Bloomberg CASEO Businessweek STUDIES mizli W Weighted Average Cost of Capital Analyze how the theoretical concepts This lesson explores how several companies and industries are impacted by changing variables in the weighted average cost of of weighted average cost of capital capital (WACC) formula. To apply WAOC learning to real work (WACC) connect to the real world by complexitles, we will examine how Boeing is impacted by intes exploring the impact of changing WACC est rates in class and then apply the same lessons to Disney for variables on a company. homework. Case Study Notes Companies within the same sector typically share similar capital RISK FREE RATE structures and costs of capital. For example, most power utili The risk free rate is the U.S. government bond. A U.S. bond's ties are engaged in fundamentally the same business, genera yield is considered risk free because the U.S. has not and is not tion, transmitting, and distributing electric power. The utility expected to default. business is highly dependent upon expensive fixed-asset invest ments (i.e., power plants) which are often financed with debt. TAX RATE Consequently, analysts expect companies within the same see The company's tax rate impacts the after tax cost of debt but tor or industry to have similar betas, capital structures, bond has no bearing on either the cost of preferred equity or com ratings, and WACCs. mon equity. The higher a company's tax rate the lower the after Disney is a diversified entertainment company. Its diversi tax cost of debt. Consequently, as a source of capital, debt is a fication exists because its revenues come from four different, tax shield. but related, business segments-parks and resorts, studio enter tainment, broadcasting and media, and consumer products. PRE-TAX COST OF DEBT Since there is no other enterprise quite like Disney, we exam. The pre-tax cost of debt can be determined calculating the ine the WACCs of companies that operate within one or more yield to maturity on the company's bonds. A bond's yield to of its segments. maturity can be influenced by many factors including inflation, Beta credit quality, macroeconomic fundamentals, and how the com The beta of a stock is a representation of how the stock moves pany's bonds are structured. with the broader equity market. Disney has a beta of 0.96 which implies that when the broad equity market goes up or down by one percent, Disney's stock will rise or fall by 0.96 percent. Low beta stocks, between 0.5 and 0.8, tend to be defensive. They do not rise much when the market rises, but they also do not fall significantly when the market falls. Disney's beta indi- cates a closer relationship to the market than any of its peers used in this case. Botas of Companies Comparable to Disney Segments Af Duta as of July 31 2019 160 140 12 110 0.00 0.00 0.92 0.00 OTT 120 100 080 0.80 0.40 0.20 000 U Nu EXPECTED RETURN OF THE MARKET The expected return of the market is a fairly general observa tion. In reality, no one knows by what degree the stock mar ket will rise or fall over the next year. Nevertheless, in order to assess an individual stock we must have a view on where the broader market is heading. The expected return of the market is the same for every stock. Case Questions Use the Terminal Tutorial to calculate Disney's weighted average cost of capital (WACC) for Q1 2019. Bloomberg includes more elements in the WACC calculation than the textbook does. For our purposes, use the textbook formula with the data points from Bloomberg. Use the Bloomberg Terminal to gather the necessary data to make a similar calculation for Q2 2019. Using the Case Study Notes and the accompanying spreadsheet, calculate the WACC of each Disney segment comparable. Describe the primary WACC drivers that explain the differences between the WACC of Disney and its comparables. In the WACC Sensitivity tab on the accompanying spreadsheet, alter the cells as described below to see how changes to WACC's inputs impact the WACC. Write a few sentences describing each change. O FED RATE INCREASE An increase of the Federal Reserve interest rate by 200 basis points (2.0%) lifts the borrowing costs of every debt issuer. What is Disney's adjusted WACC? O CREDIT RATING CHANGE A downgrade in Disney's credit rating should increase its cost of debt to the same level as Six Flags, all other conditions being equal. What is Disney's adjusted WACC? O DEBT FOR ACQUISITION In 2018, Disney announced it would acquire Twenty-First Centry Fox assests for $71.3 billion. Assume Disney paid for the acqui- sition in cash by raising additional debt. What is Disney's adjusted WACC? OU.S. EQUITY MARKET DOWNTURN Equity market expectations may cool resulting in an expectation that equity markets may only expand by 200 basis points (2.0%) over the coming year. What is Disney's adjusted WACC? O INCREASED MARGINAL TAX RATE The tax rate cut has ended. A new administration is in power. Assume Disney's marginal tax rate rises to 30.0%. What is Disney's adjusted WACC? Disney WACC Elements All Data as of Q2 2019 Metric Value Beta 0.88 Expected Return of the 9.64% Market Risk Free Rate 2.41% Tax Rate 21.83% Pre-Tax Cost of Debt 2.99% Metric Equity Preferred Equity Value 197,744 0 Short-Term Debt Long-Term Debt Total Capital 19.158 37,803 254,705 I 2 Cell Styles Adobe PDF H7 ex fx Pre-Tax Debt Cost M Weighted Average Cost of Capital Case Calculations WACC Cost of Capital Components Expected retumske Bond of Man Rate Tax Rate OCON Rating Capital Stricture Components Short Term Long-Tom Equity Deel Debt Total Catal Beta Doney 0.00 9.6 249 21.8% 3.0%