The report looked at strategies for increasing stock prices and shareholder value. The strategies focused on were capital expenditures, mergers/acquisitions, stock buybacks, dividend increases, reduction of debt, expansion into a new geographic area, and introduction of new projects. The ratio analyses revealed that the company is liquidity enough, has a high level of debt, and shows stability as far as EPS and DPS are concerned. The suitable strategies chosen are capital expenditures, a reduction of debt, expansion into a new geographic area, and the introduction of new projects. The company’s WACC is 6.958%. It has been found that the company can fund activities using internally available cash. Debt finance (2.757%) is a suitable alternative as it has a lower cost than equity (11.22%). The alternative would increase debt proportion in the capital structure and lower the WACC. Since high debt levels increase the risk for common stock, it has been found that shareholders would demand high returns. That would offset the low cost of WACC affected by debt. What is more, the stock price would decrease as demand decreases.

Apple Inc.

Theoretically, companies have various objectives that managers work effortlessly to achieve. The objectives include profit maximization, uphold business ethics, pursue growth, embrace social responsibility, and maximize shareholders’ wealth. By tradition, profit maximization was considered the most significant objective. It alludes to generating the highest level of profit possible, in a financial year. Firms may opt to achieve the goal by either increasing the level of sales or minimizing expenses (Profit = Revenue – Expenses). Shareholders’ wealth maximization alludes to maximizing the net present value of projects undertaken by a firm. Net present value (NPV) is the difference between the sum of all cash flows and the initial amount of investment. Investment decisions with positive net present value maximize shareholders’ wealth. To achieve this objective, investors must reject projects with negative NPV.

Firms often face the choices of whether to operate in shareholders’ best interest or extend responsibility to other stakeholders such as employees, customers, suppliers, and the community. Firms may undertake activities that do not benefit the shareholders but positively influence the community. Other firms may choose to pursue projects that directly benefit shareholders at the expense of other stakeholders. Concerning business ethics, businesses are expected to maintain a high standard of moral behavior. The goal is related to a firm’s policies and how they impact employees, customers, suppliers, creditors, among other stakeholders. Business ethics suggest that companies treat stakeholders with the utmost fairness and honesty. Lastly, businesses seek growth by venturing into projects or setting up subsidiary companies to expand the scale of operations.

Strategies used to increase stock prices and shareholder value

Capital Expenditures–capital expenditure is commonly known as funds directed at purchasing plants, equipment, technology, among others. It is normally for financing major projects with long economic life. The acquisition of such assets helps companies increase operation capacity(Brigham &Daves, 2015). For instance, if Apple Inc. acquired another equipment to increase the volume of computer motherboards produced within an hour, the equipment has the potential of increasing the volume of sales, assuming the demand for such products is high. If apple increases the revenue level, the level of profits is likely to increase. An increase in the level of profit sends a message of financial stability and growth opportunities to investors. Increased levels of revenue and profits increase the value of shareholders as measured by the return on investment(Brigham &Daves, 2015). On a similar note, more investors would be willing to purchase the company’s stocks, thus increasing the demand level. Based on market forces of demand and supply, the company’s stock would increase.

Mergers/acquisitions–companies may opt to acquire or merge with other companies for various reasons such as synergy, bargain purchase, diversification, short-term growth, among others. When two companies are combined, extra value is created, synergy. When preparing a combined financial statement after a merger/acquisition, it is visible that assets, liabilities, and equity of both target and the acquiring companies are combined(Brigham &Daves, 2015). Combining the assets of both companies increases the value of the new company formed (more assets). Just before the process of a merger/acquisition is commenced, the share prices of the acquiring company decline, while that of the targeted company increase. The increase is evoked by the fact that acquiring companies often pay more than the actual value of the targeted company (premium)(Brigham &Daves, 2015). After a merger/acquisition, the price of shares of the new company is more than that of both the pre-merger targeted and the acquiring company. As such, a merger/acquisition increases both a company’s share price and the shareholder’s value.

Stock buybacks–Publicly traded companies sell shares to the public and get funds in return. The companies may opt to buy back shares from the shareholders, a term known as a share repurchase. By repurchasing shares, the number of issues stock is minimized, thus the value of equity(Brigham &Daves, 2015). Share repurchase significantly affects earnings per share (EPS) based on the formula EPS = (Net income/number of ordinary shares). Based on the formula, a share repurchase reduces the number of outstanding shares, which has an effect of increasing the EPS(Brigham &Daves, 2015). High EPS look attractive for potential investors, who will swiftly attempt to purchase the shares. The demand for shares will increase, thus increasing the price of the stocks. An increased share price automatically increases the stock value.

Dividend increase – dividend payment is the method used by companies to reward investors, stockholders. Distribution of dividends can take the form of shares, cash, or both(Brigham &Daves, 2015). Companies often inform investors, in advance, the amount of dividend they would pay. In addition, potential investors get information concerning when dividend earning stocks should be purchased (ex-dividend date). When investors know the ex-dividend date, most of them are willing to pay an extra fee for the shares (premium)(Brigham &Daves, 2015). It happens when the ex-dividend date is approaching due to an increase in demand for the shares. The phenomenon leads to an increase in share prices.

A reduction of debt– debt, equity, and retained earnings are among the sources of finance companies seek. However, the chief sources of finance, those that fund long-term projects, are equity and debt. As such, the capital structure of most companies is composed of debt and equity. While borrowing is logical from a financial point of view, excess borrowing is risky as it increases the chances of a debt default(Brigham &Daves, 2015). Companies that fail to pay interest on and the principal amount of borrowed funds face high solvency risk. Thus, it is advisable to maintain a manageable level of debt. A reduction of debt levels increases shareholders’ confidence in the company as it may show that projects are generating enough cash to settle debt obligations. In addition, it shows the company is not likely solvent. The demand for the company’s share is likely to increase, leading to an increase in the price(Brigham &Daves, 2015).

Expansion into a new geographic area – one of the main aims of business expansion into a new geographic area is to conquer the new markets and expand the customer base. Companies employ various strategies for new market entrances such as franchising, direct exporting, joint venture, partnership, among others(Brigham &Daves, 2015). Conquering new markets is a strategy that helps in increasing the sales level of products. Most companies use the strategy to establish subsidiary businesses. Thus, it helps businesses improve sales levels and expand operations.

Introduction of new projects – new projects such as introducing a new product line or product differentiation is aimed at increasing sales level and attracting growth. For instance, apple company manufactures a wide variety of iPhone such as iPhone 4S, iPhone 5, iPhone 5c, among others(Brigham &Daves, 2015). The mentioned products have different features, and as such, attract more customers. The strategy increases the sales level and, thus, the value of the company.

Financial Statement and Ratio Analysis

Table 1: Ratio analysis

In this case, the following financial analyses will be the focus: current ratio, debt-equity ratio, ROCE, EPS, and DPS.

Current ratio – measures the capability of a company to pay dues resulting from day-to-day operations. In other words, it measures a company’s liquidity level. Companies should maintain enough cash to meet obligations arising from daily operations. In 2018 and 2019, the ratios were 1.133 and 1.540, respectively. It shows the company can meet its daily obligations(Brigham &Daves, 2015).

Debt/equity ratio – shows the capital structure of a company. A high debt level is not advisable. In 2018 and 2019, the ratios were 133% and 157.3 %, respectively. The company has more debt than equity. It should consider lowering debt levels.

Net profit margin – shows the ability of a company to minimize operating costs and the cost of sales. A high ratio is a sign of good financial health. In 2018 and 2019, the ratios were 22.41% and 21.24%, respectively. The company’s capability is medium (Brigham &Daves, 2015).

EPS –shows earnings that every share invested in a company generates. A high ratio shows high profitability levels. In 2018 and 2019, the ratios were $ 12.01 and $ 11.97, respectively. The EPS shows stable financial health, profitability wise.

DPS – shows the level of dividend (cash) shareholders receive for every share held in a company. A high ratio sends a signal of financial stability. In 2018 and 2019, the ratios were $ 2.71 and $ 3.00, respectively. The ratio is increasing, showing a sign of an increase in growth(Brigham &Daves, 2015).

Apple company, through its mission, ensure that customers enjoy while using their products. The unique slogan of working while enjoying the experience makes Apple’s products widely accepted by clients. As such, it continues to conquer new markets and generate more revenue(Brigham &Daves, 2015). The company’s innovative products continue to appeal to clients, thus driving up other elements such as share prices. See figure 1 for the share price increase between 11 September 2019 and 31 January 2020. In addition, the company heavily invests in research and development activities, as shown in the financial statements (14, 236 million and 16, 217 million in 2018 and 2019 respectively).

Figure 1: Share Prices between 11 September 2019 and 31 January 2020

Based on the analysis, it is evident that Apple’s level of debt is currently high. However, the amount of common stock is relatively low. The company could consider reducing the level of debt and acquire plants and equipment (Capital expenditure).

Pros and cons

Capital Expenditures – Pros:

• It helps in understanding financial uncertainty and how it impacts a company’s performance.
• The strategy has a wide array of tools such as the NPV, sensitivity analysis, among others.
• The strategy allows managers to consider all factors affecting a project’s performance (Brigham & Houston, 2015).

Cons:

• The strategy relies on assumptions and estimations, which may never be realized.
• When incorrect decisions are made, the performance of the company is affected.
• Once decisions are made, they cannot be reversed(Brigham & Houston, 2015).

Stock buybacks – Pros:

• Companies borrow funds through selling shares via (initial public offering) IPO. The borrowed funds are expected to be invested to generate returns. Moreover, companies use the profits generated to pay dividends, which is the cost of equity. Investors expect dividends payment to compensate for their sacrifice to use funds for other activities. As such, it becomes financially unreasonable to hold a substantial amount of equity, which is not put to use. Therefore, stock repurchase helps firms minimize the cost of capital(Brigham & Houston, 2015).
• Stock repurchase makes the financial statement looks appealing to potential investors. By buying shares, a company reduces the number of weighted average outstanding shares. The value of EPS is increased in the process. Since investors are interested in returns, more will attempt to buy the stock. That will increase the demand for the shares, and with less supply, the price will increase.
• Share buyback can be a useful defensive mechanism against a hostile takeover(Brigham & Houston, 2015).

Cons:

• It leads to an artificial increase in the share price.
• Spending money to buy back shares reduces the available cash for dividend payments. Companies are sometimes forced to reduce or postpone dividend payments for a particular period.
• Buying back share may be economically unfit. Companies may be investing in research and development activities, developing new products, acquiring smaller companies, among others(Brigham & Houston, 2015).

Mergers/Acquisitions – Pros:

• It reduces operating expenses when two companies operating independently combine operations. Duplicated positions such as the CEO, chief financial officer, Human resource manager, among others, are eliminated thus, reducing related costs.
• It leads to a competitive edge when two companies combine both financial and non-financial resources.
• It leads to increased economies of scale when two or more companies combine operations. The cost of operation is minimized, and the buying power is increased.
• Companies are able to produce large volumes of products, which leads to financial benefits such as tax shields, among others.
• It helps companies enter new markets (when the entities are established in different countries)(Brigham & Houston, 2015).

Cons:

• It is challenging to harmonize the different cultural norms. The culture clash resulting from a merger/acquisition could lead to a failure, if not effectively handled.
• Mergers/acquisitions minimize competition. As such, customers will have fewer goods as alternatives(Brigham & Houston, 2015).
• It may lead to a monopoly. For instance, if only two companies producing a commodity or services in the area merge, there will be only one company producing the product. As such, it is highly likely for prices to rise.
• It leads to a loss of jobs. When duplicated jobs mentioned above are eliminated, people become jobless.
• A merger that causes confusion in the market often leads to a loss of brand identity(Brigham & Houston, 2015).

Dividend increase – Pros:

• Signaling effect –investors prefer stocks that pay a dividend. What is more, they prefer companies that pay constantly increasing dividends. Dividend payment attracts more investors, thus leads to an increase in share price(Brigham & Houston, 2015).

Cons:

• When a dividend-paying company changes policies, say to reduce or avoid dividend payment, the choice sends a negative message to investors. The impact of such changes in policy is a downward trend on stock prices(Brigham & Houston, 2015).

Reduction of Debt – Pros:

• A low debt level reduces the solvency risk.
• It reduces the interest expense.
• It leads to an increased level of profitability(Brigham & Houston, 2015).

Cons:

• A company loses funds that could be invested in other income-generating activities.

Expansion into a new geographic area – Pros:

• It increases a company’s market share.
• It leads to an increase in revenue generation capacity.
• A company enjoys a diversified market.
• It leads to growth(Brigham & Houston, 2015).

Cons:

• Issues such as language barriers pose challenges.
• Risks such as currency or interest rate fluctuation may erode profits.
• Legal and political issues may pose challenges.
• Market research is expensive(Brigham & Houston, 2015).

Introduction of new projects – Pro:

• Increases sales levels, thus profitability.
• Leads to long-term growth
• Create jobs(Brigham & Houston, 2015).

Cons:

• The cash flows are estimated, thus are uncertain.
• Most projects are expensive.
• Future cash flows are subject to risks such as inflation(Brigham & Houston, 2015).

The best strategies

Based on the ratio and strategy analyses above, it would be wise if Apple company chose a combination of the following strategies: capital expenditures, a reduction of debt, expansion into a new geographic area, and introduction of new projects. Based on the company’s high debt levels and drawbacks of dividend increase, the mentioned strategies are the most suitable. A reduction of debt is suitable due to the current high debt level (133% in 2018 and 157.3 % in 2019). The net profit margins obtained can sustain strategies such as capital expenditures, expansions into a new geographic area, and the introduction of new projects. The strategies will increase revenue capacity, reduce solvency risk, and improve growth. More investors would be interested in the company’s shares leading to an increase in share price due to market forces of demand and supply. The efficient market hypothesis holds that the prices of assets reflect all relevant information. As such, the prices of stocks are perfect as it reflects all information made available to the investors. In other words, the hypothesis holds that investors would earn a similar rate of return, given they have the same details regarding an asset. Since investments generate dissimilar returns, it can only be concluded that the market is inefficient.

Weighted Average Cost of Capital (WACC)

The formula for determining WACC is (K_e*w) + (K_d*w), where K_eis the cost of equity, K_d is the cost of debt, and w is the weight.

w= equity/ (equity + debt)

Since Apple Inc. pays dividends, the dividend capitalization model is suitable for determining the cost of equity in this case. Based on the formula, K_e = (D₁/P_o) + g, where D₁ is next year’s dividend, P_o is the current share price, and g is the dividend growth rate (Besley& Brigham,2015).

Table 2: Dividend growth

Apple’s adjusted closing share price as of 10 February 2020 from yahoo finance is $ 321.55 (Yahoo finance, n.d.)

The dividend growth = (D_t/D_t-1) – 1, where Dt is year t dividend, D_t-1is dividend for the previous year (See table 1). The average growth rate = (13.33 + 10.29 + 10)/3 = 11.21%

Therefore, the cost of equity = (3.3/321.55) + 11.21 = 11.22%.

The interest expense from the company’s SEC filings in 2019 = $ 3,200,000,000, whereas the non-current liabilities were 91,807,000,000. As interest rate was (3,200/91, 807) *100 = 3.49%

After-tax cost of debt = 3.49(1-0.21) = 2.757%

Weight of equity = 90,488,000,000/ (90,488,000,000 + 91,807,000,000) = (90,488/182,295) = 0.4964

Weight of debt = (1-0.4964) = 0.5036

Therefore, WACC = (11.22*0.4964) + (2.757*0.5036) = 5.57 + 1.388

WACC = 6.958%

The company generated a net income of $ 55,256,000,000 in 2019. The total cash generated by operating activities in 2019 was $ 69,391,000,000 (Form 10-k, 2019). The figure is more than half the company’s total shareholder’s equity. As such, it is sufficient to fund the strategies recommended above internally. However, should there arise the need for external financing, debt financing would be suitable. The reason is that based on the WACC above, the cost of debt is less than that of capital. Therefore, debt would be a cheaper alternative as compared to common stock. More debt would increase the proportion of debt in the capital structure, thus increases the risk of the company’s stock.WACC is expected to decrease since debt proportion will be more than equity. However, due to the high risk of the company’s stock, shareholders would want a high return. That will cancel the effect of increased debt finance on WACC. All the effects will eventually lead to a decrease in stock price.

References

Besley, S., & Brigham, E. F. (2015). CFIN.Stamford, CT: Cengage Learning.

Brigham, E. F., &Daves, P. (2015). Intermediate financial management. Andover, UK: Cengage Learning.

Brigham, E. F., & Houston, J. F. (2015). Fundamentals of financial management. Andover, UK: Cengage Learning.

Form 10-k. (2019). SEC filings: Apple Inc. Retrieved from https://s2.q4cdn.com/470004039/files/doc_financials/2019/ar/_10-K-2019-(As-Filed).pdf

Yahoo finance. (n.d.). Apple Inc. Retrieved from https://finance.yahoo.com/quote/AAPL/history?period1=1568073600&period2=1581379200&interval=1d&filter=history&frequency=1d

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