Nordstrom Investment Funding Proposal Moe Ba

MBA-640 9-1 Final Project Submission: Nordstrom Investment Funding Proposal Maham Ba Southern New Hampshire University  I. Executive summary This funding proposal provides an analysis and evaluation of an investment opportunity that could provide Nordstrom with the growth it needs to stop declining profitability. The investment opportunity is building a clothing store in the Nine Elms neighborhood of London, United Kingdom that is currently undergoing regeneration and is projected to attract millions of visitors annually once the ongoing redevelopment is completed. This will be Nordstrom’s first international expansion outside North America and will act as a springboard for the company to grow internationally. The project will cost an estimated $440 million to build and will take approximately 14 months to complete. Methods of analysis include trend, horizontal and vertical analyses as well as ratios such as Debt, Current and Quick ratios. Other calculations include payback, NPV, and IRR and detailed explanations appear throughout the report with summary tables and graphs appearing in the appendices. Results of the data analyzed show that undertaking this project will be beneficial for Nordstrom, and will help to stem the current slump in the company’s profitability. The report finds the prospects of the company going forward will be greatly improved by the project and recommends that the committee approves the requested funding required to implement the project. II. Investment opportunity I have explored various investment opportunities that Nordstrom, Inc. could undertake in the short-term to support the management’s goal of integrating the company’s multiple retail channels and boost long-term growth. Nordstrom’s primary goal is to deliver the best customer experience possible (Nordstrom, n.d.), and to achieve this goal the company will need to fulfill customer orders fast and cost-effectively. With the company looking for growth opportunities beyond its traditional markets in the west coast, I believe that building a fulfillment center that can serve customers especially in the Northeast and New England markets will contribute to the company’s growth. A. Project description The investment project is building of Nordstrom’s first flagship store in the Nine Elms neighborhood of London, United Kingdom marking the beginning of the company’s overseas expansion outside of North America. This will be the company’s first store outside the United States and Canada which are the only 2 countries that the company operates in as of April 2020, so it will be a signature store only second to the company’s New York and Seattle stores in terms of size. The proposed store will be 350,000 square feet and is expected to open its doors to customers on August 1, 2020. The Nine Elms neighborhood was selected for the new store because of the ongoing renovation of the Battersea Power Station and adjacent areas that is expected to bring in large corporations including Apple, and with it increased traffic from the apartments, hotels, and offices that are currently under construction. A flagship store in one of the most iconic cities in Europe will place Nordstrom in the perfect position for expansion into other cities in the United Kingdom as well as the broader European Union market in the coming years. London is the biggest financial capital in Europe and already attracts more than 30 million visitors per year. The selected location already has an ongoing redevelopment project worth approximately $18 billion that is projected to be finalized in 2025. Additionally, the U.S embassy in London located at 33 Nine Elms Ln is in the same neighborhood only 2 blocks away from the proposed investment project. One of the primary reasons why the investment is needed is that it will increase Nordstrom’s presence and enable the company to expand internationally. The company is in need of growing its market share due to increasing competition in the domestic market and international expansion presents a roadmap for achieving this objective. The primary financial metric that will be used to determine the success of the project is the internal rate of return (IRR). At the moment, the company’s capital structure comprises of 72.3% equity and 27.7% debt and the resulting weighted average cost of capital is 4.31%. Consequently, the new project if it has an IRR of 15% which is marginally lower than individual stores IRR in the more established domestic market and Canada which is currently 20%. The primary reason for choosing IRR as the method of evaluating the success of the project is that IRR takes into account the time value of money. This is important because the project will be partially financed using debt, and this will result in the change of capital structure 68% equity and 32% debt, thus an increase in the cost of capital. At 15%, the IRR will have exceeded the cost of capital by at least 10%, thus the project would have met the financing costs. B. Resources required Financing is one of the major resources that will be required for this project to be realized because given the location, and the square footage of the new store it will cost an estimated $440 million to build. The large financial outlay will be partially financed using capital, of which the company’s management is expected to provide $140 million representing about 21.4% of the company’s budgeted capital expenditure for the 2019 financial year. The remaining $300 million will be financed partly through a consolidated bank loan where the company will seek $150 million from financial institutions, and the additional $150 million will be financed using a 10-year coupon bond at the rate of 4% paid semiannually. This capital mix is expected to significantly impact the company’s capital structure and result in a slight increase in the overall cost of financing. However, the impact will be offset by the increase in market share and added cash inflows. The second resource that will be needed for this project to be realized is human resource, and the company will primarily rely on contractors to provide the necessary human capital. Building 350,000 square feet of retail space in a location that is currently undergoing extensive reconstruction calls for reliable contractors with the requisite resources to meet the labor needs needed for the project. The project will require sufficient human resources with the correct skill sets and experience to deliver within the strict timeline given that the new store is expected to be operational before the fourth quarter of 2020. Another key resource that is related to the human resources discussed in this section is subcontractors. A complex building project executed from scratch requires accessibility to subcontractors at different phases of the building project, thus subcontractors will be vital to delivering the project within the stipulated timeframe. Products and materials are another key resource that is vital to the timely implementation of the project. Since this is a project that will be executed overseas in a country where Nordstrom does not have existing contractor and supplier relationships it is expected that the contractors will use their existing supply chains to implement the project. Another set of resources vital to the realization of the building project is construction plant, tools, and equipment. These will be provided by contractors throughout the project implementation. Additionally, space and facilities are a vital resource for a project of this nature that requires putting up a new building along with the necessary amenities from scratch. Other resources that will be needed for this project to be successful are government approvals, and access to labor because the store is estimated to require about 300 personnel to run efficiently. C. Project time frame The anticipated economic life of the project is 30 years, how and when to exit the project will primarily depend on whether it will be meeting the minimum IRR requirement of 15%. As highlighted in the description of the project section above, meeting the IRR is the primary project viability evaluation, thus it will guide future decisions about when and how the project will be exited. Provided that the project continues to meet its financial performance requirements it will run through the entire project lifecycle, but if it turns out to be a loss-making investment its viability will be reevaluated whenever the minimum IRR requirement is not met. The construction phase of the project is expected to last for approximately 14 months starting on May 1, 2019, when the initial proposal and documentation will be done to August 27, 2020, when construction will be completed as shown in the project deliverables timeline in the following table. ACTIVITY DATE 1 Proposal and Documentation 1/5/2019 2 Design 10/6/2019 3 Contracts/Bids 24/6/2019 4 Permits 1/7/2019 5 Inspections 7/7/2019 6 Site Preparation 21/7/2019 7 Hazardous Material Abatement 21/8/2019 8 Shoring 7/9/2019 9 Earthwork 21/9/2019 10 Paving & Surfacing 15/10/2019 11 Water Systems 1/11/2019 12 Sewerage & Drainage 28/11/2019 13 Electric Power Transmission 7/12/2019 14 Foundation/Framing 21/12/2019 15 Roof/Exterior Finishes 1/2/2020 16 Plumbing/Electrical/HVAC 21/2/2020 17 Insulation/Drywall 7/3/2020 18 Interior Finishes 21/3/2020 19 Painting 1/4/2020 20 Flooring 8/4/2020 21 Fixtures/Appliances 21/4/2020 22 Landscaping/Design 1/5/2020 23 Individual Store Closet 7/5/2020 24 Display/Dressing/Changing 15/5/2020 25 Equipment Storage 21/5/2020 26 Office[s] 28/5/2020 27 Restroom 7/6/2020 28 Vehicle Parking 33,000 SF 14/6/2020 29 Irrigation 21/6/2020 30 Final Details/Closure 28/6/2020 31 Fences & Gates 13/7/2019 32 Other 21/7/2020 Given the cost implications of this project, its ability to meet the financing needs will be a vital component in assessing its continued viability. As highlighted in the resources the project will need section above, more than two-thirds of the project cash outlay will be financed using debt, therefore the project will be expected to fund interest payments starting in 2021. The following table and graphs appearing in the appendix summarize the bond repayment over the 120 months that it will be outstanding given the current interest rate on Nordstrom’s comparable bonds outstanding, and an average annual inflation rate of 2.0% over the next 10 years: Bond Amount 150,000,000 Annual Interest Rate 4.00% Bond Period in Years 10 Average Annual Inflation Rate 2.0% Calculation Results Monthly Bond Repayment 1,518,677.07 Total Interest over Bond Period 32,241,248.70 Total Bond Repayment over Bond Period 182,241,248.70 Net Disposable Income 30,000 Maximum Bond Qualification Amount 2,963,105.25 Minimum Required Net Disposable Income 1,518,677 Interest Rate Safety -56.78% Increased Instalment Repayment Amount 1,518,677.07 Total Adjusted Interest over Bond Period 32,241,248.70 Adjusted Bond Repayment Period (in months) 120.00 Adjusted Bond Repayment Period (in years) 10.00 Interest Saving - Present Value of Interest Saving - Monthly Bond Repayment @ 4.00% 1,518,677.07 Monthly Bond Repayment @ 0.00% 1,250,000.00 Monthly Difference -268,677.07 As shown in the table above, the store will require a minimum net disposable income of at least $1.5 million to finance the interest payments that are projected to rise to $32 million over the life of the bond. The funding obtained from banks will also have interest payment obligations amounting to $1,530,825.65 in interest and principal repayments per month. III. Justification A. Investment timing This is a good time for the investment for a variety of reasons that I will highlight in this section. Firstly, the United Kingdom is one of the most business-friendly nations in the world and it is an established major trading nation. Establishing a new business in the United Kingdom takes less than 2 weeks which is the lowest in Europe. This combined with the United Kingdom being the sixth largest economy globally with a population of $66 million people and a median household disposable income of £28,400 (approximately $37,000) makes the United Kingdom an attractive investment destination. The second reason has to do with the post-Brexit scramble to attract new foreign direct investment which will likely result in attractive incentives for businesses willing to invest in the United Kingdom. It is, therefore, a good time to take advantage of available incentives as this will significantly reduce the initial costs (UK Trade & Investment, 2013). Another reason why now is a good time to undertake this investment is because of the tax environment that the United Kingdom affords foreign investors. Prior to the passage of the jobs and tax act 2017, the United Kingdom had the lowest corporate tax rate in the G7, and at 28% it remains a fairly competitive country to invest in. Additionally, the United Kingdom is the most flexible labor market in Europe, and this will enable the company to access a diverse and skilled labor force to meet the needs of the new store. Another reason why now is a good time to invest is because of the few barriers to investment that make the United Kingdom a great investment destination. The country is only second to the US when it comes to product market regulation and has the least barriers to trade investment globally. This combined with the fact that the United Kingdom is one of the most productive places for innovation makes this a timely market to enter for Nordstrom (UK Trade & Investment, 2013). With regard to political stability, the United Kingdom is ranked higher than even the US, Germany, France and Japan and this makes the investment a great opportunity for the company. The United Kingdom also has a stable regulatory environment and easy property registration. Additionally, because English is the operational language, it will much easier for Nordstrom to launch its operations because there are no language barriers and the additional costs of doing business that comes with it. Other advantages that make this a good time to launch the investment include the United Kingdom having a strong communication network, transport links, rapid productivity growth, and being the leading global financial center, which will make it easier for Nordstrom to raise the required debt financing. Lastly, the Elms neighborhood where the proposed store will be located is undergoing a transformation with many multinational corporations setting up base in the area which makes it the perfect location for a new Nordstrom store (UK Trade & Investment, 2013). B. Strategic fit Nordstrom’s organizational goals include serving customers better, always being relevant in their lives and forming lifelong relationships. Establishing a new store in London makes strategic sense for Nordstrom because it gives the company a Launchpad for international expansion outside the company’s core markets in North America. With retail trade gradually moving online and Nordstrom focusing on having an optimal number of stores to avoid the store closures that have affected retail clothing company’s in the United States in the past, having a few signature stores in the most attractive addresses in the world will give the company the visibility it needs to continue growing its brand. The US and Canadian markets will not provide the growth opportunities that Nordstrom needs going forward, so this is a good time to focus on the international stage (Nordstrom, 2019). From a financial perspective, and based on analysis of Nordstrom’s financial statements, this investment makes sense for Nordstrom because it will provide the cash flow boost that the company needs to continue growing. As shown in appendix 2, Nordstrom has been experiencing declining profitability, thus the company could use a store that will boost sales and bring profits of it is to recover to the profitability levels it had 5 years ago when net income was approximately 5.33% of total revenues compared to 2018 when it was 2.82% (SEC, 2018). A review of the EBITDA as a percentage of total revenues further indicates that the company’s profitability has indeed been declining so a new profitable store would come in handy. London is a key fashion market and by not having a store there Nordstrom is practically leaving money on the table. The new store would tap unmet demand for the company’s key products and services and enable the company to capitalize on its nearly 120 years of experience in the industry (Nordstrom, 2019). C. Financial Impact Analysis of the projected incremental annual cash flows associated with the proposed project indicates that it will be very beneficial to Nordstrom. The growth rate in net sales and the resulting net income is projected to be higher than the company’s current organization-wide performance of 4% annually. Demand is projected to grow at 40% early in the project but later slow down to about 22% from year 4 and again to 10% annually starting year 7. Price, volume, capital purchase costs, incremental hiring, and other expenditures are projected to remain constant as a percentage of revenues. Thus, over the 10-year period, the project will result in about $7,557 million of incremental net sales, cost $2,715 million in operating expenses and $435 million in tax expenses. The following table presents a summary of the incremental, annual, and cumulative cash benefits and outflows associated with the proposed expansion for the next seven years: As highlighted in the investment risk, the anticipated economic life of the project is 30 years. Additionally, the investment is expected to have a salvage value of $20 million thus the depreciable $420 million value of the investment will be depreciated straight-line over 30 years. This will result in an annual depreciation expense of $14 million, thus at the end of the 7-year period covered in the consolidated financial projection of revenue, pretax income, and cash flow the carrying value of the investment will be $336 million. Growth assumptions both for the income statement and balance sheet appear in Appendix 3 while the line item component percentages assumption appears in Appendix 4. Based on the assumptions highlighted above, the project will add significant value to Nordstrom as shown in the tables below:   PROJECT ALONE Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Net Sales $300 $420 $440 $530 $645 $785 $956 $1,052 $1,157 $1,272 Cost of Goods Sold 110 105 170 185 216 263 320 358 393 433 Expenses 121 140 155 180 234 285 347 379 416 458 EBT $69 $175 $115 $165 $195 $237 $289 $315 $347 $382 Taxes 13 33 22 31 37 45 55 60 66 73 Net Income $56 $142 $93 $134 $158 $192 $234 $256 $281 $309 PROJECT WITH COMPANY FINANCIALS Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Net Sales $16,160 $16,914 $17,594 $18,370 $19,199 $20,081 $21,024 $21,922 $22,862 $23,846 Cost of Goods Sold 10,186 10,584 11,068 11,519 12,003 12,522 13,069 13,617 14,183 14,774 Expenses 4,781 4,986 5,195 5,421 5,685 5,954 6,243 6,510 6,794 7,090 EBT $1,193 $1,344 $1,331 $1,430 $1,510 $1,605 $1,712 $1,795 $1,886 $1,982 Taxes 249 279 277 297 313 332 354 371 389 409 Net Income $944 $1,066 $1,054 $1,133 $1,197 $1,273 $1,358 $1,425 $1,497 $1,574  IV. Investment risks I have explored various investment opportunities that Nordstrom, Inc. could undertake in the short-term to support the management’s goal of integrating the company’s multiple retail channels and boost long-term growth. Nordstrom’s primary goal is to deliver the best customer experience possible (Nordstrom, n.d.), and to achieve this goal the company will need to fulfill customer orders cost-effectively and fast. With the company looking for growth opportunities beyond its traditional markets in the west coast, I believe that building a fulfillment center that can serve customers especially in the Northeast and New England markets will contribute to the company’s growth. Internal Risks and Opportunities One of the key internal risks related to the investment is that the results may differ from Nordstrom’s guidance as a result of projection errors. The company relies on estimates and projections with regard to sales and operating performance in different seasons, thus any errors in connection with the future performance of the investment will adversely affect the outcome of the project. Market valuations also change as more information becomes available and this may have a negative impact on the project’s performance results. Additionally, Nordstrom’s announcements may impact the performance of the company once factored into analysts’ recommendations as these tend to affect buyer sentiment and shareholder returns (SEC, 2018). Investment and partnerships in new business strategies and acquisitions may end up disrupting the company’s core business including the new store. Nordstrom’s pursuit of growth in recent years has seen the company invest in or pursue strategic growth opportunities not only in other businesses but also in new technologies with the aim of fulfilling its goal of providing superior customer shopping experiences across its platforms. For example, in 2018 Nordstrom completed the acquisitions of digital start-ups BevyUp and MessageYes to help the company keep pace with retail rivals online (Nordstrom, n.d.). As the company pursues the online market its investments in the traditional brick and mortar stores may slow down. Nordstrom utilizes working capital not only to finance operations but also to make capital expenditures and manage debt, thus failure to appropriately manage capital may negatively impact the project. As highlighted in the investment project and justification section, out of the $440 million total project costs, the company will seek $150 million from financial institutions, and the additional $150 million will be financed using a 10-year coupon bond at the rate of 4% paid semiannually. Consequently, adverse changes in the credit and capital markets, including market disruptions, limited liquidity, and interest rate fluctuations, may increase the cost of financing or restrict access to a potential source of liquidity (SEC, 2018). Another key internal risk related to the investment project is the concentration of stock ownership in a small number of shareholders which limits shareholders’ ability to influence corporate matters (SEC, 2018). Members of the Nordstrom family collectively own approximately 31% of the company’s common stock, thus they wield considerable influence and could potentially influence investment decisions. An investment of this magnitude in a foreign market requires shareholder approval because the corporate law of the State of Washington where Nordstrom is incorporated requires that significant corporate transactions get the affirmative vote of two-thirds of a company’s outstanding shares. Without the approval of these shareholders, therefore the investment may not be undertaken. The biggest opportunity that Nordstrom has in relation to the investment project is the company’s relatively low cost of capital which enables it to access capital easily compared to industry peers. Marks & Spencer Group PLC which would be one of Nordstrom’s major competitors in the UK market has a WACC of 5% while Dillard’s Inc. another major competitor has a WACC of 8.35%. This indicates that Nordstrom is in a great position to raise the capital required to finance the investment relatively faster and more cheaply compared to its major competitors. Additionally, Nordstrom has a rich corporate culture and reputation to enable it to attract, retain, train and develop talent. Microeconomic Factors and Significant External Qualitative Risks There are numerous qualitative risks outside Nordstrom that the company faces that could have a significant impact on the investment project given its size and cost implications. As highlighted in the description of the investment project, the proposed flagship store in the Nine Elms neighborhood of London, United Kingdom will be a signature store measuring 350,000 square feet, thus only second to the Nordstrom’s New York and Seattle stores in terms of size. Consequently, this project exposes the company to the liabilities and losses that come with ownership and leasing of real estate. The primary risk with such projects is that the value of the assets could decrease (SEC, 2018). Property values are subject to numerous external forces that are beyond an investor’s control. Therefore, should the value of the assets decrease then Nordstrom stands to make a loss on the investment, yet the company has no control over real estate trends. Another significant qualitative risk that comes with ownership of real estate is that operating costs could increase beyond what has been projected in the pro forma statements supporting the investment (SEC, 2018). If the operating costs increase then the company’s operating margin and by extension, the net income projections will not be met and this will have a bearing on the success of the project. The summary timeline presented in the investment project and justification section is based on the plan that the construction phase of the project will take approximately 14 months. Construction planning starts on May 1, 2019, when the initial proposal and documentation will be done while the construction phase itself is expected to last until August 27, 2020, when constructions works will be completed. However, there may be changes in the real estate market, demographic trends, economic environment and site competition which may prevent the store from opening within the projected timeframe. This is further exacerbated by the fact that the timely opening of the store is largely dependent on third-party performance. As a retailer, Nordstrom’s business is seasonal in nature, thus the company’s revenues and operating results are subject to seasonal fluctuations and cyclical trends in consumer spending (SEC, 2018). In Nordstrom’s domestic market, the company records high sales in the second and fourth quarter, but because the UK is a foreign market there might be variations in these seasonal trends. Additionally, Nordstrom sells high-quality items and as such a downturn in general economic conditions may have a negative impact on the company’s business. High-quality items may be seen as discretionary, thus during economic downturns, the number of consumers could fall drastically, and those who shop may limit their spending. The store will be located in a part of London that is undergoing regeneration, so its performance may be adversely affected by a decline in consumer traffic or the location failing to generate the anticipated interest. Operating performance is predicated on there being sufficient consumer traffic as a result of the new Nordstrom store itself, the Battersea Power Station and other retail businesses in the area being able to generate consumer traffic. Additionally, the availability of other retail and leisure destinations near the proposed store coupled with the success of other anchor tenants will affect the success of the investment given that there are other bigger retail destinations in Central London. Dependence on third parties for the production, supply, and delivery of materials during construction as well as of goods once the store begins operating (SEC, 2018) is another qualitative risk. In general, Nordstrom’s business is tied to timely receipt of quality merchandise from third parties, and the company will be putting up a signature store in a foreign country with contractors that it has not worked with in the past. Additionally, identifying quality vendors and accessing quality products once the facility is operation will be complex because the company will need to find new suppliers in addition to its current ones to meet the unique needs of the new market. Other significant qualitative risks outside the company that might affect the success of the project include supply chain disruptions, port disruptions, severe weather patterns, natural disasters, widespread pandemics and other natural or man-made disruptions (SEC, 2018). The UK often experiences severe weather disruptions that interrupt transportation especially in winter which is one of the busiest shopping period. Additionally, London has experienced a number of terror-related incidences in recent years (Hayden, 2017). Such disruptions could result in a decrease in consumer spending and this would negatively affect Nordstrom’s sales at the new store, because staffing shortages, disrupt the flow of merchandise, increase operational costs and damage the reputation of the company. Alternate Financial Scenarios The primary financial metric that will be used to evaluate the success of the investment project is the internal rate of return (IRR). At the moment, the company’s capital structure comprises of 72.3% equity and 27.7% debt (SEC, 2018) and the resulting weighted average cost of capital (WACC) is 4.31%. The primary reason for choosing IRR as the method of evaluating the success of the project is that IRR takes into account the time value of money. This is important because the project will be partially financed using debt, and this will result in the change of capital structure 68% equity and 32% debt, thus an increase in the cost of capital. As highlighted in the investment justification, to be viable the new store will require a minimum net disposable income of at least $1.5 million to finance the interest payments that are projected to rise to $32 million over the life of the bond. The funding obtained from banks will also have interest payment obligations amounting to $1,530,825.65 in interest and principal repayments per month. Additionally, the anticipated economic life of the project is 30 years and the minimum IRR requirement for the project is 15%. The following is a pro forma income statements with the projected financial performance for the new store for the 4-year period between 2021 and 2024: 2021 2022 2023 2024  Net Sales $300 $420 $440 $530 Total Cost of Goods Sold $110 $105 $170 $185 Gross Profit (Loss) $190 $315 $270 $345 OPERATING EXPENSES          Selling           Salaries and wages $35 $41 $46 $52   Commissions 12 14 16 18   Advertising 10 12 14 20   Depreciation 14 15 16 16   Other 5 6 6 7 Total Selling Expenses $76 $88 $98 $113 Total General/Administrative Expenses $45 $52 $57 $67 Total Operating Expenses $121 $140 $155 $180 Net Income Before Taxes $69 $175 $115 $165   Taxes on income 22 32 26 28 Net Income After Taxes $47 $143 $89 $137 As shown above, the base assumption is that the new store will record $300 million in revenue in 2021 and that revenues will steadily rise year-on-year reaching $530 million by 2024. The pace of growth is projected to slow down slightly in 2023 before improving marginally in 2024 and beyond. Based on the performance projection shown above, the net margins for the new store for 2021, 2022, 2023, and 2024 will be 15.66%, 34.05%, 20.23%, and 25.85% respectively. This level of sales and resulting margins will be sufficient to support the new store’s operational costs as well as to service the debts that Nordstrom will acquire to finance the investment. Should sales exceed the base assumption by 20%, then the net margins for the new store for 2021, 2022, 2023, and 2024 will be 29.72%, 45.04%, 33.52%, and 38.21% respectively. However, should net sales fall 20% short of the projected base scenario highlighted in the table above, then the net margins for the new store for 2021, 2022, 2023, and 2024 will be -5.42%, 17.56%, 0.28%, and 7.31% respectively. This performance implies that in 2021 and 2023 the store would perform worse than Nordstrom’s organization-wide net profit performance has been in the past few years, but that performance will have improved to better margins than it currently is by 2024. The sensitivity analyses indicate that the viability of the project depends on meeting or exceeding the base scenario assumptions. If the project fails to generate the projected annual revenues and meet the expected growth levels then it will result in negative NPV, thus it will not meet the funding criteria. Additionally, net revenues falling 20% short of the base scenario means that the 15% IRR goal will not be met and embarking on the investment will cause Nordstrom to lose money, thus the funds that would have been used to fund it would rather be redirected to other projects. In terms of payback period, with the base scenario projections the investment would be recouped in just over 4 years, but if revenues fall short by 20% won’t have recovered even $100 million of the invested funds within 4 years. Conclusively, the investment is only viable if it meets the base scenario assumptions. V. Financing Raising money using internal financing mechanisms has numerous advantages, but there are also a number of disadvantages. The first major advantage is that internal financing does not require the company to pay interest on the funds raised, thus keeping debt levels low. Additionally, unlike equity financing which requires a company to give up equity thus reducing its overall control, internal funding does not result in loss of control. A company that raises capital using internal financing mechanisms does not have to rely on external sources of funding which in turn enables the business owners to retain ownership. Internal funding carries minimal risk in terms of loss of ownership and control. Another advantage of using internal financing mechanisms to raise capital is that it keeps operational costs low, thereby improving profitability. Some forms of external funding such as the proposed loan and issuing bonds result in interest payments which form a part of operational costs, therefore they reduce net income. Additionally, the less debt a company carries in its book the more attractive it is to potential investors and capital sources in terms of creditworthiness. However, while it is desirable to raise funds internally a company is limited in terms how much it can raise without external sources, so it may not be able to take advantage of emerging investment opportunities. Nordstrom may use business combination as a mechanism for expanding into the UK market as there are a couple of high street stores that the company could acquire. A 2018 report by the British Fashion Council indicated that the UK fashion industry was worth approximately £32 billion (about $41 billion) to the UK economy (Sleigh, 2018). To put this into perspective, Harrods Limited which is one of the company’s that Nordstrom could acquire to enter the UK market had revenues of £2.1 billion in 2018. In comparison, Selfridges Retail Limited another potential target for business combination that Nordstrom could target to enter the UK market had revenues of £1.75 billion. In 2018, Harrods enjoyed approximately 6.56% of the total revenues in the UK fashion industry while Selfridges accounted for approximately 5.47% of the annual revenues. Both Harrods and Selfridges boast rich histories and occupy a special place in British luxury retail with the former having been established in 1849 and the latter founded in 1908. The market value of Harrods as of April 2019 is approximately £500 million while Selfridges is valued at about £420 million. The proposed total project cost is $440 million (approximately £340 million), so if Nordstrom could raise an additional £100 million, it could acquire Selfridges and for an additional £160 million, it could acquire Harrods. As highlighted above, business combination is a viable option for Nordstrom to expand into the UK market because there are attractive targets that could be acquired if the company can secure the necessary funding. Selfridges has iconic stores across the UK and some of its locations such as the one in Oxford Street and the one in Birmingham are architectural gems that are tourist attractions in their own right. Similarly, the Harrods store in Knightsbridge alone attracts 15 million customers annually, so business combination with either Harrods or Selfridges is a very reasonable option for Nordstrom to consider as a mechanism for expanding into the UK market (Sleigh, 2018). VI. Track Record Nordstrom is one of the strongest companies in its industry from a financial point of view, thus the company is on a solid financial footing with a minimal risk of defaulting. Additionally, the company has traditionally preferred a capital structure that is biased toward equity financing rather than debt financing with over 70% of the company’s assets financed using equity as of April 2019 (SEC, 2018). As highlighted in the investment justification and investment risk analysis, Nordstrom has the lowest WACC among comparable company’s not only in the company’s domestic North American market, but also among firms the company will be competing with in the UK market. The following table presents a summary of WACC analysis for Nordstrom and three of its major competitors: Company Weighted Average Cost of Capital (WACC) Nordstrom a) weight of equity = E / (E + D) b) weight of debt = D / (E + D) WACC = E / (E + D) * Cost of Equity + D / (E + D) * Cost of Debt * (1 - Tax Rate) Weight of equity = 6508.016 / (6508.016 + 2711) = 0.7059 Weight of debt= 2711 / (6508.016} + 2711) = 0.2941 Cost of Equity = 2.57% + 0.39 * 6% = 4.91% Cost of Debt = 119 / 2711 = 4.3895% WACC = 0.7059 * 4.91% + 0.2941 * 4.3895% * (1 - 33.87%) WACC = 4.32% Dillard's, Inc. a) weight of equity = 1834.912 / (1834.912 + 649.396) = 0.7386 b) weight of debt = 649.396 / (1834.912} + 649.396) = 0.2614 Cost of Debt = 52.571 / 649.396 = 8.0954% Cost of Equity = 2.57% + 1.02 * 6% = 8.69% WACC = 0.7386 * 8.69% + 0.2614 * 8.0954% * (1 - 7.235%) WACC = 8.38% Macy’s, Inc. a) weight of equity = 7638.770 / (7638.770 + 5317) = 0.5896 b) weight of debt = 5317 / (7638.770} + 5317) = 0.4104 Cost of Equity = 2.57000000% + 0.31 * 6% = 4.43% Cost of Debt = 261 / 5317 = 4.9088% WACC = 0.5896 * 4.43% + 0.4104 * 4.9088% * (1 - 10.38%) WACC = 4.42% Marks & Spencer Group PLC a) weight of equity = 6008.125 / (6008.125 + 2630.6876) = 0.6955 b) weight of debt = 2630.6876 / (6008.125} + 2630.6876) = 0.3045 Cost of Equity = 1.1885% + 1.18 * 6% = 8.2685% Cost of Debt = 133.2402 / 2630.6876 = 5.0648% WACC = 0.6955 * 8.2685% + 0.3045 * 5.0648% * (1 - 45.425%) WACC = 6.59% As shown in the table above, Nordstrom has the lowest WACC compared to some of its major competitors. Additionally, Moody’s rates Nordstrom’s long-term debt at Baa1 and commercial paper at P-2 while Standard & Poor’s rates the company’s long-term debt and commercial paper at BBB+ and A-2 respectively indicating that the company is considered stable. This signifies that the company’s operations carry the lowest level of risk when compared with major companies in its industry, thus the company would incur the least expenses to raise additional capital. Another set of financial indicators that prove just how financially strong Nordstrom is are the liquidity and financial health ratios. The following table presents a summary of the company’s liquidity/financial health ratios over the last 7 years: 2013 2014 2015 2016 2017 2018 2019 Current Ratio 2.28 2.06 1.87 1.04 1.07 1.07 1.00 Quick Ratio 1.53 1.33 1.12 0.27 0.4 0.4 0.33 Financial Leverage 4.23 4.12 3.79 8.84 9.03 8.3 9.03 Debt/Equity 1.63 1.49 1.28 3.21 3.18 2.74 3.07 Interest Coverage 8.31 8.34 9.53 8.8 6.61 6.6 7.16 Nordstrom does not have any difficulties meeting its financial obligations as indicated by the ratios in the table above. With regard to interest coverage, the company is in a much stronger position compared to 2017 and 2018, although the current interest coverage ratio is slightly lower than it was 4 years ago. The company can cover its interest payments 7 times over using its operating income even though it is twice more leveraged compared to 5 years ago. Lastly, like any other company, Nordstrom faces the risk of various claims and lawsuits arising in the ordinary course of business. However, as of 2019, the company did not have any legal proceedings that could have a material impact on operations, financial position or cash flows. VII. Questions and Answers Why is this investment needed? The primary reasons why the investment is needed is that it will increase Nordstrom’s presence and enable the company to expand internationally. The company is in need of growing its market share due to increasing competition in the domestic market and international expansion presents a roadmap for achieving this objective. The Nine Elms neighborhood was selected for the new store because of the ongoing renovation of the Battersea Power Station and adjacent areas that is expected to bring in large corporations including Apple, and with it increased traffic from the apartments, hotels, and offices that are currently under construction. Why choose London as a location? A flagship store in one of the most iconic cities in Europe will place Nordstrom in the perfect position for expansion into other cities in the United Kingdom as well as the broader European Union market in the coming years. London is the biggest financial capital in Europe and already attracts more than 30 million visitors per year. The selected location already has an ongoing redevelopment project worth approximately $18 billion that is projected to be finalized in 2025. Additionally, the U.S embassy in London located at 33 Nine Elms Ln is in the same neighborhood only 2 blocks away from the proposed investment project. What will be the financial implications of the loan? The loan obtained from the bank will have interest payment obligations amounting to $1,530,825.65 in interest and principal repayments per month. Additionally, the loan will increase Nordstrom, long-term liabilities, thereby altering the current capital mix. The capital mix is expected to significantly impact the company’s capital structure and result in a slight increase in the overall cost of financing. However, the impact will be offset by the increase in market share and added cash inflows. Why would the loan be attractive to the bank? Nordstrom is one of the strongest companies in its industry from a financial point of view, thus the company is on a solid financial footing with minimal risk of defaulting. Additionally, Nordstrom has the lowest WACC compared to some of its major competitors, and the company does not have any difficulties meeting its financial obligations. The company can cover its interest payments 7 times over using its operating income, so it will be in a position to meet scheduled interest and principal repayments for the loan request.  References Hayden, M. E. (2017, September 15). Terror in the UK: A timeline of recent attacks. Retrieved April 21, 2019, from https://abcnews.go.com/International/terror-uk-timeline-recent-attacks/story?id=47579860 Nordstrom. (n.d.). Nordstrom Investor Relations. Retrieved April 18, 2019, from https://investor.nordstrom.com/investor-relations Nordstrom. (n.d.). Nordstrom Investor Relations. Retrieved March 30, 2019, from https://investor.nordstrom.com/investor-relations SEC. (2018, July 28). Nordstrom Form 10-K: Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934. Retrieved April 26, 2019, from https://www.sec.gov/Archives/edgar/data/72333/000007233318000049/jwn-232018x10k.htm Sleigh, S. (2018). The UK fashion industry is worth £32 billion to the UK economy, says British Fashion Council CEO. Retrieved from https://www.standard.co.uk/fashion/uk-fashion-industry-32-billion-uk-economy-british-fashion-council-caroline-rush-a3934781.html. Accessed on April 23, 2019. UK Trade & Investment (2013). Why invest in the UK. Retrieved April 18, 2019, from https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/253662/Why_Invest_in_the_UK.pdf Appendix 1: Graphs showing the capital and interest saving for the bond  Appendix 2: Income statement analysis Fiscal year ends in January. USD in millions 2015 2016 2017 2018 Revenue 100.00% 100.00% 100.00% 100.00% Cost of revenue 62.24% 63.50% 63.97% 63.90% Gross profit 37.76% 36.50% 36.03% 36.10% Operating expenses Sales, General and administrative 27.97% 28.87% 29.24% 30.12% Total operating expenses 27.97% 28.87% 29.24% 30.12% Operating income 9.80% 7.63% 6.79% 5.98% Interest Expense 1.03% 0.87% 0.83% 0.91% Other income (expense) 0.01% -1.33% 0.03% Income before income taxes 8.77% 6.76% 4.64% 5.10% Provision for income taxes 3.44% 2.60% 2.24% 2.28% Net income 5.33% 4.16% 2.40% 2.82% EBITDA 13.56% 11.62% 9.83% 10.32% Appendix 3 Common-size income statement   2015 2016 2017 2018 2019 5-Year Average Revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Cost of revenue 62.24% 63.50% 63.97% 63.90% 64.03% 63.53% Gross profit 37.76% 36.50% 36.03% 36.10% 35.97% 36.47% Operating expenses   Total operating expenses 27.97% 28.87% 29.24% 30.12% 30.69% 29.38% Operating income 9.80% 7.63% 6.79% 5.98% 5.28% 7.10% Interest Expense 1.03% 0.87% 0.83% 0.91% 0.75% 0.88% Income before income taxes 8.77% 6.76% 4.64% 5.10% 4.62% 5.98% Provision for income taxes 3.44% 2.60% 2.24% 2.28% 1.07% 2.33% Net income 5.33% 4.16% 2.40% 2.82% 3.56% 3.65% Common-size balance sheet   2015 2016 2017 2018 2019 5-Year Average Current assets   Total current assets 56.51% 39.15% 41.26% 43.17% 42.78% 44.57% Non-current assets   Total non-current assets 43.49% 60.85% 58.74% 56.83% 57.22% 55.43% Total assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Current liabilities   Total current liabilities 30.29% 37.82% 38.55% 40.53% 42.87% 38.01% Non-current liabilities   Total non-current liabilities 43.32% 50.87% 50.38% 47.43% 46.06% 47.61% Total liabilities 73.61% 88.69% 88.93% 87.96% 88.93% 85.62% Stockholders' equity   Total stockholders' equity 26.39% 11.31% 11.07% 12.04% 11.07% 14.38% Total liabilities and stockholders' equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% *Assumption 1: Future growth will mirror the average growth over the last 5 years, thus Nordstrom’s common-size income statements between 2020 and 2026 will be as shown in the 5-year average column above.  Appendix 4 Income statement trend analysis   2016 2017 2018 2019 5-Year Average Revenue 7% 2% 5% 2% 4% Cost of revenue 9% 3% 5% 3% 5% Gross profit 3% 1% 5% 2% 3% Operating expenses   Total operating expenses 10% 4% 8% 4% 7% Operating income -17% -9% -8% -10% -11% Interest Expense -10% -2% 16% -16% -3% Income before income taxes -18% -30% 15% -7% -10% Provision for income taxes -19% -12% 7% -52% -19% Net income -17% -41% 23% 29% -1% Balance sheet trend analysis   2017 2018 2019 Average Assets   Current assets   Total current assets 7.56% 8.05% -3.68% 3.98% Non-current assets   Total non-current assets -1.45% -0.09% -2.17% -1.24% Total assets 2.08% 3.27% -2.82% 0.84% Liabilities and stockholders' equity   Current liabilities   Total current liabilities 4.05% 8.58% 2.80% 5.14% Non-current liabilities   Total non-current liabilities 1.10% -2.78% -5.64% -2.44% Total liabilities 2.36% 2.15% -1.75% 0.92% Stockholders' equity   Total stockholders' equity -0.11% 12.30% -10.64% 0.51% Total liabilities and stockholders' equity 2.08% 3.27% -2.82% 0.84% **Assumption 2: Year-on-year revenue growth will mirror the average growth over the last 5 years. Running head: MBA-640 NORDSTROM 35 Running Head: MBA-640 NORDSTROM 15 Running Head: MBA-640 NORDSTROM 13 Running Head: MBA-640 NORDSTROM 1