Problem: Capital Budgeting and Valuation
Netflix.shop is contemplating a partnership with Alibaba-the e-commerce company-to get a stronger foothold in China. The project entails the following projections:
1. An initial investment of $100 million.
2. Revenue of $200 million in 2022, with 10% growth per year until 2026, and 3% per annum afterwards. So, 2021 is Year 0, 2022 is Year 1 and Terminal Value is after 2026.
3. Operating income margin of 4% in the first four years, and 5% per annum afterwards.
4. Working capital / sales of 5% per year i.e., on average, the level of working capital is 5% of sales. Working capital in year 0 (2021) is $0.
5. No additional capital expenditure and no depreciation/amortization.
6. Assume 21% as corporate tax rate.
To determine the WACC, you are given the following information:
1. Netflix's overall WACC is 8%
2. Netflix's WACC for merchandising in North America is 7%.
3. Netflix estimates that any venture, streaming or merchandising, in Southeast Asia (including China) commands an incremental WACC of 4% over the same venture in North America.
Financing Decision
1. Netflix is at a crossroads in terms of how to sustainably finance its growing and increasingly complex operations. First, you want to understand the company's recent financing strategy
2. Using information from the relevant annual 10-K's (2019-2021), which was the primary source of external financing that Netflix used in 2019 (two thousand nineteen)?
3. Netflix management mentioned that the company was ready to self-finance its growth going forward. What data in the financial statements is the clearest evidence supporting that shift?
4. If Netflix was to pursue with the Alibaba partnership, how do you think the company should finance the project: raise equity, issue debt, or tap into its cash reserves? Explain or justify your selection in a few sentences with appropriate references to the 10-K.