... 3

1.2. EVA and the Drives of the Value Creation .................................................................................... 3

2. Apple’s Computers Financial Performance and Value Creation ............................................................. 5

2.1. Apple’s Economic Value Added and NOPAT ............................................................................... 6

2.2. Apple’s EVA and Capital Management ......................................................................................... 7

3. List of References ................................................................................................................................. 9

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1. Introduction to EVA (Economic Value Added)

1.1. General Overview

Financial measuring tools are many and varied. Traditionally, analysts focus on financial accounting metrics

such as sales and sales growth, margin, operating profit and operating profit growth, bottom-line earnings

and earnings per share (EPS), market value, return on equity, and return on assets or cash flow.

Each of these metrics is flawed. Neither sales nor operating profit accounts for the financial requirements

necessary to achieve them, in terms of either annual expenses or capital invested. Bottom-line profits and

EPS take no account of the fact that equity has a cost. Market value ignores the capital employed to create it

- invest more, and of course market value rises, without necessarily creating value.

EVA however is a performance metric that calculates the creation of shareholder value, but it distinguishes

itself from traditional financial performance metrics. EVA is the calculation of what profits remain after the

costs of a company's capital - both debt and equity - are deducted from operating profit. The idea is simple

but rigorous: true profit should account for the cost of capital (McClure, 2010).

1.2. EVA and the Drives of the Value Creation

In general terms, EVA is defined by the following formula (Stern, Shiely, Ross, 2001):

EVA = NOPAT - WACC x Capital Employed

NOPAT is the net operating profit after taxes;

WACC is the weighted average cost of capital.

Thus, in order to create value, i.e. generate positive Return on Invested Capital (ROIC), an organization must

improve its EVA. Based on arithmetical rules, these may be achieved in several ways, including: increasing

NOPAT, lowering the WACC, and reducing invested capital.

Conducting further analysis to establish dependency between economic value creation and its main drives,

one can use deductive method (similarly to the DuPont analysis (Ross, Westerfield, Jordan, Firer, 2008)).

Picture below illustrates these dependencies:

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↑ Increase sales

↓

less

↑ ↓ Improve GP margin

↓ ↑

less less

↓ Decrease overheads

↑

↑

↓

↓ Reduce Percieved Risk

↑

↓ ↓ Reduce Percieved Risk

↑ ↑

multiply

↑ Use Debt rather than Equity

↓ (Debt is cheaper than Equity)

↓ optimise CAPEX utilisation

↑

↓ plus ↓ Reduce Cash

↑ ↑

less

↓ Reduce Debtors age

↑

↓ less

↑ ↓ Reduce Inventories

↑

plus

↑ Increase Creditors age

↓

EVA

NOPAT

WACC

Capital

Employed

Sales

Cost of Sale

(Variable), %

Overheads

(Fixed Costs)

Cost of Debt

Cost of

Equity

Gearing ratio

Inventories

Debtors

Creditors

Cash

CAPEX

Working

Capital

Picture 1-1. Key drives of EVA

Therefore, more detailed recommendations can be made:

• First, operating performance with respect to operating profit margins or asset turnover ratios could be

improved to generate more revenue without using more capital.

• Second, the capital invested in the business might be reduced by selling under-utilized assets or choosing

off-balance sheet financing of the assets; this strategy will simultaneously improve operating

performance through a higher asset turnover ratio, as well as a reduced capital charge against those

earnings because of a reduced debt or equity capital investment.

• Third, redeploy the capital invested to projects and activities that have higher operating performance

than the current projects or investments are exhibiting.

• And fourth, if the business is not highly leveraged, change the capital structure by substituting lower cost

debt for higher cost equity. Although this last strategy will decrease net income because of the higher

interest cost, it will improve the EVA of the business because the total cost of debt and equity is reduced,

and EVA measures the value created after all costs of capital (debt and equity) have been taken into

account.

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2. Apple’s Computers Financial Performance and Value Creation

Equipped with the EVA methodology, one can analyze Apple’s financial performance over the last 25 years through value creation according to EVA

principles as well as to understand the major contributing factors in this process.

As it is shown on Picture 2-1, Apple went through 4 major cycles of destruction-creation of economic value. The first one falls on the period between

1982 and 1985; the second occurred between 1985 and 1997, where the third can be attributed to 1998 to 2001-2002 and the forth on has started in

2002 and is on uprising phase. All three complete cycles can be characterized by the initial growth of EVA followed by its downfall into negative

values. Every consecutive cycle had shown fluctuation with increasing magnitude.

Figures $m 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Economic profit (EVA), $m 30.0 35.0 -5.0 -3.0 107.0 163.0 309.0 282.0 330.0 153.0 388.0 -145.0 39.0 78.0 -1,106.0 -1,202.0 220.0 507.0 625.0 -186.0 -3.0 13.0 261.0 1,284.0 1,790.0 3,135.0

Value Creation / Destruction ↑ ↑ ↓ ↓ ↑ ↑ ↑ ↑ ↑ ↑ ↑ ↓ ↑ ↑ ↓ ↓ ↑ ↑ ↑ ↓ ↓ ↑ ↑ ↑ ↑ ↑

Year on Year Dynamics ↑ 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

-2,000

-1,000

0

1,000

2,000

3,000

4,000

Economic profit (EVA)

Picture 2-1. EVA Cycles

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2.1. Apple’s Economic Value Added and NOPAT

In terms of value creation and economic value add, Apple has built very interesting business model, which since 1997 almost completely excludes

cost of both Working Capital & CAPEX out of the EVA equation (explained in Section 2.2) and leaves NOPAT to be a major driver of economic value

added (with coefficient of correlation of 0.99).

As per the scheme on Picture 1-1, NOPAT is determined by 3 factors: SALES, GP margin and Fixed Costs. Thus, through understanding of trends in

this 3 factors, one could understand the underlying reasons for Economic Value creation or distruction.

-1,500.0

-1,000.0

-500.0

0.0

500.0

1,000.0

1,500.0

2,000.0

2,500.0

3,000.0

3,500.0

EVA vs. NOPAT

Economic profit (EVA), $m EBIAT (NOPAT), $m

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007



Year on Year Dynamics ↑ ↓ ↑ ↑ ↑ ↑ ↓ ↑ ↓ ↑ ↓ ↑ ↑ ↓ ↓ ↑ ↑ ↑ ↓ ↑ ↑ ↑ ↑ ↑ ↑

Sales 583 983 1,516 1,918 1,902 2,661 4,071 5,284 5,558 6,309 7,087 7,977 9,189 11,062 9,833 7,081 5,941 6,134 7,983 5,363 5,742 6,207 8,279 13,931 19,315 24,006

Year on Year Dynamics ↑ ↑ ↑ ↓ ↑ ↑ ↑ ↑ ↑ ↑ ↑ ↑ ↑ ↓ ↓ ↓ ↑ ↑ ↓ ↑ ↑ ↑ ↑ ↑ ↑

Gross margin 50.6% 48.5% 42.0% 41.8% 53.1% 53.1% 51.1% 49.0% 53.1% 47.5% 43.7% 43.2% 25.5% 25.8% 9.8% 19.3% 24.9% 27.6% 27.1% 23.0% 27.9% 27.5% 27.3% 29.0% 29.0% 34.0%

Year on Year Dynamics ↓ ↓ ↓ ↑ ÷ ↓ ↓ ↑ ↓ ↓ ↓ ↓ ↑ ↓ ↑ ↑ ↑ ↓ ↓ ↑ ↓ ↓ ↑ ÷ ↑

Overheads (Fixed Costs) 193 347 546 702 736 1,042 1,460 1,955 2,239 2,550 2,242 3,365 1,846 2,232 2,262 2,422 1,188 1,116 1,261 1,486 1,619 1,695 1,937 2,410 3,187 3,793

Year on Year Dynamics ↓ ↓ ↓ ↓ ↓ ↓ ↓ ↓ ↓ ↑ ↓ ↑ ↓ ↓ ↓ ↑ ↑ ↓ ↓ ↓ ↓ ↓ ↓ ↓ ↓Picture 2-2.Correlation between EVA and NOPAT

Ec. Value

destruction 1

Economic Value

destruction 2

Ec. Value

destruction 3

Economic Value

created 2 Ec. Value

created 3

Economic Value

created 4

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Cycle 1. The first time Apple had achieved negative EVA was in 1984-1985 when despite growth in sales and consistently high GP margin could not

compensate for excessive growth in overheads (partly contributed by increasing R&D cost in Apple III, which never took off), which has doubled

over 2 years from 1983 to 1985.

Cycle 2. Apple successful launched of Macs range in 1986-1990 and Powerbook range in 1990-1992, and had secured sustainable growth in revenues

which was covering shrinking GP and increasing fixed cost and continued creating value of the company. Falling to recognize the early symptoms of

the forthcoming problems as exurban fixed cost and shrinking GP started affecting EVA in 1991-1993, by 1994 Apple had found itself in a position

of losing its competitive edge. As the management chose the strategy of lowing GP from 45% to 25% in 1995 to the lowest-ever 9.8% in 1996, Apple

found itself in the position of economic value destruction of over $1.1bn a year. The desperate attempts to boost the dropping sales and drastic job

cuts had a little effect on EVA.

Cycle 3. Jobs is back to Apple. The successful launch of iMac boosts sales in 1998-2000 and improves GP margin; massive job and R&D cuts, which

reduce fixed cost by half, pushes EVA into the black in 1998-2000, but failes to secure sustainability. In 2001 EVA drops to -$186.0m again.

Cycle 4. The company changes its distribution strategy and opens the chain of its own retail outlets and starts to sale online. Successful launch of iPod

and iTune bost the sales, which reach $13bn in 2005; the GP margin is improved to stable 27%-29% and despite increasing spend on R&D, which

doubled from 2001 to 2006, Apple has reached cumulative EVA of $6.4bn over period of 2004-2007 with ever-highest $3.1bn in 2007.

2.2. Apple’s EVA and Capital Management

As it was mentioned in the previous paragraph, after drastic increase in cost of capital in 1992-1996, where cost of capital rose from $100.0m to

$300.0m, having negative impact on EVA. Since 1996, the company had started aiming on operational optimization to improve Capital assets

utilization and improve a position of working capital – the main contributor of the costly capital growth. Thus, through implementation of off-balance

sheet capital financing and sale of unused CAPEX, Apple had reported positive capital spending over 1998-2001, while improvement of stock

management and extension of the debtors age had positively affected working capital (See Picture 2-3).

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10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

22.0%

WACC

-1,000

-500

0

500

1,000

1,500

2,000

2,500

Ave capital employed-350.0

-300.0

-250.0

-200.0

-150.0

-100.0

-50.0

0.0

50.0

100.0

- (WACC * Capital Employed)

Ave. Annual Cost of Capital, $m-3,000

-2,000

-1,000

0

1,000

2,000

3,000

4,000

Woking capital, $m

0

2,000

4,000

6,000

Creditors, $m

0

1,000

2,000

3,000

Debtors, $m

0

1,000

2,000

Inventories, $m

0%

10%

20%

30%

40%

50%

60%

Gearing

Picture 2-3. Cost of the Employed Capital

The drastic improvement in capital requirements in 1996-1999 from $2.0bn to -$0.5bn in combination with improving the Apple’s gearing over the

same period had brought cost of capital (i.e. the WACC * Capital Employed factor) to 0 in 2001 and furthermore turned it into sustainably positive

factor in 2004. See Picture 2-4 for more details.

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007



Year on Year Dynamics ↑ ↓ ↑ ↑ ↑ ↑ ↓ ↑ ↓ ↑ ↓ ↑ ↑ ↓ ↓ ↑ ↑ ↑ ↓ ↑ ↑ ↑ ↑ ↑ ↑

WACC 20.9% 18.5% 19.8% 18.1% 15.1% 15.9% 16.4% 15.9% 16.1% 15.4% 14.5% 13.4% 14.6% 14.1% 13.9% 13.9% 12.6% 13.1% 13.6% 12.8% 16.0% 11.4% 11.7% 11.8% 12.4% 12.2%

Year on Year Dynamics ↑ ↓ ↑ ↑ ↓ ↓ ↑ ↓ ↑ ↑ ↑ ↓ ↑ ↑ ↑ ↑ ↓ ↓ ↑ ↓ ↑ ↓ ↓ ↓ ↑

Ave capital employed 110 173 293 282 166 195 428 660 654 798 979 1,446 1,840 2,218 2,081 1,083 507 237 279 141 -13 18 -214 -592 -461 -490

Year on Year Dynamics ↓ ↓ ↑ ↑ ↓ ↓ ↓ ↑ ↓ ↓ ↓ ↓ ↓ ↑ ↑ ↑ ↑ ↓ ↑ ↑ ↓ ↑ ↑ ↓ ↑

Ave. Annual Cost of Capital, $m -23.0 -32.0 -58.0 -51.0 -25.0 -31.0 -70.0 -105.0 -105.0 -123.0 -142.0 -194.0 -269.0 -312.0 -290.0 -150.0 -64.0 -31.0 -38.0 -18.0 2.0 -2.0 25.0 70.0 57.0 60.0

Year on Year Dynamics ↑ ↑ ↓ ↓ ↑ ↑ ↑ ÷ ↑ ↑ ↑ ↑ ↑ ↓ ↓ ↓ ↓ ↑ ↓ ↓ ↑ ↓ ↓ ↑ ↓

Picture 2-4. Dynamics in Cost of the Employed Capital

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3. List of References

McClure, B. (2010, 03/12/2003) All About EVA, last accessed 25/April, 2010, from URL

http://www.investopedia.com/articles/fundamental/03/031203.asp.

Stern, J. and Shiely, J. and Ross, I. (2001) The EVA Challenge: Implementing Value-Added Change in an

Organization, Wiley, New York.

Firer, C. and Ross, S. and Westerfield, R. and Jordan, B. (2008) Fundamental of Corporate Finance, 4th SA

ed., McGraw-Hill Education, New York.

MBA_Finance-(BUSA 5099)_Individual Assignment 1_(EVA-Apple Comp)_2000!04!26 (Final)

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