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Advanced Micro Devices Inc; Weighted Average Cost of Capital Analysis Tan Jun Ze Kelston 13570897 Alvaro Antonio Segura Sapina 13668330 Luu Duc Huy 13666546 James Cook University

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Contents Advanced Micro Devices Inc; Weighted Average Cost of Capital Analysis ...................... 3 1.0 Introduction ................................................................................................................... 3 2.0 Weighted Average Cost of Capital ............................................................................ 3 2.1 Calculating the Cost of Equity (𝑹𝑬) .................................................................... 5 2.2 Calculating the cost of Debt 𝑹𝑫. .......................................................................... 6 3.0 Profitability Analysis of the WACC and ROIC. ....................................................... 8 4.0 Gearing Ratios (Capital Structure Analysis) ............................................................. 9 4.1 Debt-to-equity ratio............................................................................................. 10 4.2 Interest Coverage Ratio........................................................................................11 5.0 Recommendations ................................................................................................... 13 6.0 Reflections .............................................................................................................. 13 6.1 Market value or Book value while calculating WACC ....................................... 13 6.3 Beta in CAPM ..................................................................................................... 14 References ......................................................................................................................... 15 Appendix ........................................................................................................................... 17

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Advanced Micro Devices Inc; Weighted Average Cost of Capital Analysis 1.0 Introduction From its humble beginnings as a Silicon Valley start-up back in 1969, Advanced Micro Devices Inc. (AMD), has grown into a global company of 10,000 people. The company manufactures semiconductor products which include; microprocessors, embedded microprocessors, chipsets, graphics, video and multimedia products. AMD operates through two segments: Computing and Graphics and Enterprise, Embedded and Semi-custom. Computing and Graphics products, accounting for about two-thirds of sales, whilst the latter accounts for a third. According to (Bloomberg, 2019) The company outsources manufacturing of its products to third-party foundries, including GLOBALFOUNDRIES and Taiwan Semiconductor Manufacturing Company. In 2018, the Computing and Graphics segment’s revenue jumped nearly 40% in 2018 from 2017 from higher prices and great shipment volumes, driven by demand for Ryzen processors. AMD’s sales rose 23% to $6.5 billion, an increase of about $1.3 billion from 2017 with its newer products accounting more about two-thirds of sales (Bloomberg, 2019). The company’s operations generated $34 million, investing activities used $170 million, and financing activities provided $28 million. By analyzing the Weighted Average Cost of Capital of AMD, this report will give recommendation to help maximise profitability and shareholder’s wealth. 2.0 Weighted Average Cost of Capital In order to satisfy all its investors, which includes their shareholders, debtholders and preference shareholders, the Weighted Average Cost of Capital (WACC) is a minimum return a firm would need to earn (Ross et al., 2017, p.400).

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In other words, according to Ross et al. (2017, p.389), the WACC is the overall return a firm must earn on its existing assets to maintain the value of its shares. A firm’s WACC represents its blended cost of capital across all sources; which includes common shares, preferred shares and debts (WACC, 2019). A firm’s WACC, as seen in the formula below, can be calculated by weighing the cost of each type of capital by its percentage of total capital and then adding them together; 𝑬 𝑫 𝑾𝑨𝑪𝑪 = ( ) × 𝑹𝑬 + ( ) × 𝑹𝑫 × (𝟏 − 𝑻𝑪 ) 𝑽 𝑽 Where; E represents the market value of the firm’s equity D represents the market value of the firm’s debt V represents the total value of the firm’s financing; where V = E + D 𝐸

𝑉 𝐷 𝑉

represents the percentage of financing that is equity represents the percentage of financing that is debt

𝑅𝐸 represents the cost of equity (required rate of return) 𝑅𝐷 represents the cost of debt (yield to maturity of existing debt) 𝑇𝐶 represent the corporate tax rate

Hence, by using the data, provided by Bloomberg Terminal, for Advanced Micro Devices Inc. We can find out the company’s WACC for the financial year of 2016 by utilizing the above formula;

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2.1 Calculating the Cost of Equity (𝑹𝑬) The first step to calculating a firm’s WACC is to find the cost of the firm’s equity 𝑅𝐸 . The cost of equity refers to the return investors require from their investment (Ross et al., 2017). According to Ross et al., (2017), there are two methods of calculating a firm’s cost of equity; dividend growth model and capital asset pricing model (CAPM). Based on the data provided by the Bloomberg Terminal, the best method to calculate the firm’s cost of equity is via CAPM and the formula is as follow; 𝑹𝑬 = 𝑹𝒇 + 𝑩𝑬 (𝑹𝑴 − 𝑹𝒇 ) Where; 𝑅𝑓 represents the risk-free rate 𝐵𝐸 represents the estimation of the relevant Beta (𝑅𝑀 − 𝑅𝑓 ) represents the market risk premium Hence, 𝑅𝐸 = 2.72 + 1.63(8.05) = 15.84%

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2.2 Calculating the cost of Debt 𝑹𝑫 . The second step to calculating a firm’s WACC is to find their cost of debt, 𝑅𝐷 . According to Ross et al., (2017), the cost of debt is the return that lenders require on the firm’s debt and it is calculated as such where; 𝑹𝑫 = {[(

𝑺𝑫 𝑳𝑫 ) × (𝑻𝑵 × 𝑨𝑭)] + [( ) × (𝑻𝑩 × 𝑨𝑭)]} × (𝟏 − 𝑻𝑹) 𝑻𝑫 𝑻𝑫

Where; SD represents the Short-term debt LD represents the Long-term debt TD represents the Total Debt TN represents the Average Rate of Treasury Notes TB represents the Treasury Bond AF represents the Debt Adjustment Factor TR represents the Tax rate Hence 𝑅𝐷 = {[(0.11) × (2.52 × 1.67)] + [(0.89) × (2.72 × 1.67)]} × (1 − 0) = 4.46% The last step involves subbing the figures from the calculations into the formula; Hence, 𝑊𝐴𝐶𝐶 = (0.93)(0.1584) + (0.065)( 0.0446)(1 − 0) = 15.10% The WACC is an important investment tool for both investors and the firm. It is useful during decision making for investment by the company; by using the WACC as a benchmark to help decide whether a firm should enter the project (Investopedia, n.d.). Similarly, investors can

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make decisions based on the WACC as the opportunity cost of their capital. If returned offered by the firm is higher than the WACC, investors would choose to invest in the firm. In addition, Return on Investment (ROIC) is a calculation that is used for evaluating a the efficiency of the company in assigning the capital under its control to cost-effective investments (Investopedia, n.d.). Comparison of a company's return on investment with its WACC discloses whether the capital invested is being effectively used. If the ROIC is higher than the weighted average of the WACC, the most frequent cost of the metric of capital, the equity is being created (Investopedia, n.d.). One way to calculate ROIC is by applying the formula: 𝑅𝑂𝐼𝐶 =

(𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠) 𝐼𝑛𝑣𝑒𝑠𝑡𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙

A more comparative analyses of WACC and ROIC will be shown under Profitability Analysis of ROIC and WACC.

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3.0 Profitability Analysis of the WACC and ROIC. Given the information and data collected from the Bloomberg terminal, a benchmarking analysis of AMD and Nvidia's WACC and ROIC during the last three years is carried out as indicated below: AMD Financial year 2016 2017 2018 Table 1. AMD’s WACC and ROIC

WACC 14.50% 17.00% 15.10%

ROIC -32.36% 6.03% 19.81%

Nvidia Financial year 2016 2017 2018 Table 2. Nvidia’s WACC and ROIC

WACC 11.70% 13.50% 16.20%

ROIC 8.54% 21.92% 35.23%

Table 1 shows that AMD's WACC remained practically constant during the 3 years studied, while ROIC in 2016 was even a negative value (-32.36%), in 2017 it ceased to be negative (6.03%) and in 2018 it increased significantly, reaching (19.81%). Therefore, the AMD Company managed to make a profit in 2018 after 2 previous years of investment. AMD has progressed remarkably from 2016 to 2018. Appendix A6 presents a graph showing the WACC and ROIC values of Nvidia over the three-year period. Table 2 shows it can be observed that there is a positive and direct relationship between WACC and ROIC, as WACC increases, ROIC increases as well. An increase in WACC shows that the cost of financing Nvidia is increasing from 11.70 in 2016 to 16.20 in 2018. Therefore, the return on the Nvidia investment is expected to be slightly lower

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in the future, which will translate into lower company profitability. However, WACC's growth is very small and its impact is likely to be minimal. After analyzing both tables, it can be concluded that the WACC of both companies remains stable throughout the 3 years studied while, the most important difference is the growth of AMD's ROIC has experienced a very sharp change in favor of the company. While Nvidia has also been increasing its ROIC in a more natural and less abrupt way. However, both companies compared in 2018, Nvidia is outperforming AMD because its ROIC is about 15% higher than AMD. 4.0 Gearing Ratios (Capital Structure Analysis) Gearing ratio represents a group of financial ratios that compare several forms of company's capital to debt and it is a measurement of the entity’s financial leverage which demonstrates the amount of debt to equity financing as well as the reflection of the firm’s assets are gained more whether from externals or internals (Kenton, 2019). Gearing ratios are useful for both internal and external components and financial institutions use acceptable gearing ratio calculations in preparation of issuing loans or to analyze future cash flows and leverage. According to Rosemary research (2019), an organization with a high gearing ratio has more financing risks structure than a one with a lower gearing ratio. There are such many types of gearing ratio and the two such ratios which are the debt-to-equity ratio and the interest coverage ratio will be covered below.

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4.1 Debt-to-equity ratio The debt-to-equity (D/E) ratio is the measurement utilize to calculate an organization’s financial leverage by dividing a company’s total liabilities by its shareholder equity (Kenton and Adam, 2019). The formula to measure the debt-to-equity ratio is: Debt − to − Equity Ratio =

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡 𝑥 100% 𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦

For the financial year of 2018, AMD’s gearing ratio is calculated as: Debt − to − Equity Ratio =

𝑈𝑆𝐷 $136.00𝑚 + 𝑈𝑆𝐷 $1114.00𝑚 𝑥 100% = 6.98% (𝑠𝑒𝑒 𝐴𝑝𝑝𝑒𝑛𝑑𝑖𝑥 1.3) 𝑈𝑆𝐷 $17909.10𝑚

Therefore, the debt-to-equity ratio for ADM in the financial year 2018 is 0.0698 or 6.98%. This result indicates that AMD owes around 7 cents per dollar of its equity financing. For the comparison based on Bloomberg given data in 2018, the debt-to-equity gearing ratio of Nvidia is: Debt − to − Equity Ratio =

𝑈𝑆𝐷 $15. 00𝑚 + 𝑈𝑆𝐷 $1985.00𝑚 𝑥 100% = 1.36% (𝑠𝑒𝑒 𝐴𝑝𝑝𝑒𝑛𝑑𝑖𝑥 2.3) 𝑈𝑆𝐷 $147458.00𝑚

Hence, the debt-to-equity ratio for Nvidia in the financial year 2018 gave the result of 0.0136 or 1.36%. This presents that Nvidia owes around 1cents per dollar of its equity financing. Then, to determine the performance of AMD and Nvidia, more calculations of the debt-to-equity ratios for the past three years need to be operated. Financial year 2016 Total Debt (millions of USD) 1435 Total Equity (millions of USD) 10602.9 Gering ratio 0.135 Table 3. AMD’s debt-to-equity ratio

Financial year 2016 Total Debt (millions of USD) 1514 Total Equity (millions of USD) 15787.3 Gering ratio 0.096 Table 4. Nvidia’s debt-to-equity ratio

AMD Debt-to-Equity 2017 1395 9940.8 0.14

2018 1250 17909.1 0.068

Nvidia Debt-to-Equity 2017 2820 65385.4 0.043

2018 2000 147458 0.014

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By these gearing ratio comparation of Table 3 and Table 4, it is clearly seen that in the past three years, AMD has a higher debt-to-equity ratio than Nvidia. Thus, the analysis presents that big amount of debt funding raised on AMD’s financial risks and the variability of cash flow to the company equity (Kenton et al, 2019). This means AMD suffers more investment risks and provides fewer financial stability than the Nvidia from 2016 to 2018. 4.2 Interest Coverage Ratio The interest coverage ratio (ICA) is another crucial gearing ratio for an organization, it is a measure of an organization ability to meet its interest payments. In another word, interest coverage ratio is a profitability ratio and debt ratio utilized to determine how simply a firm manage it interest payment on its outstanding debt in a given period of time (Adam, 2019). The interest coverage ratio can be calculated by dividing a company's earnings before interest and taxes (EBIT) in a certain period by the organization’s interest expenses of the same period. The formula for the interest coverage ratio is: Interest Coverage Ratio =

𝐸𝐵𝐼𝑇 𝑥 100% 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒

AMD’s interest coverage ratio in the past 3 years are displayed below: 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐶𝑜𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑎𝑡𝑖𝑜2016

−373 = −2.39 156

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐶𝑜𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑎𝑡𝑖𝑜2017

127 = 1.007 126

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐶𝑜𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑎𝑡𝑖𝑜2018 (See Appendix1.7)

451

121

= 3.27

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According to these three results, from the financial year of 2016 to 2018, in 2016, Qantas’s Airways’ interest coverage ratio was negative, shown that the company even made a big loss in given year. The situation has been improved in the past two years when the organization begins to make profits businesses which can be seen from the positive amount of interest coverage ratios in these two years (2017 and 208). However, based on Maverick study in 2019, a negative interest coverage ratio is any number below 1, as this translates to the firm's recent earnings being insufficient to service its outstanding debt. Furthermore, as another guide of Birt et al (2014), the interest coverage ratio should not be below three times. Thus, based on the data analysis above, AMD’s interest coverage ratio over the past 3 years are mostly lower or just even equal to 3, proved that the company is unable to cover its financial expenses in certain period of time. This is a negative reflection of a poor performance and unstable financial position of this micro devices company. For the competitor Nvidia, the company’s interest coverage ratios in the past three years are presented below: 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐶𝑜𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑎𝑡𝑖𝑜2016 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐶𝑜𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑎𝑡𝑖𝑜2017 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐶𝑜𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑎𝑡𝑖𝑜2018

747 47

= 15.89

1934 58

= 33.34

3210 = 52.62 61

(See at Appendix 2.4) As seen from the above calculations, Nvidia’s interest coverage ratios not only present way bigger number than AMD, they also created profits and continue developed the numbers from 15.89 in 2016 to 52.62 in 2018. Meaning that the company is more than able to cover and deal its financial expenses on such outstanding debts.

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5.0 Recommendations As WACC is larger than AMD's ROIC in the years 2016 and 2017, investors will surely not see it as a good option to invest money in this company, on the other hand, Nvidia during those 2 years was a viable option since WACC was similar or lower than ROIC. Nvidia has much less risk than AMD in 2016 and 2017. This is due to the fact that AMD obtained less profit since it has to acquire more capital assets to boost the company's ROIC. Further increase ROIC, AMD may sell its non-operational or unproductive shares so that the company can increase its ROIC instead of its WACC. Apart from that, AMD may try to grow its businesses and invest in new ones. Projects that are potentially profitable so that you can make full use of debt financing such as well as maximizing shareholder wealth. If an investor sees the WACC and ROIC of these companies, he would almost certainly invest the money in Nvidia as it is very stable and progresses over time increasingly. 6.0 Reflections 6.1 Market value or Book value while calculating WACC The AMD ROIC calculation poses the question of either the market value or the book value of the company. The carrying amount of an asset is its original acquisition cost, restated for any subsequent changes, such as depreciation, while the market value is the price that could be achieved by disposing of an asset in an open and competitive market (AccountingTools, 2017). We have selected the enterprise's market value, even if it changes every day because share prices change frequently, as it would be more precise compared to the book value that does not change over the financial period. A second explanation would be that investors' market values mirror the price investors have to pay to partially own the business, no matter what the book values are.

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6.3 Beta in CAPM Beta used in CAPM calculates the expected return of an asset. It is used to describe the activity of a security’s returns, reacting to the market’s fluctuation. Although useful in finding out a security's short-term risk, and for analyzing volatility, there are a few limitations of using it. Firstly it is less meaningful for investors looking to predict future stock movements as Beta is calculated using historical data points which do not consider new information of the market (Investopedia, n.d.). Hence using the market overall index would be a better choice.

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15 References

Investopdea. (n.d.). Understanding Beta and How to Calculate It. Retrieved from https://www.investopedia.com/terms/b/beta.asp

Investopedia. (n.d.). Debt/Equity Ratio. Retrieved from https://www.investopedia.com/terms/d/debtequityratio.asp

Investopedia. (n.d.). Gearing Ratio. Retrieved from https://www.investopedia.com/terms/g/gearingratio.asp

Investopedia. (n.d.). Interest Coverage Ratio. Retrieved from https://www.investopedia.com/terms/i/interestcoverageratio.asp Investopedia. (n.d.).

Return on Invested Capital – ROIC. Retrieved from https://www.investopedia.com/terms/r/returnoninvestmentcapital.asp

Kenton, W. (2019, August 31). How the Gearing Ratio Works. Retrieved from https://www.investopedia.com/terms/g/gearingratio.asp

Maverick, J. B. (2019, April 15). What is a bad interest coverage ratio? Retrieved from https://www.investopedia.com/ask/answers/121814/what-bad-interest-coverage-ratio.asp

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Peavler, R. (2019, August 22). What High Gearing Ratios Say About a Company. Retrieved from https://www.thebalancesmb.com/calculating-gearing-ratio-393228 Ross, S., Westerfield, R., & Jaffe, J. (2013). Corporate finance (10th ed., pp. 400-417). New York: McGraw-Hill Irwin.

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Figure 1.

Figure 1. AMD WACC (2016). Figure 2.

Figure 2. AMD WACC (2017)

ANALYSIS OF AMD Figure 3.

Figure 3. AMD WACC (2017) Figure 4.

Figure 4. AMD cost of equity