Walt Disney

Executive Summary

Tokyo Disneyland was opened to the public on April 15, 1983. This amusement park was owned and operated by an unrelated Japanese corporation. The Walt Disney Company received royalties, paid in Yen, on certain revenues generated by Tokyo Disneyland. This new overseas business venture was bringing some concern about the foreign exchange risk to Disney. The management team at the Disney has been considering hedging future Yen inflows from Disney Tokyo since 1985. Mr. Anderson, the director of finance at The Walt Disney Company, focused his attention on a possible 15 billion ten-year term loan with an interest rate of 7.5% paid semiannually. On the other hand, Goldman Sachs, who had been working with Disney on this problem, presents a rather unusual but potentially attractive solution: Disney could issue ECU Eurobonds and swap into a Yen liability. Goldman Sachs suggested them to create a Yen liability by swapping 10-year ECU Eurobonds with a sinking fund, the all-in costs of which were denominated in Yen.

As financial consultants, we have been asked by Walt Disney’s management to provide an evaluation of this alternative to the company for this financing decision. For this estimate, we have reviewed the data of the Consolidated Income Statements from 1982 to 1983, the Consolidated Balance Sheets of 1984 and 1983, the Historical Summary of Average Yen/Dollar Exchange Rates and Price Indexes, ECU/Yen Swap flows in the following ten years, Yen Long-dated foreign exchange forward, Cash flow of 10-year ECU Euro bonds with sinking fund (Exhibit 6), and also the list of the French Utility’s outstanding publicly Traded Eurobonds.

We employed the internal rate of return analysis to evaluate the each alternative. If taking the Goldman’s swap solution, Disney’s borrowing cost would be 7.004% in Yen (9.979% in dollar). If adopting the 10-year term loan, the total effective cost would be 7.748% in Yen (10.694% in dollar). Furthermore, by these data we also determined the total expected future revenue under different assumption of the growth rate and found it could cover all the future interest expense in the following ten years

We recommend the management of Walt Disney to ACCEPT the Goldman’s Solution to create10-year ECU Euro bonds with sinking fund and swap with the French utility since this indirect Yen financing has smaller XIRR that means it would be lower borrowing cost than a similar 10 year Yen term loan. We need to point here although all the current data seems quite good and supports adopting this solution, we cannot guarantee the profit and the Walt Disney’s management has to proceed with caution. Because the long length of the project would involve in a plenty of uncertainties of the international exchange market (such as inflation rate fluctuation and economic cycles) Moreover, the market reception of the ECU Eurobond issued by Disney should be taken into consideration, because Disney would be only the second U.S. corporation to access this market. These facts have to be reviewed carefully before making a final decision.

The Problem

Walt Disney is a diversified worldwide entertainment company headquartered in Burbank, California. It was established in 1938 to engage in the motion picture business. After several years of expansion, it has operations in four business segments: entertainment and recreation, filmed entertainment, community development, and consumer product.

As the Disney’s business is expanding, the revenue and net income were steadily growing up year by year. The consolidated income statement (Exhibit 1) shows the consolidated revenue for the company and its subsidiaries increased by almost 27% in 1984 to $1.7 billion. The total entertainment and recreation revenues, including royalties from Tokyo Disneyland, increased 6% to $1.1 billion at the end of 1984. Filmed entertainment income increased 48% to $245 million in 1984 due to strong domestic theatrical film rentals. Community development and consumer products revenues added another $204 million and $110 million, respectively. Net income totaled $97.8 million in 1984, an increase of 5% from 1983.when looking at the Consolidated Balance Sheet (Exhibit2), we found that the total assets grew 15% to $2.7 billion at the end of fiscal 1984 due to addition of real estate inventories as part of the acquisition of another company. The ratio of debt to total capitalization jumped to 43% at 1984 from 20% at previous year.

With the first opening of Tokyo Disneyland operated by an independent Japanese company and the inflow of Yen royalty receipts, the foreign exchange rate risk began to emerge. As the Yen depreciated, the revenues from the royalties were shrinking from 1980 to 1985. Therefore, the weak Yen had a negative influence on Disney’s total net income. We also know the goal of the firm’s management is to make the firm as valuable as possible, and then the firm should pick the debt-equity ratio that makes the pie as big as possible. Usually, the total value of the firm equals the sum of the total debt and total equity. (V=D+E). As shown in the right chart, we can clearly get a conclusion that an increase in total value of debt will increase the total value of Disney from 1983 to 1984. We can maximize Disney’s value by creating more value of the debt. If we expose the Yen debt to the risk of the fluctuation in Yen-dollar exchange rates, it would also have great impact on the total value of our debt and the value of the firm. But we need to remember, the interest expense of the debt bringing the big benefit of the tax deduction is also an important fact to the Disney Company. Thanks to increasing debt and the interest expense, the Disney Company could gain 5 million on the tax benefit in 1984 compare to the tax payment 7 million in the previous years.

In 1985, with the current spot rate of 248 Yen/dollar represented almost an 8% depreciation in the value of the Yen from 229.7 from just over a year ago. The managers had to decide which solution to hedge further exchange rate risk in order to decrease impact to the annual royalties due to unpredicted future depreciation risk in Yen.

The stream of future Yen royalties was expected to grow around 10% to 20% per year throughout the 1980s and Disney was considering alternative hedging techniques for its foreign exchange transaction exposure. These techniques included foreign-exchange option, futures, and forward. Also they thought about swapping