\This problem is based on Netflix Inc. and it is designed to underscore the power of financial ratios and the relationship between numbers and strategy. Whether we are making a personal plan for retirement or we are leading an organization, when making decisions that involve financial resources and strategies, ratios are an important because they highlight relationships. In the introductory paragraphs of their SEC Form 10-K, prepared for the 2018 fiscal year, Netflix describes their company as the worlds leading internet entertainment service with over 139 million paid memberships in over 190 countries enjoying TV series, documentaries and feature films across a wide variety of genres and languages. (Netflix Inc., 2018) Numbers are an essential part of the Netflix story. Netflix was founded in 1997 on a business model that employed the then new idea of placing videos in mailers and mailing them to subscribers in return for small rents. Subscribers would take the videos out of the mailers, watch them on their players at home, and send them back to Netflix. The company has come a long way since 1997. Netflix is an outstanding example of a company that has continuously reinvented itself in response to challenges emanating from a rapidly changing environment. Still, their future success is in no way guaranteed. The excerpt which follows is taken from the 2018 10-K report Netflix filed with the SEC. We are a pioneer in the internet delivery of TV shows and movies, launching our streaming service in 2007. Since this launch, we have developed an ecosystem for internet-connected screens and have added increasing amounts of content that enable consumers to enjoy TV shows and movies directly on their internet-connected screens. As a result of these efforts, we have experienced growing consumer acceptance of, and interest in, the delivery of TV shows and movies directly over the internet. Our core strategy is to grow our streaming membership business globally within the parameters of our profit margin targets. We are continuously improving our members' experience by expanding our streaming content with a focus on a programming mix of content that delights our members. In addition, we are continuously enhancing our user interface and extending our streaming service to more internet-connected screens. Our members can download a selection of titles for offline viewing. (Netflix Inc., 2018) Netflix has embraced the concept of providing original programming. Their programs and documentaries have been honored with Emmy, Golden Globe, and Academy Oscar awards.

3.1. Managing liquidity is a challenge faced by individuals and organizations alike. In the case of a shutdown by the Federal government, employees who do not receive their regular paychecks are acutely aware of the potential for a liquidity crisis in their household. The business strategy embraced by Netflix is a high-risk strategy which also underscores the importance of managing liquidity. You can think of the current ratio as a financial vital sign corresponding to pulse or blood pressure in the domain of medical vital signs.

3.1.A .Compute the current ratio for Netflix as of December 31, 2018, December 31, 2017, December 31, 2016. Note: Do NOT include Deferred revenue in the computation of this ratio. Round to 2 decimal places. Answers: December 31, 2018 _______; December 31, 2017 _______; December 31, 2016 _______

3.1.B Is there a trend in Netflixs current ratio over the three-year period under consideration and, if so, does the trend indicate that Netflixs short-term liquidity position has significantly improved or deteriorated? Explain. Operating/Profitability Metrics

3.2 Over the three-year time period covering fiscal years 2018, 2017, and 2016, the amount Netflix spent on marketing more than doubled. During this same time period revenues also increased dramatically.

3.2.A. Expressed as a percentage of sales revenue, by what percent has the amount spent on marketing increased or (decreased) when the ratio for the fiscal year ended 12/31/16 is compared to the ratio for the fiscal year ended 12/31/18? Round to 2 decimal places. Answer _________%

3.2.B Marketing appears to be a crucial part of Netflixs operating strategy and their cost structure. Without a major commitment to marketing it appears that Netflix could not achieve its goal of increasing revenue from subscriptions. If they could, we can assume that Netflix would cut back on marketing and devote those funds to other purposes. Explain how the relationship between revenue and marketing expense creates a cost structure that results in a barrier to entry that would discourage or prevent existing and potential competitors from attempting to compete with Netflix for market share.

3.3 Netflix uses the term content which roughly corresponds to inventory and the term cost of revenue which roughly corresponds to cost of goods sold. The inventory that Netflix streams includes previously canceled series from other networks, licensed and co-produced content, and Netflix original content. Content assets are intangible property rights. Our course has considered the importance of managing costs and cost accountingthese topics are of crucial importance to Netflix now that they have made the decision to produce their own original content.

3.A. The ratio of cost-of-revenue to revenue (cost-of-revenue/revenue) provides a metric to assess how well Netflix is able to manage its gross profit percentage. An increase in rates charged to customers and/or a decrease in the cost of revenue will result in an increase in the gross profit percentage. If the ratio of cost-of-revenue to revenue reported for the year ended December 31, 2016 did not change over the three-year period from the number computed for the year ended December 31, 2016, how much in thousands of dollars would operating income for the year ended December 31, 2018 have increased or (decreased)? Answer $_____________________ indicate whether the change is an increase or decrease

3.3.B ( Rather than making a tangible product, such as furniture or widgets, Netflix makes content for streaming. When accounting for the cost of original content, Netflix will account for the direct materials, direct labor, and overhead expended to create the content. Producing content requires production assets, licenses, and an investment in technology. Explain how accounting choices regarding methods of depreciation and amortizations can influence the determination of the amounts reported as cost-of-revenue.

Capitalization Metrics

3.4 Many individuals have chosen to purchase their homes rather than rent, and many of these owners depend upon mortgages as a source of long-term financing. During the housing crisis beginning in 2008, homeowners who bought with minimal down payments and homeowners who borrowed extensively against their homes appreciation found themselves in a highly leveraged position when the housing crisis struck. These decisions made by homeowners parallel decisions made by Netflix executives.

3.4.A As reported on December 31, 2018, December 31, 2017, and December 31, 2016, what percentage of total assets is financed by long-term debt? Round to 2 decimal places. Ans.: December 31, 2018 ______ %; December 31, 2017 ______ %; December 31, 2016 ______ %

3.4.B As reported on December 31, 2018, December 31, 2017; and December 31, 2016 what percentage of total assets is financed by contributed capital paid-in by stockholders? Round to 2 decimal places. Ans.: December 31, 2018 ______ %; December 31, 2017 ______ %; December 31, 2016 ______ %

3.4.C As reported on December 31, 2018, what percentage of total assets is financed by past profits that were reinvested in the company? Note: Ignore the amount reported as Accumulated other comprehensive loss; it is relatively small and immaterial. Round to 2 decimal places. Answer _______ % 3.4.D (4 points) During the three-year period ended December 31, 2018, has Netflix depended upon leveraging debt as an essential part of their growth strategy? Explain.

3.4.E In October of 2018, Netflix announced its intent to sell to institutional buyers $2 billion in bonds through an offering of U.S. dollar and Euro denominated bonds. The bonds are not secured by fixed assets or any other collateral and the proceeds will be used for operating purposes. At the time of the issuance, Moodys assigned Netflix a long-term credit rating of Ba3, which is considered speculative, or 'junk.' Investors purchasing these bonds will receive relatively higher interest payments to compensate them for the underlying risk and Netflix will incur higher debt carrying expense because of the relatively high rate they must pay. Netflix stockholders, on the other hand, have not received any dividends during the three-year period ended December 31, 2018. How do you explain the stockholders willingness to accept the Board of Directors decision to withhold dividend payments to stockholders?