Running head: PART B: NETFLIX 1

Course Name

Semester

Term Project

Netflix

Name

ID

Date
 PART B: NETFLIX 2

Netflix is the leading company for streaming movies and series worldwide. It was

established in 1998 as an American DVD by mail service, which was later developed as a

streaming service in 2007. The company began to expand its operations in Canada in 2010 and

currently it serves 190 countries around the world. As of 2016, Netflix has reported over 75

million subscribers around the world and 44 million subscribers in the United States alone (Wall

Street Research Network, 2015).

Standalone Risk

Standalone risk is the risk associated with the single operating unit of an asset. This type

of risk would not exist if the company did not invest in the investment project or asset portfolio.

Netflix had a standard deviation of 0.109999 as seen in appendix 1. Its standard deviation is

actually higher than 0.039989 of Starbucks and 0.019185 of S&P 500. The higher the risk, the

higher the returns expected from a particular portfolio.

The coefficient of variance of returns or the correlation coefficient is the relationship

between two variables, which ranges between -1 and 1. In this case, the two variables being

considered are Netflix and S&P 500. The covariance of those two variables is 0.33 as shown in

appendix one. Netflix and S&P 500 have a low degree of positive correlation. This implies that

the two variables move in the same direction.

Market risk

A stocks beta measures the stock’s volatility in relation to the market where the market’s

beta is one. A beta of less than 1 implies that the stock is less volatile as compared to the market

while the beta that is greater than 1 shows a high volatility in relation to the market. According to

appendix 2 and appendix 3, we calculated a beta of Netflix 1.9053 while the market is one. Since

the beta of Netflix is greater than one, it implies that the stock is risky as compared to the market.
 PART B: NETFLIX 3

The stock’s beta can be used in the capital asset pricing model to determine the cost of equity or

the required rate of equity.

Calculated Beta in Comparison to the Reported Beta in the Financial Websites

We calculated a stock beta of roughly 1.9053 for Netflix. The beta was calculated after

performing a regression analysis between Netflix returns for the period of May 2003 to March

2016 and the market return that is the S & P 500 of the same period. The financial website that is

the yahoo finance reports a beta of 0.98 as shown in appendix 9. The beta we calculated and the

one in the Financial Website differ because we may have used a different formula than the Yahoo

Finance had used to calculate their beta (www.yahoo-finance, 2015). Lastly, the beta we

calculated of Netflix differs from the market due to the difference in risks.

Systematic and Unsystematic Risk

The total risk of a firm can also be divided into systematic and unsystematic risk. The

systematic risk is the undiversifiable risk that affects the aggregate outcomes while the

unsystematic risk is that which cannot be diversified. According to appendix 4, Netflix has a total

risk of 0.0121. Out of this 0.00134 is the systematic risk, which comprises of 11.04 percent while

roughly around 0.01076 is the unsystematic risk which comprises 88.96 percent of the total risk.

The market risks are those forces that affect stock simultaneously. These risks are often

dependant on the state of the economy. For example in the case of Netflix, the company had a

beta of 1.9053. Since Netflix' un-diversifiable risk comprises of 11.04 percent, there will be need

to compensate them with higher returns as they cannot invest in other portfolios. However, those

investors who partake 88.96 percent risk in Netflix can be able to diversify their funds and

therefore there will be no reason to compensation them with higher returns. In conclusion, the
 PART B: NETFLIX 4

higher the risk incurred by investors the higher the return of their investment portfolios

(OECD.org, 2013).

Required Rate of Return Estimates

The required rate of return is the cost of equity of any company. In order to find the

required rate of return of Netflix, we can use the capital asset price model or the dividend-pricing

model since the company pays dividends to its shareholders. In the capital asset price model, we

must first determine the risk free rate, which we calculated as 0.23 percent. We also need to

determine the risk premium. In this scenario of Netflix, we calculated the risk premium, which

can be gotten from the market risk less the risk free rate to be 6 percent. Together with the beta of

Netflix of 1.9053 as shown in appendix 3, we can be able to calculate the cost of equity of the

company (Morningstar, 2012).

Ke=Rf + Rpβ

Ke=0.23 + ( 6 ∗1.9053 ) =11.6620

The required rate of return of Netflix from the CAPM is therefore 11.6620%. We also

used the dividend model to calculate our cost of equity. In this case, one must know the

company’s dividend for the year of the company at hand, the forecasted growth in stock, and the

market price per share of that company. In our case of Netflix, the company did not pay any

dividends during that year, the forecasted growth of the company’s shares were 26.94% while the

market price of the company was $ 59.64. The cost of equity in this scenario can be calculated as

shown below.

D1
Ke= +g
p0

0
Ke= +26.94 =26.94
59.64
 PART B: NETFLIX 5

The required rate of return using CAPM and the dividend model differ because in the

dividend model, the company does not have any dividends. I feel that the capital asset price

model is more realistic as the dividend model is only used when the company has given out

dividends in that respective year.

Efficient Frontier and Optimal Portfolios

According to appendix 6, we constructed an efficient frontier curve for Netflix. Here, an

investor who believes in efficient markets can determine where he will be exposed to high

returns at low variance when he decides to invest in the company. From the appendix, it is clear

that the investor who buys shares in Netflix can be able to get maximum return from the

portfolio at high level of risk. A decrease in the standard deviation of the company would result

in a decline in the expected returns. Investors who invest in Netflix are therefore encouraged to

diversify their funds. Diversification is where the investor invests in two different stocks or

companies. If the risk of investing in Netflix is high, an investor is advised to invest some funds

in another company say Star Bucks to benefit in both portfolios despite the risk. Lastly, the

efficient frontier curve of Netflix tells us that the higher the risk of an investment the higher the

amount of return expected from a portfolio asset or company. In the case of Netflix, an investor

who invests in the company will realize maximum return at 0.6136% when the market risk is

0.006%. As the return decreases, the risk of the company increases up to a point where the

efficient frontier reaches its maxima.

 PART B: NETFLIX 6

Appendixes

Appendix 1: Standalone Risk of Netflix, S&P 500 and Starbucks

Standalone Risk Netflix Starbucks S&P 500

Mean 0.006136 0.003392 0.000888
Standard Deviation 0.109999 0.039989 0.019185
Variance 0.007551 0.001832 0.000597
Covariance 0.000701 0.000642
Coefficient of variance of returns 17.925727 11.787983 21.602633
Correlation 0.330679 0.614368

Appendix 2: The Market Risk of Netflix

Market Risk Netflix Starbucks

Beta 1.9053 1.7437

Appendix 3: Calculation of Cost of Equity using CAPM

Required Rate of Return

CAPM Netflix Starbucks Note
r_f (3 month) 0.23% 0.23% as of 03/30/16
Market Risk-Premium 6% 6% given
Beta 1.9053 1.7437
Cost of Equity 11.6620% 10.6920%

Appendix 4: Calculation of Systematic and Unsystematic Risk

Systematic risk and Unsystematic risk Netflix Starbucks

Total Risk 0.0120998079 0.0015990875
Systematic risk 0.0013361816 0.0011190495
Unsystematic risk 0.01076362629 0.00048003796
Portion of Systematic risk 11.04% 69.98%
Portion of Unsystematic risk 88.96% 30.02%

Appendix 5: Calculation of the required rate of return estimates

Dividend Valuation Model Netflix Starbucks

 PART B: NETFLIX 7

r = (D1/P0) + g
Dividend for year 2016 N/A 0.2
Stock Price on 03/30/15 59.64 46.61
Forecasted Earnings growth in next 5
26.94% 17.60%
yrs
Required Rate of Return 26.94% 18.03%

Appendix 6: Efficient frontier graph

Efficient Frontier
0.7000%

0.6136%
0.6000%
0.5862%
0.5588%
0.5313%
0.5000% 0.5039%
0.4764%
0.4490%
0.4216%
0.4000% 0.3941%
0.3667%
0.3392%
0.3000%

0.2000%

0.1000%

0.0000%
0.0020 0.0040 0.0060 0.0080 0.0100 0.0120 0.0140 0.0160 0.0180 0.0200

Appendix 7: Stock Prices of Netflix of 2002 to 2016

 PART B: NETFLIX 8

$140.00

$120.00

$100.00

$80.00

$60.00

$40.00

$20.00

$-

Appendix 8: Weekly Return of 2002 to 2016 of Netflix

60.00%

40.00%

20.00%

0.00%
0 2 02 03 0 3 04 04 0 5 05 06 0 6 0 7 07 0 8 0 8 09 0 9 1 0 1 0 11 1 1 1 2 12 1 3 1 3 14 14 1 5 15
2 8/ 25/ 27/ 24/ 24/ 22/ 23/ 21/ 22/ 20/ 21/ 19/ 19/ 17/ 18/ 16/ 17/ 15/ 16/ 14/ 14/ 12/ 13/ 11/ 12/ 10/ 11/ 09/
/ / / / / / / / / / / / / / / / / / / / / / / / / / / /
05 11 05 11 05 11 05 11 05 11 05 11 05 11 05 11 05 11 05 11 05 11 05 11 05 11 05 11
-20.00%

-40.00%

-60.00%

Appendix 9: Netflix’s Beta as per Yahoo Finance

Beta 0.98
52-week change 50.15%
S&P 500 week change -2.57%
 PART B: NETFLIX 9

52-week high (Dec 7, 2015) 133.27

52-week low (April 15, 2015) 67.36
50-day moving average 99.17
200-day moving average 106.14
Source: www.yahoo.finance, 2015)

Appendix 10: Summary Output of Netflix

SUMMARY OUTPUT
Regression Statistics
Multiple R 0.325837
R Square 0.10617
Adjusted R
Square 0.104486
Standard Error 0.084917
Observations 533
ANOVA
Significanc
df SS MS F eF
Regression 1 0.454812 0.454812 63.0725 1.2E-14
Residual 531 3.829013 0.007211
Total 532 4.283825
Coefficient Standard Upper Lower Upper
s Error t Stat P-value Lower 95% 95% 95.0% 95.0%
Intercept 0.00345 0.003678 0.93803 0.348655 -0.00378 0.010676 -0.00378 0.010676
-0.01584 1.099432 0.138436 7.94182 1.2E-14 0.827483 1.371381 0.827483 1.371381
 PART B: NETFLIX 10

References

Wall Street Research Network. (2015). More about Netflix. Retrieved on 12 th April 2016 from

http://www.wsrn.com/Netflix/

OECD. Organization for Economic Cooperation and Development. Retrieved on 12 th April 2016 from

http://www.oecd.org/

Morningstar. (2015). Morningstar’s Approach to Stock Analysis. Retrieved on 12 th April 2016 from

http://news.morningstar.com/iandwin/Msapproach.pdf/

Yahoo Finance (2015). The Beta of Netflix. Retrieved on 12th April 2016 from http://www.yahoo-

finance.com/Netflix/Beta/