Netflix Company Cost of Capital

Posted: August 27th, 2021

Netflix Company Cost of Capital

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Institutional Affiliation

Netflix Company Cost of Capital

The Cost of Capital of a company refers to the average blended cost of its equity and debt. It is explained by the company’s mix of debt and equity. The company’s equity and debt securities have different costs, implying that its weighted average is capital cost(Class 5 Notes – Cost of Capital, 2021). For the companies that are 100% funded, the cost of equity is equal to the weighted average cost of capital (WACC). In this case, weights show the equity and debt funding volume(Class 5 Notes – Cost of Capital, 2021). Thus, the blended cost of equity and debt represents the WACC. Hence, the paper aims to examine the cost of capital for Netflix Company to obtain its equity, debt and WACC, capital structure, credit markets, and debt ratings.

Question 1: Equity and Debt Cost of Capital and WACC

Equity and debt cost of capital are components of WACC. Therefore, the following formula is applied in calculating WACC;

Using Netflix 2020 financial reports, there is a need to ascertain the weight of equity and debt. The current Netflix equity market value (E) is about $231,040.74 million (GuruFocus. (n.d)) and short-term and long-term debt is $249.939 million and $15,284.12 million, respectively, total to book value of debt of about $15,534.112 million (GuruFocus. (n.d)). Hence;

Weighted equity

Weighted debt

Cost of Equity

Cost of equity =

Current risk – free rate = 1.74% (updated daily) (GuruFocus. (n.d))

Netflix Beta (which is the sensitivity of potential asset return) = 0.79

Therefore,

Cost of Debt

Netflix’s Interest Expenses (2020) = $1,385.9 million

Total Book Value of Debt (D) = $15, 534.12 million

Average tax rate = 11.58% (GuruFocus). Thus;

The Netflix WACC is 6.571%. The current return on invested capital is about 11.44% (GuruFocus. (n.d)). This implies that the company has higher returns than the costs of raising capital from the investment. Thus, it has excess returns on investment. Hence, Netflix is likely to have an increase in its future value because of high returns.

Question 2: Capital Structure and Cost of Capital

The current Netflix capital structure is such equity market value accounts for 0.93 while debt book value is 0.0634. However, the cost of equity, which is 6.48%, is lower than the debt cost, that is, 6.571%(GuruFocus. (n.d)). Thus, it implies that the company has a high capital cost, hence a high gearing level compared to the debt level.

Question 3: Credit Markets, Debt Ratings, and Cost of Capital

Credit Markets and Cost of Capital

The company credit market establishes a current debt of about $10 billion, which is likely to increase to $15 billion. However, the current flow of income and equity to debt ratio shows that its resources are mainly financing it(GuruFocus. (n.d)). Thus, it can meet its obligations besides adequately servicing its debts.

Debt Ratings and Cost of Capital

The current debt or credit rating for Netflix is BB+ (S&P 500). This is attributed to increased free operating cash flows. It is also due to the company’s potential to generate a sustained positive flow of cash towards 2021(Purnanandam, 2020). Therefore, this would likely lower its cost of capital besides improving the company’s capital value.

References

Class 5 Notes – Cost of Capital. (2021). In Advanced Corporate Finance.

GuruFocus. (n.d.). Netflix WACC % | NFLX – GuruFocus.com. Retrieved from https://www.gurufocus.com/term/wacc/NAS:NFLX/WACC-/Netflix

Purnanandam, A. (2020, April 27). Why Netflix’s Bond Offering Is Good News for the Markets and Economy. Retrieved from https://www.forbes.com/sites/amiyatoshpurnanandam/2020/04/27/why-netflixs-bond-offering-is-good-news-for-the-markets–economy/?sh=9e6a41354bcf