Xing Chen & Yuanyuan Pan
FIN 5190---Special Topics: Financial Modeling
Prof. Michael D. Boldin
Final Project
Evaluation of Google and Apple
Overview of project and modeling objectives
The objective of our project is to decide Apple or Google, which one is a better buy. Based on the
financial statements, we discovered that both Google and Apple experienced tremendous evolvement in
recent years, especially from 2010 to 2012. In order to analyze whether their stock prices are undervalued
or overvalued, we constructed the Pro Forma for both companies. First, we computed WACC for both
Google and Apple. Second, we forecasted the Income Statement and Balance Sheet for three years. Third,
we constructed the free cash flow based on the projected items from the previous step, and calculated the
enterprise value by using WACC as the discount rate. Finally, we obtained the implied value per share
and compared it to the current market price.
Explanation of financial modeling techniques applied
Google
 WACC---Weighted average cost of capital
Since Google does not declare dividends, we decided to use CAPM model to calculate the cost of
equity. The results of cost of equity and cost of debt for Google are shown in the Table-1 and Table-2
below.
Table-1
Expected market return, E(rM)
GOOG beta
GOOG tax rate, Tc
Risk free rate, rf
GOOG cost of equit, rE,GOOG
GOOG: Cost of Equity rE Based on CAPM
8% Given
From Yahoo
1.09
Beta(last 8 years)
20.50% From GOOG financial statement
(last 4 years)
1% Given
Average Beta
Classic CAPM
Tax-adjuested CAPM
1.23
1.08
0.95
1.09
8.60%
8.62%
Table-2
Computing the cost of Debt for GOOG
Sep-30-2012
Sep-30-2011
Cash and Equivalents
$15,160
$8,730
Short-term Borrowings
$4,904
$4,273
Long-Term Debt
$2,996
$2,986
$151
$190
Net Debt
$7,900
$7,259
Net interest cost
1.00%
Net Interest Expense
According to these results, we calculated the average estimated WACC based on the classic
CAPM and tax-adjusted CAPM model. Finally, we got the weighted average cost of capital is 8.35%. We
used this rate as the discount rate to compute the enterprise value later.
 Pro Forma---Forecast Income Statement and Balance Sheet for three years.
We collected the previous three years historical financial statement, from Sep, 2010 to Sep, 2012
to forecast the following three years’ financial statements until Sep, 2015. In order to construct the
reasonable Pro Forma, one of the most important forecasting assumptions is the sales growth rate. The
average historical growth rate of the previous three years of Google is almost 50% which is unsustainable
in the future. Therefore, based on the forecast from Bloomberg for the following four years, we computed
the sales growth rate is 13.7%. (Please see Excel Spreadsheet for more details.)
 Free Cash Flow
Based on the forecast of the Pro Forma, we constructed the Free Cash Flow chart illustrated in
Table-3 and calculated the average free cash flow rate, which equaled to 12.91%.
Table-3
Free Cash Flow (FCF)
Sep-30-2013
Sep-30-2014
Sep-30-2015
Profit after tax
4,923.1
5,623.3
6,384.5
Add back depreciation
1,201.9
1,410.4
1,635.1
Increase in operating current assets
(740.9)
(1,127.5)
(1,282.0)
Add increase in operating current liabilities
2,235.1
2,277.5
2,589.5
(3,221.1)
(3,248.9)
(3,725.6)
Change in net working capital
Subtract capital expenditures
Subetract increase in other assets
Add back after-tax interest
-
-
-
(16.7)
(16.7)
(16.7)
FCF
4,381.3
4,918.0
5,584.9
FCF Growth rate
12.25%
13.56%
Average FCF rate
12.91%
 Evaluating Google
According to the projected financial statement and WACC, we can evaluate the company.
However, because of the rapid growth of Google, the free cash flow growth rate is higher than the
discount rate. We cannot use the perpetuity model to calculate the terminal value directly. Otherwise, we
will get the negative value. According to Bloomberg, the estimated growth rate of Google will decrease to
5.42% in 2016; we assumed that the cash flow of Google would continue to grow at 12.91% for three
years. And then, the growth rate will drop to 9% for another three years until 2018. In 2019, we assumed
that the growth rate is down to 5.8%. At that time, we applied the perpetuity model into estimating the
terminal value, and summed up all discount values of free cash flow with terminal value together to get
the enterprise value. Finally, we got the implied value per share was $812.9 per share which is very close
to its market price at September. The results are shown in Table-4. Therefore, we think that Google is
fairly valued
Table-4
Valuing the firm
Weighted average cost of capital
Period
FCF based 2013 Forecast
8.35%
3
4,381.28
Year
2013
Long-term free cash flow growth rate
12.91%
PV of FCF
Terminal value
Sum
Discounted value
Add back initial cash
Firm value
Subtract total debt value, Sep 2012
Implied equity value
Number of shares outstanding, Sep 2012
Implied value per share
Market price per share, Sep 2012
GOOG over or under-valued?
4,565.66
2014
Stage1
12.91%
4,757.81
2015
12.91%
4,958.04
2016
2017
Stage 2
9.00%
9.00%
4,987.99
5,018.11
2018
9.00%
2019
Perpetual
5.80%
5048.42
209,824.36
239,160.40
Sep-30-2012
229,764.9
44,624.0
274,388.9
7,268.0
267,120.9
328.6
812.9
754.5
Ok
Apple
 WACC---Weighted average cost of capital
Apple keeps an incredibly low level of inventory (only 0.5% of its annual revenue) as
well as operating costs (about 0.8% of annual revenue) and never uses debt to finance. Its cost of
equity constituted the only source of its cost of capital. This remove the constraints that may be
imposed by creditors and thus empower the company to pursuit more creative outcome. The cost
of equity for Apple is shown in Table-5.
Table-5
WACC based on Tax-adjusted CAPM and Average
cost of equity method
Cost of equity, re
10.37%
Cost of debt, rd
2.87%
Equity value, E
550,570.00
Net Debt
0.00
Tax rate, Tc
25.20%
WACC
10.37%
 Pro Forma---Forecast Income Statement and Balance Sheet for three years.
To enhance comparison, we used their financial data from Sep. 2010 to Sep. 2012 and
chose the Q Tech ETF as the standard to compare the stock price of these two companies against
the performance of the industry. Please refer to the spreadsheet for detailed information.
 Free Cash Flow & Evaluating Apple
For analyzing purpose, we combined the average growth rate calculated from historical
data, including the 8-year average and the last year quarterly average, and the analysts’ estimate
from Bloomberg to reach a reasonable 11.3% annual growth rate. And we adopted this growth
rate for the following three year and changed to 5% for another three years. By utilizing a
perpetual 3% growth rate in the long run, we calculated the terminal value at 843,445.4million
dollars. At the end of the day, we obtain an estimated value per share at 863.9 dollars, which
indicates that its stock price is undervalued. The outcomes are shown in Table-6&7.
Table-6
Free Cash Flow (FCF)
Sep-30-2013
Sep-30-2014 Sep-30-2015
Profit after tax
44,229.4
49,943.9
56,509.4
Add back depreciation
2,593.8
2,928.7
3,492.7
Change in net working capital
Increase in operating current assets
(1,822.0)
(1,732.9)
(1,928.7)
Add increase in operating current liabilities
4,309.0
4,668.7
5,196.3
Subtract capital expenditures
(1,290.6)
(4,527.5)
(5,272.2)
Subetract increase in other assets
Add back after-tax interest
FCF
48,019.5
51,281.0
57,997.5
Average FCF rate
9.94%
Table-7
Valuing the firm
Weighted average cost of capital
Period
FCF based 2013 Forecast
Year
10.37%
3
48,019.5
2013
2014
2015
2016
2017
2018
2019
Stage-2 growth rate
Perpetual
Stage-1 growth rate
9.94%
9.94%
9.94%
5.00% 5.00%
5.00%
3.00%
47,835.7
47,652.6
47,470.2 45,161.7 42,965.5 40,876.0
571,483.7
843,445.4
Long-term free cash flow growth rate
Terminal value
Sum
Discounted value
Add back initial cash
Firm value
Subtract total debt value, Sep 2012
Implied equity value
Number of shares outstanding, Sep 201
Implied value per share
Market price per share, Sep 2012
Apple over or under-valued?
Sep-30-2012
802,854.7
29,129.0
831,983.7
19,312.0
812,671.7
940.7
863.9
664.1
undervalued
Results and conclusion
Many analysts try hard to predict the future of Apple and most of them remain positive
about its performance, even though the stock price fell to the 550 level in December this year.
Based on the result of our financial model, Apple’s stock price is undervalued, with an estimated
stock price at 863.9 per share, contrast with its current 550 per share. And the stock price that
truly reflects the value of the company has yet been reached in the company’s history so far.
However, the stock price for Google falls into a reasonable range based on its corporate value,
and this is convinced by its stable performance over years.
When relating the stock performance from these two companies to the market movement,
we discover a similar up-and-down shape between Apple and the market, while a drastic
different one between Google and the market. The financial reports have limited information for
us to unveil the reason behind this discrepancy. But if we assume the macro economy will
gradually recover in the coming years, Apple will be more profitable for investors for its
accordance with the market movement.
So in all, we recommend a strong buy for Apple.
What I learned
In the process of completing this project, several issues lightened us up. The first and
most important one is the use of historical data. Since Google and Apple are both high growth
rate companies, their past performances are not reliable factors to predict their future. In this
case, subjective judgment is needed and reference to other professional analysts' opinion is
helpful for us to set a reasonable estimated growth rate in order to conduct further evaluation.
Moreover, we use the Q Tech ETF, which mimic the performance of Nasdaq 100
Technology Sector Index, as the standard to compare the stock performance of these two
companies over years. This comparison backed our recommendation for Apple for its accordance
with the overall market movement, as well as outperforming the market for a couple of times.
Last but not the least, we successfully conducted a thorough analysis, from determining
the cost of capital to comparing the implied value per share with the current market price. This
cohesive process put scattered knowledge parts together and enhanced our analyzing skills as
well as our understanding about corporate finance. At the end of the day, it made us feel more
confident about financial modeling.
References
1. Capital IQ. < https://www.capitaliq.com/home.aspx>
2. Bloomberg. < https://www.capitaliq.com/home.aspx>
3. Yahoo. Finance. < https://www.capitaliq.com/home.aspx>