# Financial Returns and Capital Constraints

Financial Returns and Capital Constraints

BUS 401

Principles of Finance

Financial Returns and Capital Constraints

When companies publish their financial statements, they divulge the ins and outs of their operations. The finding within the financial report is a useful tool for investors to utilize when making investment decisions. Companies, and those managing them, always must consider ways to appeal to these investors. A way to appeal to investors is to use financial leverage, which is the use of debt, to purchase more assets, and to increase their return on equity. When investigating the economic conditions and performance of businesses, such as Amazon.com, Inc., a tool called DuPont analysis is used. According to the Corporate Finance Institute (n.d), “The basic DuPont Analysis model is a method of breaking down the original equation for ROE into three components: operating efficiency, asset efficiency, and leverage.”

Amazon.com, Inc. Returns on Equity (ROE)

Return on equity (ROE), “measures the profits accruing to shareholders per dollar of contributed equity.” (Hickman, Byrd, & McPherson, 2013). The ROE ratio is calculated as follows: ROE = Net Profit Margin × Asset Turnover × Equity Multiplier.

According to Amazon.com, Inc. 2019 financials, ROE is calculated using the DuPont formula as follows;

Therefore, the ROE would be equal to: ROE = 0.0413087 * 1.446377 * 3.672944 = 0.2194. From this analysis, it shows that Amazon.com, Inc.’s 4.1% net income margin indicates that for every dollar the company generates in sales, the company keeps \$4.13 as profit. Now we investigate Amazon’s asset turnover of 1.44. According to My Accounting Course (n.d), “The asset turnover ratio is an efficiency ratio that measures a company’s ability to generate sales from its assets by comparing net sales with average total assets. In other words, this ratio shows how efficiently a company can use its assets to generate sales.” This means that for each dollar of assets, it generates \$1.45 of sales. Lastly, equity multiplier shows the percentage of assets that are financed or owned by shareholders, in addition to the level of debt financing that is used to acquire additional assets. Amazon has an equity multiplier of 3.67%, which indicates that more of their assets were funded by equity than debt, which means investors funded more assets than creditors. This also shows that Amazon’s low leverage and less risky for investors and creditors. This is great since investors own more of the company.

• Net profit margin = Net income / Revenue = 11588 / 280522 = 4.13%
• Asset turnover = Sales / Average total assets = 280522 / 193948 = 1.446377
• Equity Multiplier (financial leverage) = Average total assets / Average Shareholder’s Equity = 193948 / 52804.5 = 3.672944

Constant Growth Stock Valuation (CGSV)

The constant growth stock valuation (CGSV) is a way of valuing stocks. “The growth rate plays a very important role in determining the value of a share of stock (or any asset).” (Hickman, Byrd, & McPherson, 2013). CGSV is calculated as follows: P0D= D0/(1+gn)/ r-gn. Unfortunately, Amazon.com, Inc. does not pay dividends to its shareholders instead, they cycle the revenue back into their business, and with stock prices at \$1,785 investors are not hurting. According to Bob Ciura (2020), “Amazon’s lack of a dividend certainly has not hurt investors to this point, as Amazon has been a premier growth stock. Over the past ten years, Amazon stock generated returns of over 30% per year.” Since Amazon does not provide dividends, we will follow the following as stated in our lecture and based off Amazon.com, Inc.:

Therefore, \$6.47/(\$1,785 +6.9%) = .36% +6.94% =0.073%

• Do = Use the Earnings per-share of your chosen company \$6.47
• Re = Chosen company return on equity (6.47/1785 + 6.94)=6.94
• EPS = \$6.47
• Po or stock price = \$1,785 current stock price
• G= growth rate of the EPS = 6.94%

Capital Constraints

Amazon is on top of their game when it comes to leading in their industry. With competitors like eBay, Chewy.com, Walmart, and a few others, Amazon still manages to keep up and stay ahead of their competitors. There are three ratios that help assist to examine the financial strengths of a company’s capital position.

References

• The debt and debt/equity ratio
• The capitalization ratio (total debt/total capitalization)
• The sum of obligations categorized as debt + total shareholders’ equity

Asset Turnover Ratio: Analysis: Formula: Example. (n.d.). Retrieved from https://www.myaccountingcourse.com/financial-ratios/asset-turnover-ratio

Ciura, B. (2020, January 27). Will Amazon Ever Pay A Dividend? Retrieved from https://www.suredividend.com/amazon-dividend/

DuPont Analysis – Learn How To Create A DuPont Analysis Model. (n.d.). Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/finance/dupont-analysis/

Hickman, K. A., Byrd, J. W., & McPherson, M. (2013). Essentials of finance. Retrieved from https://content.ashford.edu/