Value Analysis Using EVA

The EVA valuation method measures the profitability of a company using the level of earning generated for the shareholders above the expected costs of capital. The paper breakdown Amazon Inc. into three segments International, N. America, and AWS segments as identified in Amazon's financial reporting for the year ended 2018. An analysis of the individual segments in using EVA valuation suggested that combined N. American and AWS generated the highest wealth above the expected cost of capital for the shareholders in 2018 relative to the individual segments and the sum of all segments that make up Amazon Inc. The EVA for combined AWS and North America segments is 9044.767 million as compared to 6661.764 million for all segments that make up Amazon Inc., 4883.346 million for the AWS segment, 4161.422 million for North America segment, and -2358.17 million for the international segments. Separating the international segment from N. American and the web services segments would help increase the valuation and allow the management to concentrate on the unique challenges, opportunities, and competitiveness requirements in the different segments. 

Value Analysis Using EVA 

The economic value added (EVA) valuation method measures the profitability of a company using the level of earnings generated for the shareholders and in excess of the expected costs of capital (Sharma & Kumar, 2010). In other words, the EVA valuation method evaluates whether a business is able to make sufficient returns as to be considered as a good investment. An EVA of above zero means that a business is able to generate funds that translate to more than the minimum return that investors expect to earn. On the other hand, a negative EVA means that a business generates funds that are lower than the required return expected by shareholders. 

EVA = Net Operating Profit after Tax – (WACC * Invested Capital) 

Net operating profit after tax 

NOPAT evaluates the performance of business operations after accounting for taxes and before paying interest (Sharma & Kumar, 2010). It is, therefore, a theoretical amount of earning that a company would pay the shareholders if the company had no obligation to pay debt. NOPAT is considered as the most efficient method of evaluating financial performance for a company that has taken advantage of financial leverage because it does not consider the financial structure of the company. NOPAT is easily obtained by adjusting the operating income for tax deductions. According to (Sharma & Kumar, 2010), the formula for finding NOPAT is: 

NOPAT = operating income * (1-tax rate) 

NOPAT can also be calculated from net income by adjusting to cover the interest charge. The adjustment is made by adding the net interest after tax to the net profit. The formula is: 

NOPAT = Net Income + Net interest* (1- Tax) 

The weighted average cost of Capital (WACC) 

WACC estimates the rate of profit that investors in the company's stocks would expect to receive (Sharma & Kumar, 2010). WACC is calculated using the weight of the various types of financing that include debt, preferred stocks, and common stocks. A high WACC means that a company experiences higher risk, and therefore consumers would only be willing to purchase the stock only if they anticipate a high yield rate. 

WACC = debt proportion * debt discount rate (1-Tax) + preferred stock proportion * rate of return on preferred stocks + equity proportion * rate return on the stock 

WACC = (  * Ke +  (  * Kd (1-T) 

Where: 

Ve is the total value of equity financing 

Vd is the value of total debt financing 

Ke required rate of return for equity 

Kd the interest rate of debt 

Vp is the value of preferred stocks 

Rp is the rate of return of the preferred stocks 

T is the applicable tax rate 

(  represents the business proportion that is equity-financed 

(  represents the business proportion that is debt-financed. 

 represents the percentage financed by preferred stocks 

Invested capital 

Invested capital is the total business operations financing obtained through lending or sale of stocks (Pavelková et al., 2018). Invested capital includes the value of stocks and debt less all cash and other current assets. Capital invested is, therefore, easily estimated as the difference between total assets and the financial obligations due within a year. The amount of earnings generated by a business must be above the invested capital for a business to earn an economic profit. 

Invested capital = Total Assets – Current Liabilities 

The weighted average cost of capital 

WACC
Total Stockholders' equity, Ve	43,549
Total liabilities and stockholders’ equity, (Ve + Vd)	162,648
Total liabilities, Vd	119,099
Cost of Debt, Kd	1.24%
Required rate, Ke	9.81%
Tax rate (21%)	21%
Risk-free rate, rf	0.68%
Beta risk	1.32
Market Return, Rm	7.60%
Proportion of debt financing (Vd/(Vd+Ve))	0.73225
Proportion of equity financing (Ve/(Vd+Ve))	0.26775
WACC	3.3428%

The costs of equity were calculated using the CAMP model. The CAMP model estimates investors' return by multiplying beta and the market premium and then adding the risk-free rate (Farber, Gillet, & Szafarz, 2006). The calculation of required return assumed that the risk-free rate is equal to a return of a US bond with the expiry of 10 years, 0.68% ( Finra, 2020). The US bond is considered as risk free because of the ability of the US to repay, which is supported by the ability to collect taxes. The market rate of return is assumed at 7.60%. 

Ke = rf + beta risk *(Rm - rf) 

= 0.68% + 1.32 *(7.60% - 0.68%) 

= 9.81% 

Beta estimates the level of risk that is experienced by investors in a company's stocks. It estimates the volatility of the stock prices of a company relative to the price changes in the entire stock market. Beta risk obtained by dividing the covariance between the stock prices and the variance of the average return of a group of stocks selected as the benchmark representing the entire stock market mainly the DJIA and S&P 500 Index. A beta risk < 1 suggests that the value of the stocks of a company change less rapidly relative to the value of the whole market. A beta risk >1 suggests that the value of the shares of the target company change more rapidly relative to the value of the whole market. Similarly, a beta of 1 suggests that the rate of change of the value of a share is equivalent to the rate of change of the entire market value. The beta for Amazon Inc. is 1.32, indicating that the level of Amazon's stock price volatility is slightly above the entire market ( Finance Yahoo, 2020). Amazon Inc. can, therefore, be interpreted as a low-risk stock. 

The cost of equity estimates the minimum gain rate at which stockholders are willing to accept in order to assume the risk associated with the stocks. An expected stock yield of 9.81%, therefore, means that investors in Amazon Inc. would expect a 9.81% return rate as compensation for the risk associated with Amazon's stocks. The rate of return of a stock is determined by the amount of dividend payouts and the increase in prices of stocks. The cost of debt for Amazon Inc. was estimated as the yield of Amazon's 10-year bond with expiring in in 2030 ( Finra, 2020). From the table above, the value of the WACC is 3.3428%, implying that investors would only invest in Amazon Inc. if the expected return is at least 3.3428%. 

Amazon Inc. segments 

Amazon Inc. is composed of numerous subsidiaries that are categorized into three during reporting ( Amazon Inc., 2018). The three segments identified in the company's financial reporting include N. America, and Amazon Web Services (AWS) and International (Amazon Inc., 2018). The company's segmentation is based on the categorization of management operations and financial performance reports. Amazon Web Services (AWS) segment provides services such as computing, cloud-based storage solutions, and database services to all size enterprises such as government agencies, start-ups, and academic institutions. International segment includes all the retail sales revenue generated through online stores in countries outside the North America region. The revenue includes both sales of products as well as revenue from subscriptions. The major risk associated with the international market is the fluctuation of currency value that triggers huge gains or losses. The North America segment entails all revenue generated from the online retail of products as well as the subscriptions. The table below shows the Capital Invested, operating income, and NOPAT of the various segments. 

Table 1 : Invested Capital, NOPAT, and operating income of North America, International, and AWS segments (Amazon Inc., 2018). 

Segment Data
Capital Invested
North America	47251
International	19923
AWS	26340
Net Sale
North America	141366
International	65866
AWS	25655
Operating Expense
North America	134,099
International	68,008
AWS	18,359
Operating Income
North America	7,267
International	-2,142
AWS	7,296
Tax rate (21%)
NOPAT
North America	5,741
International	-1,692
AWS	5,764

North America Segment 

North America Segment
NOPAT	5,741
Invested Capital	47251
WACC	3.3428%
EVA = Net Operating Profit After Tax – (WACC * Invested Capital)	4161.422

The economic value added (EVA) value of 4161.422 million indicates the amount of earnings generated by the North American Amazon segment for the shareholders and above the expected minimum return. Since the EVA is positive, we conclude that the North American Amazon segment generated sufficient returns to be considered as a good investment in the year ended in 2018. 

AWS Segment 

Table 2 : EVA for the North America region 

AWS Segment
NOPAT	5,764
Invested Capital	26340
WACC	3.3428%
EVA = Net Operating Profit After Tax – (WACC * Invested Capital)	4883.346

The EVA value of 4883.346 million indicates the amount of earnings generated by AWS Segment for the shareholders and above the expected minimum return. Since the EVA is positive, we conclude that the AWS segment generated sufficient returns to be considered as a good investment in the year ended in 2018 (Pavelková et al., 2018). The EVA value of the AWS segment, 4883.346 million, is more than the EVA for the North America segment, 4161.422 million. This indicates that the amount of earnings generated by the AWS segment for the shareholders and above the expected cost of capital is more than that of the North America segment. Although both AWS and North American segments are positive, meaning that they both generated earnings above the cost of capital, the AWS segment would be more profitable than the North American segment. 

Combined North American and AWS Segments 

Table 3 : EVA for combined North America and AWS segments 

North American Segment and AWS
North America, NOPAT	5,741
North America, Invested Capital	47251
AWS NOPAT	5,764
AWS Invested Capital	26340
Total, NOPAT	11,505
Total, Invested Capital	73591
WACC	3.3428%
EVA = Net Operating Profit After Tax – (WACC * Invested Capital)	9044.767

The EVA value of 9044.767 million indicates the amount of earnings generated by the North American and AWS segment for the shareholders and above the expected minimum return. Since the EVA is positive, we conclude that North American and AWS segments generated sufficient returns to be considered as a good investment in the year ended in 2018. The economic value added (EVA) value of combined North American and AWS segment, 9044.767 million is more than the EVA for the AWS segment, 4883.346, and North America segment, 4161.422 million. This indicates that the amount of earnings generated by combined North American segment and AWS segment for the shareholders and above the expected cost of capital is more than that of the North America segment and AWS segment individually (Pavelková et al., 2018). Although AWS, North American segment as well as combined AWS and North American segments are positive, meaning that they both generated earnings above the cost of capital, combined AWS, and North American segments would be more profitable than North American or AWS segments. 

International Segment 

Table 4 : EVA for the International Segment 

International Segment
NOPAT	-1,692
Invested Capital	19923
WACC	3.3428%
EVA = Net Operating Profit After Tax – (WACC * Invested Capital)	-2358.17

The economic value added (EVA) value of -2358.17 million indicates the amount of earnings generated by the North American and AWS segment for the shareholders and above the expected minimum return. Since the EVA is below zero, we conclude that the International segment generated insufficient returns to be considered as a good investment in the year ended in 2018. The economic value added (EVA) value of the International segment, -2358.17 million is less than the EVA for North America segment, 4161.422 million, AWS segment, 4883.346, and combined AWS and North American segment, 9044.767. This indicates that the International segment is the only segment that would not generate sufficient earnings for shareholders above the expected cost of capital (Pavelková et al., 2018). 

Entire Amazon, Inc. 

Table 5 : EVA for combined segments that make up Amazon Inc. (Amazon Inc., 2018). 

Amazon Inc.
Total Assets	162,648
Current Liabilities	68,391
Invested Capital	94,257
Operating Income	12,421
NOPAT	9813
WACC	3.3428%
EVA = Net Operating Profit After Tax – (WACC * Invested Capital)	6661.764

The economic value added (EVA) value of 6661.764 million indicates the amount of earnings generated by Amazon Inc. for the shareholders and above the expected minimum return. Since the EVA is positive, we conclude that the Amazon Inc. segment generated sufficient returns to be considered as a good investment in the year ended in 2018. The economic value added (EVA) value of the total segments that make up Amazon Inc. is 6661.764 million. The EVA for Amazon Inc. is 6661.764, which is above the individual segments of the AWS segment, 4883.346 and North America segment, 4161.422 million but less than the combined North American and AWS segment, 9044.767 million. This indicates that the amount of earnings generated by combined North American segment and AWS segment for the shareholders and above the expected cost of capital is more than generated by the combined segments that make up Amazon Inc. as well as the individual segments (Sharma & Kumar, 2010) . 

Discussion 

Using EVA analysis to breakdown Amazon Inc., combined North America and AWS segments indicate that they generate more cash for shareholders above the expected minimum return. This means that a combination of the two segments could be valued more for investors if separated from the international segment. North America and AWS segments face significantly different competition, challenges, and opportunities. Amazon retail and AWS market in North America, for example, faces stiff competition from Walmart Inc. on advanced technologies such as computing technology, cloud-based solutions, and robotics. The focus should be on research and development and improvement of the omnichannel experience of consumers at a faster pace, given the rapidly growing competition. According to (Amazon Inc., 2018), the international segments pose unique challenges that make it difficult to succeed in the initial stages. Amazon Inc. management is, however, convinced on the importance of rolling out an expansion strategy that will help establish new markets outside the North America region. Unfavourable regulations, laws, and protectionist policies are a major hindrance to the competitiveness and profitability of the international segment. Furthermore, the limitations such as unfriendly internet legislations, limited practices in distribution through physical and digital channels, export duties and unwillingness to implement the intellectual rights are major limitations that influence the performance of the international segment. 

As the opportunities in the international physical and e-commerce market increase, running the international segment separately may be necessary to ensure that attention is paid to the unique challenges ( Amazon Inc., 2018). Amazon Inc.'s international segment may need to establish more partnerships with the local companies that have a competitive advantage due to expansive knowledge of local customers, established distribution channels, and popular brand names. India and China are, for example, the two largest markets with more than 2.5 billion people but are pervaded with protectionist laws and limitations on the use of the internet. Strategic cooperation with local businesses in such cases may work well in the interest of expanding the international business. The international segment also requires extensive resources for hiring, training, and managing human resources as well as expanding the physical presence, which is needed to realize the required growth. Amazon Inc. should leverage more on strong technological capabilities such as artificial intelligence, robotics, and cloud-based solutions. 

Conclusion 

In conclusion, the WACC of Amazon Inc., assuming a risk-free rate of 0.68%, and the market rate return of 7.60% is 3.3428%. A breakdown of Amazon Inc. using the economic value added (EVA) indicates that combined N. American and AWS segments generate the highest wealth for the shareholders as compared to the entire Amazon Inc. and individual segments. The EVA for combined AWS and North America region is 9044.767 million as compared to 6661.764 million for all segments that make up Amazon Inc., 4883.346 million for the AWS segment, 4161.422 million for North America segment, and -2358.17 million for the international segments. All the segments generate wealth in above the minimum return expected by the shareholders apart from the international segment. Separating the international segment from N. American and web services segments would help increase the valuation of the Amazon and allow the management to concentrate on the unique challenges, opportunities, and competitive requirements. 

References 

Amazon Inc. (2018).  Amazon Inc 10-k Report Retrieved https://ir.aboutamazon.com/sec-filings/default.aspx 

Farber, A., Gillet, R. L., & Szafarz, A. (2006). A General Formula for the WACC. International Journal of Business, 11(2). https://ssrn.com/abstract=898420 

Finance Yahoo. (2020).  Amazon.com, Inc. (AMZN) . Yahoo Finance - Stock Market Live, Quotes, Business & Finance News.  https://finance.yahoo.com/quote/AMZN? 

Finra. (2020, April 7).  Amazon Bonds . Market Data Home.  https://www.finra.org/investors/market-data-center-bonds-guide 

Pavelková, D., Homolka, L., Knápková, A., Kolman, K., & Pham, H. (2018). EVA and key performance indicators: The case of the automotive sector in pre-crisis, crisis, and post-crisis periods. Economics and Sociology. Fundacja Centrum Badań Socjologicznych. https://scholar.google.com/scholar ? 

Sharma, A. K., & Kumar, S. (2010). Economic value added (EVA)-literature review and relevant issues. International journal of economics and finance, 2(2), 200-220. www.ccsenet.org/ijef