Did Apple Pay Too Little Tax? Appealing the EU Ruling on Illegal State Aid Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Did Apple Pay Too Little Tax? Appealing the EU Ruling on Illegal State Aid case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Did Apple Pay Too Little Tax? Appealing the EU Ruling on Illegal State Aid case study is a Harvard Business School (HBR) case study written by Morten Bennedsen, Brian Henry, Mark Stabile. The Did Apple Pay Too Little Tax? Appealing the EU Ruling on Illegal State Aid (referred as “Apple Tax” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, International business, Policy, Technology.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment

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Case Description of Did Apple Pay Too Little Tax? Appealing the EU Ruling on Illegal State Aid Case Study

On 30 August 2016, Margrethe Vestager, the European Commissioner for Competition, ordered Ireland to recover a‚¬13 billion in illegal state aid that the state had granted Apple over a decade from 2003. In allowing Apple to pay close to zero in taxes, she ruled, Ireland had given the foreign company a selective advantage over other businesses paying the regular corporate tax rate of 12.5%. Tim Cook, CEO of Apple, and Enda Kenny, the Irish Prime Minister, appealed the ruling, a process that is still ongoing. The case explores this event from five analytical pillars: 1) the role of Ireland's low corporate tax rate in attracting FDI; 2) Apple's decision to allocate its earnings to a paper company in Ireland with no physical presence in the country; 3) the repatriation of foreign earnings to the United States; 4) the transfer payments that Apple makes to the US to pay for R&D; 5) the Commissioner's decision to impose a retroactive tax penalty on a foreign company that acted in accordance with the tax arrangements granted by its host country.

Case Authors : Morten Bennedsen, Brian Henry, Mark Stabile

Topic : Global Business

Related Areas : International business, Policy, Technology

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Calculating Net Present Value (NPV) at 6% for Did Apple Pay Too Little Tax? Appealing the EU Ruling on Illegal State Aid Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10023510)	-10023510	-	-
Year 1	3450627	-6572883	3450627	0.9434	3255308
Year 2	3980642	-2592241	7431269	0.89	3542757
Year 3	3959557	1367316	11390826	0.8396	3324520
Year 4	3226089	4593405	14616915	0.7921	2555365
TOTAL			14616915		12677951

The Net Present Value at 6% discount rate is 2654441

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting

What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.

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Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Payback Period
2. Internal Rate of Return
3. Net Present Value
4. Profitability Index

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Apple Tax shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Apple Tax have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of Did Apple Pay Too Little Tax? Appealing the EU Ruling on Illegal State Aid

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Global Business Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Apple Tax often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Apple Tax needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 15 %	Discounted Cash Flows
Year 0	(10023510)	-10023510	-	-
Year 1	3450627	-6572883	3450627	0.8696	3000545
Year 2	3980642	-2592241	7431269	0.7561	3009937
Year 3	3959557	1367316	11390826	0.6575	2603473
Year 4	3226089	4593405	14616915	0.5718	1844527
TOTAL					10458482

The Net NPV after 4 years is 434972

(10458482 - 10023510 )

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Calculating Net Present Value (NPV) at 20%

If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 20 %	Discounted Cash Flows
Year 0	(10023510)	-10023510	-	-
Year 1	3450627	-6572883	3450627	0.8333	2875523
Year 2	3980642	-2592241	7431269	0.6944	2764335
Year 3	3959557	1367316	11390826	0.5787	2291410
Year 4	3226089	4593405	14616915	0.4823	1555791
TOTAL					9487059

The Net NPV after 4 years is -536451

At 20% discount rate the NPV is negative (9487059 - 10023510 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Apple Tax to discount cash flow at lower discount rates such as 15%.

Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Apple Tax has a NPV value higher than Zero then finance managers at Apple Tax can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Apple Tax, then the stock price of the Apple Tax should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Apple Tax should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

What will be a multi year spillover effect of various taxation regulations.

What can impact the cash flow of the project.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Understanding of risks involved in the project.

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.

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Negotiation Strategy of Did Apple Pay Too Little Tax? Appealing the EU Ruling on Illegal State Aid

References & Further Readings

Morten Bennedsen, Brian Henry, Mark Stabile (2018), "Did Apple Pay Too Little Tax? Appealing the EU Ruling on Illegal State Aid Harvard Business Review Case Study. Published by HBR Publications.