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Part I. The fundamental information of Walt DisneyThe Walt Disney Company, a diversified international company operated entertainment andrecreational complexes, produced motion picture and television features, developed communityreal estate projects, and sold consumer products. The company was founded in 1938 as asuccessor to the animated motion picture business established by Walt and Roy Disney in 1923.The company operated the Disneyland amusement theme park in Anaheim, California, and theWalt Disney World destination resort in Orlando, Florida. In addition to the domesticentertainment and recreation revenues from Disneyland and Walt Disney World, the companyreceived royalties, paid in yen, on certain revenues generated by Tokyo Disneyland. Owned andoperated by an unrelated Japanese corporation, Tokyo Disneyland was opened to the public on April 15, 1983.In year 1984, the consolidated revenues for The Walt Disney Company and its subsidiariesincreased by almost 27% to $1.7 billion. Total entertainment and recreation revenues, includingroyalties from Tokyo Disneyland, increased by 6% to $1.1 billion in the fiscal year endedSeptember 30, 1984. Net income totaled $97.8 million in 1984, an increase of 5% from 1983.During fiscal 1984, yen royalty receipts had been just over ￥ 8 billion, however, Disney foresawa constant further growth at 10% to 20% per year over next few years. At the same time, therewere volatile fluctuations in the yen/dollar exchange rate. Yen has depreciated almost 8% lastyear, which indicated a shrink in royalty receipts in yen.Rolf Anderson, the director of finance at The Walt Disney was considering various ways of hedging the exposure. Besides, considering the increased interest costs on high level of borrowing and excessive short-term loan and commercial paper, the company planned to reducesuch short-term debts.Part II. Should Disney hedge its yen royalty cash flow? Why or why not?Disney should hedge its yen royalty cash flow. During fiscal 1984, yen royalty receipts had been just over ￥ 8 billion, however, Disney foresaw a constant further growth at 10% to 20% per year over next few years. At the same time, there were volatile fluctuations in the yen/dollar exchangerate. The current spot rate of 248 yen/dollar represented almost an 8% depreciation in the valueof the yen from 229.70 just over a year ago, indicating a shrink in royalty receipts in yen. The benefits of hedging:Hedging can help smooth the royalty receipts in dollar, eliminating the operating exposure. ThusDisney could be able to focus more on the operation, rather than distracting by the exchange ratefluctuation.Hedging can help to reduce the translation exposure. As an international corporation, thefluctuation in the exchange rate can affect the earnings in the consolidated Income Statement.Some potential problems with hedging:Hedging might introduce other uncertainties, especially when Disney chooses to enter into someobligation, for example, forward, future and swap. The hedging is based on the forecast that thecompany will keep receiving increasing yen cash flows in the future years. However suchforecast may not be guaranteed. Just consider the following situation: Disney has entered into aforward contract to hedge its yen income, while for some reasons, the income from Japandecreased or ceased to come. At the same time, yen is appreciating against dollar. Then Disneycould lose a great amount of money for entering into the hedge. All the above, Disney should hedge its royalty receipts in yen, but with more cautious evaluationof different situation.Part III. Hedging techniques available to the treasurer:1. FX futures Advantage: Foreign exchange future is an open market and its liquidity is good.Disadvantage: Firstly, the maturity is often two years or less which causes a mismatch betweenthe period in which Disney want to hedge the fluctuations in the yen/dollar spot rate and theperiod of futures.Secondly, futures will not produce any cash flow to reduce short-term debt. Thirdly, future is an obligation, which could induce some potential risks given Disney’s inaccurate forecast. 2. Long-dated forwards Advantage: Forward is more customer-tailed and its maturity can be long enough to satisfyDisney.Disadvantage: FX forwards will be considered by banks as a part of their total exposure toDisney, so the valuable credit line will be tied up. And it provides no cash flow to cover short-term debt. What’s more, it is also an obligation as futures. 3. FX options: Advantage: FX options have an open market with easy access. The most important thing is thatoption is a right, rather than an obligation, which can keep Disney from the potential risks that willbe induced by future or forward.Disadvantage: Disney has to pay a premium to obtain the right. The costs could be significant.4. Convert existing dollar debt into yen liability: Advantage: It is a comparably cheap method to hedge.Disadvantage: The hedge would be short- term since Disney’s Eurodollar issue matured in on e tofour years. The arrangement neither provides any additional cash nor reduces its short-term debt.5. Issue a long maturity Eurodollar debt which can be swapped into yen Advantage: The costs are probably low.Disadvantage:Disney has recently issued Eurodollar note and has temporarily high debt ratio, which make itdifficult to employ this approach.6. Issue Euroyen bond Advantage: It will incur low transaction cost, only front-end fees.Disadvantage: Disney has no intention to issue Euroyen bond under the current Japanese strictfinance guidelines.7. Create a yen liability through a term loan from a Japanese bank Advantage: The Japanese bank can provide a loan with ten year’s maturity. The company can reduce short-term debt by converting short-term debt to long-term debt. Disadvantage: The loan could decrease the Disney’s credit and induce cut in its credit line withbanks. And Disney’s credit rate in Japan is single A, which makes it harder and more expensive to take loans from local banks. The last strategy is the one proposed by the Disney and we can calculate this method’s ‘all - in’ cost with the information provided in the paper:Yen liability through a term loan from a Japanese bank |Principal | JPY 15 million |Term | 10 years |Interest payment | 7.5% | Front-end | 0.75% |Underwriting fees | 2.000% | Additional expense | $75000 |Exchange rate($/ECU) | 0.7420 |Sinking payment(6th -10th year) | (21.840) |Further data about the cash flow of the yen liability:Period | Cash flow(billion) |0 | 14.8875 |1 | (0.5625) |2 | (0.5625) |3 | (0.5625) |4 | (0.5625) |5 | (0.5625) |6 | (0.5625) | …… | (0.5625) | 19 | (0.5625) |20 | (15.5625) | ‘All - in’ cost of JPY liability is calculated as follows: i=120CFi1+IRRi=0Use the data in the above chart, we can figure out that: (in billion)14.8875-i=1200.56251+IRRi-15.56251+IRR20=0IRR= 3.80423% (semiannually) Thus, the annual ‘all - in’ cost is (1+3.80423%)^2 -1=7.75319% Part IV. Evaluate Goldman’s proposal for an ECU bond issue accompanied by an ECU/Yenswap.a) What is the 'all-in' cost of the proposed ECU bond before executing the currency swap?The details of issuing ECU bond are listed in the table:10-year ECU Eurobonds before swap |
